Scott Sumner Calls My Bluff on Krugman
Look, if Sumner wants to boast that he knows more about Fed history, or more about ordering in a hibachi restaurant, or more about Swedish apartments, I won’t bat an eye. But in this post (HT2 Daniel Kuehn) he tried to make fun of Krugman…that’s my job. Look at Sumner’s swipe at Keynesians (and he has Krugman in particular in mind):
[Sumner writing:] Each day I check out the major stock markets. This morning I saw that Hong Kong and Singapore were down over 1%. Britain, Germany and France were also down. But the Japanese market, which tends to move with the other Asian markets, was up by 1.90%. That’s a surprisingly large divergence. Is there any news? It turns out that there is news, but only if you don’t believe in “liquidity traps.” Travis Allison sent me the following:
The yen slumped to the lowest in more than six months against the dollar on prospects Japanese elections next month will hand power to an opposition party that advocates more aggressive monetary easing.
. . .
Japan’s currency weakened to almost a two-week low versus the euro on speculation the vote will favor Shinzo Abe, who called for the central bank to provide unlimited stimulus.
. . .
“The leader of Japan’s opposition is coming down quite heavily, saying what he would like the Bank of Japan (8301) to do in terms of easing and that’s pressuring the yen,” said Jane Foley, a senior currency strategist at Rabobank International in London.
…
“The biggest economic problem is prolonged deflation and a strong yen,” Abe, the head of the largest opposition Liberal Democratic Party, said in a speech in Tokyo today. “Markets will only start to react once unlimited monetary easing is conducted.”The Bank of Japan must cut its benchmark interest rate to zero or even lower to boost lending, Abe said. The rate is currently set at a range of between zero and 0.1 percent. Earlier this month, Abe said the BOJ should conduct monetary easing until the nation achieves 3 percent inflation. Consumer prices excluding fresh food fell 0.1 percent in September, declining for a fifth month.
[Back to Sumner’s commentary:] Of course if you are one of those Keynesians who do believe in liquidity traps, then you’d have to conclude that this speech had no impact on the Japanese exchange rate, or the Japanese stock market.
Sumner then goes on to talk about Switzerland, and links to a Krugman post where he and Sumner disagreed about the implications of the liquidity trap for the Swiss currency.
In the comments I was succinct:
Scott, I really don’t get this post. (I hope you were sitting down for that.) You’re saying Paul Krugman has no way of explaining why the promise of future monetary expansion by the BoJ could be expansionary today? How can you possibly say that?
I actually thought that would be the end of it. I thought it would be like Encyclopedia Brown pointing out that things look upside-down when they are reflected in a spoon, and so, “Caught in his lie, Bugs Meany returned the stolen hamster.”
But no, Scott pushes more chips in, with this being his whole comment in response to my concern (and another guy who echoed me):
People should look at my second link if they wish to understand Krugman’s views.
Thanks for the Japan info.
Liberal Roman, That’s possible.
No, Scott, when it comes to how Krugman would explain a promise of future monetary expansion by the BoJ affecting aggregate demand today, I don’t think we should go read your post (“my second link”) on Switzerland. I googled “krugman liquidity trap japan”) and this was the top hit. Take a look at this excerpt:
The purpose of this paper is to show that the liquidity trap is a real issue – that in a model that dots its microeconomic i’s and crosses its intertemporal t’s something that is very much like the Hicksian liquidity trap can indeed arise. Moreover, the conditions under which that trap emerges correspond, in at least a rough way, to some features of the real Japanese economy. To preview the conclusions briefly: in a country with poor long-run growth prospects…the country therefore “needs” expected inflation….
If this stylized analysis bears any resemblance to the real problem facing Japan, the policy implications are radical. Structural reforms that raise the long-run growth rate (or relax non-price credit constraints) might alleviate the problem; so might deficit-financed government spending. But the simplest way out of the slump is to give the economy the inflationary expectations it needs. [Bold added.]
