Wow, I don’t know if you kids have been following the blow-up over Stephen Williamson’s arguments about QE–I gave you a hint in this Potpourri when talking about Nick Rowe’s blog rage–but it has the potential to rival the Great Debt Debate of 2012. At this point we’ve got a full-blown shooting war, with Williamson, David Andolfatto, and Noah Smith on one side, arrayed against Nick Rowe, Paul Krugman, Brad DeLong, Gene Callahan, and a bunch of other people on the other side. If you click the links, you’ll see it’s hard for an Austro-libertarian economist to pick sides. They’re all dirty commie inflationists, to be sure, but you see DeLong and Krugman saying some pretty neat stuff about having a disequilibrium process to explain how the market reaches equilibrium, and Nick Rowe actually complains that Williamson’s approach throws out “methodological individualism” (!!).
Part of what’s fascinating in this whole exchange is the humility and honesty we see from two of the participants. Noah Smith says:
BUT, what Steve and I usually argue about is the general state of macro – he says macro is in fine shape, I say it hasn’t discovered much. I think this reversal supports my thesis. If a top-flight macroeconomist, who knows the whole literature backwards and forwards, can so easily change his workhorse model in one year, and reverse all of his main predictions and policy prescriptions, then good for him, but it means that macroeconomics isn’t producing a lot of reliable results.
Sure, I know that Williamson (2012) and Williamson (2013) have different sets of assumptions, and that’s why their conclusions are so opposite. But how does Williamson expect us to tell which set of assumptions corresponds to the real world, and which is just fantasy-fun-land? The papers, of course, offer no guidance, which is utterly normal for macroeconomics. A million thought experiments, and no way to tell which one to use. Is this science, or is this math-assisted daydreaming?
(I know it’s confusing that I’m saying Noah Smith is on Williamson’s side, when I just quoting him apparently giving the evil eye to Williamson. But, Noah is saying Williamson is not guilty of the specific thing that is making Rowe, Krugman, and DeLong go nuts, with DeLong saying Williamson needs to turn in his economist union card. Of course, DeLong has also told me in the past to quit my job as an economist. Is he just trying to drive up his own salary?)
Nick Rowe, upon whom I might have a man-crush at this point, actually has the courage to say, after constructing a very clever analogy, that:
I am a very amateur auto mechanic. On a good day, if it’s something simple, I can maybe diagnose and fix a problem with my car. I am a professional economist. But I understand how cars work better than I understand how economies work. I can diagnose and fix cars better than I can diagnose and fix economies.
Great stuff all around. And yet, I think everybody is flying off in tangents that miss the essential problem with Williamson’s argument. I put a question mark in the title of this post, because I’m not certain that everybody is missing the true problem, but…I’m pretty sure.
Nick Rowe’s original critique didn’t actually center on this particular passage, but Krugman made it the center of the attack. Here’s Williamson, explaining his counterintuitive claim that QE is actually reducing the rate of price inflation:
The change in monetary policy that occurs here is a permanent increase in the size of the central bank’s holdings of short-maturity government debt – in real terms – which must be balanced by an increase in the real quantity of currency held by the public. To induce people to hold more currency, its return must rise, so the inflation rate must fall. [Bold added.]
So that’s become the focal point of the attack. Krugman, DeLong, and Rowe are saying that Williamson is nutty for focusing on this necessary equilibrium condition, without worrying about how the economy will reach that new equilibrium.
In general, I’m very sympathetic to what they’re saying, and I was truly surprised by how much they sounded like Austrians who stress the market process and complain about a narrow-minded focus on equations specifying equilibrium conditions. And yet, I don’t think that’s really the problem with Williamson’s argument.
To see this, suppose we weren’t talking about a sudden surprise QE announcement. Instead, imagine we are in the midst of a Friedmanite rule where the quantity of money grows at a constant rate–let’s say it’s 2%–year after year, regardless of circumstances. Further suppose this rule has been in place for 10 years, and the public is convinced it will continue to be the rule for as far as the mind can forecast.
Thus, there is no question that we are bouncing from one equilibrium to another. We are in the long-run equilibrium (in terms of any standard way you are going to model such a situation). Now, within this long-run equilibrium path, Williamson could still make his claim: Each year, the rate of inflation has to perpetually fall, because each year you have to convince the public to hold more cash than they held the previous year. Thus, for any positive growth in the quantity of money, the rate of price inflation must constantly fall. Perhaps it asymptotically approaches some lower bound, rather than turning into outright deflation, but the return to holding a dollar bill has to keep increasing, year after year, otherwise the public would refuse to accept the new money that the government tried to put into circulation.
OK, does anyone like Williamson’s argument now that I’ve placed it in the context of a decades-long equilibrium that everybody sees coming? Of course not. Something is still totally screwy with the argument, and the problem is not one of “stability.”
Rather, what Williamson’s argument leaves out is the fact that, other things equal, you want to hold more money when its purchasing power falls. This is because people want to hold a certain amount of real cash balances. Just focusing on this effect, you would think that as price inflation occurs, people want to hold more money. So this effect works in the opposite direction from the effect that Williamson isolates.
Look, you can whip up a cute little model–with all the bells and whistles, and without worrying about the “story” behind it–where the long run equilibrium outcome has a constant rate of positive price inflation, and in which the stock of money is constantly growing, even per capita. In fact, we would expect the two to be positively related in equilibrium: The faster the stock of money is growing, the higher the (constant) price inflation rate. Williamson’s logic–insofar as it goes–is still “right” in such an outcome, but it’s clearly being offset by other forces. Thus, I don’t think his fundamental problem is that he’s failing to draw little green arrows funneling the economy into his equilibrium (as Krugman suggests).
This is such a basic point I’m making, that I’m a little bit afraid that Noah will send me a private email explaining that DeLong was right–I really do need to find another job. But I call ’em like I see ’em, and the above seems to me to be the true problem with Williamson’s argument about QE causing low price inflation.