Woodford has something for everyone

Paul Krugman is impressed with Michael Woodford’s recent paper on fiscal stimulus, and I am too.  But probably for different reasons.  Keynesians like the paper because it shows that fiscal stimulus in the form of government spending can work under a surprisingly wide range of circumstances, even with “Ricardian Equivalence” (where tax cuts just get saved.)  On theoretical grounds I agree, although I have practical reservations, as does Woodford himself.  But I’d like to focus on some interesting points of overlap with my blog.

I often say “there is no such things as the multiplier.”  Not in the sense that it is zero or one, but rather that there is no stable relationship between government spending and aggregate demand.  Much of this is based on an argument that many people seemed to find quite novel, my claim that there was no such thing as “holding monetary policy constant.”  There is no “neutral” monetary policy, just lots of different things that could be targeted; the base, M2, nominal rates, exchange rates, inflation, NGDP, etc.  Here’s Woodford:

If prices or wages are sticky, monetary policy affects real activity, and so the consequences of an increase in government purchases depend on the monetary policy response. One might suppose that the question of interest should be the effects of government purchases “leaving monetary policy unchanged”; but one must take care to specify just what is assumed to be unchanged. It is not the same thing to assume that the path of the money supply is unchanged as to assume that the path of interest rates is unchanged, or that the central bank’s inflation target is unchanged, or that the central bank continues to adhere to a “Taylor rule,” to list only a few of the possibilities.

So any statement along the lines of “the multiplier” is 1.6 is pretty much nonsensical.

Another provocative maxim that I repeat over and over again is:

All multiplier estimates are nothing more than forecasts of central bank incompetence.

I think it fair to say that’s not something you learned in your intermediate macro class.  (Although I’m not claiming to have invented that idea, or any others that appear in this blog.)  In any case, let’s see what Woodford has to say about multiplier estimates:

Yet it is important to remember that in New Keynesian models, both the size of the output gap and the size of the multiplier will depend on monetary policy; and while there might well be significant opportunities for fiscal stabilization policy under the assumption that prices, wages or information are sticky and that monetary policy is inept, the most obvious solution in such a case is to increase the accuracy of monetary stabilization policy. Indeed, given that effective monetary stabilization policy should prevent there from being large variations in the ratio of u’ to v’ (by stabilizing the output gap), it is not obvious that the novel considerations [for fiscal stimulus] mentioned in the previous paragraph should be of great quantitative significance when monetary policy is used optimally.  (italics in original!)

‘Inept’ seems pretty close to “incompetent,” doesn’t it?  I’ve also argued that monetary [edit: I meant fiscal] policy should focus on efficiency, not stabilization.  Here’s Woodford:

Thus one may conclude that, regardless of the path of government purchases, an optimal monetary policy achieves the allocation of resources predicted by the neoclassical model. But then the condition for optimality of the level of government purchases is again simply (5.2), which is to say, the principle of efficient composition of expenditure.

I also emphasize that fiscal and monetary policies aren’t simply two different tools, each of which can be used for stabilization (as in the intro textbooks.)  Rather monetary policy is far more efficient.  Here’s Woodford:

It is not simply a matter of there being two instruments which can each, in principle, address the problem of an insufficient level of aggregate nominal expenditure, given the existing level of prices or wages, so that it does not matter which instrument is used for the job. Rather, to the extent that the problem can be solved using monetary policy, it is costless to do so, since monetary policy has no other aims to fulfill; whereas, while government spending can also be used to ameliorate the problem, this has a cost, since it requires the diversion of real resources to alternative uses. Whenever government purchases are used for aggregate demand management, there is a tension between this goal and the choice of government purchases so as to maintain an optimal composition of expenditure. Since there is no equally important conflict in the case of the use of monetary policy for aggregate demand management, monetary policy should be used to the extent possible; and this should largely allow decisions about government purchases to be made from the standpoint of the optimal composition of expenditure.  (italics in original.)

Comments:

1.  In other words, Joe Stiglitz is wrong.

2.  What does the phrase “aggregate nominal expenditure” remind you of?

3.  Ben Bernanke keeps saying the Fed has plenty of unused ammunition, but is taking a wait and see attitude before deciding whether additional stimulus is appropriate.  How would that information affect Woodford’s view of the relative desirability of additional fiscal and monetary policy?

Woodford does take the zero bound problem more serious than I do, and that produces the multiplier estimates that Krugman likes.  But there is also this issue:

In a neoclassical model (where real marginal cost can never differ from 1 in equilibrium), the increased tax distortion will lower equilibrium output, and may even negate the increase in equilibrium output that would occur with lump-sum taxation for the reason explained in section 1.

