“Regime Uncertainty” or “Monetary Policy Misjudgments”?

Robert Higgs argues for “regime uncertainty”:

Making sense of economic fluctuations is a daunting task. The economy comprises a gigantic set of interrelated assets, inputs, processes, transactions, and outputs, and its dimensions can be and have been measured in countless ways. If we are to speak sensibly about the economy as a whole—recognizing that almost anything we say about the whole may not apply to various subsets of it—we must carefully choose the variables that hold the most promise for helping us to understand its broad movements.

Economists largely agree that net private investment is a key variable. Such investment adds to the private capital stock (with its embodied technologies), which makes inputs of labor increasingly productive over time—that is, net private investment (with the technological improvements it embodies) drives economic growth in the long run. And because private investment spending varies much more than consumption outlays (either private or governmental) in the short and medium terms, such investment also drives aggregate fluctuations in output and employment.

When investment collapses, recessions ensue; when investment expands, so do output and employment.

His conclusion:

The current situation is not simply an artifact of wounded banks’ reluctance to make new loans; many businesses are in a position to invest in long-term projects by using low-cost internal financing, but they are not doing so. Something else must be invoked to account for the bloodlessness of investors and entrepreneurs during recent years. I have repeatedly suggested that regime uncertainty deserves serious consideration in our attempts to understand the economy’s present sluggishness.

Nothing in the foregoing survey of real net private domestic business investment leads me to abandon this view of the matter at this time.

Obviously, I beg to differ. To my mind, the collapse of net private investment, just as the collapse of other GDP components, including, a rare occasion, the collapse of consumption (excluding durables) is due to an excessively tight monetary policy – in which case money supply is not offsetting the fall in velocity. The result is that NGDP (nominal spending) drops and if the monetary policy error is big enough, it ‘tanks’.

Everyone knows the dictum: “don´t reason from a price change”. Less known is the one that says: “don´t reason from a GDP component change”. And that´s the ‘error’ Higgis makes. The chart shows Nominal Net Private Investment and the spending gap (how distant NGDP is from the trend level). I really believe that´s the ‘driving process’.

Regime Uncertainty_1

There´s the productivity boom of second half of the 1990s which is an independent force propelling NPI. In fact this period marks a monetary policy error, with monetary policy turning expansionary due to the positive supply shock which reduced inflation. The contractionary monetary policy that followed (to compensate the error) ended up being excessive. It was corrected by “forward guidance”. The moves in NPI are closely synchronized with the movements in NGDP, being reactions to the fluctuations of spending relative to trend.

In the present cycle, NPI tanked with the big MP mistake of 2008. What´s apparently ‘dissonant’ is the more recent period where we see positive (albeit low) moves in NPI in spite of a still rising spending gap.

One reason may be that the gap is smaller than indicated because the trend (and it´s growth rate) has been reduced. Even if that´s the case I believe the gap, although smaller, is still not being closed. In fact, the positive (but low) increase in NPI is consistent with the lackluster spending growth over the four years since the recession ended. The chart illustrates.

Regime Uncertainty_2

To me and other market monetarists, the only ‘regime uncertainty’ of any relevance is the ‘unknown’ monetary regime in place. Notice that the ‘bets’ are all about ‘instrument settings’: When will taper begin? How long it will last? For how long the policy rate will remain at the ZLB? And so on and so forth. There is no target and no set of rules to guide monetary policy to reach the target.

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