David R. Henderson  

Sumner on the Big Macro Debate

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Lots of brilliant people talking past each other. Lacking a common language for communication. Welcome to elite macroeconomics, circa 2011.

The right doesn't think we need more NGDP [Nominal Gross Domestic Product] and the left doesn't understand that the Fed is our only realistic hope for more NGDP. Welcome to elite macroeconomics, circa 2011.

If I was going to assign blame I'd single out Krugman/DeLong for rudeness and Fama/Cochrane for poor communication skills. But of course I have no business attacking such distinguished economists.


This is from Scott Sumner's latest post. I think this is one of the best posts Scott Sumner has done this year. Given the average quality of his posts, that's a high bar. He explains the debate between Fama/Cochrane and Krugman/DeLong and tells where he stands on the debate.

In the last two years, no economist has affected my views of macro/monetary policy more than Scott Sumner. Unlike Scott, I would like to abolish the Federal Reserve Board. But if it's going to exist, I agree with Scott that it should be increasing NGDP as a way out of the rigid wage problem.

Scott has distinguished himself, which means he is a "distinguished economist." So, yes, it absolutely is proper for him to "attack such distinguished economists." Although I wouldn't call his post an attack. It's simply a clarification and a holding of various other economists to account.


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COMMENTS (11 to date)
Silas Barta writes:

Et tu, David? Now you've bought into the story that shuffling more green pieces of paper between people would get the economy back on a firm basis?

Yancey Ward writes:

This is perhaps a very naive/stupid question, but on the rigid wage problem, why are wages rigid downward, but not on the upward side?

Alex J. writes:

Silas, if in the right circumstances, shuffling fewer pieces of green paper would weaken the economy, then there are circumstances where shuffling more pieces of green paper would strengthen it.

Yancey, because workers are happy to take raises, and unhappy to take pay cuts. I think the paradoxical asymmetry is between employers and employees. Perhaps people running a business are more capable of thinking like economists, or maybe employers would be just as upset, but there are fewer of them?

Julien Couvreur writes:

"But if it's going to exist, I agree with Scott that it should be increasing NGDP as a way out of the rigid wage problem."

That makes no sense. If you'd rather it didn't exist, then it should behave as discretely as possible (almost as if it didn't exist). That means avoiding big interventions. Rather it should either hold the supply of (hard) money constant, or close to constant, so that it does not create yo-yo effects.

Silas Barta writes:

@Alex_J.: Silas, if in the right circumstances, shuffling fewer pieces of green paper would weaken the economy, then there are circumstances where shuffling more pieces of green paper would strengthen it.

By tautology, sure. But NGDP targeting involves making nominal transfers happen that people wouldn't otherwise make, which puts it in the category of paying people to dig and refill holes. Is that one of those cases where shuffling green pieces of paper around strengthens the economy?

Scott Sumner writes:

David, Thanks for the very kind post.

In response to some commenters, I favor NGDP futures targeting, where the market determines the money supply and interest rates, not the Fed. But given we have a busybody Fed right now, I'm trying to reduce the damage they do. I'm not trying to use the Fed to "solve problems," rather stop them from causing them.

Yancey has a good question. In theory wages should be sticky in both directions, and they are to some extent (i.e. slow to adjust.) However there is strong empirical evidence (for instant in a wages post Krugman did two weeks ago) that they are much more sticky in the downward direction, when at the 0% change level. This is actually hard to square with rationality, and some attribute it to money illusion. The term 'money illusion' means that workers are more willing to accept a 1% raise during 4% inflation, than a negative 1% raise during 2% inflation. It's not rational, but seems to exist.

Lord writes:

Unfortunately, the Fed has proven it not a realistic hope at all.

fundamentalist writes:

Forgive the off topic post, but I though Dr. Henderson would be interested in something I found that relates to Cowen's Great Stagnation book, which Dr. Henderson has reviewed.

From “Business Cycles” by James Arthur Estey pages 135, 136. Prentice-Hall 1950.

“It is conceivable that the depression [Great Depression] that hung over this country for a decade was not merely the result of the various forces analyzed above…Some have held that capitalism has reached a turning point and that the driving forces that made it such a powerful engine of economic well-being have lost their vigor…In short, progress, so characteristic of the nineteenth century, may have been interrupted, and the long upward trend checked at last.
“This problem of what has come to be known as ‘secular stagnation’ was presented by Alvin H. Hansen in his 1938 Presidential address to the American Economic Association, and we may well follow his analysis.14
“The great economic expansion of the last century was based on the triple foundation of: (1) technical innovation and the rise of new industries based thereon, (2) the opening up of new territory or new resources in old territory, (3) the growth of population. These three sources were the prime causes of that great and continuous increase of capital formation and investment that gave the period its vigor. Through them was made possible not only a continued rise in the level of real income, but also a fairly full employment of the productive resources, human and other, of the country. Apparently, only through great capital investments has reasonably full employment been reached…
“These foundations of our economic structure, it is argued, are beginning to be threatened. Population growth is declining, even in the United States…The world’s frontiers are closing. The era of development and settlement of new territory is coming to an end…Technology and invention will have to be responsible for perhaps twice as much capital investment as when population and new territory played their part.
“As stagnationists see the matter, this is asking too much from technology. With well-to-do societies continuing to accumulate harge volumes of savings, and with newer industrialized areas adding their quota to the flow of saving, the pressure on investment outlets will continue to be severe.”

14. A. H. Hansen, “Economic Progress and Declining Population Growth,” American Economic Review, March 1939, pp. 1-15.

Justin R. writes:

"But NGDP targeting involves making nominal transfers happen that people wouldn't otherwise make, which puts it in the category of paying people to dig and refill holes. Is that one of those cases where shuffling green pieces of paper around strengthens the economy?"

One thing I always try to bear in mind when analyzing monetary policy: money is just like any other good - when you restrict supply, you cause disequilibrium when demand changes.

If we consider the non-government form of money (e.g. free banking, most likely under a gold standard), during a recession a similar expansionary process would occur. As the demand for money increases, banks would create/print more, either to satisfy depositor demands or to benefit from the fact that their (the banks') money can buy more assets as the relative value of money increases. This process works in reverse as the economy recovers

With this countercyclical note creation and adjustments in the gold market, we would expect nominal output to stay around zero (though new discoveries of gold would trigger one time inflationary jumps). Hence, Scott's idea of targeting NGDP via a futures market mechanism is IMHO a second best alternative.

David R. Henderson writes:

@Justin R.
Absolutely right! That's why I said I want to get rid of the Fed. And your point helps make my response to Julien Couvreur's point. If we're stuck with the Fed in the short run, I want it to act as close as possible to how a free market in money would act.

johnleemk writes:

David, Justin R.,

Exactly. One great point Scott and other commenters on his blog have repeatedly made is that if the Fed does not touch the money supply at all, that is still monetary policy. "Hard money" is as much a monetary policy intervention as "soft money" is.

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