Market Monetarism Jumps the Shark

Seriously, what does this mean?

The US economy is currently in equilibrium. It’s not a market-clearing equilibrium. It’s not a very good equilibrium. But it is an equilibrium. If it wasn’t an equilibrium, it would be somewhere else. But it isn’t somewhere else, so it must be.

Nick Rowe

I find this incomprehensibly circular. The beetle is red because if it weren’t red it would be something else, but it isn’t something else, so it’s red. Nick, we must first prove that the bloody beetle is red! Furthermore, ‘proving’ something does not entail making analogies to driving rules or how we manage time, which are both 100% arbitrary, maneuverable human constructs.

Also note that the entire post is about how people who want to know what market monetarists are talking about are somehow crazy for asking. Imagine if engineers had this type of attitude: “heh, so you want to know what we’re making the bridge out of? Doesn’t matter, just believe that it will stand up. God, stop being so concrete! (No pun intended)”.

I’ll give some credit to Rowe – he goes on to try and list some transmission mechanisms, but doesn’t get very far:

1. The Fed clearly announces its target path for NGDP. That’s by far the most important bit. Everything else is secondary. And if the Fed had credibility, that would be enough.

Irrelevant, as credibility depends on transmission mechanisms; expectations can only ever work if there is something to anchor them to. So this one is a no-go, as it depends on the actual transmission mechanisms below:

2. The Fed makes a threat. On the first day the Fed will print $1 billion and use it to buy assets. On the second day the Fed will print $2 billion and use it to buy assets. On the third day the Fed will print $4 billion and use it to buy assets. And the Fed will keep on doubling the amount it prints and buys daily, forever and ever, until E(NGDP) rises to the target path. (And will go into reverse and sells assets if E(NGDP) rises above the target path).

And, if my calculations are correct, just over half way through the month the fed will own every asset in the US economy. Then what? But don’t worry, this won’t materialise because:

3. The Fed puts on its best James Dean (oops, Marlon Brando, thanks Andy) voice and replies: “What have you got?”

There are two rooms at a party. The first room is nearly empty. The second room is nearly full. Because everyone wants to be where everyone else is. Then Chuck Norris enters the second room. He threatens to beat up 1 person at random in the first minute, 2 people in the second minute, 4 people in the third minute, and so on, until the room is empty. This is no longer an equilibrium.

More analogies. But as somebody, somewhere in the blogosphere, once said: if Chuck Norris has no arms or legs, nobody will listen to him.

Why will buying assets actually have an effect on the economy? What if people just hold the money, or put it into banks? What if they don’t want to sell their assets? Do you wonder if people/banks/firms are not spending right now because of the the fact that they are in bad financial positions and facing a lack of demand, and buying their assets (presumably at market prices) wouldn’t change this? Finally, are there any examples of this ever working, on the scale and in the ‘rule-based’ way you outline, in similar conditions to the one the US/UK/EZ economies are in now?

Market monetarists: please tell everyone what you mean, and without using any analogies, either. Because right now your school of thought doesn’t sound like a serious attempt at economics, but an article of faith.

Edit: I’m aware I used analogies here, but there’s a difference. Think of analogies as a First, analogies where you only replace one or two words are more useful than those that attempt to model complex systems by another complex system. Second, I regard my analogies as tools of communication, rather than a means of proof.

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  1. #1 by TravisV on August 17, 2013 - 3:45 pm

    Unlearning Econ,

    There are lots of examples. I’ll name three.

    Beginning in March 1933, FDR aggressively devalued the dollar. By July 1933, industrial production had risen over 57%. http://www.themoneyillusion.com/?p=308

    Paul Volcker famously clamped down on NGDP expectations beginning in 1980. Inflation and employment collapsed.

    Then, beginning in November 1982, Volcker was satisfied and reversed course, pumping more money into the economy. Employment surged and we had the “Reagan Recovery.”

    There’s also the example of Sweden. In 2009, their central bank charged banks negative interest on reserves rather than positive interest on reserves. As a result, their economy performed better than almost all other wealthy countries (possible exception of Sweden). Sweden continued to do great until their central bank reversed course and aggressively tightened policy beginning in June 2010. http://www.themoneyillusion.com/?p=20779

    • #2 by Unlearningecon on August 17, 2013 - 3:54 pm

      Thanks for your examples, though I find them unconvincing.

      In the first two examples, interest rates were not at the ZLB (perhaps I should have made clear that that’s what I was talking about). According to this, 10 year bonds went from 4% down to 2% under FDR. He also used fiscal policy. The 1980s – well, everyone knows where interest rates were then.

      As for Sweden: you can’t just point to a country that used a policy you like and attribute its success to that. You have to trace clear causal links. Sweden had solid financial regulation after their experience in the 1990s, so their banks weren’t as badly affected, and they also used fiscal stimulus. To be frank, Sumner doesn’t make real arguments in that post but repeatedly refers to his own beliefs as fact: “textbooks tell us….”, “no good model says..” etc. I’d have to see some more comprehensive studies of Sweden’s experience to be convinced.

      I’m perfectly willing to believe that increasing rates by tightening monetary policy will have a contractionary effect, btw. It’s the other direction that bothers me.

      • #3 by Mark A. Sadowski on August 17, 2013 - 7:02 pm

        “In the first two examples, interest rates were not at the ZLB (perhaps I should have made clear that that’s what I was talking about). According to this, 10 year bonds went from 4% down to 2% under FDR.”

        Then you’re effectively redefining the liquidity trap.

        Keynes’ original description of a liquidity trap refers to the existence of a horizontal demand curve for money at some *positive* level of interest rates. Given that there is no evidence of the existence of a liquidity trap for an interest rate greater than zero, in modern macroeconomics liquidity trap refers to a situation in which the nominal *short term* interest rate is near zero.

        Your completely novel definition of a liquidity trap, in which 10 year bonds must have a yield near zero does not even exist. The lowest annual average yield for government issued 10 year bonds on historical record was for Japan in 2012, and it was equal to 0.84%, and is in fact the only time it has ever been less than 1%. In fact no other country on earth has ever had a government issued 10 year bond close below 1.17%.

        Thus you are asking TravisV to go on a snipe hunt.

      • #4 by Unlearningecon on August 17, 2013 - 7:27 pm

        I have not even used the concept of a liquidity trap and neither have I argued yields must be at 0. You can define the interest rate ‘floor’ as whatever level is empirically observed; my point is that once it is reached, not much can be done.

      • #5 by Mark A. Sadowski on August 17, 2013 - 8:09 pm

        Then why did you dismiss TravisV’s examples because 10 year bond rates were not at the ZLB? ZLB stands for “zero lower bound” does it not?

      • #6 by Unlearningecon on August 17, 2013 - 8:45 pm

        Well, ZLB just seems to me to be common shorthand for ‘interest rates can’t go any lower’. What I was actually highlighting – and maybe I didn’t make this clear – was that interest rates decreased over the period in question. I think that when rates can’t be lowered any further, monetary policy becomes impotent.

        It’s not a new argument, but market monetarists often seem to take it as a given that it’s not true. I’m looking for examples that demonstrate this.

      • #7 by Mark A. Sadowski on August 17, 2013 - 9:06 pm

        Isn’t that circular reasoning?

        You seemingly want an example of interest rates being lowered further when they cannot be lowered further.

      • #8 by Unlearningecon on August 17, 2013 - 9:11 pm

        No, no: I am saying that when interest rates cannot be lowered further, I don’t think monetary policy can do more. Apologies if that’s not clear.

      • #9 by Mark A. Sadowski on August 17, 2013 - 9:37 pm

        Every counterexample I can think of involves nominal 10 year bond rates falling below where they were before the act of monetary stimulus at least near the beginning.

        The liquidity effect almost guarantees this. In most cases the bond rate stayed lower for many years.

        I fail to see what that proves if anything.

  2. #10 by Rob Rawlings on August 17, 2013 - 3:55 pm

    If the aim is just to increase NGDPT to a certain level then just giving money away would surely work (helicopter drops). This may be sub-optimal compared with asset-purchases however for a number of reasons but if you truly believe that asset-purchases wouldn’t work , then here is your sure-fire “concrete step”..

    I think the point Rowe is making is that the reason NGDP fell in the first place is likely because people are not spending for largely psychological reasons and if the CB can address that via expectations setting the problem will solve itself.

    • #11 by NicTheNZer on August 17, 2013 - 6:23 pm

      Its somewhat odd that a certain group of economists literally want to conduct fiscal policy using helicopters. Isn’t the most likely outcome that the pilot ends up with most of the proceeds? Seems rather corrupt really.

    • #12 by Unlearningecon on August 17, 2013 - 6:35 pm

      Helicopter drops are fiscal policy, though.

      And ‘psychological’ reasons are not necessarily some artificial barrier; they are a reflection of scarcity of income, high debt, low demand etc.

      • #13 by Rob Rawlings on August 17, 2013 - 9:07 pm

        I thought you were doubting that ‘concrete steps” to increase NGDP exists and here is an obvious one. I’m not sure how deeming it “fiscal policy” is meant to be an argument against it.

        Scarcity of income can have either either supply-side reasons or demand-side reasons. If the reasons are demand side then psychology likely plays a huge part. People may not spend in the present because they are uncertain about future income. If we have a monetary regime that stabilizes future income then on average people (and business) will have less uncertainty and spend more in the present. . I agree that some things (like high debt) can not be fully addressed thru expectations and real increases in the money supply would be needed to increase NGDP.

      • #14 by NicTheNZer on August 17, 2013 - 9:19 pm

        Nobody is arguing against it, that would be advocacy. What’s being said is that if you do it, and it works then fiscal policy works in the situation you were in. It’s a scientific argument.

        And the government is going to have to actually do it, not just threaten to do it. Most people don’t have the foggiest idea what a central bank does and as such central bank policy plays no part in their economic activity, unless they see some effects.

      • #15 by W. Peden on August 17, 2013 - 9:47 pm

        If helicopter drops are always effective, then that’s a refutation of Keynes’s ideas about liquidity trap economies, because his argument was that increases in the money supply could become ineffective. A Keynesian liquidity trap is when an increase in the quantity of money cannot reduce the yield on long-term government bonds, i.e. increasing the money supply fails to stimulate investment and get the economy of out of a slump.

        Whether one defines a particular way of increasing the money supply as monetary policy or fiscal policy is irrelevant to the way that Keynes framed the debate, which is part of the reason his argument was so brilliant i.e. it had relevance across very different institutional arrangements.

      • #16 by Hedlund on August 17, 2013 - 9:55 pm

        Helicopter drops are fiscal policy, though.

        Bingo. This is why I view MM and MMT crowds as arguing for the very same thing (i.e., the mother of all macroeconomic automatic stabilizers), just with different views of how credit money works. Since we’ve had all these natural experiments in the form of QE from Japan to the USA, I keep expecting to see more MM people finally give up and add a T, but c’est la vie.

        Heck, to run with the comparison, MMT folks even fall back on a (somewhat more qualified and nuanced) version of the quantity theory in discussions of demand-pull inflation and their proposed tax-based treatment for it. Though, the concept of demand-pull inflation itself kind of seems like the most “monetarist-y” keynesian idea, anyway, since the transmission mechanism is left a bit vague. I guess it depends on flexprice markets absorbing the increase first, then transmitting them to the administered/fixprice end of the economy? I haven’t seen a satisfying discussion of it, though if anyone knows of one I will gladly have a look.

      • #17 by PeterP on August 17, 2013 - 11:41 pm

        Hedlund,

        The difference is the MMT folks *know* they are advocating fiscal policy. MM people claim we only need fiscal policy and proceed to advise… fiscal policy.

      • #18 by Rob Rawlings on August 18, 2013 - 1:11 am

        I think you are all getting too hung up on somewhat arbitrary definitions of fiscal v monetary. Surely the key issue is whether the policy works or not rather than what label you choose to ascribe to it ?

      • #19 by PeterP on August 18, 2013 - 1:49 am

        Rob Rawlings,
        Sure, but MMs say: no deficits, austerity is ok, but then they talk about helicopter drops which is spending and not taxing, the opposite of austerity and simply running a deficit. So they are trying to have it both ways, total confusion.

        Every time they are showed that swaps of assets (QE) change almost nothing, they bring up a helicopter drop which is an argument for fiscal policy and against the rest of what they say. It make one doubt they know what they are talking about.

      • #20 by NicTheNZer on August 18, 2013 - 9:30 am

        There is also the very important question of how a helicopter drop was organised in the 1930’s when there were no commercial helicopters. This makes it impossible for the great depression to have been solved by helicopter drop.

      • #21 by Rafael on August 18, 2013 - 4:42 pm

        This is the way I like to look at it.

        If the operation results in solely an asset swap of existing securities, it is monetary policy.

        If the operation results in the creation of a new security than it is fiscal policy. Fiscal policy can be constructed in a way where only new securities are created and distributed without effecting the real economy. “Fiscal policy” could stop being such a dirty word that is often conflated with a corrupt political process.

        If the Fed were to start swapping reserves for securities, initially this might appear as nothing more than an asset swap. That is until those sellers of securities to the Fed see what is happening and just start creating securities at will. I issue an IOU to a friend in exchange for bank deposits. My IOU consists of me writing “IOU” on a napkin. The Fed buys this napkin IOU by working through the banking system. The end result is my friend now has a bank deposit instead of my napkin IOU.

        When the Fed realizes that it has purchased a worthless napkin security, the Treasury will have to recapitalize the Fed by issuing credible securities, T-Bonds in exchange for say my friend’s bank deposits.

        The end result is a treasury auction and a new net financial asset, a T-Bond.

        So in a really round about way, the Fed buying potentially (eventually) worthless securities will result in fiscal policy.

        Instead, why not just have the Treasury issue new t-bonds where the banks buys. The Treasury then instructs the bank to credit my bank account. The Fed can now acquire a credible security, T-Bond, from the bank instead of a worthless napkin IOU in exchange for Fed reserve credits.

        Why not just skip right to the treasury auction and save us all some time? That way this prolonged slump ends sometime in my lifetime.

  3. #22 by TravisV on August 17, 2013 - 4:02 pm

    Excuse me, I meant to write “possible exception of Australia.” Sumner has done some very interesting analysis of Australia’s success. Their secret? A faster trend rate of NGDP growth prior to 2008. As a result, interest rates there never fell to 0% and they avoided recession. http://www.themoneyillusion.com/?p=12985

    • #23 by metatone on August 19, 2013 - 5:38 pm

      That’s a really odd post. Australia avoided recession because:

      1) Talk about global commodities booms ignores that Australia exports a lot of LNG & Iron Ore to China on long term contracts. Given the shipping challenges for both of these sectors, looking at global indexes only gives a partial picture. Not to mention that lucrative long term contracts were not globally large, but large compared to the Australian economy. Hence the 2000 – 2007 prosperity.

