Arnold Kling  

Scott Sumner, on One Foot

What Leonhardt Leaves Out... Politics is Not About Policy...

From his own blog

I have a very unconventional way of thinking about the monetary transmission mechanism. A monetary shock is essentially a change in the future path of the money supply relative to velocity, in other words, a change in the expected NGDP growth. If the NGDP target is 4%, for instance, than an expected NGDP growth rate of 3% is tight money, and an expected NGDP growth rate of 6% is easy money.

The Taylor rule says that you adjust interest rates by a specific amount in response to recent past performance of inflation and unemployment. The Sumner rule says you do whatever it takes to make market indicators of expected future nominal GDP growth hit your target.

A question that I discussed at lunch and afterward with some George Mason folks and John Haltiwanger of Maryland is: why didn't Ben Bernanke expand the money supply more last fall? Possible answers.

1. He did not really foresee how badly things would turn out in terms of unemployment. Sumner would say that Bernanke should have looked at the market indicators that suggested very low nominal GDP growth going forward.

2 (or perhaps 1a). He thought that as long as there were no major bank failures, the economy would not do too badly.

3. With interest rates at zero, he needed to do quantitative easing, for which he lacked the authority, and Henry Paulson would not co-operate (Tyler Cowen seems to like that explanation).

I lean toward (2). He was more worried about the banking system than the rest of the economy.

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COMMENTS (9 to date)
Tyler Cowen writes:

I wouldn't quite say he lacked the authority, I sooner interpret it as needing Treasury to "cover" his more speculative balance sheet and not receiving an OK on that score. We haven't had an independent central bank lately.

winterspeak writes:

This encapuslates what Scott does not understand about the monetary system he studies.

He seems to believe that bank reserves are in some way connected with 1) credit extension, and 2) spending.

How else can you interpret "a change in the future path of the money supply relative to velocity"?

Unfortunately for him, bank lending is not reserve constrained, and hasn't been for quite some time now, and 2) private sector spending is likewise unconnected with money supply.

The Sumner rule also focuses on monetary policy, and does not allow for fiscal. That's actually a blessing in this case.

q writes:

i generally believe with #2, but...

perhaps bernanke did not have metrics to gauge the sensitivity of the economy (ie output gap etc) to the size of his balance sheet. how much do we know about that? i remember krugman claiming in his blog, on thin evidence, that a balance sheet expansion of $10 trillion would be required to fill the output gap.

he may also have been thinking that some large bank balance sheets (ie citigroup, or some of the GSEs) were likely to be explicitly taken on by some combination of the treasury and fed, and he may in fact have been surprised that this did not happen.

in any case 'filling the output gap' is a very different animal from 'creating inflation expectations'.

but again, was he prepared to do something that was tailored toward changing expectations without any data with which to calibrate the size of his move? it's not as if he had any kind of tight feedback loop -- too small or too large and, well, major screwup.

to me, it's amazing that we don't have a less painful way of dealing with deflation.

q writes:

by the way, i believe the way that the scott sumner story and the recalculation story are connected is through inflation expectations. people will think and behave differently depending on whether their perceived universe is expanding or contracting.

Jorge Landivar writes:

Other options:,
* He did expand the money supply enough, but didn't foresee the effect of paying for interest on reserves?

* He did expand the money supply for what would have been enough, but the bailouts kept firms that would have otherwise gone out of business from going out of business. These "zombie" firms "soaked up" a lot of the extra money.

* The problems in the economy were structural and just expanding the money supply wouldn't fix them


The above is just my speculation, however your option (3)... I was pretty sure he did do quantitate easing by buying treasury bonds and other securities?

Jorge Landivar writes:

I have an question for you guys.
How does this question of how to properly price the loans from the federal reserve differ significantly from the pricing problem in the socialist calculation debate.

I don't really know an answer to this and can't figure it out, so I was wondering if one of you knew the answer.

Josh writes:


While it is true that the original work on the Taylor rule was based on past (or contemporary) values, there has been a great deal of work in the last few years that utilizes a Taylor rule in which the monetary authority adjusts the interest rate to expected inflation. In fact, I would argue that this has become more of the standard in recent years.

Scott Sumner writes:

I mostly agree, but . . .

It is factually incorrect to say interest rates were at 0% last fall. In early October when the economy was clearly falling off a cliff, the fed funds target was 2%. On October 6th the Fed started paying interest in reserves, and stated that the purpose of the policy was to prevent interest rates from falling below 2% as they added reserves. In other words, to encourage banks to hold the extra money, not lend it out.

I don't see why people say Bernanke lacked authority to do QE. He doubled the monetary base in the fall of 2008. Had that been done without paying interest on reserves, it would have constituted QE.

BTW, I think the recalculation story is not enough to explain severe cycles, but I do agree with your asymmetry point in another post.

Tom Dougherty writes:

Second quarter NGDP is down -2.4% year on year. If Bernanke had engaged in more traditional central banking actions of expanding the money supply by purchasing treasury securities instead of engaging in completely unconventional activities of buying assets of dubious value and paying interest on reserves, then do you think he would have been able to prevent NGDP from falling as much as it did?

It seems to me that because the focus was misdirected toward bank bailouts and the financial sector in particular he failed to prevent or mitigate the fall in NGDP of the overall economy. I think with the passage of time we may question Bernanke's unconventional Central Banking activities. Bernanke more than doubled reserves at what traditionally might be considered an alarming rate, but since he was paying interest on those reserves they ended up as unused excess reserves.

Couldn't Bernanke, using the traditional methods (pre-September 2008), have had a smaller and not so alarming increase in reserves using Treasuries but with a greater impact on the money supply to mitigate the fall in NGDP?

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