Market Monetarism needs people to predict recessions … and growth

A James Alexander post

Scott Sumner made a somewhat light-hearted comment in a recent post that “no-one can predict recessions”. It made me stop and wonder what was the point of Market Monetarism in that case. The essence of MM is that market forecasts of NGDP Growth should guide monetary policy, should be monetary policy. Fair enough. But does this imply, in the case of a negative demand shock, which increases money demand, an immediate increase in base money supply? Perhaps it does and we will all be very happy.

In our imperfect current world where the monetary authorities seem to mostly target less than 2% Core CPI two years out, the markets will still anticipate the impact of this goal on monetary policy and therefore on both real and nominal economic activity.

But markets are nothing more than numerous individuals, or trading robots programmed by individuals, making investment decisions. Some will certainly forecast recessions and invest appropriately. Is Scott saying that these people are inevitably going to be wrong? The Efficient Market Hypothesis (EMH) may say that it is impossible to be right all the time, to consistently beat the market, but it doesn’t and won’t stop people trying.

Indeed, people have to try to forecast the future or Market Monetarism would not work. You have to have markets for Market Monetarism. Scott has correctly advocated a specific market for NGDP Futures, but all financial markets are essentially futures markets, in the sense of forecasting or predicting future streams of revenues from assets, either income or some capital gain.

Is Scott saying no one can forecast future streams of revenues?

Perhaps he is just being careful, like most academic economists. The most famous economist of the twentieth century, J M Keynes, was of course famous also for his financial acumen. Putting his money where his mouth was, or at least putting his money to work in a highly successful way. Perhaps he made his pile by inside information, who really knows, but successful at forecasting asset price movements for money he certainly was.


German Finance Minister Wolfgang Schaeuble sought to turn the tables on critics of his fiscal-discipline push, saying he’s actually the better Keynesian.

Schaeuble, the guardian of Germany’s balanced budget and Chancellor Angela Merkel’s point man on austerity in the euro area, dealt a slap at antagonists such as Nobel laureate Paul Krugman by rebuffing “star economists” who advocate deficit spending. Instead, years of debt reduction are giving Germany the leeway to pump at least 6 billion euros ($6.7 billion) into the economy next year as aid for a record number of refugees arriving in the country, Schaeuble said.

Brad DeLong misses the “put”

In “Why Small Booms Cause Big Busts”, DeLong writes:

As bubbles go, it was not a very big one. From 2002 to 2006, the share of the American economy devoted to residential construction rose by 1.2 percentage points of GDP above its previous trend value, before plunging as the United States entered the greatest economic crisis in nearly a century. According to my rough calculations, the excess investment in the housing sector during this period totaled some $500 billion – by any measure a tiny fraction of the world economy at the time of the crash.

The resulting damage, however, has been enormous. The economies of Europe and North America are roughly 6% smaller than we would have expected them to be had there been no crisis. In other words, a relatively small amount of overinvestment is responsible for some $1.8 trillion in lost production every year. Given that the gap shows no signs of closing, and accounting for expected growth rates and equity returns, I estimate that the total loss to production will eventually reach nearly $3 quadrillion. For each dollar of overinvestment in the housing market, the world economy will have suffered $6,000 in losses. How can this be?


Today, we recognize that clogged credit channels can cause an economic downturn. There are three commonly proposed responses. The first is expansionary fiscal policies, with governments taking up the slack in the face of weak private investment. The second is a higher inflation target, giving central banks more room to respond to financial shocks. And the third is tight restrictions on debt and leverage, especially in the housing market, in order to prevent a credit-fueled price bubble from forming. To these solutions, Keynes would have added a fourth, one known to us today as the “Greenspan put” – using monetary policy to validate the asset prices reached at the height of the bubble.

Just rewrite the underlined sentence as “keeping nominal spending on a stable level path” (a.k.a. NGDP-LT)!

So, it appears even Keynes knew that to be the best option!

Keynes Put