Reply to George Selgin

In a recent post George Selgin made the following comment:

Scott Sumner, like Milton Friedman, forthrightly denies that there’s such a thing as booms, or at least of booms caused by easy money, to the point of taking exception to a recent statement by President Obama to the effect that, among its other responsibilities, the Fed should guard against “bubbles.” But here, and unlike Friedman, Sumner basis his position, not merely on the claim that prices are more flexible upwards than downwards, but on a dichotomy erected in the literature on asset price movements, according to which upward movements are either sustainable consequences of improvements in economic “fundamentals,” or are “bubbles” in the strict sense of the term, inflated by what Alan Greenspan called speculators’ “irrational exuberance,” and therefore capable of bursting at any time. Since monetary policy isn’t the source of either improvements in economic fundamentals or outbreaks of irrational exuberance, the fundamentals-vs-bubbles dichotomy implies that monetary policy is never to blame for changes in real asset prices, whether those changes are sustainable or not. If the dichotomy is valid, Sumner, Friedman, and the rest of the “monetary policymakers shouldn’t be concerned about booms” crowd are right, and the Austrians, Schwartz, Taylor, and others, including Obama and his advisors, who would hold the Fed responsible for avoiding booms, are full of baloney.

I’m happy to reassure George that I do not believe the things he claims I believe.  I believe the Fed often creates booms, and that these booms often lead to recessions. So in that sense my views are quite Austrian. I am particularly surprised by his claim that I don’t believe that monetary policy affects real asset prices, as he recently commented on a post that was devoted to exactly that proposition:

Now here’s where I part company with Keynesians who might have been with me so far.  Although short term interest rates are one of those “asset prices” that cause the money market to achieve near instantaneous equilibrium, even as the goods and labor markets are in disequilibrium, they actually have very little role in moving NGDP and prices to the level necessary to restore long run macro equilibrium (and to move interest rates back to their original level.)  In my view 60% of the heavy lifting is done by what Keynes called “confidence” and I call “expectations of NGDP growth” and Ford Motors economic forecasters call “expected nominal incomes in 2014 available to buy Ford cars.”  Another 35% of the transmission is done by asset markets like stocks, forex, commodities, real estate prices, junk bond yield spreads, etc.  And maybe 5% by risk-free short term rates.  At most.

So I just claimed that 35% of the transmission effect of monetary policy works through changes in real asset values, and have been saying similar things all along. George is a smart guy, so clearly something I said was misleading, or created a false impression. Perhaps it’s my denial of “bubbles.” I believe in the EMH (i.e. no bubbles), but only for asset markets. Because goods and labor markets have sticky wages and prices, they are not efficient, and monetary stimulus creates booms and busts in terms of output.  In some cases, such as the 1970 recession, the blame is almost 100% the preceding boom. Indeed the preceding boom also played a big role in the next few recessions. Where I differ from some Austrians is that I believe the preceding booms in 1929 and 2007 were not major factors in the subsequent slump. In those two cases I think tight money is mostly to blame, perhaps 90% or more.  It’s hard to be more precise as the trend line is a judgment call (in the absence of NGDPLT.)

I see booms and bubbles as unrelated phenomenon.  If boom means “excessive nominal spending” then I don’t see a strong correlation between booms and bubbles.  The biggest excesses in AD tended to be associated with almost no bubbles.

In the standard AS/AD model, which I accept, business cycles can be created by either increases or decreases in AD.  It’s symmetrical.  The only asymmetry is that the SRAS curve probably becomes somewhat steeper to the right of the LRAS, and hence overshoots do less damage.  That’s one reason booms feel less bad that recessions.  The other reason booms feel good is that they overcome government distortions that normally hold employment below the optimal level.  If only they could do so forever!  But alas, there is a price to pay, as Selgin has ably pointed out.

I do agree that a few market monetarists may underestimate the importance of symmetry, the importance of avoiding excessive expansion in NGDP.  It’s a big group of people now, and many came on board with this crisis, which obviously affects their overall worldview.

