There has recently been a lot of pushback against QE from conservatives.  In this post I pointed out that plenty of conservatives support monetary stimulus.  Here I’d like to direct 7 arguments against my fellow right-wingers:

1.  The Fed isn’t really trying to create inflation.

The Fed doesn’t directly control inflation; they influence total nominal spending, which is roughly what Keynesians call aggregate demand.  Whether higher nominal spending results in higher inflation depends on a number of factors, such as whether the economy has a lot of underutilized resources.  But it’s certainly true that for any given increase in NGDP, the Fed would prefer more RGDP growth and less inflation.  Even after QE2, the Fed still expects less than 2% inflation for years to come.  If the Fed had any marketing sense, they’d be telling the public they are trying to boost recovery by increasing national income, not increasing the cost of living.  It would also have the virtue of being true.

2.  “But doesn’t economic theory teach us that printing lots of money creates high inflation?”

In general that is true.  But there are three important exceptions:

1.  If the monetary injections are expected to be temporary, the inflationary effect is far smaller.  The Japanese central bank did lots of QE in 2003, but pulled much of the money out in 2006 when deflation ended.  It worked in preventing high inflation, indeed it may have worked too well.

2.  If interest rates are near zero, the public demands more liquidity.  The Fed can supply that liquidity with little impact on the price level.

3.  If the Fed pays interest on reserves, then the quantity theory of money (more money means more inflation) doesn’t necessarily hold.  They recently started paying interest on reserves, and that’s one reason why the big injections from 2008 didn’t have an inflationary impact.  The Fed can adjust the rate as necessary, and indeed in my view a lower IOR would be more effective that QE2.

3.  “But isn’t the gold market signaling high inflation?”

Possibly, but the indexed bond market is superior to gold prices for two reasons.  First, gold is trading in a global market, and we are interested in US inflation.  More importantly, gold prices reflect all sorts of factors (industrial demand in Asia, central bank demand, a recent drop-off in new discoveries, a hedge against all sorts of financial risks, including eurozone turmoil.)  Furthermore the indexed bond market (TIPS spreads) has recently been more accurate than gold—correctly predicting low inflation in the US since late 2008.

4.  “Doesn’t printing money just paper over real (structural) problems in the economy?”

There are structural problems, but there is also a shortfall of nominal GDP.  The structural problems showed up when growth slowed in late 2007 and early 2008 as a result of sharply lower housing construction.  This is necessary re-allocation of resources and should not be resisted.  But even Friedrich Hayek suggested that we needed to avoid a “secondary deflation”, which would show up as falling NGDP, and would depress output in even those healthy industries that had not over-expanded.  In late 2008 output fell across the board as NGDP declined.  Monetary policy can only address the insufficiency of total nominal spending, not the structural problems.  Furthermore, more nominal spending would boost employment, which would speed up the time when Congress eliminates the 99 week extended UI benefits–which is one of the structural problems.

5.  “Isn’t this just hubris—the idea that money can be centrally planned?”

Most right wing economists are not comfortable with the idea of giving discretion to the central bank.  I am no exception.  I happen to favor making the dollar convertible into NGDP futures contracts as a way of stabilizing NGDP growth expectations at a low and stable rate.  Milton Friedman favored a stable money supply growth rate, but late in his career (after velocity bounced around) endorsed a policy of stabilizing market expectations of inflation in the indexed bond market.  These systems would allow the market, not the Fed, to determine the appropriate level of money for the economy’s needs.  But we aren’t there yet, and given the Fed does use discretion, Friedman was not at all hesitant about recommending policies that he thought would do the least damage.  I believe that is stable NGDP growth expectations.

6.   The conservative critique of stimulus is incoherent

When I started my blog in early 2009, fiscal stimulus was the hot issue.  Many conservatives were opposed to fiscal stimulus, arguing (correctly in my view) that it would fail.  And they made it quite clear that “failure” meant deficit spending would fail to boost nominal spending.  The implicit assumption was (almost everyone agreed) that more nominal output would be desirable, and the argument was that fiscal stimulus could not deliver it.  With monetary stimulus, the right is making exactly the opposite argument—they are opposed to QE because it might succeed in boosting NGDP.  Both fiscal and monetary stimulus boost NGDP (if they work at all) by shifting AD to the right.  Whether that extra spending shows up as inflation or real growth is of course an important issue.  But it makes no sense to argue fiscal stimulus would fail because it would not boost NGDP, and simultaneously argue that monetary stimulus would fail because it would increase NGDP.  I’m sure the right doesn’t think of its views in those terms, but that is essentially the message they are sending out, and it is an extremely incoherent message.

7.  “Won’t monetary stimulus just paper over the failures of the Obama administration, allowing him to get re-elected?”

That’s an argument unworthy of principled conservatives.  After 30 years of major neoliberal reforms all over the world (even in Sweden!) it’s time for conservatives to become less defeatist about the possibility of making positive improvements in governance.  We need to do the right thing, and let the political chips fall where they may.  If monetary stimulus is tried, and succeeds in boosting NGDP (which even conservatives implicitly acknowledge can happen when they worry about inflation) then it would drive a stake through the heart of the Krugmanite fiscal stimulus argument (for future recessions.)

