2011-11-07

A Walk Down Memory Lane

As a research project, I will be taking a deep dive into NGDP targeting. I assume that deep dive will have an impact on the material that appears on my blog. You can (I think) expect to see more commentary on macroeconomic policy here at Stationary Waves. If not, I'm sure you will see the inevitable impacts of a deep dive such as this, eventually.

Part of that deep dive involves poring over some of the older information on NGDP targeting available out there. This morning I decided to take a trip down memory lane, back almost three years ago, to see what the state of the blogosphere was then, as compared to now.

On February 2nd, 2009, Scott Sumner published this post on his blog, The Money Illusion. It's a long post, but it can be succinctly summarized in the following excerpt (italics in the original, bold text mine):
Premise 1: The only coherent way of characterizing monetary policy as being either too“easy” or “tight” is relative to the policy stance expected to achieve the central bank’s goals. 
Premise 2: “Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.” 
Premise 3: After mid-2008, and especially in early October, the expected growth in the price level and nominal GDP fell increasingly far below the Fed’s implicit target. 
In plain English, the first premise means the Fed should adopt the policy stance most likely to achieve its goals.  It is a point forcefully advocated by Lars Svensson, who Paul Krugman recently cited as an expert on the role of expectations in monetary policy.  The second is a quotation from Mishkin’s best selling monetary economics text (p. 607), i.e. it’s what we have been teaching our students.  And I have encountered few if any economists who disagree with my third assumption.  Indeed, if this were not so, why would Bernanke be calling for fiscal expansion?
To restate, Summer's Premise 3, in Q3 2008, market behavior with respect to inflation and spending in inflation-unadjusted dollars was less optimistic than what the Federal Reserve expected of the US economy. In the next paragraph, Sumner goes on to say that "few if any economists" disagree with this premise. (Clearly, Sumner is ignoring the Austrians, but that is not a uniquely Sumnerian problem.) If this were not the case, Sumner asks, why would the Fed want to expand the money supply?

We can thus summarize the totality of Sumner's position as follows: The Federal Reserve engaged in expansionary fiscal policy, but market behavior was contractionary. Therefore, the Federal Reserve should expand even more, in order to correct the contraction. QED.

I have been reading Sumner's blog for a long time, and I have never seen his position diverge much from this basic argument. This old post, however, provides a couple of interesting footnotes:

Sumner addresses the question of why he thinks money was tight in the ramp-up to the Great Recession: "Because markets expected NGDP growth to fall far short of the Fed’s implicit target."

Sumner addresses the question of why this could be, despite the fact that interest rates were at record lows: "Interest rates are a very misleading indicator of monetary policy."

Sumner addresses the question of why this could be, despite the fact that the money supply increased greatly:
During periods of deflation and near-zero rates, there is a much higher demand for non-interest bearing cash and bank reserves.  In addition, last October 6th the Fed began paying interest on reserves, which caused banks to hoard bank reserves.
So, in Sumnerland, low interest rates are not an expansionary policy, and a sharply increasing money supply is not an expansionary policy. Why not? Because the market behaved otherwise. The market contracted.

The assumption throughout Sumner's blog is that if the economy contracts, the Federal Reserve is engaging in a contractionary policy; if the economy expands, the Federal Reserve is engaging in an expansionary policy.

In other words, Sumner believes that the Federal Reserve is ultimately responsible for everything. Of course, he would never say so himself, but as you can see above, that is precisely what he has indicated. Money was tight because the economy contracted. Expansionary Fed policies are not really expansionary because the economy sometimes contacts during those policies.

Either Sumner is being hideously obtuse and ignoring reality to make his pet theory look good, or he is willfully ignorant of both his argument and the fact that the Federal Reserve is not the Prime Mover of the entire global economy. I wonder which.

More on this story as it develops... ;)