The Vacuity of Scott Sumner’s Approach to Monetary Policy
My latest at Mises CA, sparked by Scott responding to Tyler Cowen on “causality.” The punchline:
…I want to point out an odd feature of Sumner’s worldview, which partly explains why it is (arguably) vacuous as an “explanation” of recessions. For the sake of argument, suppose Janet Yellen announces next Monday: “I have been reading the work of the Austrian economists, particularly this bald guy Murphy. I have realized that my predecessor, Mr. Bernanke, did a horrible thing by expanding the monetary base so much. Henceforth, to protect the value of the dollar and remove the Fed’s role in fueling asset bubbles, we will lock-in the current dollar-price of gold along the lines that Ludwig von Mises recommended for governments wishing to go back on a gold standard.”
But wait, the scenario gets more implausible. As soon as Yellen’s press conference ends, Barack Obama addresses the nation in this way: “My fellow Americans, well, some folks in my party lost their seats in the recent election. I realize government is the problem, not the solution, and in conjunction with the Republican leadership, we’re going to cut federal spending by 20% over the next quarter, and give a dollar-for-dollar reduction in personal income taxes across the board. Furthermore, effective immediately, all provisions of the Affordable Care Act will not be enforced, and we will repeal it as soon as Congress sends me a bill doing so–just so long as it abolishes the FDA and EPA too.”
Okay, now what would happen in this ridiculous story? There might be a technical recession upfront according to the NBER, but I think it’s safe to say that for 2015 as a whole, there would be strong economic growth, coupled with a decline in most consumer goods prices. Just grabbing numbers, let’s say when the dust settles, the BEA announces that in 2015, the U.S. economy experienced real GDP growth of 15% with a drop in consumer prices of 7%, yielding a growth in NGDP of 8%.
Thus, as the Fed announced it was going back on the gold standard, Scott Sumner would be forced to tell his readers, “Uh oh, Yellen has overshot. Thank goodness she eased the monetary tightness of the mad Bernanke, but now she’s erring on the other side, allowing NGDP to grow too rapidly. This type of easy-money regime will lead to the problems of too much Aggregate Demand that we suffered in the 1970s.”
I submit that this is a crazy way of discussing monetary policy.
How do I become a world champion runner?
Pretty easy, just always get to the finish line first.
Can you give me some tips to improve my golf game?
Yeah, hit the little ball so it goes in the hole.
… and the great classic …
http://cleverjoke.com/computer-joke/microsoft-air-directions
We have seen LK do it too. He defines “austerity” as any policy that does not produce growth.
From LK’s perspective, Abenomics is stern “austerity” (of the money printing variety) because it sure isn’t producing any growth. Whatever it takes.
The difficulty is finding a workable monetary policy. Let’s say all central banks move to the gold standard, but a few decide to hoard gold. Or let’s say some large central banks coordinate a large general inflation. What are the effects?
Every monetary policy has imperfections. A nominal income target as a rule automatically adjusts a nations base money stock to account for changes in holdings of that nation’s currency by central banks. A central bank managed gold standard cannot do this.
Hint:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2490313
http://moneymarketsandmisperceptions.blogspot.com/2014/11/microfoundations-pascal-salin-needs.html
A weakness of nominal income targeting is one of finding the appropriate level target, if one exists at all. As history suggests something along the lines of a 2-3% growth rate in nominal income in the U.S. over the long-run, then a level in the region seems reasonable. If the estimate undershoots the actual growth rate, as in the case that you suggest, a positive inflation target can prevent deflation. Compare this to a gold standard where the quantity of gold produced could not quite keep up with an 8% growth rate. And it definitely could not keep up with central banks that hoard gold if they hoard gold at a high rate.
#shamelessselfpromotion
Jim Caton, Don’t you mean a 2-3% growth rate in REAL income, not nominal income?
David,
Yes. Thanks for catching that 🙂
I think Sumner would respond by saying that it is not crazy to think the Fed was too loose, because NGDP really is the proper standard, and that regardless of what happens to the monetary base or fiscal policy, if NGDP rises too much, or falls too much, then it is the Fed that is responsible and they can and should be held to account. They are supposed to keep an eye on that variable of NGDP. If so-called “velocity” increases, such that with less money “turned over” more rapidly the net effect is “overshooting” of nominal expenditures, then the Fed “should have” reduced the monetary base to whatever degree necessary to prevent that.
The reason it seems crazy, other than it actually being crazy, is that it forces us to purposefully ignore every other nominal variable the Fed affects (other meaning other than NGDP).
I submit that monetary *policy* (as such) is crazy …
You’re obviously being sarcastic.
