In the light of previous discussions here I found this remark from Scott Sumner very interesting. After observing that in a recent post he and John B. Taylor agreed almost completely about Fed monetary policy if you replace the word “accommodative” (used by Taylor) with “contractionary”, i.e. they believe things that are completely opposed. Here’s the remark:
How can this be? How can two economists disagree on something so fundamental? It would be like two physicists disagreeing on whether a rising bar of mercury in a thin glass tube indicates rising or falling temperatures. No, it’s even worse. It would be like one scientist saying it indicates rising temps, and arguing that’s why ice is melting, and the other arguing that it indicates falling temps and arguing that’s why ice is melting. I.e. that H2O has the property of melting when things get really cold.
So the next question is; who is the crackpot who thinks a rising bar is colder temperatures, and who also thinks water melts when it gets really cold.
Obviously I don’t think either of us is a crackpot.
He goes on to explain why he thinks what he thinks. Isn’t it possible that, at least under some circumstances, nominal GDP can’t be influenced by monetary policy the way he assumes it can?
WHOA! Open HTML tag!
Wow, fixed as I was typing.
Sumner:
“And we can disagree about whether ultra-low interest rates and a bloated monetary base indicate easy or tight money, but surely we can all agree that ultra-slow NGDP and CPI growth are signs of tight money?”
No I wouldn’t agree with that at all.
“So central banks are forced to massively increase the ratio of base money to NGDP, to avoid severe deflation.”
We ARE moving toward deflation despite a monetary base that’s quadrupled in three years. I’ll be honest and state that I do not understand what specific policy market monetarists want. The best I’ve come up with is they think the Fed should inflate, but its been trying that since 2008. Sumner and Krugman in particular seem convinced the Fed should generate so much inflation the private sector is forced to spend what meager savings it has left to it (great policy by the way: rather than accomodate household desire to save government should dictate how much savings the American people are allowed to have).
I can’t imagine what could go wrong.
No I wouldn’t agree with that at all.
Explain. If prices are rising but wages are stagnant, how can that be easy money? If it were easy I should be getting raises by the wheelbarrowfull. The 1970s were a period of rising nominal wages with no new buying power. Until wages are rising I would say we’re in a period of hard money.
Ben Wolf –
I don’t know if Sumner’s right or wrong, but he is extremely specific about what he wants the Fed to do.
@Maxwell James
Here’s the problem:
1) “I’d like to see the Fed set an explicit target path for nominal GDP. But at this point even a price level or inflation target would be better than nothing.
Do “level targeting,†which means you commit to a specified path for NGDP or prices, and commit to make up for any deviations from the target path. Thus if you target NGDP to grow at 5% a year, and it grows 4% one year, you shoot for 6% the next.”
This will apparently be accomplished via seance, whereby the Fed develops powers beyond open-market operations. I have no idea how else the Fed is supposed to accomplish this.
2) “Let market expectations guide Fed policy. Ideally this would involve the sort of NGDP futures targeting regime that I have proposed in this blog. Right now they could focus on the yield spread between inflation-indexed and conventional bonds. The spread is currently than 1/2% on two year bonds, which means inflation expectations are far too low for a vigorous recovery. It should be closer to 2%”
I spend quite a bit of time studying central bank operations and even so, I have no idea what he thinks this will accomplish. Again, he just assumes the Fed can inflate when it wants to if it just tries harder. But people have tried to explain to him that the central bank does not control the money supply.
3) “The Fed should stop paying interest on excess reserves, and if necessary should put a small interest penalty on excess reserves.”
We just had an asset bubble characterized by private-sector over- indebtedness blow up in our faces, and Sumner is proposing that we effectively force banks to resume making loans indiscriminantly. He also continues to make the mistake of confusing the monetary base with the money supply. Any loans made only temporarily expand the private sector’s net financial assets; as the loans are repaid the supply shrinks.
I am beginning to wonder whether Summer understands that banks are not constrained by their reserve positions. Nothing the Fed does can increase the capacity of banks to make loans other than lowering capital requirements. Even if it did that, the bank cannot make a loan if no one wants to borrow, and right now people consider debt to be toxic.
4) “This would encourage banks to stop sitting on all the money that has been injected into the system.”
That’s the really damning quote: banks do not (despite his assertion) loan out reserves. They are used for clearing payments and the capacity of banks to make loans is not dependent on the quantity of reserves. Summer is still stuck in a useless loanable funds framework whereby those reserves are composed of deposits and represent the nation’s collective savings. People have repeatedly explained to him the only limits on the capacity of banks to make loans are capital requirements and the number of credit-worthy customers who wish to borrow.
Basically he, like Krugman, wants the Fed to stimulate by doing things it can’t do.
Bernkanke v.2003 seems to believe it’s as simple as Sumner + Krugman say:
from WSJ:
“Mr. Bernanke felt that Japan’s central bank needed to make a commitment to get inflation higher and keep policy accommodative until it increased. Among his proposals was a suggestion that the bank publicly adopt an inflation target of 3% to 4%.”
@Sam
And Sumner has attacked Bernanke for not “accomplishing” monetarist goals as he had advocated prior to becoming Fed chairman. My take is that Bernanke has figured out the Fed is much more limited in its capabilities than he had once thought.
Stephanie Kelton has a post today where she hypothesizes a memo was released instructing establishment liberals to blame the Fed so as to deflect responsibility from the White House. It wouldn’t surprise me.
@Ben Wolf
In a previous thread about Paul Krugman, @Dave commented about bank booking and Krugman not understand how it works. My guess is that Krugman, Summer, etc. think banks use traditional double entry bookkeeping. This would explain some of the issues you point out.
Personally, I consider them idiots, but what do I know.