      2) Key resource export industries recovered quickly (thanks to the Chinese market) – key element natural gas again.

      3) During 2008-10 the AU govt ran record deficits – stimulus to avoid recession… (note, fiscal not monetary action – not saying they were avoiding monetary action, but it’s not a good proof for monetary causality.)

    • #24 by gbgasser on August 20, 2013 - 12:18 am

      Calling anything Scott Sumner does “analysis” is a travesty. Scott is a one trick pony and his level of investigation is so shallow he doesnt deserve to be called an academic. Any one who wants to understand our monetary economy and says “we dont need to look at banks” should be laughed out of the room.

      He’s a fucking joke.

      Scott thinks commercial banks are just very large piggy banks and they work the same way. People and govt put money in and sometimes bankers turn them upside down and lend some.

      He really should be embarrassed.

  4. #25 by TravisV on August 17, 2013 - 4:17 pm

    How bout Japan?

    They’ve had 0% interest rates, 0% NGDP growth and a horrible stock market for decades. But then along came Shinzo Abe’s campaign. As a result, NGDP expectations, the stock market and real growth have soared. Why is Japan’s QE working this time where it didn’t work during the early 2000’s? The BOJ is actually trying to increase NGDP and inflation expectations this time. In fact, they’ve announced a 2% inflation target. They didn’t do anything like that during the early 2000’s.

    http://thefaintofheart.wordpress.com/2013/07/28/a-monetary-revolution-is-also-needed-elsewhere

    http://noahpinionblog.blogspot.com/2013/04/abe-surprised-me.html

    http://www.themoneyillusion.com/?p=9404

    • #26 by Unlearningecon on August 17, 2013 - 6:47 pm

      My response for Australia is predictable: its housing bubble has simply not burst yet.

      Japan is still unfolding, but I’d be inclined to characterise the rise in expectations as, broadly speaking, irrational. I believe that they have already started to (and will continue to) fall as the reality becomes apparent.

      However, I cannot draw a definitive conclusion from Japan yet – maybe it will prove me wrong.

      • #27 by TravisV on August 17, 2013 - 8:00 pm

        Imagine that a central bank announced that it wanted the amount of currency in circulation to instantly permanently double.

        Would an increase in inflation expectations be “irrational”? Of course not. It would be perfectly rational.

        People would start buying widgets up like crazy until prices roughly doubled. Expecting higher sales in the future, firms would hire tons of people in order to make more widgets and capture market share.

      • #28 by NicTheNZer on August 17, 2013 - 9:27 pm

        You mean the amount of cash in circulation when you said cash would double? The central bank provides as much or as little cash as the banks require, it doesn’t even try presently.

        What’s the transmission mechanism, how will it implement this policy. The central bank can wish for whatever it wants, unless it can influence it this has no impact. Its probably wishing the recession was over right now! There have been pretty regular announcements in the media that the recession might be over, will that ever work?

  5. #29 by TravisV on August 17, 2013 - 8:07 pm

    The other point here is that your comment on Australia is expressing flawed “bubbled” thinking. Are you really a “Post-Keynesian”? Are you sure you’re not an Austrian?

    A “bubble” happens when there’s an unsustainable level of economic activity. When that happens throughout the economy, the unemployment rate will fall below the natural level (say to 2%). When that happens, you’ll see a very high level of inflation and it will accelerate. Essentially, RGDP is growing at a faster rate than the country’s long-run potential. That hasn’t happened in Australia.

    When an asset bubble “bursts” that doesn’t mean mass unemployment has to happen. That only happens if NGDP growth collapses. The stock bubble collapse of 1987 proved that. In that case, the Fed didn’t allow NGDP growth to collapse.

  6. #30 by TravisV on August 17, 2013 - 8:26 pm

    By the way, Patrick R. Sullivan helpfully provided me data that shows the U.S. was in the ZLB in 1933. So FDR’s relaxation of the gold standard / devaluation is a perfect example.

    http://www.themoneyillusion.com/?p=23059&cpage=1#comment-267985

    “look at short term rates in figure #5 here;

    http://research.stlouisfed.org/publications/review/92/03/Depression_Mar_Apr1992.pdf

    They are near zero.”

  7. #31 by Luis Enrique on August 17, 2013 - 8:43 pm

    “credibility depends on transmission mechanisms; expectations can only ever work if there is something to anchor them”

    On what basis do you make claims like that? It’s obviously false. People can be bluffed. If the BoE announced a 4 per cent inflation target, with absolutely no thought of how it could be achieved, some people would believe them. Or at least believe inflation will probably be somewhat higher, whcih is enough. Wage negotions, pricng decisons, would take place against a new background. Ironically, your position is like a hardcore rational expectations stance, where people can’t be fooled.

    I don’t see that you have ever tackled the argument why buying assets could affect real spending decisions. First you have to understand it is only going to affect some people: those who currently demand assets but have other choices open to them. So not most of us struggling to put by £50 a month. And many of us with savings have a strong desire to store purchaing power for the future, so wont be swayed. You have to imagine an economic agent is a particular position, facing a choice between continuing to hold assets and doing something else. The key idea is the relative attractiveness of different choices. As asset prices rise, expects future returns fall. Selling up become more attractive. When expectd real returns on asserts were 5% I’d rather save than redecorate the house, when real returns are -2% I’d rather decorate the house. The change in relative attractiveness won’t make everyone change behaviour, just – and you’ll like this – those on the margin, who were only slightly infavor of choice B and don’t need much pushing to choose A. Think of a pension fund manager looking at prospective returns if the Fed has reduced available stock of assets and pushed up prices so future returns are low or negative, ie when the Fed starts to unwind prices will tank, so maybe you want to sell up and find something else to i invest in, maybe a VC fund giving money to start ups, maybe a big infrastructure project, whatever. The idea is that as holding assets is made less attractive, some people will switch into buying some good or service instead.

    Now no doubt your going to pick holes in this, you keep going on about how you think all this stuff just stays in the financial sector and doesn’t touch the real. The point is people face choices, and making once choice less attractive will tip some people into the other, ie real spending.

    I don’t get that passage about equilibrium either, but Rowe is a legend so I’ll give him a pass.

  8. #32 by Mark A. Sadowski on August 17, 2013 - 9:02 pm

    The initial recovery from the Great Depression under FDR was swift. Real GDP growth averaged 9.5% a year from 1933-37 and unemployment dropped from 20.9% to 9.2%. And we know based on analysis by E. Cary Brown, Christina Romer, Barry Eichengreen etc. that the contribution of fiscal policy to the recovery was minor. Thus this was primarily a monetary policy led recovery.

    Real GDP increased by $27.9 billion in 1937 dollars. Let’s see how it is divided up (billions):

    Source——Amount-Share
    Durables—-$3.2—11.5%
    Nondurables-$7.3—26.2%
    Services—-$4.9—17.6%
    Structures–$1.4—-5.0%
    Equipment—$3.2—11.5%
    Residential-$1.3—-4.7%
    Net Exports-$0.2—-0.7%
    Defense—–$0.3—-1.1%
    Nondefense–$2.1—-7.5%
    State&Local-$0.6—-2.2%

    Data comes from here:

    http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&step=3&isuri=1&910=X&911=0&903=7&904=1933&905=1941&906=Q

    Government spending accounted for 10.8%, nonresidential investment accounted for 16.5%, durables accounted for 11.5%, other consumption for 43.2%, residential investment 4.7% and net exports 0.7% of the increase in real GDP.

    Based on E. Cary Brown’s estimates fiscal stimulus contributed less than 5% to the recovery during this time period.

    http://www.jstor.org/discover/10.2307/1811908?uid=3739592&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=21101160986841

    Here are the cyclically adjusted general government budget deficits and their changes claculated from E. Cary Brown’s “Fiscal Policy in the “Thirties: A Reappraisal” (American Economic Review, Vol. 46, No. 5, December 1956, pp. 857–879). This reflects state and local budgets as well federal, but as you might imagine most of the impact comes from the federal budget . Note that I’ve reversed the signs of the changes so that positive corresponds to fiscal stimulus and negative corresponds to fiscal consolidation (everything is in percent of potential GDP):

    Year Balance Change
    1929 -0.804 ——-
    1930 -1.364 0.56
    1931 -3.311 1.95
    1932 -0.854 -2.46
    1933 1.005 -1.86
    1934 0.172 0.83
    1935 -0.056 0.23
    1936 -1.078 1.02
    1937 1.828 -2.91
    1938 0.608 1.22
    1939 -0.147 0.76

    As you can see the largest cyclically adjusted deficit as well as the largest increase in the deficit took place in calendar year 1931.The largest cyclically adjusted deficit under FDR was in 1936 and it is less than one third as large. One has to be careful with 1929 and 1933 since the fiscal years ran to the middle of the year and calendar 1929 was half Coolidge’s doing and 1933 was split between Hoover and FDR. But it’s clear that the fiscal stance was much tighter under FDR than Hoover with probably the only cyclically adjusted fiscal year deficit being run in FY 1936 and the only balanced budget under Hoover by this standard being in FY 1933

    Barry Eichengreen has estimated that the fiscal multiplier was 2.5 on impact and fell to 1.2 after a year.

    http://emlab.berkeley.edu/~eichengr/great_dep_great_cred_11-09.pdf

    Thus its hard to see how fiscal policy contributed much if anything to the rapid growth during 1933-37. And this matches the fact that total government debt as a percent of GDP actually declined by about a sixth during this period.

    WHAT ENDED THE GREAT DEPRESSION?
    By Christina Romer
    September 1991

    ABSTRACT
    “This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=226730&http://papers.ssrn.com/sol3/papers.cfm?abstract_id=226730

  9. #33 by Mark A. Sadowski on August 17, 2013 - 9:20 pm

    The UK fell into economic depression in 1929. Uemployment rose from 8.0% to 16.4% by 1931. In September 1931 the UK abandoned the gold standard which enabled monetary stimulus. GDP expanded by 23.0% between 1931 and 1937 and unemployment fell to 8.5%.

    What’s interesting about this incident is that it started with a fiscal austerity in which total government outlays fell in both real and nominal terms from 1931-1934. And although it rose afterward it rose at a slower rate than GDP. (UK began a very modest rearmament in 1936.) From 1931 to 1937 general government outlays as a percent of GDP fell from 33.1% to 28.6%. So this expansion out of a liquidity trap situation owes virtually nothing to fiscal expansion.

    More specifically the UK steadily improved its budget balance from 1931-1934 and ran a surplus in 1933 and 1934. The cyclically adjusted budget balance was in surplus throughout 1929-36. Gross government debt as a percent of GDP fell from 179.2% in 1933 to 147.2% in 1937.

    What about exports? The pound preceded most of the major currencies in depreciating in the Depression. But it had become more expensive than the dollar by 1934 and the franc by 1937. And in fact net exports contributed a very minor amount to the initial expansion.

    So to summarize:
    1) UK was in a liquidity trap type situation
    2) Abandonment of the gold standard permitted quantitative easing.
    3) Fiscal austerity was pursued initially followed by growth in government spending much slower than overall growth
    4) Net exports contributed little to the recovery

    Delivering growth while reducing deficits: lessons from the 1930s
    Nicholas Crafts
    2011

    Executive Summary:
    “In the Great Depression of the 1930s Britain grew strongly despite significant cuts in the government’s deficit, short term interest rates which were already as low as possible, and the international economy being in disarray. That is exactly what policymakers need to achieve today. This paper sets out what happened in the 1930s and what we can learn from that experience.

    Over fiscal years 1932/33 and 1933/34 the structural budget deficit was reduced by a total of nearly 2 per cent of GDP as public expenditure was cut and taxes increased, the public debt to GDP ratio stopped going up while short term interest rates stabilized at about 0.6 per cent. Yet, from 1933 to 1937 there was strong growth such that real GDP increased by nearly 20 per cent over that period.

    In the early 1930s, fiscal consolidation without a compensating boost from monetary policy was not conducive to recovery and ran the risk of prolonged stagnation in a difficult world economic environment which had little to encourage business investment and exports. The potential parallels with today are readily apparent.

    The key to recovery was the adoption of credible policies to raise the price level and in so doing to reduce real interest rates by raising the expected rate of inflation. This provided monetary stimulus even though, as today, nominal interest rates could not be cut further. Fiscal stimulus was not a factor in the UK recovery until after 1935 when rearmament began.

    The ‘cheap money’ policy put in place in 1932 provided
    an important offset to the deflationary impact of fiscal consolidation that had led to the double-dip recession of that year. A major way in which this stimulated the economy was through its favourable impact on housebuilding in an economy without strict planning rules; the private sector built 293000 houses in the year to March 1935.

    The key implication for today is that, if a further policy action is needed in 2012 in the face of sluggish growth or even a double-dip recession, there is an alternative to using fiscal policy or continuing with the present policy of quantitative easing. Even though interest rates cannot be further reduced, monetary stimulus can be delivered by modifying the current inflation-targeting framework under which the Monetary Policy Committee operates.

    A close approximation to the successful 1930s policy would be to commit to a price-level target which might entail an average rate of inflation of about 4 per cent for three years. Crucially, this would have to be clear and credible so that the inflation was fully anticipated by the public and it would work by reducing the real interest rate.
    If the lessons of the 1930s were fully taken on board, a complementary policy would be implemented to liberalize planning rules and encourage private housebuilding.

    It must be accepted that, while implementing these reforms envisaged in this paper would stimulate growth, the outcome is most unlikely to be a repeat of the 4 per cent growth rate seen in the 1930s. The output gap is probably smaller now, consumer spending will surely be less buoyant and the Eurozone crisis threatens to undermine business confidence and exports. Although these are important caveats, the fact that we cannot rely on consumers or the international economy for demand growth strengthens the case for a policy response as it makes an early spontaneous recovery less likely.”

    http://centreforum.org/assets/pubs/delivering-growth-while-reducing-deficits.pdf

    • #34 by W. Peden on August 17, 2013 - 9:52 pm

      Mark Sadowski,

      Nick Crafts says in that paper (which is brilliant) that the Treasury adopted a price level target in the UK in the 1930s (aiming to reach the 1929 price level by 1935) so Sweden isn’t the only country to have done so.

