Scott Sumner  

Is George Selgin defending Keynes on liquidity traps?

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George Selgin recently quoted Keynes, from late 1933:

"Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor."

And then George made this curious request:

This near the very bottom of the Great Depression. Perhaps Keynes was wrong then. But is there not a strong case to be made, nevertheless, that the recent rounds of QE were, what with all that heaping-up of excess reserves, just so much unhelpful belt-loosening?

What say ye, my Market Monetarist friends?

Not quite sure what to make of this, as I seriously doubt that George is trying to defend Keynes' odd views on liquidity traps. But let's start with the letter itself (one I've often quoted over the years.) The letter was dated December 16, 1933, and was a critique of FDR's gold-buying program. The first thing to emphasize is that the gold-buying program was not QE. Quantitative easing was the policy of Herbert Hoover in 1932. The monetary base was $8.41 billion in March 1933, right before the dollar was devalued, and $8.41 billion in February 1934, the first month after the dollar was re-fixed to gold (at $35/ounce.) So the program that Keynes was criticizing was clearly not QE. Why then did Keynes consider it QE?

I can only speculate, but perhaps professional jealousy played a role. The dollar depreciation program was both highly successful, and it was widely seen as enacting the preferred policies of Irving Fisher and George Warren. Keynes initially favored dollar depreciation, but turned against it later in the year. He preferred fiscal stimulus. Since Fisher was widely viewed as a quantity theorist, perhaps Keynes assumed that Fisher's program was designed to work by increasing the quantity of money. But that was not the case.

Is QE a good policy today? Compared to what? Surely it's a lousy way of achieving higher aggregate demand; NGDP level targeting is far simpler. But if central banks insist on such a clumsy, roundabout method, then it's worth contrasting their actions with "not QE." And there is lots of evidence that QE is marginally better than not QE. I put the most weight on strongly positive market reactions to QE announcements. But for those that prefer actual macro data, Japanese inflation has risen since their QE was adopted in 2013, and the US has done far better in terms of both inflation and NGDP growth that the eurozone, which refrained from QE.

Dollar devaluation under FDR did much better than QE under Hoover for exactly the same reason that NGDP targeting would be much better than QE today.

So do market monetarists favor QE? It depends what you mean by "favor."

HT: TravisV

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CATEGORIES: Monetary Policy

COMMENTS (17 to date)
TravisV writes:

This post by Prof. Sumner is an old favorite:

"We’re all Austrians now . . . make that Keynesians."

TravisV writes:

Another long-lost gem:

"How does market monetarism differ from new Keynesianism?"

Joe Teicher writes:

Prof. Sumner,

What actual tool(s) would the fed use to achieve NGDP level targeting in your scenario? I feel like you must have written about this on your blog but I've only read your stuff on econlog. I am not at all an expert on monetary policy, but I do pay attention to the fed, and my impression has been that they had the ability to lower interest rates to basically 0, and after that they had QE. Is there something else that they could have done but decided not to do?

maynardGkeynes writes:

Prof Sumner: The belt analogy could hardly be clearer. It's a causality argument, nothing more nothing less. Correct or incorrect, it raises once again the fundamental objection to the monetarist theory you have advanced, that objection being that monetary expansion will not cure a recession/depression where there is a deficit of demand. Perhaps I misunderstand your response, but it strikes me as purely ad hominum -- that Keynes was jealous (I doubt Keynes paid enough attention to others to be jealous, at least in matters non-sexual.) It strikes me that you are trivializing what is by far the most fundamental objection to both your views and the authors of the many rounds of QE's. I am no one to criticize you, but I would really love to see a better answer to what is clearly the most fundamental objection to both QE and to your views on NGDP targeting Both appear to me to be equally susceptible to the Keynes critique, and you have not rebutted it in the least, with your answer, which unusually for you, seems rather beside the point, if not evasive.

Michael Byrnes writes:

@Joe Teicher,

What the Fed could have done is drawn a trend line on a graph of NGDP vs time, and announced that as long as actual NGDP was below that line, the Fed Funds rate would stay at zero. Or they could have done QE, and announced that asset purchases would continue for as long as NGDP was below the line. Further they could have stated that whatever monetary expansion was needed to attain the target level of NGDP would be permanent.

What they actually did instead was to bend over backwards to assure everyone that the monetary expansion was only temporary.

