Scott Sumner  

The problem is not tight money, it's unstable money

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Here's Business Insider:

Janet Yellen's warning about low rates causing a recession doesn't make sense

Federal Reserve Chair Janet Yellen told Congress this week that the US central bank could cause a recession if it waited too long to raise interest rates.

Wait, what? Isn't it the other way around? Yes, according to Yellen's testimony just a year earlier.

In the past, Yellen and her most recent predecessor, Ben Bernanke, have emphasized that, because interest rates are still near zero and inflation has remained persistently below the Fed's 2% target, it is safer for policymakers to err on the side of leaving borrowing costs low for longer.

People often assume that recessions are caused by tight money. It would be more accurate to say they are caused by unstable money. Money was not "tight" in any absolute sense during the 1980 and 1982 recessions, rather it was tight relative to the wildly expansionary monetary policy right before those two recessions. Yellen understands that the way to avoid recessions is a stable monetary policy. Business Insider doesn't understand that this means rate cuts are appropriate at certain times, and rate increases at other times. Early next year she may not be re-appointed as Fed chair. If so, she may end up being the most successful Fed chair in history (in terms of stable NGDP growth, not banking regulation).

Just as valleys can be caused by mountains, recessions can be caused by overheated booms:

Screen Shot 2017-02-16 at 4.12.42 PM.png

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COMMENTS (15 to date)
Andrew_FL writes:
Just as valleys can be caused by mountains, recessions can be caused by overheated booms:

Wow! This is quite the concession!

Mark Bahner writes:

Hi Scott,

I think you should let your readers know about the trends in inflation and unemployment, rather than assuming they know the latest details.

For example, I was very surprised to see that inflation has consistently risen since July 2016 to a value in January 2017 of 2.5%:

U.S. inflation rate

And U.S. unemployment is very close to its lowest rate in the last 40 years:

U.S. unemployment

Best wishes,

Scott Sumner writes:

Andrew, Concession?

Thanks Mark.

Andrew_FL writes:

What you said in that quote is something Milton Friedman explicitly denied was true.

Scott Sumner writes:

Andrew, Can I see the quote? I'm just using the natural rate hypothesis, which Friedman invented.

Alex S. writes:

My take on the exchange:

I think Andrew_FL's comment about concessions had to do with the overheated boom can cause a recession line.

It's an Austrian point that a overheated boom inevitably ends in a crash.

I think the comment on Friedman probably applies to his plucking model.

It would make for an interesting post...what would happen if NGDP overshoots E[NGDP]? I do see why the reverse is more cogent given 2008 though.

Kevin Erdmann writes:

Off topic, Scott. I have a question on the border adjustment tax. Maybe this just exposes some ignorance I have in thinking through this. I don't know.

It makes sense to me that the adjustments in currency values could simply lead to a new equilibrium where real trade wasn't much affected. But, then, with the persistent deficit, the government would end up with some billions of dollars in tax receipts. Those dollars had to come from somewhere. Is there some sort of seigniorage effect from the higher dollar? Would the trade deficit actually have to grow larger in order for foreign savers to continue to invest the same amount of after-tax dollars in the US?

Scott Sumner writes:

Alex, I'd wager almost anything that Friedman would view the 19% NGDP growth rate in late 1980 and early 1981 as one of the causes of the 1981-82 recession. Recall that Friedman argued that unemployment rose when inflation was less than expected. As a practical matter than meant unemployment rose when the rate of inflation fell sharply. That's likely to occur after an overheated boom, which is exactly Yellen's point.

The Austrian mistake is to look at periods like 1929 and 2006, and see overheated booms when in fact they were fairly normal booms with around 6% NGDP growth. Maybe a bit overheated, but nowhere near enough to explain what happened next. 1978-81 is an overheated boom, with very high NGDP growth.

Scott Sumner writes:

Kevin, In a pure border tax/subsidy there is no revenue in the long run, as there's no long run persistent deficit. If there is, then the tax system is flawed, missing some of that dark matter. (I think that's likely, in fact.) If the tax raises money in the long run, it will be because it misses a large share of US exports (which are intangibles.)

Kevin Erdmann writes:

Ah. So, to the extent that this is the reason for a persistent trade deficit, the public revenue would come from US global firms who don't capture the subsidy on their foreign income?

Andrew_FL writes:

I am in fact referring to his paper on the plucking model.

The Austrian mistake is to look at periods like 1929 and 2006, and see overheated booms when in fact they were fairly normal booms with around 6% NGDP growth.

So apparently you only concede the existence of the business cycle in theory, but never in reality.

Bob Murphy writes:


I understand why Andrew_FL is confused by your statements. Let me try to illustrate so you can clarify (if you want).

(1) In this post, you seem to be saying that you agree artificially low interest rates can fuel an unsustainable boom, and that's why Yellen is wise to want to raise rates sooner rather than later to avoid a crash.

(2) Andrew_FL said (paraphrasing), "Oh? So you agree with the Austrians that it was loose money that caused the housing boom and crash?"

(3) You said (paraphrasing), "No, the housing bubble only involved 6% NGDP growth. That's not enough to cause a big crash when you slow it down."

==> So the reason your statements are confusing, is that the latest year/year growth rate of NGDP was about 3.5%. And it hasn't broken 5% in a decade.

Do you think if Yellen doesn't raise rates in the next 6 months, that NGDP growth will break (say) 7% and get into the territory of a dangerous boom?

marcus nunes writes:

"If so, she may end up being the most successful Fed chair in history"

Someone has concluded she is!

TMC writes:

I've got nothing against Yellen, but isn't she just the beneficiary of a dead cat bounce?

Yaakov Schatz writes:

When the interest rate goes up, how will the government pay interest on its debt of 20 trillion dollars?


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