Putting one’s own house in order

Here is S.C. over at Free Exchange:

Mr Osborne believes that substantive macroeconomic cooperation is neither desirable nor feasible. He’s right about the latter. He’s less right about the former.

Was the Fed merely the trigger for emerging-market troubles–troubles they should instead blame on their own shortcomings? The evidence for this view, Mr Osborne said, is that some emerging markets have been hit harder than others. That is true, and instructive. But it does not acquit the Fed. Its decisions can and do hurt emerging economies. Yes, their injuries vary. But that does not necessarily mean the injuries were self-inflicted.

And does the pursuit of national resilience add up to global resilience? Not necessarily. There are occasions when one country’s attempts at good housekeeping make it harder for other countries to be domestic goddesses themselves.

Let’s think about the phrase “attempts at good housekeeping.”  The Fed’s tapering moves seem to have hurt some emerging markets. How do we know this? One piece of evidence is that EM stock markets fell on the news.  But if that evidence is reliable (and I suspect it is) isn’t it also worth noting that tapering rumors hurt US stock prices as well?  Does this mean the decision to taper will hurt the US economy?

In my view the answer is pretty clearly “yes,” although I base that on other factors as well, not just US stock prices.  If S.C. had said “good housekeeping” rather than “attempts at good housekeeping,” I would have been much more skeptical of the claim.

In my view the so-called “one-size-fits-all” problem is greatly exaggerated.  I don’t deny it exists, but in the majority of cases I’ve looked at policies that have negative effects on other countries also have negative effects on the home country.  The ECB’s tight money policy has certainly been bad for Greece and Spain, but it’s quite likely that it has also harmed Germany and the Netherlands.

When the Fed makes a dramatic move, US stock prices often respond strongly.  Does anyone recall a single clear case where the response of foreign equity markets went in the opposite direction from US markets?  I can recall lots of cases where the foreign market responses were obviously in the same direction, and a few that were perhaps ambiguous.  But overall I’d say that “what’s good for the US is good for the EMs” is a reasonable assumption to make.  I’d have to see some pretty strong evidence to the contrary to overcome the presumption that the US should focus on keeping its own house in order, and should not get involved in international cooperation on monetary policy.  Can anyone cite a clear case (under floating rates) where cooperation was needed?

On the other hand many people who favor cooperation are also opposed to the recent tapering decision.  I believe they are right about the tapering, but that’s because I suspect the decision also hurt the US economy.



29 Responses to “Putting one’s own house in order”

  1. Gravatar of John Becker John Becker
    27. February 2014 at 07:00


    I see the heart of the debate between you and the Austrians to be that Austrians see interest rates as coordinating saving with lending decisions which coordinates production across time. Interest rates are not simply a mechanism for guiding total spending anymore than the price of gas would be a mechanism for manipulating total spending. Hence, on a fiat money system with an active central bank, it is impossible for interest rates to play this coordinating function between the supply of real savings and profitable investment projects. How would switching to targeting NGDP futures change that, or do you simply deny that this Austrian point about interest rates being an important market price?

  2. Gravatar of Major_Freedom Major_Freedom
    27. February 2014 at 07:01

    “The Fed’s tapering moves seem to have hurt some emerging markets. How do we know this? One piece of evidence is that EM stock markets fell on the news.”

    This belief is associated with another shortcoming of NGDP based theorizing. If the Fed is highly expansionary such that it generates booms in other countries tied formally or informally to the dollar, while US spending remains “stable”, then one would miss the cause of why there is a boom in emerging markets.

    It is a very clear case of why we should not reason from an NGDP change. Hayek also knew that a country with an independent central bank would cause international instability if it did not behave in a way that would suggest a world monetary order is in place. So for countries with high budget deficits, a domestic inflation targeting regime would cause international instability.

    Of course, MMs are mercantilists redux, so we’re supposed to call for the government to protect US companies and workers from foreign entities stockpiling US dollars.

  3. Gravatar of Major_Freedom Major_Freedom
    27. February 2014 at 07:11


    I’ll jump on and say that the answer to your question will be based on a false belief of what the market process is capable of doing. It will be based on a form of EMH, and the traditional false belief that government takes care of the macro without affecting the micro, and “the market” takes care of the micro without affecting the macro.

    In short, we are supposed to believe the falsehood that interest rates will be market driven if the Fed stops intentionally changing them, and instead purposefully changes NGDP.