      The British recovery in 1931-1937 is a great example of how one can have a very good recovery (unemployment nearly halved in just six years in spite of many factors that one would expect to raise structural unemployment) with fiscal austerity, monetary stimulus, and very low nominal interest rates. We would do well if we did as well as the National Government did.

      • #35 by W. Peden on August 17, 2013 - 9:54 pm

        And Roger Middleton (hardly a monetarist!) agrees that monetary policy was a central part of the 1930s British recovery-

        http://oxrep.oxfordjournals.org/content/26/3/414.short

      • #36 by Mark A. Sadowski on August 19, 2013 - 3:54 am

        On page 16 Crafts says:

        “Senior Treasury officials wanted the price level to rise and when the cheap money policy was introduced believed that prices would return at least to the 1929 level by 1935.”

        In my opinion it’s a bit farfetched to say from this that Crafts is claiming that this is an early example of Price Level Targeting (PLT).

    • #37 by PeterP on August 17, 2013 - 11:47 pm

      In other words we need more private debt and more bubbles. Brilliant…

      Even it this was a good idea there is ZERO empirical evidence that people take on more debt when they sniff that the monetary base increased. Actually the causation runs the other way.

      http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf‎

      • #38 by Mark A. Sadowski on August 18, 2013 - 7:33 am

        Unfortunately we don’t have very good data on private sector debt for the UK in 1930s. We do know however that building society mortgage debt rose from 6.7% of GDP in 1930 to 12.0% in 1937 due to boom in residential construction.

        But government debt, which was the bulk of debt in those days, fell from 170% of GDP in 1931 to 147% of GDP in 1937. Thus overall leverage probably fell, mostly due to the strong growth in nominal GDP.

        As for bubbles, this time in British history was remarkably free of any speculative asset price bubbles, and would remain so for decades to come.

        Now for your claims with respect to the paper:
        1) There is no correlation between money supply and leverage.
        2) The monetary base is determined entirely by central bank open market operations.

        As for the relationship between the monetary base and money supply it is a complicated one as the paper you link to notes. But in the final analysis empirical evidence supports the idea money supply growth is mostly determined by central bank actions.

      • #39 by PeterP on August 19, 2013 - 12:09 am

        Exactly, we don’t have the data, And yet you claimed a QE-like mechanism was at work. This is a perfect illustration of the argument in this post: MMs *postulate* stuff and never prove it, cite some examples that cannot be traced to the proposed mechanisms and never discuss mechanisms themselves because they quickly find themselves out of their depth. It is just a religious belief.

        “The monetary base is determined entirely by central bank open market operations.”

        Yes, and if the CB doesn’t want to blow up the banking system it HAS TO provide reserves demanded. So much for its freedom in this respect. It can provide more, by QEs of any kind, but again, any logical mechanism why this would do anything is missing and there are no empirical proofs, besides the fact thet inflation actually fell during QE1 in the US and during QEs in Japan and Sweden.

        “As for the relationship between the monetary base and money supply it is a complicated one as the paper you link to notes. ”

        Yes, it is complicated and data shows that the causality runs in opposite direction than MMs believe.

        “But in the final analysis empirical evidence supports the idea money supply growth is mostly determined by central bank actions.”

        Nope. Not the broad money, the money that can actually be spent in the economy like demand deposits and cash. These are endogenously determined by the demand from the private sector. The private sector demands credit, the banks provide it and swap their securities holdings for the monetary base as required, that is actually what the data tells us, and bankers too.

      • #40 by Mark A. Sadowski on August 19, 2013 - 2:39 am

        “Exactly, we don’t have the data, And yet you claimed a QE-like mechanism was at work.”

        We don’t have comprehensive private sector debt data but since the amount of debt is not particularly important to the Monetary Transmission Mechanism (MTM) it makes little difference. We do however have fairly complete residential mortgage data and that probably constituted about 80% of all household sector debt.

        “Yes, and if the CB doesn’t want to blow up the banking system it HAS TO provide reserves demanded.”

        The central bank elastically provides base money at the policy interest rate it chooses to target. If it wants to provide less it is always at liberty to raise the policy rate.

        “Yes, it is complicated and data shows that the causality runs in opposite direction than MMs believe.”

        This is of course ludicrous. No central bank on earth believes this.

        “Nope. Not the broad money, the money that can actually be spent in the economy like demand deposits and cash. These are endogenously determined by the demand from the private sector. The private sector demands credit, the banks provide it and swap their securities holdings for the monetary base as required, that is actually what the data tells us, and bankers too.”

        When a central bank does an open market operation this unbalances banks’ portfolios and they will proceed to try to rebalance and in the process will alter the amount of currency and deposits the public wants to hold. Thus the supply of money is exogenous.

      • #41 by Mark A. Sadowski on August 19, 2013 - 2:59 am

        “It can provide more, by QEs of any kind, but again, any logical mechanism why this would do anything is missing and there are no empirical proofs, besides the fact thet inflation actually fell during QE1 in the US and during QEs in Japan and Sweden.”

        I’ve already addressed Japan’s 2001-06 QE below.

        The big four advanced currency areas that are currently at or near the zero lower bound in policy interest rates are the U.S., the eurozone, Japan and the U.K.

        One proxy for the amount of QE done is monetary base expansion. This isn’t perfect of course since it also measures other policy responses such as “credit easing”. The ECB has done credit easing but no QE for example. But let’s not make things too complicated for the moment.

        As of May the BOE’s monetary base was up by 348% since August 2008, the Federal Reserve’s up by 260%, the BOJ’s up by 75% and the ECB’s up by 48%:

        Now here’s the broadest monetary aggregate reported by each of the four central banks (the Fed’s MZM, the ECB’s M3, the BOJ’s L and the BOE’s M4) indexed to 100 in August 2008:

        As of May the Fed’s MZM and the BOJ’s L were up by 34% and 4% respectively. As of April the ECB’s M3 and the BOE’s M4 were up by 7% and 16% respectively. In terms of monetary base growth the BOJ recently surpassed the ECB in April, so other than that recent change in positions and the temporary surge in the BOJ’s monetary base in March to August 2011, the relative money supply growth rankings of the ECB and the BOJ match the relative monetary base growth rankings very well. And since changes in broad money supply seem to lag changes in monetary base by several months, and given the current trajectory of the BOJ’s L, it’s likely that the BOJ’s L will surpass the ECB’s M3 in terms of relative growth before too long. On the other hand a consistent pattern between the relative money supply growth rankings and the relative monetary base rankings of the Fed and the BOE is far less easy to detect. Nevertheless it is clear that the two currency areas that have most significantly expanded their monetary base since the Great Recession have also led in money supply growth.

        Since aggregate demand (AD) is the appropriate measure of the effectiveness of macroeconomic policies whose ultimate purpose is in fact to stimulate AD, perhaps we should look at the relative AD performance of the four large advanced currency areas since the Great Recession. But before we do that, we should take a look at the other main policy tool for stimulating AD, namely fiscal policy.

        In my opinion the most objective way of measuring fiscal policy stance is the change in the general government cyclically adjusted balance, particularly the cyclically adjusted primary balance (CAPB). The cyclically adjusted balance takes into account any changes in the general government budget balance due to the business cycle. Thus changes in the cyclically adjusted balance are mostly due to discretionary fiscal policy, and consequently may be taken as a proxy for the degree of fiscal stimulus. The CAPB goes a step further, factoring out changes in net interest on government debt and thus ensuring that practically all of the changes in fiscal balance are discretionary in nature. The following is a graph of the changes in CAPB by currency area over the calendar years 2009-13. All data comes from the April 2013 IMF Fiscal Monitor.

        The first thing you should note is that Japan has had the most expansionary fiscal policy every year without exception. And although all of the currency zones adopted a much less expansionary fiscal policy stance in 2010, it was the U.K. that took the lead in fiscal consolidation, having the most contractionary fiscal policy in both 2010 and 2011. The U.S. has had the most contractionary fiscal policy starting with calendar year 2012.

        Now, let’s take a look at relative AD performance. To be technical, AD is nominal GDP (NGDP) when inventory levels are static (i.e. nominal Final Sales of Domestic Product). Thus for all intents and purposes AD is virtually identical to NGDP. The following is a graph of the NGDP of the four big advanced currency areas with NGDP indexed to 100 in 2008Q2, that is, before large scale monetary base expansion started in September 2008.

        https://research.stlouisfed.org/fred2/graph/?graph_id=133383&category_id=0

        Note that the U.K. led in relative NGDP growth from 2009Q3 through 2011Q3 with the sole exception of 2011Q2. The U.K. also led in relative monetary base growth from June 2009 through January 2011 and relative money supply growth from July 2009 through August 2011. And as previously noted the U.K. had the most contractionary fiscal policy in 2010 and 2011.

        The U.S. has led in relative NGDP growth since 2011Q4. The U.S. also led in relative monetary base growth from February 2011 through January 2012 and has led in relative money supply growth since September 2011.And as previously noted the U.S. has had the most contractionary fiscal policy starting with calendar year 2012.

        Japan has ranked last in relative NGDP growth throughout. Japan has also ranked last in relative monetary base growth with the exception of March through August 2011 and since April 2013, and Japan has ranked last in relative money supply growth throughout with the sole exception of June 2010. And as previously noted Japan has had the most expansionary fiscal policy throughout.

        I threw in Sweden as a bonus since you brought it up. How do you think it’s doing?

      • #42 by PeterP on August 19, 2013 - 7:43 pm

        “When a central bank does an open market operation this unbalances banks’ portfolios and they will proceed to try to rebalance and in the process will alter the amount of currency and deposits the public wants to hold. Thus the supply of money is exogenous.”

        Riiight. Somehow it doesn’t show in the Granger causality studies. Apparently God tries to trick us. Again, devoid of empirics, religious belief by people who know nothing about how banking works and actually claim they don’t need to know. Too funny.

        “This is of course ludicrous. No central bank on earth believes this.”
        Really? LOL. http://rwer.wordpress.com/2012/01/26/central-bankers-were-all-post-keynesians-now/

        Chew on these too (btw. no need to mix in fiscal policy when discussing QE):

      • #43 by Mark A. Sadowski on August 20, 2013 - 7:37 am

        “Riiight. Somehow it doesn’t show in the Granger causality studies. Apparently God tries to trick us. Again, devoid of empirics, religious belief by people who know nothing about how banking works and actually claim they don’t need to know. Too funny.”

        As I said before the central bank elastically provides base money at the policy interest rate it chooses to target. If it wants to provide less it is always at liberty to raise the policy rate. The policy interest rate also ultimately determines the level of money supply and the level of nominal GDP.

        However, at zero interest rates the central bank can no longer change the interest rate to influence the level of money supply. Hence it would be important to determine if QE Granger causes money supply. I’ve actually done such tests and the results are very interesting.

        I did my analysis with the monetary base and the broadest measure of money supply for Japan, the US and the UK during ZIRP ( 0.1%, 0.25% and 0.5% for Japan, the US and the UK respectively) . For Japan this means their L measure of money supply between March 2001 and May 2006. For the US this means MZM from December 2008 to July 2013. For the UK this means M4 from April 2009 to May 2013. I haven’t tested Japan since the Great Recession since it really didn’t do any significant QE until April 2013. I found that to make the variables stationary I had to use the third differences for Japan and the US, and second differences for the UK.

        I set up two equation VARs in the levels of the data including an intercept for each equation. The various information criteria all suggested a maximum lag length of 8, 2 and 2 for Japan, the US and the UK respectively. LM tests showed no sign of serial correlation. AR roots graphs suggested they were all dynamically stable and Johansen’s Trace Test and Max. Eigenvalue Test showed no sign of cointegration.

        Then I restimated the levels VAR with three, two and two extra lags of each variable in each equation for Japan, the US and the UK respectively. But rather than declare the lag interval for the 2 endogenous variables to be from 1 to 11, 1 to 4 and 1 to 4 for Japan, the US and the UK respectively I left the intervals at 1 to 8, 1 to 2 and 1 to 2 respectively and declared the extra lags of each variable to be exogenous variables.

        In Japan’s case monetary base Granger causes money supply and money supply Granger causes monetary base at the 5% significance level each. So I suppose the result is ambiguous although the two variables are obviously significantly correlated. In the US the monetary base Granger causess money supply at the 10% significance level but money supply does not Granger cause the monetary base. Similarly in the UK the monetary base Granger causes money supply at the 5% significance level but money supply does not Granger cause the monetary base.

        This really shouldn’t be too surprising, especially in the case of the UK where visual inspection of the graphs of the monetary base and M4 strongly suggest that causality flows from monetary base to money supply during this time period.

      • #44 by Mark A. Sadowski on August 20, 2013 - 8:58 am

        “Really? LOL.”

        1) Alan Holmes was contrasting the virtues of interest rate targeting versus monetary aggregate targeting in the days before central banks targeted interest rates. He certainly believed that central banks determined the level of economic activity otherwise why debate the merits of the two proposed policies.

        2) Kydland and Prescott were Real Business Cycle theorists (RBC) who did not believe that business cycles were primarily driven by shifts in aggregate demand. Thus they obviously didn’t believe that fiscal policy had much effect on the economy either.

        3) Charles Goodhart thinks that central banks should target the inflation rate through interest rate policy. Thus he evidently believes that central banks determine the level of aggregate demand.

        4) Piti Distayat en Claudio Bori’s central thesis is that monetary policy determines lending activity through its effect on banks’ balance sheet strength and risk perception. Thus rather than saying monetary policy has no effect on lending activity they are simply proposing a different transmission mechanism.

        5) Seth B. Carpenter is merely observing that simple textbook explanations of the monetary creation process are indeed simple.

        6) Vitor Constancio obviously believes that central bank policies determine the inflation rate, so he too evidently believes central banks control aggregate demand.

        7) Ulrich Bindseil presents a history of something he calls the “reserve position doctrine” by which a central bank would steer the economy. He nevertheless believes central banks control the economy through short term interest rate targeting.

        8) What Hayek believed depended on the year, if not the time of day, so who cares what he said?

        I take it by this list of readings you are one of those people who believes that they have a deep insight into the hidden secrets of the monetary universe, somehow missed by generations of economists.

      • #45 by Mark A. Sadowski on August 20, 2013 - 9:11 am

        “Chew on these too (btw. no need to mix in fiscal policy when discussing QE):”

        The biggest problem with the graphs is that they assume that inflation is a reasonable way to determine the impact of monetary policy. But have you noticed that MMs all want to do away with Inflation Targeting (IT) and replace it with NGDP Level Targeting (NGDPLT)?

        Here’s a relatively simple way to frame this.

