The League of Monetary Cranks

This is inspired by Mankiw’s Pigou Club; and like Mankiw I’m not asking permission—I get to decide who belongs.  Surely some of the people who participate in this blog would qualify, but I’ll leave that up to them.  I have also clearly hinted that I think George Warren, Earl Thompson and Robert Hall all belong.  Warren is dead.  My hunch is that Thompson wouldn’t mind being included, whereas Hall would.  But they have no choice—all three go in.  Today I add another member to this distinguished group:


Now I know what you are all thinking.  What?  Has Sumner lost his mind?  Mishkin is just another new Keynesian, with his best-selling textbook full of IS-LM diagrams.  Former member of the Board of Governors.  Distinguished professor at Columbia.  Not known for saying highly controversial or outrageous things about monetary policy.  But please hear me out.  If you still insist he doesn’t belong we can have a vote, and kick him out if necessary.

I have used Mishkin’s text in my money class for many years.  I always end with his chapter on transmission mechanisms, where he makes an impassioned argument that we can draw four lessons for monetary policy from his book.  These lessons are on page 606-07 of the current (8th) edition, and clearly provide a sort of summation of everything that has come before.  Here are the four lessons for monetary policy:

1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.

What???  No one told me this.  I thought we had been told for months that the constant rate cuts by the Fed last year were “monetary easing.”  Yes, Mishkin didn’t say low nominal rates were never a sign of monetary easing; he merely said that it was dangerous to make that assumption.  We don’t know that he would agree with my views on Fed policy during 2008.  So let’s go on and look at the second lesson:

2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

Note that he doesn’t say that monetary aggregates contain important information, only asset prices.  Does this sound familiar?  In two separate posts here and here, I collected graphs and tables showing the movement in six key asset prices in late 2008:

1.  Real interest rates

2.  Expected inflation

3.  Commodity prices

4.  Stock prices

5.  Housing prices

6.  Exchange rates

If you read chapter 23 of Mishkin’s text, he makes it very clear that these are exactly the sort of “asset prices” that he is referring to.  So what happened to these asset prices in late 2008?  The fall in housing prices, which had previously been mostly confined to certain (sub-prime) markets, spread across almost all housing markets after August 2008.  Real interest rates rose sharply in the indexed bond market.  Inflation expectations plummeted (as measured by the TIPS/conventional yield spread.)  Commodity prices crashed spectacularly.  So did the stock market—falling 23% in just the first 10 days of October, and nearly in half between mid-May and mid-November.  Despite the extreme weakness in the U.S. economy, which would normally depress the exchange rate, the dollar soared in value between July and November—the key months I keep referring to.

If Mishkin believes it is “dangerous” to assume low nominal rates mean easy money, and if he says “other asset prices . . . contain important information about the stance of monetary policy,” and if all of those other indicators were screaming warnings that policy was highly contractionary, then I think it’s safe to say that the message of Mishkin’s best-selling text is that Fed policy was not just contractionary late last year, but highly contractionary.

You might argue that he does agree with me that monetary policy had accidentally stumbled into a contractionary stance, but that doesn’t mean he agrees with my specific criticism of Fed policymakers.  After all, once they had cut rates to zero there was nothing more the Fed could do.  So let’s move on to lesson #3:

3.  Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero.

The sine qua non of a monetary crank is the bizarre belief that even depressions featuring zero interest rates can be magically cured by printing money.  In his explanation of point three he discusses the widespread view that the Japanese case showed that policy was ineffective when rates hit zero, and then indicated that “this view is false.”  You might argue that just because monetary policy might be effective, doesn’t make it as desirable as fiscal policy.  But Mishkin also says that “because of the lags inherent in fiscal policy and the political constraints on its use, expansionary monetary policy is the key policy action required to revive an economy experiencing deflation.”

The only lesson that is slightly different from my own view is number 4:

4.  Avoiding unanticipated fluctuations in the price level is an important objective of monetary policy, thus providing a rationale for price stability as the primary long -run goal for monetary policy.

It is clear from his other writings that by “price stability” Mishkin means something more like 2% inflation.  So I don’t really see any great difference from my own 5% NGDP growth target.  That target shares 2% inflation “as the primary long-run goal for monetary policy.”  Regarding the short run, Mishkin observes that:

Inflation targeting also does not ignore traditional stabilization goals.  Central bankers in inflation-targeting countries continue to express their concern about fluctuations in output and employment, and the ability to accommodate short-run stabilization goals to some degree is built into all inflation targeting regimes.  (p. 407)

In other words, if there is a severe supply shock that depresses output, then the Fed should let inflation exceed the target for a period of time—which is just what occurs under an NGDP growth rule.  Now I am not saying Mishkin supports NGDP targeting, but we aren’t all that far apart.

Here you might say there are some similarities in our views of monetary policy, but he certainly doesn’t hold my extremely wacky “reverse causation” view, the idea that rather than the financial crisis causing the falling NGDP, it was the other way around.  As anyone with two eyes can see, the financial crisis came first, and just as in Japan it was the financial crisis that caused the deflation, not the other way around.  Well, you are right that Mishkin has nothing to say about reverse causation in 2008, but that’s because his text was published before the current crisis.  However he does have something to say about Japan:

“The deflation in Japan in recent years has been an important factor in the weakening of the Japanese financial system.”  (p. 407.)