I don’t think conservatives realized it at the time, but I (and a few other quasi-monetarists) had the strongest argument against fiscal stimulus in late 2008 and early 2009.  We said; “Yes, stimulus is needed, but monetary stimulus is much more effective and less costly than deficit spending.”  At the time, most on the left argued that monetary stimulus wouldn’t work if rates were near zero.  Well rates are still near zero, and many of those same liberals are now insisting that the Fed is responsible for fixing the AD shortfall.  They’ve come over to our side.  Just as in earlier decades they gradually accepted the Friedman/Schwartz argument that monetary policy errors caused the Great Contraction of 1929-33, not the failures of capitalism.  If conservatives keep predicting inflation that the financial markets don’t see, Krugamn will continue to rub their faces in failed predictions.  If we adopt the view that monetary policy is the appropriate way to keep NGDP growing at an adequate rate, then we win and Krugman loses.  So which will it be?

This article in the National Review is a very fair and balanced look at the pro- and anti-monetary stimulus camps.   Ramesh Ponnuru points out that a number of economists generally regarded as right of center have favored monetary stimulus and/or a higher inflation target.  He mentions John Makin, Greg Mankiw, David Beckworth and yours truly.  There are others as well, many of whom have blogs (Bill Woolsey, etc—I won’t try to mention all the names because I’m never sure who likes being called conservative.  I prefer the term ‘right-wing liberal.’)  The article also mentions George Selgin’s productivity norm.  BTW, people have asked me about his co-authored piece on the Fed (which is excellent) and I plan a post soon.

The article points out that the left is also split, although among professional economists I think liberals are significantly more in favor of stimulus.  Brad DeLong has a new post that shows the famous graph of NGDP growth falling far short of trend, and then makes this point:

The problem with our economy is not that something bad happened to our productive capacity while the flow of nominal spending continued to blip along, it is that something bad happened to the flow of nominal spending and that carried real production and employment down with it. At the moment our flow of nominal spending at $14.7 trillion per year is some 12% below its pre-2008 trend. And in the absence of any 12% decline in prices and wages, that shortfall in spending has to produce our current macroeconomic distress: there is not enough “money” to support enough of a flow of spending to chase all the goods we could produce. We don’t have a deficiency of real supply (for whatever reason). We have a deficiency of nominal demand.

That’s what John Walter Bagehot would say. That’s what Irving Fisher would say. That’s what Jacob Viner would say. That’s what Milton Friedman would say.

And they would say that it is a central bank’s business to intervene in asset markets to boost the flow of nominal spending back to what everybody expected it to be and counted on it being

Excellent points.  But before DeLong does too much conservative bashing, he might want to ask which two blogs were best known for presenting quite similar arguments for monetary stimulus in February 2009, and what was the political orientation of those two bloggers.  And by late 2009 you could have added Bill Woolsey.

HT:  JimP, for both links.

I’ve argued that monetary policy is the fatal flaw of the right.  In 1929 the US had an outstandingly efficient model.  Banks were conservatively managed (although branching laws meant there were far too many of them.)  We ran budget surpluses, trade surpluses, zero inflation, low unemployment, low taxes, etc.  Tariffs were a bit too high, but nobodys perfect.  And this policy regime was destroyed by the same people who had built it; conservatives.   The left blamed the Depression on the economic model, not deflation.   Then they proceeded to dismantle the model, which delayed the recovery for six years more than necessary.

In the 1990s Argentina finally started to move away from their statist model.  There were signs they might follow in the footsteps of Chile.  They achieved fast growth from 1991-98, even while bring inflation down from 171% to less than 1%.  But the conservatives always seem to go too far.  If low inflation is better than high inflation, then what’s wrong with deflation?  What’s wrong is that deflation causes depressions, which opens the door to left wing governments.  Sure enough the new Argentine government started moving back toward statism.  Naturally they got a cyclical recovery after a sharp devaluation, but the statist policies will insure years more of economic under-performance in Argentina.

And now the once-promising Baltic States.  This is from Ed Dolan’s blog:

In contrast, in the Czech Republic, the post-accession boom was accompanied by rapid appreciation of the Czech koruna, which strengthened from 33 per euro to 23 per euro in just 4 years. The strong currency kept import prices low and helped restrain inflation. Without the need to hold the exchange rate fixed, the Czech central bank was able to use monetary policy to avoid excessive wage increases or a housing bubble. When the crisis hit, the koruna depreciated as quickly as it had earlier strengthened, quickly restoring competitiveness. The recession in the Czech Republic was among the mildest in the EU.

The effects of the crisis on Latvia were entirely different. Without a devaluation, the only way Latvia could restore competitiveness was through deflation of prices and wages. This strategy, often called “internal devaluation,” has been extremely painful. The unemployment rate has soared to 22 percent as prices and wages fall. Meanwhile, unemployment in the Czech Republic has risen only slightly and has remained below the EU average throughout the crisis.

