Would you have blamed the Fed for this policy?

Even people who are sympathetic to my policy views often have trouble swallowing my thesis that the Fed caused the crash of 2008.  In my previous post (which you should read first) I argued that people make unjustified distinctions between “active” and “passive” monetary policy stances.  The argument is often that the Fed did not “do anything” that might have caused the crash of 2008.  Here I will reprise and extend an argument I used in response to Josh over in Nick’s blog.

I would like everyone to consider the following counterfactual.  Instead of keeping the fed funds target fixed at 2% between April and October 2008, suppose the Fed had increased it from 2% to 8%.  Also assume the following seven indicators had responded to this hypothetical policy in exactly the same way as they did in late 2008:

1.  Real interest rates rose sharply.

2.  Inflation expectations plummeted into negative territory.

3.  Commodity prices crashed.

4.  Stocks crashed.

5.  The real estate crash spread nationwide.

6.  Industrial production suddenly plunged sharply.

7.  The dollar soared in value against most currencies.

Let’s see a show of hands as to how many people would have blamed the Fed for this crash.  OK, I can’t see your hands, but I assume everyone is raising them.  Now do the exact same thought experiment, but assume the fed funds rate had stayed at 2% the entire time.  How many still blame tight money by the Fed?  I don’t see many hands (maybe Earl T. and JimP.)

Let’s say I am right in my presumptuous assumption that I know how you guys would respond.  (And if I am wrong about my readers, then I would still argue that most mainstream economists would have responded exactly as I assumed.)  So it all comes down to the fed funds rate.  Doesn’t this imply that most people assume the fed funds rate is a pretty good indicator of the stance of monetary policy?

Now I can see several ways that economists could wiggle out of the box I put them in, but I will argue that in each case they would do so at the expense of ending up in an even more untenable position.  Let’s start with the obvious argument that not only did the Fed keep rates low in 2008, but they also increased the monetary base sharply once things got really bad.  But is the monetary base any better a policy indicator than the fed funds rate?  The Fed cut rates to below 2% and raised the base sharply in the 1930s.  Are most economists prepared to argue that money was “easy” during the early 1930s?  I don’t think so.

Another argument might go as follows:  Yes, both the short term interest rate and the base signaled easy money in the 1930s, and both signals can be misleading, but we know that money was actually tight because Friedman and Schwartz showed that M1 and M2 fell sharply during this period.  It’s certainly convenient to revive outdated monetarist theories when they come in handy.  Let’s review why this aspect of monetarism was discredited.  During the 1980s the monetary aggregates soared as inflation fell to low levels.  Friedman famously made some erroneous predictions that inflation was just around the corner.  Why were the monetary aggregates so unreliable?  Because as inflation falls the demand for money rises.  Does this sound familiar?

During the 1930s people took money out of banks and hoarded cash and gold.  Why?  Because 1000s of banks were failing.  Today people are pouring money into FDIC-insured bank accounts (and gold) because they see increased risk in the stock and (non-Treasury) bond markets.  All the monetary aggregates tell us is what is happening to the public’s demand for one specific financial asset; they tell us nothing about whether money is easy or tight.

For me, the 1990s were the 1930s.  I spent the 10 years reading virtually every single New York Times from the Great Depression.  I began to feel like the 1930s were the real world.  I saw things as they appeared at the time.  (Or at the Times.)  And everything I read today reminds me of how people saw things in the 1930s.  “This isn’t an ordinary recession; it’s the end of laissez-faire capitalism.”  “The problem wasn’t caused by the Fed; rather the international financial system is to blame.”  “The greedy bankers are at fault.”  “The stock market was a bubble.”  “The 1920s were a false prosperity.”  “Even though we have deflation, hyperinflation is the real danger.”  “The Fed is pushing on a string.”  It’s all there, and when I first read those newspapers I wondered how people could be so stupid.  Hadn’t they read Friedman and Schwartz?  No, because the Monetary History wouldn’t be published for another 40 years.  The people weren’t stupid, monetary policy is just incredibly counterintuitive.

