A note on the ineffectiveness of monetary stimulus (updated and corrected)

A commenter on the previous post raised the idea, promoted by the “market monetarist” school, that monetary policy is so effective as to make fiscal policy entirely unnecessary, at least when interest rates are above the zero lower bound. My views on this issue were formed by the experience of the late 20th century, and in particular, the recession that began in 1990, following steep increases in interest rates. Having planned a “short, sharp, shock”, the RBA started cutting rates in January 1990.

They didn’t go for 25 basis point moves in those days. Over the period to March 1993, rates were cut by more than 12 percentage points, from 17.5 per cent to 5.25 per cent. Over the same period, unemployment rose from 6 per cent to nearly 11 per cent, a record for the period since the Depression, and stayed around that level well into 1994, until the adoption of the Working Nation package of fiscal stimuuls active labour market policies. As I said in the previous post, tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.

Update As pointed out by Mark Sadowski in comments, these are nominal rates of interest. To get the real rate, which is more relevant, you need to subtract the expected rate of inflation, which fell from around 7 per cent to around 4 per cent over this period (as measured by surveys, and by the premium for inflation-adjusted Treasury bonds). So, you get a 9 percentage point reduction in the real rate from 10 per cent to 1 per cent. This doesn’t make much difference to the story. Most economists would regard policy as contractionar/expansionary if real interest rates are above/below the long-run neutral level, about 3 per cent. So, we still have a shift from strongly contractionary to moderately expansionary.

However, market monetarists want to argue that the stance of policy should be assessed relative to a policy rule (Taylor rule or NGDP) that already incorporates a prescription of cutting rates when GDP falls and unemployment rises. This doesn’t make a lot of sense to me. It’s like arguing that Obama’s stimulus was actually a contractionary policy because it wasn’t as big as (according to a standard analysis based on Okun’s Law) it should have been. It’s partly a question of semantics, but it’s associated with the claim that, if only rates had been cut even more, we wouldn’t have had the recession, or would have recovered quickly. Having been around at the time, I disagree.

98 thoughts on “A note on the ineffectiveness of monetary stimulus (updated and corrected)

  1. It would be easier to think of monetary policy as forcing bankrupcies on debtors.

    Rising interest rates increase bankrupcy rates by raising costs of debt above profit rates.
    Decreasing interest rates provide no help for debtors that can not get refinancing on cheaper terms that others with good standing credit rating can.
    No matter that interest rates went down so much in 1990′ since companies were bankrupt and could not get refinancing of debilitating debts which created unemployment. You could argue that monetary easing came too late for already overdebted businesses.

    In any case, monetary policy trough bankrupcy of private sector by deminishing their profits can only prevent overconfidence but not return it.

    That is the reason that monetary policy can only destroy, not improve. And if taken that “independence” of a Central Banks means that CB is supposed to counter Congress’ fiscal policy by bankrupting stimulated companies.

  2. NZ and australia had rapid recoveries from their great depressions. Both had fiscal consolidations and monetary expansions.

  3. There is another way to think of inefectivness of monetary policy, by John Kenneth Galbriath’s book, The Good Society: The Humane Agenda:

    “The serious flaw in monetary policy is that it may have little or no effect on the flow of aggregate demand. As noted, the lowered interest rates are assumed to work against depressive conditions by encouraging consumer borrowing and expenditure and business investment. The latter responds to the lower cost of borrowing and therewith the improved possibility for profit. But when times are poor and unemployment is high, lower interest rates do not reliably inspire consumer expenditure; depressive attitudes, including those which are the product of unemployment or uncertain employment, are in control. And at such times, excess business capacity being evident, business firms, old and new, may not be encouraged by low interest rates to borrow and invest and so contribute to the income flow; the larger prospect is too uncertain. There is also the adverse effect of low rates on those whose income comes from interest — a reduction in their contribution to aggregate demand. None of this, however, discourages faith in monetary action as a decisive economic instrument. Quasi-religious conviction here triumphs over conflicting experience.”