I mean the state monopolizing food and enforcing a “food policy” is not crazy, why would almost one half of ALL trades be crazy? Right?
Dr. Murphy, FYI, your subtitle hyperlinks “federal reserve” and “shameless self-promotion” link to a “404 error”.
Yeah all of those categories are screwed up; some bug in WordPress. I’m moving the whole blog and maybe we can fix it then.
Sumner gets a little too cute with definitions and semantics for my taste, though maybe it’s just a lack of context on my part. An analogy which helps me make sense of his policy statements is that of tightening a bolt to a particular torque spec. One can loosen the bolt and Scott may say that “it’s (too) tight”. He would be correct if it was torqued originally to 100 Nm, loosened to 50 Nm, yet the spec is 25 Nm. It was too tight before, loosened some, but still too tight for the spec. Of course, Scott would never put it so clearly, and his is a world without (static) torque specs.
I’m not sure this does explain things correctly, and I’m not being very charitable here, but it’s the best I can do for now. Thoughts?
But that’s the whole point, none of them will give you any way to measure policy itself … only the outcome of policy is defined. Thus, you are driving at a speed of 50mph and you are instructed to loosen the bolt until your speed comes up to 60mph, and the very definition of a loose bolt is whatever bolt exists while moving at 60mph.
If you loosen the bolt and a wheel falls off and the whole thing crashes, then that bolt was way too tight, and it remains tight by definition… because you aren’t moving at 60mph.
Well put, thanks.
[golfclap.gif]
I think Bob has raised a really interesting point here and I hope he provokes Nick Rowe into a response.
So in this example was 8% NGDP growth easy or tight money ?
I think the answer to that question depends upon the monetary policy in force. If you are targeting 5% NGDP growth and get 8% then by definition policy is too loose. If you are targeting a stable price of gold then it depends if the price of gold rises or falls relative to this target.
And of course what really matters is not whether policy is loose or tight in relation to your goal – but what is the goal that stands the best chance of optimizing RGDP, in the short and long term – and that’s a different topic.
This way of thinking always bothers me. It’s amazing that there are people that believe if they just figure out the right way to micromanage 300 million people with ever changing wants and goals, then we’ll have an economy running as close to max capacity as possible. People that want to micromanage the whole economy should have to prove they can herd every stray cat in this country before anyone begins to listen to their ideas on how to run the country.
Don’t Austrians think that the optimal monetary policy is for the authorities to to do nothing ? So by definition any “artificial” increase in base money is loose policy and any decrease tight money.
I’m just pointing out that one’s definition of tight or loose money depends on what you think the best policy should be, and you will probably choose your favored policy based on your view of what effect it will have on overall economic health.
The power of the money printer is undeniable. Civilization has a long, sordid history with monetary meddling. The Austrian view is merely the baseline, first doing no harm. The secretive, insidious, and political nature of the origins of the Federal Reserve should prompt extreme skepticism at the very least, particularly among those most concerned with economic inequality.
The power embedded in the money printer is undeniable, and undeniably tempting. Ask any counterfeiter. Aren’t they doing us a favor by generating inflation at this critical juncture?
Human civilization has a long, sordid history with monetary meddling. The Austrian view is merely the baseline, first doing no harm. The secretive, insidious, and political origins of the Federal Reserve should prompt extreme skepticism at the very least, particularly among those most concerned with economic inequality.
Banksters, yo.
Yes, Austrians believe the State/central bank should not have anything to do with monetary policy.
I’m just pointing out how absurd I believe it is for people to think they can micromanage 1/2 of every transaction.
Bob, is it or is not the case that in your example there will be inconsistency between the plans of savers and of investors? If not, why not?
The Gold Standard had Austrian business cycles too, after all.
To be clear here, what I’m saying is that bizarro world Scott seems to be right that bizarro Yellen’s policy is too easy, just not for the right reasons.
As LK has dutifully noted, the 19th century was not a gold standard.
A gold standard does not prevent fractional reserve banking, which allows monetary expansion by circulating IOU notes and deposit accounts. The concepts of central banking, a monopoly on general purpose IOU note issue, and a “lender of last resort” were all introduced by the Bank of England during the mid 19th century.
Of course IOU notes have been circulating for much longer than that.
