Ideology and monetary policy shouldn´t mix

In a piece for Free Exchange presumptuously called “The new monetary ideology”, Robert Skidelsky writes:

QUANTITATIVE easing, which almost no one had heard of five years ago, is the great new discovery in macroeconomic policy. Policymakers put their faith in it as the engine of recovery; variations in the quantity of money supplied by the central bank has graduated from an emergency measure to a permanent tool. As Adam Posen recently put it, given the failure of interest-rate policy alone to determine the economy’s credit conditions, future central bank governors ‘will have to make unconventional monetary policy conventional’.

This new enthusiasm for unconventional monetary policy is the more remarkable in that no one is quite sure how it works. There are several possible transmission mechanisms from money to prices (or nominal income) – notably the bank lending channel and the portfolio rebalancing channel. They have been extensively tested, with inconclusive results.

All of this led John Kay to wonder why so much attention was given to unconventional monetary policies ‘with no clear explanation of how they might be expected to work and little evidence of effectiveness?’ His answer: they are helpful to the financial services and those who work in them.

Coincidentally, Scott Sumner just published “A market-driven nominal income targeting regime” at The Mercatus Center, in fact emptying monetary policy of ideological content. It´s an eminently pragmatic piece:

The monetary regime proposed is ideally suited to a world where economists have relatively similar views about what constitutes good outcomes but cannot agree how best to get there. I sidestep the question of whether to target interest rates, the money stock, or exchange rates by jumping right to the goal variable. If the goal is stable nominal GDP growth, then the central bank should stabilize the price of nominal GDP futures contracts.

[it] is not necessary for economists to agree on a structural model of the economy, nor on how monetary policy affects the economy, nor even on what monetary policy isIf economists can agree that steady growth in nominal GDP constitutes a good outcome, then they ought to be able to agree on a monetary regime in which the market sets the money supply, interest rates, and exchange rates at a level most likely to produce on-target nominal income growth.

A stable nominal income growth was, albeit unwittingly, obtained during the twenty-plus years of the “Great Moderation”. What Scott proposes is to make it an explicit goal garnered through a well specified instrument, an NGDP futures contract.

Summers: QE is a placebo

At the FT Robin Harding dug up some recent comments on economic policy by Larry Summers:

Lawrence Summers made dismissive remarks about the effectiveness of quantitative easing at a conference in April, raising the possibility of a big shift in US monetary policy if he becomes chairman of the Federal Reserve.

“QE in my view is less efficacious for the real economy than most people suppose,” said Mr Summers according to an official summary of his remarks at a conference organised in Santa Monica by Drobny Global, obtained by the Financial Times.

“If we have slow growth, we are not going to keep thinking that 5.5 per cent unemployment is normal,” said Mr Summers. “We are going to decide rightly or wrongly that the potential of the economy is less and therefore we are going to decide that we are closer to that potential and that is going to operate in favour of suggesting that we should normalise interest rates.”

And he sides with Krugman on the importance of fiscal stimulus:

 “More of what will determine things going forward will have to do with fiscal policy and that there is less efficacy from quantitative easing than is supposed,” he said in his Santa Monica remarks.

Mr Summers said that while QE does little good it also does little harm. “If QE won’t have a large effect on demand, it will not have a large effect on inflation either,” he said.

The market monetarist view is that QE does little good because it was designed for exactly that. And in this case doing “ little good” is tantamount to doing great harm! Much better to design what Christy Romer calls a “regime shift”.


No wonder the potential is of a Summers Chairmanship has been “spooking bond markets

And a great punch-line:

Yet at some point, you have to wonder if Mr. Obama really wants to go the Summers route again. Mr. Summers wasn’t exactly a visionary, and he didn’t show remarkably sound judgment.

Or it could just be a matter of Mr. Summers being at the wrong place at the wrong time. Bad pennies have a knack for that.

Of course, Mr. Obama does have a choice. He could try his luck elsewhere.

Cocky Paul

Decides to stand Friedman on his head:

There are, I think, a couple of morals here. One is that economics textbooks probably talk too much about high inflation; it’s a nice pedagogical set-piece, but not something that’s a real issue in today’s world. Another is that high inflation doesn’t happen just because a country’s rulers are spendthrifts or don’t know about the Emperor Diocletian or something; it is always associated with severe political and social disruption. To stand Milton Friedman on his head, high inflation is never and nowhere a merely monetary phenomenon.

He also says he has a hard time understanding ‘those Scots’. Maybe he should try more with the ones that go by the name of Adam and David.

Also, before ‘flipping’ Friedman he should try to give an alternative explanation for the money-inflation configuration shown by this chart.

