A friend who is a very sharp economist mentioned to me that when he reads my critiques of Sumner, it is very challenging to discern my argument. So if he was having trouble following my posts, I pity the fool with a normal IQ.
So for this post, I will start out at Square One. It’s appropriate to do so, because my ultimate point is going to be that–from what I can tell–Scott Sumner and Paul Krugman are taking what should be a stunning refutation of their position, and somehow turning it into a glorious confirmation. I am not accusing them of lying; I actually think that we’re so hip-deep into the arguments, that up becomes down.
So like I said, let’s start simple. Sumner (and Krugman but I’ll focus on Scott since I know his position better) believes that “money matters.” In other words, changes in the supply of, and demand for, money can lead to “real” changes. For example, if all of a sudden the quantity of money fell in half, it’s not the case that instantly all prices would go down 50% as well, leaving the “real” economy undisturbed. On the contrary, there would be a huge convulsion in the market, with lots of people getting thrown out of work, and the production of physical goods and services dropping sharply.
So far, so good. And to be clear, Austrian economists agree that monetary disturbances can affect the “real” economy; that’s the essence of the Mises-Hayek theory of the business cycle.
OK, so where does the disagreement begin? When it comes to our current recession, I say that the tremendous boom under Greenspan distorted the capital structure of the economy. We had painted ourselves into a corner, as it were, and output had to fall (relative to its height at the end of the boom) while workers and resources were shuffled around into more sustainable niches. When the crisis hit, the Fed and the government should have sat back and done nothing. (Or better yet, pegged the dollar to gold, cut spending, and cut marginal tax rates–I can dream.)
I admit there would have been an awful recession–the worst since the early 1980s at least–and a lot of investment banks would have gone down. But after 6 months or so, unemployment would have peaked, and a genuine recovery would have begun. By now, the awful Depression of 2007-08 would have been a bad memory. Unfortunately, the Fed and the government didn’t do what I would have recommended. Instead, they implemented the same strategies that their predecessors deployed in the face of the dot-com crash–times ten.
Sumner’s views are very much different. He says that the housing boom did indeed necessitate some “recalculation,” but that the reason for our disastrous economy since 2008 is that Bernanke hasn’t inflated enough. Specifically, the demand to hold money went way up, and Bernanke did not offset it with a corresponding increase in the quantity of money. The result is that nominal GDP (NGDP) fell. NGDP measures how much total spending occurs, and is the flip side of how much income people earn. So in the aggregate, people were earning less income in 2008 than they would have guessed the year before.
Sumner would admit that this “monetary shock” would be no big deal, so long as wages and other prices could adjust quickly. (In that scenario, people earn less money income than they expected, but no big deal because their money expenses are lower than they expected, etc.) Unfortunately, in the real world, prices and in particular wages are “sticky downward,” meaning they can’t go down as easily as they go up.
So as far as policy conclusions, Sumner and I are in complete disagreement: I think the Fed should stop pumping in more base money, and let interest rates rise as they may. (It’s a little harder for me to say if the Fed should start selling off its assets, or just let them mature without rolling them over, etc.) Sumner, on the other hand, would buy a round at the bar if Bernanke announced that he’d buy another $1 trillion in long-term Treasuries over the next 6 months.
Now instead of the more conventional open market operations, suppose instead that Bernanke decided to implement his infamous helicopter-drop scenario. In other words, Bernanke was literally going to print up $1 trillion in new Federal Reserve Notes, and then start randomly distributing them to US citizens. What would Sumner and I predict?
I grant you there are nuances on both sides, but I think to a first approximation–if we were on Family Feud and had to summarize our positions in 10 seconds before facing off–I think we would say something like this:
MURPHY: That’s a terrible idea! The problem with the economy is real, or structural. You don’t fix that by throwing green pieces of paper at the problem. Dumping more money into the economy won’t increase physical output, it will just make nominal prices go up. Monetary inflation won’t lead to real GDP, it will just lead to price inflation.
SUMNER: Murphy should stick to making YouTubes. The problem with the economy is nominal. It’s not structural, it’s monetary. Dumping more money into the economy will increase the output of physical things. The monetary injections will boost nominal GDP all right, but it will also boost real GDP. So we won’t see prices going up, as Murphy predicts.
Like I said, I’m obviously oversimplifying. But to a first approximation, I think the above is fair. In particular, Sumner (and Krugman) have been gloating over the fact that people like me wrongly predicted large consumer price inflation (at least measured by official CPI) when Bernanke started pumping in money. To restate the important conclusion: Sumner and I both agree that pumping in a trillion new dollars would raise NGDP. But I think it would (mostly) show up as increases in P, without raising RGDP (much). Sumner in contrast thinks it would (mostly) show up as an increase in RGDP, without raising P (much).
We’re almost to the finish line. Let’s take out nominal GDP and put in stock prices. Again, to a first approximation, the people like me who think the economy is stuck because of “real” issues right now, would think that pumping in a bunch of new money could very well raise the nominal level of stocks, but it would also raise expected price inflation.
In contrast, I would have thought Sumner’s position would logically entail that monetary pumping should lead to rising stock prices with stable (price) inflation expectations. This would match Sumner’s interpretation that the monetary pumping raised the prospects for future income growth, which would be “soaked up” by an expansion of real output. So nominal incomes would rise, but prices not nearly as much.
OK so assuming my rough characterizations of the “real” vs. “monetary” camp is right, let’s go to the tape and see which side has the data on its side:
The above chart shows the movement in the S&P 500 (blue line, index on left) against a common benchmark of “inflation expectations” (red line, gap between yields on 10-year regular Treasuries and TIPS on right).
As you can clearly see, ever since the crisis set in, movements in the stock market have matched perfectly with movements in expectations about the future price level. In other words, whenever the stock market has gone up, there has been a corresponding increase in expected price inflation over the next ten years.
I would have thought, to a first approximation, this would be a stunning victory for the “real” theorists. If, contrary to the above chart, the data had shown that the huge upswing in the stock market starting with QE1 in March 2009, went hand-in-hand with stable inflation expectations, then Sumner could have said, “Well now Murphy, what’s your story? If the market is booming just because of funny-money, and not because investors expect real economic growth, then why aren’t inflation expectations moving up too?”
(Don’t get me wrong, I wouldn’t have surrendered. I would have said, “Uh, it’s a bubble.”)
But I don’t have anything to be embarrassed about; the chart above is exactly what the “real” theorists would have hoped for, if they want to claim that the economy is stuck in a structural rut, and that throwing more money at it can only raise nominal figures.
And incidentally, one last thing: My real purpose in this post isn’t to say, “Ha ha, what fools. They don’t even know the implications of their own position.” On the contrary, my purpose is to show what a scam macroeconomics is. Sumner and Krugman no doubt can (and Sumner perhaps will, in response to me) tell a great story, with all the i’s dotted and t’s crossed, about why the above chart proves they are right.
And yet, if the chart had looked the other way–say, if the behavior of the red and blue lines during 2006-2007 was shifted forward to 2009-2010–then it seems to me, they could have just as easily told a great story, with all the i’s dotted and t’s crossed, about why that chart from an alternate universe proved that they were right.