But stupid or not, they were wrong about everything back then—sharply falling NGDP is simply a monetary policy failure.  As Krugman would say “Period. End of story.”  That was true then, and it is true today.

We do not have any regulatory fixes that we can be confident would prevent another financial crisis.  We do have a potential monetary regime that can prevent sudden collapses in NGDP growth expectations.  It is called NGDP futures targeting.  That is the sense that the Fed caused the crash of 2008.  If the Fed had been doing what it should be doing (targeting the forecast) the crash never would have happened.  That is the “practical implication” of my causality argument.



23 Responses to “Would you have blamed the Fed for this policy?”

  1. Gravatar of JimP JimP
    19. May 2009 at 07:58

    In the attached article from Bloomberg the following quote appears. Lets hope the Fed is reading – but I would not bet on it.

    Start of quote:
    John Makin, a principal at hedge fund Caxton Associates in New York, wants the Fed to go further and target the level of prices instead of simply a rate of inflation. Such a policy would mean that if inflation fell short of 2 percent over a period of time, the Fed would have to push inflation above that rate subsequently to make up for the shortfall and keep prices rising on the desired trajectory.

    While that might sound radical, it’s the same sort of policy that Bernanke advocated Japan follow in 2003 to fight deflation. In a speech in Tokyo that year, then-Fed Governor Bernanke called on the Bank of Japan to adopt “a publicly announced, gradually rising price-level target.”
    end of quote


  2. Gravatar of Bob Murphy Bob Murphy
    19. May 2009 at 08:44

    Scott wrote:

    he Fed cut rates to below 2% and raised the base sharply in the 1930s. Are most economists prepared to argue that money was “easy” during the early 1930s? I don’t think so.

    Ah, but I accept your challenge eagerly. I grant you that most mainstream economists are inconsistent, and so you think you’ve won.

    But I offer (again) my own consistent vision: Printing green pieces of paper doesn’t make the economy richer or help us pull out of a bad recession. The Fed had very easy policy back in the early 1930s–it cut discount rates down to record lows, and grew the monetary base (after a brief drop). The result? The worst decade in US economic history.

    In contrast, during the 1920-1921 depression, the NY Fed raised discount rates to record highs, and the monetary base contracted the most in US history. (See graph here.) The result? Arguably the most prosperous decade in US history.

    Why people from the Chicago School think we need central planning in money and interest rates is beyond me.

    Scott, a final question: If we’re still stuck in a recession a year from now, are you going to say, “Many people thought 0% nominal interest rates and a doubling of the base in 6 months were ‘easy money,’ but they must not have been”? In other words is there any way to disprove your worldview, or would the continued failure of record-easy policies just prove they weren’t easy enough?

    (I realize I may sound very hostile in this comment; I don’t mean to.)

  3. Gravatar of Lord Lord
    19. May 2009 at 13:59

    I do find this a very intriguing approach, though I think there is probably a learning curve during which the market determines how to interpret the Fed, how much faith to place in its pronouncements, how effective they believe its actions may be, how long before they expect it to show up in the data, etc. If we had such futures in the past, if we had experience using them, we might be in a much better position to anticipate their results and form expectations accordingly. Would public targeting promises that were disappointed lead to doubts about belief, will, efficacy and dashed expectations? Would the market be impatient or overly patient? Would the actions calm or worry? Would expectations switch between bipolar extremes at the slightest change in data?

  4. Gravatar of JimP JimP
    19. May 2009 at 16:42

    The Fed just refuses to act. Again – I find the whole thing almost beyond comprehension. As that quote from Bernanke given above shows – he is well, very well, aware of all of this – and just sits there doing nothing whatever about it. EarlT proposed in his article that Obama should call Bernanke in and flat fire him – for gross incompetence. Thousand of families destroyed. Lives ruined – because there is just to little cash money around. It is utterly insane. It is just beyond my ability to grasp. A whole era defined – and destroyed.

