Will economists ever learn?

Here’s Jason Furman, in a WSJ article calling for tighter money:

What makes the current inflation particularly troubling is that all the hoped-for saviors have come and gone without reducing underlying inflation very much. Inflation was supposed to go away after base effects receded, when the economy got over the Delta and Omicron surges, when the ports were unclogged, when timber prices fell, when the fiscal stimulus wore off, when microchips were available, when energy prices came back down again after the Russian invasion. All of that has happened, and yet the underlying inflation rate remains above 4.5% on just about every time horizon and every measure.

All the forecasts I’m seeing are suggesting that NGDP in the first quarter of 2023 will come in very hot. So what went wrong in 2022?

In my view, we made some of the mistakes of 2008, but not all. This time, both inflation and NGDP were telling the same story—so that wasn’t the problem. And I don’t think the key problem was a lack of reliance on market forecasts. Instead, I see policymakers repeating these two mistakes from 2008-09:

1. Not doing level targeting.

2. Assuming that interest rates represent the stance of monetary policy.

Both hawks and doves tended to view policy in 2022 as contractionary, due to sharply rising interest rates. Actually, monetary policy in 2022 was highly expansionary. The rising rates were caused by the rapid growth in NGDP.

Interest rates do not now and never have represented the stance of monetary policy. Throughout history, many policy blunders have been based on that misconception. Focus on the level of NGDP, not the rate of interest.

Our textbooks tell us not to reason from a price change. Our money and banking texts say that interest rates are not monetary policy. But we don’t seem to be able to help ourself.

PS. Tyler Cowen sent me this tweet. I fear for our profession if a concept as fundamental as “Don’t reason from a price change” is associated with a crackpot like me.



30 Responses to “Will economists ever learn?”

  1. Gravatar of Spencer Spencer
    4. March 2023 at 07:10

    A measure of money demand (the inverse of velocity) would be M2/gDp. Increasing at first and now declining.

    M2/Gross Domestic Product | FRED | St. Louis Fed (stlouisfed.org)

    See: Why Does Velocity Matter? By Daniel Thornton
    Why Does Velocity Matter? (stlouisfed.org)

    Dr. Daniel Thornton: “Because the concept of velocity stems directly from the theory of the demand for money, anything that affects velocity can be related to some aspect of the demand for money.”

  2. Gravatar of Can Can
    4. March 2023 at 11:22

    When you say that the rise in rates was caused by the rapid NGDP growth do you mean indirectly because central bankers raised rates as a reaction? Or is there some more direct mechanism that I’m missing.

  3. Gravatar of ssumner ssumner
    4. March 2023 at 11:30

    Can, I find it useful to think about it in terms of the policy rate and the natural rate. NGDP growth pushes up the natural interest rate. If the Fed doesn’t adjust the policy rate in response, then we spiral into hyperinflation. In reality, they do adjust the policy rate to the rising natural rate in order to prevent hyperinflation, but it’s really the rising natural rate that drives the process.

  4. Gravatar of Tacticus Tacticus
    4. March 2023 at 12:24

    ‘Interest rates do not now and never have represented the stance of monetary policy.’

    Perhaps it would help matters to re-write this somehow (which, to be clear, I absolutely agree with).

    Maybe we need to differentiate between policy and status. Or, to put it another way, we need to differentiate between monetary intention and monetary reality.

    Monetary policy/intentions may be tightening, but monetary reality is not.

    I say this as someone very frustrated with all of the ‘historic Fed tightening’ etc articles going around – and as someone who has done a good job forecasting NGDP and bond yields the last several years.

  5. Gravatar of Lance Lance
    4. March 2023 at 15:19

    The part where I end up confused is what policy lever needs to be pulled to actually create “tight money” (and/or NGDP targeting). Raising the interest rate doesn’t get it done; what does?

  6. Gravatar of Effem Effem
    4. March 2023 at 16:21

    The difference from 2008 is that once the Fed realized they were wrong they changed course fairly aggressively over a short time horizon – including multiple 75bp cuts.

    The Fed has now clearly been wrong for over a year (and is becoming more wrong) and is still struggling with whether they can possibly dare to raise 50bp next meeting. It defies explanation.