        The following link is to a dynamic AD-AS diagram, and which can be found in “Modern Principles: Macroeconomics” by Tyler Cowen and Alex Tabarrok:

        You’ll note that the rate of change in the aggregate demand (AD) curve is equal to the sum of the inflation rate and the rate of change in real GDP (RGDP), and so is precisely equal to the rate of change in nominal GDP (NGDP). The rate of change in NGDP is determined by both fiscal and monetary policy in the short run but in the long run the rate of change in NGDP is determined solely by monetary policy.

        Note also the short run aggregate supply (SRAS/AS) curve and the Solow growth curve. The Solow growth curve is essentially the long run AS curve (LRAS). In the short run wages and prices are sticky causing the SRAS curve to be upwardly sloped. In the long run money is neutral and wages and prices are flexible so the Solow growth curve is vertical. Thus shifts in AD influence the rate of growth of RGDP in the short run, but not in the long run.

        Similarly, shifts in AS influence the inflation rate in the short run, but in the long run the inflation rate is determined solely by AD (i.e. monetary policy).

        The point is, the only coherent way to assess the short run impact of monetary policy (or fiscal policy for that matter) is its effect on NGDP, not inflation.

      • #46 by Mark A. Sadowski on August 20, 2013 - 9:30 am

        The example of Sweden during the 1990s not very relevant for a number of reasons. It wasn’t QE in the conventional sense. It is better described as Credit Easing. The Swedish Central Bank lent heavily to the financial sector due to the financial crisis. Interest rates were extremely high throughout the period in order to defend the exchange rate. The policy interest rate actually reached 500% in September of 1992. This was no ZIRP.

  10. #47 by Mark A. Sadowski on August 17, 2013 - 9:22 pm

    Knut Wicksell’s norm of price stabilization and Swedish monetary policy in the 1930’s
    Lars Jonung
    October 1979

    Abstract
    “This paper examines the conduct and the effects of Swedish monetary policy in the 1930’s. Three major conclusions emerge from the study: (1) The conduct of monetary policy specifically the devaluation of the Swedish currency in 1931 and the subsequent program of price stabilization, had a major effect on the aggregative behavior of the Swedish economy in the 1930’s. (2) The impact of the new fiscal policy was insignificant compared to the effects of monetary measures and international developments. (3) The framing of Swedish monetary policy in the 1930’s was strongly influenced by Wicksell’s norm of price stabilization and the recommendations of the old generation of monetary economists represented by Gustav Cassel and Eli Heckscher.”

    http://www.sciencedirect.com/science/article/pii/0304393279900102

    This episode is particularly interesting because it is the first and only known example of a country adopting price level targeting, which is closely related to nominal GDP level targeting, as its monetary policy. Lars Jonung has another paper devoted to a more detailed discussion of this aspect of Swedish monetary policy during this period:

    http://swopec.hhs.se/hastef/papers/hastef0290.pdf

  11. #48 by NicTheNZer on August 17, 2013 - 9:32 pm

    I quite like the wikipedia article on this topic,

    http://en.wikipedia.org/wiki/Jumping_the_shark

  12. #49 by Mark A. Sadowski on August 17, 2013 - 9:39 pm

    The Origins and Nature of the Great Slump Revisited
    Barry Eichengreen
    May 1992

    Abstract
    “More than a decade has passed since the Economic History Society last published a survey of the depression of the I930s. That survey was notable for the lack of consensus it revealed. The events requiring explanation were clearly identified, but for each there seemed to be many potential explanations and little agreement among scholars. Given this state of affairs, the reader may ask what justifies another survey of familiar terrain. The answer is that the last decade has witnessed a hidden revolution in our understanding of the I930s. On many of the central issues raised by the earlier literature, a striking degree of consensus has now emerged.”

    http://bev.berkeley.edu/ipe/readings/The%20origins%20and%20nature%20of%20the%20Great%20Slump%20revisited.pdf

    Pages 234-235:
    “Thus, the recent literature, by emphasizing the contribution of domestic and international monetary initiatives to economic recovery in the 1930s, has inverted the previous tendency to dismiss monetary policy as ineffectual and to regard fiscal policy as the critical policy variable. Upon reflection, this is not surprising. In the US, the most important fiscal policy change of the period, in 1932, was a tax increase, not a reduction. Observed budget deficits were small. Cyclically corrected budget deficits were smaller still. Even in the presence of large fiscal multipliers, the increment to aggregate demand attributable to fiscal policy remained modest until rearmament spending got underway in the second half of the 1930s. In contrast, in countries like the US (and to a lesser extent the UK), the expansion of currency and bank deposits was enourmous. The one significant interuption to monetary expansion in the US, in 1937, revealingly coincided with the one significant interuption to economic recovery. Nor is there evidence for Britain of a liquidity trap that would have rendered monetary policy ineffectual. Even in Sweden, renowned for having developed Keynesian fiscal policy before Keynes, monetary policy did most of the work. Clearly the tendency to dismiss monetary policy in the 1930s on the grounds that one ‘cannot push on a string’ has been pushed too far.”

    For an overview of the international monetary history of the Great Depression see this paper. In particular see Table 2.1 on Page 37:

    http://www.nber.org/chapters/c11482.pdf

  13. #50 by Mark A. Sadowski on August 17, 2013 - 9:44 pm

    In Japan during 1993-2002 real GDP growth averaged 0.9%, unemployment rose almost consistently every year from 2.2% in 1992 to 5.4% in 2002. CPI fell from 2.5% in 1992 to (-0.7%) in 2002. The Japanese announced their plan of ryōteki kin’yū kanwa (QE) on March 19, 2001 and maintained it through March 9, 2006. Real GDP growth averaged 2.1% during 2003-2007. Unemployment fell every year until it reached 3.9% in 2007. Deflation slowed down to -0.4% by 2007.

    AN INJECTION OF BASE MONEY AT ZERO INTEREST RATES:
    EMPIRICAL EVIDENCE FROM THE JAPANESE EXPERIENCE 2001–2006
    Yuzo Honda, Yoshihiro Kuroki, and Minoru Tachibana
    March 2007

    Abstract:
    “Many macroeconomists and policymakers have debated the effectiveness of the quantitative monetary-easing policy (QMEP) that was introduced in Japan in 2001. This paper measures the effect of the QMEP on aggregate output and prices, and examines its transmission mechanism, based on the vector autoregressive (VAR) methodology. To ascertain the transmission mechanism, we include several financial market variables in the VAR system. The results show that the QMEP increased aggregate output through the stock price channel. This evidence suggests that further injection of base money is effective even when short-term nominal interest rates are at zero.”

    http://www2.econ.osaka-u.ac.jp/library/global/dp/0708.pdf

    It’s often claimed that it was the huge increase in exports that led to the “Koizumi Boom”. But the problem with that hypothesis is there was also a huge increase in imports.

    Japanese net exports increased from 1.34% of GDP in 2002 to 1.69% of GDP in 2007:

    https://research.stlouisfed.org/fred2/graph/?graph_id=86204&category_id=0

    Thus net exports added only 0.35% to Japanese GDP over 2003-2007 or about 0.07% a year on average. Excluding net exports real GDP still grew by over 2.0% a year on average over 2003-2007.

  14. #51 by Mark A. Sadowski on August 17, 2013 - 9:48 pm

    The Traditional Interest Rate Channel is only one of the nine channels of the Monetary Transmission Mechanism (MTM) as enumerated by Frederic Mishkin.

    The following paper by Mishkin gives an overview of the MTM:

    http://myweb.fcu.edu.tw/~T82106/MTP/Ch26-supplement.pdf

    You might find the following table, found in the author’s best selling intermediate monetary economics textbook useful:

    To understand what’s been driving the recovery since 2009Q2 it might be useful to look at real GDP (RGDP):

    http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&step=3&isuri=1&910=X&911=0&903=6&904=2009&905=2013&906=Q

    Over the past 16 quarters RGDP has increased by $1291.8 billion in 2009 dollars at an annual rate. Net exports have subtracted $91.2 billion and government consumption and investment has subtracted $191.6 billion. Thus the other components of RGDP have grown by $1574.6 billion. Investment has contributed $594.1 billion (37.7%), consumption $567.8 billion (36.1%), durable goods $321.6 billion (20.4%) and residential investment $109.2 billion (6.9%). (It doesn’t add up to 100% because of the residual.)

    There are some immediate takeaways from this breakdown.

    1) Given that there are only two ways policy makers can impact aggregate demand, fiscal and monetary policy, and that government consumption and investment has been an enourmous drag on the recovery, it’s safe to say whatever recovery we have is due entirely to monetary policy.

    2) Since net exports have been a net drag it’s also safe to say that the Exchange Rate Channel has not contributed to the recovery. This is not surprising given the dollar’s relative strength compared to many of the U.S.’ trading partners, as well as relatively weak demand abroad.

    3) Non-residential investment has contributed substantially to the recovery. But since so many channels impact it, it’s difficult to say without further analysis what the relative contribution of each of the channels is.

    4) Consumption’s contribution to the recovery is also substantial, and this implies that the Wealth Effects Channel is probably the most important source of the recovery so far. This should not be too surprising in that household sector net worth has risen from about $48.7 trillion in 2009Q1 to $70.3 trillion in 2013Q1 according to the Federal Reserve Flow of Funds:

    http://www.federalreserve.gov/releases/z1/

    5) Durable goods have also contributed strongly to the recovery and this implies that the Traditional Interest Rate Effects Channel and the Household Liquidity Effects Channels have been important. (Note that the Household Liquidity Effects Channel is also asset price driven.)

    6) Residential Investment so far has contributed relatively little, which tends to speak against the Bank Lending Channel’s importance during this recovery, since mortgage lending accounts for three quarters of household sector debt. This shouldn’t be too surprising given that the household sector’s outstanding mortgage balance has shrunk by $1,083.1 billion since 2009Q2.

  15. #52 by TravisV on August 18, 2013 - 12:46 pm

    Mark Sadowski,

    Many thanks, excellent examples. Everyone here should read them!

  16. #53 by Unlearningecon on August 18, 2013 - 3:01 pm

    Thanks for the comments everyone.

    Just to outline my position briefly: I endorse a policy of permanently low interest rates, long and short term, as well the base rate. However, I do not believe this would lead to a particular rate of NGDP or RGDP growth; just that it’s desirable. Long term rates of about 2.5% are about the level I’m thinking.

    Neither to I think expectations are absolutely irrelevant. I just think that they need to accompany a policy which is good on its own merits. So I would say: low interest rates are good because X, and the central bank also needs to commit to keep them low to give the policy enough bang for its buck. All too often (eg with Rowe) it seems MMers miss out the first part, and their ‘solution’ is so close to the end goal that the reasoning can become circular.

    Re: helicopter drops, innovative monetary policy and so forth – generally speaking, I’m all for it. However, I think it is at odds with what Market Monetarists want, which is a rule-based approach. I think policy innovations would have to be more discretionary: a helicopter drop, for example, would be calculated based on people’s debt levels and need rather than an NGDP target. A CB financed state-bank would surely make lending decisions based on the perceived efficacy of investments ratehr than an arbitrary income rule. Also, saying something is ‘fiscal policy’ is not just meant to be word games: once you start increasing the deficit it sort of ruins the whole ‘Sumner Critique’ of fiscal stimulus.

    @luis

    First, I like Nick Rowe too. He states his case clearly, is willing to engage those he disagrees with and is always civil.

    Second, this ‘guilt by association’ thing you’re doing with the RatEx guys is silly. All I’m saying is that, yes, expectations may rise following a policy announcement, but if they are not fulfilled, they will drop again. It’s more of an adaptive expectations position – a Keynesian one, in fact.

    Third, I just don’t see that people who are looking for assets have the same motivations as people who are buying, investing etc. If somebody is investing in assets they are looking to store ‘value’ in some form, and you can change their choice set but ultimately they are still going to be looking to store, not buy, and this could take the form of bank deposits, houses, stocks, bonds, cash or many more things. I just think we’re treating the symptoms by buying assets.

    @travis

    Imagine that a central bank announced that it wanted the amount of currency in circulation to instantly permanently double.

    Would an increase in inflation expectations be “irrational”? Of course not. It would be perfectly rational.

    Well, I think it might (wrongly) scare people at first, but actually the central bank couldn’t do this. The money would just end up as bank reserves, which is what has happened in the past. See Scott Fulwiller on this.

    The other point here is that your comment on Australia is expressing flawed “bubbled” thinking. Are you really a “Post-Keynesian”? Are you sure you’re not an Austrian?

    I’m not sure what you’re talking about here. Australia has very high private debt levels and very high house prices, just as other wstern countries did before the cash. That’s why I think it’s in a housing bubble.

    A “bubble” happens when there’s an unsustainable level of economic activity. When that happens throughout the economy, the unemployment rate will fall below the natural level (say to 2%). When that happens, you’ll see a very high level of inflation and it will accelerate. Essentially, RGDP is growing at a faster rate than the country’s long-run potential. That hasn’t happened in Australia.

    A bubble is defined as a period where something is being traded at prices much higher than its ‘real’ value. Your definition seems idiosyncratic to me, not to mention there’s little evidence of such inflation acceleration.

    When an asset bubble “bursts” that doesn’t mean mass unemployment has to happen. That only happens if NGDP growth collapses. The stock bubble collapse of 1987 proved that. In that case, the Fed didn’t allow NGDP growth to collapse.

    Not all recessions are the same. Central banks can ameliorate some recessions; they cannot do as much in others. I believe 2008 is an example of the latter.

    @mark

    On the Great Depression in the UK: government spending rose as a % of GDP from 1931 to 1933. The deficit went down because growth was high. Furthermore, banks were willing to lend (mostly for housebuilding) because they were in better financial positions and there was a need for such housing. I don’t see more debt-fueled house building as a feasible way out of our current recession.

    On the Great Depression in the US: the fed was able to lower the discount rate somewhat, down to 1%, over that period, which it can’t do now (well, it can lower it by 0.5%, which I’d be all for, but I don’t think that’s what’s holding back recovery). I am also willing to believe that the lowering of BAA yields depended to a degree on the commitment to low rates, which Keynes advised FDR to do. Also, what about FDR’s more drastic measures, like confiscating gold and having an 8-day bank holiday so banks could sort out their financial positions?

    On Japan: an injection of base money will have some impact, as it will ‘grease the wheels’ of the monetary system. However, once you reach saturation point wrt reserves, it will not do any more. So I am not surprised by that paper’s results, but I don’t necessarily think you can extrapolate from it.

    I can’t access that Sweden paper. I’d be interested to see what interest rates were over that period, though again I can’t seem to find anything.