  5. Gravatar of ssumner ssumner
    19. May 2009 at 17:20

    JimP, I like that quotation. I just mentioned level targeting in a reply to a more recent post. The idea of catch-up if you fall behind is the true test of a central bank’s commitment. If they get 1% inflation this year they should go for at least 3% next. Will they make that commitment?

    Bob, There’s a lot there, but a few points.

    1. I actually think 1920-21 and 1929-30 are very similar. The base fell about 7% between October 1929 and October 1930. Hoover’s high wage policy made things worse. After that, the rise in the base merely reflected the Fed partly (not completely) accommodating the increased cash demand during banking panics. It wasn’t expansionary, which is why the price level fell during the 1930s.

    2. If we get the 10% inflation you predict for later this year, or even close, I’ll have a lot of crow to eat.

    3. I don’t know if we need central planning in money, but if we have it I’ll try to give them advice so that they don’t drive the economy off a cliff.

    4. No, you didn’t sound horrible.

    Lord, I can’t fully address your question. But my view is that while markets are often wrong (the world is complex) they are pretty good at figuring out what policymakers are up to. If the policy has no crediblity (as in Japan) there are probably good reasons for the markets to be skeptical. So I don’t worry too much about spontaneous irrationality in the markets. Predicting GDP or inflation in futures markets is very different from speculating in condos in Miami Beach. Many of the institutional factors that explain the housing bubble, for instance, are not applicable to well defined problems like forecasting inflation.

    JimP, I go back and forth. Earl’s argument seems logical. But how can Obama fire him when 90% of economists don’t blame the Fed, probably including Obama’s other advisors?

  6. Gravatar of JimP JimP
    19. May 2009 at 17:53


    Obama has said he is the next Roosevelt. Fine. Let him act like Roosevelt then. Obama should give Bernanke the political backing he (Bernanke) needs to do what he (Bernanke) presumably wants to do. Set a price level target and stop paying interest on reserves. For my money Obama is all talk and Bernanke just cant do openly inflationary things without political cover. I blame Qbama much more in this than I do Bernanke.

  7. Gravatar of ssumner ssumner
    20. May 2009 at 04:34

    JimP, I think that is a really good point. It is possible that Bernanke wants to do more. The article linked to in my “former central banker” post suggests most but not all FOMC members support inflation targeting. That may be a problem. My fear is that Obama (like most economists) thinks that monetary policy is already expansionary.

  8. Gravatar of JimP JimP
    20. May 2009 at 09:38


    If Obama thinks that then he should read your blog. Or – check out the stock market. Obama should notice the difference between the market rise early in Roosevelt’s first term – now that was confidence in action – confidence as correctly defined by you as confidence in future positive NGDP – vs the pitiful damp squib of these early days of the Obama administration.

    He is no Roosevelt. Which I think is really really too bad.

    He just does not have Roosevelt’s joy. Roosevelt’s supreme confidence in himself. And boy oh boy could we use that now.

    Rather – we have the FT, Baseline, Krugman, all the gloomsters – telling us that this is some deep profound existential crisis. Telling us we are doomed unless we totally reorganize everything – to the benefit of big government of course.

    That is just false. It is a simple mistake – in inflation targeting. What a total shame.

  9. Gravatar of Thruth Thruth
    20. May 2009 at 09:58

    I find it odd that James Hamilton believes that the oil price run up and not a housing bust or monetary shock is the root cause of our ills (Today’s JEC testimony):


    “The price of oil doubled between June 2007 and June 2008, a bigger price increase than in any of those four earlier episodes. In my mind, there is no question that this latest surge in oil prices was an important factor that contributed to the economic recession that began in the U.S. in 2007:Q4.”

    later he says:

    “Could anything have been done to prevent this? The decision by the Federal Reserve to drop interest rates so quickly in the first few months of 2008 likely contributed to some of the commodity price speculation.”

    but he also says:

    “The reality is that no policy could have prevented a substantial increase in the price of oil between 2005 and the first part of 2008.”

