What if we don’t know who’s right?

Here is Tyler Cowen on the current debate over fiscal stimulus:

5. Macroeconomics really is just a theory.  Politicians are reluctant to spend more money, in tough times, on the basis of a mere theory.  Advocates of fiscal stimulus make it sound as simple as solving an undergraduate homework problem and I think they sometimes genuinely do not realize how much the rest of the world, including politicians, views them as simply being very convinced by their own theory.  There are plenty of historical examples with confounding factors and I’ve linked to some of them lately.  One default hypothesis is that the ranges of fiscal policy being discussed, whether looser or tighter, aren’t going to matter much one way or the other.

That’s my view as well.  Of course I suppose one could say that my monetary ideas are also “just a theory.”  But there is no significant budget cost if I am wrong.  (If I am right then the Fed may see the market value of its assets fall a bit, but the Treasury will gain by even more.)

Unfortunately, many conservatives are opposed to greater monetary ease.  Fortunately, some of them are now paying a price for their irrational fear of inflation, when disinflation is the real problem.  This is from the WSJ (via a recent post by Niklas Blanchard):

Putting his money where his mouth is? Eric Cantor, the Republican Whip in the House of Representatives, bought up to $15,000 in shares of ProShares Trust Ultrashort 20+ Year Treasury ETF last December, according to his 2009 financial disclosure statement. The exchange-traded fund takes a short position in long-dated government bonds. In effect, it is a bet against U.S. government bonds””and perhaps on inflation in the future.

Here’s Matt Yglesias’s take:

Given his investment positions, Cantor should be joining me in calling for more short-term fiscal stimulus and urging the Federal Reserve to act more aggressively to raise the price level. But either Cantor doesn’t understand his economic self-interest properly, or else he’s more committed to his principled opposition to sound macroeconomic stabilization than he is to the performance of his portfolio. One doesn’t normally urge members of congress to be more greedy and venal, but in this case it might do a lot of good.

Please, no more greed, more enlightenment.  Here are three forms of government:

The Good:  Enlightened and civic-minded

The Bad:  Unenlightened and civic-minded

The Ugly:  Greedy

We’ve got enough problems without encouraging Cantor to move from unenlightened to greedy.  (Yes, I know that Yglesias was kidding.)

The reason this Cantor story is such good news is that if conservatives and libertarians keep losing money this way, perhaps they will re-evaluate their views of cause and effect.  Maybe they’ll start taking markets more seriously, instead of believing they are smarter than the markets.  Or maybe not.

Better yet, let’s turn monetary policy over to the (NGDP futures) markets.  Let them determine who’s model is right.



18 Responses to “What if we don’t know who’s right?”

  1. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    19. June 2010 at 13:10

    As a conservative libertarian the only time when I wanted to go long treasuries was in June 2009 when the yields were at the peak (it’s a pity I was on a holiday where internet was not available so I didn’t do that, on the other hand it was one of the nicest holidays I’ve ever had).

    What we urgently need is more congressmen that would go long treasuries in June 2009 (if they are in opposition) or go hard on Fed (if they are in the majority).

  2. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    19. June 2010 at 13:16

    Maybe Cantor thought that Obama is a FDR II (he clearly isn’t as there is no repeat of 1933 devaluation in 2010).

  3. Gravatar of Mike Sandifer Mike Sandifer
    19. June 2010 at 14:20

    My impression is that even Keynesians acknowledge that monetary policy is the first best option. Of course, I have nothing like a random sample of opinions.

  4. Gravatar of William William
    19. June 2010 at 15:35

    What we urgently need is more congressmen that would go long treasuries in June 2009 (if they are in opposition) or go hard on Fed (if they are in the majority).

    Perhaps the Fed and (and maybe Congress too) should have part of their pay determined by how close they stay to inflation/price level/NGDP targets. The further from the target, the less $$$ earned, and thus incentives would drive off beliefs and employees with poor efficacy. Kinda like some employees receive stock in the company they work for.