Cocky Paul

Bad prospects: Larry Summers becoming Fed Chairman

Scott Sumner vented frustration. And he´s right. Obama appointed 6 of the 7 Fed Governors and for quite some time up to 3 vacant slots remained unfilled, and this at a time that monetary policy could have done wonders to the economic recovery, So it hurts to read from Ezra Klein that:

At 12:55 p.m. today, President Obama is scheduled to deliver his much-hyped speech articulating his long-term vision for the economy. Five minutes after the speech, GOP leaders are scheduled to send out press releases decrying the speech as more of the same old big-government tax-and-spend talk.

Sigh. This Town.

What’s interesting, though, is that the biggest economic decision Obama is likely to make in his second term will almost certainly be left out of the speech. Obama will talk about all kinds of things that Republicans in Congress almost certainly won’t let him do, but he won’t talk about the one big thing they will let him do, and that will have profound effects on the path of the economy even after he leaves office. I’m talking, of course, about naming the next chair of the Federal Reserve — a decision that House Republicans (and, for that matter, House Democrats) don’t even have a role in.

And back in April 2010 Neill Irwin wrote:

With his nomination of three new Federal Reserve governors Thursday, President Obama set the stage for a central bank that is more focused on the oversight of banks and more attuned to identifying emerging risks in the economy.

But with his selections, the president has done little to strengthen the Fed’s ability to understand the inner workings of financial markets in the United States or abroad, and the board of governors would include fewer experts on monetary policy than in the recent past.

At that time Larry Summers was the NEC Director, but he never bothered to advise the President on the importance of getting the nominations right and quickly. This wouldn´t have happened if he thought (as Christy Romer does) that monetary policy could really make a difference!

Jeffrey Frankel´s recession take

In his “One recession or many? Double-Dip downturns in Europe”, Jeff Frankel notes:

The recent release of a revised set of GDP statistics by Britain’s Office for National Statistics showed that growth had not quite, as previously thought, been negative for two consecutive quarters in the winter of 2011-12.  The point, as it was reported, was that a UK recession (a second dip after the Great Recession of 2008-09) was now erased from the history books — and that the Conservative government would take a bit of satisfaction from this fact.    But it should not.

The right question is not whether there have been double or triple dips; the question is whether it has been the same one big recession all along.

And goes on to show real output behavior in several European countries.

The case of Eurozone countries is interesting because they are all subject to a single monetary policy. But the individual real output behavior is markedly different among them. The set of charts below reproduces (with some differences) the charts JF puts up.

Note, for example, that the ECB´s rate increases in April and June 2011 was bad all over but quite damaging to the ‘southern’ countries such as Italy and Spain. Britain seems to be in a ‘limbo’, while QE1 apparently did ‘wonders’ for the US.






Frankel argues that discussions about double or even triple-dips are not very useful. I agree and my view is that all the countries considered, with the exception of Germany (at least so far) are mired not in a single recession but in a continuing state of depression (with some in deeper than others).

Note in the charts below how most countries were evolving along a long term level nominal spending trend. None (with Germany again an exception) is nowhere near going back to the previous level, even if you lower that level somewhat. The “gap” gives, I believe, a measure of the depth of the “depression” that is being experienced by most countries, and just like what happened with regards to the “Great Depression” of the 1930s, in a few decades time the verdict that will come in is: “The Central Banks did it” (again).







PS: Four years into the “recovery” the majority still thinks we are in recession!

A majority of people — 54% — in a newMcClatchy-Marist poll think the country is in an economic downturn, according to the survey conducted last week and released Tuesday.

Bruce Bartlett takes on Inflationphobia, Part III

In Inflationphobia, Part III, Bruce Bartlett concludes his series. Part I is here and my comments here. Part II is here and my comments here. In each I took issue with one paragraph. I do the same now with the very first paragraph (which does not mean I don´t agree with other parts  of the post):

When the most recent recession began in December 2007, there was no reason at first to believe that it was any different from those that have taken place about every six years in the postwar era. But it soon became apparent that this economic downturn was having an unusually negative effect on the financial sector that threatened to implode in a wave of bankruptcies. The Federal Reserve reacted by doing exactly what it was created to do — be a lender of last resort and prevent systemic bank failures of the sort that caused the Great Depression and made it so long and severe.

This has been the conventional wisdom about the “Great Recession”. The recession became “great” because of the accompanying financial crisis and, furthermore, we should be thankful that the Fed reacted appropriately and “did what it was created to do…”.

