Bryan Caplan  

Sumner on Why Friedman Was Too Klingian

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Caught My Eye... Responses to Two Critics...
Milton Friedman famously argued that "money matters," but he had a caveat: Money matters with long and variable lags.  Over at Cato Unbound, Sumner suggests that even Friedman was far too Klingian:
Most economists assume that interest rates or the money supply are good indicators of the stance of monetary policy. Because of this they mis-identify monetary shocks, and this leads to estimates of long and variable lags in the effect on NGDP. But this view is hard to reconcile with the fact that when shocks are easily identifiable, the lags seem very short.
Sumner's key test cases:
The most expansionary monetary shock in U.S. history, by far, was the 1933 dollar devaluation and the decision to leave the gold standard. During the first four months of this policy, the WPI rose by 14 percent and industrial production soared 57 percent, regaining half the ground lost in the previous 3 ½ years. And these stunning gains in nominal output occurred during one of the worst financial crises in American history, when much of the banking system was shut down for months. Other easily-identified monetary shocks, such as the 17 percent decline in the U.S. monetary base between late 1920 and late 1921 had an immediate and severe impact on both prices and output.
Do any Klingians care to comment?


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COMMENTS (7 to date)
Todd writes:

Maybe I'm misreading Arnold, but I thought the point wasn't that the Fed couldn't influence nominal GDP at all, but rather that it couldn't do it in a precise and responsible manner. If that's the case, and unless the Fed was actually targeting the movements in GDP that occurred, then it seems to me that the examples provided by Sumner would actually support the Klingian position. After all, I thought what we wanted from the Fed was the maintenance of a stable environment in which real economic growth could take place.

Paul Zrimsek writes:

How come you deleted the comment from the Klingon? I thought that was pretty good.

George writes:

This is only tangentially related to the post, but:

I frequently find myself needing to look up acronyms used on EconLog (e.g. WPI). It'd be nice if you added a little search box on the left side that let readers enter economic abbreviations and get relevant decodings.

CK writes:

As Todd says, I suspect none of us are really arguing that dramatic monetary policy can't affect NGDP.

The issue I see is that grand monetary policy (dropping the gold standard) may in practice be a completely different creature than petty monetary policy (moving the interest rate a quarter-point or three).

To the extent that expectations are a primary effective mechanism of monetary policy, the speed at which knowledge of the policy change spreads, and its emotional impact, would clearly be quite important.

"Small" policy changes have measurable effects quickly on the money center banks whose policy changes will long-and-variably lag their way to your barber, who may over a year or three adjust his practices almost unconsciously in response. Meanwhile, grand policy makes front-page news and and becomes the subject of conversation while you're getting your hair cut.

Pace Friedman, such changes may in fact not have long and variable lags, at least for their initial effect. It's like comparing a policy of lower interest rates (which make car loans more affordable) against Cash for Clunkers, which if you were in the auto industry, might as well have been monetary policy.

fundamentalist writes:

"Most economists assume that interest rates or the money supply are good indicators of the stance of monetary policy. Because of this they mis-identify monetary shocks, and this leads to estimates of long and variable lags in the effect on NGDP."

That's nonsense! All you have to do is perform a distributed lag analysis regressing many years of money supply data against cpi or wpi. It's not rocket surgery, for crying out loud! Anyone who has a decent statistical program can do it. You can even do it in Excel if you have the time to set up the data. The statistical proof is there for anyone who cares about the truth. Sumner just ignores the fact so he doesn't have to give up on his pet theory. Facts are hard on most theories.

Bill Woolsey writes:

Todd:

Kling says that velocity will change to offset the increase in the quantity of money. I don't know what you mean by increacing nominal GDP in a responsible manner, but there is no doubt that the danger is overshooting. Or undershooting. The point is that the expected value of nominal GDP should be on target. If Fed says that we expect it to remain below target next year, it is saying that we have set base money too low.

What they should say is that with current unsettled conditions, we could see weak recovery or else a strong recovery and growing inflationary pressures. (We may undershoot or we may overshoot, but because we have uncharted territory, our confidence is less than usual.)

winterspeak writes:

The Fed cannot impact the velocity of money because there is no such thing as a "money multiplier", ie. bank lending is not reserve constrained in any way.

Woolsey and Sumner have never spoke to anyone who actually manages reserves in a bank, otherwise they would know this.

And since reserves have no linkage to bank lending (or velocity) there is no transmission mechanism for any of their "theories". Their arguments boils down to 1) "make people think there will be inflation so they will spend more, never mind if they are income constrained" and 2) "throwing money out of helicopters is too monetary policy, although it is indistinguishable for fiscal policy at that point."

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