    I also think the inverted yield curve has added to their confusion.

  7. Gravatar of marcus nunes marcus nunes
    4. March 2023 at 16:48

    Interest rate targeting is usually bad for the health of the economy!

  8. Gravatar of ssumner ssumner
    4. March 2023 at 17:42

    Lance, Before specifying what needs to be done, you have to decide what you are trying to do. Different policy targets require different policy actions. If they had adopted NGDP level targeting (or even committed to average inflation targeting), they could have succeeded with lower interest rates than is currently required on their actual policy path.

  9. Gravatar of Effem Effem
    5. March 2023 at 03:48

    Wouldn’t it be more accurate to say they are doing “level targeting” but only in one direction? FAIT proxies level targeting and is apparently intended to be asymmetric for some unknown reason.

  10. Gravatar of Spencer Spencer
    5. March 2023 at 07:09

    “Interest rates do not now and never have represented the stance of monetary policy.”

    Right. Monetarism involves targeting total legal reserves and their reserve ratios. That was the true policy instrument.

    Monetarism does not mean targeting nonborrowed reserves, which as Volcker found out, was not restrictive. Volcker stopped inflation by imposing reserve requirements on NOW accounts in April 1981.

    The distributed lag effects of legal reserves have been mathematical constants for > 100 years.

    But the time horizon of the trading desk’s policy has been 24 hours rather than 24 months.

    And we knew this already

    The problems stemmed from using the wrong criteria (interest rates, rather than member bank legal reserves) in formulating & executing monetary policy. Net changes in Reserve Bank credit (since the Accord) were determined by the policy actions of the Federal Reserve. But William McChesney Martin, Jr. changed from using a “net free” or “net borrowed” reserve approach to the Federal Funds “Bracket Racket” c. 1965. Note: the Continental Illinois bank bailout provides a spectacular example of this practice.

    The effect of tying open market policy to a fed funds bracket was to supply additional (& excessive) legal reserves to the banking system when loan demand increased. Since the member banks had no excess reserves of significance, the banks had to acquire additional reserves to support the expansion of deposits, resulting from their loan expansion.

    If they used the Fed Funds bracket (which was typical), the rate was bid up & the Fed responded by putting though buy orders, reserves were increased, & soon a multiple volume of money was created on the basis of any given increase in legal reserves.

    This combined with the rapidly increasing transaction velocity of demand deposits resulted in a further upward pressure on prices. This is the process by which the Fed financed the rampant real-estate speculation that characterized the 70’s, et. al.

    As Dr. Richard G. Anderson e-mailed me: “Spencer, this is an interesting idea. Since no one in the Fed tracks reserves, such a coincidence in the data perhaps confirms that the Fed funds rate settings have been correct.”

    Anderson never studied that relationship.

  11. Gravatar of ssumner ssumner
    5. March 2023 at 11:05

    Effem, Yes, in one direction, and the opposite of 2008-09.

  12. Gravatar of Michael Sandifer Michael Sandifer
    5. March 2023 at 20:49

    Should we care much about current inflation or high expected NGDP growth when proxies for inflation expectations are not far above the Fed’s mean target?

    The 5-year inflation breakeven finished last week at roughly 2.4% in core PCE terms, surging 24 basis points this week alone. This was perhaps at least partly due to the nearly 4.5% rise in oil prics this week, hence markets perhaps expect the Fed to see through this real shock.

    That said, oil prices have varied in a relatively narrow range since late last year, indicating that monetary policy has probably loosened a bit since then. But, if so, that has only barely taken inflation expectations above the Fed’s target.

  13. Gravatar of ssumner ssumner
    6. March 2023 at 03:29

    “Should we care much about current inflation or high expected NGDP growth when proxies for inflation expectations are not far above the Fed’s mean target?”

    You could have said the same a year ago. We should care because levels also matter.

  14. Gravatar of Michael Sandifer Michael Sandifer
    6. March 2023 at 05:03

    Yes, obviously inflation would come down more quickly if the Fed lowered the level of the expected NGDP growth path. Thus far, the actual path has only slowed, but the YOY growth rate has fallen pretty consistently since last year began. That’s gone from over 12% to over 7%. Of course, they don’t level target NGDP, though they could under their current regime if they really wanted to.

