Arnold Kling  

Awaiting Comments from Scott Sumner

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Two papers on Milton Friedman's monetarism (both in the same pdf), one from Jerry Jordan and one from Allan Meltzer. They come from a 2010 symposium sponsored by the LIberty Fund and the Pacific Research Institute, and they are reproduced by the Macdonald-Laurier Institute.

I will excerpt from the Meltzer paper. But first, let me quote from the media release of Macdonald-Laurier.


In a period of runaway monetary stimulus by the industrialized world...

I do not think that Scott Sumner would characterize the monetary situation that way. To be fair, neither Jordan nor Meltzer characterizes it that way.

Meltzer reviews the Keynesian-monetarist debate of the 1960s and 1970s in a way that I think is broadly similar to part 2 of my "million mutinies" essay series.

Later, Meltzer writes,


The best writers, including Jevons, Marshall, Fisher, Wicksell, and Keynes, were concerned not only with long-run stability of the price level or exchange rate but also with the costs experienced in achieving that goal. The gold standard, for example, was often criticized on the grounds that money growth was procyclical-rising in periods of inflation and falling in recession. One of the monetarist complaints about discretionary monetary policy in the 1960s and 1970s renewed this classical criticism.

This made me think that the main goal of rule-based monetary policy is to keep monetary policy from being procyclical. However, I would argue that the policies that were most procyclical in recent years were housing finance policies. When housing prices were rising, Congress complained any time lenders used underwriting standards to turn down loans. Then, after the mortgage crisis hit, Congress complained about lenders not being strict enough.

In fact, while we are talking about non-monetary factors in economic performance, I might mention the much-discussed Fed study suggesting a 40 percent decline in median household wealth between 2007 and 2010. Timothy Taylor has the link and some helpful analysis.

I think that economists who believe that aggregate demand was a big factor in the recession (which means most economists, just not necessarily including me) are inclined to view this wealth decline as the cause, rather than taking Scott Sumner's view that this was a monetary contraction. To rescue a role for money, you could try to argue that the wealth decline was the result of monetary austerity (impossible to disprove, but I do not believe it) or, more plausibly, that a vigorous monetary expansion could have maintained nominal GDP in the face of the huge decline in the relative price of houses and bank stocks.

Meltzer also writes,


Economics is not the science that generates small short-term forecast errors for GDP growth, inflation, and other macro variables. There is no such science. Basing policy on forecasts of macro variables cannot be an optimal policy procedure given the size of forecast errors.

That strikes me as an argument against market monetarism, which is based on forecasts--albeit market forecasts--for nominal GDP. I presume Meltzer would prefer a rule fixing the growth rate of a monetary aggregate (the monetary base seems to be his choice). On this issue, I tend to side with the market monetarists, but for non-monetarist reasons. A nominal GDP target will be imperfect because of forecasting errors. A monetary aggregate target will be imperfect because of velocity instability. I think I would rather take my chances on the forecasting errors.

And Meltzer channels Bagehot, writing,


Financial institutions should be permitted to discount freely, using marketable assets, at a penalty rate. This lender-of-last-resort rule should be part of the monetary rule.

To me, this seems like the simplest solution to the problems posed by financial panics. It is much better than providing government guarantees in order to support money market funds and repo markets. However, I am cynical enough to believe that in a world where indebted governments and large banks lean on one another, the lender-of-last-resort model goes out the window. Instead, bailouts become the first and only resort.

Thanks to Daniel Klein for the pointer.


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COMMENTS (5 to date)
Cedric writes:
Economics is not the science that generates small short-term forecast errors for GDP growth, inflation, and other macro variables. There is no such science. Basing policy on forecasts of macro variables cannot be an optimal policy procedure given the size of forecast errors.

This strikes me as a bit silly. Forecast errors are inevitable, but . . .
1. An NGDLT futures market would probably help smooth out errors;
2. As would a policy of making up for previous errors -- i.e., if you aim for 5% NGDP growth and you get 4%, do 6% the next year;
3. In monetary policy, expectations drive reality. You don't have to get it perfect, you just have to credibly announce a level target and let the market do the work.

Mike Rulle writes:

It is difficult to square various data the government puts out. The Fed's June 7th issue of "Balance Sheet of Households and non-profit Organizations" shows the total net worth of the country as having declined 10.6% during the 2007-2010 period.

Why they chose 2007-2010 period when they produce a balance sheet each quarter is also odd. The 2007-Q1 2012 period shows total net worth is now 5% off the peak (not by household, just total).

I also realize there is a difference between median and mean, but I do not believe the difference between 38% and 10% can be accounted for just by a large right tail of the wealthy (although by definition of "households", it is so).

But we all know "households" are treated as equal sized units when they are not. I wish I could find where I read this, but I believe recall reading T. Sowell saying that there are three times as many people (by income not balance sheet---so not quite the same) in the upper quartile of of "households" versus the lower quartile of "households". I assume there are comparably odd "anomalies" when looking at balance sheets.

I do not know what motivated The Fed to use 2010 as an endpoint. They used 2007 because that was the peak. Nor do I know why they use "households" as the base unit as that can be a very misleading unit of measure.

Obviously nominal or stated net worth has gone down, but I can't help but think for some reason they decided to chose the most alarming net worth decline (38%) they could find to go out as a headline.

I have no guess as to why they did so---perhaps they are trying to create general support for their implied easing statements the last few days. I find it irritating when government obfuscates----which means I am always irritated at government.

Philo writes:

“. . . not necessarily including me . . .”? Why so noncommittal? Do you or do you not “believe that aggregate demand was a big factor in the recession”? (Granted, the question is a bit vague.)

And why do you allow only *plausibility*, rather than *obvious truth*, to the thesis “that a vigorous monetary expansion could have maintained nominal GDP in the face of the huge decline in the relative price of houses and bank stocks”?

Philo writes:

Market monetarism is based on forecasts—market forecasts of NGDP—because it recognizes the importance of expectations; market forecasts are simply the economy’s expectations. If the market gets it wrong—if NGDP comes in far from the market forecast—no harm is done: in a market monetarist world the authorities don’t care about the latest NGDP figures, they are continually focused exclusively on *the market forecast for next year*.

happyjuggler0 writes:

Philo correctly stated that under a Sumnerian Fed, i.e. under market monetarism, the Fed will be targeting the market forecast, which thanks to the wisdom of crowds ought to be superior to the Fed's internal forecast.

Perhaps more importantly however, is the fact that under Sumner's market monetarism it is not NGDP targeting, nor is it NGDP targeting of the forecast, but it is NGDP level targeting of the forecast.

By engaging in level targeting, if the Fed undershoots or overshoots (both of which it will be doing), it will then make up for its mistake by compensating in the other direction. Imagine a chart with a target of 5% NGDP out to the future as far as one can see. Due to level targeting by the Fed, when you overlay what actually happens in the future, you will see the empirical data tightly snaking over and under the forecasted trend line. Such as in the second chart from Sumner's blog

P.S. I tried using the html buttons on my post here. The ones for bold and italics worked fine, but I had to use my knowledge of html to get the link to Sumner's blog to work correctly. Maybe I am missing something, but maybe instead it simply doesn't work correctly....

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