Scott Sumner  

Rethinking Macroeconomics

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I recently attended a conference at the Peterson Institute on "Rethinking Macroeconomics", which mostly meant returning macro to its Keynesian roots. Readers may know that I have a contrarian take on the crisis---I believe it occurred because macroeconomists did not take macro theory seriously enough. We do not need to rethink macro by adding in fiscal policy or paying more attention to the financial sector, rather we need to impress upon the world's central banks the importance of doing whatever it takes to keep aggregate demand growing at an adequate level. The major central banks (except in Australia) did not do that in 2008 (for many different reasons) and hence we had the Great Recession.

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I don't get invited to many left-of-center conferences, for some reason I'm more likely to get invitations from groups like Cato, AEI, Heritage, etc. Thus I thought it might be interesting to provide a few impressions:

1. At an intellectual level the conference was very impressive---there were many brilliant economists presenting and also in the audience. The overall impression was of a center-left perspective, but hardly monolithic. After Alan Auerbach presented a paper on fiscal policy, several panel members (including Robert Rubin) expressed skepticism---viewing the problems we face as mostly supply-side.

2. I sometimes had a sort of "Paul Krugman reaction", as the general discussion seemed more grounded in reality than at a right-of-center macro conference. Most speakers seemed very aware of the importance of shortfalls in AD during the Great Recession, a basic understanding that I often feel is missing on the right.

3. On the negative side, I was extremely disappointed by some of the comments on monetary policy. In response to calls for a higher inflation target to avoid the zero bound problem, Jeremy Stein of Harvard University asked something to the effect "What makes you think the Fed can achieve higher inflation?" (Recall that Stein was recently a member of the Federal Reserve Board.) I was pleased to see Olivier Blanchard respond that there is no doubt that we can achieve 4% inflation, or indeed any trend inflation rate we want. But then Larry Summers also suggested that he shared Stein's doubts (albeit to a lesser extent.)

I kept thinking to myself: Why do you guys think the Fed is currently engaged in steadily raising the fed funds target? What do you think the Fed is trying to achieve? How can a top Fed official not think the Fed could raise its inflation target during a period when we aren't even at the zero bound? Why has the US averaged 2% inflation since 1990---is it just a miracle? When Summers came out for NGDP targeting I briefly wondered whether I'd made a mistake in favoring Yellen for Fed chair, but this comment reconfirmed my initial preference.

4. While the left is ahead of the right in their understanding of the importance of demand shocks, they lag far behind in understanding the importance of more subtle forces shaping the economy. Thus they are even less likely than the right to blame the Fed for destabilizing aggregate demand, and they almost entirely ignored the problem of moral hazard in a panel on the financial system. On the left there's a reflex to always seek solutions in more government (financial regulation, fiscal policy, etc.), not in removing government policies that cause problems (moral hazard, unstable monetary policy.) Unfortunately the solutions offered by the left do not address the root causes of economic crises, and hence are likely to be ineffective. Banks will eventually find their way around any regulations enacted to limit their risk taking. Fiscal policy has been repeatedly shown to be largely ineffective. (Remember the 2013 recession trigger by "austerity"? Me neither.)

5. Larry Summers dominated the conference due to a combination of his force of personality and his intellectual brilliance. (That's right, I don't judge intellects based on whether they agree with me.) At one point he was asked what he'd do if put in charge of the Fed. Although Summers had expressed support for a higher inflation target, he was surprisingly cautious in response to this question. He pointed out that it was the job of intellectuals in academia to throw out provocative ideas worth considering, and the job of top policymakers to enact policies based on well-established economic principles. He indicated that he wasn't sure whether it would make sense to use a lot of political capital trying to move the entire Federal Reserve System over to his preferred policy. (This is based on my memory, and may not be precisely correct.)