However, I can’t buy Woodford’s argument here:

In the case of an increase in government purchases while monetary policy is constrained by the zero lower bound, the multiplier would actually be increased if we assume that the increased government purchases are financed by a balanced-budget increase in the tax rate on wage income. The reason is that the increase in the tax wedge makes the policy even more inflationary, for the reason just explained. But an increase in expected inflation during the period while the nominal interest rate is constrained to equal zero will mean that real interest rates fall even more than in the analysis in section 4, resulting in an even greater increase in output.

I think what matters in NGDP growth, which isn’t boosted by adverse supply shocks.  I’d also point to the unhappy experience in Britain after the VAT went up recently (recall that a VAT is a consumption tax, just like a wage tax.)  I focus more on NGDP and sticky wages, whereas Woodford focuses on real interest rates and sticky prices.

The conclusion starts off by noting that fiscal stimulus may be appropriate in a major downturn like the Great Depression, but then ends by raising lots of caveats, such as this paragraph:

Nonetheless, under less extreme circumstances, the case for using variations in government purchases for stabilization purposes is much weaker. Even when the zero lower bound is a binding constraint, if the disturbance that causes it to bind is not expected to be too persistent, then even though the multiplier for increased purchases while the constraint still binds will be at least slightly greater than one, it need not be much greater than one; and the optimal increase in government purchases is probably only a small fraction of what would be required to “fill the output gap.” When monetary policy is not constrained by the zero lower bound, there is a good case for leaving output-gap stabilization largely to monetary policy, and basing decisions about government purchases primarily, if not entirely, on the principle of efficient composition of aggregate expenditure.

And finally, he even throws some support to those awful Republicans who blame President Obama for the job loses right after he took power, before the stimulus was spent.  Indeed he suggests they aren’t being awful enough.  Obama should have been able to influence economic growth almost immediately after being elected in November 2008, merely by announcing his fiscal stimulus policy:

It follows that when Eggertsson obtains a multiplier of 2.3, 1.0 of this is due to the increase in government purchases during the current quarter, while the other 1.3 is the effect of higher anticipated government purchases in the future.

Hence even if there were no increase in government purchases in the current quarter at all, an expectation of higher government purchases in all future quarters prior to date T would increase output immediately by an amount that is 1.3 times as large as the promised future increase in the level of government purchases.

I’d love to see Romney use that quotation in the debates this fall, but I don’t expect it.

PS.  Nick Rowe has a post on this paper, and Matt Rognlie has some comments.  I’ll be watching what they come up with, because it’s all way over my head.


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64 Responses to “Woodford has something for everyone”

  1. Gravatar of Greg Ransom Greg Ransom
    18. January 2012 at 20:32

    There is also no stable relationship between aggregate demand and the rate of unemployment.

    The demand for goods is a not a demand for labor, production goods can be substitutes for labor, etc., etc.

    Scott writes,

    “there is no stable relationship between government spending and aggregate demand.”

    What we see again and again is that “rigorous” math produces fraudulent pretend functional relationships between categories which are ill-grounded in the causal structure of the real world. Top economists have been pointing out such things for over 100 years, e.g. Benjamin Anderson’s marginalist expose of the causal inoperative of the functional equations of the crude quantity theory of money in his _The Value of Money_, etc.

  2. Gravatar of Benjamin Cole Benjamin Cole
    18. January 2012 at 21:01

    I have to say, the more I read Sumner, the more I think he gets it, and other economists are just not as good.

    Woodford’s idea about raising taxes on wages to spur real growth (by increasing inflation, and thus decreasing real interest rates) is just stupid. If you stop hitting yourself in the head with a hammer…

    I will say it again: There are two kinds of economists: Market Monetarists, and Theo-Monetarists.

    Market Monetarists have a plan to increase nominal GDP (and thus real GDP) along a steady path. Theo-Monetarists have plans to kill inflation, and then pray the economy will grow, and growth is less important anyway than strict adherence to the stagnant value of money or possibly the gold standard.

    Keynesians are just Market Monetarists in drag, who want government spending to boost aggregate demand (accommodated by the Fed), instead of pumping lots of money through QE into the private sector and let businesses and consumers do the stimulative spending.

    You know, Sumner is dead on the money again.

  3. Gravatar of K K
    18. January 2012 at 21:55

    “In other words, Joe Stiglitz is wrong.”

    No! It doesn’t mean that *at all*. He said the central bank *should*. SHOULD. Not “does”. Not “has”. Not even “will”. Just “should”. Stiglitz says Say’s law is worthless, by which he means that central banks do, and have always failed to properly regulate the level of desired savings. He is right. And especially in the period he is talking about – the period of most staggering central bank failure in living memory. And even then, Woodford doesn’t claim that even a competent CB can always regulate demand – just read his many papers on the liquidity trap and the role of fiscal policy. This is a gross misinterpretation of what he says.

