07 Jun 2018

Another Bold Sumner Thesis

Scott Sumner 28 Comments

UPDATE: See my remarks below.

Say what you will about Scott Sumner, he’s not afraid to take on conventional wisdom, even when it sure seems to be backed up by staring-us-in-the-face evidence.

For example, Scott believes the Federal Reserve adopted an incredibly tight monetary policy and that’s the fundamental explanation for the financial crisis and Great Recession. Even though the Fed’s assets look like this:

Now, Scott is praising a new Mercatus study by Kevin Erdmann, and in doing so Scott denies there was a housing bubble. [Edited slightly. Originally I thought Kevin was denying there was a bubble, but upon second reading it looks like he’s just offering a different explanation. Scott is the one who thinks “bubble” is a useless term.] Even though the national home price index looks like this:

28 Responses to “Another Bold Sumner Thesis”

  1. Transformer says:

    It looks like the national home price index has been rising at a steady rate since the mid-90s apart from a blip between 2008 and 2012.

    When does Scott think the period of too tight money was ? I’m wondering if there could be a link between his two weird theories.

    • Ken P says:

      Yes, maybe since around late 97 which would be about the time Freddie/Fannie mortgage backed security guarantees really took off. The increase is roughly $3 trillion from 1999 to 2008. Look at page 38 – (figure 1) of the link https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr719.pdf

    • Bob Murphy says:

      Transformer wrote: “It looks like the national home price index has been rising at a steady rate since the mid-90s…”

      Nah Transformer the year/year percentage *rate* steadily increased from the early 1990s onward. Look at this chart.

  2. Ken P says:

    One problem I have with the efficient market hypothesis is that advocates of it assume there is this efficiency from information and yet the people who are correct are merely lucky and had no information.

    And since it is all luck we should all just buy index funds and noone asks if the lower information level could reduce market efficiency.

    • skylien says:

      Right, speculation means you think for certain reasons a price is wrong and will go up or down in the future, that is why you speculate on a price move. But if according to the EMH everything is priced in all the time since there can be no bubbles (which is just a hugely wrong price), there is no need to speculate on price moves. But since a lot of prices today are what they are because of speculation, it means they must be wrong and right at the same time which is not possible.

      Saying there are no bubbles is like saying a lot of people cannot be wrong.

  3. Ryan Murphy says:

    relative prices are rising while there is a readily available explanation for prices rising, must be a bubble. science.

    regarding the first graph, which is approximately the twentieth most appropriate indicator of monetary policy, I wonder what it would look like if you subtracted the reserves that fed is now paying interest on. is there some other serious explanation as to why this number jumped up? https://fred.stlouisfed.org/series/WRESBAL

    • Ken P says:

      Thanks Ryan! I’ve been wanting to see how big reserves are.

      So $3.5 trillion pumped into economy and reserves rise by $2.8 trillion. Your explanation makes sense. INteresting that $800 billion flows out of reserves in the past 4 years. But debt has increased by $7 trillion in the past 3 yrs. Where did that money come from? https://fred.stlouisfed.org/series/TCMDO?sid=TCMDO

    • Bob Murphy says:

      Ryan Murphy wrote:

      relative prices are rising while there is a readily available explanation for prices rising, must be a bubble. science.

      regarding the first graph, which is approximately the twentieth most appropriate indicator of monetary policy…

      You mad bro?

    • Andrew_FL says:

      “Readily available explanation for prices rising”

      Erdmann hasn’t offered one, so I can’t imagine what you’re talking about. He has never explained what changed about zoning policy in the early 2000s, simultaneously, almost everywhere in the country.

      Erdmann has only offered an explanation for high prices, not rising prices.

      • Kevin Erdmann says:

        In 2/3 of the country prices are quite easily explained by a moderate sensitivity to low real long term interest rates. In fact, using aggregate rental value and market prices to construct a yield on housing nationally, this tracks with long term TIPS yields until 2007.

        The piece referenced by Scott explicitly lays out the local mechanisms that caused prices in some places to rise more.

        • Andrew_FL says:

          In other words, your claim that there was no excess demand generated by loose monetary policy rests on your claim that monetary policy was perfect or even just slightly too tight right up until some time ca 2007/8.

          • Kevin Erdmann says:

            According to this post, Fed assets are a good measure of monetary policy, and $4 trillion is only capable of producing 2% inflation. Seems like following the logic of the post, all monetary policy before 2008 was extremely tight.

            On a more serious note, you would think that after 20 years of 5% inflation and 8% NGDP growth, this would be a tough position for me to take, but eventually there will be a deflationary shock that will prove I was right all along.

            • guest says:

              What if it’s not a deflationary shock, but rather just the end of a boom in demand that was only possible because of inflation of the money supply?

              • Kevin Erdmann says:

                If core inflation hit 3% or 4% for some period of time I would be happy to call that loose monetary policy. I don’t really care if money is loose or tight. I don’t have a horse in the race. So it’s not rocket science. Two decades with core inflation that ranges from the stated target to something below the target is an obvious sign of tight to moderate policy. Its weird that this is treated as some sort of outlandish conclusion.
                If you consider deflationary shocks to be proof of loose money, I wonder what outcome would lead you to say money had been tight or neutral.

              • guest says:

                I’m just appealing to logic, not the CPI (as measured by the government).

                Just ask yourself if you think that it’s at least *plausible* that a deflationary shock – a dramatic sustained fall in prices – *could* be the result of consumers ceasing their spending in the directions that the money-printers intended them to, and if that ceasing of spending *could* occur because the money that was being printed *for that purpose* (to direct spending) is no longer being made available or in sufficient quantities to entice such spending?

                In other words, could it be that the spending stops when the printing stops, and people go back to economizing based on what they do have, rather than on what has been printed for them?

              • Kevin Erdmann says:

                No. Most of that isn’t logical or plausible. One sign you can use to help you see if you’re going off track is if you have to cast doubt on widely accepted metrics for inflation to make your story plausible. To credibly cast doubt on them, you would have to do a lot of work to overcome the reasonable presumption that they are generally accurate in an acceptable range.
                Maybe there never was a housing bubble. Maybe those price indexes were wrong too. Maybe the government measures of mortgages outstanding are wrong too. So maybe it’s plausible that there was never a housing boom either.

              • guest says:

                “Most of that isn’t logical or plausible. One sign you can use to help you see if you’re going off track is if you have to cast doubt on widely accepted metrics for inflation to make your story plausible.”

                But if I claim to use logic as my basis for casting doubt on widely accepted metrics, does “widely accepted” get the benefit of the doubt over “logic”?

                Even according to the mainstream position, printing money is intended to increase “aggregate demand” (whatever that means).

                So, one of the effects, according even to mainstream economists, is to increase spending.

                Is it that implausible to suppose that if an increase in printing increases spending, that a lack of printing, or lack of sufficient printing, *decreases* spending?

                There is a correlation there. What I’m suggesting is that the increased spending isn’t solving a problem of a lack of spending, but rather aggravating a definitional problem of “sufficient spending” (or “adequate aggregate demand”).

                The “widely accepted metrics” can’t tell you which theory is correct, because they support both.

                I’m claiming that logic can show that the current mainstream position is wrong, and the Austrian one is correct.

            • Andrew_FL says:

              Your criteria for what would constitute loose monetary policy is fallacious and in any case, intellectually dishonest. It is literally impossible for monetary policy to ever be too loose in your framework.

  4. Capt. J Parker says:

    “Scott believes the Federal Reserve adopted an incredibly tight monetary policy and that’s the fundamental explanation for the financial crisis and Great Recession. Even though the Fed’s assets look like this:”

    Well, dates matter. The TED spread was saying it was time to freak out in August 2007. By September 2008 the damage was done. https://fred.stlouisfed.org/graph/?g=k7Ha

    General Sumner: A major reason for the success of the Allied Invasion of Normandy is that the German command had adopted a Tight Ammunition Policy.

    General Murphy. Wow, that’s a pretty Bold hypothesis for General Sumner. (shows graph of German ammunition use spiking on June 6, 1944.)

  5. trent steele says:

    What if Sumner just called it “conditionally” tight or loose; does this solve the problem?

    For instance:

    The Fed expanding or contracting the balance sheet is loose or tight monetary policy.

    The Fed contracting, not expanding, or not expanding enough when e.g. Sumner’s methodology says it should be expanding by X = conditionally tight monetary policy. And vice versa.

    I thought about “relatively,” but that makes it seem like there is an objective standard that it moves “relative” to. Instead, “conditionally” implies reference to conditions, such as those set forth by Sumner.

    I think of this as a “Caplan Problem” a la “rational irrationality.” No one has a problem with the idea behind it, it’s just that the author insists on hijacking established and useful language in a way that contradicts the original definition (or amends it in some way to the same effect). This is done because its fun to be contrarian and, practically, it gets extra attention.

    I wonder how much less you’d have written on Sumner’s “tight” or “loose” policies, or we would have debated Caplan’s “rational irrationality” if they’d just named them e.g. “conditionally tight/loose” and “rational but self-defeating,” respectively. Conversely, how much more time spent on the merits or the arguments?

    • trent steele says:

      I wonder if obfuscation is more the point with Sumner, and instigation with Caplan.

      His terminology to me smells like changing the definition of “inflation” to be synonymous with “price inflation.” If you are successful in making this change (as they have been) then you can “inflate” and not call it “inflation” (for instance, when prices would otherwise be falling). Or, you can understate the rate of “inflation” (when your “monetary” inflation outpaces the natural “price” deflation).

      Similarly with Sumner, I see this as a way to be able to describe the Fed’s activities as being “contractionary” in the future when we would have described those same actions as “expansionary” in the past.

  6. Kevin Erdmann says:

    The first $trillion spike in the balance sheet was a highly contractionary policy and was one of the two or three primary errors committed during the crisis.

    http://idiosyncraticwhisk.blogspot.com/2018/06/housing-part-303-fed-balance-sheet.html

    • Bob Murphy says:

      I am glad you exist Kevin. It reminds me how I must sound to normal people when I suggest privatizing military defense.

    • Giovanni says:

      Your link doesn’t explain how it was contractionary. You just say the interest rate of 2% was above the neutral level, without any evidence supporting it (well, actually there’s evidence in contrary: the extra trillions in the balance sheet).

      • Kevin Erdmann says:

        The Fed was never even able to hit the 2% target. The effective Fed Funds Rate collapsed after the September meeting. To meet the target would require selling billions of dollars of treasuries, which is the mechanical definition of tight money. Bernanke has stated outright that the reason they asked for the ability to pay interest on reserves was because they were afraid they would run out of treasuries to sell. By paying interest on reserves, they could get cash from the banking system so they wouldn’t need to sell treasuries to get cash.

  7. Clayton Soultz says:

    Bob, what would you say in response to Capt. J Parker’s objection, that the Fed’s increase in assets came too late? I consider myself a little Austrian, and I’m sympathetic to your view, and my first response would be “the increase in assets clearly didn’t help the economy recover in the next 4 years”. But it sounds like they’re saying “too little, too late”, the damage was already done. What would you say to that?

  8. Housing: Part 303 – The Fed Balance Sheet | Growth Investing Research says:

    […] of my pushback against the bubble story. Economist Bob Murphy saw the post and reacted with some chagrin that Scott or I could question the idea that the pre-crisis housing market should be broadly […]

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