Summers' comment made me think back to lots of debates I'd had in various comment sections, where I defended Bernanke for trying to nudge the Fed in the right direction. Summers' remarks make me even more confident that I was correct, as if even an "alpha male" like Summers thinks he'd have trouble moving the Fed to his preferred policy regime, imagine the challenge facing a more mild-mannered, consensus-seeking personality like Bernanke (or me!). Summers has worked in the Treasury, and knows how difficult it is to enact policy changes in the real world.

6. When I proposed negative interest on reserves back in January 2009, the idea was widely ridiculed in my comment section. I recall reporters from the Financial Times suggesting that the policy would actually be contractionary. (They looked at monetary policy from the false "finance perspective", not the true "monetarist perspective".
Indeed the success of negative IOR helps to confirm the truth of monetarism). On one panel Mario Draghi indicated that negative IOR had indeed been effective, had failed to produce market distortions such as disruption to MMMFs, and had also failed to reduce bank profitability. (Note that an expanding economy is good for banks.) I was very pleased to see that my proposal had worked out so well.

7. Greg Ip from the WSJ asked a really interesting question. He pointed out that many of the factors cited by Larry Summers in his "secular stagnation" hypothesis also might serve to make recessions much less likely in the future. Previous recessions often occurred either when there had been an inflation overshoot (i.e. 1970 or 1981), or (perhaps) when investment has become excessive (think tech in 2000 or housing in 2006.) But under secular stagnation there are no inflation overshoots, and we also don't see high levels of investment. (Don't be fooled by recently recovering home prices; actual construction of homes remains severely depressed relative to the long run average.) I'm already on record predicting that this will end up being the longest expansion in US history, and Ip's question made me even more confident in that prediction.

Some people responded by pointing to past "this time is different" predictions (i.e. 1929, 1966, 2006), which ended up being overly optimistic. But I don't think that sort of cynicism is an adequate response to Ip, especially in a world where Australia has not had a recession in 26 years.

PS. Even though Adam Posen's views are far to the left of mine, I'd like to thank him for inviting me and for hosting an extremely high quality conference. This site has links to videos of the various panels, so you can check the accuracy of my memory.

Comments and Sharing

COMMENTS (11 to date)
Morgan writes:

"There is no doubt that we can achieve 4% inflation..."

There is no doubt that we can obtain any increased level of inflation we wish by simply dropping enough cash in plain white envelopes on every household's doorstep. Is there?

I don't understand why, if inflation is "too low", we need to funnel money into the economy through intermediaries who are expected to profit from lending it out (and will have trouble doing so under some circumstances). I admit that my not understanding it is not strong evidence that it's the wrong way to do it. But I'd be grateful if someone could set me straight.

Scott Sumner writes:

Morgan, You said:

"I don't understand why, if inflation is "too low", we need to funnel money into the economy through intermediaries who are expected to profit from lending it out (and will have trouble doing so under some circumstances)."

We don't have to--we can have the Fed buy bonds.

Peter Gerdes writes:

Short version: you sure that Summers isn't implicitly assuming greater practical constraints on the Fed than you are in doubting the 4% target?

Certainly the government in total can raise inflation to any desired amount. The treasury could print more cash or the Fed (with congressional approval) could directly credit citizens with cash (by crediting money to bank balances at the Fed).

However, I presume Summers is asking whether the Fed, given the normal constraints of statute and customary powers could, acting alone, achieve a 4% inflation target.

Maybe you can explain how they could do this because its not obvious to me. At the zero bound they are basically left with open market operations that let them purchase securities. Now, presuming that they purchase those securities at roughly their former market value they place a more liquid asset into circulation in place of a less liquid one (dollars in account balances versus bonds) but its not obvious that lets them increase inflation arbitrarily.

Sure, if they make it clear that they will purchase some huge number of securities come what may and thereby drive up the price they could underhandedly pass out money but I suspect one could make an argument that such an extreme instance of QE would be beyond at least the spirit of the Feds power.


