This week’s EconTalk is Scott Sumner on monetary policy. Sumner argues that monetary policy was too restrictive in late 2008 and turned a mild recession into a doozy. I don’t agree yet but that argument and his whole perspective is very interesting.
Sumner on monetary policy
Previous post: The Will to Think Unclouded by Romantic Foolishiness
Next post: It Was Twenty Years Ago Today
Podcast RSS Feed
Full EconTalk Text
{ 21 comments }
Sumner does a great job explaining the coincidence of Keynesianism and monetarism. Too many people see Keynes as saying “spend spend spend” when the whole point is he only said to spend under certain circumstances. Keynes said as much to Hayek himself over dinner once – that his policy only applied to deflationary periods. He died shortly after, and Hayek lamented the fact that he died before he was able to impress this on his followers in the fifties and sixties when Keynesian theory was terribly abused and did lead to inflation as a result.
The problem is the misidentification of inflation/deflation, I think. When one examines prices over Greenspan’s reign it’s obvious, at least to me, that we were experiencing price inflation. The deflation claims in this current crisis ignore the possibility of low-cost-of-credit induced price inflation and are leading us all to continue to pay for the easy money policies of the past decade (or further if you wish). Since I think you’ll agree that deflation is a relative term I think it highlights the biggest flaw in Keynes own rules of application. He never layed out the ground rules well enough, so to speak.
1. I don’t think there are many people that would disagree with you on Greenspan and price inflation. I’m curious why you say “past decade”, though. I’ve heard most people date the problematic departure to 2002 or so. Granted, I’d certainly believe that Greenspan departed from sound policy before then at some point too.
2. On Keynes – I don’t know. All his major supporters since Friedman’s revisions seem to have been able to identify the distinction. The only people I see that can’t make the distinction are (1.) politicians who want and excuse to spend, and (2.) people who disagree with Keynes.
1. I suppose it did all begin then, but as far as a debate is concerned, the data overwhelmingly shows that we had been experiencing inflation not being captured by the normal metrics. I appologize for my imprecision with the number of years. I just didn’t want to introduce something into the conversation that would sidetrack the point. I don’t think it has thus far, but suffice it to say we’ve seen price inflation.
2. (1.) Politicians have economics advisors and the Fed and Treasury have them as well. The issue goes beyond politics unless your definition concludes any economist who makes a bad choice as being political… I don’t see the distinction as important. Economists get it wrong, too. And they tell politicians to do things based on those poor assumptions. (2.) People who disagree with Keynes that aren’t politicians (I’ll just follow along with your first sub-point) often don’t agree with Keynes for theoretical reasons and those alternative theories often include suppositions as to why things are they way they are that would invoke Keyne’s recommended actions. In other words, I don’t buy it. People who disagree with Keynes do so because he did such a bad job of deliniating when to apply and when not to so that entire generations of economists have had to develop re-interpretions of his work. Your sub-point also makes it seem as if only Keynesians are able to properly identify inflation/deflation. I think that’s obviously false. And there may be quite a few economists who’ve made misinterpretations of Keyne’s recommendations, but the same goes for the Keynesians and I don’t see that as a particularly illuminating point. Macro is politics, unfortunately. It will always be politicized, often for profit and fame.
Nothing to apologize for! I was just curious if you had something else in mind I wasn’t aware of. We seem to be on the same page, then. I think what we saw really was asset price inflation – and I’m not sure why that never seems to figure more prominently in discussions about inflation. But I think it goes beyond Greenspan – he wasn’t the only source of loose money at this time. The discussion has to include China too.
I wasn’t trying to say that only Keynesians can identify inflation/deflation. I’m not sure how that would make sense – but even in this podcast, Russ represents Keynes as advocating government spending to target growth. There’s no recognition that from what I’ve always been taught, Keynesians only advocate deficit spending in a deflationary environment when interest rates can’t be adjusted. Which was sort of the point of my original post – I’ve never accepted this monetarist/Keynesian distinction, and it’s always good to hear people (like Sumner) point out that Keynesians only advocate fiscal policy under specific conditions.
If we’re discussing “G”, who else matters?I enjoyed this episode almost as much as the last (which had no comment section at CH btw), but I typically roll my eyes when economists discuss macro monetary policy. The soundness of credit extended is the key to sound monetary policy, and that’s a micro issue fundamentally.If monetary authorities at the “bottom” of the monetary system, the direct lenders to the public, don’t credit real productive factors with rational accounting for risk, no simple, macro policy can fix the problem. Never mind that “rational accounting for risk” could be a unicorn, given Black Swans and the non-Gaussian nature of financial markets.Ultimately, simple, quantitative models of the money supply, interest rates and the rest are modeling second order effects, or even worse, they’re only modeling denominations of relative value that are essentially arbitrary. I just don’t see how tinkering with the parameters of these models can create real economic activity. Maybe the wrong tinkering can cloud economic signals destructively, but there is no “right tinkering” on other side of this counterproductive tinkering to promote growth.More specifically, I don’t get Sumner’s policy of targeting some fixed nominal GDP growth rate. What happens when the labor force expands extraordinarily, as in the seventies and eighties, or contracts extraordinarily as in the current period? Nominal GDP is supposed to grow at the same rate regardless? Fundamentals don’t matter? Productivity growth varies inversely with labor force growth to keep the growth rate constant? Is that a law of economics?Also, Roberts asserts that problematic deflation is only a matter of expectations, or a bit of deflation is no more problematic than a bit of inflation as long as people account for it in their investment decisions. I can’t agree.First, deflation implies that simply holding money is a profitable strategy. This expectation defies common sense. Real productivity requires human action, not human inaction.