Guys, my point is that Bob seems to imply that it’s crazy to think that 8% NGDP growth is “loose monetary policy” if it consists of 15% “real” growth (that is, some measure of quantities) and -7% change in over all prices. But it’s not crazy. If voluntary savings and investment are to remain consistent with one another, those two values should have the same magnitude and opposite signs. It seems to me that if “loose” policy means fostering malinvestment, and “tight” policy means fostering secondary deflation, then the scenario Bob described is one in which transition to gold actually loosened policy. Which sounds crazy perhaps because the numbers in Bob’s scenario are unrealistic, or perhaps under a Gold Standard really can be that loose, and the craziness of the idea is “more apparent than real.” I don’t know which it is, but I do know that thinking 8% NGDP growth is not “loose monetary policy” is what seems really crazy to me.
Andrew_FL, suppose there were no central bank at all. Suppose people dug up gold and then competing, private mints stamped them into coins. All prices were quoted in weight of physical gold.
You’re saying in that scenario, you think it’s possible that systematically, voluntary savings and investment would diverge?
Under that scenario, I really don’t think NGDP could increase 8%. But I’m inclined to say no, not in the direction of investment exceeding voluntary savings, unless I’ve missed something important. People could defer consumption without supplying loanable funds in so doing, by burying the coins in the ground, so I’d think that investment would systematically tend to be less than voluntary saving.
But my original comment was about the scenario I understood you to originally be offering, in which there was still a Central Bank, unless I misunderstand?
Suppose saving is any expenditure of money other than consumption.
If money holding were saving, then there will always be total savings equal to the money supply.
Societal savings are not increased when one person earns money and then holds it. That would be a reduction in one person’s saving and an equal increase in another person’s saving.
Since earning money requires me to hold money for at least some positive period of time, it would mean that I am a saver if I only worked and spent money on consumption. I would be a saver even if I never invested in labor or capital or financial securities.
Since there would always be saving equal to the money supplyas long as money exists, I prefer not to include cash holding in the concept of saving.
When Austrians talk about saving being less than investment, what they mean is not that cash holding is less than investment, but rather that investment in money terms is greater than the earning of money and abstaining from consumption.
Credit expansion and inflation make that possible. Merely holding cash cannot.
“If money holding were saving, then there will always be total savings equal to the money supply”
Further to this point…
I say that total saving would be equal to the money supply, because even if we include investing in capital goods into the category of saving, total savings would only increase when there is an increase in the supply of money.
Consider the example of someone investing in a capital good the price of which is $1 million.
The person who invested in the machine would decrease their savings in money by $1 million, and increase their saving in a capital good for a value of $1 million. So the individual investor would not have increased their saving.
Similarly, for the person who sold the capital good, they would increase their savings in money by $1 million, and decrease their saving in a capital good valued at $1 million. So the person who sold the capital good to the investor would also not have increased their saving either.
And taking both individuals together, there would be no increase in “total” saving.
Yet we have a capital good that was produced and sold. If savings did not increase, where did the capital good come from? Are we to say that investment can take place without any saving? That is not what the classicals had in mind, and it’s not what most today have in mind either.
Money is best understood as a medium of exchange, not a good to be invested in. It is a means to investing. Money is a means to save…in capital goods.
My definition of saving is what I think most people are thinking of when they talk about saving and investment.
If we only define using money for purposes other than consumption, then the above paradox does not arise.
Meh, maybe it’s just a preference…
MF-I’m speaking of savings, above, as a flow, not a stock. Obviously total money holdings is always equal to the money stock.
I think of saving, as a flow, as deference of consumption to some later date. In this sense, during a finite period, a decision to hold money to the end of the period is a decision to save money during that period-but, of course, everyone must do that. At the end of any finite period, all money is held. So what I mean is a change in the tendency to hold money.
So an increasing tendency for people to hold money is an increasing tendency to defer consumption until some later date, or dates, actually.
But, obviously, holding more cash does not cause investment to exceed savings, I was asserting the opposite, that holding more cash causes savings to exceed investment. More accurately, an increased tendency to hold cash rather than spend it on present consumption will result in that.
“But, obviously, holding more cash does not cause investment to exceed savings, I was asserting the opposite, that holding more cash causes savings to exceed investment. More accurately, an increased tendency to hold cash rather than spend it on present consumption will result in that.”
I think the issue is that you have to have two groups. One group is “savings” in the sense that someone forwent consumption and put a given balance into the loanable funds market via an intermediary. The other group, which I think doesn’t exist much in reality, is literally someone who just puts physical money in a jar. If funds moved from group 1 to group 2, savings and investment would both decline.
AG, can the members of group two take the money out of the jar later, and spend it on consumption? If so, they deferred consumption, so they saved money.
“AG, can the members of group two take the money out of the jar later, and spend it on consumption? If so, they deferred consumption, so they saved money.”
For 1 person to hoard, another person has to spend. It’s true the hoarder could dishoard, but total purchasing power wouldn’t have changed.