Here’s George again:

With so many old-school monetarists switching sides, the challenge of denying that monetary policy ever causes unsustainable booms, and of claiming, with regard to the most recent cycle, that the Fed was doing a fine job until house prices started falling, has instead been taken up by Scott Sumner and some of his fellow Market Monetarists.

Housing prices started falling in 2006, but I never criticized the Fed until it was clear to me that NGDP was falling in late 2008.  I wrote posts pointing out the broader economy did well during the first 27 months of the housing bust.  If my memory is correct, some Austrians were still skeptical that money was too tight in November 2008 (at the SEA meetings), just as Hayek was skeptical that money was too tight in the early 1930s, even when his NGDP norm would have called for easier money.  I will be glad to stand corrected if wrong.

I want central bankers to ignore “bubbles” and focus like a laser of stabilizing NGDP.

Here’s George:

In the meantime, it seems to me that there is a good reason for not buying into Friedman’s view that there is no such thing as a business cycle

This strikes me as odd.  Friedman clearly believed there are business cycles as I understand the term (ups and downs in GDP.)  Maybe Friedman criticized the term “cycle” as implying regularity.  But he clearly believed monetary stimulus was unhealthy in the 1960s, and his natural rate model of 1968 implies that the easy money in the 1960s was to blame for the 1970 recession (which could only have been avoided by steadily higher inflation leading to hyperinflation.)

I do disagree with George on a few points (the EMH, the importance of Cantillon effects, etc) but not on nearly as many points as he assumes.



20 Responses to “Reply to George Selgin”

  1. Gravatar of Benjamin Cole Benjamin Cole
    30. August 2013 at 20:53

    Selgin just sent out an e-mail with a lot of fun reading, including the drunk who comes home and get bashed on the head with an iron pan by his wife. Was it the drinking (easy money) the bash (tight money) that caused his hangover in the morning?”

    I disagree with Selgin, but he sure seems like a nice guy. I think he is wrong and that monetary policy does not cause bubbles.

    Bartenders (central banks) serving up drinks do not make drunks; drunks drink too much of their own volition. You cannot blame happy hour for your hangover.

    Side note:

    Just read a piece in an institutional investor real estate magazine.

    It pointed out that every major financial calamity of recent times was connected to real estate, including the infamous 2008 dump.

    Of course, banks like to lend on appreciating real estate (they consider it collateral, despite abundant evidence that lending into real estate rallies is dangerous) and buyers can leverage up to buy. (Oddly enough, after a real estate collapse is a safe time to lend, but banks won’t lend then—exacerbating the swings).

    I suggest that real estate is sui generis, and plays havoc with neat models, hypotheses, dogmas, theories and hysterical auriferous econo-religious beliefs.

    It may be that proper monetary and macroeconomic policy has to get real estate right–I think Market Monetarism does this, mostly by dodging the bullet. Keep nominal growth on path, and nominal real estate values should not tumble, thus avoiding tumbling real estate taking everything down too.

    Maybe some regulatory fine tuning too. Bigger down payments.

  2. Gravatar of Greg Ransom Greg Ransom
    30. August 2013 at 21:06

    What Selgin needs to do is to walk Sumner through the causal mechanism of systematic distortion in all relative prices across time, the the causal mechansim of the changing liquidity of securitized assets and the yo-yo in the debt to GDP gap and the changes in the debt service ratio, and how these thing are all made possible by the facts of limits & imperfections of human knowledge especially projected across time by individuals with different conceptions of the world dealing with rival production processes of alternative and changing time cost horizons.

    (On changing debt to GDP gap & changing debt service ratios see, on changing asset liquidity & valuation and yo-yoing demand and supply of shadow money see )

    Sumner is blind to the mechanism ast work producing the Austrian empirical pattern Sumner acknowledges, as if Sumner acknowledged ‘Darwin’ by admittting the evolution of species over time — but remaining utterly blind to Darwin’s causal mechanism of natural selection responsible for it all. In other words, he’d remain ignorant of the science, of the causal explanation, and have only a superficial grasp of what it taking place across time.

