Scott Sumner  

I'm not "the NGDP guy"

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When I was much younger, right wing macroeconomists like me used to think we were smarter than left wing macroeconomists. The old Keynesian model ran into some pretty severe problems during the 1970s, and the monetarist critique of the model had a lot of merit (even though the monetarists also made mistakes, as when they recommended targeting M1 or M2.) In particular, we prided ourselves with understanding that "the interest rate is not the price of money, it's the price of credit." We knew that low rates don't mean easy money, and high rates don't mean tight money. That there was only a temporary trade-off between inflation and unemployment. That monetary policy drives the nominal economy, not fiscal policy. That tight money causes most recessions, not a lack of animal spirits on the part of consumers or business. That the "liquidity trap" is not a trap at all, monetary policy remains highly effective at the zero bound.

By the early 2000s the new Keynesians had accepted much of this. Our crowning achievement! We should be gloating. And yet as I look around it seems like most right-of-center macroeconomists have forgotten much of this. Mishkin's textbook no longer says monetary policy is "highly effective" at the zero bound. John Cochrane says it's useless at the zero bound. John Taylor doesn't seem to think tight money caused this recession. The Austrians say low rates caused the housing bubble. Lots of conservatives have rejected Friedman's claim that recessions are caused by tight money.

Today, most conservative economists seem to think a low interest rate environment represents an easy money policy, an idea that would have been strongly criticized at the University of Chicago that I remember. Here's Milton Friedman discussing zero rates in Japan:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

. . .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.


Note that he says, "has been tight". Yes, there is a very short-term liquidity effect linking low rates with easy money. But when rates have been low for an extended period of time, without inflation rising, it reflects the longer-term income and expected inflation effects. Contrast that with this article discussing the views of Charles Plosser:

Plosser, who is one of the Fed's most outspoken "hawks" expressed concern over the low rates. Last month, the Fed confirmed that it would hold the target range for the federal funds rate at 0 to 0.25 percent.

"There are many indicators that tell us interest rates are too low," Plosser told CNBC from the UBS European Conference in London.

. . .

"There is no precedented history to have rates at zero. I think we are really behaving in a way which is outside of historical norms and that should make us nervous," he added.

Plosser conceded that "wage growth has been very modest" and that falling oil prices were pressuring short-term inflation lower--but said that rates were too low nonetheless.


He doesn't come right out and say low rates mean easy money, but that's the clear implication of the entire interview. And he's so worried about low rates that he wants to raise them even though he concedes the wage data doesn't suggest a need to. Friedman would have said we should ignore interest rates.

I could find dozens of other examples. Much of what Friedman taught us about money has been forgotten, even by the "new monetarists."

I was recently reading a new book on monetary policy alternatives, edited by Larry White. One thing I noticed was that when my name came up it was always in the context of NGDP targeting. Yes, I am a big fan of NGDP targeting. But I don't really see myself as "the NGDP guy." The most distinguished center-left macroeconomist in the world (Michael Woodford) has advocated NGDP targeting. Ditto for one of the most distinguished center-right macroeconomists (Bennett McCallum.) So did Hayek. NGDP targeting would not have been much different from the Taylor rule during 1984-2007, when interest rates were positive. It's a very conventional idea, not radical at all. There are many proponents of the policy.

I see myself as the "monetary misdiagnosis guy." I'm the one that claims almost the entire profession has it wrong, and Milton Friedman had it right. (Just as Frederic Mishkin and Ben Bernanke had it right in 2003, but not in 2013.) Monetary policy has been tight since 2008. There should be no debate about whether the Fed should end its extraordinarily accommodative policy, as there has been so no such policy. These views distinguish me from almost all other economists on both sides of the spectrum. It's why I think a tight money policy from the Fed caused the Great Recession, whereas 99% of macroeconomists think that claim is nuts, both because money was not tight (in their view) and the financial crisis "obviously" caused the recession.

Yes, I do strongly support NGDP targeting, especially level targeting. But that's not my primary beef with the profession right now. I'm the misdiagnosis guy. (Hopefully it's not me doing the misdiagnosing!)