  4. Gravatar of Morgan Warstler Morgan Warstler
    18. January 2012 at 22:01

    First, Scott – woot!

    Second, Greg…

    “The demand for goods is a not a demand for labor, production goods can be substitutes for labor, etc., etc.”

    This is EXACTLY RIGHT, and it is the reason we need to do Guaranteed Income / Auction the Unemployed.

    Third, Benji…

    Good for you! Real insight on the drag comment. I even agree, this the kind of post where Scott puts distance between himself and others.

    But Scott is another step closer to Austrianism. He’s an actual step towards smaller government, less inflation, and less insider bias on monetary policy.

    Those things HAPPEN under Scott’s plan. It is an anti-Democrat plan.

  5. Gravatar of Kevin Donoghue Kevin Donoghue
    19. January 2012 at 01:11

    In other words, Joe Stiglitz is wrong.

    For a man who bitches a lot about being misrepresented, you surely like doing some wild misrepresentation.

    What does the phrase “aggregate nominal expenditure” remind you of?

    The aggregate demand function relates any given level of employment to the “proceeds” which that level of employment is expected to realise. The “proceeds” are made up of the sum of two quantities “” the sum which will be spent on consumption when employment is at the given level, and the sum which will be devoted to investment.

    Various other passages also come to mind.

    I’d love to see Romney use that quotation in the debates this fall….

    Ever since J.S. Mill, liberals have hankered for more intelligent conservatives.

  6. Gravatar of Kevin Donoghue Kevin Donoghue
    19. January 2012 at 01:38

    Meanwhile, back in the real world:

    In an interview with Wolf Blitzer that will air today at 5:25 pm E.T. on CNN, Newt Gingrich said he will ask Sarah Palin “to play a major role” in his administration if elected President.

    Now, what I’d love to see is Sarah Palin explaining how a Nominal GDP futures market could facilitate optimal monetary policy. Tina Fey will never get better material than that.

  7. Gravatar of tom tom
    19. January 2012 at 02:08

    Ok Scott so now it’s time to admit that “On theoretical grounds I agree” with Wren and Krugman. They are also “theoratically” right.

  8. Gravatar of rob1 rob1
    19. January 2012 at 02:15

    Hey Kevin Donoghue: If Scott is spewing gibberish, why are you visiting this blog. It is one thing to criticize, it is quite another to find fault with each and every one of Scott’s posts.

    Rob1

  9. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 04:26

    Greg,

    The demand for goods may not be the same thing as a demand for labour, but I’d be surprised if you could find one instance where the two were not closely correlated. As a modeling assumption, it’s rather innocuous. It’s like assuming that the person you are corresponding with online has legs. Sure, it’s possible that they’re lost their legs in a car wreck or whatever, but nobody is going to accuse you of making a fundamental error of reasoning for assuming the contrary.

    All the good objections to mathematical modeling are not really criticisms of modeling in and of itself, but rather what people think they are doing with those models. For example, I assume Woodford agrees that the demand for goods is not the same thing as a demand for labour. However, he probably lets the point slide because the relationship is strong enough that it’s not important for the purposes of his model to labour (heh heh) the distinction.

    I agree with you that sloppy thinking often leads people to mistake their models, simplifying assumptions and all, for reality itself, but that’s a problem with people rather than the models. I just think you ought to be more careful about how and why you criticise people for these types of things, or else you’ll be the one assuming away important distinctions.

  10. Gravatar of Ram Ram
    19. January 2012 at 05:01

    I’ll just note that I have referenced most of these passages in previous comments on this blog, in support of what you have been saying from time to time. This paper also agrees with you to a remarkable degree:

    http://www.columbia.edu/~mw2230/OMP_Hbook.pdf

    Indeed, it was the realization that much of what you were saying that seemed so controversial was all right there in Woodford (the least controversial macroeconomist in the business) that convinced me something had gone wrong in the macroeconomics profession. Where you and Woodford disagree I often side with him in theory, but in practice I don’t think there’s a whole lot to disagree with there. He seems to think fiscal stimulus is worth trying since there may be systematic reasons why monetary policy may not be able to get the job done under circumstances like this. He also favors flexible price level targeting, rather than nominal GDP targeting, at least in theory, but in practice nominal GDP seems the better target for a number of reasons even he’d agree with. But the sense most readers get, that you’re on the fringe of the discipline, is completely off as can be seen here and in the paper I linked to, where it can be seen that your differences mostly chalk up to disagreements about practical judgments. Which is part of why I’m hesitant to throw out NK in favor of market monetarism. I think everything you need is right there in NK, and I’m a devil you know kind of guy.

  11. Gravatar of Dennis Dennis
    19. January 2012 at 06:20

    Typo? “I’ve also argued that monetary policy should focus on efficiency, not stabilization.” – I think you meant fiscal?

