Scott Sumner  

Two dubious ideas

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Here's The Economist:

In places stuck in deflationary quicksand it may be necessary to be more radical still. Olivier Blanchard and Adam Posen of the Peterson Institute for International Economics have argued that Japan would benefit from an incomes policy. Under their proposal the state would mandate an across-the-board 5-10% increase in salaries in order to jump-start a spiral in which high wages drive up prices that drive up wages, thus soon leaving deflation behind.

. . .

Those with memories of the dismal failure of incomes policies in the 1970s (aimed then at capping, rather than spurring, inflation) will be aghast that the idea might be considered at all. For one thing, employers back then often found ways to escape the mandate. Advocates argue that companies would be encouraged to meet the costs of the pay rises through higher prices--indeed that is the whole point. In the 1970s low real interest rates undermined the income policies' wage caps; today monetary policy and incomes policy would be pushing in the same direction.


The incomes policies of the 1970s were enacted to prevent tight monetary policies from increasing unemployment. In contrast, a policy trying to force nominal wages higher would have the effect of making unemployment higher during a period of reflation. Maybe the BOJ wants to do that, but it's not obvious to me why that would be the case.

Policies aimed at artificially boosting wages were tried by FDR during the 1930s, and failed.

Here's another head scratcher:

The academics suggest central banks are following a rough rule of thumb. They postpone rate increases when volatility is high, for fear of causing further upset, but respond to high volatility with rate reductions.

Investors may thus have learned that if they throw the equivalent of a toddler's tantrum, central banks will eventually come to their rescue. Over the long run this might have encouraged risky behaviour of the kind that was common in the run-up to the crisis of 2007-08.

The power of tantrums may still apply. In September the Fed postponed a rate increase in part because markets seemed to point to a slowdown in the global economy.


That's a very odd metaphor, which seems to get things exactly backwards. Markets have buyers and sellers. If a stock prices plunge, the people who would be "rescued" by monetary stimulus are those with a long position. But the "tantrum" would be thrown by sellers. If the Fed switched to easier money, it would be punishing the people who threw the tantrum, not rescuing them.

Nonetheless, I suspect this sort of muddled thinking is quite common. And it might even help to explain why people get upset when Fed policy seems to help the stock market, even though this is exactly what you'd expect when the Fed adopts a policy that is in the best interest of the America people. Is what's good for the market also good for America? Not always, but when we are talking about monetary policy the correct answer is "usually".

PS. In response to my previous post, some commenters pointed to certain aspects of the real economy that might make it more stable than 100 years ago. However I was talking about the nominal economy, which is a totally different concept from the real economy. This earlier Econlog post explains why. In order to make the nominal economy more stable, an allegedly stabilizing property must either stabilize the monetary base, or else stabilize the share of income that people and banks prefer to hold as base money. (aka the "Cambridge k".)


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COMMENTS (9 to date)
Njnnja writes:

Markets have buyers and sellers. If a stock prices plunge, the people who would be "rescued" by monetary stimulus are those with a long position. But the "tantrum" would be thrown by sellers. If the Fed switched to easier money, it would be punishing the people who threw the tantrum, not rescuing them.

Not quite right. Institutional investors have huge positions, so they can dump lots of assets, driving down prices, while still having significant long positions that need "rescuing."

MikeDC writes:

In order to make the nominal economy more stable, an allegedly stabilizing property must either stabilize the monetary base, or else stabilize the share of income that people and banks prefer to hold as base money. (aka the "Cambridge k".)

Don't income policies stabilize V?

In old-fashioned recessions, V fell sharply as money holders (say, factory owners) held his money and laid off his workers. The hold decision amplifies the problem because it pushes successive decisions by money holders in the same (hold money) direction.

In an economy with something like social security and other incomes policies, this effect gets muted. V still falls, but because folks with government guaranteed income are still spending their money, it's not going to fall as much.

Kevin Erdmann writes:

I thought my comment was about nominal fluctuations. My link was to nominal measures.

Andrew_FL writes:

To underscore your point about a nominal volatility having decreased where others pointed to real volatility:

Ritschl, Albrecht, Samad Sarferaz, and Martin Uebele. "The US Business Cycle, 1867–2006: A Dynamic Factor Approach." Review of Economics and Statistics 00 (2015).

This paper estimates a Stock/Watson index of aggregate economic activity to assess U.S. business cycle volatility in the long term. We replicate the Great Moderation of 1980-2006. Evidence of wider postwar moderation relative to pre-1914 is not robust to structural change, implemented by time-varying factor loadings. We find postwar moderation in the nominal series, except for agriculture, historically an important sector. We conclude that even during the Great Moderation of 1980-2006, the U.S. business cycle may have been as volatile as under the Classical Gold Standard pre-1914. The only exception is the 1960s where volatility remained at an historical low.

For those of you who can't parse abstract speak: the pre-Fed economy in real terms does not appear to have been more volatile than the post WWII economy. But there is evidence of nominal moderation.

Scott Sumner writes:

Njnnja, Well the tantrum itself certainly would not be rewarded. The institutions that did not throw a tantrum would do better.

Mike, Social Security is not an incomes policy, it's an automatic stabilizer. But yes, it's possible that Social Security might provide some stability. I doubt it would be very much, but I can't rule out some effect.

Kevin, I forgot that, but there was another comment by Jose that I was also thinking of.

Andrew, The truth is we don't have good enough data to be sure, but most of the data that I have seen suggests that recent decades have been the most moderate. But it's an open question.

jj writes:

Scott,

I don't know your exact position, but based on the review of your book in the link, you endorsed FDR's revaluation of gold. How can you reconcile that your libertarian views? Do you think its moral to make a move like that to improve the economy even though confiscating gold is theft by any standards?

Andrew_FL writes:

jj, Scott's a utilitarian. He doesn't believe in the non aggression principle.

Prakash writes:

Why would someone even suggest such a policy? Isn't helicopter money radical enough? And wouldn't helicopter money achieve what is needed there without the unemployment effects?

Scott Sumner writes:

jj, I don't regard the devaluation as confiscating gold. If you mean do I approve of FDR's policy making it illegal to own gold, then the answer is no.

The devaluation of the dollar was justified by the national emergency, and the fact that previous deflation had greatly increased the purchasing power of gold.

In my view monetary policy should keep NGDP growing along a slow but steady path, and that this policy will lead to many libertarian reforms in other areas. In contrast, Hoover's tight money policy opened the door to socialist ideas, and hence was quite anti-libertarian.

Prakash, Yes, and even helicopter money is not needed, good old-fashioned open market purchases are all you need.

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