Scott Sumner  

Market monetarism and market macroeconomics

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Frequently Insightful but Ofte... Education: Free Matters...

Here's Scott Aaronson:

I love when important decisions fall into the hands of people who constantly second-guess themselves and worry that their own 'tribe' might be mistaken, who are curious about science and have a sense of the ironic and absurd.
This is clearly good advice, and got me thinking about what would push me away from market monetarism. For instance, I recently did a post suggesting that negative interest on reserves is expansionary (ceteris paribus). On the other hand, this hypothesis is not easy to test, at least using conventional economic tools, as negative interest on reserves will generally be associated with bad outcomes over any extended period of time, for the same reason that brain surgery is often associated with bad outcomes.

One nice thing about market monetarism is that it comes attached to a clear procedure for refuting the theory. There is a simple answer to the question, "What would make me abandon market monetarism?"

Markets!

If that seems too cute, let me explain. Suppose that over the next few months I noticed that exchange rates were appreciating on news of larger than expected reductions in interest on reserves. My market monetarist theory predicts that larger than expected cuts in IOR should lead to currency depreciation. If I was seeing one example after another of currency appreciation, all in response to negative IOR surprises, I'd have to reject that particular tenet of market monetarism, at least below the zero bound. Much as I'd like to believe that increasing the cost of holding the medium of account would reduce its value, and hence increase the price level, if the markets suggested otherwise then I'd have to abandon my hypothesis.

If, in addition, markets suggested that inflation expectations were not affected by the announcement by a central bank that it would buy up whatever assets it took to hit an inflation target, then market monetarism would be further weakened. Add to that a couple cases where the announcement of higher government spending did boost inflation expectations, and I'd be inclined to convert from market monetarism to market Keynesianism. Or more accurately, I'd be inclined to invent market Keynesianism, as no one has done so thus far.

[Just think about that for a moment. No one has invented market Keynesianism. What does that tell us? I'm not sure, but it's a question worth pondering.]

I hope it's apparent where I'm going with all this. The set of all "market isms", including market monetarism, market Keynesianism, market RBCism, market Austrianism, market MMTism, and, well why not, market Marxism, are embedded in a sort of meta-theory called "market macroeconomics."

Market macroeconomics suggests that the markets provide the best way of evaluating the impact of policy shocks on the key macro variables. If the yen plunges on news of negative IOR, then we can infer that negative IOR is expansionary. But that raises an even deeper question--what makes us think this market macro meta-theory is valid? Doesn't the meta-theory also need to be constantly re-evaluated?

Yes it does, but at the moment it would take for more evidence to push me away from market macro than to push me away from market monetarism. I believe it's quite possible that at least some kinds of fiscal stimulus surprises would boost NGDP futures prices, if we had such a market, and indeed would boost equity prices even without such a market. In other words, I think it's quite possible that I'm wrong about monetary offset.

In contrast, I think it's exceeding unlikely that if a surprise cut in IOR causes the yen to depreciate by 2% in 5 minutes, that the optimal forecast of the one month forward yen doesn't also fall by something on the order of 2%. If, for instance, the optimal forecast of the one month forward yen did not change at all, then there'd be lots of 10,000 yen notes on the sidewalk, just waiting for traders to pick them up.

What I'm trying to say here is that for the meta-theory of market macro to be wrong, it's not enough that the EMH doesn't hold "true". Heck, it's obviously not literally true. Rather, the EMH would have to be spectacularly wrong, making it easy to earn large excess returns. That's possible, but seems exceedingly unlikely to me.

So if someone far smarter than me, such as Scott Aaronson, asks me whether I should constantly re-evaluate the correctness of market monetarism, I'd say yes. If he then asked me about confirmation bias, I'd have to agree that's a problem. We can't be trusted to evaluate the accuracy of the theories that we hold dear, because we've fought for them for so long. So who can we rely on to evaluate market monetarism? Not people with other ideologies like Keynesianism, because they also have an axe to grind. Not people with no alternative theory, because they are not well enough informed. There's only one group I trust---market participants who have money on the line. To paraphrase Richard Rorty might have said truth is what the market let's you get away with.

Can the market also answer "scientific" questions? Sure it can. Aaron Jackson and I once wrote a paper advocating futures markets for both global average temperatures and CO2 levels. (Robin Hanson has pushed this line of thinking in all sorts of directions.)

Of course you need to eventually have some clear observational data to answer the question, or a market won't work. AFAIK, there are some deep scientific questions (string theory, "many worlds", etc.) where we currently lack the ability to do an empirical test. But for global warming we can. Time will tell. Even better, markets can provide an optimal forecast of what exactly "time will tell".

Many readers of this blog favor market solutions to many of society's problems. So do I. But I'm even more confident about the utility of markets in science, in deciding what's true and what's false, than I am that markets are a good way to organize health care or education. Indeed, as a follower of Rorty, I'd be inclined to define "truth" as "what the market believes". And yes, that obviously means that truth is always provisional. How provisional? It depends on the hypothesis, and to find out you need options markets.

