Scott Sumner  

Another disappointing reaction to The Great Market Monetarist Experiment

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In a recent post I discussed how Keynesians like Mike Konczal began the year claiming that we were going to have a test of market monetarism, and specifically the doctrine of "monetary offset." 
[As recently as 2007, monetary offset (roughly zero fiscal multiplier) was standard new Keynesian doctrine, and yet by 2010 some bloggers were calling the concept "the Sumner critique."  The fact that it had become so unpopular that they had to name it after a lowly Bentley professor speaks volumes about the recent decline of macroeconomics.]

Back in April 2013, Paul Krugman agreed with Konczal: 

Mike Konczal points out, we are in effect getting a test of the market monetarist view right now, with the Fed having adopted more expansionary policies even as fiscal policy tightens. 

And the results aren't looking good for the monetarists: despite the Fed's fairly dramatic changes in both policy and policy announcements, austerity seems to be taking its toll. 

Now the results are in and they show that market monetarism easily passed the test, as growth in 2013 is exceeding the pace of 2012. We know how Mike Konczal reacted, but what about Krugman? Today we got an answer:

One way to look at the US economy in 2013 is that it was, in effect, trying to begin a strong recovery, but was held back by terrible federal fiscal policy. Housing was making a comeback, state and local austerity was, if not going into reverse, at least not getting more intense, household spending was starting to revive as debt levels came down. But the feds were raising the payroll tax, slashing spending via the sequester, and more. 

Incidentally, these other factors are why I don't take seriously the claims of market monetarists that the failure of growth to collapse in 2013 somehow showed that fiscal policy doesn't matter. US austerity, although a really bad thing, wasn't nearly as intense as what happened in southern Europe; it was small enough that it could be, and I'd argue was, more or less offset by other stuff over the course of a single year. 

Where do I begin? Yes, growth did not "collapse" as the Keynesian model predicted. It increased.  So say so!  There was a dramatic reduction in the cyclically adjusted budget deficit, by any measure.  I'm tempted to point out that a reduction in the cyclically-adjusted budget deficit (including the exact same 2% boost in the payroll tax) is what the Keynesians claim caused the severe 1937-38 depression.  And yet growth accelerated in 2013.  Or I could point out that the fiscal austerity in the US was just as intense as in the eurozone, whereas the unemployment rate in the US has fallen sharply since 2010, while the rate in the eurozone has risen sharply.  The key difference was monetary policy, which was much tighter in the eurozone. 

But none of this really matters, does it?  Paul Krugman was the one that said 2013 was a test of market monetarism.  He's the one who said it was a test of whether monetary policy could offset the drag of fiscal stimulus.  And now the results are in. And what is Krugman's response? I can't quite tell, but it almost seems to me that he's denying that any test took place. Suppose real GDP had fallen at 1% instead of rising at 2.5%? Would he still be saying that no test took place in 2013? Would he say market monetarism didn't fail the test because "other things weren't equal?" Or would he say that a test did occur and market monetarism failed? I'll leave that question to my readers.  But if you are interested, I have another post that cites Krugman criticizing other economists who failed to admit they were wrong.

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COMMENTS (24 to date)

Moving the goal posts is a time honored tradition among pundits, pendants and partisans.

ThomasH writes:

And if income grew (slowly) in spite of bad fiscal policy (reducing expenditures across the board instead of reducing those with low C/B rations and increasing those with high C/B ratios) rather than fell becasue of it and Krugman as Konczsa thought, so what?

Ross Levatter writes:

"I have another post that cites Krugman criticizing other economists who failed to admit they were wrong."

Ah, but Scott, "Quod licit Jovi non licit bovi."

Brian writes:

"so what?"


The "so what" is that Krugman's expectations were wrong and he's now making excuses. The so-called "bad fiscal policy" shows no evidence of being bad at all. Where are the negative consequences? That's right--they're not there.

If I remember correctly, I think you've defended Krugman before by talking about all the predictions he's gotten right. Well, he got this one wrong and he should be honest enough to admit it. So should you.