    Any idea what he’s thinking here Scott? He seems to be implying that monetary policy becomes ineffective in the face of sharply rising commodity prices. Maybe I’m reading too much into this.

    My reading is the initial sub-prime bust drove money into safe assets, both Treasuries and commodities. The commodity run-up was extreme but in line with short-run inelastic supply and no more extreme than the flight to Treasuries (there’s a side argument about evidence of commodity stockpiling that needs to be dealt with, but I’ll ignore). Despite this, everything was sailing along ok in the aggregate, except that Fed actions to date were more just kicking the can down the road than creating real solutions for the banks. When the dam finally broke in September, the Fed was caught flat-footed and deflationary expectations set in. With TARP, Stimulus and guarantees up the wazoo, expectations at least have the right sign now, but we’ll see for how long. How’s that sound?

  10. Gravatar of ssumner ssumner
    21. May 2009 at 03:07

    JimP, Yes, every time a country experiences deflation, people always blame it on something other than monetary policy. It is usually blamed on the symptoms of deflation.

    Thruth, I also have trouble with Hamilton’s hypothesis. He seems to be hinting that money should have been tighter in early 2008, but that would have made the recession even worse. I strongly disagree with one of your assertions however, the idea that increased financial risk drove money into commodities. Very few investors have any interest in hoarding commodities (where would you put it all?) They might buy commodity futures, but that doesn’t impact the spot price. In addition, when the financial crisis got much worse last fall, commodity prices fell sharply. I also notice a disturbing tendency of people in this blog to talk as if commodity prices are determined in the US. They are determined in world markets, and shifts in world economic growth are the key driving factor. There is nothing at all “mysterious” about the world commodity boom and bust. Commodities boomed when the developing world boomed, and fell when developing world slowed sharply. China alone used nearly half of the all world’s cement in 2008. We are small potatoes by comparison. They also led world consumption by a wide margin in coal, steel, etc. The Fed can have some effect on world commodity prices—but not by affecting interest rates, rather by affecting (world) economic growth rates. Commodity prices correlate with world growth, they don’t correlate with US interest rates.

    According to Hamilton, shouldn’t the US have boomed late last year when commodity prices fell?

  11. Gravatar of Thruth Thruth
    21. May 2009 at 05:21

    “I strongly disagree with one of your assertions however, the idea that increased financial risk drove money into commodities. Very few investors have any interest in hoarding commodities (where would you put it all?)”

    As an asset pricing guy, I’m having a tough time understanding what would be so disagreeable…

    The run up started precisely at the time securitization markets started to break. Coincidence? Which country was long a lot of US paper and uses a lot of commodities? Isn’t that country’s manufacturing sector inexplicably growing.

    I don’t think you need a lot of hoarding to get a short-run price run up – your “where would you put it all” line is precisely the reason.

    “They might buy commodity futures, but that doesn’t impact the spot price.”

    ?? The basic futures pricing relation says the futures price = spot price + adjustment for carry. If the futures price is going up, the spot is coming with it (albeit imperfectly due to frictions).

    Investor goes long futures creating excesss demand for futures, so someone needs to be induced to go short. The natural candidate are the producers. Now they’re committing to deliver actual commodities in the future. They do that by piling up inventory or ramping up production. The efficient trade off between those raises spot prices today.

    “I also notice a disturbing tendency of people in this blog to talk as if commodity prices are determined in the US.”

    Not being a US citizen, I certainly don’t hold this view, but given the US share of world GDP, it would be hard to believe US conditions don’t play a big role. International capital mobility is extremely high — capital price shocks in one part of the world hits prices in other sectors and other parts of the world pretty quickly.

