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.

4 comments:

  1. The way to understand nominal spending vs real spending is to consider what changes in each mean.
    A rise in real spending is a way to say more goods and services were exchanged for money. You can measure this by the volume of transaction or hours worked or changes in inventories.
    A rise in nominal spending is a way to say more money changed hands. The effect is ambiguous. If more money changed hands, and prices stayed the same, then real spending rose. If more money changed hands, and prices rose exactly in proportion, then no real spending rose; there was only inflation.
    Sumner's point is that if the fed committed to a higher rate of nominal spending tomorrow, whether it be through inflation or higher real growth, then nominal spending would rise today. Since wages and prices chase nominal spending with a lag, then the outcome of today's rise in nominal spending will be more exchanges of goods and services today, ie more real spending and thus lower unemployment.
    I don't really see why one would assume that any additional transaction made today would be "malinvestment," as long as higher nominal spending really does lie in the future. People are choosing to buy things they think are good. No one forces them to choose certain transactions over others, and they can openly observe monetary policy.

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  2. Lewis -

    In my line of reasoning, "more goods and services were exchanged for money" is synonymous with "more money changes hands." The real crux of the matter is whether or not the total capital stock has increased. If so, the economy is developing. If not, we are consuming our capital on inefficient means of production, and this is malinvestment.

    Likewise, if a massive influx of printed money falls from a helicopter with no synchronous increase in new capital stock, people will simply spend the money on existing inventories. This, too, is malinvestment and represents a consumption of capital rather than a production of capital.

    Capital is at the heart of ABCT, and it really is the added dimension that makes Monetarism and Keynesianism look short-sighted to me. Spending is more than just spending. There are real things and people involved. You can't just get money changing hands without some consumption of capital. You can call this real or nominal, but the result is the same: malinvestment of resources in less productive means of production.

    It is the flood of printed money that causes this market distortion and leads people to malinvest. Unless, as noted above, they see through the ruse and the boom does not occur.

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  3. What is the capital stock? Is it machines and inventory? If higher nominal income leads businesses to invest more, then there are more inventories and machines.

    I don't understand this line:
    In my line of reasoning, "more goods and services were exchanged for money" is synonymous with "more money changes hands."
    Obviously the latter can happen without any real change in production, whereas the former indicates more production.

    I think you have wrongly fixed capacity utilization. The point is there is lots of excess capacity. When Monetary policy increases consumption and investment, it doesn't do so at the expense of alternative allocations of the resources. More resources are simply deployed overall. Some of the capacity is obviously malinvestment, but there's no reason that a shift away from those sectors should induce a temporary idling of enormous numbers of workers, offices, and factories that will, once aggregate demand resumes, be employed profitably in voluntary exchanges.

    The whole Austrian idea seems pegged on an analogy about gravity or fluid or something: "what comes up must come down!" or "it's just moving water from one end of the pool to the other." That's useful sometimes, and it's very easy to understand, and it gives you kind of a wise, sober feeling to say it, but it doesn't mean the analogy accurately corresponds to reality.

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  4. "What is capital stock?"
    -- In the Austrian sense, capital stock is the physical means of production.

    "If higher nominal income leads businesses to invest more, then there are more inventories and machines."
    -- Yes. If. The Misesean view is that a greater velocity of money does no such thing. (Nominal income as you have defined it is synonymous with velocity of money.)

    "Obviously the latter can happen without any real change in production, whereas the former indicates more production."
    -- If you want to talk about increased production, then I think that's a good idea. But most Austrians would never call this "income."

    "When Monetary policy increases consumption and investment, it doesn't do so at the expense of alternative allocations of the resources. More resources are simply deployed overall."
    -- Actually, Austrians completely reject this line of reasoning. Mises argued thoroughly and effectively that currency is not neutral. That is, changes in inflation impact different sectors of the economy differently. There are many reasons for this, but one obvious one is that the prices of some goods are more heavily impacted by interest rates, for example. Another important reason is that ordinary people are never the direct recipients of a money supply increase - only select investment banks.

    "Some of the capacity is obviously malinvestment, but there's no reason that a shift away from those sectors should induce a temporary idling of enormous numbers of workers, offices, and factories that will, once aggregate demand resumes, be employed profitably in voluntary exchanges."
    -- First of all, the Misesean framework rejects the notion of "aggregate demand." Of what real meaning (like, in the physical world) is the sum total of all money-denominated transactions in an economy? It is largely a meaningless number. What's important is what new goods get produced and how real people employ them for satisfying their wants.

    Second of all, not all factories, offices, and other such things are perfectly equipped to move from one sector of the economy to the next. Malinvestment is disruptive for this reason. Part of the capital stock must be broken-down and re-designed before it can be re-deployed. This is a deadweight loss. (See also: the broken window fallacy.)

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