Scott Sumner writes:

Joe, NGDP level targeting is by far their most powerful "actual tool." What else they need to do is up to the market; the money supply and interest rates should be determined by market forces. I suspect they'd have to do very little, just ordinary open market operations--normal central banking.

Maynard, I'm afraid I don't understand your comment. I've done 100s of posts explaining why the liquidity trap claim is nonsense. What more can I do? If you don't agree with my arguments then please tell me why. But the belt metaphor is just silly.

And if I am wrong about Keynes I'd like some evidence. Are you claiming his letter was not a criticism of FDR's gold buying program? Have you read the entire letter? (It's very long.) What precisely is wrong with my interpretation of the letter, and my observation that Keynes made a fundamental error in using an anti-quantity theory argument against a policy of currency devaluation?

Yes, I may well be wrong about the jealousy claim, but that was a throwaway comment.

George Selgin writes:

I'm grateful to Scott for his detailed and very good answer to the question I posed--one which seems to me much more careful than what I gather I might get from other MMs (and fellow travelers) who have been rather more enthusiastic in their support for QE. I also confess to having been quite unaware of the fact that Keynes was referring specifically to gold purchases, though I find it difficult still to interpret his words as anything save an argument against "monetary expansion" per se.

Was QE better than nothing? Maybe--so far. (Though perhaps not by much, to judge by some attempts at careful assessment.) But we must bear in mind that there are shoes yet to drop, having to do with the difficulties the Fed has created for itself--or rather for the proper conduct of monetary policy--by having acquired so many long-term assets that it can not afford to dispose of in substantial quantities, or once interest rates rise to any significant degree, whether because of increased real equilibrium rates or because of higher inflation. When the time comes for tightening, and not before, we will be in a position to begin assessing QE's full benefits and costs.

And yes, I fully agree that NGDP targeting would have been far better.

ThomasH writes:

@ Selgin What is the "nothing" that QE is being compared to?

@ Scott I think some of us are still a little unclear about how NGDP works in practice. I accept that Fed actions would depend on the market and real economy reaction to the announcement of NGDP targeting, but some scenarios?

Don Geddis writes:

@Joe Teicher & @ThomasH: 98% of the power of monetary policy is in setting expectations for the future path of money, not in the day-to-day concrete operations. Nonetheless, you two seem to be concerned about how the concrete steps would actually work, in order to implement NGDPLT. You should probably start by reading Nick Rowe's classic post "...for the people of the concrete steppes."

A summary of the basic answer: all you need to a clear target, and a powerful enough threat. If the threat is credible, you don't have to actually carry it out. Does the US Fed have the power to inflate the nominal economy? Yes. It could make the money supply double, triple, 10x. It could buy up all Treasuries on the market. It could buy other financial assets. There is simply no problem in offering a sufficient inflation threat. And, again, once you have the threat, you don't need to actually use it.

Andrew_FL writes:

@Don Geddis-Right, basically the threat of forcing NGDP up by way of M, makes the people increase it by way of V.

I mean, threat is probably not a word you want to use to sell people on the idea, but yeah.

Brian Donohue writes:

Another excellent post Scott.

By the way, the link from Travis in the first comment may be the best starting point for understanding your perspective that I have ever read. From 2009 too, when the profession was scratching its collective head! Bravo.

Joe Teicher writes:

Prof. Sumner and others,

Thanks for your responses. I think I get it now. What I guess is still a question for me is how realistic is relying on fed expectations to drive market behavior? I know that markets react violently to every fed announcement, but they also seem to discount what the fed claims its going to do in the future. For instance, at the last meeting the fed said their best guess for the fed funds rate at the end of 2015 is 1.35%. And yet Jan 2016 fed funds futures are trading around 99.34 (implying a rate of only .66%). That's a big difference!

Maybe the fed is constrained in what they do by what the market will find credible. They have no problem keeping the current fed funds rate at what they want it to be, so they do that. For QE, they have no trouble saying "we're gonna buy $85B/month of stuff" and then doing it. But if no one knows what it would take to get NGDP growth up to 5%, maybe no one will take the fed seriously if they claim that they will do that. If no one takes them seriously, maybe what they would have to do to force NGDP growth up would be so massive that they just won't have the guts to do it. In that case, the market would be right to be skeptical. If there was a "mechanical" way for the fed to force NGDP around that was politically palatable to both Paul Krugman and Ron Paul, then NGDP targeting would be very plausible. Absent that, I wonder if it just might not work.