    Re: transmission mechanisms as with Japan, I might not disagree substantially, but I still think there is a limit to what things like the wealth effect can do. Can we just increase asset prices indefinitely and induce people to spend, or do we come up against a sort of upper limit? I think events imply that we do; sometimes it feels like just because monetary policy hasn’t produced results, MMers take it as proof that it hasn’t done enough, and disregard the concrete measures central banks have taken as insufficient.

    • #54 by Mark A. Sadowski on August 18, 2013 - 7:59 pm

      “On the Great Depression in the UK: government spending rose as a % of GDP from 1931 to 1933.”

      That’s false, your own source shows that it falls from 32.1% in 1931 to 31.9% in 1933.

      http://www.ukpublicspending.co.uk/spending_chart_1900_2015UKp_13c1li011tcn_F0t

      It’s true government spending rose in 1932 to 33.1% of GDP but much of that was transfer payments related to the poor state of the economy. If you read the Crafts paper you’ll see his measure of government spending, which he gets from Middleton and is cyclically adjusted (as it should be for the purpose of estimating fiscal stimulus), was lower in nominal terms that is was in 1931 throughout 1932-35. The Middleton paper, which is excellent, may be found here:

      http://oxrep.oxfordjournals.org/content/26/3/414.short

      “The deficit went down because growth was high.”

      And growth was high because of monetary policy.

      “Furthermore, banks were willing to lend (mostly for housebuilding) because they were in better financial positions and there was a need for such housing. I don’t see more debt-fueled house building as a feasible way out of our current recession.”

      Although Crafts emphasizes the role of residential construction I think it needs to be put into perspective. Residential investment peaked in 1934. Real (1929 pound sterling) GDP and real residential investment increased by 437 and 68 million pounds respectively between 1931 and 1934, so residential investment accounted for 15.5% of the increase. Even assuming spillover effects it was not predominantly responsible for the economic expansion. Moroever from 1931 through 1937 real GDP and real residential investment increased by 990 and 36 million pounds respectively so residential investment accounted for only 3.6% of the increase.

      “On the Great Depression in the US: the fed was able to lower the discount rate somewhat, down to 1%, over that period, which it can’t do now (well, it can lower it by 0.5%, which I’d be all for, but I don’t think that’s what’s holding back recovery).”

      I don’t think the discount rate was very important during the recovery from the Great Depression either. From 1922-1929 borrowings of depository institutions from the Federal Reserve, which essentially means discount loans, averaged about 9% of the monetary base. But with the exception of the bank panics and the bank holiday they fell below 4% for much of the contraction. The expansion started in April 1933 and by February borrowings were less than 1% of the monetary base. They would remain there because banks were not reserve constrained due to the explosive growth of the monetary base:

      http://research.stlouisfed.org/fred2/graph/?graph_id=133349&category_id=0

      A better measure of interest rates than the discount rate during the Depression is the yield on short term U.S. securities:

      http://research.stlouisfed.org/fred2/graph/?graph_id=133351&category_id=0

      Note that once the importance of borrowings declined a large gap opened up between short term rates and the discount rate. Note also that with the exception of the March 1933 bank holiday short term rates were near zero from May 1932 on forward.

      “I am also willing to believe that the lowering of BAA yields depended to a degree on the commitment to low rates, which Keynes advised FDR to do.”

      But note that corporate debt declined in nominal terms from 1933 to 1937 so it was not an important source of funding during the recovery from the Great Depression (page 989):

      http://www2.census.gov/prod2/statcomp/documents/CT1970p2-11.pdf

      “Also, what about FDR’s more drastic measures, like confiscating gold and having an 8-day bank holiday so banks could sort out their financial positions?”

      The confiscation of gold and the ending of the gold clauses were an important part of detaching the US from the gold standard so it could move to a more fiat regime. Fortunately we don’t have that constraint anymore.

      And the shoring up of the financial sector was important because it helped stop the soaring currency ratio which was holding back the growth of money supply as Friedman and Schwartz observed in their “Monetary History”:

      http://research.stlouisfed.org/fred2/graph/?graph_id=123172&category_id=0

      “On Japan: an injection of base money will have some impact, as it will ‘grease the wheels’ of the monetary system. However, once you reach saturation point wrt reserves, it will not do any more.”

      I totally disagree. What do you think happened to bank reserves during the swift recovery Great Depression? They soared.

      http://research.stlouisfed.org/fred2/graph/?graph_id=133352&category_id=0

      And when they stopped soaring, because the US started sterilizing gold inflows, the 1937 recession followed within months.

      Moreover the same thing happened in Japan. The BOJ reduced the monetary base by 24.4% from January to November 2006, causing bank reserves to fall to more “normal” levels. Economic weakness followed within months. Japan was one of the first major economies to have negative RGDP growth when it fell in 2007Q3. RGDP fell 4.7% at an annual rate in 2008Q2, and 4.0% at an annual rate in 2008Q3, causing Japan to suffer serious consecutive quarterly declines in RGDP before the U.S. did the same. RGDP proceeded to fall 12.4% at an annual rate in 2008Q4 and 15.1% at an annual rate in 2009Q1. All told RGDP fell 9.2% from peak to trough:

      http://research.stlouisfed.org/fred2/graph/?graph_id=124475&category_id=0

      In short Japanese RGDP fell sooner, faster and further than every other major country this recession. It’s hard not to connect the dots between this result and the BOJ’s sudden and sharp withdrawal of QE, given one literally followed upon the other within months.

    • #55 by Mark A. Sadowski on August 18, 2013 - 8:15 pm

      “Re: transmission mechanisms as with Japan, I might not disagree substantially, but I still think there is a limit to what things like the wealth effect can do. Can we just increase asset prices indefinitely and induce people to spend, or do we come up against a sort of upper limit?”

      It is well known that there is normally little correlation between US inflation expectations and US stock prices. Higher inflation might boost stock prices if associated with growing aggregate demand, but higher inflation can also lead to expectations of tight money, or higher taxes on capital, since capital income is not indexed. Indeed the high inflation of the 1970s seems to have depressed real stock and bond prices. In general, the stock market seemed content with the low and stable inflation of recent decades, at least judging by reactions to changes in inflation expectations.

      After 2008 stock prices became strongly correlated with inflation expectations from the TIPS markets. David Glasner documented this pattern, which is actually pretty obvious to anyone who followed the TIPS spreads and equity prices in recent years.

      http://research.stlouisfed.org/fred2/graph/?graph_id=133355&category_id=0

      Stocks and TIPS spreads became highly correlated after 2008 because the economy’s main problem was too little nominal GDP, and higher inflation expectations were correlated with higher NGDP growth expectations. Prior to 2008 higher inflation merely had no effect on real returns.

      Glasner looked at 8 years of data, from January 2003 until December 2010, and divided the sample up into 10 sub-periods. He found almost no significant correlation between inflation expectations (TIPS spreads) and stock prices (S&P 500) until March 2008. (Actually, there was a modest positive correlation during the first half of 2003, another period when people worried about excessively low inflation.) After March 2008, the correlation was highly significant, and positive. Right about the time where the US began suffering from a severe AD shortfall, the stock market began rooting strongly for higher inflation. And it still is, even in the most recent period. Money is still too tight.

      There is no way to overstate the importance of these these findings. The obvious explanation is that low inflation was not a major problem before mid-2008, but has become a big problem since.

      The Fisher Effect under Deflationary Expectations
      David Glasner
      January 2011

      Abstract:
      “The response of nominal and real interest rates to expected deflation becomes problematic when nominal interest rates fall toward zero while the expected rate of deflation is increasing. As nominal interest rates approach their lower bound, further increases in expected deflation cannot cause the nominal rate to fall. Either the Fisher equation is violated or the real rate must increase. One way for the real rate to rise is for asset prices to fall. Regressions between 2003 and 2010 of the daily percentage change in the S&P 500 on the TIPS spread measuring inflation expectations show little correlation between asset prices and expected inflation from 2003 until early 2008. However, since early 2008 the correlation between changes in stock prices and in inflation expectations has been strongly positive and statistically significant.”

      http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1749062

      It’s probably worth mentioning that the only other period in US history that a positive correlation has been found between inflation and stock returns was the 1930s, a period often characterized as an example of a liquidity trap.

      Monetary policy, stock returns and inflation
      By Ding Du
      January-February 2006

      Abstract:
      “The relationship between stock returns and inflation depends on both the monetary policy regime and the relative importance of demand and supply shocks. A simple analytical framework by which to empirically examine the relative importance of these two factors is developed in this paper. Our findings indicate that the positive relationship between stock returns and inflation in the 1930s is mainly due to strongly pro-cyclical monetary policy, while the strong negative relationship of stock returns and inflation during the period of 1952–1974 is largely caused by supply shocks that were relatively more important in that period. Our results are broadly consistent with the general economic literature on monetary policy and stagflation.”

      http://www.be.wvu.edu/div/econ/work/pdf_files/02-01.pdf

      And the Dow Jones more than tripled during FDR’s QE:

      http://research.stlouisfed.org/fred2/graph/?graph_id=120229&category_id=0

  17. #56 by TravisV on August 18, 2013 - 3:43 pm

    Unlearningecon,

    A couple quick questions for you. Consider the examples of Spain and the Virgin Islands (here http://www.slate.com/blogs/moneybox/2013/08/13/virgin_islands_recession.html). Those two places are suffering super-duper high rates of unemployment.

    Do you believe that it’s possible to implement a policy (or policies) that would dramatically reduce unemployment in those places within, say, a year? Are there any policies that could possibly get those countries down to 6% unemployment within three years?

    If your answer is “yes, it is possible” then what do you think those policies would look like? If you were dictator, I’m curious how you personally would attack the problem of mass unemployment.

    • #57 by Unlearningecon on August 18, 2013 - 4:25 pm

      The differences between market monetarists and other demand-siders – mostly Keynesians – are exaggerated by historic rivalries between the two groups due to the left-right divide. I would be for restructuring banks, writing off debt, capital controls and a permanent policy of low interest rates, as well as fiscal stimulus. I cannot predict what kind of RGDP or NGDP growth we’d be seeing udner such circumstances, but I don’t believe that NGDP growth should be capped by a rule.

      Somewhere as small as the Virgin Islands is too complex (and I know too little about it) for me to give a laundry list of prescriptions, but it does seem to me their economy has deeper problems than monetary policy can solve.

      • #58 by TravisV on August 18, 2013 - 4:50 pm

        Unlearningecon,

        Fair enough. Personally, I have more confidence in an approach of increasing QE by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first. I think that that would do more to reduce the unemployment rate than all the things you cited combined.

        Another point: it’s not totally accurate to characterize Market Monetarists as imposing some kind of a crude “cap” on NGDP growth. We believe in ngdpLT or “Level Targeting.” With level targeting, we should aim for “catch-up” NGDP growth of 7%+ for a couple years or so until NGDP growth returns to the previous 5% growth trendline.

        The great thing about announcing a policy of level targeting is that it reassures the market that, while NGDP growth will be rapid in the short-term, it will not be allowed to accelerate out of control.

        To understand “level targeting,” check out the excellent graph David Beckworth created here: http://macromarketmusings.blogspot.com/2012/04/bernanke-conundrum-and-level-targeting.html

  18. #59 by TravisV on August 18, 2013 - 4:55 pm

    Unlearningecon,

    Another question: when you’re dictator and you’re doing bank restructuring, writing off debt, capital controls and fiscal stimulus, what will your monetary policy be? Will it be a policy of low interest rates forever in perpetuity? What actions would your central bank take in order to ensure that interest rates remain low forever in perpetuity?

  19. #60 by TravisV on August 18, 2013 - 5:05 pm

    After all, if NGDP growth (and thus inflation) accelerates, that will put upward pressure on virtually all interest rates, right? Lenders will demand to be compensated with higher interest rates if they expect inflation to accelerate in the future.

  20. #61 by Anon on August 18, 2013 - 8:49 pm

    Unlearning, it is hard to take your responses seriously when you dismiss out of hand the 1930s because long-term rates did not hit 0% and claim fiscal policy was an important part of the 1933 recovery. ZLBs are not defined by long-term rates hitting zero but when short-term interest rates–those controlled by monetary policy–are and thus undermine conventional monetary policy. And this clearly happened in the 1930s. Most observers recognize this point. You can pretend otherwise and make up your own definition, but that only undermines your critique.

    Also, it is widely understood that fiscal policy was not that important in the recovery of 1933. For example, look at Christina Romer’s work. Once you account for the cyclical changes in the budget balance (ie. don’t be fooled by headline budget balance), fiscal policy was not that important during this time.

    • #62 by Unlearningecon on August 18, 2013 - 9:29 pm

      At no point did I state that the 1930s didn’t count because rates weren’t at 0. What I said was that the fact they were lowered over the period indicates that monetary policy had not reached its limits (we can call this limit ZLB, though it may be practically above 0 for long term rates).

      And actually, from a Keynesian (not new keynesian) standpoint the central bank can indeed control long term rates. It was their policy post-WW2.

  21. #63 by Jim Whitman on August 18, 2013 - 9:12 pm

    On the question of interest rates hitting a policy bound, maybe the government sets it at zero, I guess that particular monetary policy intervention may not have finished its work – if for example it helps on keeping some mortgage holders from going under water, or it may keep on making it cheaper to borrow if you are borrowing to finance the next month’s production run. I’d agree with the general sense of @unlearningecon’s point, that once you’ve hit a policy boundary, then ‘that’s it’. And it’s a policy intervention that is also a very broad headed screw driver to use to screw or unscrew a lot of differing sized screws heads. A veritable ‘Birmingham screwdriver (a hammer). But that’s the limit of my patience with people who obsess over any form of monetary policy hoping for a reprieve from its deficiencies.

  22. #64 by Boatwright on August 19, 2013 - 12:14 am

    As some have resorted to Keynesian authority here, it might be useful to reflect on what he actually said on the subject of issuing new money in a stalled economy,

    “If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”

    JMK, Book 3, Chapter 10, Section 6 pg.129 “The General Theory..”

  23. #65 by Luis Enrique on August 19, 2013 - 9:56 am

    UE

    what, exactly, is your claim about expectations? I thought you wanted to argue something like this: market monetarists cannot avoid the need for concrete mechanisms by saying expectations will bring about inflation, because people will not expect inflation unless they know the central bank has a concrete mechanism it can exploit to control inflation. That’s pretty close to a rational-expectations position, which I think it ironic coming from you. You may call that guilt by association, but I don’t.

    However, now you write: “expectations may rise following a policy announcement, but if they are not fulfilled, they will drop again.”

