The empathetic, the amoral, and the sadistic (pt. 1 of 2)

My posts are too long, so I’ll break this up into two parts.

Consider the following policy options.  Assume a standard AS/AD model with some wage and price stickiness.

1.  An amoral monetary policy:

Let’s suppose central bankers cared only about keeping inflation at a steady rate of 2%/year.  They know that monetary policy also affects employment fluctuations, but they don’t care about workers.  Let’s call that policy “amoral.”

2.  An empathetic monetary policy:

Now let’s assume the central bank still prefers stable inflation of about 2%, but also wishes to avoid suboptimal employment fluctuations.  What should they do if unemployment rises to 10%, and many workers lose jobs because wages and prices are not completely flexible?  In that case the central bank must trade-off two goals; stable inflation and stable employment.  It will probably be optimal to allow slightly higher than 2% inflation, if the policy that does that (monetary expansion) also reduces unemployment in the short run.  So they might allow 3% percent inflation to reduce unemployment to 8%.

What if employment is too low?  Suppose NGDP has risen fast and companies are forcing workers on long term contracts to work lots of overtime.  They miss deer hunting season.  They are grouchy to their wives.  But they have no choice.  The Fed can reduce inflation slightly below 2% with tight money, and this will tend to push employment levels down closer to their optimal point.  That would be the amount of work that would occur if labor contracts had been negotiated with full knowledge of current levels of AD.

You may have noticed that this is roughly what NGDP targeting does, although there are many other versions of this general idea.

3.  A sadistic monetary policy:

Now suppose central bankers get pleasure from the suffering of workers.  They enjoy the thought of workers losing their jobs.  If unemployment hits 10%, what is the optimal policy response from the central banker’s perspective?  Recall that, other things equal, they prefer a steady inflation rate of 2%.  If unemployment hits 10%, they will want to make workers even a bit worse off with tight money.  This will result in lower than 2% inflation.  Perhaps 1%.  The lower inflation is bad from the central bank’s perspective, because they prefer a steady 2% rate.  But they are willing to pay the price of lower than desired inflation in order to get more unemployment–as they enjoy the suffering of workers.

This is just the standard economics of a trade-off between two goods; price stability and worker suffering.  A very simple model.

At this point the more astute readers may assume I am about to accuse the Fed of being a bunch of sadists.  Actually no.  Indeed I find the thought rather preposterous.  No matter how much you might dislike central bankers, they are not sadists.  I don’t even think they are amoral.

In addition, although the sadistic scenario seems to apply to the current policy situation, it actually fits almost every recession in my lifetime, in the US and many other industrial countries.  I could tell the same story about the BOJ or the ECB.

Instead, I’d like to argue that central bankers are a bunch of well-meaning (or at worst amoral) people who act like sadists because they have the wrong model in their heads.  They think that it is “natural” for inflation to fall during periods of high unemployment.  And we know that ‘natural’ means good.  After all, natural foods are good for you, aren’t they?  Why do they think low inflation is natural in a weak economy?  Because it almost always happens.  When it doesn’t happen, e.g. 1974, the event is viewed as bizarre.

Here’s the problem with their reasoning.  The reason inflation almost always falls during a weak economy is because the cause of a weak economy is almost always, at least partly, a reduction in M*V.  When M*V growth falls sharply, so does both inflation and real growth.  (I emphasize sharply, because this is less true of mild declines.)

This is why central bankers can sleep at night knowing that inflation is likely to be only 1% over the next year or two, they see that as a natural occurrence during a severe recession.

But I can’t sleep at night.  I see insufficient NGDP as the cause of the problem.  To me, a steady 5% growth in NGDP is “natural.”  If we had that, then inflation would rise when unemployment was high and output was low.  During an oil shock you might get a year of 1% real growth and 4% inflation.  During a tech boom you might get two years of 4% real growth and 1% inflation.  In the long run you’d get 3% real growth and 2% inflation.  When unemployment was high (oil shock) the Fed would push inflation higher than 2%.  That’s what’s normal for me.  What the Fed considers normal, I consider sadistic.  Not just this Fed, but earlier Fed’s, and foreign central banks as well.  If I knew there was 10% unemployment, I couldn’t sleep at night knowing the markets were predicting only 1% inflation, whereas the target was 2%.  I’d keep asking myself; “Why not do more stimulus?  We’d improve both the unemployment and inflation situations at the same time.”