The only way for there to be a *general* increase or decrease in the quantity of money is for an entity such as the central bank to create it or destroy it.
AG, I’m confused here. What is it about one person stowing money away that would entice someone else to spend? I can think of circumstances under which this is true (for example, if the money being stowed away is someone else’s liability) but how is this supposed to work with gold coins?
Ah, well, I thought of a way, if by decreasing the supply of Gold coins, I increase their price in goods, ie purchasing power.
Andrew,
I brought up the stock aspect because I think it should be included. I don’t think it should be one or the other.
If you define saving as cash holding, and in the flow aspect you define deferring consumption to the future as holding cash for a period of time, and, finally, an increasing tendency of people holding money as an increasing tendency to defer consumption to a later date, then the question that comes to my mind is this:
In general, if we say there is an increased flow of something, then ceteris paribus, there should be an increasing accumulated amount of that something.
So, an increased flow of saving should, ceteris paribus, result in an increased accumulation of stock saving. The flow is connected to the stock. An addition to the flow should add to the stock.
So what happens when we include, in the definition of the stock aspect of saving, cash holding, and we include, in the definition of the flow aspect of saving, waiting times of holding money?
If, in the flow aspect of saving, an increase in saving takes place, then as just mentioned this means cash is held for longer. But has there been an increase to accumulated savings? No, there hasn’t.
(Caveat, I still think that reducing consumption and holding cash for longer has a net effect of capital accumulation, by the effect this had on relative profits between consumer and capital goods)
MF, perhaps it makes more sense to think of the stock as not dollars, but dollar-years (amount held times time held for)?
It does seem a paradox, otherwise, that what seems to me an increase in saving does not increase the stock.
Andrew:
“perhaps it makes more sense to think of the stock as not dollars, but dollar-years (amount held times time held for)?”
If you do that, then are you OK with the implication that merely printing money increases savings? That adding a couple of zeroes to every Fed note, and to every demand deposit account, will increase society’s savings a hundred-fold?
Seems problematic to me.
“It does seem a paradox, otherwise, that what seems to me an increase in saving does not increase the stock.”
All the more reason to not include holding money in saving, either flow or stock. Paradoxes don’t exist in reality; they are a result of contradictory premises.
Now don’t get me wrong, I have to grapple with the fact that someone earning money and accumulating cash on purpose, to buy say a nice watch at the end of the year, would seem to be an act of saving. He is clearly abstaining from consumption, and he is clearly adding to his cash balance, so he is accumulating something.
The problem I think happens when we take what is concrete and micro level, and try to find universal truths in it that apply to whole economies.
I think in the whole economy level, money holding should not be included in the concept of saving. If the so-called “velocity” of money fell, which means the money stock is turned over fewer times, which is an increase in the “waiting time” of money spending in the aggregate, there is no addition to accumulated savings.
I think the economist should always think of at least two variables at once, as a minimum standard. Think of the economy as a whole, but don’t reify the aggregate. Think of the whole, and think of all the individuals and their actions and wealth that make up the whole, at the same time.
Think of micro actions and production of wealth and exchanges, and also think at the same time the totality of such micro actions and production of wealth and exchanges.
When you think of yourself earning money, and adding to your cash balance, “saving up” to buy a nice wristwatch at year end, think also at the same time the other people and their actions that are a part of it:
Your adding to your cash balance is “saving” from your perspective, but because someone else, or more than one other person, had to “dissave” their money by giving to you in exchange, then from both of your perspectives, total savings did not increase. Not in the flow aspect and not in the stock concept.
Another problem with my definition is that in a free market economy, there is good reason to think of money as a commodity the increase in supply of which does seem, to me, to be an increase in wealth. This can happen when the existing supply of money is, in the opinions of private property owners, too low to effectively facilitate exchanges of low value goods. More money here would make people better off, IMO, because that is their voluntary choice.
MF-You’ve given me much to ponder. I just want to state for the record that I emphatically do not believe that printing money increases saving. Which was partly why I was uncomfortable with the idea of treating the money stock as savings.
Also, good point about another person first dissaving their cash balances by exchanging them for something with the person that then “saves” them. It’s another way of saying that the total quantity of cash holdings at any times is just the total stock of it.
I want to thank you guys for being so patient with me. I think I’ve learned a lot here.
Andrew,
FYI, there is absolutely no thought in my mind that deserves any thanks for being patient. No thanks are necessary. You are a thinking person who is neither above nor below anyone else here. No worries are needed.
“… but rather that investment in money terms is greater than the earning of money and abstaining from consumption.
Credit expansion and inflation make that possible. Merely holding cash cannot.”
It might be helpful to say that the investments that occur under credit expansion are being funded by the otherwise reasonable expected return on the savings of others (“investment” in future consumption, if you will); This is the Cantillon Effect.
The credit expansion, per se, doesn’t make any more resources available.
NGDP can rise 8% if the “turnover” rate of spending out of an increasing or flat quantity of money increases sufficiently.
Okay, so the change is in V, basically. But if NGDP is increasing it means that people are increasing consumption more than they are decreasing saving or increasing investment more than they are decreasing consumption, in nominal terms. In my understanding, this is what an Austrian Boom is. Where am I getting this wrong, in your estimation?
As I understand it, NGDP measures growth in certain aggregates.
Aggregates of acting individuals are meaningless numbers, as far as economic calculation is concerned.
So, you could have a lot of output in one sector of the economy, yet still have a pareto inefficiency (not to mention that someone is benefitting from cronyism in this scenario).
Guest, yes, as long as there is a central bank deciding where to direct new money you’ll have cronyism and resource misallocation. Even if NGDP does not change.
With regard to aggregates, I don’t assert NGDP says much of anything, apart from being a measure, however crude, of expenditure.
In a private, close economy, it’s just the sum of all consumer spending, and all investment spending. This is relevant to Austrian ideas, in so far as Austrians are concerned with whether, broadly, Investment equates to deferred consumption. But of course, it is also true that Austrians are very much concerned with allocation within the total investment and to a lesser extent, the total consumption terms.
So what I would say is that increasing NGDP seems to me prima facie evidence that investment and savings have gotten out of wack. But it’s not the only circumstance under which malinvestment can occur. It’s just the circumstance under which malinvestment is a most acute problem.
Andrew,
NGDP includes capital goods expenditures, the investments in which requires abstaining from consumption.
MF, I don’t believe I said otherwise?
Andrew:
I think my confusion over what you said was due to my not defining cash holding as saving, such as how you define it.
Let’s suppose a group of people build a road, then get paid to build the road (paid in coins) and choose to bury those coins under the ground. Has there been investment?
If we say that investment occurred in the building of roads, the funds to do so had to come from prior savings. The money buried in the ground is new savings, that is not available to be invested by anyone else until it is taken back out of the ground.
Those people who built the road produced more than they consumed. We know this because they had coins left over which they could then go about burying.
If they were given cash notes in payment and they buried the cash, you would get the same result.
Andrew,
Money isn’t really invested.
As long as they don’t bury land, labor, or capital goods, then I didn’t see how new savings can’t be invested.
Right, in period one, they produced so much, and thus received a certain income, and in the next period, they spent some of it on consumption, and they saved the rest, including in the form of storing a portion of their money income.
Of course, people do not hold money, or store it, except to eventually spend it, so the act of storing the money is deferring consumption. They bury the money, with the intention of unburying it later, and spending it. So it’s new savings. This is of course true whether it’s paper or gold.
Ben B-Well, there are circumstances under which holding, or storing money, would entice someone else to invest money. If for example, the money is the liability of someone else, as opposed to “outside money”, means that, if I bury it, the person who it’s a liability of has to worry less about me coming to him and asking him to make good on it. He’s able to expand his liabilities, able to supply loanable funds, in much the same way he would be if I were using him as a financial intermediary.
I suppose if it’s gold, I’ve decreased the supply of gold, and thus increased it’s price in terms of other goods. Eventually people will realize their gold is worth more, because I buried gold. My thinking is that this would take more time, though
Andrew,
I was responding to your statement that “the money buried in the ground is new savings that is not available to be invested by anyone else until it is taken back out of the ground.”
But the actual savings comes from the act of deferring consumption and not the act of burying the money in the ground.
However, the owner of the buried money is not eliminating potential investment of others, because he is not the actual owner of the real savings (unsold consumer goods). Thus, these real savings are still available to the rest of the market for investment purposes. If those investors operating closest to final consumption begin to see a decline in such consumption, then they will begin to reinvest their incomes in those opportunities furthest away from final consumption.
Although, even the money hoarder is an investor. He is investing in the present in order to reach a goal in the future (higher cash balances). He believes that in a future time period, he will need more money. This is the same as an investor of real goods, who believes that in a future time period there will be a certain type and quantity of goods that will be more urgently wanted than others. The money hoarder believes this too; he just doesn’t know if he will need higher order goods or lower order goods.
Thanks, Ben B, I hadn’t thought of it that way. Makes sense.
Although, looking at it again, you say nothing about the banking system, except that there is no Central Bank. So it’s hard to say, actually.