Queen of the Prom

"When economists write textbooks or teach introductory students or lecture to laymen, they happily extol the virtues of two lovely handmaidens of aggregate economic stabilization -- fiscal policy and monetary policy." - Arthur Okun

Isn't it odd that economists argue about whether monetary policy is loose or tight? Shouldn't that be the simplest thing to agree on?

Sumner:

It is precisely because students were taught IS-LM and IS-MP that we are in this mess. Both models teach students that easy money reduces interest rates. So 99.999% of people in 2008-09 inferred that the Fed was easing monetary policy, even as they adopted the tightest policy since 1938.

Woodford and Bernanke are right; the stance of monetary policy depends on outcomes like NGDP growth and inflation, not interest rates and the money supply.

Scott Sumner is saying we know monetary policy is tight because NGDP is sluggish.

I want to say that's oversimplified. (I know, he was dumbing it down so I could understand. But still.) Sumner is right unless something else is going on: unless there is some other factor making NGDP growth sluggish. Something like accumulated debt.

Oh, but it couldn't be debt, because Sumner tells us "Forget about debt".

When a debt is created, money is created and goes into circulation. Eventually, most of that money settles out of circulation and ends up in savings or maybe in some other nation's central bank. But the debt still exists, and the maintenance (interest) cost of the debt still exists.

And the principal repayment has to happen eventually. But from what money?

So there are costs associated with an abnormally massive accumulation of debt, costs that can be overlooked in a normal economy. Yet for some reason economists have missed those costs. Maybe it's because they have "forgotten" about debt.

Those abnormal costs hinder growth and, hindering growth, they make it appear that monetary policy is too tight. As Sumner sees it, if NGDP growth is slow, money must be tight. But it's abnormal costs that make NGDP growth slow, and Sumner's evaluation is not quite right because he continues to overlook those costs.

The other guys, the 99.999%, think money was too loose because interest rates were so low. And, by historical standards, interest rates *are* low. Yet low interest rates have done little to boost growth, because of the accumulation of debt and the abnormal costs arising from all that debt.

But what is it that's important, really? Is it that one high school clique is right and another is wrong about whether the prom queen is loose or tight? Or is it the abnormal cost arising from our massive and unnatural accumulation of debt?


Related post: The Monetary Cause of the "Macroeconomic Miracle"