  5. Gravatar of Joe Joe
    19. June 2010 at 19:26

    Professor Sumner,

    On a similar note, whenever Krugman writes he speaks of the recession of 1937 as the holy grail of the failure of deficit spending. He always says that the recession happened because FDR balanced the budget.

    Yes, I was always under the impression that the recession happened because the Fed doubled the reserve ratio. That sounds like a much more powerful explanation.

    Krugman never mentions this fact, nor even brings it up and then refutes it.

    Whats the deal?


  6. Gravatar of Doc Merlin Doc Merlin
    19. June 2010 at 23:54

    Krugman never looks at arguments that are harmful to his argument.

  7. Gravatar of Niklas Blanchard Niklas Blanchard
    20. June 2010 at 03:19

    @Doc Merlin:

    I’ll give Krugman the benefit of the doubt to say he knows all about the arguments, and may even hold similar beliefs…but as my co-blogger, Adam, wrote yesterday:

    “I think the difference in their [Yglesias and Krugman’s] approaches can be attributed to their goals in writing: Matt writes to inform his readers and argue for the truth as he sees it, Paul writes to arm his readers for battle against Republicans, which are ruining this country.”

    Paul seems to be perfectly comfortable overlooking some arguments, or adding them as an “aside” or “caveat” after making a characteristically strong point in his favor (which, of course, is a strong minimalization technique). Prescient as he is, I believe that he, himself, identified the issue in his obituary for Milton Friedman:

    “What’s odd about Friedman’s absolutism on the virtues of markets and the vices of government is that in his work as an economist’s economist he was actually a model of restraint. As I pointed out earlier, he made great contributions to economic theory by emphasizing the role of individual rationality””but unlike some of his colleagues, he knew where to stop. Why didn’t he exhibit the same restraint in his role as a public intellectual?

    The answer, I suspect, is that he got caught up in an essentially political role. Milton Friedman the great economist could and did acknowledge ambiguity. But Milton Friedman the great champion of free markets was expected to preach the true faith, not give voice to doubts. And he ended up playing the role his followers expected. As a result, over time the refreshing iconoclasm of his early career hardened into a rigid defense of what had become the new orthodoxy.”

  8. Gravatar of scott sumner scott sumner
    20. June 2010 at 05:34

    123, But the yields weren’t that high, were they? The time to go long was 1981.

    123#2, That’s probably right.

    Mike, It’s complicated, but I have a different impression. Here are my impressions:

    1. Most economists are Keynesians.
    2. Most economists think monetary policy would be ineffective right now.
    3. Most economists aren’t pressing the Fed to do more monetary stimulus.
    4. Most economists think we’d be better off with higher AD right now.

    What does all that mean? I’m not sure, But I don’t think my views on monetary policy have much in common with my colleagues—otherwise they’d support my call for monetary stimulus.

    William, I discussed that idea in a recent post. But then why stop there, why not have the futures markets determine monetary policy. Markets are more efficient than policymakers.

    Joe, The recession was mostly caused by tight money (gold hoarding and higher reserve requirements.) Higher payroll taxes also played a small role, but Krugman seems to think payroll taxes are less influential than government spending.

    Niklas, You quoted your co-blogger Adam with:

    “I think the difference in their [Yglesias and Krugman’s] approaches can be attributed to their goals in writing: Matt writes to inform his readers and argue for the truth as he sees it, Paul writes to arm his readers for battle against Republicans, which are ruining this country.”

    And the irony is that Yglesias’s approach actually prepares his readers for battle much better than Krugman’s. If I debate a Krugman reader, I have no problem picking apart their arguments. They’ve been told that conservatives are morons who lack any good arguments. They don’t know what they have missed. It’s like shooting apples in a barrel.

    Yes, when I read the Friedman essay a few years ago I had two impressions:

    1. Why is he saying those terrible things about someone who just died.
    2. He seems to be describing himself better than Friedman.

