Scott Sumner  

The economy should be "left alone to sort things out" during a recession

My Moment with Gary Becker... Gary Becker, A Reminiscence...

Broadly speaking, there are three approaches to stabilization policies and business cycles:

1. Stop the excesses: In this view, monetary policy is too expansionary at certain times. Some people worry about excessive real GDP growth. Others worry about asset prices bubbles and/or an orgy of lending. In this view, the excessive monetary stimulus leads to a later relapse into recession or depression. Policymakers need to "fix" this problem by being less expansionary during the periods of excess.

2. Stimulate during recessions: In this view the real problem is not RGDP or financial excesses, but shortfalls in economic growth. The problem of recessions and depressions must be fixed with an expansionary monetary policy. But policy should not try to stop economic booms. Keynes is a famous proponent of this view--he argued that we should aim for a permanent boom.

3. Laissez-faire: In this view monetary policy should pay no attention to any of these issues. It should not try to push back against excessive RGDP growth or asset price bubbles or excessive lending, nor should it try to boost the economy during recessions. Rather it should try to provide a stable path for some sort of nominal aggregate that is a proxy for the value of money itself, such as the overall price level or NGDP. Thus the central bank should ignore problems such as recessions and bubbles, and (to use the phrase of Robert Murphy) the economy should be "left alone to sort things out" during a recession.

I would put Friedrich Hayek and myself into the third group. Hayek favored a monetary policy aimed at a stable path for NGDP, and so do I. Perhaps this is all pretty obvious, but when I read other bloggers I often see confusion between NGDP cycles (i.e. nominal or monetary instability issues) and the sort of RGDP cycles that would occur even under a policy of stable NGDP growth (a topic covered by "real business cycle" theory.)

Some people erroneously conclude that those who favor a stable path of NGDP also favor policies aimed at "fixing" recessions or booms. Not so, it is those who claimed monetary policy was too easy in 2004 for financial/realGDP reasons, and those who claim monetary policy was too tight in 1974 for unemployment reasons, who are the activists. I'd call the first groups "conservative activists," and I'd call the second group "left wing activists." Both groups are wrong, and for essentially the same reasons. Even if it were true that monetary policy should try to stabilize some sort of real or financial variable (and it isn't true), you'd want to do so symmetrically. The asymmetric views of these ideologues are the "tell" that they have a different agenda.

The second reason they are wrong is that monetary policy should not be used to fix real problems such as fluctuations in real GDP, fluctuations in real asset prices, or fluctuations in real quantities of lending. Provide a stable path for the value of money and let the economy take care of itself.

PS. I'd like to think Robert Murphy is with Hayek and myself in the third group, but I can't quite tell. Like many other people, Bob Murphy frames the issues in a slightly different way than I do.

PPS. Although I did not know Gary Becker personally, I did take a class from him back during my first year at Chicago (1977-78.) I had many great teachers at Chicago but he was the most brilliant. The opening few paragraphs of his Nobel Prize lecture clear up some misunderstandings regarding his views on rationality and selfishness. I was very sad to hear that he died. Tyler Cowen has a number of very good links relating to Gary Becker.

HT: David Henderson

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COMMENTS (17 to date)
Bob Murphy writes:

Phew! My stomach muscles clenched when I saw the title of this post. I was getting ready for Scott to bludgeon me for letting NGDP growth fall.

Jeremy Goodridge writes:

Why did Hayek call for letting the deflation run its course the 1930s? That' doesn't seem like someone who wants NGDP to be on a stable path.

Scott Sumner writes:

Bob, Sorry to disappoint you. :)

Jeremy. Good question. Hayek later realized his error and regretting his policy views during the 1930s. You are quite right that his opposition to monetary stimulus in the early 1930s was inconsistent with his advocacy of NGDP targeting.

Andrew_FL writes:

Hayek would have said policy ~2004 was too easy.

I don't think your name for group 3 matches what group 3 actually wants to do. Group three is named in such a way as to suggest doing nothing, in reality it is described as keep doing what you were doing before. Group 3 is more accurately labeled "steady as you go."

Laissez-faire isn't merely the position that the state should do nothing. It's that they should have started doing nothing a long time ago.

Mind you, a true Laissez-faire system would have a tendency to follow an implicit rule. It would in some sense be a subset of group 3.

MichaelT writes:

Wouldn't a Laissez-faire monetary policy be to not have a monetary policy at all, without a central bank or government issued currency? And if Hayek really supported something like an NGDP targeting policy, isn't he committing the Fatal Conceit that he spent most of his career trying to make people understand?

Lawrence D'Anna writes:

Hayek advocated NGDP targeting!? (or something like it?) I didn't know that. Can somebody provide a reference please?

ThomasH writes:

I assume that the optimal Federal fiscal response to a recession would be to take note of the changes in opportunity costs and benefits of different activities and adjust the activity levels accordingly. For example if a recession causes a fall in local government revenues so that librarians are laid off and libraries shorten hours, an optima response would be to increase the before-recession transfers to local governments (possibly zero before the recession) to restore library hours. Mutatis mutandis for pothole repair, Hover Dam building, SNAP benefits. Should monetary policy be different if policy makers know that fiscal policy makers will be unwilling to run the deficits implied by this optimal policy?

Jordan writes:

Does option 3, if done correctly, approximate what a well-crafted symmetrical activist policy would? RGDP too slow so inflation is effectively boosted w/ a stable NGDP output and thus "expansionary" policy is underway. And vice versa. Almost like an automatic stabilizer effect. Or is this not the way to think about it?