  4. How do you define easy vs. tight monetary policy?

    Imagine that increased government spending increases aggregate demand and inflation. And the central bank allows inflation to increase to, say, 6%.

    Is that an example of monetary policy staying constant? Heck no, that was a hugely aggressive easing!

  5. It might be better to look at both monetary and fiscal policy; if they act against each other they could cancel each other out. The UK is one example, where austerity policy weakens the effects of QE. Japan is another, with tax hikes during the Asian crisis eating into dwindling revenue.

  6. 17.5% to 5.25% over 2 years. Since 1) 5.25>0 and 2) 2>0, monetary policy wasn’t as easy as it could have been even assuming that it becomes totally ineffective at the zero lower bound.

  7. What model do you use to justify the pushing on a string theory? Most macroeconomists reject the hypothesis (Mishkin etc)…

  8. Zac, no knowledge of “string theory” is required. (String theory is a math theory.)

    JQ’s ‘ pushing the string’ argument relies on the assumption that monetary policy (cash rate, QE) works via the financial sector and not via the budget sets of individuals and non-financial businesses. This assumption corresponds to observables (is a fact). Therefore effective demand is not influenced for a long time. (Effective demand shows up under ‘revenue’ in the accounts of businesses and it shows up as ‘expense’ in the accounts of customers.)

    May I suggest you read up on where the QE money went and how it was ‘invested’ by those who had access to the QE money of the Fed and then ask the question, why did it take so long for anything to happen in the US in response to QE and then ask, why did security market (share market to be precise) prices increase (could it be financial asset price inflation – another bubble in the making?)

    Simpler still, did you get any QE money in your letter box?

    You guys should read J.M. Keynes rather than being second hand dealers in ideas.

  9. This could be a good way to think about monetary expansion. If you think of fiat currency instead as flash drives holding information and productive work as creating information, then up to a point building flash drives increases data output (because there is a place to store data that would be produced –i.e. potential AD), but eventually the benefit goes away (“pushing on a string”) and you start building flash drives that sit in a vault somewhere.

    http://informationtransfereconomics.blogspot.com/2013/08/visualizing-diminishing-marginal.html

  10. @Ernestine Gross In retrospect the Ken Henry advice to “go early, go hard and go households” was right on the money.

    I was in the US a bit later and people were (pleasantly) amazed and astounded at the Australian stimulus package.

  11. @Zac

    I think Prof. J.Q. is not relying on a model (theory) to justify the “pushing on a string” critique. He is relying on empirical evidence.

    Do you remember the very amusing Seinfeld epsiode characterised by this didactic statement? “First you TAKE the reservation then you KEEP the reservation.”

    In the same spirit I would say; “First you take the evidence THEN you make the theory.”

  12. @Jim Rose

    That’s an interesting claim and one I was tempted to ridicule, However, on checking the facts (at least according to Wikipedia) it appears that Australia and the Premiers did respond to the Great Depression by fiscal consolidation (austerity) and monetary expansion.

    Whether Australia’s recovery from the Great Depression was “rapid” is open to debate. It still took a long time to recover but recovered faster than the US whose depression was much deeper and longer.

    This begs the question of what other factors, other than fiscal and monetary policy might affect depression recovery? Obviously, how deep it is in the first place is one of the issues. I would be particularly interested in the opinions of John Quiggin and Ernestine Gross on this matter. It also indicates to me that I should employ a bit more caution about being a total Keynesian or worse still, as the more orthodox might see it, an MMT pro-deficit warrior.

    There you go! A red letter day! Not often do I back down even a bit. 🙂

  13. @rog .IMHO Ken Henry’s advice for Australia was right at the time, not only with the benefit of hindsight, and so was the Government in acting on the advice on time.

    It was right for Australia because a) the banking sector was in relatively good shape b) the government debt was relatively low, c) household debt in 2008 was relatively high. By contrast, in Germany conditions a) and b) were similar but household debt was relatively low. In Germany, which also survived the GFS reasonaby well, the government reacted with public works programs – many small scale but spread geographically. There are many other differences but above may suffice to illustrate the importance of ‘initial conditions’.