I rest my case.

My goal is to find as many economists as possible saying things before 2008 that might be retrospectively viewed as critical of current Fed policy.  So please help me look for incriminating statements by Mankiw, McCallum, Woodford, Svennson, etc.  Perhaps something said about 1936-37, pointing out how the Fed caused a depression in late 1937 by encouraging banks to raise their reserve ratios.  Even better would be statements from Obama people like Christy Romer and Larry Summers.  The more they would abhor being included in with a minor right-wing monetary crank like me, the more fun it will be to hunt them.

But there are two people that I would especially like to be able to include in my league (based on past statements.)  One is obviously Ben Bernanke.  I won’t mention the other name. Let’s just say I have an Ahab-type obsession with catching this other economist making monetary crank-like statements.  (And no, merely having a cranky personality doesn’t count.)  Let’s just call him the “Keynes of the 21st century.”  I think you know who I mean.


1.  BTW, how do I get included in Mankiw’s Pigou Club?  Will this work?

“Because massive holdings of excess reserves are privately beneficial to banks, but deflationary for the economy as a whole, excess reserves create negative externalities during a liquidity trap.  Therefore they should be taxed.”

It seems to me that Mankiw only includes famous people in his exclusive club.  Although he called me a “prominent economist,” I think even that was a stretch.  Let’s see if he takes the bait.

2.  I added an update at the end of my previous reserve penalty post, reflecting some advice offered by Bill and JKH.



8 Responses to “The League of Monetary Cranks”

  1. Gravatar of Tyler Cowen Tyler Cowen
    25. April 2009 at 06:56

    Many of Mishkin’s ideas come from Manley Johnson and other offshoots of the early supply-side circles.

  2. Gravatar of Bob Murphy Bob Murphy
    25. April 2009 at 09:10

    I’m new to this site, so I apologize if I’m missing sarcasm etc. With that caveat: Are *you* a monetary crank? I.e. do you believe that printing a bunch of money when interest rates are at zero can get an economy out of depression?

    It seems what you are doing in this post is pointing out that your own “crankish” views are actually not so oddball, and so you are using the term with irony. Is that correct?

  3. Gravatar of Tom Powers Tom Powers
    25. April 2009 at 10:16

    Haha, I hope Mankiw bites. TheMoneyIllusion has become my favorite blog of late, keep it up!

  4. Gravatar of ssumner ssumner
    25. April 2009 at 12:15

    Tyler, Yes, that is correct. It seems to me that there were two or three related schools of thought during the early 1980s that used the “price of money” approach (as opposed to the Keynesian rental cost of money (i) and the monetarist quantity of money approaches.) One was the supply-sider focus on exchange rates (Mundell), then the price of gold, and then commodities and stocks in general. At about the same time the “New Monetary Economics” was developed by Black, Fama, Hall, Greenfield and Yeager. The supply-siders did influence my thought, and were the underlying reason I came up with my NGDP futures targeting idea. I discovered the NME later, and realized it was also very close to my way of looking at things. A third figure–Earl Thompson of UCLA also pioneered the price of money approach.

    I suppose I cheated a bit in calling Mishkin a “new Keynesian,” but his textbook is standard IS-LM, and is the most popular money textbook. And he is an establishment figure. It hides a pretty radical critique of current policy–indeed of current macro in general.

    Bob, Your second paragraph is entirely correct. I agree with all the points Mishkin makes. Occasionally I may get a bit too sarcastic, but I try not to be mean. This post was meant more for those already familiar with my views, but I welcome newcomers. Other posts (especially “welcome to viewers” from a few weeks back) will give you links to my basic ideas.

    Thanks Tom.

  5. Gravatar of JTapp JTapp
    27. April 2009 at 12:17

    I decided to switch to the Laurence Ball text this fall. Do you know of others with texts that you think fall in line with your views?

  6. Gravatar of ssumner ssumner
    27. April 2009 at 15:23

    JTapp, Mishkin is the best I have seen. But there may be better one’s out there. BTW, in case you are new to the blog, I view the term “monetary crank” as a compliment.

  7. Gravatar of Bill Stepp Bill Stepp
    28. April 2009 at 17:24

    Take a look at the wikipedia article for “IS-LM” (or something like that. There’s a good critique of the IS-LM model in the literature cited at the end. I think it appeared in Economic Journal Watch originally. The author names names of people still using this stuff.
    It seems to be an easy and apparently impressive pedagogical device, which is probably why some (most?) macroeconomists use it. But not the better ones.
    (Didn’t Hicks repudiate it?)

  8. Gravatar of TheMoneyIllusion » Mishkin’s revealing omissions TheMoneyIllusion » Mishkin’s revealing omissions
    12. December 2010 at 08:40

    […] year ago I did a long post discussing how Mishkin’s text provided a template for my critique of the conventional wisdom […]

Leave a Reply