    That is a completely different argument and one nobody is going to disagree with. Nobody, not even Scott Sumner, thinks people will continue to expect high inflation if high inflation fails to materialise. You seem to be skipping the point that inflation expectations are self-fulfilling, or put differently, you cannot have (sustained) inflation unless people expect it. Crudely, people are only going to increase nominal wages and prices by x% per year if they expect the price level to rise at x% per year. Inflation is all about expectations. The qualifier “sustained” is to distinguish inflation from price shocks, which strictly speaking aren’t the same thing:

    http://www.clevelandfed.org/research/commentary/2008/0608.cfm

    If you agree that “expectations may rise following a policy announcement” then you think that firms and workers are going to set or bargain wages expecting inflation, you think that firms are going to choose prices expecting inflation, and that is going to bring about … inflation. Maybe not precisely the degree of inflation announced by the CB, but something. Remember, nobody thinks the CB can reliably hit its target, but they do think it’s target has an effect .

    Now I agree there is a self-fulfilling mechanism at work here, that I suppose may or may not kick off. What I mean is that if you think reducing expected real returns on assets boosts nominal aggregate demand, then you think raising inflation expectations reduces expected real returns, which further boosts AD, with further raises inflation expectations etc. But if inflation expectations refuse to budge then maybe you cannot get the process moving. But that’s where central bank asset purchasing come in – if the central bank keeps pushing asset prices up, it can push expected returns from holding them into negative territory. So it does have handle with which to wind up the process.

    Next you write: “I just don’t see that people who are looking for assets have the same motivations as people who are buying, investing etc. If somebody is investing in assets they are looking to store ‘value’ in some form” You might as well write “people looking to buy a car have a different motivations from people looking to buy jelly beans”. Of course that’s correct, but if you make buying cars less attractive, people will still shift into something else. Yes as I said demand to store purchasing power is very strong, so many people may not shift, that’s why you have to think at the margin, just those who are close to indifferent actually changing their behaviour. Here’s another reductio ab absurdem for you. I may want to store value, but suppose the real return on savings was negative 100%, I would not do so, because buying anything – jelly beans or cars – would be better than losing everything. Now if the the real return on savings was negative 50% some people might have such a high demand for storing purchasing power that they’d tolerate, that others may prefer jelly beans. You imagine a million people, with rates at -100% zero will save, you start to increase rates, the proportion that choose to save will rise, you get rates all the way to +10 let’s say everyone saves. Then the central bank starts pushing returns on assets down, it will push some people into buying jelly beans instead of saving.

    Maybe you’d be better off restating your position, instead of claiming there is no mechanism, or that the effects will “just stay in the financial sector”, you could claim that the mechanism is weak, and that large changes in expected returns will only yield small changes in jelly bean purchases (aggregate demand) hence you favour other more powerful policies.

    “I just think we’re treating the symptoms by buying assets”

    Do you think we are suffering from deficient aggregate demand, or not? If you do, then increase AD by pushing down returns on assets and pushing some people into spending instead of saving, is treating AD.

  24. #66 by metatone on August 19, 2013 - 5:30 pm

    The problem with MM is multiple:

    1) MM economists don’t actually show their working. We’ve been engaged in small scale asset buying through QE and the transmission mechanism to the non-asset economy has been basically nil. This is crucial because everything hinges on “wage inflation” but (and I digress) economics has no good theory of the mechanism between asset inflation and wage inflation, because it doesn’t like to think about the distribution of asset ownership.

    2) MM economists (like Rowe as quoted) will fantasise about truly radical actions, like enormous asset purchases. However they provide no meaningful way to make it politically possible. We can’t even get people to agree to renationalise our broken railways because “the government should own too much of the economy” – how is a Central Bank promise to buy up even 10% of the private sector going to go down?

    3) Related to radical actions, but on a more technical note: How does the Central Bank convince people to sell assets? There’s an easy bit where people have assets they want to offload – and that easy bit is larger if you’re prepared to buy bad assets off banks at inflated prices, but there comes a point where it all gets more complicated. Some serious actors (pensions funds, insurance companies) are not allowed (by regulation) to just dump a lot of assets for cash. Not to mention that if I know there is a committed buyer, maybe I’ll hold out for more money, but that risks a freezing up of the market that looks a lot like a crunch. (Which I guess is a critique at heart of rule-based purchasing…) Do we have any sense (beyond Rowe’s intuition) that we’ll kickstart growth before we hit the complicated threshold?

    4) In the end, when pushed, MM resort to fiscal policy examples to prove “monetary policy can work” – now that might all be about semantics, but if you call semantics, then it runs the other way too, why isn’t MM just fiscal policy? Because that wouldn’t be conducive to hippy punching.

    5) On the conceptual level, as Luis mentions, this could work as a bluff, but there’s no way enough knowledge in MM circles about bluffing to propose workable policy. That’s not a slur on their academic credentials, it’s just a reality that economics curricula does very little with the mechanics of large scale bluffing. Perhaps they could spend their time with some culture/advertising/sales promotion experts, then they might come up with some concrete proposals.

    The irony is, I can write all this and still say honestly that I support higher inflation targets and even think Rowe’s proposals are small enough in risk that they are worth trying. We’re in desperate times, if this is what “serious” or “legend” economists can get behind to give a try to, let’s do it.

    I might rather they got behind fiscal measures that have a much longer, better record of success, but like I say, I’ll go with it – and then we’ll see who is right – and for the sake of my own business, I’ll be happy to hope they are right.

  25. #67 by Unlearningecon on August 19, 2013 - 7:45 pm

    @metatone

    Good comment(s).

    It’s true that most of the monetary policy measures we are discussing are illegal, and it is strange that economists don’t seem to consider this a substantial issue.

    I’m also all in favour of the goal of market monetarism, which is making sure there is always adequate demand – in fact, my own prescription of low interest rates has something similar in mind. However, I simply don’t see it working based on the existence of the financial sector, which MMers all too often tend to omit from their analysis (I believe Sumner recently said to Cullen Roche that he simply wasn’t interested in the banking system).

    @luis

    We are on massively different pages here, as I don’t think people – workers, small business owners etc – have much idea what central banks are or what they do, and they certainly don’t factor it into their decisions. Anecdotal, but people I know still seem to think money is linked to gold.

    The only place expectations really depend on CB policy (as opposed to previously observed economic behaviour) is, in my opinion, in the financial markets. Investors/traders will move based on (expected) policy, but that won’t necessarily filter down to the rest of the economy – I mean, we currently have soaring stock prices and corporate surpluses but not much going on anywhere else. I am talking about adaptive, not rational, expectations, and only for a limited sector of the economy. Once it is realised that monetary policy is not doing what is expected, things will settle back down again.

    As I’m sure I’ve said before, I do think we are suffering from deficient aggregate demand. I do not, however, think merely fiscal or monetary stimulus is sufficient, as we’d need financial reform/debt write offs, too.

    I reject your jelly bean analogy, as we are talking about different classes of goods here. I know neoclassical consumer theory suggests that somebody will switch between two options given the right price, but I just think people who do not want to spend their money on goods & services are going to buy things if their motivation for storing their money (i.e. a depressed economy) is not changing.

    My position is simply that there is no ‘hot potato’ effect because money injected into the economy will end up stored as financial assets, probably bank reserves. The central bank can lower the price of assets (perhaps it could get some corporate yields down) but this has a limited effect, and sooner or later we come against a floor (zero) or a ceiling (asset prices can’t be pushed any higher). This is why I oppose central bank rules based on outcomes: sooner or later, despite their best efforts, central banks are not going to fulfill their mandate. MMers will tell you they simply haven’t done enough, but as I’ve said this all too often seems to be skipping the crucial step of evaluating mechanisms themselves.

    @mark

    In those money base/money supply graphs I see no clear picture emerging. The UK and EZ engaged in austerity while the US had a fiscal stimulus; Japan has been bumbling along for a long time regardless of its actions. I’m not saying I have the definitive verdict, but I think you’re seeing what you want to see, when that picture is ambiguous and needs to be broken down further.

    In any case, even with a clear correlation I would have this down as an issue of reverse causality, which PeterP has pointed out. I adhere to endogenous money theory, where high income results in loan expansions, and the central bank accommodates the growth in the money base. This means that income and reserves will soar at the same time, but not that the latter is causing the former. Further, it is not inconsistent with the idea that the central bank or government placing restrictions on the issuance of bank reserves will cause problems, as happened in the US in 1937, in Japan and so forth.

    Re: the UK – yes, I got the dates mixed up, my bad.

    And growth was high because of monetary policy.

    I agree, but I attribute it to low rates rather than a rise in M or the ‘hot potato’ effect. I don’t think we can manage anything similar now. I simply believe the CB can exogenously control interest rates and asset prices within reason, but once these hit a floor (ceiling), we’re stuck. IMO, further attempts to increase income by pumping money into the system will simply increase holdings of financial assets, whether bank deposits, reserves, cash or whatever else.

    @travis

    First, I know most are NGDPLT and have seen that Beckworth post before. However, you still have a potential problem: if RGDP is growing fast and NGDP is at its policy limit, are you holding back growth by sticking to an NGDP target? And my other problem is in the other direction: surely it is logically feasible that eventually the central bank just runs out of all available channels (as they seem to have now, at least within the law, as metatone points out), and we are back to it not being able to fulfill its mandate?

    Will it be a policy of low interest rates forever in perpetuity?

    Yes.

    What actions would your central bank take in order to ensure that interest rates remain low forever in perpetuity?

    It would just commit to the policy and buy and sell them accordingly. I actually see high rates as potentially causing cost push inflation, as well as speculation, so I don’t think the low rate policy would lead to accelerating inflation to the extent that it would create problems. This is probably a tangent I don’t want to go off on, though I will note it seemed to work post-WW2.

    Edit for everyone: this is worth reading. The fed has the limitations it has because it ‘serves’ the financial system. Anything else makes it essentially a fiscal entity, which makes it far more political.

    • #68 by Mark A. Sadowski on August 20, 2013 - 10:16 am

      “In those money base/money supply graphs I see no clear picture emerging. The UK and EZ engaged in austerity while the US had a fiscal stimulus;”

      This is incorrect. The UK, Austria, Belgium, Finland France Germany, Luxembourg, the Netherlands, Portugal, Slovakia and Spain all enacted discretionary fiscal stimuli over 2008-2010:

      http://www.oecd.org/eco/outlook/42421337.pdf

      In my opinion the most objective way of measuring fiscal policy stance is the change in the general government cyclically adjusted balance, particularly the cyclically adjusted primary balance (CAPB). The cyclically adjusted balance *takes into account any changes in the general government budget balance due to the business cycle*. Thus changes in the cyclically adjusted balance are mostly due to *discretionary fiscal policy*, and consequently may be taken as a proxy for the degree of fiscal stimulus. The CAPB goes a step further, factoring out changes in net interest on government debt and thus ensuring that practically all of the changes in fiscal balance are discretionary in nature. The following is a graph of the changes in CAPB by currency area over the calendar years 2009-13. All data comes from the *April 2013 IMF Fiscal Monitor*.

      You can see from the graph that the 2009 change in CAPB in the US, the eurozone, Japan and the UK was 3.30%, 1.78%, 3.72% and 2.59% of potential GDP respectively. So among the big four advanced currency areas the US fiscal stimulus was second only to Japan’s and only slightly larger than the UK’s. And even the eurozone’s fiscal policy was expansionary through 2010. But more importantly that was over three years ago, and over 2011-13 in aggregate the US has had the most contractionary fiscal policy of the four big advanced currency areas and yet it easily leads the eurozone and Japan in NGDP growth.

      “Japan has been bumbling along for a long time regardless of its actions. I’m not saying I have the definitive verdict, but I think you’re seeing what you want to see, when that picture is ambiguous and needs to be broken down further.”

      These are numerical facts that are not much subject to opinion.

      “In any case, even with a clear correlation I would have this down as an issue of reverse causality, which PeterP has pointed out. I adhere to endogenous money theory, where high income results in loan expansions, and the central bank accommodates the growth in the money base. This means that income and reserves will soar at the same time, but not that the latter is causing the former.”

      Even economists who believe in full blown “accomodative endogeneity” such as Charles Goodhart believe that central banks determine the state of the economy through interest rate policy.

      “Further, it is not inconsistent with the idea that the central bank or government placing restrictions on the issuance of bank reserves will cause problems, as happened in the US in 1937, in Japan and so forth.”

      Keep in mind neither the US in 1937 nor Japan in 2008 were ever reserve constrained.

      • #69 by Unlearningecon on August 20, 2013 - 12:52 pm

        This is incorrect. The UK, Austria, Belgium, Finland France Germany, Luxembourg, the Netherlands, Portugal, Slovakia and Spain all enacted discretionary fiscal stimuli over 2008-2010:

        You can see that broader measures of the money supply switched direction depending the change in the stance of fiscal policy. This is particularly visible when you compare the UK and US around 2010, when the Coalition were elected in the former and announced and started their austerity program.

        I also don’t think only discretionary policy counts as stimulus. Automatic stabilisers contribute, too.

        Even economists who believe in full blown “accomodative endogeneity” such as Charles Goodhart believe that central banks determine the state of the economy through interest rate policy.

        I agree with this. The problem is that once rates are low, you run out of oomph.

        Keep in mind neither the US in 1937 nor Japan in 2008 were ever reserve constrained.

        But rates did rise before that crash, at least in 1937.

      • #70 by Mark A. Sadowski on August 20, 2013 - 6:29 pm

        “You can see that broader measures of the money supply switched direction depending the change in the stance of fiscal policy. This is particularly visible when you compare the UK and US around 2010, when the Coalition were elected in the former and announced and started their austerity program.”

        It’s of course plausible that fiscal policy has an effect on money supply, but consider the following. The UK’s M4 fell by 7.4% between January 2010 and June 2012. But its monetary base also fell 11.3% between February 2010 and September 2011.

        And the US also went through a relatively long flat period in money supply growth. MZM didn’t increase at all between February 2009 and May 2010. This happened to coincide precisely with the time period when US federal fiscal policy was hugely expansionary. See this graph that was posted by Jared Bernstein for example:

        A more plausible explanation relates to the fact that after more than doubling between August 2008 and January 2009, the US monetary base only increased by 2.8% from January to September 2009. (By the way I’ve done Granger causality tests for both countries during this time period and they suggest that the direction of causality is strictly from monetary base to money supply, and not the other way around.)

        “I also don’t think only discretionary policy counts as stimulus. Automatic stabilisers contribute, too.”