    Economics isn’t all mystry if one ignores the macro-economic ‘schools of thought’. (I feel save to say this on this blog-site because JQ is not a schools of thought economist by his own statement.)

  14. GFS should read GFC
    “but above” should read “but the above”
    “mystry” should read “mystery”

  15. But John isn’t relying on evidence. He is relying on one data point (the 1990s recession) with no counterfactual!

    A proper atheortical evaluation of the evidence would look at multiple countries over multiple time periods. For example there is strong evidence that easing monetary policy (going off the gold standard) ended the great depression. Not too mention current evidence from Japan and the US on the effectiveness of monetary policy – even at the zero lower bound.

    If Australia hadn’t lowered interest rates in the early 1990s then the recession would of been even worse – that’s why you need a counterfactual. And in macro with its highly limited data its why you probably need a model too.

    Models, even obviously wrong models, are good for clarifying your thinking. Why does fiscal policy work when monetary doesn’t for example? There are a lot of unstated assumptions in that sentence.

    As for the mechanisms of monetary policy there are far more then just the financial system – house prices, wealth effects, the exchange rate, expectations of future monetary policy. All of those effect the economy, and yes even QE works to increase agreegate demand. I see little reason why this mechanisms are impaired in a downturn.

    I’ve read Keynes, but he is not the solution to all the worlds problems (he is after all 70+ years out of date!) An appeal to authority is a terrible way to debate public policy.

  16. Zac :
    What model do you use to justify the pushing on a string theory? Most macroeconomists reject the hypothesis (Mishkin etc)…

    @Zac

    An appeal to authority is a terrible way to debate public policy.

  17. To expand a bit on that gotcha, I wouldn’t appeal to Mishkin’s authority given his record eg on Iceland

    As regards evidence, the 1990 episode was particularly striking. But the “pushing on string” metaphor, which I learned well before 1990, reflected the whole experience of the postwar period.

    Everyone knew it at the time. The policymakers of 1990 knew it too, but assumed, falsely, that the micro reform of the 1980s had made the economy so resilient that past experience could be disregarded

  18. I am alas a raging hypocrite. And I completely concede that point.

    If you would allow me to rudely recharactertise my point, I would expand by saying when I mentioned Mishkin I meant not so much the economist specifically, but the author of the top selling monetary textbook, which of course cribs heavily from the foremost ‘conventional’ monetary economists around the world. Ideas like sticky wages, sticky prices, Euler equations etc. the basic building blocks of the main stream consensus.

    I agree I probably wouldn’t trust Mishkin’s assesment of a financial system/stability, but I think his record as a monetary economist is much stronger. One does not nessacarily tarnish the other.

    I find the Japanense evidence today, and the evidence from the Great Depression, as particuarly good (atleast good relative to other macro evidence) examples of monetary inflation at the zero lower bound/recession. Even the fact that the US has continued to produce jobs at the same rate as last year, despite the tax increases and the sequester seems to indicate that there is somesort of monetary offset at work.

    Are you refering to the post-war (70s) stagflation? I, and think quite of few others, would characterise that as a supply side shock (oil) which I agree the monetary policy (or any demand side tool) can’t do much about.

  19. The age old adage about pushing on a string is based on an equally old misnomer about monetary policy: that it works without lags. The peak effect of (real) interest rate movements on nominal GDP is 4 or more quarters; people who are looking for contemporanious movements are barking up the wrong tree.

  20. The 1990-1992 increasingly severe recession (in terms of unemployment, bankruptcies…) belongs to the entrepreneurial 1980s debt bubble – the time when some famous entrepreneurs didn’t seem to know the difference between Assets and Owners’ Equity in terms of financial accounting. Some of these then heroes were indeed giving support to the weakest conceivable notion of ‘market efficiency’ (defined here as markets aggregate the expectations of many people) by being slower than the share market participants in recognising that their ‘asset growth’ couldn’t last because debt was growing faster. Stock exchanges crashed in October 1987 all over the place (except in Cairo – reportedly a stockbroker hadn’t even heard about the NY crash a day or two after the event).