He´s right when he says that when the recession that began in December 2007 there was at first no reason to think it was ‘special’. Employment, for example, dropped less during the first 5 or 6 months of this recession than in all other post war recessions. Unemployment, which was 5% in December 2007 climbed only to 5.4% in May 2008, five months into the recession.

The Fed is thought to have saved the economy from plunging into a second great depression. But the Fed is also blamed for ‘instigating’ the financial crisis by having pursued an easy money policy in 2002-05, which fueled the house price boom (and then bust).

In other posts I have argued contra the view that money was “easy” back then and also discussed the house price boom and bust.

It´s not about money being “easy” some years ago but about it being “tight” beginning in 2007! It was tight money that caused both the recession and the ensuing financial crisis.

But that lesson has not been grasped. So now many say that current “easy” money policy is fueling all sorts of bubbles and paving the way for another financial crash, this time accompanied by ballooning inflation! Here´s Ben Powel at Freedomfest:

Inflation is a hidden tax that threatens the savings that people rely on for financial security. And by eroding the purchasing power of savings—the source of private investment and job creation—inflation also undermines economic growth. That most pundits are not worried about the current rate of retail price inflation is irrelevant, Powell explains. What matters far more is that the Federal Reserve has added considerably to the balance sheets of the banking system.

The only reason this hasn’t translated into rapidly rising retail prices is that the Fed is paying banks interest on their reserves. Once they stop doing so, we can expect prices to begin to soar soon afterward. The classical gold standard tamed the fiscal behavior of government. But people’s failure to understand this critical point allowed governments to abandon it and usher in an age of inflation. Rome’s emperors assaulted their currency and brought an end to their empire. Will the same fate await the United States?

In early May Nick Rowe published a must read post on this topic: “Monetary stimulus vs financial stability is a false trade-off”. A short sample:

People are not all identical. At any given rate of interest, some will want to borrow and others will want to lend. So some people will actually borrow from other people. Maybe via financial intermediaries. And some of those financial intermediaries issue liabilities that are used as media of exchange and so are called “banks”.

And sometimes some people will borrow too much. Which means, of course, that sometimes some other people will lend them too much. Accidents happen, even on safe roads, because some people drive too fast or aren’t paying enough attention. But the biggest accidents happen when an apparently safe road suddenly and unexpectedly becomes unsafe. Because the drivers can’t slow down quickly enough. Or even if one driver can slow down quickly enough, another driver who can’t simply ploughs into the rear of the slowing car.

OK, that’s just an argument by analogy. But I think you can see the link. If central banks keep nominal income growing smoothly, most people will adjust their borrowing and lending (speed) to the prevailing conditions. And some won’t, of course. But if the central bank lets nominal income fall, without giving people lots of advance warning, that means that even some otherwise safe borrowers and lenders suddenly become risky, and they crash too. And the best palliative is to get nominal income back onto as close to its previous path as possible as soon as possible. Even if that does cause drivers to speed up, now that the roads are safe again.

As the chart shows, the surprise plunge in nominal income AND the failure to get it back closer to trend  remains the best explanation for the both the “great recession” and the weak recovery, both in the US and anywhere else you care to look (in the EZ and the UK, for example).


Which elephant in the room?

To Peter Wallison it´s Dodd-FranK:

We all know that the recovery from the financial crisis has been historically slow. Economists refer to Obamacare, the Fed’s monetary policies, and tax policies. What they all have in common is that they can be measured. It’s like the drunk looking for his car keys under the street lamp because that’s where the light is. We are literally ignoring the elephant in the room. Since the enactment of the Dodd-Frank Act, the US economy has not grown on average more than 2%. Before the act, the average was 2.5%. Dodd-Frank is the reason for the historically weak recovery. The costs and uncertainties it has imposed on the financial system have shocked the system into silence.

I don´t know where he got his numbers, because in fact since the recovery began in June 2009 annualized real growth has been 1.95% on average and if we separate the period into pre D-F, which was signed in July 2010 and post D-F the average growth in each period is exactly the same – 1.95%.

What Wallinson does is to assume the financial crisis caused the “Great Recession”, and since Dodd-Frank has “shocked the system into silence” the recovery doesn´t get traction.

More likely, as Scott Sumner argues in a new article written for Policy (“A new view of the great recession”), the causation goes the other way. Tight money caused the “GR” which in turn brought on the financial crisis.

And since money is still tight (despite “zero” rates), no wonder the recovery has been week, and uniformly so!

Will Paul respond?