    “There is nothing at all “mysterious” about the world commodity boom and bust. Commodities boomed when the developing world boomed, and fell when developing world slowed sharply.”

    Are we talking about the same commodity run up? July 2007 through July 2008: http://futures.tradingcharts.com/chart/RC/M

  12. Gravatar of Thruth Thruth
    21. May 2009 at 06:25

    just to be clear

    “Commodities boomed when the developing world boomed, and fell when developing world slowed sharply.”

    I agree that this is the right story for the longer term run up from about 2002. (However, I suspect the boom in those countries is linked to the US credit splurge over the same period)

  13. Gravatar of Scott Sumner Scott Sumner
    21. May 2009 at 10:17

    thruth, I understand the connection between spot and futures prices. As you say, it requires hoarding by producers or someone. Only one problem there–world oil production actually increased between mid-2007 and mid-2008, unless I am mistaken. So the hoarding theory doesn’t explain things. Thus speculation didn’t cause the bubble.

    The U.S. is a big country, but places like China are driving the world commodity boom as their consumption is rising much faster. I think China uses nearly 50% of cement, and 30% plus of coal, iron, copper etc. When you look at rates of change the effects are even more dramtic. If the steep recession hadn’t occurred last fall, I see no reason why the “bubble” wasn’t sustainable. The Chinese car market is exploding, and there are a lot of Chinese and not much elasticity to the supply of oil.

    In general, real asset prices never change because there is extra money sloshing around looking for a home. In fact money cannot “go into” a market, there is no “into” for it to go. Every transaction is a purchase AND sale. Asset prices change because the expected future conditions in the particular asset market change. Oil went up in 2007-08 partly because investors rationally thought Chinese demand would stay high for quite some time. They were wrong. (Of course nominal prices are impacted by inflation (and hence money), but we all agree the commodity bubble was about more than CPI inflation. The real price of commodities soared.)

  14. Gravatar of Thruth Thruth
    21. May 2009 at 12:05

    Scott, I definitely think we’re talking past each other. I think you might have misinterpreted my original post and I didn’t do anyone justice in my follow up.

    “I understand the connection between spot and futures prices. As you say, it requires hoarding by producers or someone. Only one problem there-world oil production actually increased between mid-2007 and mid-2008, unless I am mistaken. ”

    My story is that the financial fallout in Summer 07 caused the equivalent of a large positive demand shock for commodities. With an inelastic supply curve, we would see a slight increase in production and a massive jump in price. That’s what we saw, right?

    On re-thinking, I think it’s irrelevant whether there is hoarding or not. It doesn’t matter to me if the commodities were put to immediate use or stockpiled (we’ll never really know). My point was and is that the price rise was a rational response to the banking crisis — the global economy began shifting out of financial services production and into real commodity based production (in relative, and maybe absolute, terms). From a portfolio allocation perspective, commodities are a counter cyclical asset class (in as much as banking assets are pro-cyclical), hence their rise in value.

    So from my perspective, Hamilton is focusing on a symptom of the crisis not a cause (if there is one).

    “So the hoarding theory doesn’t explain things. Thus speculation didn’t cause the bubble.”

    My story wasn’t intended as a “speculation” story. As I said, I think there are rational reasons (risk-based or otherwise) for the shift.

    “In general, real asset prices never change because there is extra money sloshing around looking for a home. In fact money cannot “go into” a market, there is no “into” for it to go. Every transaction is a purchase AND sale.”

    I know this as well as you. I was being clumsy in my follow-up post.

    “Oil went up in 2007-08 partly because investors rationally thought Chinese demand would stay high for quite some time.”

    by official statistics, the Chinese only account for 10% of oil consumption, the US twice that much. I’m sure there’s an anticipation of China’s rising share, but I’m not sure that was news to anyone in the summer of 07.

