Summers and Furman on monetary policy

A new paper by Jason Furman and Larry Summers has attracted a lot of interest. They advocate the increased use of fiscal policy, largely because they view monetary policy as ineffective during recessions:

First, fiscal policy must play a crucial role in stabilization policy in a world where monetary policy can counteract financial instability but otherwise is largely “pushing on a string” when it comes to accelerating economic growth. The roughly 600 basis point reductions in rates that have been found necessary to counteract recessions will be infeasible for the foreseeable future. Limitations on how far interest rates can be reduced given the zero lower bound and the possible inefficacy of lower rates in stimulating demand raise the possibility that full employment may be infeasible with overly restrictive fiscal policies.

Keynesians focus too much on the target interest rate as a transmission mechanism for monetary policy. The effect of monetary policy on the natural interest rate is far more important that small tweaks in the policy rate.

The estimated 600 basis point rate cut is only necessary when a tight money policy lowers the natural rate of interest by 600 basis points. If the Fed were to adopt a 5% NGDP level targeting regime, with a “target the forecast” approach to policy, there would be no need for fiscal policy at all. Just buy bonds until the market expectation of NGDP growth will put us back on the 5% trend line. Under that sort of regime, the natural rate of interest would be much more stable than under the current regime, and you would not need those 600 basis point rate cuts.

To a much greater extent than Furman and Summers realize, the Fed has been an arsonist, not a firefighter. (Here I’m thinking of earlier recessions, I agree with those who suggest that the current recession is largely non-monetary.)

PS. I strongly encourage people to read George Selgin’s new paper discussing the 2015 rate hike. He makes his case very persuasively.

HT: David Levey



17 Responses to “Summers and Furman on monetary policy”

  1. Gravatar of Anonymous Anonymous
    5. December 2020 at 15:24

    I’ve seen your EconLib post about some of Summers’ vaguely Market Monetarism aligned statements from a few years ago ( but I wonder if he’s actually engaged with it directly somewhere? I’m trying to figure out if he just hasn’t really looked into it or if he has but disagrees (and why?). My default assumption is that he’s just sticking to what he knows but given the importance of the topic I’d have assumed he’d have searched far and wide for other explanations.

  2. Gravatar of Benjamin Cole Benjamin Cole
    5. December 2020 at 16:20

    Interesting post. The nice thing about macroeconomic debates is that no one has ever wrong.

    I still suspect that money-financed fiscal programs, perhaps in combination with QE are the best way to go.

    Not more federal spending, but less taxing + QE.

    For example, there could be holidays on Social Security taxes whenever unemployment rose above 5%, or perhaps 4%. In concert, the Federal Reserve would buy Treasuries and place them into the Social Security fund to offset lost tax revenues.

    I see one problem with NGDPLT, though unlikely. Suppose the Fed hits NGDPLT, but unemployment is still high.

    Free market nations that desire social stability should always shoot for the lowest unemployment rate possible.

  3. Gravatar of Benjamin Cole Benjamin Cole
    5. December 2020 at 16:31

    Re George Selgin: Here is a practical question, and adds to the in probability that the Phillips Curve is a valuable tool

    Unit labor costs.

    The index on Q4 2008 stood at 101.45.

    Then, latest, Q3 2020 at 114.04.

    You are looking at unit labor costs rising at less than 1%, annually compounded.

    I cherry picked a little bit, but not too bad. Less so than most academic studies.

    If unit labor costs, over a pretty long and very recent stretch, are rising at less than 1%…

    Does this mean the Fed should engage in more QE?

    Is there a reason to allow unemployment? What is that reason?

  4. Gravatar of Benjamin Cole Benjamin Cole
    5. December 2020 at 16:32

    “improbability that”

  5. Gravatar of ssumner ssumner
    5. December 2020 at 17:09

    Anonymous, The only thing I can recall is that Summers favors NGDP targeting, but this is a separate issue.

  6. Gravatar of Ricardo Ricardo
    5. December 2020 at 17:21

    – The link in the blog to the Furman and Summers paper is broken. Probably should be this:

    – There’s a discussion of this on a recent PIIE-Brookings zoom. Its 2 hours, available on Youtube, entitled “Fiscal policy advice for Joe Biden and Congress”:

    – Ben Bernanke, “..basically agrees..” with Furman and Summers, but takes about five minutes in the video to “defend monetary policy” starting at about 01:09:35, which is a few seconds after here:

  7. Gravatar of ssumner ssumner
    5. December 2020 at 17:34

    Thanks Ricardo, I fixed it.

  8. Gravatar of Benjamin Cole Benjamin Cole
    5. December 2020 at 19:31

    Well, I read the Selgin paper, which is interesting.

    There are problems with forward guidance, including that there are multiple voices and votes on the FOMC. So….whose forward guidance?

    The market is left to reading tea leaves, and digesting semantics, and wondering (at times) if there will be a putsch of doves or hawks at any time (this nearly happened when Volcker was Volcker, but he threatened to quit. The money-easing Reaganauts had out-voted Volcker on policy, but then backed down).

    Better that a lone, responsible and accountable individual be in charge of monetary policy.