    It shpuld be rather easy for them to understand why that is false, becausw they believe the Fed affects NGDP even if it doesn’t purposefully change it, but instead interest rates or prices.

  4. Gravatar of TravisV TravisV
    27. February 2014 at 08:18

    Prof. Sumner,

    Any idea why this is happening?

    “Everyone Is Talking About The Recent Disconnect Between Stocks And Bonds”


  5. Gravatar of TravisV TravisV
    27. February 2014 at 08:26

    Excellent graph below that supports Prof. Sumner’s analysis.

    Lower inflation –> lower interest rates –> higher stock multiples.


  6. Gravatar of Dilip Dilip
    27. February 2014 at 08:42


    Here is another view:


  7. Gravatar of ant1900 ant1900
    27. February 2014 at 08:45

    OT: Does this recent Yellen comment illustrate that the Fed believes in the monetary offset? That seems like a reasonable reading to me.

    “Fiscal policy really has been quite tight and has imposed a substantial drag on spending in the U.S. economy over the last several years … The drag is likely to lessen substantially during the current year, but nevertheless there remains some drag. Of course it is true that because there has been fiscal policy drag THE BURDEN ON MONETARY POLICY HAS BEEN LARGER.” (emphasis added)


  8. Gravatar of Major_Freedom Major_Freedom
    27. February 2014 at 09:02

    Most people who go out of their way to ensure everyone that they are not “conspiracy buffs”, are in fact conspiracy buffs who just want to portray themselves as non paranoid, strong and in control. You can tell when they respond to newly revealed conspiracies (NSA, etc) with something along the lines of “I am not surprised.”

  9. Gravatar of Paul Paul
    27. February 2014 at 09:02

    Prof. Sumner,

    Off topic (more or less) but is there any chance we can get some monetary policy thoughts on China? Would you still advocate a non-discretionary policy regime as they undertake such a wide variety of significant policy changes.

    I’m curious whether you think stabilizing NGDP growth would offer the same, more, or less benefit in an economy struggling to modernize as it would a mature economy.

  10. Gravatar of W. Peden W. Peden
    27. February 2014 at 09:36

    Britmouse has a very interesting little post, with a good chart of a natural experiment (the introduction of a minimum wage for under-18s in the UK in 2003) –


    Note that the overall national UK unemployment rate didn’t start rising until mid-2008.

  11. Gravatar of Jean Jean
    27. February 2014 at 10:01

    Wouldn’t the fact that China is tightening since last year be more relevant in explaining what is going on in the emerging economies? If I remember correctly (and I may not!) in 2011 or so China became both the world’s largest importer and exporter.

  12. Gravatar of Doug M Doug M
    27. February 2014 at 10:24

    The Taper is killing EM’s story doesn’t hold water for me.
    Bernanke announces that he is thinking about tapering in June.
    The US market does a little freak-out.

    Fed officials spend a month spinning Bernanke’s statement.

    The fed does not taper in September, and there is a very minor freak out…where is the expected taper.

    The taper is finally announced in December. By this time it has been so telegraphed (forward guidance) no one was fooled an the market reacted with a yawn.

    The degree of the taper seems pretty slow to me. And, the Fed certainly has the prerogative to stop tapering if the economy appears to slow.

    So, 3 weeks after the taper begins EM markets begin to sell of, and we say, “it must be the taper!”

    Sorry, try again.

    What we have had are political problems in a handful of countries that are politically messed up!

  13. Gravatar of Tommy Dorsett Tommy Dorsett
    27. February 2014 at 12:11

    Scott, I think one could make the argument that despite the taper, 2014 will be somewhat faster. In short, the slowdown in M will be offset by a less rapid fall or a rise in V. I say this not just because the S&P 500 is up 2.4% since the December 18 taper decisions, but that it is up double digits since last May when Bernanke first mentioned cutting back on asset purchases. Ten year TIPS are 2.17%, and has not fallen materially since last May. Risk/high yield spreads narrower across the board. Other forward indicators are also consistent with faster NGDP and job gains.

  14. Gravatar of Benjamin Cole Benjamin Cole
    27. February 2014 at 16:30

    David Beckworth has done excellent blogging of the role of the Fed as a de facto international central bank.

    That said, the Fed should be transparent, accountable–and should serve national interests. Other nations have to make their central banks work for them.

    With flexible exchange rates, I do not see problems.

    The Fed tapering at this time poses unforeseeable, unintended and potentially catastrophic risks, as well as possibly permanent corrosion in our national output.

