The first market monetarist book.

Marcus Nunes and Benjamin Cole are familiar names to those who follow market monetarist ideas.  Marcus has an excellent blog, and has supplied me with some of my best ideas.  Benjamin Cole is a frequent commenter and a very persuasive writer.  Now they have produced the first book applying market monetarist ideas to monetary policy during recent decades.  I wrote the foreword:

During the 1930s most people thought the Great Depression represented a relapse after the exuberant boom of the 1920s, worsened by a severe international financial crisis.  Then in the 1960s Milton Friedman and Anna Schwartz showed that the real problem was an excessively contractionary monetary policy.  Yes, the Fed cut interest rates close to zero, and did what is now called “quantitative easing,” but it was too little too late.  At Friedman’s 90th birthday party Ben Bernanke gave a speech that included this memorable promise:

“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

In this path-breaking study of the Great Recession, Marcus Nunes and Benjamin Cole show that Ben Bernanke and the Fed made many of the same mistakes that were made during the 1930s.  Yes, the Fed was more active this time.  And yes, it could have been much worse.  But our monetary policymakers still haven’t fully understood the importance of adopting a monetary policy that does whatever it takes to keep nominal GDP growing at a rate consistent with economic prosperity and low inflation.

Nunes and Cole are part of a new movement called “market monetarism” which first arose on the internet and has recently revolutionized the way economists think about monetary policy in a deep slump.  Prior to the recession, the standard formula called for adjusting interest rates up and down in order to target inflation.  The hope was that a low and stable inflation rate would insure economic prosperity.  We now know that this policy is not enough.

Nunes and Cole trace the evolution of monetary policy from the 1960s to the present.  They show how monetary policy failures led to the Great Inflation of the late 1960s, how Paul Volcker and the Fed brought inflation to much lower levels in the 1980s, and then how the Fed was able to produce a long period of stable growth and low inflation.  The key was that the Fed never slavishly targeted inflation, but rather kept nominal GDP (i.e. total spending) growing at close to a 5.5% trend line.

They also show how the ideology of “inflation targeting” became increasingly dominant at the Fed in recent years.  The Fed lost its focus on nominal spending, and during 2008-09 didn’t realize the dangers of the sharp decline in nominal GDP until it was too late.  By that point, interest rates had fallen to zero.  But this didn’t represent “easy money” as people often assume, just as high interest rates during hyperinflation don’t represent “tight money.” Low interest rates reflected the weak condition of the economy.

With rates near zero, the Fed had to move on to more “unconventional” stimulus techniques.  This is where the inflation targeting ideology created problems for policymakers.  They saw a need for stimulus, but were so afraid that inflation would rise above 2% that they were very slow and tentative in developing alternative policies.  Their job was made much harder by their refusal to admit their mistake, and switch to a nominal GDP target, which would boost current demand by increasing expectations of future growth in spending.

Meanwhile economists outside the Fed were increasingly drawn to nominal GDP targeting, with an all-star list including Christina Romer, Paul Krugman, Jan Hatzius, and Jeffrey Frankel endorsing the market monetarist proposal for NGDP “level targeting.” More recently, Mark Carney endorsed the idea.  Carney’s endorsement represents an important breakthrough, as he will assume leadership at the Bank of England later in 2013.

Over the past few years both Marcus Nunes and I have developed blogs focused on promoting market monetarist ideas.  Benjamin Cole has also participated in the blogging debate, doing guest posts at various sites.  Marcus brought to light some of Ben Bernanke’s earlier academic papers that warned Japan not to be timid in using monetary stimulus when interest rates fell to zero.  And yet after 2008 the Fed refused to do some of the more aggressive monetary actions that Bernanke recommended to the Japanese.

Marcus is also very skilled at using graphs to tell a story, and the graphs in this book are one of its strong points.  I’d add that Benjamin Cole also contributed greatly to the market monetarist movement, and is a powerful writer.

