What´s easy/tight money?

DeLong and Sumner “duel it out”. First Sumner:

Some people think easy money is low nominal interest rates.   (DeLong)

Some people think easy money is low real interest rates.   (DeLong)

Some people think easy money is an inflationary monetary policy; rising commodity prices.  (Laffer)

Some people think easy money is a rising non-interest bearing monetary base.  (DeLong)

Some people think easy money is a rising interest-bearing monetary base.  (DeLong)

Some people think easy money is a rising M2.  (Milton Friedman)

Some people think easy money is a depreciation of the currency in the forex market.  (Mundell)

Some people think easy money is a rising NGDP growth rate.  (Sumner)

Now DeLong:

The problem is that we need much more monetary expansion (or fiscal expansion, or something) than we have, given the damage done by the financial crisis. We need to push the real interest rate substantially below zero to get the economy back to full employment. We need enough monetary expansion to drive expectations of inflation up so that the relevant interest rate once again matches the supply of to the demand for the flow-of-funds through financial markets at full employment.

The IS-LM framework has the virtue of not forcing you to say things like the things Rognlie and Sumner do: that the Lesser Depression struck in late 2008 because monetary policy turned contractionary, and because the Federal Reserve tightened. That simply leads–in my view at least–to a lot of confusion.

DeLong “exogenizes” the “Lesser Depression”, with it being a consequence of the financial crisis. Contrary to what he surmises, it is thinking in those terms that leads to a lot of confusion – arguments about liquidity traps, necessary size of fiscal stimulus, needed financial regulation and so on. The MM view, based on the manifestation of monetary disequilibrium, is much more straightforward. It was tight money (with money supply not accommodating the steep rise in money demand (this in part a consequence of the housing price/financial crisis pre-Lehman) that threw aggregate spending “down the drain” so it´s not enough for monetary policy to satisfy the new higher demand for money, it has to be expansionary enough to more than satisfy it, thus increasing spending to some level closer to where it should be if the initial error had not been made.

Lars Christensen “moderates” the debate. But he´s “biased”!

In a world of monetary disequilibrium, one cannot observe directly whether monetary conditions are tight or loose. However, one can observe the consequences of tight or loose monetary policy. If money is tight then nominal GDP tends to fall – or growth is slower. Similarly, excess demand for money will also be visible in other markets such as the stock market, the foreign exchange market, commodity markets and the bond markets. Hence, for Market Monetarists, the dictum is money and markets matter.

9 thoughts on “What´s easy/tight money?

  1. My reading of you, DeLong, and Sumner often leaves me thinking that you are talking past each other in a very strange way, and this is a perfect example. You said: “It was tight money (with money supply not accommodating the steep rise in money demand (this in part a consequence of the housing price/financial crisis pre-Lehman) that threw aggregate spending “down the drain”…”

    Brad has said: “the downturn begins not when the market economy tries to shift resources from construction to exports, but rather when the financial crisis disrupts everything.” (http://delong.typepad.com/sdj/2011/09/karl-smith-tells-austrians-and-structuralists-about-wesley-clair-mitchell-1913-business-cycles.html)

    Financial crisis is a transmission/amplification mechanism that takes a relatively small nominal or financial shock (the pre-Lehman crisis, in this case) and turns it into a general disaster. The mechanism is money (and credit): a financial collapse decimates the money supply and simultaneously drives money demand through the roof as existing debts become more onerous and liquidity unavailable – but tight money did not cause the financial crisis; it was a result of the destruction of money that happened in the collapse.

    So you market monetarists are right on the one hand – tight money is the current problem, and Brad agrees that there is a monetary solution in that quote. But you are missing the other point, which is that the financial crisis caused money to be tight, and so it is, as Brad said, much more logical to say that “the financial crisis caused the recession” and that “the monetary response has been inadequate” rather than “tight money caused the recession”.

    Analogy: you live in a very cold place and rely on a furnace in the winter. The furnace is overworked on a particularly cold day and it breaks; you start getting very cold. The “heat shortage” is indeed what’s killing you, but still: the failure of the furnace was the “cause”.

    Also, just because money is the “problem” doesn’t mean that monetary policy is the answer. There are a range of reasons to choose fiscal stimulus anyway, which I discuss in more detail here: http://www.benjaminbdaniels.com/reaction-to-market-monetarism-2348

    • Benjamin Daniels: You said:
      “But you are missing the other point, which is that the financial crisis caused money to be tight, and so it is, as Brad said, much more logical to say that “the financial crisis caused the recession” and that “the monetary response has been inadequate” rather than “tight money caused the recession”.
      MM´s don´t think the financial crisis “caused” money to be tight. But that tight money made an ongoing financial crisis much deeper and broader. Remember that by the time Lehman came along, nominal spending had already plunged close to 50% of the total fall! Monetary policy was mistaken to start with and continued contractionary afterwords.