Chase writes:

It is reasonable to mark predictions to market and I do think Krugman needs to do so in this case. However, I don't agree with the notion that if 'Austerity' didn't cause a slowdown then it must have been monetary offset that prevented it. I happen to be one that believes both fiscal and monetary policy have contributed to the recovery. The strength of each one is likely impossible to fully substantiate. I was looking at household liabilities as a % of disposal income and as early as 2004 the UK was only around 10-15% higher than the US. During the crisis and still currently the UK is over 30% higher than the US. The US is back around where it was in 2000. Most of this improvement happened prior to 2013. Now, I don't know if that improvement was mostly attributed to fiscal or monetary policy (I lump mortgage relief and GSE lending in with fiscal policy) but I suspect both played major parts. That reduction in financial burden to households might be playing the largest positive role in 2013's better performance and I don't know that fiscal or monetary policy in 2013 can or should be given credit/blame.

Anecdotally, the company I worked for throughout and after the crisis had one year where a government contract was the major reason we made our numbers and undoubtedly prevented large layoffs and cutbacks for that year. In addition, as soon as rates plummeted the company began securing larger lines of credit and long term funding arrangements for potential future investments. That being said, they still weren't materially utilized when I left several months ago. For us, both courses of action were beneficial.

At the end of the day was Krugman wrong, yep. However, it is impossible to prove the counterfactual. Would GDP and employment have been a little higher if budget cuts had not happened? Probably. So, the two cited Keynsian's were wrong on the slowdown, but I don't see how deducing one thing automatically proves the other.

Jim Otteson writes:

Scott, the mistake you make is to think Krugman's goal is to be right. No: he wants to win. That is a very different enterprise.

Scott Sumner writes:

Chase, So I take it that you think Krugman was wrong in saying 2013 was a test of market monetarism? Yes, I think one can make a strong argument that he was wrong on that point.

In my view that also makes him wrong in claiming that European "austerity" theories have been tested by recent events in Europe.

Dustin Irwin writes:

Chase, I'm not sure those things are relevant to this post, which is basically:

Mike Konczal says that due to fiscal austerity, MM will more or less be the deciding factor for 2013 growth
+Paul Krugman endorses Mike's view
+2013 results are strong
= The Keynesian model linking growth to fiscal policy is wrong, and they should pony up!

This is not the same as claiming 2013 is definitive proof of MM's success, which you focused on. Perhaps there are other factors that deserve due consideration, but I don't see that as the point of this post.

Mr. Econotarian writes:

Perhaps we can now all agree that both debt to GDP over 100% as well as a 2% of GDP deficit reduction do not represent magical "red lines" for growth?

Yancey Ward writes:

Color me surprised to find the goal posts moved by Krugman to the Antarctic. One could have predicted that with 100% certainty.

John Soriano writes:


It's far from just that one post where he chides others for not admitting when they are wrong, he's been doing it in virtually all of his recent posts about inflation and more!

The fact that it had become so unpopular that they had to name it after a lowly Bentley professor speaks volumes about the recent decline of macroeconomics.

'I know it's working, because they don't call it Reaganomics anymore.'

Chase writes:


I do think Krugman was wrong to state it was a test of market monetarism, but I concede that if you can eliminate enough variables or identify enough direct outcomes attributable to one variable (in this case monetary policy) then you could make it a test in any year. I also agree that attributing the woes in Europe currently to fiscal austerity would require a lot more substantiation. I want to be clear, you have made solid arguments in favor of MM and I think you are right to point out that Austerity hasn't driven the US back into recession as the two prominent Keynesians suggested. However, I think it would be jumping the gun to say monetary offset is the main reason without further research.


When statements are made such as; "He's the one who said it was a test of whether monetary policy could offset the drag of fiscal stimulus. And now the results are in.", the question of whether monetary policy is responsible for the absence of a growth slowdown is of primary importance to the post. I think Scott would agree that his motivations are not solely to discredit Krugman and Konzcal, but to prove the efficacy of MM and to draw a clear delineation when MM appears to outperform the Keynesian models. Pointing out the errors in the predictions of prominent Keynesian economists is just one method Scott has used to further the MM and NGDP concepts.

Troy Camplin writes:

The great thing about Keynesianism is that, no matter what happens, it is proof of Keynesianism. If you increase government expenditures, and the economy grows, Keynesianism works! If you increase government expenditures, and the economy doesn't grow, you should have increased spending even more -- and Keynesianism works! And if you decrease government spending and the economy doesn't grow, Keynesianism predicted that! And if you decrease government spending and the economy grows, just imagine how much more it would have grown if you hasn't cut spending -- and Keynesianism works! Everything is a confirmation of Keynesianism, even disconfirming evidence. Which makes is religion, not science.