    Sumner’s grasp of the science remains utterly superficial — again like a 19th century evolutionists affirming ‘Darein’ while knowing nothing of Darwin’s science, beyond the surface historical pattern of ‘evolution’, whatever that might be.

  3. Gravatar of Greg Ransom Greg Ransom
    30. August 2013 at 21:55

    Processes that can’t go on forever, won’t.

    That’s a simple empirical fact about the world.

    The fact of the existence of production processes of rival time lengths & costs, the existence of credit & leverage, the existence of government debt, the existence of the changing liquidity and value of assets of various kinds, all of these combined with rival and incompatible and changing and severely limited and imperfect individual human perceptions of the world — these things together make the inevitable conditions for processes that can’t go on forever.

    Sumner denies this constellation of facts and denies the systematic processes made inevitable by these facts.

    That is what the EMH is all about for Sumner — it’s like theologians denying that the world could be older than 3,000 years or Mach denying that atoms exist or that atomic explanations help us to understand anything.

    It’s a dogma derived from a radically and self-evidently false view of the world, used to stipulate that the self-evident causal processes of the world can’t exist.

  4. Gravatar of jknarr jknarr
    30. August 2013 at 22:30

    Scott, you might like some of the comparative historical data and conclusions (finance standpoint) on the unwinding of overleveraged economies, i.e. busts.–ray-dalio-bridgewater.pdf

  5. Gravatar of George Selgin George Selgin
    31. August 2013 at 04:35

    Benjamin, I think you have identified a flaw in my analogy rather than in my argument. For if central banks didn’t differ from bartenders in being able to compel their clients to overindulge, they would be unable, not only to cause asset booms, but also to cause general inflation.

    But thanks for calling me a nice guy: over at, my critical commentators’ preferred description is “statist.”

  6. Gravatar of ssumner ssumner
    31. August 2013 at 06:09

    Ben, I think that is because real estate is by far the biggest capital market, and also one of the riskiest. By comparison, car loans are much smaller and safer, for instance.

    jknarr, What are the conclusions?

    George, If they think you are a statist, that speaks volumes about their own ideology. 🙂

  7. Gravatar of John Papola John Papola
    31. August 2013 at 06:28

    I believe they think George is a “statist” because he doesn’t think the banking (lending out demand deposits) should be legally banned in favor of glorified safety deposit boxes. One would think that proposing legal bans on voluntary agreements is a “statist” position, not the opposite. Oh well.

    Please don’t judge the Austrian intellectual tradition by the ad hominem attacks of some of its non-economist fanbase. Heck, I’m a non-economist who makes rap videos about Hayek but started off with Rothbard and I managed to figure out that banning the practice of banking is neither libertarian nor good economics.

  8. Gravatar of ssumner ssumner
    31. August 2013 at 06:31

    John, That’s interesting.

  9. Gravatar of John Papola John Papola
    31. August 2013 at 07:30

    Indulge me as I try to thread a few needles here at the intersection of the various models and popular views on them, from the view of a interested non-economist.

    I find it interesting that seeing “demand-side” deflation as problematic should be labeled “monetarist”. I’ve found references to this problem in Hume, JS Mill and other classicals. I believe Milton himself said that we’ve only moved one derivative away from Hume in our understanding of money and macro (or something like that).

    So everyone but Rothbardians agree that money-demand deflation causes problems. Hayek called it “secondary deflation”. He wrote in newspapers in the 1930s that he, Robbins and others agreed it was a problem. That said, the 1922 recovery in the face of serious deflation is a pretty interesting counter-example.

    So the problems of demand-deflation must be couched in assumptions about wage/price stickiness. Got it. I’ve said before that this forms the litmus test for serious macro policy. Which is to say, if you claim to care about the problems of nominal collapses, you sure as hell better be a vociferous advocate of policies which REDUCE wage/price stickiness. Since most Keynesians seem to support policies which INCREASE wage/price stickiness, they fail the test and shouldn’t be taken seriously.