    Production/consumption stats

  15. Gravatar of ssumner ssumner
    21. May 2009 at 14:19

    Thruth, I still don’t get your point about oil prices. When I said that future transactions don’t directly raise oil prices, you correctly said that expectations of higher oil prices might have caused producers to keep it in the ground. My production data showed that didn’t happen. And by the way there was a lot of study of oil stocks above ground, and they also weren’t unusual. So here is what happened between 2007 and 2008—people actually consumed more oil, despite the high price. What happened is that even though Americans consumed less, the Chinese consumed a lot more. This extra demand bumped up against higher prices

    Financial instability might cause more demand for stocks of commodities as an investment. But it did not.

  16. Gravatar of bob bob
    21. May 2009 at 16:18

    I have to agree with Thruth here.

    The financial instability cause a huge demand for commodities as investment – just look at the USO holdings of futures contracts last spring. Airlines don’t buy ETFs to get their oil.

    I’m increasingly coming to the conclusion that academic economists have pretty close to 0 comprehension of how commodity futures markets actually function (this is really not even directed at you Scott). They don’t even understand the theory of futures pricing, let alone the real world nitty-gritty.

    Evidence: Krugman spent weeks elaborating a model of futures pricing that failed to rise to a WIKIPEDIA level of understanding of futures pricing. He admitted his error, but it was Steve Waldman (a trader) who pointed it out after it was missed by more or less every single academic economist who reads Krugman’s blog – a list which would include Mankiw, DeLong, Hamilton, Thoma etc. etc. etc. None of them caught an extremely basic error that anyone who can read wikipedia would see, and every trader/manager/analyst would have to know in order to pass the CFA. Many traders were reading the debate about speculation, scratching their head and wondering what fantasy world these academic economists live in where it is impossible for speculation to affect prices without a build-up in inventories – a patently false claim. Michael Masters got lambasted by Krugman & co., but really all they succeeded in doing is displaying their own ignorance for all the world to see.

    This paper is a complete embarrassment for Krugman (he knows it), but can you spot the absurdly basic error?


    Here’s the hint:


    How can a Nobel prize winning economist pose as an authority on oil pricing, when he is completely ignorant of the most basic aspects of futures pricing?

  17. Gravatar of Thruth Thruth
    21. May 2009 at 18:27

    Let me give this another shot. This issue has really been bugging me, so indulge me one more time.

    >Financial instability might cause more demand for stocks of
    >commodities as an investment. But it did not.

    I’m claiming: “Financial instability caused more demand for stocks of commodities.” The “as an investment” clause is superfluous.

    Commodities are both an investment and a consumption good. If you believe in intertemporal optimization (which as an EMH devotee, you must to some degree) then at the margin you believe that markets are equating the value of the two uses. Thus, you can say the consumption value went up, I can say the investment value went up and we are both right.

    I don’t think the oil production/consumption stats really address the causality issue either way. One plausible causal explanation for rising oil production and consumption is that it simply had to keep rising to make up for the lost output linked to the financial sectors (i.e. worldwide monetary and fiscal stimulus were working to keep AD up over the period). I think the bigger story is that the prices were indicating that the market participants believed commodities were the safe play.

    I’m coming at this from the perspective of parsimony, Scott. From mid 2007 we learned of the increasingly dire position of the world financial sector. Bank stocks have declined steadily since. At the same time, commodity prices ran up steeply. I just find it hard to believe the commodity run up was due to some independent shock. Was there unanticipated news about China et al that wasn’t connected to this crisis?

    I realize your monetary story is an easier sell if you can diminish the importance of the original crisis. But to me it defies logic to think that turmoil in one sector wouldn’t have implications for others. None of that rules out the central role of monetary authorities in accommodating such shocks, right?

  18. Gravatar of Lawton Lawton
    21. May 2009 at 19:19

    Maybe there’s a middle ground on terminology. Even if you’re right in the abstract about “cause”, the word is a sticking point and makes it harder to communicate the important policy implications.

