Market monetarism: a first look
One of the more confusing of the macroeconomic debate is the emergence of a profusion of schools of thought with very similar names, but very different viewpoints. The one I’ve had most to deal with is Modern Monetary Theory. I had a go at this topic here and . My brief summary is that MMT pretty much coincides with traditional Keynesian views in the context of a liquidity trap, but that I reject the claim commonly made in popular presentations of MMT, that increased government spending doesn’t imply increased taxation.
Then there’s New Monetarism, associated with Stephen Williamson. He and I had a set-to a while back, which entertained many but didn’t produce a lot of enlightenment, and left me disinclined to put a lot of effort into understanding the differences between New and Old Monetarism. (For the record, I’m pretty much an Old Keynesian, but I have learnt a fair bit from New Keynesians like Akerlof and Shiller).
The third entrant is “Market Monetarism” associated mainly with Scott Sumner (though Wikipedia tells me the term was coined by Lars Christensen). I was aware in general terms that Sumner advocated a more expansionary monetary policy in response to the current crisis (I agree), that he prefers Nominal GDP level targeting to inflation targeting as the basis for monetary policy (I agree again
though I’d prefer targeting levels rather than growth rates) and that he thinks this would be sufficient to fix the problem without any role for fiscal policy (I disagree). However, I wasn’t really aware that these ideas formed the basis of a school of thought, and I still haven’t investigated the underlying theory in any detail.
Sumner has commented on my recent posts on fiscal and monetary policy with a couple of his own, so I guess it’s time for me to look more closely at what he is saying. A first response is over the fold.
There is a lot in these posts that makes no sense at all to me – I usually find that in cases of this kind there is fault on both sides. Responding to all Sumner’s claims seems likely to produce the worst kind of blogospheric mess, so I’ll focus on what I take to the key point.
In his first post, Sumner is mainly concerned to use me as an example of his claim that the economics profession wrongly equates low interest rates with easy money.
He starts with a bit of a gotcha, in that the original version of my post looked at a huge reduction in nominal rates of interest (from 17.5 per cent to 5.25 per cent) without adjusting for the small change in inflation expectations that took place at the same time (from about 7 per cent to 4 per cent). As I said in the update, the example works just as well if you look at the reduction in the real rate from 9 per cent to 1 per cent. But this is a side issue, since Sumner says “real interest rates are not much better.
At this point, it's difficult to see why Sumner is bothering to pick bones with me. The idea that the stance of monetary policy can be assessed as expansionary, neutral or contractionary depending on whether the interest rate controlled by the central bank is at, above, or below its
real long run average neutral value isn't just mine. It's that of nearly all economists, notably including the US Fed. UpdateThe neutral value changes gradually over time in response to a variety of factors, but is sufficiently stable that it can be regarded, for most purposes, as a long-term average, typically assumed to be in the range 1.5 per cent to 3.5 percent. End updateSumner claims that “People get defensive when I make fun of the view that low interest rates mean easy money” but doesn’t name any names. Does anyone really deny that this is the standard view?
So far, despite a lot of heat, there is no real disagreement. Sumner says, and I agree that, under normal conditions, most economists assess the stance of monetary policy by looking at the real interest rate controlled by the central bank. This wasn’t always the case. The term “monetarism” is generally associated with Milton Friedman’s view that the central bank can and should target the rate of growth of (some measure of) the money supply. This definition has a lot of problems, though it has the merit that it’s applicable even when nominal interest rates have reached the lower bound of zero. But that doesn’t matter much because Sumner doesn’t like Friedman’s approach any more than I do.
Sumner’s alternative, as I understand it comes down to three propositions
(1) The central bank can set policy to achieve whatever rate of nominal GDP growth it desires
(2) Nominal GDP growth can be regarded as a policy instrument, in the same way as the cash rate or, in Friedman’s version of monetarism, the money supply
(3) The best measure of the stance of monetary policy is the expected rate of nominal GDP growth
If you grant the first of these propositions, the others follow pretty directly. But most economists, including central banks, don’t think it’s true, at least in the context of a liquidity trap. It’s hard to assess the argument without a clear and quantified statement of what monetary policies would be needed to end the current recession. Perhaps Sumner has set this out somewhere, and if so, can link to it. It’s worth pointing out that the Keynesian advocates of fiscal stimulus, notably including Romer and Krugman, have been willing to specify the size of stimulus they think was needed in 2009 and would be needed now.
If you don’t accept (1), then the whole argument becomes circular. An expansionary monetary policy, on Sumner’s view, is one that expands the economy. In that case, of course, expansionary policy could never fail, in much the same way as treason never prospers.
Going a bit more out on a limb, I don’t think the validity of the liquidity trap argument depends on whether interest rates have reached the zero lower bound. The economy is in a liquidity trap when people want to build up money balances, regardless of the consumption and investment opportunities available to them. If central banks face such a situation, they may give up on interest rate reductions, even before the rate hits zero, if only to avoid making their impotence obvious.
Anyway, that’s enough from me. I expect there will be plenty of responses and I hope they may help to illuminate the issues.