A slightly off-center perspective on monetary problems.
There has recently been a lot of pushback against QE from conservatives. In this post I pointed out that plenty of conservatives support monetary stimulus. Here Iâ??d like to direct 7 arguments against my fellow right-wingers:
1. The Fed isnâ??t really trying to create inflation.
The Fed doesnâ??t directly control inflation; they influence total nominal spending, which is roughly what Keynesians call aggregate demand. Whether higher nominal spending results in higher inflation depends on a number of factors, such as whether the economy has a lot of underutilized resources. But itâ??s certainly true that for any given increase in NGDP, the Fed would prefer more RGDP growth and less inflation. Even after QE2, the Fed still expects less than 2% inflation for years to come. If the Fed had any marketing sense, theyâ??d be telling the public they are trying to boost recovery by increasing national income, not increasing the cost of living. It would also have the virtue of being true.
2. â??But doesnâ??t economic theory teach us that printing lots of money creates high inflation?â?
In general that is true. But there are three important exceptions:
1. If the monetary injections are expected to be temporary, the inflationary effect is far smaller. The Japanese central bank did lots of QE in 2003, but pulled much of the money out in 2006 when deflation ended. It worked in preventing high inflation, indeed it may have worked too well.
2. If interest rates are near zero, the public demands more liquidity. The Fed can supply that liquidity with little impact on the price level.
3. If the Fed pays interest on reserves, then the quantity theory of money (more money means more inflation) doesnâ??t necessarily hold. They recently started paying interest on reserves, and thatâ??s one reason why the big injections from 2008 didnâ??t have an inflationary impact. The Fed can adjust the rate as necessary, and indeed in my view a lower IOR would be more effective that QE2.
3. â??But isnâ??t the gold market signaling high inflation?â?
Possibly, but the indexed bond market is superior to gold prices for two reasons. First, gold is trading in a global market, and we are interested in US inflation. More importantly, gold prices reflect all sorts of factors (industrial demand in Asia, central bank demand, a recent drop-off in new discoveries, a hedge against all sorts of financial risks, including eurozone turmoil.) Furthermore the indexed bond market (TIPS spreads) has recently been more accurate than goldâ??correctly predicting low inflation in the US since late 2008.
4. â??Doesnâ??t printing money just paper over real (structural) problems in the economy?â?
There are structural problems, but there is also a shortfall of nominal GDP. The structural problems showed up when growth slowed in late 2007 and early 2008 as a result of sharply lower housing construction. This is necessary re-allocation of resources and should not be resisted. But even Friedrich Hayek suggested that we needed to avoid a â??secondary deflationâ?, which would show up as falling NGDP, and would depress output in even those healthy industries that had not over-expanded. In late 2008 output fell across the board as NGDP declined. Monetary policy can only address the insufficiency of total nominal spending, not the structural problems. Furthermore, more nominal spending would boost employment, which would speed up the time when Congress eliminates the 99 week extended UI benefitsâ??which is one of the structural problems.
5. â??Isnâ??t this just hubrisâ??the idea that money can be centrally planned?â?
Most right wing economists are not comfortable with the idea of giving discretion to the central bank. I am no exception. I happen to favor making the dollar convertible into NGDP futures contracts as a way of stabilizing NGDP growth expectations at a low and stable rate. Milton Friedman favored a stable money supply growth rate, but late in his career (after velocity bounced around) endorsed a policy of stabilizing market expectations of inflation in the indexed bond market. These systems would allow the market, not the Fed, to determine the appropriate level of money for the economyâ??s needs. But we arenâ??t there yet, and given the Fed does use discretion, Friedman was not at all hesitant about recommending policies that he thought would do the least damage. I believe that is stable NGDP growth expectations.
6. The conservative critique of stimulus is incoherent
When I started my blog in early 2009, fiscal stimulus was the hot issue. Many conservatives were opposed to fiscal stimulus, arguing (correctly in my view) that it would fail. And they made it quite clear that â??failureâ? meant deficit spending would fail to boost nominal spending. The implicit assumption was (almost everyone agreed) that more nominal output would be desirable, and the argument was that fiscal stimulus could not deliver it. With monetary stimulus, the right is making exactly the opposite argumentâ??they are opposed to QE because it might succeed in boosting NGDP. Both fiscal and monetary stimulus boost NGDP (if they work at all) by shifting AD to the right. Whether that extra spending shows up as inflation or real growth is of course an important issue. But it makes no sense to argue fiscal stimulus would fail because it would not boost NGDP, and simultaneously argue that monetary stimulus would fail because it would increase NGDP. Iâ??m sure the right doesnâ??t think of its views in those terms, but that is essentially the message they are sending out, and it is an extremely incoherent message.
7. â??Wonâ??t monetary stimulus just paper over the failures of the Obama administration, allowing him to get re-elected?â?
Thatâ??s an argument unworthy of principled conservatives. After 30 years of major neoliberal reforms all over the world (even in Sweden!) itâ??s time for conservatives to become less defeatist about the possibility of making positive improvements in governance. We need to do the right thing, and let the political chips fall where they may. If monetary stimulus is tried, and succeeds in boosting NGDP (which even conservatives implicitly acknowledge can happen when they worry about inflation) then it would drive a stake through the heart of the Krugmanite fiscal stimulus argument (for future recessions.)