        Government expenditures (and taxes) are endogenous to the state of the economy. Thus in order to detect the true fiscal policy stance its important to factor out automatic stabilizers. Take for example Ireland in 2009. According to the IMF Fiscal Monitor the general government deficit increased from 7.4% of GDP in 2008 to 13.9% of GDP in 2009 or by 6.5 points. (Keep in mind that this was a year before Ireland’s government nationalized the debt of its TBTF banks.)

        By this measure it sounds like Ireland’s fiscal policy was hugely stimulative. But in fact Ireland was one of the very few countries that enacted a fiscal consolidation in 2008-10, equal to 4.4% of GDP and consisting of both spending cuts and tax increases (see the OECD link I posted above). The cyclically adjusted primary budget balance (CAPB) increased from (-11.1%) of potential GDP to (-8.9%) of potential GDP, or by by 2.2 points. Using the CAPB captures the actual fiscal policy stance in a way that just using deficits, which are bloated by increased automatic stabilizer expenditures in economic downturns, cannot.

      • #71 by Mark A. Sadowski on August 20, 2013 - 6:40 pm

        “But rates did rise before that crash, at least in 1937.”

        Interest rates are an epiphenomenon, so its interesting that you ascribe so much importance to them. I’m actually much more skeptical of the Traditional Interest Rate Channel of the Monetary Transmission Mechanism (MTM) than you are. For example there’s considerable evidence that both nonresidential investment and residential investment are relatively interest rate inelastic.

        Douglas Irwin has written a really nice paper on the 1937 recession and concludes that neither the fiscal policy tightening nor the increase in reserve requirements were primarily responsible. Instead he argues it was the decision to sterilize gold inflows in December 1936:

        Gold Sterilization and the Recession of 1937-38
        Douglas A. Irwin
        December 2012

        Abstract:
        “The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet our understanding of this severe downturn is incomplete: existing studies find that changes in fiscal policy were small in comparison to the magnitude of the downturn and that higher reserve requirements were not binding on banks. This paper focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. The transmission of this monetary shock to the real economy appears to have worked through lower asset (equity) prices and higher interest rates.”

        http://www.dartmouth.edu/~dirwin/1937.pdf

      • #72 by philippe on September 1, 2013 - 6:27 am

        “And the US also went through a relatively long flat period in money supply growth. MZM didn’t increase at all between February 2009 and May 2010. This happened to coincide precisely with the time period when US federal fiscal policy was hugely expansionary”.

        To paraphrase Scott Sumner, if NGDP was below target then by definition fiscal policy can’t have been expansionary. Instead fiscal policy was too tight. Duh!

      • #73 by Unlearningecon on September 2, 2013 - 2:46 pm

        +1, I’ve previously noticed this asymmetry.

  26. #74 by Luis Enrique on August 20, 2013 - 9:38 am

    well, now I am going to accuse you of something else: faith based economics. You understand, I hope, that people face choices and even those who wish to save (store purchasing power, hold assets) have other things they could be doing with their money [*]. Your insistence that they will not deviate from their chosen behaviour, regardless of what happens to the expected return on their savings, is something you believe without empirical evidence. You write money injected into the system will just end up on reserve [**] – but of course money cannot exist anywhere in the system except on reserve or as cash in hand, so what I take you to mean is that we have had QE but it has failed to boost aggregate demand. But of course you do not know this because you do not know what the path of the economy would have looked like in the absence of QE. Estimates exist that say QE helped to some extent, but of course you won’t be swayed by them.

    To repeat, I think you would be wiser to moderate your position, and instead of denying the existence of the hot potato effect and claiming that perfectly feasible things cannot happen, you could instead argue that these mechanisms are weak, have adverse distributional and other consequences, and that other policies are preferable.

    [*] you reject may analogy because we are talking about different classes of goods here, as if people do not face choices between different classes of good and cannot switch between them if the relative attractiveness of those different classes of good varies.

    [**] that objection is perilously close to the fallacy of composition highlighted here – “Individuals can get rid of the cash they don’t want, but society as a whole cannot, at least not in nominal terms.”

    as for expectations … sheesh. You think if the BoE announced a 4% target, Unison wouldn’t mention it when reacting to public sector pay settlements? Yes I know most of us pay not attention to the central bank, but people watch the news and read newspapers.

    If you really did mean to talk about adaptive explanations, rather than deny the existence of an expectations channel distinct from concrete steppes, and you will admit that expectations may initially react to policy announcements, then you have acknowledged the existence of mechanisms central banks can exploit, because you have opened up the path: policy announcement=> some people’s expectations change (financiers) =>expected returns on assets change =>some behaviour changes (financiers) => effects of these changes are observed and expectations adapt => and so on.

    • #75 by Unlearningecon on August 20, 2013 - 1:09 pm

      Your insistence that they will not deviate from their chosen behaviour, regardless of what happens to the expected return on their savings, is something you believe without empirical evidence.

      I simply think that people who are looking to store value, not buy things, will simply hold cash if worst comes to worst and no other assets are available. I could easily say the converse: you believe that they will start buying jelly beans, without empirical evidence. In fact, the fact that corporate surpluses remain high even with QE and so forth seems to be consistent with my point.

      Estimates exist that say QE helped to some extent, but of course you won’t be swayed by them.

      To the extent QE lowers interest rates and increases liquidity in the banking sector, I would expect it to have a positive impact on income. But this would be limited.

      “Individuals can get rid of the cash they don’t want, but society as a whole cannot, at least not in nominal terms.”

      Sumner revealing more about how his lack of understanding of banking matters, despite his insistence to the contrary. Society can get rid of cash: by putting it into the banking system. This ‘injection’ into banks has almost no impact on their lending decisions, unless they are reserve constrained, which they are currently not. The only thing banks can do with the reserves is engage in asset swaps with the fed or other banks, which has no impact on ‘real’ economic activity.

      as for expectations … sheesh. You think if the BoE announced a 4% target, Unison wouldn’t mention it when reacting to public sector pay settlements? Yes I know most of us pay not attention to the central bank, but people watch the news and read newspapers.

      Well I can’t say what they would do, but personally I would wait to see what materialised and go from there.

      policy announcement=> some people’s expectations change (financiers) =>expected returns on assets change =>some behaviour changes (financiers) => effects of these changes are observed and expectations adapt => and so on.

      This is fine, as it goes. But it does not result in any actual economic recovery.

      Btw, luis:

      To repeat, I think you would be wiser to moderate your position, and instead of denying the existence of the hot potato effect and claiming that perfectly feasible things cannot happen, you could instead argue that these mechanisms are weak, have adverse distributional and other consequences, and that other policies are preferable.

      Here’s me:

      The central bank can lower the price of assets (perhaps it could get some corporate yields down) but this has a limited effect, and sooner or later we come against a floor (zero) or a ceiling (asset prices can’t be pushed any higher).

      I acknowledge some effects, but they are just not the same effects as market monetarists.

      • #76 by Luis Enrique on August 20, 2013 - 2:30 pm

        UE

        “you believe that they will start buying jelly beans, without empirical evidence”

        well I wouldn’t insist that nobody will, so I guess I am claiming some unknown proportion will without empirical evidence, but I’d need empirical evidence (or a convincing theory) to have some idea of how many would. Perhaps few would. Which is why keep saying you’d be wiser to say you think the response will be small, rather than trying to claim available returns on financial assets don’t affect demand for real goods.

        ” Society can get rid of cash: by putting it into the banking system. ”

        no, I think you’re really missing the point here. Forget about lending decisions, that’s not what he’s on about. This is about economic agents who find themselves holding cash but don’t want to. Holding cash in a bank account isn’t getting rid of cash, quite the opposite. Buying something in exchange for cash – perhaps another kind of asset – is getting rid of cash. The hot potato effect is about agents who want to get rid of cash by buying something else, but of course that just means cash has moved from buyer to seller, it just moves from hand to hand like a hot potato, and hasn’t vanished from the economy, which is why the economy as a whole can’t get rid of cash. I repeat myself, but cash can only exist as cash in hand or on reserve at the CB or in vaults in banks, and it would be there whether getting passed from hand to hand like a hot potato or being held like a cold one. If you want to argue that against the hot potato effect, you have to say that people will find themselves holding cash and be content, and not trying to get rid of it by buying something else (the cash will be in the banking system either way). Maybe that’s what you meant. Well fine, but that brings us back to inflation expectations. If expectations keep rising, it’s harder to believe people are going to be content to hold cash.

        “This is fine, as it goes. But it does not result in any actual economic recovery”

        why not? you appear to have just accepted a story in which if it chooses to the CB can increase nominal aggregate demand because it can bring about increased inflation expectations, and then actual inflation, at the ZLB. The story involves some people changing behaviour – switching from saving to spending.

        “The central bank can lower the price of assets [but] sooner or later we come against a floor (zero) or a ceiling (asset prices can’t be pushed any higher).”

        UE, think about equities. You agree that QE has pushed up stock market prices, right? There is no upper bound on equity prices, and the higher they rise the lower expected returns from continuing to hold them are (but higher the gains from selling them and then finding yourself holding cash you need something to do with are). If the CB started buying equities, it could easily push expected returns from holding them into negative territory. Suppose the shares of UE Plc trade at 50p, and the CB pushes them up to £1 – what are the expected returns from holding UE Plc at £1, if you think the CB will unwind its holdings at some point. Now we all agree that conducting monetary policy by buying equities would be hairy, but the point is that the CB has ammunition, that it could use to push NGDP around even at the ZLB, which is what I thought you needed convincing of.

      • #77 by NicTheNZer on August 20, 2013 - 7:23 pm

        “Holding cash in a bank account isn’t getting rid of cash, quite the opposite. Buying something in exchange for cash – perhaps another kind of asset – is getting rid of cash.”

        On the contrary, putting cash into a bank gets rid of cash. This is because the Fed ensures that the banking system is responsive to public demand for cash. Also spending cash doesn’t reduce the aggregate cash balance held by the public, as the cash transfers to the seller. Presumably the seller will place the cash in the bank which reduces the aggregate cash balance held by the public.

      • #79 by Luis Enrique on August 20, 2013 - 8:01 pm

        nic

        are you talking about the individual level of the aggregate?

        at the individual level, if I find myself with £50, depositing it in my bank isn’t getting rid of it from my point of view, any more than putting it in my pocket would be. That’s what I meant in the bit you quote from me.

        for the aggregate point of view, when it comes to the CB’s response, I think you are making an argument, by saying the CB responsds, that if people don’t demand cash, this will imply that a CB that wants to hit an interest rate target will have to remove cash from the system. OK. But we are talking about the response to a CB expansionary policy of injecting cash so putting money in the bank isn’t going to remove cash in aggregate in the context of this discussion.

        another possible argument could be that rather than talking about high powered money (which only exists as cash in hand or on reserve) we are talking about broader measures of the money supply, including what we’d call current accounts in the UK, I think maybe demand deposits elsewhere. So you could tell a story here in which the hot potato – people not wishing to hold cash – causes private credit to shrink, the money multiplier to go into reverse, reducing money in aggregate in that sense. They don’t want to hold money, so what they do with it instead is pay off debts. Is that what you had in mind? If so, it’s not very well described by the claim “society can get rid of cash: by putting it into the banking system”

      • #80 by NicTheNZer on August 20, 2013 - 8:16 pm

        Luis, I am talking about the aggregate of course.

        If the central bank some how gets the cash out there, then it will end up as surplus vault cash at banks soon after being deposited. It would be a bit odd for the central bank to refuse to buy surplus vault cash so the effect is unclear in terms of what this does to the banks, but probably that cash just ends up in one banks vault or another’s. There is little to no evidence the Fed can target the amount of cash held by the public.

      • #81 by Luis Enrique on August 21, 2013 - 9:16 am

        nic

        right, well then I repeat myself again: of course the money ends up in bank reserves. that’s the only place high powered money can exist, other than in people’s wallets or down the back of sofas. When Sumner say society cannot get rid of money as a whole, he does not mean reduce the amount of cash they hold in hand, he means including cash held within the banking system.

        I’ve been thinking about the idea I had above about paying off debts and the money supply, I am not sure it holds water. But either way, it is quite a different story to the idea that people who wish to hold assets will be content holding cash because they wish to store purchasing power.

      • #82 by NicTheNZer on August 21, 2013 - 9:00 pm

        Sumner can define cash in circulation as that held by banks if he wants. The question is what effect this has on the rest of the economy however. Plainly the banks are not going to go out and spend their surplus vault cash, and just because its there its not going to cause people to withdraw and spend it.

        This looks like another variation on QE, and we can plainly see how that doesn’t stimulate the economy (apart from financial markets).

  27. #83 by Luis Enrique on August 20, 2013 - 11:35 am

    I know you dislike repeated posts, but I feel I should add: maybe what we need to acknowledge here, as we informally debate possibilities if agents have adaptive expectations, but also react to some extent to policy announcements, and central bank mechanisms (QE) to manipulate aggregate demand at the ZLB are of dubious power, is that we are probably thinking about a world in which multiple equilibria are possible. And this may provide a reason for fiscal stimulus.

    I don’t know these arguments terribly well, but I know plenty of models with adaptive expectations at the ZLB include the possibility of deflationary spirals. relevant papers probably include.

    http://economistsview.typepad.com/economistsview/2012/05/liquidity-traps-and-expectation-dynamics-fiscal-stimulus-or-fiscal-austerity.html

    I haven’t read this new one from Woodford, but it looks very relevant

    http://www.columbia.edu/~mw2230/AREcon.pdf

  28. #84 by Blue Aurora on August 20, 2013 - 4:13 pm

    It’s perfectly possible for a macro-economy to have multiple equilibrium states. It just doesn’t have to be in a full employment equilibrium…

    • #85 by Unlearningecon on August 20, 2013 - 7:56 pm

      Well, Keynes showed that economic theory needn’t imply a full employment equilibrium, but neither is it necessary for the economy to be in any equilibrium at all. Rowe seems to assume it is.

  29. #86 by Unlearningecon on August 21, 2013 - 1:10 pm

    OK, this will be my last reply on the thread, so the MMers can have the last word if you so choose. Thanks for all your constructive comments, particularly Mark for the evidence-based studies. I’ll probably make one last post on the matter over the next few weeks, once the dust has settled.

    @luis

    Ok: people will be content holding cash, or at least least some form of liquid asset. I see nothing in the proposed policies changing their motives for holding liquid assets.

    why not? you appear to have just accepted a story in which if it chooses to the CB can increase nominal aggregate demand because it can bring about increased inflation expectations, and then actual inflation, at the ZLB.