    Scott, where you (and Milton) seem like you part ways with George, other Hayekians and the classical tradition is in a depreciation of compositional imbalances due to the short-run non-neutrality of money. “Cantillon effects”. Perhaps these are better understood as interest-rate effects, rather than as “injections”. Your posts can come across as having analysis that’s over-aggregated.

    It seems to me that the compositional impact of monetary effects perhaps are best understood as impacting real growth, rather than employment. Your points about 2006-2008 have been very thought provoking for me in this regard. So policy-induced deviations of interest rates from their natural rate lead to sectoral/structural imbalances. Too many houses get built relative to other goods and the composition of future of demand. But the marketplace is generally good at re-allocating labor and capital. So the housing bust leads to an exit from the housing market and entrance into other areas. The real unemployment doesn’t kick in until the deflationary shock.

    What fellow travelers rarely discuss is that this same effect can be seen in 1946-48. Demobilization was a huge sectoral shift, yet soldiers came home and found ways to make a living being productive (I hate talking about “jobs”. Our goal is to create output and get a job DONE, not have a job.)

    So the Keynesians blew their predictions of a power WWII depression, but a rigid adherence to the idea that unemployment is purely from sectoral imbalance also fails to explain the power-war boom. Of course, Keynesians so deeply misunderstand the basic point of economic exchange that they disregard whether activity is value-creating or value-destroying. They advocate jobs for the sake of jobs. Work to work, not work to live. So nobody should mistake this as being pro-Keynesian. Their model is a vortex of deep misunderstanding. Separate your model from them at every opportunity.

    In defense of the Rothbardians, I think their desire to limit private credit expansion has some real merit in the moral hazard world that is reality with a lender of last resort and deposit insurance effectively destroying the natural market discipline banks need to remain prudent. If we can’t get rid of the lender of last resort or deposit insurance, we at least need strong reserve requirements. This is a third best piece of advice, of course, but it does have merit. The irony, of course, is that this position puts ardent libertarians in the position of demanding “more gov’t regulation” in a certain sense, though I guess it could be viewed as “better/different regulation”.

  10. Gravatar of Morgan Warstler Morgan Warstler
    31. August 2013 at 10:05


    “Which is to say, if you claim to care about the problems of nominal collapses, you sure as hell better be a vociferous advocate of policies which REDUCE wage/price stickiness. Since most Keynesians seem to support policies which INCREASE wage/price stickiness, they fail the test and shouldn’t be taken seriously.”


  11. Gravatar of nickik nickik
    31. August 2013 at 11:22

    @John Papola

    Im not sure but I think you missed in your analysis of keynsians like krugman is that they clame, that even without sticky prices/wages you would have a buissness cycle.

    But even If you agree to that I still see know reason why the would want to make prices less flexible. Maybe that the belive that if prices/wages are flexible but nominal debt is not, the real losers of the recession are the people with high nominal debt while if you make it hard to fire people, the real losers are compmanys.

    I dont know, eitherway its inconsitstent.

  12. Gravatar of kebko kebko
    31. August 2013 at 23:17

    On the topic of bubbles, I just put together a post arguing that home prices in the 2000’s were a reasonable reflection of low real interest rates. Prices might have gone just as high in the 1970’s, but in the 1970’s the relative value of the investment wasn’t the constraint on home prices. The constraint was qualifying for the mortgage with such high nominal rates, so owner occupied homes could not be bid up to prices that would have been efficient relative to other investment options. Prices weren’t too high in the 2000’s. They were just kept unnaturally low in the 1970’s. And, since home values are sensitive to real rates, they were low in the 80’s and 90’s because real rates were high.

  13. Gravatar of Lee Waaks Lee Waaks
    1. September 2013 at 04:23

    John Pappola:

    Keynesians did mistakenly predict a post-WWII recession, which certainly makes their model look bad, but David Steele (author of From Marx to Mises) argues that the failure of a depression to materialize is also a problem for Austrians too, as capital reallocation from war production to consumer goods — given the heterogeneous nature of capital in the Austrian view — should also have also led to a recession.

  14. Gravatar of ssumner ssumner
    1. September 2013 at 07:38

    John Many good points, where I mostly agree. Yes, the “Cantillon effects” is where I differ with George and many others.