  15. Gravatar of Scott Sumner Scott Sumner
    27. February 2014 at 17:04

    John, I’m not involved in any debate with Austrians. I don’t see interest rates as a mechanism for controlling the economy, but rather as a mechanism for coordinating saving and investment.

    Travis and Dilip, Thanks for those links. I have no view on the recent disconnect between stocks and bonds.

    ant1900, Yes, she is indicating monetary offset. Of course the other side will insist it’s not 100% offset.

    Paul, I think NGDP targeting would help, but China’s problems lie elsewhere. I try to focus on issues that are important for China, like structural reform.

    W. Peden, Thanks I’ll take a look.

    Jean, It could be, but I suspect the impact was small–China didn’t slow all that much. It’s imports are still rising, aren’t they?

    Doug, I agree the taper story is exaggerated.

    Tommy, That’s possible, the end of extended UI will also boost growth a bit.

  16. Gravatar of Major_Freedom Major_Freedom
    27. February 2014 at 17:08


    “John, I’m not involved in any debate with Austrians. I don’t see interest rates as a mechanism for controlling the economy, but rather as a mechanism for coordinating saving and investment.”

    The key nature of interest rates is controlling the temporal stages of production.

  17. Gravatar of Matt Waters Matt Waters
    27. February 2014 at 18:47


    On the first link, the Y axes make very little sense. The textbook correlation would say one of the Y axes needs to be inverted. If earnings remain the same, then a lower risk-free rate also means a lower earnings yield and thus higher stock prices.

    The interest fact is not that they have diverged, but that the correlation between yields and stock prices were positive for a time. The previous paragraph assumes that earnings are constant, but there was positive correlation due to higher yields signalling higher future economic growth. So, although rates were higher, the higher economic growth and thus higher resource utilization increased prices. Now the “divergence” is more what one would expect in a normal economy.

    “Lower inflation -> lower interest rates -> higher stock multiples.”

    I like how Minerd at the link tries to adorn a fairly simple concept with very VSP-like language. I.e. “the lack of price pressure facilitates easy monetary policy which encourages multiples expansion.”

    It’s far simpler when you realize interest rates go down as inflation goes down. Then lower interest rates means higher P/E or “multiples expansion.” That’s because E/P is the ratio that really matters. Many bears with tea party followers try to look smart by saying P/E’s are at “unsustainable levels,” but they’re perfectly sustainable in reference to interest rates.

  18. Gravatar of Matt Waters Matt Waters
    27. February 2014 at 18:52


    The link basically seems to say “tighter monetary policy will reduce growth.” I would say that’s pretty safe thinking.

    Not sure about all that stuff he talks about with emerging markets as well as EU and US. Usually, people who talk like they have authoritative knowledge on many different things really have thin knowledge of few things.

  19. Gravatar of TravisV TravisV
    27. February 2014 at 19:39

    Matt Waters,

    See below by David Glasner:

    “Why the Stock Market Loves Inflation”


    I’d say that when capacity utilization is low, higher capacity utilization –> higher ROI –> higher real interest rates and real stock prices.

  20. Gravatar of Matt Waters Matt Waters
    27. February 2014 at 21:54

    I think Glasner is confusing inflation with NGDP. Inflation in a vacuum, where NGDP does not change, is terrible. People will pay higher prices for stuff without total revenues (NGDP) changing. Inflation without NGDP increase is possible in supply-side inflation.

    If you assume above-market wages in a recession, NGDP increases by itself will increase utilization. With an excess supply of workers with a price floor, workers do not have bargaining ability to ask for higher wages. Instead, higher NGDP has to go to higher volume for some industries.

    (NGDP increase) = (Higher Volume for Industries with Above-Market Prices)*(Constant Price) + (Higher volume for industries with market price)*(Higher price).

    The latter term is the case with commodities, which always reach some market-clearing price. Demand goes up for gas, but gas price wouldn’t remain constant. The price needs to be bid up to pay for more gas being brought out of the ground.

    The former term dominates in recessions. So higher NGDP growth will increase inflation and thus interest rates, but will also increase utilization in industries under the former term. Utilization increases earnings and even with a higher discount rate, the nominal price increases. I’m not sure where real interest rates apply, which were on a long-term negative term before the recession. Real interest rates went abnormally very high for a time, as deflation set in, but they quickly went to negative when the Fed continued pre-recession NGDP growth (although not higher growth to come back to pre-recession levels).