  12. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 06:49

    ‘So any statement along the lines of “the multiplier” is 1.6 is pretty much nonsensical.’ – Sumner

    That’s too strong. It’s not nonsensical. I mean, you actually made sense of such statements in this post. The problem, rather, is that such claims are contingent on multiple tenuous assumptions.

  13. Gravatar of dwb dwb
    19. January 2012 at 06:54

    I really don’t know why Krugman would point to this paper as proof he is right. The point of the paper, it seems to me, is to show that under a wide range of assumptions the fiscal multiplier is low when properly offset by countercyclical monetary policy (the multiplier depends on the degree of offset).

    Even at the ZLB in woodfords model, fiscal stimulus acts essentially by increasing inflation (p21). to the desired level. If the Fed has other tools other than lowering interest rates (say, through QE) I expect this result too would be turned on its head since the Fed could raise inflation (expectations) without lowering nominal rates.

    So under most conditions, the fiscal multiplier is a function of monetary policy. Even at the ZLB, fundametnally, the fed merely needs a higher inflation (expectations) target. I have to say: game, set, and match. The real question to me is whether some really smart NK understand their own models.

  14. Gravatar of tom tom
    19. January 2012 at 07:27

    dwb,
    There is no statement in Woodford’s paper that “fiscal stimulus acts essentially by increasing inflation” but rather: “In this equilibrium” (i.e. ZLB) “there will be both deflation and negative output” and “Under such circumstances it can be highly desirable to stimulate aggregate demand by increasing the level of government purchases” (p.22).

    Besides Krugman considers higher inflation expectations as second best solution after fiscal stimulus so there is no dispute that it would be a good thing. But the big question is how to it?

  15. Gravatar of dwb dwb
    19. January 2012 at 07:40

    @tom, p24

    “It follows from (4.7) that the multiplier dYL=dGL = vG for government purchases up to the level ^G crit is necessarily greater than 1 (for any m > 0). The reason is that, given that the nominal interest rate remains at zero in periods t < T; an increase in GL; which increases pL, accordingly increases expected inflation (given some positive probability of elevated credit spreads continuing for another period), and so lowers the real rate of interest."

    As i said, the key assumption in the ZLB analysis is that the Fed has no other way to raise inflation expectations.

  16. Gravatar of tom tom
    19. January 2012 at 07:41

    dwb,
    Woodford: “For levels of government purchases up to Gcrit” (for G1). Increases in government purchases beyond that level result in even higher levels of GDP, though the increase per dollar of additional government purchases is smaller” (so multiplier>0) “owing to the central bank’s increase in interests rates in accordance with Taylor rule (positive inflation)
    (p.22-23)

  17. Gravatar of tom tom
    19. January 2012 at 07:44

    dwb, corected version:
    Woodford: “For levels of government purchases up to Gcrit” (for G1). Increases in government purchases beyond that level result in even higher levels of GDP, though the increase per dollar of additional government purchases is smaller” (so multiplier>0) “owing to the central bank’s increase in interests rates in accordance with Taylor rule (positive inflation)
    (p.22-23)

  18. Gravatar of tom tom
    19. January 2012 at 07:46

    dwb, corrected once again
    Woodford: “For levels of government purchases up to Gcrit” (for G less than Gcrit ZLB holds) “each additional dollar spend by the government increases GDP by Vg dollars” (by multiplier greater than 1). Increases in government purchases beyond that level result in even higher levels of GDP, though the increase per dollar of additional government purchases is smaller” (so multiplier greater than 0) “owing to the central bank’s increase in interests rates in accordance with Taylor rule (positive inflation)
    (p.22-23)

  19. Gravatar of tom tom
    19. January 2012 at 07:48

    dwb, your quote support multiplier greater than 1 but outside of liquidity trap it is still greater than 0. read my previous post

  20. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 07:53

    Since NGDP = M*V, fiscal stimulus can only work by either increasing M, V, or both. There are no other options. Since we know it doesn’t increase M, then fiscal stimulus must, in some roundabout way, increase V instead. There are no other possibilities. Increasing V amounts to reducing the demand for money, more or less. Therefore, fiscal stimulus acts “essentially” by, somehow, inducing the public to hold smaller money balances. This is the fundamental point that seems to allude many people.

  21. Gravatar of Mike Mike
    19. January 2012 at 07:56

    Scott: Keep going. This is good and important stuff, even if I don’t understand it or know who is right. Ignore commentators who say to move on. As long as you have the energy and interest and something useful to say, you’re doing a great service by keeping the debate alive. This is one way knowledge increases.