    It can increase nominal return on assets, but this doesn’t necessarily result in an aggregate increase in nominal income. Other incomes can shrink at the same time.

    There is no upper bound on equity prices

    I disagree. I think there are diminishing returns to buying up assets: support the market somewhat, and you’ll see a bigger impact than announcing, say, your third QE program (indeed this seems to have been borne out in the US).

    @mark

    This causality issue is really the crux of what’s going on. I actually don’t know of any studies that found causality from the money base to the broader money supply; only Kaldor, Kydland & Prescott and numerous endogenous money papers which find it the other way. As I’ve said: the endogenous money story is not inconsistent with there being some effect on the economy from a large MB expansion, as this will make the interbank market more liquid. However, there is a saturation point.

    Thus in order to detect the true fiscal policy stance its important to factor out automatic stabilizers.

    I agree that in order to understand policy stance we should use CAPB; however, I still think that automatic stabilsiers contribute to growth/stimulus – this is a much touted benefit they have.

    Interest rates are an epiphenomenon, so its interesting that you ascribe so much importance to them.

    This is where we differ. I can only assume you see the money supply impacting economic activity, which impacts interest rates, a la Friedman (?) Conversely, I see the central bank as only controlling interest rates and therefore the ‘cost’ of money. JakeS helpfully compared the endogenous money view of a central bank to an electricity supplier.

    I also think sterilising gold inflows being contractionary is consistent with both – and indeed most – macroeconomic theories.

  30. #87 by Luis Enrique on August 21, 2013 - 1:50 pm

    fair enough. my last words:

    “It can increase nominal return on assets, but this doesn’t necessarily result in an aggregate increase in nominal income. Other incomes can shrink at the same time.”

    UE I think you typed up when you meant down. Through purchasing assets (and raising inflation expectations) the CB decreases the expected real return on holding assets (including cash: heating the potato), which causes some people to stop trying to store purchasing power and get spending instead, which increases aggregate demand. At least that’s the story.

    There is no upper bound on equity prices
    I disagree.

    you misunderstand. The shares of UE plc could trade at 50p, or £50, or £50,000000, prices can keep going up, there is no upper bound on nominal equity prices, when the buyer has a printing press at their disposal.

  31. #88 by Luis Enrique on August 26, 2013 - 10:29 am

    I break my promise of last words for this: http://www.interfluidity.com/v2/4522.html

    excellent post. See footnote [2] for community being unable to get rid of base money.

  32. #89 by MM on August 28, 2013 - 5:15 pm

    Market Monetarism: Give lots and lots of money to wealthy people in the hope that they might spend some of it. If they don’t spend it, give them even more money. Keep giving wealthy people more and more money for free until they start spending some of it. If they don’t spend enough of it, just keep giving them more money, for ever, until the end of time. Just keep shovelling money into the hands of the wealthy at an ever increasing rate and all will be well, someday, because of expectations or something.

    • #90 by TravisV on August 28, 2013 - 6:23 pm

      • #91 by Unlearningecon on August 28, 2013 - 6:48 pm

        The economy is not zero sum but that doesn’t mean that increasing stock prices/wealthy people’s income will translate into recovery. In fact, it hasn’t so far.

      • #92 by TravisV on August 28, 2013 - 6:53 pm

        Unlearningecon, what is your position?

        Right now, there are huge political obstacles to fiscal stimulus. It ain’t gonna happen any time soon.

        If you controlled monetary policy and faced that obstacle, what would you do? Would you aggressively tighten and throw millions out of work just to stick it to the rich?

        Seems to me you should do the opposite. You should increase QE by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.

      • #93 by Unlearningecon on August 28, 2013 - 10:23 pm

        As I’ve said, I advocate a policy of low long term rates, so I’d implement that. I’ve never advocated tightening, not now and not when the economy is recovered.

        As for increasing QE by 20% per month, the fed is not legally allowed to buy everything on planet earth, so we’d come up against the same political roadblocks as with fiscal stimulus. I’d be perfectly willing to go up to the limits of what is operationally possible with monetary policy, but I’d prefer a discretionary approach that helped people directly instead of a rule-based one.

        @MM, please try to keep it to one comment at a time.

      • #94 by NicTheNZer on August 29, 2013 - 8:16 am

        “You should increase QE by 20% per month, until we are out of the zero rate bound”

        It seems pertinent to point out that QE policy causes the target rate to fall to zero. It can’t take you out of zero-lower-bound, and will put the you there if your not there and do it!

        The Fed could get out of this however by paying interest on reserve balances.

        http://neweconomicperspectives.org/2013/01/understanding-the-permanent-floor-an-important-inconsistency-in-neoclassical-monetary-economics.html

  33. #95 by MM on August 28, 2013 - 7:22 pm

    “You should increase QE by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.”

    Translation: “you should increase shovelling money into the hands of the asset-rich by 20% per month”

    • #96 by Boatwright on August 28, 2013 - 7:32 pm

      Keynes’ proposal to bury money in old coal mines and sell licenses to those who would hire people to shovel it up, solves the problem I think.

      Seriously: Debt forgiveness, large scale public works, etc. all make much more sense than handing money out to bankers.

  34. #97 by mm on August 28, 2013 - 8:52 pm

    using monetary policy exclusively to try and stimulate/ regulate the economy always tends to favor the wealthy. Market Monetarism is transparently just another form of trickle-down economics.

    Just throw more money at the rich at an ever increasing rate, that’s MM in a nutshell.

  35. #98 by MM on August 28, 2013 - 8:54 pm

    “This is really dumb. The economy is not a zero-sum game.”

    Those Krugman articles are pretty dumb. Who said anything about zero-sum? You can dump plenty of free money on the wealthy, as Market Monetarism recommends, without that having anything to do with zero-sum.

  36. #99 by Min on September 3, 2013 - 12:53 am

    Just a quick comment.

    I also think that the US economy is in a (quasi-)equilibrium. (I say “quasi-” because I do not believe in actual economic equilibria, at least until the human race is wiped out.) I say that because of the depression. In fact, suboptimal equilibria are fairly common, IMO.

    • #100 by Boatwright on September 3, 2013 - 7:50 pm

      “suboptimal equilibria” ?????? What exactly does this mean?

      Please address the work of Minsky who argues that the financial system is inherently UNSTABLE, that it will always move towards disequilibrium — booms, bubbles and crashes — and that this is because of the inevitable
      misperception of risk by bankers — under-estimated in good times and over-estimated in bad

      • #101 by Unlearningecon on September 4, 2013 - 9:44 am

        In fairness to min, it is feasible that the economy can be in a sort of ‘quasi-equilibrium’, where it sits at a roughly stable, high rate of unemployment.

      • #102 by Boatwright on September 4, 2013 - 3:14 pm

        I think many skip over Minsky’s fundamental insight because of a reluctance to abandon a neat model that posits an economy fine tuned to functional equilibrium — pleasing porridge that is never too hot or too cold.

        Minsky’s point is: Whenever things are going along happily and employment, prices, etc. seem stable, returns on investments in enterprise tend to flatten. This draws banks and financial markets to speculation in asset values. Over time ‘investment’ and money creation becomes a game of musical chairs, a Ponzi scheme dominated by arcane highly leveraged financial instruments, hedges, puts, calls, and the Bernie Madoffs and Jamie Diamonds of the world.

        We are living in such a world now. Describing this carnival as a ‘quasi-equilibrium’ is no more than a pleasant fairy tale. I remember well the 2007 pronouncements from our financial leaders about the great moderation, and how the then rampant speculation in assets was different from past bubbles. Once again as it has time after time, history has proven Minsky right.

      • #103 by Min on September 4, 2013 - 8:15 pm

        Example of a suboptimal equilibrium:

        In the initial conditions, farmers in and around Oklahoma practice conservation. But then a few farmers abandon conservation practices in order to increase yields by 5%. Over time more and more farmers follow suit, until we reach conditions such that practicing conservation means the difference between expected profit and expected loss, so that none of the farmers practice conservation. Later a drought hits the area and, since nobody has been practicing conservation, the area becomes a dust bowl and then turns into a semi-desert which will not support farming.

        The third condition after desertification is an obvious suboptimal equilibrium. The second condition, where no farmer practices conservation, is also a suboptimal equilibrium, because the risks of farming outweigh the expected benefits.

      • #104 by Min on September 4, 2013 - 8:18 pm

        Note: The expected profit and expected loss in the second condition are short term expectations.

      • #105 by Boatwright on September 5, 2013 - 11:46 am

        Min:

        I fail to see the equilibrium in your examples. Bad farming practices leading to desertification is a perfect description of a disequilibrium.

        It is also a false analogy to argue that because we find equilibria in a micro-economic situation or in ecology it must necessarily exist in the macro-economy. I am also puzzled by your use of the expression; ‘short term expectations’. At some point, instabilities appearing over shorter time frames begin to look like a general lack of equilibrium.

        Please explain what you meant by ‘the US economy is in a (quasi-)equilibrium’. I continue to find this completely opaque.

      • #106 by Min on September 6, 2013 - 9:40 pm

        @Boatwright

        Do we not agree that there is an equilibrium after desertification, and that it is suboptimal?

        May we not also agree that the farmers are in a game equilibrium before desertification when the only way to farm profitably (to play the game) is to do so without practicing conservation? (OC, one does not have to play the game.) If so, do we not agree that it is suboptimal, given the chance of a dust bowl and desertification? (Nature is not a player in the game.)

      • #107 by Boatwright on September 9, 2013 - 3:05 pm

        Min:

        No. The problem is your expectation that every student of economics must accept a-priori arguments simply because they are logically consistent.

        The development of the Oklahoma Dust Bowl was a mix of factors only one of which was bad farming practice. You are somewhat correct that economic conditions motivated too many farmers to plow up the thousands of years-old prairie sod ecosystem that characterized the region. However, the actual conditions were much more complex than your simple a-priori ‘competition forced farmers to adopt unsound practices followed by a change in weather conditions’ model. This model does fit nicely into classic supply/demand equations and produces what many choose to call equilibrium.

        I reject the claim that an historical period characterized by wild swings in commodity prices, widespread bankruptcies and bank failures, gluts in the countryside, as well as widespread hunger and homelessness can be described as being in economic equilibrium. When the a-priori assumption of equilibrium becomes the starting point for all modelling, the term loses any meaningful usefulness.

        Shumpeter, Minsky, Keen and others have very ably made the point that markets do not in fact predictably converge to supply/demand equilibrium, and that producers and consumers also do not axiomatically maximize utility. We would do well to begin considering valid economic models as necessarily emergent from actual economic behavior and ecological conditions rather than forcing these conditions to fit an a-priori assumption.

        I suppose, looking at actual events, one can find periods where things change slowly and supply and demand exhibit stability, but to extend that observation as proof that there is a general condition called economic equilibrium is unproven. This is why I find statements about ‘quasi or sub-optimal equilibrium’ meaningless.

      • #108 by Min on September 9, 2013 - 3:30 pm

        Boatwright:: “The problem is your expectation that every student of economics must accept a-priori arguments simply because they are logically consistent.”

        Obviously, you think that I am somebody else, or you think that I am saying what I am not.😉

        You asked what a suboptimal equilibrium was. I tried to explain with a hypothetical example, and now your objection is that that example is not the same as a historical event. (Actually, my example is closer to current conditions than to the Dustbowl of the 20th century.) If you really want to get your head around the idea of a suboptimal equilibrium, we can continue this discussion.🙂

      • #109 by Boatwright on September 9, 2013 - 5:10 pm

        If by suboptimal equilibria you simply mean that an area of depressed economic activity can become fixed in an apparently static pattern for a period of time, then I do understand your hypothetical example. This is classic Keynesianism.

        I still have two problems with your argument:

        1) It is a-priori. One could for example argue that since markets ALWAYS converge to equilibrium, our present low-growth austerity must be a condition of equilibrium. This seems weak.

        2) You have made several statements about our current condition being a sort of ‘suboptimal equilibria’ while ignoring the fine detail of our actual economic circumstances. When the next bubble inflates or the next crash occurs, what do we say then? Where did the equilibrium go? And if the seeds of those events lie in the present as they surely do, how can one say much at all about how stable things actually are?

        Minsky, for one, argues that the seeds of a coming bubble are always present in any period of apparent ease and stability. Conversely, the seeds of the next war or other social upheaval are surely present in any depression.

        The real world is in fact chaotic where the approximate present does not approximately determine the future. I remain interested in what is and economic models that are emergent. Rather than how good we are at fitting events to a pre-conceived model of necessary equilibrium.

      • #111 by Unlearningecon on September 14, 2013 - 3:31 pm

        Yes, Boatwright, min is a regular commenter and he’s certainly not the type to believe in the type of equilibrium you are arguing against!

        I simply interpret him as saying that the economy might remain in a depressed state with no tendency to move quickly in any direction away from it. We don’t have to call this an ‘equilibrium’ – surely, it isn’t, as things are changing constantly in capitalist economies. However, it does bear some similarity to an equilibrium, in that key variables don’t move much.

      • #112 by Boatwright on September 15, 2013 - 8:53 pm

        At times it is hard to abandon something which seems to hold intuitive truth. In the case of economic equilibrium, the idea seems simple: Supply balances demand; money growth balances true economic growth; the supply of labor will trend toward full employment; consumers will always maximize utility, etc..

        Certainly we can talk about an ideal, conceptual equilibrium. We can imagine simple barter economies where the supply of apples, bananas, rainfall, sunshine, and tribal tastes are in perpetual balance. However, when we look for actual equilibrium we find it always elusive. I agree that there can be variables not moving much; that we can have periods and situations where things SEEM static. We are living in a period right now that fits nicely with Keynes’ “failure of demand”, and we do seem to be stuck in an extended period of under-employment.

        I object however to calling this an equilibrium. When examined, we find ourselves in difficulty when we try to define what it is exactly we mean when we use the term. Qualifiers such as ‘quasi’, & ‘sub-optimal’ are used. Unlearning you just used the term, ‘similarity to an equilibrium, in that key variables don’t move much’. As you can tell by now, my objection to describing the situation as an equilibrium is strong. I ask: Is it an equilibrium or not? And, if we have to qualify it all the time, I suggest we need to look for another way to describe the situation.

        Perhaps it’s time to reconsider the concept as a founding principal of how we look at economics, and start looking for emergent properties of the real world rather than trying to fit the world to what seems to me to be a very fuzzy idea.

      • #113 by Unlearningecon on September 17, 2013 - 11:49 am

        Yeah, I see what you mean about equilibrium. I don’t believe in equilibrium at all; perhaps we might prefer the term ‘permanently depressed state’ or some such.