    Macroeconomists have yet to clarify whether QE, in combination with concurrent federal deficits, is fiscal or monetary policy.

    OK, so the even the fundamentals are all jumbled up and major credentialed experts disagree.


  9. Gravatar of Postkey Postkey
    6. December 2020 at 04:30

    “Keynesians focus too much on the target interest rate as a transmission mechanism for monetary policy. The effect of monetary policy on the natural interest rate is far more important that small tweaks in the policy rate.”

    From my favourite ‘spoiler of the planet’.

    “Equation (22) indicates that the change in government expenditure ∆g is countered by a change in private sector expenditure of equal size and opposite sign, as long as credit creation remains unaltered. In this framework, just as proposed in classical economics and by the early quantity theory literature, fiscal policy cannot affect nominal GDP growth, if it is not linked to the monetary side of the economy: an increase in credit creation is necessary (and sufficient) for nominal growth.
    Notice that this conclusion is not dependent on the classical assumption of full employment. Instead of the employment constraint that was deployed by classical or monetarist economists, we observe that the economy can be held back by a lack of credit creation (see above). Fiscal policy can crowd out private demand even when there is less than full employment. Furthermore, our finding is in line with Fisher’s and Friedman’s argument that such crowding out does not occur via higher interest rates (which do not appear in our model). It is quantity crowding out due to a lack of money used for transactions (credit creation). Thus record fiscal stimulation in the Japan of the 1990s failed to trigger a significant or lasting recovery, while interest rates continued to decline. ”

  10. Gravatar of Thomas Hutcheson Thomas Hutcheson
    6. December 2020 at 07:48

    Or, buy bonds or something else (foreign exchange?) until TIPS inflation expectations are on target. On the other hand, “fiscal policy” (increasing expenditures on activities with positive NPV when activity costs are calculated at marginal costs of the inputs which will be below market prices) in recessions has been insufficient, so in practice if not in theory, Summers-Furman’s prescriptions are probably correct.

  11. Gravatar of ss ss
    6. December 2020 at 08:10

    Seems like your forces have moved Prof. Cochrane. 😀 In his recent post he seems to suggest that central banks should target the market spread between indexed and non-indexed treasuries. Now that he is on market forecast targeting, you just need to move him toward NGDP.

  12. Gravatar of Zamba Zamba
    6. December 2020 at 08:50


    if I understand correctly, by targeting a futures market you try to make sure the expectations for NGDP are going to be constant, so that there is no sudden shift in confidence capable of affecting the economy in the short run.

    So in our current system, if expectations (animal spirits) goes bearish, that translates into a fall in the natural rate of interest, and because of the lag in monetary policy it won’t fix the problem instantly, and you will have a recession.

    If the Fed can stabilize expectations, then it won’t need to fight recessions that comes from a shift in confidence, right?

    I’m wondering if there could be any lag to futures targeting too. Could the Fed fastly react to any sudden shift in confidence and meet its future target?

  13. Gravatar of ssumner ssumner
    6. December 2020 at 09:29

    ss, Yes, he mentioned that idea a few years ago. I recall discussing the concept with him a while back; don’t know if this influenced his thinking. But John is a EMH guy, so the policy makes sense.

    Zamba, If financial markets are efficient, then there should be no lag. But even if there were a lag of a few days it probably wouldn’t be a big problem, as long as it was promptly corrected.

  14. Gravatar of Patrick R, Sullivan Patrick R, Sullivan
    6. December 2020 at 12:09

    From Andy Kessler in today’s WSJ:

    ‘ “Why the Fiscal Multiplier is Roughly Zero” is the title of a 2013 paper by Scott Sumner for George Mason University, summarizing the Obama stimulus. The key line is that “estimates of fiscal multipliers become little more than forecasts of central bank incompetence,” meaning the Federal Reserve’s job of maintaining stable monetary conditions should actually require it to fight against stimulus. ‘

  15. Gravatar of ssumner ssumner
    6. December 2020 at 13:41

    Patrick, Thanks. Cool!

  16. Gravatar of Spencer B Hall Spencer B Hall
    7. December 2020 at 15:49

    Selgin could have easily picked on Powell’s 12/20/2018 hike.

    As American Yale Professor Irving Fisher claimed: “In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification.”

    The FOMC’s monetary policy objectives should be formulated in terms of desired rates-of-change, roc’s, in monetary flows, volume times transaction’s velocity, relative to roc’s in the real-output of final goods and services -> R-gDp.

    Roc’s in N-gDp, or nominal P*Y, can serve as a proxy figure for roc’s in all physical transactions P*T in American Yale Professor Irving Fisher’s truistic: “equation of exchange”. Roc’s in R-gDp have to be used, of course, as a policy standard.

  17. Gravatar of Spencer B Hall Spencer B Hall
    7. December 2020 at 15:53

    Link: Dr. Philip George – October 9, 2018: “At the moment, one can safely say that the Fed’s plan for three more rate hikes in 2019 will not materialise. The US economy will go into a tailspin much before that.”

    “When interest rates go up, flows into savings and time deposits increase.” ( the ratio of M1 to the sum of 12 months savings )

    I.e., an increase in bank CDs adds nothing to GDP. In fact, it destroys velocity.

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