I have long said that I would be much more confident debating Paul Krugman than Scott Sumner. I disagree with Krugman on economics, you see, but with Sumner our disagreement is almost metaphysical.
For example, Austrians like me think that the 1929 stock market crash was (partially) due to expansionary Fed policy during the 1920s, which caused an unsustainable boom. In rejecting that view, Scott tries to show that there was no sensible “inflationary boom” during the 1920s. He first said you didn’t see it in the figures for the monetary base, and then he said: “The broader monetary aggregates rose significantly [during the 1920s], but the government didn’t even keep data on M1 and M2 until fairly recently. No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.” In the comments he elaborated:
I’ve shown there was no inflation as the term was defined at the time. I’ve shown that there was no alternative non-inflationary policy as understood by policymakers at the time, including those in the 1920s who claimed the Fed was too inflationary. It makes no sense to argue things were inflationary because M2 went up, if M2 didn’t exist. There are no policy implications. M2 was an idea invented much later.
That’s kind of an odd refutation of the Austrian view, if you think about it. I responded, “I wonder how Sumner explains the massive deaths during the bubonic plague? Did doctors even know what bacteria were back then?”
Anyway, we see a similar phenomenon with the large increase in medium- and long-term Treasury yields in apparent reaction to the Fed’s announcements that it will “taper” (and then went the other way when Fed officials tried to pooh-pooh the taper talk).
Tyler Cowen has admitted this surprised him, and is open to revising his views. (This is characteristic Cowen.) Paul Krugman says that the increase in interest rates doesn’t surprise him at all, that the distinction is between the ending of a pre-announced bond-buying program versus a surprise announcement of a curtailment of QE, and that anybody who thinks he made a mistake doesn’t understand what Krugman has been saying all these years. (This too is characteristic Krugman.)
But look how Sumner handles the situation. He is sort of a blend between Cowen and Krugman. On the one hand, he is as frank as Cowen about being surprised. But he wants to be like Krugman too, and somehow integrate this new development into his broader theoretical framework to show that Sumner has been right, from a certain point of view: “PS. The fact that Krugman, Cowen, Kling, myself and many others were surprised by the surge in rates over the past few weeks actually speaks well of our understanding of macro. It shows that we’ve been paying attention, that rates don’t usually behave this way.” [Bold added.]
More recently Scott used an even more impressive jiu jitsu move. Watch this:
He’s right that even a small rise in short term rates can do a lot of harm, but I’d add that another problem with the conservative argument is that they don’t seem to realize that interest rates are a lousy indicator of the stance of monetary policy. When I studied economics that was a point that conservatives emphasized.
Even small increases in interest rates in the US (1937), Japan (2000 and 2006), and Europe (2011) drove each economy right back into deflation and/or depression.
I’m still puzzled by the response of long term rates to the tapering talk. But if long rates always moved the same way in response to monetary news, then interest rates would no longer be a lousy indicator of monetary policy. [Bold added.]
Notice two things about this passage:
==> When trying to show that he’s been right about tightening being bad for the economy, Scott–I think without realizing it–shows once again that interest rates are a “good” indicator of the stance of monetary policy, the way the Austrians claim. His four examples of central bank tightening ==> a renewed slump and (price) deflation were associated with increases in interest rates, per Scott’s own authority. In case you’re getting lost, remember: Scott’s point is that everybody needs to stop thinking that the current low interest rates are a sign of loose money, that Milton Friedman taught us that very low interest rates are a sign of tight money.
==> Then, moving on to our current example of tightness –> higher interest rates, Scott says it proves interest rates are a “lousy indicator” because we can’t get any signal from the noise. In other words, Scott is arguing, “Hey, if my claim that tightening should lead to lower long-term interest rates were always true, then interest rates would be a great indicator; we would just take what the Austrians say, and put a negative sign in front of it, to be sure we were right. But now, once in a while the Austrians will be right, since it’s a noisy indicator.”