To a computer scientist like Scott Aaronson, the universe looks sort of like a giant computer (or at least I got that impression from the interview linked to above). To an economist like me, science looks kind of like a giant set of markets.

HT: David Levey


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COMMENTS (16 to date)
ThaomasH writes:

Would not the recommendation that governments invest in activities that have positive NPV's be "Market Keynesianism?" It would be "market" in that the decision rule is a standard neoclassical wealth maximization rule. It would be "Keynesian" in that it's application would lead to greater deficit spending during recessions (and would be denounced as "Keynesian" by macromedia).

Aside: what kind of experimental outcome would settle (bear on) the difference between the superiority of PL + "employment" (dual mandate) targeting and NGDP level targeting?

Philo writes:

"My market monetarist theory predicts that larger than expected cuts in IOR should lead to currency depreciation." *Ceteris paribus*! That's what makes it so hard to test economic theories of the usual, somewhat vague type--for example, a theory that *unexpected reduction in IOR* causes *currency depreciation*. To be testable, such a theory must also identify, besides the supposed causal factor, *all* the other factors relevant to the given effect. Then we need a test case where all these other factors are, indeed, unchanged. In practice, that's too much to expect, and even if we got it, and the observations we made refuted the theory, we would suspect that slightly tweaking the theory by specifying some additional causally relevant factor would save it.

Kevin Dick writes:

Given that the universe is pretty clearly a giant information processing mechanism, it's not surprising that economists and computer scientists can respectively map it into their domains. Markets and computers are both fairly general information processing mechanisms.

Philo writes:

"To paraphrase Richard Rorty, truth is what the market lets you get away with." That's not a *paraphrase*; it's a *parody*. (In my view, one that is significantly better than the original!)

"Indeed, as a follower of Rorty, I'd be inclined to define 'truth' as 'what the market believes'." That's not Rorty's view, it's yours; don't give him credit he doesn't deserve. But I think it would have been better had you made the market a test of *justified belief* rather than of *truth*: you should have said that what we at any time are justified in believing is what the market believes at that time (provided we know what this is; otherwise we have to resort to more primitive epistemic processes).

michael pettengill writes:
No one has invented market Keynesianism.

Didn't Keynes invent "market Keynesianism"?

Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; ...

I might call it supply side Keynesian capitalism economics.

Except, I've kept both my arms and look at both supply and demand because they must be equal.

Low interest rates signal an economy where the supply of money from all sources and today from savings especially, is far greater than the supply of borrower's who can repay thein debt.

For example, savings earning 0-2% were loaned to wildcatters to drill baby frack at high interest rates creating so much capital that the returns to capital are approaching zero once accounting for the usage of capital, and that means the debt can not be repaid, so the savers end up owning the capital built by the debt. Savers not interested in zero return capital now refuse to loan their savings to the capitalists who need the cash to build more capital to increase the supply. American wildcatters need to produce an additional 5 million barrels a day to meet US consumer demand. Given demand for US goods is too low to balance the costs of oil imports, the US needs to do more of what it's good at, producing lots more oil and gas using innovation.

And the savings are sitting around without being turned into productive capital, so why not maintain the past 7 years of drill baby frack even if the return on capital is zero, just like the return on savings is zero?

Or is "free market capitalism" a bad idea?

Andrew_FL writes:
Of course you need to eventually have some clear observational data to answer the question, or a market won't work. AFAIK, there are some deep scientific questions (string theory, "many worlds", etc.) where we currently lack the ability to do an empirical test. But for global warming we can.

A statement clearly indicating you haven't spent much time following the issue. The "observational data" is revised, in non trivial ways, every few years, and besides that there are several different datasets, which have non trivial differences between them. The reason for these differences is itself a source of controversy.

(although, as an aside, the blog The Blackboard has a monthly betting pool (play money) on next month's satellite temperature anomaly.)

A market forecast of the future temperature anomaly reported in a few decades by the official agencies is unlikely to settle any of the underlying issues. It's also unlikely to be right, as the methodology can and has been arbitrarily changed by those agencies on a regular basis. Interestingly almost always increasing the long term trend.

(Also I daresay most of the commenters here trying to say what they think Market Keynesianism is or would be, don't understand what the Market in Market Monetarism means. I presume that Market Keynesianism would recommend that Congress target the market's NGDP forecast. Ha!)

(Also there is no such thing as "Market Austrianism" or any qualified Austrianism. You either understand economics through the pure logic of human action or you do not.)

Scott Sumner writes:

Philo, Thanks, I changed it. Paraphrase is obviously not the right word. What was the word I was looking for?

Scott Sumner writes:

Philo, You said:

But I think it would have been better had you made the market a test of *justified belief* rather than of *truth*:"

But doesn't Rorty say that they are one in the same?

