13 Jul 2013

Sumner Turns His Interest Rate Liability Into an Asset

Federal Reserve, Krugman, Scott Sumner, Tyler Cowen 19 Comments

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.”

19 Responses to “Sumner Turns His Interest Rate Liability Into an Asset”

  1. Bob Roddis says:

    A corollary of basic Austrian analysis is that society in general does not understand and is unaware that prices have been distorted by credit expansion which are providing false information for purposes of economic calculation. That was certainly the case during LK’s mythical classical gold standard era and it was certainly the case during the 1920s leading up to the depression.

    Sumner then attempts to refute that analysis by claiming that people did not understand what was going on in the period leading up to the depression. Hmmmm.

    And the Keynesians/monetarists can never stick to the argument about distorted prices/distorted information and must always slyly shift the discussion to one about “inflation”, whatever that is.

  2. random guy says:

    Dr. Murphy, have you tried a more simplistic approach to battling Krugman? The eEconomics guy on youtube simply linked this press release from the Fed back in June:

    http://www.federalreserve.gov/faqs/what-are-the-federal-reserves-large-scale-asset-purchases.htm

    No idea if you have seen it or not yet, but it’s basically the Fed bragging about how QE is lowering interest rates.

  3. DD says:

    Despite the metaphysics, since the Krugman debate will never happen, how about Sumner?

  4. James says:

    The Sumner debate is more metaphysical than you elaborate on here. Sumner does not believe in objective reality in the same way Rothbard and Mises do. He claims truth is socially constructed. I think that’s a the root of his M2 comments. I’m sure he could debate with you from the perspective of a believer in objective reality, arguendo, but if the debate were not favorable to him, he would quickly fall back on the excuse that he was having to argue from a position he doesn’t really believe.

    On the other hand, the Austrian view is really so simple it’s hard to see why anyone would disagree. I think if you add up all of the intramural disagreements and cancel opposite terms, the Austrian view on money is (1) prices coordinate production into a sustainable pattern, (2) price controls, if binding, prevent that coordination from happening and (3) his recommended policy targets are price controls. I’m not sure how Sumner would argue against these three.

    • Scott H. says:

      Prices help markets efficiently allocate scarce resources. There is nothing about “sustainable patterns” built into market theory. Price controls do not prevent coordination; they just distort the “optimal” use of those resources.

      A fiat currency presupposes a quantity of money and velocity of money determined by the Treasury, Fed, banks, and individuals. How much baby are you proposing to throw out with this bath water?

    • Tel says:

      Sumner does not believe in objective reality in the same way Rothbard and Mises do. He claims truth is socially constructed. I think that’s a the root of his M2 comments.

      In terms of a socially constructed truth, people did well understand the difference between “hard money” like precious metal, and “soft money” like paper currency. They did not express this in therms of M2, but so what?

      https://en.wikipedia.org/wiki/File:Elastic.JPG

      It was Federal loans to farmers that got the Federal Reserve Act through, with the argument being that farmers wouldn’t be able to produce food without help from government. It was absolutely known at the time that expansion of the currency would be a result of this, even the advocates made it clear this was a feature of what they were doing.

  5. Ken Pruitt says:

    Do you know what the most common problem is regarding our perception of big trees? We’re so fascinated by how big and how many branches it has, and how the branches intertwine, how many leaves they have, that we completely lose sight of the most important part of the tree, i.e., the roots.

    Scott Summer is making the exact same mistake here that every single mainstream economist makes without exception; he is using the leaves to explain the roots, instead of using the roots to explain the leaves.

  6. Tel says:

    No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.

    There were at the time a lot of advocates for silver and gold as money, and people claiming that the Fed had no reason to even exist, generally being against banking cartels, etc.

    Housing inflation:  There was no housing bubble in 1929, so there was nothing to burst and cause a depression.

    http://www.library.hbs.edu/hc/crises/forgotten.html

    Maybe no housing bubble precisely in 1929, but just three years earlier in 1926 there was a major collapse in real estate prices, and the fact that the stock market did not collapse at exactly the same time is hardly a refutation of Austrian theory.

    In any case, it would be odd to call rising stock prices “inflation,” because none of these internet Austrian commenters call falling stock prices “deflation.”

