Suppose someone asks you, “What was the stance of US monetary policy in mid-1980? Pretend you are a Market Monetarist answering.”
BOB TRYING TO PASS AS A MARKET MONETARIST:
First thing, we would not look at interest rates; that is a totally misleading indicator. As Sumner tells us in this post, “Interest rates tell us nothing about the stance of monetary policy.” In context, he is saying that the Fed interest rate cuts in the early 1930s were still consistent with very tight policy.
Instead, let’s look at NGDP and unemployment:
Oh man, there’s a smoking gun, right? The unemployment rate (the data is monthly, too) skyrockets in the middle of 1980, while NGDP growth (blue line) collapses. (The blue line is the level of NGDP, so you can see that it falls way below the previous trend starting in 1980.) Think of all the employers who had signed wage contracts during the late 1970s, and all the consumers who took out home mortgages, expecting NGDP to grow at a brisk pace. The rug was pulled out from them by the tight-fisted Volcker, right around mid-1980.
I mean, some clown might think looking at interest rates is the way to go, but such a person doesn’t understand Wicksell’s “natural rate” concept. Whatever interest rate the Fed targeted in mid-1980, it’s pretty clear it was above the rate consistent with full employment. I mean, it’s not like there was an earthquake in 1980 that kept workers from getting to factories; the above chart clearly shows a recession brought on by super-tight money.
So that’s not bad, right? And we need this perspective in the blogosphere, because you’ve got even prominent economists saying stuff like this:
[W]hen the Fed sharply cut interest rates in the summer of 1980, despite 13% inflation, it was obvious to everyone that they were not targeting 2% inflation, and few people cared. (BTW, Paul Volcker did that insane easy money policy in mid-1980.)
See, this is why you never ever reason from a price change.
P.S. You guys surely know who I’m quoting above, right?
P.P.S. At first I started this post to be ironic, but at this point I really am confused. I have spent years trying to grasp Scott Sumner’s worldview. Maybe it’s the kind of thing where any prolific blogger is going to contradict himself a lot in the eyes of a dedicated h8er, but I swear it seems like this happens a lot, and on his signature issue too. I.e. it’s not like I’m zinging him for inconsistencies in his musical tastes.
UPDATE: I was trying to guess Scott’s possible response, and so I presume he would say Volcker had a super-tight policy in the first half of 1980, and then relented with “insane easy” money in the second half. If you look at the change in NGDP quarter by quarter, that fits. I would still point out (a) in percentage terms, the growth in 3rd quarter 1980 NGDP was lower than it had been for several years closing out the 1970s, so I would think it would throw people in terms of sticky contracts etc. a la Sumner’s model, and (b) regardless, the way Sumner told us Volcker’s policy was “insanely easy” was by looking at interest rates cuts.