    My only quibble is that prices were actually rising during 1922 (monthly frequencies) during the recovery. Wages were falling. The 1921 cycle is a completely standard AD shock cycle, it’s just that wages were more flexible than during more recent cycles (including 1930)

    nickik, I understood them as saying that more flexibility would not be helpful, but 100% flexibility would. Perhaps I am wrong. Otherwise, how to you get unemployment with 100% flexibility?

    kebko, That sounds reasonable. BTW, I just read that home prices are up 19% since the low point. Imagine where they would be today if NGDP had never collapsed!

  15. Gravatar of Free Banking » Booms, Bubbles, Busts, and Bogus Dichotomies Free Banking » Booms, Bubbles, Busts, and Bogus Dichotomies
    3. September 2013 at 05:24

    […] Addendum: Scott has responded, claiming that I am wrong in portraying him as a money-induced unsustainable boom denialist. I […]

  16. Gravatar of George Selgin George Selgin
    3. September 2013 at 06:06

    Scott, I’ve just written an addendum to my original post, replying to your reply.

  17. Gravatar of George Selgin George Selgin
    3. September 2013 at 06:10

    Kebko: “Scott, On the topic of bubbles, I just put together a post arguing that home prices in the 2000″²s were a reasonable reflection of low real interest rates.” This remark misses a key point of my post. Indeed, it’s worse than that, for the people who blame the Fed for encouraging the boom certainly aren’t saying that the boom was encouraged by Fed policy rather than low interest rates!

  18. Gravatar of Vivian Darkbloom Vivian Darkbloom
    3. September 2013 at 07:20

    “I just put together a post arguing that home prices in the 2000″²s were a reasonable reflection of low real interest rates.”

    “That sounds reasonable. BTW, I just read that home prices are up 19% since the low point. Imagine where they would be today if NGDP had never collapsed!”

    Were housing prices “too high” and there is a large element of semantics in answering that question.

    But, the Housing Affordability Index reached about 100 in 2005, after it had been bouncing between 120 and 140 for nearly 25 years. The HAI measures affordability according to median housing prices, median wages and effective mortgage interest rates (the index appears not to take into account tax consequences).

    I think it would be wrong to *merely* say that housing prices “were too high” even though the affordability index did reach a 25 year low. It is entirely possible that some other things were ‘too low” or “too high”. That would be consistent with low real interest rates as kebko suggests.

    As far as where housing prices would be today if NGDP had never collapsed, one might also reasonably ask “where would housing affordability be if NGDP had never collapsed” or “where would NGDP be if housing had never collapsed”.

    Tracking causes and effects is seldom straightforward. For example, the HAI strikes me as a useful but incomplete tool to try to figure out what happened with housing over the past, say, 15 years. To answer the question of whether housing is “affordable”, for example, I think one must also consider the other financial commitments a homeowner had during the periods in question. I think if one were to subtract from “median income” the amount needed to service the median consumer debt, housing was even less “affordable” when prices hit their peak. One might then conclude that while housing prices may have been a bit too high, so was consumer debt.

  19. Gravatar of kebko kebko
    3. September 2013 at 10:56


    The mystery that I addressed in my linked post was how the 1970’s and 2000’s both had very low real rates, and high home values, relative to other assets. The 2000’s had low inflation, and home values went much higher than they had in the 1970’s.

    I suggest that the difference in inflation between the two decades can explain the difference in home prices, because of the oddity of homes being an investment that is funded like consumption. (Mortgages are approved based on current income, and not as part of a review of an investment portfolio.)

    This seems like evidence that the low real rates are a result of secular and demographic trends, and that the rise in home prices in the 2000’s is the result of tighter monetary policy, not looser.

  20. Gravatar of Booms, Bubbles, Busts, and Bogus Dichotomies – Alt-M Booms, Bubbles, Busts, and Bogus Dichotomies - Alt-M
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    […] Addendum: Scott has responded, claiming that I am wrong in portraying him as a money-induced unsustainable boom denialist. I […]

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