    At a certain point, less and less industries are in the former term and NGDP almost purely adds to the latter term. This was the case in the 70’s, where COLA’s for unions or even non-union employees kept an above-market, high-unemployment price for labor despite very high NGDP growth.

  21. Gravatar of Matt Waters Matt Waters
    27. February 2014 at 21:55

    I also haz a blog, and I am shamelessly promoting it on Sumner’s comment feed. If this comment is deleted as spam, I’m never commenting again (not really).

  22. Gravatar of John Becker John Becker
    27. February 2014 at 23:02


    I don’t see any economists besides the Austrians able to understand that there is a difference between saving money and printing money. Both actions will tend to drive down interest rates, but actually saving money means that consumption of real goods is deferred. Driving down interest rates by creating money does not create real capital goods the same way that saving money does.

    Interest rates don’t just coordinate savings with investment, they clearly affect production decisions and specifically decisions regarding production periods. A ten year investment project is much more profitable at 5% than at 10% and may not be profitable at all at 15%. This function of coordinating production across time matches consumer preferences with production. Monetary manipulation interferes with that process and in the end will create a mismatch between consumption and consumer preferences. This mismatch inevitably leads to unemployment as the market has to fix these misallocations.

    This is all straightforward and logical but it doesn’t fit neatly into an equation or graph. Hence, the profession has seemingly chosen to ignore these important logical insights derived from the old-fashioned deductive method of evaluating economic phenomena.

  23. Gravatar of John Becker John Becker
    27. February 2014 at 23:08

    Major Freedom,

    I believe in ABCT and the EMH (in a somewhat limited form). This isn’t a contradiction.

    The EMH simply says that markets accurately form prices based off of ALL AVAILABLE information. What interest rates should be in the absence of monetary interference is simply not a piece of available information. Any good economist would admit that they have no idea what interest rates would be if the Federal Reserve did not exist.

  24. Gravatar of Michael Byrnes Michael Byrnes
    28. February 2014 at 03:45

    Matt Waters wrote:

    “I think Glasner is confusing inflation with NGDP. Inflation in a vacuum, where NGDP does not change, is terrible. People will pay higher prices for stuff without total revenues (NGDP) changing. Inflation without NGDP increase is possible in supply-side inflation.”

    Matt, I think you are taking Glasner’s comments out of context.

    This post (and other similar posts) from Glasner was an interpretation of some of his empirical work: he showed that since 2008, there was an – unprecedented -correlation between asset prices and CPI inflation. “Why the stock market loves inflation” was an attempt to explain why this was the case, not an attempt to argue that it is always the case.

    I think his argument is that the stock market “loves inflation” only when inflation and NGDP growth are both low – as in the post 2008 period.

  25. Gravatar of ssumner ssumner
    28. February 2014 at 05:01

    Matt, Read Michael’s comment.

    John, I think all good economists understand those points, not just Austrians.

  26. Gravatar of TravisV TravisV
    28. February 2014 at 07:47


    Welcome to this comment section. And thank you for creating your blog. You’re clearly a very smart guy. Look forward to reading your thoughts.

    Everyone, you should subscribe to Matt’s blog:


    I just did!

  27. Gravatar of willy2 willy2
    28. February 2014 at 14:42

    All the ‘taper talk” did not sink the Emerging Markets. When one looks at the exchange rates of a number EMs priced against the USD then the EMs bagan to “tank” in mid 2011 precisely at the moment when the USD started to higher.

    The “taper talk” simply made things worse for the EMs.

  28. Gravatar of Paul Paul
    28. February 2014 at 17:28

    Not sure if you check old comments, but you said: “Paul, I think NGDP targeting would help, but China’s problems lie elsewhere. I try to focus on issues that are important for China, like structural reform.”

    I certainly agree with that. I was just curious whether or not the logic behind your stable NGDP growth target, as an end goal for monetary policy, would be applicable in a country undergoing these structural reforms.

    Ie. Would the probability of a reform induced hard landing (or hard landing induced reform) fall under NGDP targeting?

    It seems, to me, that this would be the case. If it were possible to maintain stable NGDP. Fiat currency and all. I’d assume you would think that they could. But I don’t get why you wouldn’t advocate for that, in conjunction with the structural reforms here.

  29. Gravatar of ssumner ssumner
    1. March 2014 at 06:34

    Paul, Yes, I think NGDP targeting is a good idea for China. But again, reform is what they really need. So do both!

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