Second, the actors who must account carefully for deflation are long term borrowers, like home buyers with 30 year mortgages. Common home buyers entering the market in their twenties will demand lower interest rates expecting deflation? How reasonable is this assumption? Expecting professional money managers extending credit in their forties to account for a little inflation seems more reasonable on the face of it.
Maybe people can learn to be rational economic actors accounting for monetary gaming of entitlements, but we certainly aren’t born this way.
“Keynes said as much to Hayek himself over dinner once – that his policy only applied to deflationary periods.”
So, only reduce liberty when people stop buying stuff. Sounds a bit like “never let a good crisis go to waste.”
Ah yes, the fabled Y = C + I + G – L identity (L = liberty), whereby you increase output by doing things that piss off libertarians. Nothing made Keynes happier than reducing liberty, after all. It’s not like he was a proponent of liberalism or anything silly like that.
Actually, because he wasn’t. Keynes was after all a social darwinian committed to advancing eugenics.
Ooooh, no smarmy comeback from Daniel. Wow!
I haven’t had a chance to listen to the podcast yet, but I agree that monetary policy was too tight in late ’08, and that it intensified the downturn. By the time monetary policy responded, nominal expenditure had “dropped off a cliff.” In consequence, a doubling of the monetary base — which would ordinarily be horribly inflationary — was actually an appropriate response, but it would never have been necessary had monetary policy not been too tight to begin with.
The flow of money that prevailing prices and investment plans had been predicated upon suddenly dried up; not only where the malinvestments of the bubble being liquidated, but otherwise good investments also got caught up in the panic. In my opinion, in a free market for money and banking, automatic and timely incentives would have kicked in to stabilise nominal expenditure, but instead we have a Soviet-style central manager of the money supply, and it didn’t respond in a timely manner.
Has it occurred to anyone else that people may behave like aggregates because they are told to behave like aggregates? Is it possible that we are having a recession because we have been told to have a recession? Thought about this while watching the new this morning, and wondering what would happen to “the economy” if people stopped watching the news and started just minding their own business.
I hate to sound like a conspiracy theorist, but it sure seems to me like the Bushniks discovered their crying need for a quick trillion bucks to “save the economy” just about the time their duck was lamest. Maybe they never imagined that their successors would have the audacity to hope for two trillion.
I’ve been following the debate on Boetke’s blog. I haven’t listened to the podcast yet….can’t get enough Weezer!.
Suffice to say if Sumner doesn’t say anything he hasn’t already said in response to Pete, then I just don’t buy his argument.
Prices need to drop. There must be a correction. Looser monetary policy would and has only prolonged the misery and prolonged the inevitable painful correction to come.
Saying that we need/needed looser monetary policy is like giving heroin to a Phine addict.
To borrow and modify a statement like Thatcher – Keynesianism, like socialism, stops working when it runs out of other people’s money to spend.
Thank GOD we have the Fed, the money tree!
…and it’s always good to hear people (like Sumner) point out that Keynesians only advocate fiscal policy under specific conditions.
That is true of some Keynesians.
People are free to label themselves whatever they want but there’s nothing Keynesian about deficit spending to boost employment when interest rates are high and inflation is high. It would be how I imagine many of you would react to Greenspan saying “I’m a libertarian”. He can label himself whatever he wants, but if we just concern ourselves with what people call themselves we’re not going to get very far.
I would never do libertarians the disservice of pretending that Greenspan is of their ranks. There doesn’t seem to be any point to making that case.
How can he, it’s true. In 1946, Keynes declared eugenics “the most important, significant and, I would add, genuine branch of sociology which exists.”
What he usually does is deny that he said what you said he said.
Right, there’s no point in denying it. I didn’t say anything else because Mommsen1625 and I already had a conversation about this issue in the Keynes and Mises post. People can go there if they’re interested. Mark might be disappointed, though – there are no smarmy comebacks there either.
There’s no need to idealize the people we admire. Jefferson was a slave-owner, but I still place great value on his life and ideas. It’s not an apology for the slave-holding at all – it’s just that I’m not going to throw the baby out with the bathwater and I’m also not going to pretend the slave-holding didn’t happen. Mises said that fascism would have an eternal place in history for saving European civilization. It is what it is – he made a mistake, but people don’t just throw him out for it. He was focused on the threat of Communism and was therefore a little too casual about the threat of fascism. And Keynes has his eugenics. History is nasty sometimes, but it is what it is. And it’s also important to note – despite Mises’s dumb statements initially, he clearly wasn’t a fascist himself. Keynes, in the same way, wasn’t on some fascist mission of racial purity. He just got interested in a very despicable movement that seemed (at the time) to have good motives. It’s not admirable, but what am I supposed to do? Throw out all the Jefferson, Mises, and Keynes? That isn’t an option for me.