Lee A. Arnold writes:

I do not know the theory of market monetarism. How does it explain why a quadrupling of the monetary base since the crash has only gotten us a 2% growth rate in the 5th year afterward?

William Bruce writes:

Lee, Scott can answer this question far better than I (and hopefully will), but the equation of exchange is always a good place to start: An emphasis on velocity (the inverse of the demand for money) is something that distinguishes market monetarism. There are also institutional and regulatory factors. For example, interest on reserves has meant that what happens in the monetary base stays in the monetary base.

Peter Laan writes:

Lee, there are a few possible explanations for this.

1. Interest on reserves (as William noted).

2. The Fed has repeatedly claimed that the increase in base money is only temporary. What matters is the market's expectation for the amount of base money in the future.

3. Reduced nominal growth increases the demand for base money (compare base money to NGDP and NGDP growth rates for US/Japan/Australia:

Scott Sumner writes:

Chase, I agree.

Lee, See the next two commenters for answers.

Lee A. Arnold writes:

Peter Laan, thanks, but please help me out here, I do not follow the actual expectations and transactions in the world that fit your explanations. Taking your points in order, are you writing that,

1) If the Fed had not paid interest on reserves, then the banks would have lent the money into the real (i.e., non-financial) economy? But why would the banks do that; how would they make any money on that, if the nominal lending rate is near zero? Would it have helped homeowner negative equity; would the banks have adjusted underwater ARMs to near zero?

(2) Do you think that the market would expect the Fed to decrease the amount of base money in the near future below what would be required to conduct business in the economy? I do not see the Fed making that mistake, nor the market expecting it to make that mistake, unless there were fears of inflation -- but then the markets are usually happy to expect that inflation will be fought, because to begin with, inflation reduces the value of holding fixed-interest debt.

(3) You write, "Reduced nominal growth increases the demand for base money." I would think that it reduces that demand. What is the expectation or the transaction that causes this increased demand?

Peter Laan writes:

1. When the Fed implemented this they said it was intentionally contractionary. The banks do lend out money. So obviously they have some clients that they think they can make money from. Without IOR they would likely have had more such clients.

2. I have no idea what the market expects.

3. You are correct in the long run. But there will be a one time reduction in base demand when nominal growth falls. This is due to a lower opportunity cost of holding base money.

TallDave writes:

I do not know the theory of market monetarism. How does it explain why a quadrupling of the monetary base since the crash has only gotten us a 2% growth rate in the 5th year afterward?

Expectations uber alles; the Fed is still credibly promising not to exceed the 2% target. Also, liquidity preference.

Monetary base is no more appropriate a measure than interest rates in determining whether policy is tight or loose. The salient lesson of this era.

Scott Sumner writes:

Lee, Once market interest rates start rising above zero the market expects that the Fed will either reduce the base sharply, or increase the rate of interest on reserves, or some combination of the two.

Art Deco writes:

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Lee A. Arnold writes:

Scott, why would the markets expect that the Fed would squash the economy so sharply? Talking to investors around town, I hear that an increase in rates is what everyone wants, in order to make lending profitable again. Once deleveraging has proceeded far enough to allow a larger number of households to get back in the game, then everyone would be happy, right?

My guess is that you economists may be wrong about the Fed. In the current crisis it pays lip-service to market expectations, but the people who worry about expectations are numerically few: the people working in finance, basically. The Fed bailed out the whole financial system and that was not enough to get the real economy going. The trouble with AD is in the remainder of the economy, the non-financial economy. There, people don't worry about what the Fed is going to do, they worry about finding a job and putting food on the table.

I think the Fed's secret concern has been homeowners' negative equity and unemployment, and the Fed can't fix that directly without causing a political revolution. So the run-up in reserves has been in order to stabilize the structure of asset ownership in the financial system, to prevent the Great and the Good from collapsing, as it were, while homeowners plod along unwinding their debts without the help of fiscal stimulus to give them more income to deleverage faster. I imagine the improvements in the economy that we are seeing is finally due to household deleveraging crossing some threshold.

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