  22. Gravatar of dwb dwb
    19. January 2012 at 08:05

    @ tom: I stand by my statement. All the analysis in this paper is essentially driven by the necessity on hitting the desired inflation target (eq 4.4) to achieve the equivalent flexible-price equilibrium. In this simple model the Fed has only one policy instrument, nominal rates – so yes, in that world the fiscal multiplier is >1. If however, the Fed has other ways of hitting 4.4 and raising inflation expectations without changing nominal rates (say through QE, raising the inflation target), then we revert to the flexible price fiscal multiplier eq 1.7. Even at the ZLB, the fiscal multiplier is driven by the degree to which the central bank is able to hit the optimal inflation rate given the state of the economy.

  23. Gravatar of ssumner ssumner
    19. January 2012 at 08:06

    Greg, there is a relationship, but you are exactly right that it’s not a stable relationship.

    Thanks Ben.

    K, Stiglitz says we should not use monetary policy to stabilize the economy. He opposes monetary stimulus right now because it might cause inflation in Brazil, or something like that. Do you seriously believe those are Woodford’s views?

    Morgan, Thanks.

    Kevin, See my answer to K. Stiglitz and Woodford are at opposite extremes of the Keynesian spectrum.

    It reminded me of NGDP, BTW.

    Smarter conservatives? Hoover and Nixon were smart. But actually I agree with you on that point.

    tom, I’ve always acknowledged that there are classical arguments for the proposition that fiscal stimulus can work in some cases. Even with Ratex and RE. I’ve supported payroll tax cuts, because I think they can work. My objection has always been on various technical points–is there a reliable multiplier, what is the monetary reaction function, did they forget to account for S&I changes, etc.

    rob1, I had to slightly censor your comment (for language.)

    Lee Kelly. In my view they are pretty closely correlated at high unemployment, but at full employment you often just get inflation. Also there are issues such as changes in inflation expectations. So I partly agree with you, but also partly agree with Greg.

    Ram, Thanks, I greatly appreciate your comments, as I know you’re the sort who will tell me when I’m wrong. I’ll look at your paper later today.

    I should do a post someday exploring where I look at things differently from Woodford.

    Dennis, Yikes, I will correct that!

    Lee, Yes, I was sloppy with language there. I meant unreliable.

    dwb, I think Krugman is using this against a belief he thinks Cochrane and I hold, which we do not in fact hold. We don’t claim there’s no way fiscal stimulus can work–that would be wrong. I have a new post on that.

    dwb, and Tom, In fairness to Tom, I think Woodford’s saying that fiscal stimulus boosts inflation and also the direct effect of the spending itself–at least that’s what I recall.

  24. Gravatar of Cthorm Cthorm
    19. January 2012 at 08:13

    >Smarter conservatives? Hoover and Nixon were smart. But actually I agree with you on that point.

    Did you read Greenspan’s book “The Age of Turbulence?” I found his description of Nixon absolutely chilling. A man with an obviously sharp intellect, but coupled with a very high opinion of himself, ruthless ambition, and a cynical view of reality. He was a very dark personality. That book made me feel even more strongly that we don’t need Very Smart Men in politics, we need Average Joe with humility and a cool head. This counts double with our current Imperial Presidency.

  25. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 08:21

    Scott,

    You’re right, of course. I implicitly assumed a shortage of aggregate demand, because that seems to be the world that Woodford was addressing with his model. I should have made that clear.

  26. Gravatar of Kevin Donoghue Kevin Donoghue
    19. January 2012 at 08:26

    rob1, I had to slightly censor your comment (for language.)

    Pity I missed it since it was addressed to me; always curious to see what sort of profanity I inspire.

    rob1, FWIW my policy is to let the bloghost be my guide as to what sort of comments are welcome. Scott has made it clear that he welcomes critics and he has never asked me to adopt a more reverent tone. We disagree about Keynes, Krugman and much else, but we are in accord as to the value of lively debate.

  27. Gravatar of Kevin Donoghue Kevin Donoghue
    19. January 2012 at 08:32

    Scott, re Stiglitz: I took you to be referring to his views on sectoral problems as a root cause of slumps. But of course that was just a guess; you merely said he was wrong without saying what about.

  28. Gravatar of K K
    19. January 2012 at 08:44

    Ditto, what Kevin said. “Stiglitz is wrong,” totally unqualified, is a pretty strong statement.

  29. Gravatar of Greg Ransom Greg Ransom
    19. January 2012 at 08:45

    Lee Kelly, call me less than impressed with this rejoinder.

    I point to the bogus “clarity” and “rigor” claim of those who assert that math models somehow guarantee “rigor” and “clarity”, when the literature contains almost nothing but examples of economists being misled by their “rigorous” and “clear” math constructs.

