2015-11-03

Low Interest Rates Do What?!?

Just in case you might have forgotten that this is sometimes an economics blog, allow me to indulge in another what-the-heck-is-Scott-Sumner-saying-now post.

At EconLog, he writes:
1. Suppose that on average houses are 68 degrees in the winter, and 78 degrees in the summer. People use heat in the winter, but since they are wearing winter clothing they only heat their house up to 68 degrees. People use AC in the summer, but since they are wearing summer clothing they only AC it down to 78. I think that this is a plausible assumption. House temps then represent the "stance" of house temperature policy, equivalent to the stance of monetary policy. 
2. Suppose that turning up the thermostat makes houses warmer. And turning on the AC cools temps in the summer. Since turning up the thermostat raises temps, consider it analogous to an expansionary monetary policy "gesture". And vice versa for AC. Adjusting the AC or thermostat then represents raising and lowering the fed funds target. 
Bob Murphy's theory of temperature would be that when people are frequently turning up the thermostat, you can expect houses to be relatively warm. And when people are frequently turning on the AC, you can expect houses to be cool. The Sumner theory is that when people are most frequently turning up the thermostats, houses will be relatively cool, even though that action makes them warmer. Bob Murphy's theory is that houses are relatively warm in the winter, because people frequently turn up their thermostats in the winter. Sumner's theory is that houses will be relatively cool in the winter, despite the fact that people turn up the thermostat more frequently in the winter, and despite the fact that turning up the thermostat does in fact make houses warmer, ceteris paribus. Bob Murphy will claim that Sumner contradicts himself on house temperatures.
Before I really tackle this, let me pause to mention the comment I left there. The gist of my point was this: This all depends on when you choose to measure temperature.

  • Right before the heater comes on, the house is cold and the heater is off. 
  • Then immediately after the heater comes on, the house is cold and the heater is on.
  • Next, for a while, the heater is on and the house is warm.
  • This is followed by the heater switching off again, but the house is still warm.
You can see that every possible combination of On/Off + Cold/Warm is accounted for above. Depending on the exact point in the cycle we choose to talk about, we can make literally any claim about the state of the heater and the temperature of the house, any claim at all.

And so it is for interest rates. We're not talking about competing "theories" of interest rates and the macroeconomy. Instead, we're talking about one perfectly obvious theory that everyone agrees on, and two completely different ways of talking about it.

That's about as charitable as I can be. Now let's dig in.

One of the things I learned by taking a deep dive into Austrian School economics is that forcing everyone to use special language to discuss your pet topic hurts discourse more than it helps. So, for example, I think Austrians are totally right when they talk about inflation, but the problem is that they use that word to mean something different than everyone else.

So first an Austrian School economist has to say, "Okay, guys! Guys! Guys. Now I'm going to use my private definition of inflation. Ready?" Then he has to make his point. Then everyone else has to translate that point into the language of mainstream economics. Then, if they want to respond, they have to translate their own thoughts into the language of Austrian School economics, then they have to talk to the Austrian School guy. Etc., etc.

This is bad. If you want to make a good point, then you have to embrace the language that everyone else uses. You can't complain that people aren't using the right terminology. I bring this up because Scott Sumner has made this point himself many times at his own blog.

Anywho, back to inflation and the money supply.

If I asked you what the relationship between the heater's on/off switch is to heating your home, how would you respond? Would you say that switching the heater on will warm your house, or will you respond that if the heater is off your house is probably warm? Probably that first thing, right?

Now, if I asked you whether low interest rates increased the money supply and high interest rates decreased them, would you just say, "Yeah, duh," or would you be all, "Well, if the interest rates are low, then money must be tight?"

I'm not saying Scott Sumner is wrong, I'm just saying, why the heck would he ever say the exact opposite of what everyone expects in an effort to sell them on a new concept?

Is he just trolling?

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