    The 5 year breakeven was 46 basis points higher one year ago. Coming into last week, we were maybe 16 points above the Fed’s target in core PCE terms. Currently, GDPNow is at about 2.27% real growth for this quarter. That’s not low by the standards of first quarters over the past 10 years, but not nearly the highest reading either. Housing prices have started to decline nationally…

    One can make a good argument that the Fed should bring inflation down more quickly, as both core PCE and core CPI have been essentially flat, though volatile since May of 2021. On the other hand, both indexes have some lagged components related to housing, for example. Housing prices and rents have begun to come down in some measures, but that doesn’t seem to be reflected in CPI housing statistics, for example.

    Overall, I haven’t given up on the narrative that there’s still some supply-side healing to occur, and hence I don’t think we’re as far from the Fed’s 2% mean target as it may appear, which is why longer-run inflation expectations are relatively tame.

  15. Gravatar of Spencer Spencer
    6. March 2023 at 07:43

    Waller, Williams, and Logan seem to agree. They “believe the Fed can keep unloading bonds even when officials cut interest rates at some future date.”

  16. Gravatar of Spencer Spencer
    6. March 2023 at 08:15

    POMOs vs. TOMOs. Get rid of the O/N RRP facility.

  17. Gravatar of Edward Edward
    7. March 2023 at 02:09

    Sumner’s monopoly economists are at it again.

    His favorite mega thug in California, Governor Newsome, is such a self righteous imbecile that he is “refusing to do business” and by “he” he means “the state” with Walgreens because Walgreens is not selling abortion pills in states where it’s illegal. In other words he is so incensed at the laws of other states, voted for by the people who live there, that he’s kicking out one of the only competitors in the centralized, oligopoly, known as the pharma industry.

    This is how the totalitarian left operates. They do it domestically and globally. Globally via the supranationals; and of course they centralize via permits in economic zones (to create their monopoly power).

    Basically, if you don’t like neo-marxist postmodernism, and their economic monopoly zones, and don’t agree to centralizing the power of the state, which is to say putting all the power into the hands of a few Washington apparatchiks, then they will destroy you via NATO or financial sanctions, or call you a terrorist to sidestep your inalienable rights, etc.

    Newsome and Sumner are as dangerous as Stalin, Mao and Hitler.

  18. Gravatar of Carl Carl
    7. March 2023 at 06:32


    Our textbooks tell us not to reason from a price change. Our money and banking texts say that interest rates are not monetary policy. But we don’t seem to be able to help ourself.

    Why? Do economists find it harder to keep their jobs when they sometimes have to tell politicians counter-intuitive things about interest rates?

  19. Gravatar of Michael Sandifer Michael Sandifer
    7. March 2023 at 07:11


    Ask the various former central bank chairs in Turkey.

  20. Gravatar of stephen stephen
    7. March 2023 at 20:06

    Why isn’t the fed more aggressive? People talk about how the Fed raised rates at the fastest rate in x number of years. But it still felt like they were behind the curve. I understand that NGDPPLT would solve these issues.

    In their minds, are they worried about breaking something in the financial system if they were more aggressive? For example, during last June / July when we were getting 10% inflation prints, why wouldn’t the fed hold an emergency press conference, raise rates 2% overnight, and say, “We have every tool in the toolbox and we’re ready to throw it at this problem”.

    They threw the kitchen sink at this problem in March 2020 and it was extremely effective. Why not do the same in reverse? Instead it feels like they are shooting a kids watergun at a house burning down.

  21. Gravatar of David S David S
    8. March 2023 at 01:55

    x2 on Stephen’s questions. If I were a voting Fed member I could make the semi-plausible excuse that some selective data over the past few months pointed to a softening of PCE. BUT…that excuse falls apart when we look at corrected data and the overall trend rate of NGDP.

    Matt Yglesias pointed out sometime in the fall of 2022 that the Fed might as well just do a 2% bump and get it over with. Instead, it’s been acting like a tiny little puppy trotting behind the big dog that’s the NGDP growth rate.