When will the right ever learn?

HT: Tyler Cowen

A commenter named Richard A. asked me why there don’t appear to be any liberal economists who support NGDP targeting.  For a moment I was stunned.  I am so used to NGDP targeting be attacked from the right that I forget that it has no supporters on the left.  Recall that conservatives usually support inflation or price level targeting, and think that NGDP targeting is soft on inflation.  So why no liberal support?

Not knowing any liberal macroeconomists, I can only guess:

1.  Maybe they somehow associate the idea with the infamous MV=PY equation.

2.  Maybe they think price stickiness is a much bigger problem than wage stickiness.

3.  Maybe they think it too crude, as it seems to put equal weight on P and Y fluctuations, and pays no attention to the output gap.

I suppose some right-wingers might have arrived at NGDP targeting via the equation of exchange.  Once people started criticizing Milton Friedman’s “4% rule” by pointing out that velocity fluctuates, then it is natural to think about monetary rules that offset changes in velocity.

But of course this is no reason for a Keynesian to oppose NGDP targeting.  After all, it is equally true that price level targeting can be explained in terms of this tautology:

P = M/m

Where P is the price level, M is the supply of base money, and m is the real demand for base money.  And yet I doubt whether any economist has ever rejected inflation targeting because they found that tautology offensive.

Regarding price stickiness, I think the Keynesians are wrong about it being more important than wage stickiness.  As I recall this view is partly based on post-war studies that showed real wages to be procylical.  But (in a 1989 JPE article) Steve Silver and I showed these studies are flawed and that real wage cyclicality is consistent with sticky-wage business cycle theories.

I think the third objection is the most important (and is also mentioned by Bill Woolsey in a recent comment to this post.)  How likely is it that the optimal coefficients on price level and output fluctuations are exactly the same?  And why not take into account the output gap, rather than merely the change in real GDP?

I would give several answers.  First, we aren’t even close to developing a macro model capable of showing which coefficients would be best, and which is also generally accepted by policymakers and economists.  Indeed I’d go further and argue that even new Keynesian policymakers and economists don’t agree on these issues.

Second, we don’t know how to measure the output gap.  All we know is that when output falls sharply, there is usually an output gap.  This means we don’t know enough to make a Taylor Rule produce dependably better results than a NGDP target.

Furthermore (as Woodford recently pointed out), we really need level targeting, not growth rate targeting.  Level targeting is obviously really easy to do with an NGDP target.  There are ways to do it with a Taylor Rule, but you have to rework the model, and there is already great disagreement about which Taylor Rule is best.

Most importantly, you can’t fight something simple and appealing with something complicated and unappealing.   Americans are conservative people.  What sounds more appealing:

1.  Stable prices

or

2.   Maximize some complicated social welfare function involving inflation and output gaps.

NGDP targeting is a sort of focal point that liberals and (some) conservatives could rally around.  It also appeals to pragmatic moderates like Bennett McCallum.

Until liberals realize this they will continue to lose out to the Plosser’s of the world, who have a simple and appealing message.  We need a similarly simple message, such as “The Fed must provide enough money to keep America’s nominal income rising at 4% per year.”

I just picked 4% at random, but in principle it isn’t random, it’s the sum of the current forecast of long run RGDP growth (say 2.5%) and the current policy goal for inflation (say 1.5%.)  So it’s not an entirely new goal, but rather a better way of achieving goals we already have, whether we admit it or not.

Here’s my fallback position.  Let’s suppose liberal macroeconomists don’t think NGDP targeting is good enough, because of issues like the output gap.  OK, then call it “flexible NGDP targeting.”  After all, many liberal macroeconomists say they support flexible inflation targeting, where the term ‘flexible’ indicates that they don’t look solely at inflation.  The problem with this is that inflation still lies at the center of their policy; it is still the variable everyone sees.  But inflation didn’t provide anywhere near as unambiguous a signal in 2008-09 as did NGDP.  If we had been talking about NGDP, it would have been obvious to everyone that money was far too tight.  But when you looked at variables like core inflation (horribly distorted by its failure to detect the fall in housing prices) you got much more ambiguous signals.  It gave the inflation hawks a leg to stand on, something they wouldn’t have had if everyone viewed policy in NGDP terms (even flexible NGDP terms.)  Again, flexible NGDP targeting is hardly my first choice (too much chance for mischief) but it is still light years ahead of the vague flexible inflation targeting regime we are currently operating under.

Don’t let the perfect be the enemy of the good enough.  Forget about the policy goals embedded in Taylor Rules.  It’s going to be NGDP targeting, level targeting, or we will continue to have monetary screw-ups because we have hopelessly vague inflation targets that allow policymakers to oppose monetary stimulus after a deep fall in NGDP.  (And for you Austrians, recall that inflation targeting allows the Fed to have easy money when NGDP is rising too fast.  They just point to core inflation.)