I donâ??t think conservatives realized it at the time, but I (and a few other quasi-monetarists) had the strongest argument against fiscal stimulus in late 2008 and early 2009. We said; â??Yes, stimulus is needed, but monetary stimulus is much more effective and less costly than deficit spending.â? At the time, most on the left argued that monetary stimulus wouldnâ??t work if rates were near zero. Well rates are still near zero, and many of those same liberals are now insisting that the Fed is responsible for fixing the AD shortfall. Theyâ??ve come over to our side. Just as in earlier decades they gradually accepted the Friedman/Schwartz argument that monetary policy errors caused the Great Contraction of 1929-33, not the failures of capitalism. If conservatives keep predicting inflation that the financial markets donâ??t see, Krugamn will continue to rub their faces in failed predictions. If we adopt the view that monetary policy is the appropriate way to keep NGDP growing at an adequate rate, then we win and Krugman loses. So which will it be?
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77 Responses to â??An open letter to conservativesâ?
I know you want nothing more than for non-economists to give their seat-of-the-pants market interpretations here, so here goes: looks to me like the market was headed up in anticipation of looser money; now that the Fed has shown its hand and the market has considered it, the market is showing its disappointment, it is still hungry. The drama over Ireland is smoke for the S&P, the market is changing directions and headed down. And so goes oil and gold.
Conservatives: beware what you donâ??t wish for.
Krugmanâ??s argument is that the Holtz-Eakin and Taylor (and the GOP) desire Obama to fail, hence they donâ??t want the Fed to do anything. While I would not put them in this camp, I read too many other conservatives that want unemployment to be 10% heading into November 2012. From a political standpoint, people like Paul Ryan have their ideas supported and promoted by Cato. Cato opposes central bank activity, so Ryan backs their position as well.
Taylor, Holtz-Eakin, etc. have now opposed to QE so they now have a vested interest in seeing that the Fed does indeed fail so that Krugman doesnâ??t have another talking point.
It seems to be common knowledge among conservative/libertarian commentators that:
(1) The money supply is increasing (2) The price level is rising (3) Nominal incomes are stagnant or falling
(1) is true because the Fed is printing money at an unprecedented rate; (2) is true because most prices are higher than one year ago; and (3) is true because during recessions money is just more scarce.
I just donâ??t know what to say about this, so here are some exclamation and question marks: !!!?!?!?!?!?!?!?!?!?!!!????!!!!??!
Did Krugman ever leave your â??sideâ? on monetary policy? It seems like he comes back to it whenever heâ??s not explicitly arguing for some form of federal spending (which is quite often nowadays â?? I miss the Paul Krugman economist from the 1990s).
1 â?? People are not stupid, and they know the difference between a a real $1000 salary increase and a pretend $1000 salary increase.
2 â?? Printing money causes inflation except when people can see through the ruse, in which case it doesnâ??t work. See my point #1. This is why you spend so much time arguing that it has to be done â??convincingly.â?
3 â?? There are currency crises in Greece and Ireland. Why do you say we should not be looking at a global inflation indicator? Also, I would argue that rising gold prices are more an indicator of loss of monetary faith than of inflation.
4 â?? Hayek is not the only Austrian, and he changed his mind often. Sending new piles of money to chase after more bad investments (assuming my point #1 doesnâ??t hold) will yield nothing other than another bubble. Didnâ??t we already see this with the dot-com and 9/11 dips?Boosting malinvestment will results in (yep) more malinvestment. Itâ??s a tautology.
5 â?? You havenâ??t really addressed the hubris point, youâ??ve just accused other conservatives of the same hubris.
6 & 7 â?? I wonâ??t address these points because I donâ??t agree with conservatives or liberals here.
You gotta love the Dow and the right-wing.
They hate China for tightening money, and they hate the Fed for loosening money.
Okay.
Bravo, letâ??s sat it again avoiding inflation requires that the congress and the president take action to repeal those measures which are retarding growth and to institute new measures only when compatible with boosting the real growth rate.
Can we had more questions? Here is mine:
* As a skeptic of aggregation Iâ??m uncomfortable with the concept of Aggregate Demand, why should I be more comfortable with NGDP? And for that matter why should I fear the equation Y=C+I+G, but not fear the equation MV=PQ?
Ryan said: â??People are not stupid, and they know the difference between a real $1000 salary increase and a pretend $1000 salary increase.â?
But â??do they know the difference between a real $1000 salaryâ? decrease â??and a pretend $1000 salaryâ? decrease?
Nominal income is about 13 percent below its pre-recession trend, and yet prices are only about 2 percent lower. This suggests either a radical decline in the productive capacity of the economy or significant downward price rigidities. Since unemployment is abnormally high, the latter seems like a far more likely explanation. The difference between nominal income and the general level of prices can be corrected by expanding the money supply with policies like QE2.
If Scott and the other quasi-monetarists are correct, then inflation will be mitigated as unemployed resources (including labour) are redeployed. In other words, rising nominal income will coincide with rising real income, because we are currently inside the production possibilities frontier. Although issues of recalculation may frustrate this redemployment of resources (and inflate to some degree), much of the additional monetary income will not be â??pretendâ?.
@Lee Kelly
Market corrections almost always come with price deflation. The reason is pretty obvious: when times are tough people save more and spend less. Wouldnâ??t you expect prices to decrease? Why in heavenâ??s name is this a problem?
Where I disagree with monetarists and Keynesians is that I donâ??t believe this is an irreversible downward spiral. Lower prices are good for what you guys call â??aggregate demand.â?
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