Friday, February 21, 2014

Economic forces be damned

You can think of this post as a follow-up to my Queen of the Prom and my Loosey Goosey and the Four-Letter Word and my best criticism of Scott Sumner's analysis

"Loose" and "tight" are words one uses to evaluate monetary policy, which affects inflation and unemployment, which are captured in the Phillips Curve tradeoff.

That's all. I just wanted to make the point that Sumner's twiddling with loose and tight is an attempt to get at the workings of inflation and growth, which means his twiddlings are related to the Phillips trade-off.

Sumner's focus on loose and tight differs from everybody else's by way of the "relative to". Everybody else seems to think in terms of loose or tight relative to how things were before. Sumner seems to think of it relative to what the result looks like to Sumner. He says NGDP is not increasing at a decent rate, so money must be tight.

I may have to apologize for saying this, but Sumner's view is the most simplistic bullshit I've ever seen. That's not how the economy works.

Graph #1: Change in the Monetary Base, Different Since the Great Recession

How much money growth does Scott Sumner want? There is no limit, I guess, if what we've been doing isn't enough for him. Sumner wants whatever it takes to push NGDP growth up to 5% annual. But the economy doesn't work that way.

It shouldn't be up to an old hippie like me to explain this to a hip young economist like Sumner: The economy doesn't work that way. You can't just keep pouring in money forever in 35 or 40% bursts and getting out one or two percent inflation. Eventually -- if the economy comes back to life -- there'll be inflationary hell to pay for that kind of shortsightedness. And if the economy never comes back to life, well, that's all she wrote for the U.S. of A.

According to Sumner, people other than Sumner say that money is easy when interest rates are low, and tight when interest rates are high.

Today we might think of 5% as a high rate of interest. Rates two to three times that level might have been called high in decades not long past. In those times, 5% would have been called a low rate.

What number is a high rate? What number is low? It varies, obviously, as time goes by.

In this sense, Sumner has to be right: Low as interest rates are these days, they are too high to give us a growing economy. Remarkably, Paul Krugman seems to agree with Sumner on this. Krugman spends a lot of time talking about the Zero Lower Bound as something that prevents rates from being as low as they need to be to give us a growing economy.

Sumner seems to work backward from the "no growth" economy to an "interest rates are too high" conclusion, and he claims that money must be tight, because the economy is not growing. This is where the simplistic hits the fan: If the economy's not growing, money must be tight.

Does Sumner say why the economy isn't growing? Other than his obsessive claim that money is tight, I don't think he does. I admit I don't read him often, but I don't think he does.

And yet, Scott Sumner is right: Money is not easy enough to grow the economy. Money isn't easy enough even to inflate the economy. And if Sumner is right about this, then something changed. Something must have changed. Something in the economy is different than before.

If this is true, then the appropriate solution is to figure out what changed, and fix it. But Sumner doesn't do that. He opts for a direct, simplistic solution.

Economic forces be damned. That's what he is saying.

1 comment:

jim said...

Hi Art,

"Easy money" refers to how easy one perceives it is to borrow money. What has changed in the economy is that all of a sudden all the rose colored glasses that people viewed the world with disappeared.

Prior to 2008 the perception was that borrowing money was the way to get ahead financially. Even if you were paying a sub-prime 10% to 12% interest you would be paying the loan back with money that would become worth less and the value of your assets that you acquired would have grown enough to still come out ahead. And little thought was given to the possibility that you may at some point not have sufficient income to service the loan and therefore would end up being broke instead of better off. Many the obvious real possibilities were being ignored, like assets may not increase in value and money might not lose value. Today those factors are not ignored, making it a much different equation as to how much interest burden one is willing to carry.

Of course easy money discussions fail to notice the obvious which is that people would have more money to spend without the need for borrowing if they were taxed less. The federal govt can do all the necessary borrowing with or without easy money. And it is the onerous 15% flat tax on all wages that is dragging down spending the most. But like a monkey with his hand stuck in a bottle we definitely won't let go of that.