Wednesday, September 11, 2013

Loosey Goosey and the Four-Letter Word

Quiggin (September 1st, 2013):
The idea that the stance of monetary policy can be assessed as expansionary, neutral or contractionary depending on whether the interest rate controlled by the central bank is at, above, or below its real long run average neutral value isn't just mine. It's that of nearly all economists, notably including the US Fed. Update The neutral value changes gradually over time in response to a variety of factors, but is sufficiently stable that it can be regarded, for most purposes, as a long-term average, typically assumed to be in the range 1.5 per cent to 3.5 percent. End update Sumner claims that “People get defensive when I make fun of the view that low interest rates mean easy money” but doesn’t name any names. Does anyone really deny that this is the standard view?

Timewarp Sumner (August 29th, 2013):
I have to admit that Quiggin is right. Most economists do equate low rates with easy money. That is the accepted definition. How that occurred, how the lunatics took over the asylum, is beyond my comprehension.

Here's the thing. A measurement is a comparison. To measure the size of the hole in my head you put a tape measure to it and make a comparison. Same is true with easy and tight. Tight money is tight compared to easy money. Easy money is easy, compared to tight money.

But what if you want to look at a moment in time -- like now, say -- and see whether money is easy or tight? How does that work? It's still a comparison, but what do we use for the tape measure?

Quiggin compares the interest rate to its "neutral" or "long run average" value to determine whether monetary policy is easy or tight. Scott Sumner compares NGDP growth to its long run average value to make that determination. Sumner writes:

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.

But Sumner makes the monumental mistake of applying "other things equal" to the real world. He assumes that nothing else has changed that could possibly be depressing growth, so that if growth is slow it must be because money is tight. But if there is some other factor causing slow growth -- or if there could be such a factor -- then Sumner's evaluation cannot tell us whether money is easy or tight.

If there is some other factor making NGDP growth sluggish, easy money is probably not the solution. If there is some other factor, Sumner's whole argument falls apart.

And what else could possibly be responsible for slow growth? The four-letter word: Debt. Accumulated private debt. With excessive debt slowing the economy, you cannot use NGDP growth as a yardstick to determine if money is easy or tight.

But what does Sumner say? He says "Forget about debt".

1 comment:

Greg said...

Hey Art

I think these two wonkish papers might be right up your alley. Cullen Roche posted them the last couple days.

I think you might have some good questions for Mr Feibiger