At this point you’re saying to yourself; “But all this is because you are assuming sticky wages and prices are the problem, suppose it’s some sort of structural problems in the economy.  That changes everything.”  Actually, it doesn’t change anything, but that’s for the next post.



26 Responses to “The empathetic, the amoral, and the sadistic (pt. 1 of 2)”

  1. Gravatar of Morgan Warstler Morgan Warstler
    26. August 2010 at 18:39

    “Section 2a. Monetary Policy Objectives
    The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

    It says right there:

    Growth driven by increased production (productivity) for the long run – so as to have maximum employment (we know how to do that) stable prices (not stable inflation) and moderate long term interest rates.

    So, when we don’t have the desired outputs, we’re supposed to double down on what causes growth: SAVINGS.

    Savings causes growth. Without capital formation, we have nothing to lend.

    You can’t say, “print money” in a crisis because it punishes capital formation in the near term… digging holes.

    And you certainly cannot say “print money” in perpetuity because it it destroys capital formation FOREVER. You like $100 gaudy silk shirts? You want to dress like they do in Russia?


    Maybe we should judge inflation as the level of how sticky wages and prices are.

    Opportunistic Disinflation might be the wrong phrase… maybe it means, “Unions are Dying.”


    Just for kicks maybe in the next post you could assume that the structural problem is paying Public Employees $400B too much annually. No really… hypothetically let’s fiat that god tells you that is the structural problem…

    And then explain why targeting NGDP will do a better job of fixing it than Chris Christie.

  2. Gravatar of Morgan Warstler Morgan Warstler
    26. August 2010 at 19:01

    Speaking of Chris Christie:

  3. Gravatar of James James
    26. August 2010 at 19:04


    How is more money supposed to help when markets just aren’t clearing?

    If markets fail to clear, I take that to mean that the current vector of relative prices is different from the vector of relative prices at which markets will clear.

    If the effect of an x% increase in the money supply is a consistent across the board increase of something like x% in all nominal prices, the new vector of relative prices still won’t clear the market.

    If the effect of an increase in the money supply is supposed to be a non neutral impact which brings relative prices closer to the relative prices at which markets will clear, I’m unaware of any economist who has explained how this is supposed to happen.

  4. Gravatar of marcus nunes marcus nunes
    26. August 2010 at 19:07

    Likely all true and relevant reasons for the 1937-38 “second dip”. But no mention of contractionary monetary policy apllied by the Fed! Are they saying that today the Fed also bears no responsibility?

  5. Gravatar of Andy Harless Andy Harless
    26. August 2010 at 19:09

    At the risk of giving away the punch line: structural unemployment is pretty much the same deal as an oil shock; it’s a reduction in aggregate supply. In both cases, employment eventually readjusts: in the structural case, because workers get retrained, relocated, &c; in the oil shock case, because product prices and productivity rise faster than wages so as to re-establish profit margins. In both cases, the adjustment happens faster if monetary policy accommodates: because there is more incentive to retrain and relocate workers; or because product prices rise more quickly. In fact, it can be hard to tell the difference between the two. I’m personally of the opinion that the conventional view gives too much weight to oil shocks and too little to structural unemployment in explaining the high unemployment rates of the late 70’s and early 80’s.

  6. Gravatar of Benjamin Cole Benjamin Cole
    26. August 2010 at 19:14

    Once again, a terrific post from Scott Sumner. Oh, someday I will put my poms-poms down, and get over my (completely platonic) infatuation with Sumner and his posts. But man oh man, is there a better commentator on the market today?

    A sadistic Fed? Well now. Having been a financial reporter for 25 years, and having interviewed many, many incredibly smart and rich people on the right-side of the aisle, this may not be so far-fetched. The contempt and callousness that many on the right have towards ordinary people is astonishing. (BTW, I am no leftie. Just telling you what I see).