Michael Byrnes writes:

@ Jordan

I think you have the right way to think about it. Except that monetary policy is better in part because we will never see a "well-crafted symmetrical activist" fiscal policy in our lifetime. While it is hard to know for sure what a Congress will or won't do in the future, I think we can all be confident that a "well-crafted" response to a severe recession is beyond its capabilities. :)

@ Lawrence

In this post, David Beckworth quotes from a paper by Larry White:

"Hayek’s theory viewed the recession as an unavoidable period of allocative corrections, following an unsustainable boom period driven by credit expansion and characterized by distorted relative prices. General price and income deflation driven by monetary contraction was neither necessary nor desirable for those corrections. Hayek’s monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction."

James writes:

I'm sure Hayek was actually in favor of free banking and the denationalization of money. Just changing the policy target of a central bank doesn't take away from the central problem with central banking: it's central planning.

Government monopolies are not known for their ability to do things especially well. Why should anyone believe that stabilizing NGDP is a special case?

Prakash writes:


Even in a denationalized framework, the government has to make a simple decision as to which issuing bank's notes should it accept for taxation. Which, basically is copping out and letting the private bank run monetary policy.

Which might lead to the bank getting excessive profits and getting tempted to overissue notes and similar kind of regime uncertainty, unless the bank announces an explicit monetary policy. Which brings us back to prof sumner's point. Announce the policy and then, laissez faire. That provides a schelling point, it provides a base around which all market participants can calculate and plan.

Scott Sumner writes:

Andrew, I meant laissez-faire in the sense of letting real GDP and asset prices and lending go wherever they will go, without interference from monetary policy.

Michael, As long as you have money you will have monetary policy. There is a separate question of whether the policy should be implemented by the government or by private actors.

Thomas, There is some evidence that the economy never really bounces back from recessions that are not due to monetary policy failures. Hence it's not clear what if any role fiscal policy can play in that situation.

Jordan, There are many ways to think about it, but I think terms like 'activist' do more to confuse than enlighten. Yes, it could be similar to a policy aimed at stabilizing some combination of prices and output.

James, I have to agree that governments are not especially good at stabilizing NGDP.

Yancey Ward writes:
Andrew, I meant laissez-faire in the sense of letting real GDP and asset prices and lending go wherever they will go, without interference from monetary policy.

So, RGDP isn't a function of NGDP?

ThomasH writes:


"There is some evidence that the economy never really bounces back from recessions that are not due to monetary policy failures. Hence it's not clear what if any role fiscal policy can play in that situation."

mean that a recession caused by real shocks with NGDP targeted monetary policy would not develop changes in opportunity costs that would lead an optimal fiscal policy to run larger deficits? What about say inflation targeting monetary policy?

My larger question is when does and does not optimal fiscal policy look like Keynesian countercyclical fiscal policy and NGDP targeting look like "activist" monetary policy.

W. Peden writes:

Yancey Ward,

"So, RGDP isn't a function of NGDP?"

Only in the short run. Fluctuations in aggregate demand can alter RGDP only insofar as they can alter the position long-run aggregate supply curve, which with a few exceptions (like a central bank that has an annual inflation target that changes based on a random number program between -1,000% and 1,000%) they can't do.

As far as growth rates go, whether an economy grows at a steady rate of 5% in NGDP (Sumner) or 0% in NGDP (Hayek) makes little difference. There are various arguments for various NGDP growth rates (George Selgin and Bill Woosley have separately gone into this topic in some detail, and Friedman's "Optimum Quantity of Money" is worth reading as well) but ANY half-plausible growth rate path which is stable and predictable is better than NGDP instability.

W. Peden writes:

Actually, I exaggerate: changes in NGDP can affect RGDP in the short run, but even then it's not as simple as RGDP being a function of NGDP, because there can be shifts in the SRAS curve as well.

The key point is that an NGDP target reacts best to supply-shocks, i.e. allowing prices to fall more in response to positive supply shocks and to rise in response to negative supply shocks. Under an NGDP target, the price level is independent of monetary policy: a positive change to the LRAS curve lowers the price level; a negative change to the LRAS curve raises the price level.

James writes:


If I meet anyone who claims denationalization of money would absolutely eliminate the risk of monetary problems, I'll share your previous comment.

What do you have for people who point out that between free banking and central banking, central banking seems to be the worse choice? Free banking and central banking have both been tried in the past and central banking has not proved superior for delivering stable growth, full employment, financial stability or any of the other claimed benefits of central banking. Central banking has been widespread for about a century and in that time there have been currency crises, episodes of inflation, episodes of deflation, massive booms and busts, etc.

You may believe that the problem with central banks has been their choice of targets but this is too reminiscent of stories of factories in the former communist nations. When the production target for a nail factory was in pounds of nails, they made a few huge useless nails. When the production target was in the number of nails they made many tiny useless nails. When glass factories had targets in weight they produced terribly thick useless panes of glass. When the targets were in square centimeters they produced thin useless panes of glass. There are still apologists for central planning today who claim that centrally planned industry could work if the planners would just listen to some innovative idea about even better targets. But hardly anyone takes those ideas seriously anymore because the problem wasn't that the central planners had the wrong targets. The problem was central planning.

How is the call for NGDP targeting any different? All the central banks of the world have tried all kinds of policies and yet none of them have managed to deliver the supposed benefits of central banking. How many policy targets do central banks need to try before we can say that the problem is central banking itself?

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