From Joe Gagnon:

With short-term interest rates near zero in the major advanced economies, bloggers and pundits have argued about whether we are in a “liquidity trap,” in which monetary policy is no longer able to boost spending and economic activity. The liquidity trap hypothesis has some validity, but only if one arbitrarily restricts the definition of monetary policy to purchases of short-term risk-free bonds. There is no economic reason, and not even a historical precedent, for such a limited view of monetary policy. A broader view of monetary policy shows that we are far from any liquidity trap and it is difficult to imagine that we ever could be in a liquidity trap.

Macroeconomic models suggest that central bank purchases of long-term bonds and other risky assets can provide significant macroeconomic stimulus. Moreover, as I discussed in a previous blog post, the risk of losses to central banks that undertake such purchases is small compared to the overall fiscal benefits. These results make monetary policy far more attractive than fiscal policy in providing macroeconomic stimulus, even when short-term rates are near zero. 

The only question is why the major advanced-economy central banks have been so timid in using their powers and allowed inflation—and for the United States, employment—to fall below their targets.

On this last paragraph Christy Romer has a good discussion:

Often humility can lead to paralysis. If policymakers are unsure about the effectiveness of a policy or fear there could be large costs, they may just do nothing or be willing to take only small steps. Why take risks when we don’t know if a policy will work?

In a recent paper, David Romer and I (2013b) discuss that such views are potentially very damaging. We show that what are widely viewed as the two clearest missteps in Federal Reserve history—inaction in the wake of banking panics early in the Depression, and inaction in the face of high and rising inflation in the 1970s—were both borne of unwarranted humility. Fear that policies might not work or might be costly led policymakers to conclude that the prudent thing was to do nothing. Yet there is now widespread consensus that action would have been effective in both these periods.

But there is another direction that humility can take policymakers. Humility about how much we don’t know can lead policymakers to admit when something isn’t working. It can lead them to revise opinions and be open to new evidence. This other kind of humility can lead to experimentation. Rather than assuming that doing nothing is the best course, policymakers can choose to act aggressively on the best evidence available, even if it is highly imperfect.

Paul tilts towards Janet

He ends:

So what we have here are two highly qualified candidates, head and shoulders above anyone else I’ve heard mentioned and inconceivably better than the men who might have been in contention if that guy who ran with Paul Ryan had won. But if the final choice isn’t Janet Yellen, I think the president is going to have to offer a very good explanation of why not, or face a lot of grief from people who want to think the best of his administration.

I think the bold part is hard to envisage. Maybe it´s the ‘incumbent´s advantage’ at play, but that´s really not enough given the situation. I tend to have some distrust of academics in executive positions, no matter their academic quality.

Of the last four chairmen (ignoring G. William Miller´s 17 month stint), two were highly regarded academic economists – Arthur Burns and Ben Bernanke – and two were practitioners’ Paul Volcker and Alan Greenspan.

It may be just coincidence but the fact is that during the ‘reigns’ of the academics we had the “Great Inflation” and the “Great Recession” and during the ‘reign’ of the practitioners ‘we had the “Great Moderation”.

Burns  was focused on employment and thought monetary policy could not reduce inflation in a world of supply shocks (not only from oil and commodity prices but also from unions and oligopolies). Bernanke was focused on headline inflation and thought that monetary policy had to be tightened when oil and commodity prices rose.

Ironically, both Burns and Bernanke were students of business cycles and had deep knowledge of the “Great Depression”.

But if it´s become de rigueur to appoint an academic and on top of that a woman, my vote goes to Christy Romer.

Bruce Bartlett tackles “Inflationphobia”

Bruce Bartlett is doing a series on inflationphobia in the NYT. This week he published Part II. Part I is here and my comment here.

Last week, I discussed the phenomenon of inflationphobia – an irrational fear of inflation that is constraining the Federal Reserve and holding back the economy. The roots of inflationphobia go back at least to the Great Depression, when inflationphobes made the same arguments year after year despite continuing deflation – a falling price level.

The defining characteristic of the Great Depression was deflation, which began in 1927, two years before the stock market crash. The following data from the Bureau of Labor Statistics show the average change in the Consumer Price Index.

Change in Consumer Prices, 1927-33















I only take issue with this paragraph (my bold):

In 1933, Franklin D. Roosevelt became president and tried to stanch the deflation by suspending the gold standard and proposing legislation that would fix prices and prevent them from falling further. But these policies were ineffective because they did not get at the root of the problem, which was a fall in the money supply.

The NIRA, which included price fixing, was certainly a bad idea but suspending the gold standard was a great move. As the chart shows the down trend of NGDP was immediately reversed.


In addition, FDR said he wanted the WPI to go back to the average level of the 1920s (a ‘price level target’). This is what transpired:


And the stock market followed suit: