05 Aug 2011

Scott Sumner Proves That the Pen Is Mightier Than the Teaching Post

Economics, Federal Reserve, Inflation 34 Comments

Seeking to bolster my self-esteem, I re-read my prescient warning back in April that the stock market was overvalued and people should sell. Here’s what I wrote about Scott Sumner (the guy who has made a name for himself by declaring that our problems are due to Bernanke’s tight-money policies):

Well Scott Sumner has hung up the keyboard. In his “I’m not really serious but actually I am” kind of way, he takes credit for quantitative easing and several trillion dollars in new wealth. It’s too long to reproduce the argument here, but he’s basically saying that bloggers forced Bernanke / gave him the support to inflate more, and that has resuscitated global stock markets.

Don’t worry Scott, you are not being arrogant. I too hold you fully responsible for what happens to the world economy.

I was being somewhat tongue in cheek, but it really is true that Scott has done more than any other person in getting mainstream economists to flip on this issue. Check out Tyler Cowen’s remarks today about the possible S&P downgrade:

3. I don’t expect anyone to change their mind at this point, but the “we should have had a much bigger stimulus” argument is unlikely to go down in intellectual history as the correct view. Instead, Ken Rogoff and Scott Sumner are likely to go down as the prophets of our times. We needed a big dose of inflation, promptly, right after the downturn. Repeat and rinse as necessary. But voters hate inflation and, collectively, we proved to be cowards. Too bad.

Really, let’s not have target practice with “beltway libertarians” blah blah blah. That’s not my point here. My point is, how in the world has the economics profession gotten to this point, where it is “cowardice” to not think that multiple bursts of inflation are the key to prosperity? (And where doubling the monetary base in a single year is not enough inflation the first time?)

34 Responses to “Scott Sumner Proves That the Pen Is Mightier Than the Teaching Post”

  1. Ryan Murphy says:

    “And where doubling the monetary base in a single year is not enough inflation the first time?”

    When you are using a different definition of inflation than 98% of the economics profession.

  2. Bob Roddis says:

    Cowardice is knowing and understanding Austrian theory at one time in the past but now avoiding any mention of things like those pesky Cantillon Effects so that Yglesias will continue to refer to you as a “thoughtful mainstream libertarian” and the NYT won’t ban you for heresy.

  3. David S. says:

    Hang it up Bob. You won’t understand, because you don’t understand economics. Leave this to the professionals.

    • Martin says:

      What’s up with the tone?

      • Major_Freedom says:

        David S. has blue balls.

    • bobmurphy says:

      Hey David S., if you’re still checking this… Gold is up over $1700 today. That’s because a lot of people in Malaysia decided to buy necklaces today?

  4. Silas Barta says:

    Heck, I’ve been asking the same thing. How did we get to the point, for example, that making 0% interest loans to incompetent businesses was some kind of path to prosperity?

    It seems to me like the Sumner crowd is just doing an advanced version of,

    “When people spend a lot, that implies prosperity. Therefore, causing people to spend more will cause prosperity.”

    “When the sidewalk is wet, that implies rain. Therefore, causing the sprinkler to turn on will cause rain.”

  5. Bill Woolsey says:

    In the real world, productive investment involves risk.

    People who want to lend at little or no risk (short term government
    bonds, FDIC insured bank deposits, reserve balances at the Fed)
    are requiring that someone else bear the risk.

    Why do you think that there is anything left over after compensating
    those who bear the risk?

    BAA bonds are paying 5.7%

    In other words, no one is lending to the average corporation at
    zero percent. People willing to take the risk of making those loans
    can earn more than 5%.

    The prime interest rate at banks is 3.25%. Again, who is lending at
    zero percent?

    Anyway, one of the first lessons of economics is that the role of prices is to
    coordinate, and the “right” level of the interest rate is the one that keeps
    quantity supplied equal to quantity demanded. If that is 10%, 1%, or -5%,
    it depends on the preferences and expecations of market participants.
    If you think 0% is too low make a loan, then don’t make it.

    As for prosperity, both supply and demand are necessary. A great ability to
    supply will not result in large output unless someone is going to demand.
    But, of course, more demand will do no good unless someone is able to supply.

    I don’t agree with Rogoff’s perspective much, but I know that Sumner understands
    these things well. He actually thinks interest rates should be higher, not lower. And
    further, understands perfetly well that more spending only results in “prosperity” if
    the prices and wages are too high and sees it as an alternative to waiting for them to

    And yes, the alterrnative of having all prices and wages fall enough so that real
    money balances are large enough, so that real expenditures matches the productive
    capacity of the economy can work. But it also means a massive transfer from debtors
    to creditors. All the bankruptcy procedings are time consuming and disruptive. And
    so, more spending avoids the need to lower prices and wages and allows for a recovery
    of production and employment.

    Whether interest rates need to rise or fall, or gyrate for a time, isn’t the key
    consideration. The same thing is true of gasoline. Do gas prices need to rise
    or fall? Or do they need to rise and then fall, or fall and then rise? It depends on
    what happens to supply and demand in the gasoline market.

    • David S. says:


      I assume you mean Sumner wants higher rates resulting from expected economic recovery.

      Can you believe how ignorant Bob is? He claims to have a PhD in econ from NYU, but I find it very hard to believe. If true, NYU may need to examine its econ program.

      • bobmurphy says:

        I have a fun idea, David S. Instead of you just telling us how rich you are, please give us some predictions about the future, and moreover ones that you think I will disagree with.

    • Silas Barta says:

      The Fed is lending at 0 percent, genius.

  6. David S. says:

    To respond to a reply of yours from the Sumner thread(thread’s locked), I quote you here:

    ‘”Bob, I can simply refer you to the World Gold Council and emerging market demand versus world supply. That explains most of the run up in gold prices.”

    Oh, you explain the increase in price by saying demand has increased more than supply. My model certainly can’t handle that type of explanation…’

    Uh, the obvious point is that the biggest factor in the run up in gold demand is retail, not you crazy inflation sissies. You might want to actually look at the data presented occasionally, and then maybe you’ll be right about something someday. There’s also been an increase in industrial demand. While there’s some demand accounted for by inflation fears, it’s relatively small, and inflation’s been tiny, of course. It may serve as a flight to safety during tumult, but the dollar has performed likewise, and more consistently.

    Tell me Bob, what do you ever get right? And don’t mention random predictions that occur with circumstances that don’t fit your “model” at all, and I will continue to put quotes around model when referring to you, because it certainly isn’t a real one. It totally lacks scientific legitimacy and you admit you’ve been wrong for years. So, what are you changing in it?

    • bobmurphy says:

      David S. wrote:

      Tell me Bob, what do you ever get right? And don’t mention random predictions that occur with circumstances that don’t fit your “model” at all, and I will continue to put quotes around model when referring to you…

      You got me, David. If every time my predictions are right–like the stock market falling sharply, and gold going up, and the economy continuing to s*ck for years–you get to dismiss them as “random,” then you’re right, I am a moron. My actual predictions–defined by you as the ones that turn out wrong–are always wrong.

      • Mike says:

        Bob, forgive me but is this David character intentionally being funny or is he actually THAT thick? Either way thanks Dave for the humor. I haven’t laughed that hard in years.

      • David S. says:

        Bob, surely you’re joking. Did you predict inflation would fall again too? Did you predict it would be primarily related to the Euro zone debt problems? I don’t remember reading that.

        If you’re going to claim anything meaningful at all, you have to be able to predict what the market will do consistently, continuously, and get the reasoning right, if you offer any. You’ve done none of those things.

        You remind me of people who don’t understand sports, but predict that a certain team is going to win and when it happens, rarely though it does, they claim they were right.

        If you’re able to predict where markets will go, then why not have running predictions? Or more realistically, why not just keep quiet and get rich? Instead, you’ve spouted nothing but nonsense for as many years as anyone’s paid attention, and have been wrong the whole time.

        Bob, you were wrong about this downturn, because your “model” was all wrong. Or, you can say you were right for the wrong reasons. Either way, no sensible person would hire you as an economist.

      • David S. says:

        Oh, and gold was sharply down Friday, and silver was down about 3%, so that relationship isn’t even consistent. It would seem there was at least one bigger factor at work other than any fear trade.

        • Dan says:

          Gold is at 1663. Explain how that is sharply down.

      • David S. says:

        And yes, the S&P was neutral Friday, but look at the longer term relationship of it to gold.


        This is not exactly the story you’re telling.

        • bobmurphy says:

          David, until you lay out some predictions that you think I will dispute, and we can see who is right and who is wrong going forward, I am going to fall back on my null hypothesis that you are 24 and living in your parents’ basement.

          • David S. says:

            This coming from a peasant, pseudoeconomist?

            So, the evidence doesn’t fit your story at all, and you resort to irrelevant ad hom. lmao My ad hom is at least relevant, given that it only refers to your economic commentary.

            Either of my homes would make whatever you live in look like a basement.

            • Dan says:

              You are so cute. Just because your parents cut off your WoW accounts at both of their houses doesn’t give you an excuse to act so childish. I’m sure if you do all your choirs they will reopen them and they might even pay for another of Dr. Murphy’s classes on the Mises Academy so you can mock him just like you did in one of his previous classes. You are adorable with this fatal attraction you have for him.

            • Major_Freedom says:

              Make a prediction David S., and put your money where your parent’s basement couch is.

          • David S. says:

            I’ll just give you the quick and dirty. The Euro may fail soon, which will drag down our economy and the Fed will be late and inadequate in its response. Even less is to be expected from the politicians, so I buy inferior goods-related stocks, and short luxuries for example. I also short commodities, other than precious medals. I made a good bit being long on the Yen, but Japan had drawn a line in the sand. I also have individual securities and swap plays, but those are too complex to discuss here.

            But, timing is crucial. At the moment, I’m standing pat with the above approach, waiting to hear more from the Fed this month.

            • bobmurphy says:

              David, with the possible exception of commodities going down (we’d have to be more specific about the time frame and extent of the drop), I don’t have a problem with anything you said here. Well, you saying the Fed would be “inadequate” I disagree with, but the observational results would be the same. I.e. the Fed would do something, the economy would still be awful, and I would say, “Yep, the Fed’s tinkering didn’t help,” and you’d say, “Yep, the Fed didn’t do enough, just like I predicted.”

              So this doesn’t really allow us to separate the man from the boy.

  7. David S. says:

    Actually, that was from the EMH thread, which is locked for comments.

    • bobmurphy says:

      It’s open now. My ability to handle WordPress is matched only by my economic forecasting.

      • Bala says:


        Thanks for brightening up a Sunday morning when I have to work…

  8. Bill Woolsey says:

    The Fed isn’t lending at zero percent.

    It is lending at .75 percent right now.

    How much risk does the Fed bear for primary credit
    loans? Overnight? Collateralized with U.S. government
    bonds of less than 5 years maturity valued at 99%?

    (In truth, I worry that the Fed is accepting overvalued collateral
    in some cases. They accept all sorts of things, though at various
    rates–much lower than 100%)

    I am not fan of the discount window, but that is not
    what the Fed is really doing these days. While the $13 billion
    the Fed is lending at .75% is a big number by some standard, it
    is dwarfed by the Fed’s holdings of Treasury bonds (bills and notes)
    and mortgage backed securities.

    And that is what the Fed is really doing. It has created a huge amount of
    bank reserves by historic standards. It pays modest interest on them, which is
    new. And it is holding lots of mortgate backed securities, which is new.
    Maybe the the Fed is holding longer term to maturity government bonds than
    typical in the past, but the notion that the Fed held mostly T-bills (less than
    one year maturity) is at econmics textbook myth.

    For what it is worth, quasi-monetarists favor reducing the interest rate the Fed
    pays banks to slightly less than zero, having the Fed provide an explicit target for
    the growth path of GDP (money expenditures on output) and having the Fed purchase
    whatever amount of assets needed to hit the target. Interest rates–they could rise,
    fall, or stay the same–market forces should determine them. Sumner, (and I) think
    that market forces would make them go up with a regime aimed at returning GDP
    to its trend from 1984-2007.

    • David S. says:

      It’s nice to see some real econ discussed here. You seem to actually understand what’s going on.

      • Bala says:

        Ahhhhhh, David S!!! It would be good to see you define Economics first, what with you bringing in phrases like ‘real economics’ and words like ‘pseudoeconomist’. How about this, huh?

    • Silas Barta says:

      Banks are borrowing at 0.25% directly from the Fed and using the funds to buy government bonds with higher yields. Get with the program.