Thaomas, You said:

"Would not the recommendation that governments invest in activities that have positive NPV's be "Market Keynesianism?""

That's clearly a sensible criterion for government investment, but it has no bearing on Keynesianism, or even fiscal policy. Fiscal policy is more than government investment, it's adjustments in the deficit with a goal of macroeconomic stabilization.

Kevin, Good analogy.

Michael, You quote Keynes saying:

"Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; ..."

That's actually not Keynesian economics. And even if it were, it's certainly not market Keynesianism.

Andrew, I don't agree with you on global warming, and yes, I've read a lot on the subject.

You said:

"I presume that Market Keynesianism would recommend that Congress target the market's NGDP forecast. Ha!"

Here we agree.

Andrew_FL writes:

It was my primary area of interest and research for several years. If you disagree with me, I'm going to assume I'm right.

Actually I'm going to assume I'm right to begin with because assuming I'm wrong would be incoherent.

ThaomasH writes:

"Fiscal policy is more than government investment, it's adjustments in the deficit with a goal of macroeconomic stabilization."

But does "fiscal policy" imply departing from the NPV rule? Or does it mean adhering to the NPV rule in the face of higher deficits? When I hear "Keynesians" talking about "stimulus" I hear things about infrastructure and maintenance being good investments when the government can borrow at low rates.

Sam writes:

Scott, regarding Andrew's point on the temperature data, I think it deserves more credit than you think. Without weighing in on the merits of the various datasets, it's certainly true that predicting "the" temperature 20 years from now partly involves guessing what the procedure to compute that metric will be in two decades' time. Speculators don't generally like to speculate on the value of contracts which are ambiguously specified or involve language subject to uncertain legal interpretation, and as Argentine bond investors will tell you, such uncertainties can make a big difference.

Incidentally, I think (?) you would be sympathetic to this point as regards forecasting macroeconomic timeseries on long time horizons. Even a pretty reputable and highly transparent agency like the BEA periodically makes relatively substantial revisions to its methodology for calculating, say, GDP. Inflation is notoriously difficult to measure and I for one would not be *too* shocked if the BLS made a major change to their methodology in the next 30 years. (I wonder if 30-year TIPS investors price such uncertainty in?) And of of course these points are even more salient for economic indicators in developing countries.

Benjamin Cole writes:

Interesting post.

Lawrence J. Kramer writes:
Market macroeconomics suggests that the markets provide the best way of evaluating the impact of policy shocks on the key macro variables. If the yen plunges on news of negative IOR, then we can infer that negative IOR is expansionary.
The second sentence does not follow from the first. The second should be:
If the yen plunges on news of negative IOR, then we can infer that negative IOR can be expansionary.
Whether negative IOR is expansionary is much harder to prove, especially in the absence of any discussion of supply. Indeed, the problem with talk about the supply of money is that it seems to ignore changes in the rate of growth in the supply of goods and services. New money must fill the output gap before it can cause inflation.

But the output gap does not wait to be filled. New technologies come at us every day, each widening the gap between what we can produce and what we have figured out how to demand.

If you toss a ball up in a moving railroad car, it will fall back in your lap. Unless the train is accelerating or slowing. The supply train is accelerating, but our policymakers are still tossing the ball straight up. No wonder it is hitting them in the face.

Thank you Scott for the link, in the first line of your post, to the Scientific American interview of Scott Aaronson by John Horgan. The interview is long (51 pages from my printer) but very interesting!

Scott Sumner writes:

Thaomas, You asked:

"But does "fiscal policy" imply departing from the NPV rule?"

It would seem like it does, otherwise there'd be no distinction between Keynesian economics and classical economics. But as always, definitions are vague in macroeconomics, and there are almost as many versions of Keynesianism as there are Keynesians.

Sam, I am aware of that, but I'd expect measurement of temps and CO2 to get more accurate over time. Even today, we have markets like TIPS that depend on government estimates of the CPI. The CPI is obviously highly flawed, but it doesn't prevent TIPS spreads from being a useful market indicator.

I've read a lot of scientific papers on global warming, and a lot of stuff criticizing the science. Overall, I find the science to be more persuasive than the critics, but don't rule out that some of the science exaggerates the likely damage from global warming.

Lawrence, Good point, and I should have been more specific. I meant expansionary for AD, i.e. NGDP. Even that is hotly debated. I agree that going from NGDP to RGDP is a much more difficult proposition to establish. That's one reason I favor the creation of RGDP futures markets.

Thanks Richard, Scott is obviously brilliant, although some of the stuff he discusses is over my head. Nonetheless, I've noticed when reading his blog that he has a first rate mind, even when discussing non-scientific issues.

Andrew_FL writes:

Polemics for carbon taxes are "the science" and actual scientific papers are "stuff" and "the critics"

Okay then.

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