  9. Gravatar of Daniel Kuehn Daniel Kuehn
    20. June 2010 at 06:05

    “But there is no significant budget cost if I am wrong.”

    If you are wrong about whether monetary stimulus will lead to a recovery at a time like this there are going to be significant budget losses attributable to lost revenue, Scott.

    I have no clue why Cowen thinks advocates of stimulus are just repeating an over-simplified argument or not understanding the nuances. He doesn’t appear to be paying very close attention to what we’re saying if he really thinks that.

    Ultimately, if any of us are wrong then the downturn will continue and we may even aggravate it – that is going to have budget implications across the board.

  10. Gravatar of ssumner ssumner
    20. June 2010 at 07:05

    Daniel, I strongly disagree. Fiscal stimulus makes the deficit worse, even if it succeeds. There is no “Laffer Curve” in the standard Keynesian model.

    Monetary stimulus does not make the deficit worse than the no monetary stimulus alternative.

  11. Gravatar of Words of Wisdom «  Modeled Behavior Words of Wisdom «  Modeled Behavior
    20. June 2010 at 08:40

    […] from the comments over at Scott Sumner’s blog, we get this little bit of wisdom: And the irony is that […]

  12. Gravatar of Greg Ransom Greg Ransom
    20. June 2010 at 10:41

    As James Sweeney and Carl Lantz of Credit Suisse explain,
    Hayek’s work helps us understand how the collapse in shadow money has given us the deflationary crash:


    Hayek is the leading conservative thinker and economist of the age.

    More people need to read him.

  13. Gravatar of Luis H Arroyo Luis H Arroyo
    20. June 2010 at 13:09

    I agree completely with you; I think that what has happened in the last two years is the definite test of the total failure of Keynesianism. And the only solution to solve the huge debt problem created by this absurd keynesianism is to reduce fiscal debt, compensating the contractive effects expanding money. but politicians don´t like that. They like to increase dependence.

  14. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    21. June 2010 at 07:09

    “But the yields weren’t that high, were they? The time to go long was 1981.”
    The time to go long is when there is a mispricing. 10 year treasuries were mispriced both in 1981 (I was much too young then though), and in June 2009. In both cases mispricing had a lot to do with the evaluation of credibility of monetary and fiscal policies. In 1981 markets thought that authorities are less credible than they really were, in June 2009 investors overestimated the capacity of monetary and fiscal policymakers to drive the recovery. On a pro-EMH note, in June 2009 the obvious mispricing lasted only a few days.

    BTW I really liked the recent paper by John Cochrane. He said that Bernanke has only partially implemented the recommendations of Friedman and Schwartz during the crisis:
    “In sum, in this analysis, we can read the government’s actions as a much-modified version of Friedman and Schwartz’s advice for the great depression. In that event, the Fed failed to accommodate a demand for money at the expense of government debt. In this one, the government recognized and partially accommodated a massive demand for both money and government debt, at the expense of private debt.”

  15. Gravatar of D. Watson D. Watson
    21. June 2010 at 07:32

    Another Yglesias post comes to mind about the difference between “betting” and “hedging.” It’s thoroughly possible that Canter is saying “I don’t want inflation, but if it comes, I want to be ready. I will hedge against the inflation I fear is coming while doing all I can to prevent it.”

  16. Gravatar of ssumner ssumner
    21. June 2010 at 09:06

    Greg, Yes, more people should read Hayek.

    Thanks Luis.

    123, That is an interesting comment by Cochrane. When I debated him he expressed doubt that more monetary expansion could help. Perhaps he’s changed his mind.

    D. Watson. I think that is right. But since there is nothing he can do to stop it, I assume he fears it.

  17. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    22. June 2010 at 03:15

    He still thinks that the best stimulus is buying more risky assets.

    Modeled behavior is also comparing Cochrane to you:

  18. Gravatar of ssumner ssumner
    22. June 2010 at 12:56

    123, Thanks, I did a post.

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