    So, if central bankers are more enamored of a 1 percent inflation rate (forget 2 percent, Scott. They want 1 percent) than economic growth or full employment, it does not surprise me. A guy like Richard Fisher, Dallas Fed Prezzy, might figure a few bad years is just the strong medicine to fix labor and Obama good–he has just skirted around saying that monetary policy will ease up when we see the tax and reg policy he likes.

    BTW, do any of you ever peruse right-wing economic blogs? They are in a continual fever that Obama has destroyed America’s future with high taxes and regs. I suspect they regard a deepening recession as a small price to pay if they can ruin Obama.

    Or, we could believe the Fed is well-meaning, but seems to snuffing the life out of the economy, you know, the way doctors proscribe strict limited diets to anorexic patients.

  7. Gravatar of Morgan Warstler Morgan Warstler
    26. August 2010 at 19:26

    This total statist liberal idea actually has a chance of working with my agenda:

    “First, I sponsored H.R. 5028, the “Right to Rent Act” with my colleagues, Rep. Raul Grijalva, D-Ariz., and Marcy Kaptur, D-Ohio. This bill would allow homeowners facing foreclosure to remain in their homes by paying rent at fair market value for up to five years.”

    From The Detroit News:


    It’ll only depress the final sale of the house price, as the guys with dry powder bid even less for the homes. From what I’m gathering in MANY of these sales going on right now, the owner is staying on anyway.

    The only guys it really screws are the bankers, so if that’s what it takes to have a righteous liquidation, I think its Ok-Dokey.

  8. Gravatar of Dustin Dustin
    26. August 2010 at 19:53

    Benjamin, I’m right there with you in your appreciation for Scott. I read this blog multiple times a day.

    I’ve even trained my eyes to lose focus when I come across Morgan’s comments.

  9. Gravatar of Silas Barta Silas Barta
    26. August 2010 at 20:07

    Yep, our problems with both employment and inflation could be eased if the Fed would just print up enough money to cover the NGDP shortfall, buy apples with it, and destroy the apples. It’s a free lunch, and anyone who believes this would be economically destructive is just a crank.

  10. Gravatar of Dilip Dilip
    26. August 2010 at 20:11

    You made my day with that Morgan Warstler comment 🙂 My sentiments exactly!

  11. Gravatar of David Tomlin David Tomlin
    26. August 2010 at 20:43

    Scott Sumner:

    Let’s suppose central bankers cared only about keeping inflation at a steady rate of 2%/year.

    Then they’re out of luck, because ‘there is no such thing as “inflation” . . . Inflation is a number pulled out of the air by nerdy guys with glasses at the BLS.’

  12. Gravatar of Richard A. Richard A.
    26. August 2010 at 21:08

    “The contempt and callousness that many on the right have towards ordinary people is astonishing.”

    You see this on the immigration issue. The left emphasizes immigration visas that give immigrants the same right in the labor market as domestic labor. The right wants visas that leave foreign workers indentured to their sponsoring employers.

  13. Gravatar of Martin Martin
    26. August 2010 at 23:42

    Mr. Summer, is an empathetic monetary policy even possible in the long run without creating permenantly higher inflation in the long run? If the Fed has a maximum for what it considers unacceptable unemployement, I don’t see what will keep wages and other prices from rising to exploit that.

  14. Gravatar of Martin Martin
    27. August 2010 at 00:24

    Excuse me: *Sumner.

  15. Gravatar of Leigh Caldwell Leigh Caldwell
    27. August 2010 at 02:32

    James: “If the effect of an increase in the money supply is supposed to be a non neutral impact which brings relative prices closer to the relative prices at which markets will clear”

    In my view, that is exactly what it is supposed to be. An increase in the money supply can’t directly increase prices – there is no coordination mechanism across the economy by which every buyer and seller agrees an exact percentage increase.