So no, I have to call foul. If Scott wants to argue that Krugman’s views on Switzerland don’t match up with his FAMOUS views on Japan’s liquidity trap, OK fine. Maybe they do, maybe they don’t. But you don’t get to quote a news story about Japan doing what Krugman has said it should do since the late 1990s because they’re in a liquidity trap and then when it “works,” say how this proves Krugman doesn’t understand a liquidity trap.
MM’s “claim to fame”, or rather I should say “crutch”, is to be able to be distinguished from Keynesian “liquidity traps”. Without Keynesians being morons in believing that liquidity traps means monetary policy is ipso facto unable under any circumstances to “boost AD”, thus paving the way for MM to the rescue, then MMs can’t claim to be offering anything all that novel.
The problem is when Keynesians like PK actually believe the Fed can boost AD even at the lower bound.
“I thought it would be like Encyclopedia Brown pointing out that things look upside-down when they are reflected in a spoon, and so, “Caught in his lie, Bugs Meany returned the stolen hamster.””
Ha! I remember those. Loved those books as a kid.
Yeah, Sumner’s reasoning is – like usual – highly tortured.
Thanks for writing this.
He’s not dumb. He knows Krugman’s work. And that concerns me.
Why does it concern you?
Because pretending that more people disagree with good policy than actually disagree with good policy makes good policy less likely.
Central banks and Congresses generally don’t like taking the advice of people who claim to be lone voices that everyone else in the science disagrees with. It doesn’t play well.
It does do well for an individuals’ own profile.
Scott’s point is that if central banks can inflate even at the zero-lower bound, then the liquidity trap doesn’t exist. And since there are examples of central banks doing the whole “credibly commit to being irresponsible”, liquidity traps don’t exist.
Bob,
I think there’s a real difference between market monetarists like Scott and New Keynesians (NK) like Krugman when it comes to the Zero-lower bound (ZLB).
NKs assume that open market purchases of bonds at the ZLB have no independent effect whatsoever on asset prices. With so many excess reserves, banks don’t need more reserves to satisfy some sort of reserve constraint, nor do they need them for interbank transactional purposes. As such, the banks will only sell bonds to the Fed at their “fundamental” price of x ie. the sum of discounted future cash flows. No matter how large the Fed’s purchases, hedge funds will sell all bonds to the Fed at x so that bond prices never budge from their fundamental value. (put differently, the dollar can’t fall relative to bonds. OMOs have no effect.)
On the other hand, NKs say that during normal times, reserves are important to banks. They are useful in interbank transactions and in meeting the Fed’s reserve requirements. And only the Fed with its monopoly can provide them. When the Fed conducts an open market operation it is now able to affect asset prices because banks will transact in bonds above or below their fundamental value in order to acquire/remove all-important reserves. Thus the Fed can change asset prices with open market ops.
Now Switzerland was at the zero-lower bound so SNB open market operations should have had no effect on the price ratio of CHF:assets purchased. In the SNB’s case, it bought foreign assets. But this shouldn’t make the irrelevance proposition any less binding. What happened? The price ratio of CHF:Euroassets changed remarkably. So NK’s like Krugman are left scratching their head. How did OMOs have an effect?
MM’s like Scott can explain this because they implicitly assume that the SNB is so big that even at the ZLB traders will not be capable of fighting SNB purchases. Put differently, the threat of OMOs will cause traders to sell foreign assets to the SNB at prices above fundamental value.
So at the core, Krugman and Sumner disagree over the power of central bank OMOs. Sumner thinks they have power to change asset prices/decrease currency values at the ZLB. Krugman like other NK’s think that OMOs are intrinsically powerless. NKs think that OMOs only have an indirect effect in that they give a signal about the future path of interest rates.
Apologies for length, but I have been investigating this question for some time. See here.
Except Krugman said that even at the lower bound, the central bank can still “give the economy the inflationary expectations it needs”.