At first readers might be skeptical of some of the arguments made by Nunes and Cole.  In 2008 and 2009 it didn’t seem like monetary policy was the cause of the crisis, or even that there was much the Fed could do to fix the problem.  I’d ask readers to suspend their disbelief until they’ve looked at all of the evidence.  Monetary economics is a very counterintuitive field.  Most people think the Fed merely moves interest rates up and down, and that once rates fall to zero there’s nothing more the Fed can do to stimulate the economy.  But cutting edge research in recent decades has suggested otherwise.  We now know that low interest rates do not mean easy money, and that there are lots of things the Fed can do to boost spending once rates hit zero.

If readers take an open-minded look at the evidence in this book, I believe they will be very surprised by what they see.  The financial crisis and Great Recession that followed were not at all what they seemed to be at the time.  The profession is beginning to come around to the market monetarist view of the importance of a stable growth path for nominal GDP, and this perspective casts a whole new light on the events of the past 5 years.



13 Responses to “The first market monetarist book.”

  1. Gravatar of marcus nunes marcus nunes
    24. January 2013 at 12:13

    Many thanks for the support. I was also very pleasantly surprised to see that Tyler Cowen “plugged” the book:

  2. Gravatar of Geoff Geoff
    24. January 2013 at 12:38

    Dr. Sumner:

    “Low interest rates reflected the weak condition of the economy.”

    I know your thought process that leads to this statement, I get that statement, I get how low interest rates don’t necessarily mean easy money, but I think that statement is a non-sequitur.

    I think low interest rates do not reflect either a strong economy or a weak economy. For interest rates could fall to a minimum if the rate of saving and investment relative to consumption rises to its maximum. In other words, a very strong economy could have very low interest rates too.

    A very highly capitalist economy will tend to have lower interest rates than a “rude and crude” economy, because there is so many more productive expenditures relative to total expenditures, and that increases costs relative to revenues, and that decreases nominal profit and interest rates.

    Alongside this, there is of course a monetary component, and higher inflation tends to add a positive component while deflation tends to add a negative component.

    What I read you as saying in that quote however is that the low interest rates reflected only the negative monetary component, not the strength or weakness of the economy per se. The lower NGDP growth reduced revenues, and since costs fall with a time lag, the difference between revenues and costs (profits and interest) fell.

    Since there are factors other than inflation that can affect interest rates, I don’t think one can say that low interest rates is a reflection of a weak economy, even though the economy was indeed weak. A weak economy can have high interest rates and a strong economy can have low interest rates.

    I would understand things better if someone said “The low interest rates reflected the negative monetary component which I define as a weak aggregate money supply growth and/or spending growth in the economy.”

  3. Gravatar of New book on Market Monetarism from Nunes and Cole « The Market Monetarist New book on Market Monetarism from Nunes and Cole « The Market Monetarist
    24. January 2013 at 12:44

    […] Scott Sumner also comments on the book. Share this:Email Pin ItLike this:LikeBe the first to like this. 1 Comment by Lars […]

  4. Gravatar of OhMy OhMy
    24. January 2013 at 17:51

    The whole market monetarism and Friedman’s book as well is based on mistaking the effect for the cause. They should have done Granger analysis on what collapsed first – credit or what they call the money supply. A collapsing economy sees that credit is destroyed by debt repayment and bankruptcies, something the CB can do nothing about. Is the statement that there would be no depression if the Fed didn’t contract the money supply? There would be no depression if there was no Fed? That is absurd. Depressions happened before the era of central banks. The money supply collapses and grows with the business cycle. Monetarism has no explanation for the business cycle if it pins it on central banks.

  5. Gravatar of Benjamin Cole Benjamin Cole
    24. January 2013 at 19:28

    Many thanks, Scott.

    On this book, Marcus Nunes was the economist—the real power behind the book—and I am a long-time financial journalist and author, so the pairing was a good one.

    I know both Nunes and myself look forward to critiques, and as the book is an e-book, improvements can be made (though paperbacks are available).

    On a personal level, I also thank Sumner, as I started reading his blog only 2-3 years back, and he responded to my comments with intelligence and grace. It was initially through The Money Illusion, and then through Nunes’ blog, that i was exposed to what now seems so obvious: Market Monetarism.