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COMMENTS (16 to date)
Sam Haysom writes:

You have a tendency to list several arguments, only one or two of which you actually address, all the while pretending that every argument you listed was debunked. Whether or not one Milton Freidman assertion, your quoted portion isn't actually an argument just a sneer, disposes of Mishkin or Cochranes argument, the fact remains that it does not in any way deal with the arguments of Taylor or the Austrians. Loose or tight, higher interest rates would have meant fewer loans and less refinancing. Milton Freidman never experienced any thing like the 2006 housing bubble.

I'll add that you really shouldn't be that surprised by the fact people on the right ignore Freidman. Hayek was always more amenable to the psychological and philosophical disposition of conservatives (despite vocally rejecting conservatism himself), and Freidman's period of vogue on the right was almost entirely due to the right's need for a theoretical justification for deflation. This is why two supposed Freidman acolytes Thatcher and Reagan pursued almost diametrically opposed fiscal policies when it came to government spending. Their overlap was confined to inflation fighting monetarist policies.

Paradoxically, it is the libertarian sympathies of American conservatism that make it especially wary of anything that sniffs of inflation regardless of what MF says. To a continental Euroepan Conservative party a Weimar type situation necessitating a strong man leader is far less frightening than it is to a right in the USA which fears centralized government control.

Scott Sumner writes:

Sam, No, higher interest rates do not mean fewer loans for housing. I know of no model that predicts that.

If conservatives want to walk away from Friedman's claim that low interest rates mean easy money then they should say so. And yet when I press them I can hardly find a single one who will defend the argument that Friedman was wrong. They should say out loud that he was wrong and explain precisely why Friedman was wrong. Was money tight in the late 1970s and early 1980s? Instead all you have is either people sheepishly walking away from that widespread view when questioned, or sticking to it because they lack a basic understanding of S&D 101.

ThomasH writes:

Whether monetary policy is tight or loose depends on what you mean by "policy." I accept your prescription -- keep throwing policy instruments (low interest rates on ST government securities, LT securities, real asset purchases, announcing a higher inflation or ngdp target, whatever) at the economy until NGDP returns to the pre-crisis trend. ["The beatings will continue until morale improves."]

But for understanding's sake why not just say "traditional, ST interest rate" monetary policy is ineffective when the ST interest rate gets to zero. But non-traditional monetary and traditional fiscal policy (invest in projects whose NPV become positive at low government borrowing costs) are still effective.

As to why so many people "forgot" their MM theory, maybe it was because their main interest was to eliminate a role for fiscal policy (even though such a role persists in a MM regime) than to maximize real income.

Don Geddis writes:
"Being in a minority, even a minority of one, did not make you mad. There was truth and there was untruth, and if you clung to the truth even against the whole world, you were not mad."
(George Orwell, Nineteen Eighty-Four)
Daniel Kuehn writes:

What do you think of saying "aggregate demand has been tight" rather than "monetary policy has been tight".

My hesitation about your formulation is that it bundles two claims:

1. A claim about what causes recessions, and
2. A claim about the effectiveness of policy.

I don't think monetary policy is useless at the zero lower bound but I think it gets trickier and am a little uncomfortable with mixing up the second claim with the first claim under those circumstances.

But saying that aggregate demand has been tight seems to solve that problem. It also prevents people from falling into the tautology that we know monetary policy is tight because we're in a recession (which is defined as what happens when monetary policy is tight).

Andrew_FL writes:

In fairness to the monetarists of those days, money supply targeting made more sense then than it does now. Or at least it appeared to.

I will just note, not to "duck" the other issues raised here, that one can believe loose policy in the early to mid 2000's caused, or significantly contributed to the housing bubble without contradicting the claim that policy tightened significantly, and unnecessarily, toward the end of that decade.

I remain skeptical of the claim that it has remained tight ever since, but I think that has more to do with applying different standards on which to judge the relative tightness/looseness of policy.

John S writes:

Could you please give the title of the book edited by Larry White? I can't find it on Google.

Kevin Erdmann writes:

Scott,
"Sam, No, higher interest rates do not mean fewer loans for housing. I know of no model that predicts that."

Scott, I'm sad. I thought you were on board with my argument that low inflation was one ingredient in the housing boom, partly because of the way mortgage loans are treated like consumer loans, where the buyer has to cover the inflation premium with current income. Tight money did factor into the housing boom!