    Every household name in economics could be used for illustration, Arrow, Samuelson, Stiglitz, anyone you’d like to name. The most notorious examples are Lerner, Lange, Taylor and the other socialist planning economists — folks that the “mainstream” took as “right” for over half a century.

    A lesson about “rigor” that no one wants to think about ….

  30. Gravatar of Greg Ransom Greg Ransom
    19. January 2012 at 08:48

    Lee Kelly, a mainstream “modeler” in the philosophy of language could make the same argument you’ve just made. But the fact remains that ALL of the models get the structure of language wrong, because the modeling technique itself falsifies the phenomena, i.e. the lesson of Wittgenstein can’t be stuffed into a logical construct or semantic “model”.

  31. Gravatar of tom tom
    19. January 2012 at 08:55

    Lee: “Since we know it doesn’t increase M”
    M2 is created mainly by banks so fiscal stimulus can influance banks to increase it.

    dwb: “Even at the ZLB, the fiscal multiplier is driven by the degree to which the central bank is able to hit the optimal inflation rate given the state of the economy.”
    Actually it’s not correct because the longer central bank is not able to hit optimal inflation rate the higher multiplier. See figure 1 (p.23)

  32. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 08:59

    Greg,

    There is nothing bogus about the rigor and clarity of mathematics. Again, you’re complaining about people rather than models, and you tacitly acknowledge this in the following statement:

    ‘the literature contains almost nothing but examples of economists being misled by their “rigorous” and “clear” math constructs.’

    Misled from what? you can’t be mislead unless you can also be led in the right direction. If economists are being misled by their models, then what, in your view, is the proper role of mathematical modeling in economics? You also include the qualifier ‘almost’, and so you also recognise that not all economists commit the error you are describing.

    This takes us back to my original reply, which is to say that it is far from clear that Woodford is making the mistake you are accusing him of. He may understand the distinction between the demand for goods and the demand for labour, but for the narrow purposes of his model assume they are the same. Given that he is attempting to to model an economy in recession, this is not an unreasonable simplifying assumption to make.

  33. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 09:03

    tom,

    Fiscal stimulus might spur banks to increase the money supply, but how? By reducing the demand (or increasing the velocity of) for base money. Really, to be clear, I should have said base money to begin with.

  34. Gravatar of tom tom
    19. January 2012 at 09:08

    Lee, ok then you are right. But again it only shows how imprecise is this term velocity. It is derived from identity and it depends which money measure you use. And base money has no practical meaning right now because it tripled in the last 3 years and we are still in the shithole.

  35. Gravatar of Greg Ransom Greg Ransom
    19. January 2012 at 09:11

    The elephant in the room is the false asumption about how causation and explanation work in economics contained within almos every “top” math modelers approach to his math construct. And, more generally, the bogus understanding of science contained in his understanding of his math construct.

    The top economists never see through this most basic false assumption built within their understanding of their math “model”.

    The word “model” itself red flags the pathology and bogus science picture.

  36. Gravatar of Greg Ransom Greg Ransom
    19. January 2012 at 09:13

    Lee, I make no mention of Woodford …

  37. Gravatar of dwb dwb
    19. January 2012 at 09:16

    @tom
    Actually it’s not correct because the longer central bank is not able to hit optimal inflation rate the higher multiplier. See figure 1 (p.23)

    yes, we are in complete agreement: if the central bank cannot hit its inflation target, the fiscal multiplier is large.

    All i am saying is that, outside this model, the central bank has other policy choices besides nominal rates, and other ways of hitting its inflation target, such as printing money or raising inflation expectations. To believe these policy choices are ineffective at raising inflation, you have to believe that the money transmission mechanism is broken at the ZLB (meaning, no matter how much money the central bank prints through QE, it will not raise inflation) and/or that the Fed cannot credibly commit to higher inflation (through other policy options, like permanantly depositing 10k in everyones checking account). The weight of the evidence is that the Fed can raise inflation expectations at the ZLB, if it chooses to.

  38. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 09:25

    tom,

    Defining ‘money’ is always a bit arbitrary. For example, were the overnight repurchase agreements of the shadow banking system a kind of money? They certainly seemed very much like demand deposits, but they were also a little different.

    If we include them in the money supply, then we might say that the money supply crashed in 2008 while velocity didn’t change much. However, if we do not include them in the money supply (but merely recognise them as close substitutes for money), then velocity crashed in 2008 while the money supply didn’t change much. The important thing to note is that, in either case, we’re really just saying the same thing using two different sets of definitions.

  39. Gravatar of tom tom
    19. January 2012 at 09:31

    dwb ” you have to believe that the money transmission mechanism is broken at the ZLB” Ditto! that is exactly the case of ZLB and Woodford is explaining it.

