2010-11-16

Sumner Addresses the Conservatives

Today Scott Sumner takes on some conservative objections to QEII. He provides seven refutations for seven conservative arguments. I'm not a conservative, but I think Sumner would consider me one. Here I will address his points:
1. The Fed isn’t really trying to create inflation.

The Fed doesn’t directly control inflation; they influence total nominal spending, which is roughly what Keynesians call aggregate demand. Whether higher nominal spending results in higher inflation depends on a number of factors, such as whether the economy has a lot of underutilized resources. But it’s certainly true that for any given increase in NGDP, the Fed would prefer more RGDP growth and less inflation.
I am getting more familiar now with Sumner's style of argumentation, so I am understanding his blog posts much better these days. Here he is being a little tricky by saying that the Fed controls something called "nominal spending." But what is "nominal" spending as opposed to "real" spending? If you spend $5 on a block of cheese, is that $5 nominal or real? If the full $5 is real, then you have engaged in "real" spending. If part of that $5 (say, $1 of it) is unreflective of the true value of the cheese, then $1 is "nominal" spending and $4 is "real." How exactly does this differ from inflation?

This is an obvious ruse. People know that the money supply is increasing. They see prices rising, and they see their purchasing power disappearing. The only exceptions to this are the inside bankers hoarding the Fed monopoly money. People are not stupid.
2. “But doesn’t economic theory teach us that printing lots of money creates high inflation?”

In general that is true. But there are three important exceptions:
Rather than respond to Sumner's three scenarios, I will simply re-post the following quote from Human Action:
The boom-creating tendency of credit expansion can fail to come only if another factor simultaneously counterbalances its growth. If, for instance, while the banks expand credit, it is expected that the government will completely tax away the businessmen’s “excess” profits or that it will stop the further progress of credit expansion as soon as “pump-priming” will have resulted in rising prices, no boom can develop. The entrepreneurs will abstain from expanding their ventures with the aid of the cheap credits offered by the banks because they cannot expect to increase their gains.
Alright, on to point #3:
3. “But isn’t the gold market signaling high inflation?”

Possibly, but the indexed bond market is superior to gold prices for two reasons. First, gold is trading in a global market, and we are interested in US inflation. More importantly, gold prices reflect all sorts of factors (industrial demand in Asia, central bank demand, a recent drop-off in new discoveries, a hedge against all sorts of financial risks, including eurozone turmoil.) Furthermore the indexed bond market (TIPS spreads) has recently been more accurate than gold—correctly predicting low inflation in the US since late 2008.
I don't believe in cherry-picking inflation indicators to get the desired result. We know that the Fed increased the money supply with QEI, and we know that the reason we haven't yet seen inflation is because banks are hoarding the cash and making easy money off of risk-free investments. The spike in commodities reflects a surging lack of faith in fiat currency.
4. “Doesn’t printing money just paper over real (structural) problems in the economy?”

There are structural problems, but there is also a shortfall of nominal GDP. The structural problems showed up when growth slowed in late 2007 and early 2008 as a result of sharply lower housing construction. This is necessary re-allocation of resources and should not be resisted. But even Friedrich Hayek suggested that we needed to avoid a “secondary deflation”, which would show up as falling NGDP, and would depress output in even those healthy industries that had not over-expanded... Furthermore, more nominal spending would boost employment, which would speed up the time when Congress eliminates the 99 week extended UI benefits–which is one of the structural problems.
Sumner has been waving this Hayek quote at Austrians for a few days now. I'm not convinced.

First of all, just because someone subscribes to ABCT doesn't mean they must necessarily agree with everything Hayek ever said. That would be as stupid as constantly speculating about what Milton Friedman would do (Sumner and DeLong, I'm looking at both of you).
Second of all, boosting employment by printing money is precisely what ABCT-adherents are warning about: malinvestment fed by the printing press. How does this in any way address our objections?
5. “Isn’t this just hubris—the idea that money can be centrally planned?”

Most right wing economists are not comfortable with the idea of giving discretion to the central bank. I am no exception.
Sumner should have stopped there. He goes on to rationalize that Friedman was okay with this kind of hubris in certain cases, so what's the problem? The problem is that Friedman - like everyone else - was fallible. Just because X million people do stupid things does not mean it is okay for one person to do stupid things. This is a silly bandwagon fallacy.
6. The conservative critique of stimulus is incoherent

Sumner is right on this one - Conservatives who say what he says they say (ha ha) are wrong. But it's still not an argument for QEII.
7. “Won’t monetary stimulus just paper over the failures of the Obama administration, allowing him to get re-elected?”


That’s an argument unworthy of principled conservatives.
Similarly, Sumner is right on this point. But it's still not an argument for QEII.