Now you're throwing me in the memory hole? Am I Jonathan Gruber to your Nancy Pelosi?
;-)

Sam, the intrinsic value of homes should be highly responsive to real long term interest rates. This is largely outside of the control of the Fed. Higher long term inflation expectations can help dampen the ability of households to fund home purchases with new mortgages, but that would largely need to come from loose monetary policy.

Scott Sumner writes:

Thomas, You said:

I accept your prescription -- keep throwing policy instruments (low interest rates on ST government securities, LT securities, real asset purchases, announcing a higher inflation or ngdp target, whatever) at the economy until NGDP returns to the pre-crisis trend. ["The beatings will continue until morale improves."]

No, that is not my prescription, that's closer to current policy. My prescription is simply NGDPLT so that we don't need "beatings." I do the "beatings" with extreme reluctance; "this is going to hurt me more than you."

Daniel, You said:

"My hesitation about your formulation is that it bundles two claims:

1. A claim about what causes recessions, and
2. A claim about the effectiveness of policy."

That's probably worth a blog post. Note that other definitions like M2 and interest rates also combine these two. And it's not a claim about what causes recessions, it's a claim about what causes NGDP

You said:

"But saying that aggregate demand has been tight seems to solve that problem. It also prevents people from falling into the tautology that we know monetary policy is tight because we're in a recession (which is defined as what happens when monetary policy is tight)."

There is not tautology in my definition. Zimbabwe was in recession in 2008, but I don't claim money was tight.

Kevin, You may be right, but that's not the claim I criticized. I criticized the view that higher interest rates caused lower housing loans. Your claim is different. There are many ways that interest rates can interact with housing. For instance, in 2008-09 the Fed used a tight money policy to create lower interest rates, and this led to fewer housing loans.

But yes, I can be just as inconsistent as Gruber, maybe worse.

maynardGkeynes writes:

You may not have "invented" NGDP targeting, but you can take credit for introducing and explaining it coherently to the dummies of the world like myself, which is a far greater achievement. It's also a more important achievement, because it's the dummies who rule the world, and probably always will.

Pietro Poggi-Corradini writes:

Scott,

if you're right, then it seems to me the whole field of econometric is useless. What is the point of trying to predict the future with macro models when the future depends on what people at the Fed decide to do: if they get it right (US last few years) all goes well, if they get it wrong (EU) then the economy goes under. You can't model this with mathematics.

All the people that claim they had predicted the Great Recession, would in effect have had to predict the composition of the board at the Fed, the fact that Bernanke would change his mind, etc...all kinds of psychological data that is very hard to quantify.

It's possible that if NGDPLT is adopted, then models can say something useful again, but I'm not sure.

Nathan W writes:

In particular, I appreciate the logic of thinking of a situation as reflecting the response to it, not the opposite factor which caused the response (and who even knows 100% for sure what that was anyways?)

Brian Donohue writes:

Scott,

I think you have to keep reposting these thoughts over and over. Tedious, perhaps; necessary, undoubtedly.

RogC writes:

Perhaps the reason that views change so frequently is simply that governmental manipulation of markets, including the markets for money & credit, is never a good idea. Most academic theories dealing with such manipulations were developed either by the side in power at the time to justify their political goals or by the opposing tribe to discredit the same. The utility of any currency declines remarkably fast as it is manipulated.

Philip George writes:

In the absence of a way to measure money the debate about when money is tight and when it isn't can go on forever without being resolved.

The graph in http://www.philipji.com/item/2014-11-15/is-a-financial-market-crash-in-the-offing shows that the commonsense view is right. The Great Recession was indeed accompanied by a contraction in money. But contrary to what you have repeatedly asserted, money has expanded continuously since 2008, which is indeed what we would expect from the Fed's actions.

What the graph shows, and this too is what we would expect, is that money has been flat since around April this year.

I am not sure that most economists think the financial crisis "caused" the Recession. Keynes did not even mention the Great Crash in The General Theory. Friedman was adamant that the crash did not cause the Depression. And I am not sure their intellectual descendants think differently. Roger Farmer has written a paper titled "The stock market crash Really did cause the great recession" which at least suggests that most other economists don't think so.

Bart writes:

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