    “The weight of the evidence is that the Fed can raise inflation expectations at the ZLB” . Look but Fed is telling us all the time that it doesnt want to increase inflation. But even if it wanted the question is would the market believe them. Because how you can assure that Fed will not change its mind in the future? Ultimately they are only people and we dont have gold standard which we can just throw away.

  40. Gravatar of Doc Merlin Doc Merlin
    19. January 2012 at 09:37

    @ Benjamin Cole

    Then there are those of us who don’t believe the government should have monopoly on money at all.

  41. Gravatar of Doc Merlin Doc Merlin
    19. January 2012 at 09:41

    @tom

    Inflation expectations are not what matter here, what matters in aggregate to the money side of the economy is NGDP expectations and interest rate expectations.

  42. Gravatar of tom tom
    19. January 2012 at 09:54

    NGDP expectations = Inflation expectations
    there’s no way to change it

  43. Gravatar of Brito Brito
    19. January 2012 at 10:21

    The problem with New Keynesian models is that it basically assumes there is a monetary transmission mechanism. Monetary policy simply alters the DIS curve by setting an interest rate rule; which in turn effects the DIS curve and then substitutes the new equation for the output gap into the NKPC. Standard monetary policy in New Keynesian economics is purely interest rate based, and has nothing to say when rates are at their lower bound.

    The only other example is when instead an AD equation is derived from the QTM and expressed in logs (y = m – p), and then it assumes this line must equilibriate with the NKPC. In this case a shock to m shifts the AD curve. This is fine if velocity is constant, but velocity clearly isn’t constant. It will work if we’re talking about an increase in money IN CIRCULATION, but QE doesn’t really do this, because none of the money goes into circulation. Indeed the issue of how to actually raise M in circulation has not been addressed by NK modelling. I’d like someone to show me otherwise.

  44. Gravatar of W. Peden W. Peden
    19. January 2012 at 10:34

    Brito,

    I would argue (if I thought I knew how!) that, in both cases, the problem is that there is a model of AD which lacks references to assets, their prices & their supply/demand. I find it easiest to think about monetary policy in terms of changing asset prices via changing the supply of qualitatively different kinds of assets in the economy, and thereby changing the money supply & interest rates.

    So QE is best thought of as a means of changing the price of non-MB assets in the financial system, with any significant subsequent change in the quantity of money taking placing place endogenously through the asset price shift. In that respect, QE is not really mechanically different from normal OMOs or CB lending policies (except that the target is unusual) IF one changes focus towards asset prices.

  45. Gravatar of Brito Brito
    19. January 2012 at 10:38

    W. Peden, that’s fine but as far as I’m aware this stuff doesn’t exist in any New Keynesian model, so Market Monetarists cannot rely on Ney Keyensian models as of yet.

  46. Gravatar of Morgan Warstler Morgan Warstler
    19. January 2012 at 11:12

    NGDP expectations = Inflation expectations

    huh?

  47. Gravatar of tom tom
    19. January 2012 at 11:47

    Morgan,
    Yes even Scott admitted that from the theoretical point of view inflation expectations may be better but because of practical reasons he stands for NGDP expectations (it is easier to sell it to politicians and general public that we want to increase GDP not inflation). But it is still the same because we want the same real changes in both cases.

  48. Gravatar of W. Peden W. Peden
    19. January 2012 at 12:01

    Brito,

    Agreed. I’m not partial to New Keynesian models, even if they reach many correct conclusions.

  49. Gravatar of W. Peden W. Peden
    19. January 2012 at 12:01

    (Which they do. The monetarist parts of the New Keynesian synthesis of monetarism and Keynesianism are fine.)

  50. Gravatar of StatsGuy StatsGuy
    19. January 2012 at 12:08

    Nice Post.

    “All multiplier estimates are nothing more than forecasts of central bank incompetence.”

    Excellent quote – but not _quite_ accurate. I will help out:

    “All multiplier estimates are nothing more than forecasts of central bank incompetence OR MEASURES OF CENTRAL BANK CAPTURE BY POLITICAL OR FINANCIAL INTERESTS.”

    There, all fixed. 🙂

  51. Gravatar of Brito Brito
    19. January 2012 at 12:08

    I would like to see market monetarist ideas actually modelled, at the moment the processes still seem a bit vague. It would be good to show that the concept is at least logically internally consistent and optimal.

  52. Gravatar of Cthorm Cthorm
    19. January 2012 at 12:19

    @tom and Morgan

    >NGDP expectations = Inflation expectations

    No. No no no no. NGDP expectations = RGP expectations + inflation expectations.

    maybe: dNGDP expectations = dInflation expectations

    They are directly related but they are absolutely not equivalent.

  53. Gravatar of tom tom
    19. January 2012 at 12:27

    Cthorm,
    Yes dNGDP expectations = dInflation expectations
    because we want the same real changes in both cases.
    So in dynamic models they’re equivalent

  54. Gravatar of Cthorm Cthorm
    19. January 2012 at 12:33

    You mean in “dynamic models” that assume a static real economy?