    Instead, the money shows up initially as extra demand (usually, initially, for investment goods – but this feeds into other goods quite quickly). This extra demand is likely to push up prices (or wages) for more desired items (workers) relative to those less desired, helping to break the stickiness and make relative price adjustments easier.

  16. Gravatar of Bill Woolsey Bill Woolsey
    27. August 2010 at 03:01


    Even if all relative prices are “right” markets will still fail to clear if the quantity of money is less than the demand to hold money.

    Expanding the quantity of money will fix that problem.

    Of course, how does that fit in with inflation? Doesn’t that require shortages of just about everything? We have learned that this is not correct. Price setting will be based upon expected changes in the purchasing power of money, and then adjusted away from that increasing, decreasing, or stable baseline due to changes in the growth of real sales.

    Generally, the growth of the real volume of sales is smaller than expected, then particular prices will be increased less than expected.

    The baseline isn’t keep prices the same and then raise them if the real volume of sales is greater than expected, those causing a higher price level and inflation.


    And so, slower growth in money expenditures, in an inflationary environment doesn’t result in firms just raising prices less, it result in a painful disinflation as firms respond to slower real expenditures by raising prices less and slower the growth of production.

  17. Gravatar of Leigh Caldwell Leigh Caldwell
    27. August 2010 at 03:42

    Relax everyone! All Scott’s protests have finally worked. Or maybe it was Krugman.

    I learned from the FT yesterday that actually Bernanke is already carrying out huge QE programmes and intends to keep printing money – and eventually drop it from helicopters. He’s already on the path and there’s no stopping him.


  18. Gravatar of Silas Barta Silas Barta
    27. August 2010 at 05:08

    Morgan_Warstler, could you please focus on adding to the discussion at hand instead of posting rambling, loaded diatribes?

  19. Gravatar of Bonnie Bonnie
    27. August 2010 at 05:42

    Benjamin Cole’s comment is somewhere in the area of where my thoughts were headed when reading about the “sadistic monetary policy”. Sumner is much easier on the FOMC than it likely deserves. There has to be an alternate agenda buried in it’s near absolute reluctance to ease despite copious evidence money is and has been too tight, as well as an admission it did not stabilize the decline of NGDP.

    It kind of reminds me of those “save the children” commercials on TV. One can imagine the filming crew out there with these very sad looking (and rightly so) famished children saying something like, “Don’t feed ’em yet. They’ve got to look hungry!”
    It seems to me that the Fed is doing something similar… “Don’t feed ’em yet! There’s an election coming!”

    The analogy here might be pretty stong, but the consquences to many individuals who ended up on the short end of the stick this time around come with varing amounts of devestation. A friend of mine who lives out in CA has lost nearly everything, including her marriage and her house. The last time we spoke she was telling me about having to split a $1 Banquet frozen meal among herself, her daughter, and her elderly mother who lives with her. I gave her some money to eat, but I don’t really have that much to spare. Her ex who is a cop left because she lost her job and couldn’t get another. He thought she wasn’t trying and blamed her for the financial problems they had, not realizing just how bad things are for many or that he was lucky to still have a job. Although, I’m hearing that now there might be cutbacks in the police force and he may not end up that way.

    At any rate, Mr. Sumner may not be willing to come out and call the Fed sadistic and perhaps the people there aren’t meaning to be, but there’s a serious question about it in my mind.

  20. Gravatar of Morgan Warstler Morgan Warstler
    27. August 2010 at 06:26

    Sorry Bonnie, the government is broken, public employees are paid too much… $400B per year, give or take $50B.

    If you concerned yourself more with finding productivity gains in government, instead of coveting the pile the local businessman has, we would NOT be in this position.

    You’ve heard the phrase “never let a crisis go to waste”?

    Eat it.

  21. Gravatar of Benjamin Cole Benjamin Cole
    27. August 2010 at 07:36

    Bonnie, Dustin, Dilip–thanks for your comments. This is my outlet for nerd economics discussions. I live in Los Angeles, and there is not one to talk to about the Fed.