    I’m tripling down on my prediction that the next few years could be a repeat of the 1990’s—which isn’t necessarily a bad thing. We would just have to re-adapt to a higher NGDP growth rate environment. Who was the Fed chair during that period? Maestro Somebody?

  22. Gravatar of Spencer Spencer
    8. March 2023 at 11:18

    re: “Assuming that interest rates represent the stance of monetary policy.”

    – Recent Growth in Broad CFS Divisia Monetary Data 3

    The Treasury-Fed Accord : A New Narrative Account

    Link: Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series “Monetary Policy: Why Money Matters and Interest Rates Don’t”

  23. Gravatar of Jeff Jeff
    9. March 2023 at 08:31

    >Why isn’t the fed more aggressive?

    Because every bit they raise is interest they have to pay out?

    I remember 7-8 years ago the “contigency plan” if QE caused massive inflation supposedly was to raise required reserves and not pay interest.

    I don’t know why that was taken off the table. This time it seems like there was really no contigency plan at all. Everyone seems to have thought Covid bailouts would simply “pay for themselves” via negative real interest rates and maybe a stern speech or two from the Fed. I wonder what they are thinking everyone time I hear them say they tout their own supposed “credibility”.

  24. Gravatar of kangaroo kangaroo
    9. March 2023 at 16:20

    “Why isn’t the fed more aggressive?”

    JPow was afraid that if the fed raised aggressively in 2021, Biden would replace him with a “run hot” socialist and/or climate-regulation-crank – like Brainard. So he laid low and played it cool and got reappointed. It’s *very interesting* that it was announced that Brainard would leave the Fed shortly after JPow’s “we’re not a climate policy agency” speech. It’s already clear that Biden’s goal is to install a lefty economist to replace Brainard. The only question is how far out there that person will be.

    What I’d love to hear is Brainard’s lefty explanation of what’s going on right now. Why hasn’t inflation cooled?

  25. Gravatar of Spencer Spencer
    10. March 2023 at 06:23

    The Banking Act of 1935 gave the BOG permanent power to fix the reserve ratios applicable to member banks within limits set by Congress. The maximum and minimum limits to this discretionary power were amended by the 1948 Act for the three classes of member banks: Country, Reserve City, and Central Reserve City.

    An increase in reserve requirements immediately impacts inflation. There is no lag effect / waiting period. Draining legal reserves for 29 contiguous months caused the GFC.

  26. Gravatar of Spencer Spencer
    10. March 2023 at 06:35

    Dr. Philip George says: the corrected money supply “Still running high at 30% year on year. It was 100% a year ago.”

    N-gDp is still running too hot.

  27. Gravatar of Christian List Christian List
    10. March 2023 at 13:33

    Reasoning from interest rates and reasoning from price changes are both really simple, intuitive concepts. To break down these mental concepts, to shatter them and to re-anchor them in the general population, you need simple, straightforward explanations that are just as catchy. Can you make that work, Scott? Can anyone get it done? I assume that’s the real art here, and until that happens, there’s not going to be much change in human mindsets.

  28. Gravatar of Spencer Spencer
    10. March 2023 at 15:45


  29. Gravatar of Michael Sandifer Michael Sandifer
    10. March 2023 at 19:38

    Well, now we have a real shock in terms of some bank runs and the demand for money has increased, meaning monetary policy has seemingly implicitly tightened, at least for the moment.

    Not only are banks hurting due to a drastic loss in value of bonds, but due to the increasing spreads between deposit rates and Treasury rates.

    Here’s just another example of the Rube Goldberg device that is the Fed’s policy structure causing much more harm than good.

  30. Gravatar of Edward Edward
    11. March 2023 at 00:44

    Everyone watch as Sumner’s thugs begin their savior of another Bank — this time silicon valley.

    The Fed will be at our doorstep soon. In less than one week, without once having the courage to raise their weapons at us and declare their trespass and invasion on our property, they will steal our wealth through easing and restructuring and more capitalization, and then tell you how the economy is dependent on their intervention.

    monetarists are the modern day gangsters. they used to call themselves kings and queens, but they’ve rebranded under the veil of academy, and the pretense of respectability. They need more money, always more to fund their wars and their lifestyle, and so they’re coming for you.

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