  55. Gravatar of tom tom
    19. January 2012 at 12:48

    All current macro models are based on differential equations so they are dynamic (e.g. Woodford, Barro, Romer etc)

  56. Gravatar of Cthorm Cthorm
    19. January 2012 at 13:03

    Right. I misread your previous post as “so they’re equivalent” as opposed to “so in dynamic models they’re equivalent.”

  57. Gravatar of Bill Woolsey Bill Woolsey
    19. January 2012 at 14:59

    Tom:

    I think you are confusing Krugman with Sumner here.

    While Sumner would agree that calling for more inflation is politically unwise, he has written a good bit that is critical about the value of the concept of inflation, the importance of nominal GDP growth relative to nominal interest rates, and more.

    Further, Sumner favors a target for the growth path of nominal GDP. Inflation expectatons don’t translate directly into expectations about the future level of nominal GDP. A nominal NGDP level target is more like a price level target. But Sumner doesn’t favor a target for the growth path of the price level because of supply shocks.

    So, I read you as saving expectations for nominal GDP growth are the same as expectations of inflation. Perhaps, but that is a very awkward way of describing a target for the growth path of nominal GDP.

    And finally, Sumner rejects the approach that monetary policy impacts real output by changing real interest rates. The focus on inflation expectations points to changes in the real interest rate given the target for the nominal interest rate.

    Sumner recogizes that in disequilibrium, increases in expected nominal GDP that reflect increases in expected real output growth motivate increased real expenditures on output even if expected real interest rates are unchanged.

  58. Gravatar of tom tom
    19. January 2012 at 16:53

    Bill,

    You may be right I’m not an expert on Scott’s views but show me one model where NGDP expectations gives different results than inflation expectations.

  59. Gravatar of ssumner ssumner
    19. January 2012 at 18:36

    cthorm, Good observation.

    Lee, Then I mostly agree.

    Kevin, I recall he opposed QE2.

    K, I should have been clearer. Thought he was well known for opposing monetary stimulus and supporting fiscal stimulus.

    Tom, You said;

    “NGDP expectations = Inflation expectations
    there’s no way to change it”

    You can’t say that over here!

    Brito, I agree, I like monetary models that rely on the hot potato effect.

    Tom, You said;

    “Yes even Scott admitted that from the theoretical point of view inflation expectations may be better but because of practical reasons he stands for NGDP expectations (it is easier to sell it to politicians and general public that we want to increase GDP not inflation).”

    No, I think NGDP is much better from a theoretical perspective too.

    Statsguy, Isn’t that too long for a tweet? 🙂

    Brito, You asked:

    “I would like to see market monetarist ideas actually modelled, at the moment the processes still seem a bit vague.”

    I use the AS/AD model, where AD is a hyperbola controlled by monetary policy, and the SRAS reflects sticky wages and rational expectations. AD reflects both the current and expected future ‘hot potato effect’ of money supply changes (assuming no interest on reserves, otherwise it’s more complicated.) The base is defined as “money.” And base velocity is positively related to nominal interest rates, which in turn are related to both economic slack and expected NGDP growth. I don’t do math, maybe someone else can turn that into a model.

    I’m not an expert on the indeterminacy in fiat money models, but generally agree with McCallum that the problem is overrated, as there’s an implied promise by the Federal government to back fiat money in an emergency.

    In some ways I prefer hours worked over RGDP as the business cycle indicator.

    Bill, That’s right.

    Tom, In late 2008 NGDP expectations fell much faster than inflation expectations. They gave a much better warning of the need for aggressive stimulus. (I think both Keynesians and market monetarists agree on that point.)

  60. Gravatar of K K
    19. January 2012 at 20:26

    “Thought he was well known for opposing monetary stimulus and supporting fiscal stimulus.”

    That may be. You recently took him to task for his theory of the Great Depression. I thought that’s what you were talking about.

  61. Gravatar of tom tom
    20. January 2012 at 01:36

    Scott were they measured on the same population? I cant see how you can produce a model internally consistent with these two measures different.

  62. Gravatar of ssumner ssumner
    20. January 2012 at 07:27

    K, OK.

    Tom, All I’m really saying is that RGDP growth expectations fell in late 2008, which was pretty obvious. Those are the difference between NGDP and P expectations. So I don’t follow your complaint.

  63. Gravatar of tom tom
    20. January 2012 at 10:00

    Scott,
    But if you considered inflationa expectations + real growth expectations wouldnt the conclusions be similar to NGDP expectations?

  64. Gravatar of ssumner ssumner
    21. January 2012 at 12:37

    Tom, Yes.

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