  22. Gravatar of Philo Philo
    27. August 2010 at 08:14

    “They are grouchy to their wives.” Non-sexist version: “They are grouchy to their *spouses*.” But perhaps a truly inclusive, with-it, 21st-century blogger would write: “They are grouchy to their *significant others* (if any).”

  23. Gravatar of scott sumner scott sumner
    27. August 2010 at 11:50

    Morgan, Savings causes long run growth, monetary policy controls inflation and smooths out the business cycle.

    James, Prices will rise faster than wages. And in mon. comp. industries you will get more nominal demand.

    Marcus, The WSJ has been very disappointing recently. They used to be pro-growth.

    Andy, That’s right.

    Leigh, Thanks for the plug.

    Silas. That’s why I’d be a bad Fed chair. Bernanke =Sumner, Plosser = Morgan. We are both too patient.

    Bonnie, When I wrote that I understood that people would think I was being too nice. I suppose when you have met Bernanke, and he seems like a nice guy, it’s hard to imagine anything different. One thing we do know from that WSJ report; there are big disputes within the Fed right now.

    Benjamin, I’d hate to think your right.

    Morgan. More NGDP is better than complicated interventionist policies.

    Dustin and Dilip, Morgan needs his own blog. He thinks I care about housing, but I care about money and NGDP.

    Silas, I agree!!!!

    David: Touche. Then make it “so-called inflation estimated by the BLS.”

    Richard, BTW, a while back I mentioned that the immigration crackdown contributed to the housing slowdown in the southwest (although other factors were obviously important.)

    High immigration countries like Australia and Singapore are doing well. More immigrants means more demand for houses. Recall that new construction is a tiny percentage of the existing stock, and is thus sensitive to pop. growth.

    Martin, Yes, a 5% NGDP growth rate is an example of empathetic policy, and it results in 2% inflation over time. Even a 3% or 4% steady rate of NGDP growth would be fine.

    Leigh, Yes, that’s part of it. A Keynesian like Andy Harless or Nick Rowe could explain the idea better than me.

    Bill, Yes, that’s also a big part of it. Both you and Leigh have explained important transmission mechanisms.

    Philo, I wonder how many female construction workers there are?

  24. Gravatar of James James
    27. August 2010 at 15:16


    If the relative prices of goods do not allow for goods markets to clear, those relative prices need to get close to whatever set of relative prices will clear the market. Why should I believe that a decline in real wages (your claim that the price of goods will rise faster than wages) will make that happen? Caveat: I am assuming a world with multiple goods.

    Leigh: And if the prices of durables and capital assets are presently roo high relative to the prices of consumption goods and wages, how does more money help? Do you think central banks will make some effort to verify that the problem is low prices for durables and capital assets relative to consumption goods and wages?

    Woolsey: If prices rise, the real demand for money will also rise. Why should I like a policy which props up prices if the problem is too much demand for money?

  25. Gravatar of David Tomlin David Tomlin
    27. August 2010 at 20:25

    Scott Sumner:

    I wonder how many female construction workers there are?.

    The National Association of Women in Construction reported 886,000 in 1999, up from 617,000 in 1993. A quick Google didn’t turn up any data more recent. I would guess something over a million today.

    Then make it “so-called inflation estimated by the BLS.”

    In the earlier thread you seemed to be using ‘there is no such thing as “inflation”’ as an argument against targeting 0%. If a BLS estimate is good enough for targeting 2% or 3%, why isn’t it good enough for targeting 0% (or +/- 1% or +/-0.5%)?

  26. Gravatar of scott sumner scott sumner
    28. August 2010 at 15:25

    James, If we have chronic unemployment, then wages are too high to clear the labor markets. If prices rise faster than wages, it gives firms an incentive to increase output.

    Your question to Bill is wrong, higher prices increase the nominal demand for money, not the real demand.

    David, Wow! I sure don’t see many, I guess that shows how biased I am. I probably see them from a distance and just assume they are men.

    I am opposed to all inflation targeting. I prefer NGDP. My point is that if the Fed insists on targeting inflation rather than NGDP, they need a slightly higher target.

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