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Noah Smith is generally an excellent blogger, but when he switches over to Bloomberg.com, he . . . well let’s be charitable and assume the editors forced him to dumb things down. Waaaaay down:

One crowd-pleaser is Scott Sumner, a professor at Bentley University, who is the champion fighter of a team that calls itself the market monetarists. They believe that it’s the Federal Reserve’s job to fight recessions, doing whatever it takes in the way of monetary easing in order to get nominal gross domestic product (click on the link for a full explanation) back to a healthy trend.

Just for the record, I don’t think the Fed should fight recessions, and indeed I believe they should ignore RGDP entirely. I believe the Fed should prevent NGDP shortfalls (and overshoots.) Aren’t they the same thing (some commenters always ask me?) Check out NGDP during Zimbabwe’s 2008 recession. Or the 1980 recession (which Volcker did “fight,” and was wrong to do so.)

The basic market monetarist case against the Keynesians is that U.S. federal government spending, and deficits, have both been decreasing relative to GDP in recent years, and that this hasn’t brought us to economic ruin.

Readers of this blog know that this is not the “basic market monetarist case.” They know that monetary offset was the consensus Keynesian view in 2007. They know that MMs believe there is no reason to abandon that consensus. They know that the deficit fell by an astounding $500 billion in calendar 2013. They know that $500 billion is an extraordinary amount of austerity. They know that Paul Krugman and Mike Konczal called this a “test” of market monetarism. They know that 350 Keynesians signed a letter warning of recession if just a bit more than $500 billion in austerity were to occur. They know that RGDP growth in calendar 2013 nearly doubled over 2012. But of course readers of Bloomberg learn none of this.

Yes, if it were just a matter of the deficit decreasing in “recent years” then I’d entirely agree with Smith, it would tell us nothing. Smith makes it seem like we have no good reason to dismiss Keynesianism:

As you can see, government spending flatlined for about four years (and deficits declined) but GDP kept right on growing. In the mind of the market monetarists, that’s case closed — Keynesianism is dead.

That’s not my “mind.” Smith continues:

Others might claim that what matters is total government spending, including state and local governments, which boosted outlays quite a bit in 2013. Sumner, in his post, waves away these objections, accusing Keynesians of a “shell game” in which they claim to care about whichever method supports their thesis.

This is like those headlines stating, “Is the earth flat? Opinions differ.” I mean seriously, is there any Keynesian model that treats state and local spending differently from investment? If you are going to add S&L spending to Federal spending, then why the hell don’t you add investment too? They both have a multiplier effect. Neither are controlled by fiscal policymakers. This is why I use offensive language like “shell games.” It fits. And by the way, adding S&L spending to the 2013 experiment doesn’t significantly change anything, even if it should be included—which of course it shouldn’t.

Market monetarists have it even easier. Their credo is that the Fed is basically omnipotent, and so everything that happens is a result either of A) Fed actions, or B) expectations of Fed actions. If government spending goes up and GDP goes up, the market monetarists can say that it wasn’t because of fiscal stimulus, but because the Fed decided to be more dovish, and people realized that.

Obviously this is false. For instance, I don’t believe the Fed can prevent Noah from writing misleading opinion pieces. Or cure cancer. I do believe what almost all respectable economists believed in 2007, that central banks can and should target nominal aggregates like inflation or NGDP. I still believe that. Why so many other economists have changed their minds is an interesting question that Smith doesn’t address.

To make things worse, all the gladiators in this combat are looking at noisy time series data with very short samples, and making inferences about policy that might or might not operate with a lag, in an environment in which everything is changing at once. And the gladiators are free to pick out any data point that supports their thesis, and ignore the others. A time-series econometrician would blanch if you presented her with that kind of analysis. She wouldn’t even give it the time of day. Instead, she’d do a historical study, using data as far back as she could go, instead of picking one or two recent points. She would have to use some theory to guide her along, too. And even then, her conclusions would come with huge uncertainty.

I’ve spent most of my life studying older historical examples. And as far as I can tell it’s the Keynesians who favor making sweeping claims based on one or two data points. All I did is call them on it.

So who’s right? The answer is that we can’t really know. Chris Sims, winner of the 2011 Economics Nobel Prize, has found lots of evidence that monetary policy has an effect on the economy. Prestigious macroeconomists such as Robert Hall have found that fiscal policy has an effect as well. Maybe the market monetarists and the Keynesians are both a little bit right and a little bit wrong.

Of course Hall found that fiscal policy can affect the economy. There are lots of ways that can occur, even within the MM model. Sharply higher government spending can depress consumption, and make people work harder, as in the early 1940s. Lots of types of tax cuts can shift the AS curve. If the central bank is targeting inflation then lower VATs or employer-side payroll taxes will cause the central bank to boost AD. Then there is fiscal policy in scenarios with no monetary offset (fixed exchange rates, members of the euro, etc.)

Unfortunately a reader of this Bloomberg column would learn essentially nothing about market monetarism. But I’m less pessimistic than Smith. In the 1960s most economists believed that fiscal policymakers could and should try to do stabilization policy, even when interest rates are positive. By 2007 Milton Friedman had convinced the profession (including Krugman) that the Fed should steer the nominal economy when rates are positive. Now we just have to convince the profession that they should also do so at zero rates. And that’s what I’m trying to do.

HT Saturos, Travis

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This entry was posted on February 07th, 2015 and is filed under Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