      • This seems right to me – “tight money made an ongoing financial crisis much deeper and broader”. But why did money become tight in the first place?

        I think the answer is in fact the money destruction that went on during the crisis. Nothing else changed about the nominal situation that would have adversely affected monetary equilibrium so dramatically. If you are going to argue that “monetary policy was mistaken to start with”, then there has to be a reason why policy fell out of sync with reality. Monetary policy was fine up until about 2008 and the policy itself did not change; so there must have been an underlying change in conditions that caused policy to be “mistaken”. If that’s not the financial crisis, what is it?

  2. The more i consider market monetarism, the more sense it makes, both economically and in political and humane terms.

    It is simply peevish and inhumane for economists to pronounce money is “too easy” when there is 9 percent unemployment, and nominal GDP trend is down by 10 to 15 percent, and real estate is busted in half. Or to pompously pettifog about inflation.

    Doctor, look at the patient, not your pet theories about treatments.

    Relating monetary policy to growth is what makes sense, for business and humane reasons.

    Go Market Monetarists!

  3. BD: Bernanke and the FOMC from mid 07 all the way to September 08 were all worried about inflation, specifically about the “passthrough” of oil and commodity prices. All the way through August 08 there was at least one dissent (towards raising rates) in the FOMC meetings. Interest rates were kept on hold from April through October 08. Nominal spending was falling slightly below trend from about late 07 but took a deep dive after June 08. In other words, different from what had happened from 1987 onwards, NGDP level targeting (even if unwittingly) was substituted by Bernanke´s almost explicit inflation targeting! A very bad move!

  4. The Lars Christensen quote makes what that is wrong with Market Monetarism abundantly clear. Everything apparently hangs on a single causal factor or variable – the money quantity or “monetary conditions”. Much is alleged to depend on whether these conditions constitute “tightness” or “easiness”. In particular, the growth rate of nominal GDP is supposed to depend on monetary tightness and easiness. NGDP tends to fall when money is tight; NGDP tends to rise when money is easy.

    But this “money” of the market monetarists, and the tightness and easiness thereof, is said to be “not directly observable.” Instead it can only be inferred from the rate of growth in NGDP!

    Isn’t it obvious that so-called “monetary conditions” are doing no real explanatory work at all in this theory? This is about as classic a case of a pseudo-explanation as one can find: the occurrence of important and observable phenomena is laid at the feet of a mysteriously unobservable causal variable. Then whenever the phenomena occur, the inference is drawn that the the value of that variable must have changed. And yet, since the variable causal factor is unobservable, it is impossible to measure independently of the alleged effects, and therefore it is impossible to confirm or disconfirm the theory.

    Some critics of market monetarism have looked at various classic measures of money or the supply of money, to see whether these alleged correlations between money and NGDP and other phenomena really exist. When they find that the correlation is not strong, the market monetarists just reply, “Well, that’s not what I mean by ‘money’. ” When asked what precisely it is that they do mean by ‘money’, we seem to be told that the latter can’t be defined and is not directly observable.

    So it seems to me that market monetarism isn’t any part of economic science. It is more akin to an irrational religious dogma. It represents a desperate attempt to hang onto monetarist dogmas in the face of empirical refutation, by retreating to a theory that is impervious to empirical testing altogether.

    Benjamin Cole says its is “peevish and inhumane for economists to pronounce money is “too easy” when there is 9 percent unemployment, and nominal GDP trend is down by 10 to 15 percent, and real estate is busted in half.”

    But what is inhumane is to follow dogmatists down a pseudo-scientific rabbit hole, in pursuit of superstitious diagnoses and quack treatments of economic pathologies, when there are so many other treatments that could be tried instead, and for which there is a more solid evidentiary basis.

  5. Don K.–

    Targeting nominal GDP by sustained QE and no IOR strikes me as a very sane course. If it works, does it matter whether Market Monetarism conforms to fancy models and studies—or should we go with what works?

    Economists do the world a disfavor when they bury themselves in models and redefine the real world to fit their theories and models.

    BTW, did you know that many drugs go through extensive, double-blind FDA testing protocols, and both empirically and theory-wise should be beneficial? Yet when they are sold to the general public, many times they are ineffective or even worse. This is hard science.

    Really, fancy and fragile econometric models are that reliable? Esoteric studies?

    John Taylor gushed about the positive effects of QE in Japan 2006. Can’t we go with what works? We know if you print money you will get increased output and inflation.

    Print more money and lots of it.

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