  9. Bill Woolsey says:


    .25% isn’t 0.

    I presume you mean the upper bound of the target range for the Federal Funds rate.

    The effective Federal Funds rate last month was much lower, .07%.

    Anyway, the Fed isn’t lending money to the banks at .25% or .07%. The Fed is lending money to the banks at .75% as I said.

    The banks are lending money to one another overnight at .07%. (It may be that Freddie and Fannie are making some of those loans to banks.)

    The Fed is saying that it will purchase government bonds (or other finanical assets) to make sure that there is an excess supply of funds on the interbank loan market if the rate goes above .25%. Right now, there would be a surplus of funds at that rate, and that is why the market rate is .07%. The Fed is keeping a floor of zero.

    The Fed could do this while only purchasing finanical assets with yields that are much higher. I guess even BAA bonds, if they wanted.

    However, the Fed holds a variety of government bonds, including some of the very short term ones that have very low rates.

    Last month, 3 month bills averaged at .04%. So, the Fed is lending to the Treasury a bit at .04%, which is not zero.

    As I said, this is a very low risk loan.

    I understand that the Bank of New York is paying negative rates (charging people to lend them money with a government guarantee.) But the key, is _government guarantee_. Why shouldn’t people pay for a government guarantee?

    Maybe some banks are borrowing from the Fed and buying government bonds, but they aren’t borrowing much.
    Like I said, about $13 billion is being borrowed. I don’t know if those particular banks are holding government bonds.

    What has happened is that the Fed has purchased a bunch of government bonds and mortgage backed securities. The people who sold them to the Fed just left the money in a bank account. The Fed paid for them by crediting the reserve deposit accounts of the banks where the people who sold the bonds are keeping the deposits. And the banks are just leaving that money in their reserve accounts. The Fed is paying a .25% interest on those accounts.

    The banks holding the reserves aren’t borrowing from the Fed at .25%. The banks are lending to the Fed at .25%.

    So, the banks are lending to the Fed at .25% and the Fed is using that to fund an asset portfolio. Some of it is made up of T-bills that actually pay less, (.04%,) but the Fed is holdling longer term bonds too. The rate on 5 year T-bonds is 1.5%. And mortage backed securities have even higher yields.

    The Fed is bearing risk for the banks. In my view, the Fed should be charging for this–like the Bank of New York, making the banks pay to keep funds in reserve balances. Under current conditions, there is little point in charging a rate higher than the cost of storing vault cash.

    Total reserve balances that banks have at the Fed is about $1.6 trillion. That is way more than the $13 billion they are borrowing from the Fed.

    By the way, the banks’ commercial and industrial loans are about $1.2 trillion. Real estate loans are $3.5 trillion, and consumer loans are $1 trillion. They aren’t just holding government bonds. ($1.6 trillion.) It looks to me like about 1/3 reserve balances at the Fed and government bond holdings (lending to the government in two different ways, really), and then 2/3 loans to the private sector.

    And the banks are borrowing hardly anything from the Fed. Naturally, because banks should be able to borrow from other banks at .07%. Why pay more than 10 times as much to borrow from the Fed?

  10. jjoxman says:

    The mechanism of money supply increases matters. J. R. Hummel has an article in a recent Independent Review showing that Bernanke-style money supply increases amount to directed bailouts to certain banks. Friedman-style provision of money to all banks is, I think, the way people traditionally understand money increases. The results, as we can observe now, is highly dependent on the mechanism used.

  11. Bill Woolsey says:

    Hummel is correct regarding QE1. There was a huge amount of lending by Fed to the banks. Most of it has been paid back.

    It is also true that the Fed is currently holding large amounts of mortgage backed securities. Those are all guarnateed by the government now anyway, so it isn’t clear it matters much. Still, some on the FOMC really do think that the Fed is helping housing markets in this way. A rather troubling view.

    They are holding longer term to maturity bonds (that have higher yields,) and are paying interest on deposits. This is a way of subsidizing yields for those holding short and safe assets. I recently read a claim that the Fed is doing this to maintain the profitability of the money market fund industry. (A bad idea.)

    I think the Fed might have to purchase longer term and riskier assets, but it should be trying to keep the interest rate up on safe and short assets. If market force drive them to zero or negative, so be it. People who want to earn a return should take risk.