28 Sep 2009

Arnold Kling’s Bizarre Monetary Theory

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At EconLog Arnold Kling has been trading blows with Bryan Caplan. In his justified revulsion at Scott Sumner’s views, Kling swings too far in the opposite direction when he declares:

There is a short run in which monetary policy cannot control nominal GDP, and there is a long run in which monetary policy cannot control real GDP. That is, there is a short run in which M affects only V and a long run in which M affects only P.

Suppose we measured GDP on a weekly basis. What can the Fed do this week that would affect nominal GDP next week? I say “nothing.” Maybe Scott Sumner wants to say, “the Fed can change expectations,” in which case we can start our argument there. I don’t think that the expectations that matter for next week’s nominal GDP are expectations that can be changed quickly. Or maybe Sumner will concede that next week’s nominal GDP is given, so that for next week any big increase in M will result arithmetically in a big decrease in V.

I don’t claim to speak for Scott–I think the Zimbabwean central banker does that just fine*–but I for one would not concede that “next week’s nominal GDP is given.”

Suppose Bernanke told his minions (the flying monkeys) to go out to every grocery store as fast as they could, and start buying everything in the store. A Fed official literally calls up the general manager of a large grocery store, and says, “I want to buy every item on your shelves.”

The guy says, “Whoa, I bet you want a big discount, right?”

The Fed official says, “No, in fact, if you double all your prices before giving me the bill, that’s fine with me.”

But the catch is, it’s an actual purchase. The store owner can’t just send a bogus invoice and then sell the physical product to other customers. The Fed needs to take physical delivery of the items in the invoice, or else they cancel the (humongous) check written on the Fed.

You’re telling me that if Bernanke made it his mission in life to acquire as many gallons of milk, cartons of eggs, pounds of butter, etc. etc., as fast as he could get his operation to start doing so, that all the grocery store managers would say, “Hmm, that’s odd. Have you heard about what’s happening at Wal-Mart and Kroger? Maybe at next month’s board meeting we should bring this up.” ? Are they going to continue selling down their inventories at the prevailing price?

Now maybe Kling means, the Fed can’t change nominal GDP in the short run using only conventional monetary policy. But I think I’ve read all his posts on this topic, and I never see him giving such a caveat. No, he seems to be literally saying that the Fed can do nothing to alter nominal GDP in “the short run.”

In fact, let’s not even go to the trouble of the above. Suppose Bernanke goes on national TV and declares on a Monday, “Any store owner who can show me proof that his typical sales have increased by at least 10% this week as compared with his average weekly sales, will get a personal check for $1 billion, drawn on the Federal Reserve.”

I’m not saying I know exactly what would happen after such an announcement, but I’m pretty sure nominal GDP would be different that week, and I’m also pretty sure expectations would change very quickly. The only possible intertia would be due to the fact that people didn’t think Bernanke was actually serious. But once he started sending checks–that cleared–to business owners during the course of the week who had boosted their measured sales by buying their own inventory from their businesses, then I think people would get the hint and start brainstorming.

I suspect that eventually we’ll find Kling admitting–just as Caplan has to with his bizarre claim that “parents don’t matter”–that really he means, “If we tinker at the margins, and don’t consider examples that obviously demonstrate my claim is completely false, then the Fed [/parents] matters a whole lot less than most people think.”

* For newcomers to Free Advice, I should clarify that Scott understands my bizarre humor theory. I am 95% confident he would not be offended by the above salvos. (See fifth sentence here.)

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