    Other excellent market monetarists–Beckworth, Lars C.–were also out front lighting candles in the dark, to paraphrase Eleanor Roosevelt. In those days it seemed a fruitless and futile battle.

    Now Beckworth is predicting that central banks of the world are at an inflection point, and that the 30 years’ war against inflation has been won (they are making the rubble bounce in japan, in that regard). So central banks will adjust and starting thinking about real growth.

    I hope Beckworth is right; I am concerned central banks are too ossified to change, and we will hear pompous pettifogging about inflation for years to come. I won’t mention Richard Fisher….

  6. Gravatar of Daniel Daniel
    24. January 2013 at 20:34

    Interesting article describing why losses incurred by selling bonds worth less than the fed originally paid for them will not incur crippling losses. In fact, the fed can simple defer the losses to forgone profits to the treasury in the future however it pleases.

  7. Gravatar of Don Don
    24. January 2013 at 21:26

    Congratulations to everyone. A quote for y’all:

    Good ideas are not adopted automatically. They must be driven into practice with courageous patience.
    – Hyman Rickover

  8. Gravatar of Tom Tom
    25. January 2013 at 04:15

    It’s great that MM is coming, and NGDP targeting. And you, Scott, will deservedly get a good amount of the blame, er, credit. Maybe even a fair amount (but it’s so hard to measure relative contributions). I started coming here because Tyler was quoting you so often.

    However, the mal-investment and over-investment in housing, including the financial house of CDO cards that led to Big Bank insolvency, remains the cause of the Recession. Yes, the Fed did not rapidly increase the money supply as the “net worth” portion of the “amount of money” rapidly dissipated in the 2006-2009 years. They should have.

    I’m wondering if there is a graph of Net Worth, and a graph of Net Equity in Housing. If not, then I’ll consider the analysis of the crisis incomplete, at best.

    Similarly, a graph of total US workers, including the illegals, would also be good. Tho there are no reliable numbers for the illegals — and I flatly reject your own idea that totals of illegals “don’t matter much” (I recall you as meaning in previous response, tho perhaps not quite your words).

    You like to repeat that the house prices peaked in 2006, but the crisis didn’t happen till 2008, as if this proves it wasn’t housing. But since it was the drop in value of AAA rated MBS & derivatives that caused the financial crisis, I continue to believe the Recession was caused primarily by mal investment into excess housing & construction, with the long and still continuing period of economic readjustment.

    Finally, I hope there’s a graph of loans applied for, loans granted & loans rejected, which is possibly the clearest indication of whether money is tight (few loans given) or easy (many loans given); with loans including mortgages and MBS and CDO/ CDS derivatives and other contractual obligations to pay later.

    But again, congratulations at helping to get out a book which is likely to help change central banking for the better.

  9. Gravatar of ssumner ssumner
    25. January 2013 at 05:11

    Marcus and Ben, Thanks for doing this book—I hope it’s really successful.

    OhMy, You said;

    “Is the statement that there would be no depression if the Fed didn’t contract the money supply?”

    No! You are confusing traditional monetarism with market monetarism. Read the book for drawing any conclusions.

    Tom, I am afraid you are misinterpreting many of my arguments. I do not think the Fed would have had to print more money to prevent the recession.

    I did not say the housing bust did not contribute to banking problems, I said it did not have major impact on unemployment–which is undeniably true.

  10. Gravatar of Nick Nick
    25. January 2013 at 05:46

    Like many above, I think that it’s great that this book was written. Note that Amazon Prime members can borrow this book for free on a kindle device – excellent choice by the authors (publisher?) to more widely distribute! Let everybody know about it. I can’t wait to read it this weekend.

    PS Word seems to be out – #1 in Money & Monetary Policy category!

  11. Gravatar of marcus nunes marcus nunes
    25. January 2013 at 06:44

    For the “digitally averse”, Amazon has released a paperback version:

  12. Gravatar of Morgan Warstler Morgan Warstler
    25. January 2013 at 12:57

    Great news!

    And I get it for free. How awesome is that.

  13. Gravatar of Benjamin Cole Benjamin Cole
    25. January 2013 at 20:42

    Actually, Morgan, I was planning to charge you double…how did you get one for free?

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