Michael Byrnes writes:

Andrew from FL wrote:

"Right, basically the threat of forcing NGDP up by way of M, makes the people increase it by way of V.

I mean, threat is probably not a word you want to use to sell people on the idea, but yeah."

Here is another way of making this point (an old post from occasional commenter Lorenzo):

He draws a distinction between hard money (a focus on maintinaing the exchange value of a currency) and sound money (a focus on maintiaing the transaction utility of money) and points out that these two goals can often be at odds.

Don Geddis writes:

@Joe Teicher: "the fed is constrained in what they do by what the market will find credible ... maybe no one will take the fed seriously ... they just won't have the guts to do it. In that case, the market would be right to be skeptical."

As Yoda said, "Do, or do not. There is no try."

Yes, if you claim to be committed to a course of action, but you're lying about it and actually aren't committed after all, then the market indeed ought to be skeptical. And your attempt to manage expectations will fail, just as it should.

Around 1980, Paul Volcker asserted that he would change monetary policy, and undo the previous decade of stagflation: high inflation, high interest rates, high unemployment, low growth. Most of the economy didn't believe him. He had to force a recession -- and stick with it, despite the economic pain -- in order to finally change expectations. But, with enough time and enough (monetary) force, the market eventually realized that he really was serious, and the future was going to unfold the way Volcker predicted, and not the way everyone else had been predicting from the past.

I don't think anyone is suggesting that this would be politically easy. It's instead: if the Fed would commit to doing NGDPLT, then good things would happen to the macroeconomy.

George Selgin writes:

Thomas H: "@ Selgin What is the "nothing" that QE is being compared to?" No QE, of course! (But better still would have been no QE and no IOR.

Don Geddis: "98% of the power of monetary policy is in setting expectations for the future path of money, not in the day-to-day concrete operations."

This lately fashionable idea seems to me quite mistaken. Consider: low NGDP is depression only to the extent that it is low relative to expected NGDP, for otherwise short run supply schedules, which are themselves informed by NGDP expectations, would also be "low," and U and y would assume their long-run or natural values. It follows that combating cyclical recession is a matter of closing the gap between actual and expected NGDP, either by raising the former while leaving the latter unchanged, or by lowering expectations until they conform with reality. It seems to me that those who imagine that raising expected (future) NGDP helps to spur recovery seem to forget that increased expected spending flows, though they may increase current V, also tend to raise supply schedules. In any event, until I am convinced that it doesn't, I'm not about to hop on to the "raising expected NGDP (or the expected rate of inflation) is as good as, or even better than, raising actual values of either" bandwagon.

Don Geddis writes:

@George Selgin: Sure, the recession problem is indeed a matter of "the gap between actual and expected NGDP". And sure, expected NGDP affects short run supply schedules.

But then you seem to recommend "lowering expectations until they conform with reality". It's certainly easy enough to do that, but the whole problem is (supposed to be) that sticky nominal wages and debts means that it takes the economy a long time to adjust to the new NGDP reality. It's isn't simply a matter of expecting the new low. The problem is that contracts don't adjust quickly. So your suggestion results in a long period of unnecessary below-potential economic performance.

The alternative that you criticize, that "increased expected spending flows" will "also tend to raise supply schedules", is the intent. Not to raise them above where they are. But instead to put the economy into an state where the current short run supply schedules happen to be the equilibrium levels (since adjustment is slow).

I certainly agree that, in the long run, everything will eventually adjust, and the economy can do fine with any (stable) NGDP trend.

George Selgin writes:

Don Geddis, you say that I "seem to recommend "lowering expectations until they conform with reality." But that can only be due to a misreading on your part, for what I say is merely that lowered NGDP expectations are one potential way to regain full employment, the other being to raise actual NGDP. I never suggested, nor in fact do I hold, the view that the former solution is the easiest. You also do not seem to grasp that, in an NGDP-shortfall based recession, short-run supply schedules are above, not below, their levels consistent with full employment. Consequently no good can come from a policy that has the effect of raising those schedules still further.

Finally, though I'm glad we agree that everything adjusts in the long run, I should hope that you realize that I have never suggested that the long run is all that matters. I'm happy to leave that sort of thing to New Classical economists!

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