Friday, February 1, 2013

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?


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"

1 comment:

Greg said...

Congratulations on being able to read all the way through a Sumner post. The guy is a moron.

But I actually agree that low interest rates are DEflationarty and not INflationary. They remove lots of interest income while doing nothing to really stimulate lending in times like these.

Sumner of course doesnt see it the same way I do but we do come to the same conclusion about low rates in the current times.

The idea that high rates of the Volcker era "tamed" inflation is a joke. High rates greatly increased interest income to bond holders and savers and actually fueled inflation. It wasnt til oil prices were tamed that inflation went away but the monetarists never have let real facts get in the way of an inflation fairy tale.

Sumners understanding of the dynamics of private debt is not far from Krugmans unfortunately. They both see banks as simple intermediaries between savers and borrowers and are therefore blind to how high private debt levels can lead to our current situation. High private debt levels are as draining to an economy as high taxes, its just a different entity (banks vs govt) getting the juice.

A problem with monetary policy as I see it is that it is very infexible. It only works via rich people. It can buy lots of financial assets back form rich folks hoping they then spend or it can lower interest rates to make loans cheaper for banks to make to poor people.

Fiscal policy can do many more things. Cut taxes to all, buy guns butter or bridges, transfers, across the board tax hikes or targeted tax hikes. It can get everyone directly involved.