Yes, I imagine you would suggest that a credible commitment to the right kind of NGDP targeting for an unlimited time but lets put that aside as controversial and possibly requiring more credibility than the Fed has.

bill writes:

Great post. I definitely think the Fed can get whatever inflation level it wants.
How would you think about this problem: For 7 years, the Fed paid a rate of IOR of 25 bps. The lowest IOR I'm aware of was Denmark at -75 bps. So the rate of IOR was at least 100 bps higher and more contractionary than it could have been for 7 whole years. I think of how quickly the rate hike in Dec 2015 impacted markets and I imagine how drastic the reaction would have been if a couple weeks later the Fed raised the rate of IOR another 75 bps. How bad was the cumulative effect of this choice to pay IOR of at least 100 bps too much for 7 whole years?

maynardGkeynes writes:

Hi Professor, and I hope you are enjoying your "new" life in milder climes! Thanks to your excellent post, I was made aware of, and able watch quite a few of the presentations on streaming. An amazing event in so many ways. Question: I too was struck by the Blanchard 4% discussion. IIRC, several commentators pointed to Japan's failure to achieve desired higher inflation as the source of their doubts. Refresh my recollection, but it seems to me that you have poo-poo'd the idea that Japan is a good counter-example, many times, but I can't recall (or find) your earlier posts. I think the comment by "Peter Geres" make a good stab at getting to what may be behind Summers' apparent doubts (the political realities), but when I re-watched that part, I think his doubts are more along the "real world evidence" side of the equation. So apologizing in advance for making you repeat your views on Japan for the umpteenth time, how do you explain the Japan experience, which, while hardly a total failure, isn't exactly a ringing endorsement of Blanchard's professed confidence.

Ilya writes:

Hi Scott,

You believe the CB can hit any inflation rate it wants. But what about Japan's CB's inability to significantly raise the inflation rate in the last five years. The experience of Abenomics seems counter to your view.

Also, you believe in the quantity theory of money. Correct? If so, does it explain what happens under very low inflation like we have now? In other words, is your "theory of inflation" the same with high levels as it is with low levels of inflation?

For example, I know you don't use the phillips curve. Then what would you use instead? For example, would you use a "Sumner curve" where instead of comparing changes in the price level with unemployment, you instead compare changes in NGDP with total hours worked?

GV writes:

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Scott Sumner writes:

Peter, We are not at the zero lower bound (which in any case is lower than zero.)

So the zero bound issue in no way prevents the Fed from raising the inflation target.

Maynard, Japan made no attempt to achieve higher inflation until 2013. When they did try, the inflation rate did increase.

Ilya, The Japanese could achieve much higher inflation by simply devaluing the yen. Lars Svensson called that a "foolproof" approach, and it is.

My theory of inflation is the same at high and low levels, it depends on the supply and demand for base money. The central bank can increase inflation by boosting the supply or reducing the demand for base money.

Peter Gerdes writes:

@Scott Summer,

I apparently misunderstood you. I thought you were saying Summers was skeptical we could meet such a target *if* we were at the zero bound while you thought it didn't matter whether we were or weren't we could still meet a 4% target.

As someone who wasn't there I'm inclined to charitably assume that worries about the long term ability to meet such a target include the worry that one day we will be at the zero bound but you were there so if that not what was intended let me know.

Peter Doyle writes:


... concerning rethnking macro.

Henry writes:

"The major central banks (except in Australia) did not do that in 2008 (for many different reasons) and hence we had the Great Recession."

It was not the Australian Reserve Bank that saved Australia from the GR. It was the spending spree that the Australian Government embarked upon. The Treasury Secretary at the time advised the Australian Prime Minister to "go early and go hard". Advice duly taken. So in fact it was fiscal policy that saved Australia, as much as Scott would rather the focus was on central bank monetary policy.

(The strong Australian economic performance was also supported by a mining investment boom on the back of Chinese growth.)

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