    I certainly would call falling stock prices “deflation”, or any rapid and sustained drop in asset values. Doubly so if it was happening across the board, and doubly again if it also involved collapsing debt underneath those collapsing assets (i.e. if the asset price was backing the debt as collateral, which in turn was pumping the asset price). Classic debt deflation. Perfectly compatible with Austrian theory. A lot of Austrians don’t bang on about debt deflation, not as much as they should do IMHO, but debt deflation is the logical mirror image to debt-financed asset bubble inflation. You can’t have one without the other.

    http://1.bp.blogspot.com/-sNICFv1LD1o/UKlnnVL8zHI/AAAAAAAACYk/1_ynHjZWUtI/s1600/beta.png

    By the way, that’s from Eric Falken and he splits the market up into high beta vs low beta, but the amazing visibility you get out of this split is that the crash from the late 1990′s to the early 2000′s in US stocks was NOT across the board, it was indeed sustained for several years, but only sustained amongst the more speculative assets. Importantly, this is not the case with the crash in 2009 where the damage was universal for all stocks.

  7. Ken P says:

    “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.”

    Do they get their idea that money is tight right now from low consumer demand or the lack of borrowing? Isn’t low consumer demand more likely due to people lowering their debt burden after a debt binge? Lack of borrowing could be explained by consumer behavior, new restrictions on lending, and other factors that are independent of money supply. If a person is hungover, their lack of drinking is not necessarily due to a lack of beer.

    I also think it’s hard to argue that money is tight for the finance industry, as well as most fortune 500 companies.

  8. Major_Freedom says:

    “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.”

    Epic begging of the question.

    The argument still in play is that interest rates are a lousy indicator. That still has to be shown.

    Also, it’s strange to hear someone say interest rates are a lousy indicator on Tuesday, after saying that “low interest rates mean money has been tight” on Monday.

  9. Ken P says:

    Suppose we were talking aboit oil. Like lets say the Fed decided it would buy half the oil available on the open market. Would people not expect oil prices to go up? Bond prices are going down as the Fed cuts back on buying. Well, duh!

  10. Maurizio says:

    Bob, could you tell us what would happen if the Fed targeted stable NGDP, like Sumner advocates? Suppose it achieved stable 5% NGDP. Does this mean that those companies that usually go bankrupt in a bust, because they cannot all complete the long-term projects they have started, can now _avoid_ bankrupcy and complete their projects? But how is this possible, since (per Mises) there are not enough _real_ resources in society to complete all the projects that are started? And OTOH if this is not true, and they still go bankrupt, then what is the benefit of NGDP targeting, in Sumners’s mind? (And also, if this is not true, does this mean that RGDP still falls even though RGDP is kept stable?) Thanks to anyone who will help me undertand this.

    • Maurizio says:

      errata corrige: I meant “does this mean that RGDP still falls even though NGDP is kept stable?”

  11. Edward says:

    That’s why I disagree with Scott on “Low interest rates mean money has been tight’ it can mean that, but it can also indicate ease.

    I agree with him on the “lousy indicator” aspect. He’s making two separate arguments here. It would be better to say that, rather than ‘low interest rates mean money has been tight’

    the trouble with the Austrians is that they (gasp) actually agree with KEYNESIANS that “artificially” low rates mean money has been easy. Not necessarily. its like the seventies never happened.

    What about REAL interest rates. (thats what smarter austrians would say) Sorry but no. Real interest rates can be high due to monetary tightness, as in the GD, or they can be high during periods of epic productivity.

    Bottom Line, there is zero correlation between interest rates and the quantity of money, and NGDP. It really is a lousy indicator

    • Richard Moss says:

      the trouble with the Austrians is that they (gasp) actually agree with KEYNESIANS that “artificially” low rates mean money has been easy

      No –Austrians say ‘easy money’ leads to interest rates lower than the real economy can support (a boom/bust). They don’t say a ‘low’ interest rate is ‘artificial’ and conclude from this that money has been ‘easy’.

  12. Edward says:

    Maurizio,

    that can happen in an economy with supply side problems

    • razer says:

      Baby steps, Edward. You still haven’t grasped what inflation is. This is too far above your level of comprehension. Let’s back up a few steps before tackling natural rates of interest.

  13. RPLong says:

    If Sumner’s position is anything like Nick Rowe’s, then I would guess the concept of expectations is at the root of his idea here. If M2 doesn’t exist, then how can it drive expectations about NGDP?

    Of course, NGDP didn’t exist back then, either, but that doesn’t seem to bother him wrt his intellectual framework.

  14. Lio says:

    Sumner’s argument about monetary policy and aggregates before the crisis of 1929 is hilarious. Anyway, whenever I hear “Sumner” or “market monetarist” I zap quickly.

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