    Suggestion: every time you start to use the word “cause”, think of a way to rephrase, or at least qualify it. For example: the ship’s captain analogy is good, though may only have been in a comment rather than a post. Use it or similar over and over. Or, something like: “the Fed’s incorrect response in the fall turned a mild recession into a major crises”.

    It’s important to have a 30-second “elevator pitch” or sound-byte that’s convincing … and that doesn’t get dismissed over semantics.

  19. Gravatar of ssumner ssumner
    22. May 2009 at 16:26

    Bob, I will have a new post soon, and you can tell me what is wrong with my new post. I won’t talk about things I don’t understand, like “contango” (who thought up that term?) The other difference from Krugman is I will allow hoarding by producers, he just allowed consumer hoarding.

    Bob and Thruth, The humor in the new piece I plan isn’t directed at you guys–now that I understand where you are coming from your observations seem reasonable.

    Thruth, OK, if it’s an argument that resources in banking shifted to more energy intensive industries, that’s OK. But I don’t totally buy the argument that “it can’t be coincidence” about the oil shock and banking shock occurring at the same time. Traditionally both oil shocks and housing crises come near the end of long upswings, don’t they?

    BTW, even if I am totally wrong about oil, it doesn’t weaken my money argument. That is because oil shocks reduce RGDP, not NGDP.

    I also don’t think “safe play” is the right term for the commodities. When oil is $140, isn’t that a pretty risky investment? Almost everyone realizes what goes up may come down. I think you need some sort of expectations of continued real growth, to supplement your other arguments.

    Lawton, The advice you give is good from a pragmatic perspective. But I also think people don’t realize that the model of monetary policy that they have in their heads may be flawed. Most people have some idea of what it means to say “the Fed didn’t change policy.” But here’s the problem, these ideas are mutually contradictory. So you could put 30 people in a room, and they’d all think I’m nuts. But when they started talking among themselves, they’d think each other was nuts. Example: I know many people (including many well-known economists) who think the Fed “caused” the Depression by reducing M1 and M2 by 30%. And guess what, they are using “cause” in exactly the same way I am. But they don’t get criticized the way I do. Which means I am being criticized for the wrong reasons. The Fed doesn’t directly control M2. They try to influence by changing their monetary policy tools. The Fed doesn’t even directly control interest rates, they target them. The Fed doesn’t directly control NGDP expectations, they target it. In each case if the variable in question moves in a contractionary way, you could argue the Fed “caused it,” or allowed it to happen. So people should feel free to criticize my use of “cause,” but only if they are equally critical when their friend says the Fed “caused rates to fall to zero.” But by your argument they didn’t cause rates to fall to zero, they failed to move the monetary base in such a way as to prevent rates from falling to zero. I still don’t think many people understand this point. Yes, from a practical perspective you are right. But I am stubborn. I just read a paper today sent me by Josh where some well known economists basically took my view. They said a neutral monetary policy was one that kept the economy in macro stability. It was one of three “plausible” definitions they offered.

  20. Gravatar of Lawton Lawton
    22. May 2009 at 21:03

    > “I also think people don’t realize that the model of monetary policy that they have in their heads may be flawed.”

    Agreed! Does the word “cause” help force them to change it, or is it a barrier to educating them? I suspect the latter — but there’s no way to know for certain.

    Another compromise: sometimes use “cause” but sometimes use more long-winded versions … or an asterisk to a footnote with your captain analogy. (Which is quite clear, and perhaps even deserves its own post.)

  21. Gravatar of ssumner ssumner
    24. May 2009 at 07:21

    Lawton, You may be right. I think the key is I need to keep changing my arguments, to try to convince people from many different perspectives. The captain analogy is something I could do a blog on, it might be a different way of making my point.


  22. Gravatar of reader reader
    25. May 2009 at 07:13

    When referring to your previous posts, could you also include a hyperlink? It makes it easier to follow your thoughts

  23. Gravatar of ssumner ssumner
    25. May 2009 at 16:42

    Reader, Yes, That’s a good idea.

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