That doesn’t sound like a “monetary policy becomes impotent at the zero bound” liquidity trap stuff to me.
Major Freedom, I think the difference is this. Market monetarists see open-market operations as having an independent and direct effect on the economy at the zero lower bound. Krugman and New Keynesians see open-market operations having no independent effect on the economy at the ZLB, only an indirect effect through expectations about the future interest rate.
JP Koning, I think you are misunderstanding what is being debated here. Nobody is saying market monetarism and new keynesianism are equivalent, or similar.
The debate is this: Sumner said Krugman, and everyone else who thinks the liquidity trap, cannot explain Japan’s recent uptick. After all, there they are at the zero bound, and yet the BOJ is “succeeding” in raising AD.
Murphy is pointing out that the BOJ did what Krugman said they could do at the zero bound, which is “give the economy the inflationary expectations it needs”, i.e. print whatever quantities of money that can coax people into spending more. So that’s what the BOJ did, and Sumner said it “worked”, and then Sumner claimed those who think liquidity traps are a real problem (Krugman) somehow can’t explain Japan.
Don’t you see the problem?
Major Freedom, ok, if that’s the debate maybe I’ve deviated a bit. I’m mainly curious about why Sumner and Krugman are different at the core. If I can understand their core difference, maybe I can figure out why there seems to be the contradiction you and Bob point out.
I think it’s just sloppiness. Happens to everyone from time to time.
JP, A currency peg (or floor in this case) is a different beast from OMOs, however large. It’s the peg that changes prices, not the OMOs (in fact there shouldn’t be any OMOs if the peg is credible).
Scott is an efficient market fanatic so I doubt he believes that CBs can permanently change prices just by buying stuff, if expectations don’t change.
I think they’re the same thing. In one case the central bank threatens to buy domestic assets, in the other case foreign assets. If the price of neither moves upon the announcement, the CB has got to do massive purchases and hurt the hedge funds to make itself credible. If you’re a New Keynesian, the actual purchases don’t have any effect, it’s their influence on expectations.
Here is Eggertson saying the same thing about forex interventions as Woodford does about QE
“It is often suggested that by purchasing foreign assets the Central Bank can depreciate the exchange rate, and stimulate spending that way. As pointed out by Eggertsson and Woodford (2003), however, the interest rate parity implies that such a policy should have no effect upon the exchange rate, except in so far as it changes expectations about future policy.”
I think that’s what Krugman had in mind when he said the BOJ can “give the economy the inflationary expectations it needs”.
I’ll buy that.
Krugman said the same thing about QE3:
“Sure enough, last week’s Fed announcement included another round of quantitative easing, this time involving mortgage-backed securities. The big news, however, was the Fed’s declaration that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” In plain English, the Fed is more or less promising that it won’t start raising interest rates as soon as the economy looks better, that it will hold off until the economy is actually booming and (perhaps) until inflation has gone significantly higher.”
http://www.nytimes.com/2012/09/17/opinion/krugman-hating-on-ben-bernanke.html?_r=1&
I’ll buy that too.
On a side note, this comment:
“In plain English, the Fed is more or less promising that it won’t start raising interest rates as soon as the economy looks better, that it will hold off until the economy is actually booming and (perhaps) until inflation has gone significantly higher.”
Made me puke a little.
JP,
Directly from Scott’s keyboard:
http://www.themoneyillusion.com/?p=17749#comment-208261
“It is not clear whether asset purchses at the zero bound are effective…”
Looks like some people need to do some serious inter-group argumentation to settle this rather significant discrepancy.
The strange thing is that Sumner seemingly endorsed JP Koning’s initial post by saying something like “Let’s hope Bob reads it.” Uh, let’s hope the endorser reads it?
Endorsed, eh?
Max, if I recall correctly, Scott has also spoken well of Nick Rowe’s Chuck Norris. Chuck Norris is all about asset purchases being effective at the ZLB. So maybe Scott has to clear some things up. Effective or not at the ZLB, QE are?