    About 20 years after the height of the 1992 recession, bankers involved with the Bond Corporation’s debt induced asset bubble now have to learn their lesson in the only language they understand: money.

    http://www.watoday.com.au/business/court-appeal-backfires-as-banks-ordered-to-pay-more-in-bond-case-20120817-24cvv.html

    Those who argue that welfare effects linger on long after macro-aggregates have recovered have a point, I would suggest.

    Every major crisis is different in detail but with one common factor: Debt, in its various forms.

    The monetarists know only one form of debt: government debt. Hence they keep on ignoring the elephant in the room (they are not alone in this respect). Nobody forced the then entrepreneurs to go on a spending spree with bank money, denominated in local currency units; they did it ‘freely’.

    There is a fundamental problem with the mental model of ‘market monetarists’. They are correct in saying ‘it’ is the governments’ fault, but they are wrong as to the reason. The government allows various forms of debt (private money, denominated in fiat currency units) to be generated (‘deregulation’ to get conditions similar to those before the 1930s Great Depression). This is the correct bit of the argument. But they want a market economy at the same time, with a government sector so small that any ‘crowding out’ through fiscal policy or regulation of financial markets or both would be empirically undetectable, but big enough to get ‘monetary policy right’. But surely, if the ‘market’ bit of monetarism would be credible, then the market participants would not act like Alan Bond in the 1980s and the proverbial Wall Street bankers in the first decade of the 21st century. It seems to me the ‘market monetarists’ are implicitly asking for a strictly supervised kindergarten with monopoly money.

  21. @Tim Peterson

    Most of the case for using monetary rather than fiscal policy rests on shorter decision lags – say a month between RBA meetings as opposed to six-months between Budget and mid-year review. But if you think the impact lag for monetary policy is more than four quarters, and you have a functional Treasury, you should be relying mainly on fiscal policy, at least for anything big.

    Like most of the arguments for relying on monetary policy, a four-quarter lag is no problem if you are just tweaking a Taylor rule with 25bp nudges.

  22. A small quibble – the cash rate wasn’t cut to 5.25% until March ’93.

    What is your implied counterfactual in the early 90s – in particular, why wouldn’t any fiscal expansion have resulted in slower rate cuts, given the RBA was still worried about inflation, and actually raised rates as soon as 1994?* Do you think fiscal policy has significantly shorter lags (not clear if your reply to Tim reflects your views or his), a better short-run tradeoff with inflation, more precision, or what?

    *”We did not set out to have a recession in order to reduce inflation. … But once it was apparent that it was going to happen, it was reasonably quickly realised that there was an opportunity to achieve something of lasting value out of the unfortunate events.” – Ian McFarlane

  23. @Declan

    In 1993, we didn’t have central bank independence in the modern sense, so the idea of the RBA offsetting fiscal policy doesn’t apply. We should have had the same monetary policy and an earlier switch to fiscal expansion.

    More generally, as Noah Smith has pointed out, it’s unclear whether the MM fiscal policy ineffectiveness claim is that central banks do in fact perfectly offset fiscal policy (clearly false) or that their control of the economy is so precise that they can do so if they want to (false in general, though probably true while the Great Moderation lasted).

    On your quote, while I generally admire McFarlane this is an ex post rationalisation of failure.

  24. Pr Q said:

    tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.

    Reckless monetary policy can cause much mischief, but good monetary policy is not much of a quick fix. Even its most enthusiastic proponent conceded that “long and variable lags” were the best it could do.

    Generally speaking, loose monetary policy can reliably cause price inflation in either goods markets (seventies) or asset markets (noughties). Quantitative easing being the latest case in point, see the run up of the Dow.

    Tight monetary policy can of course restrain inflation. But goods price inflation is not a pressing problem these days.

    Loose fiscal policy gets a lot of bad press but is rarely as bad as it seems. Chronic deficits are not inherently inflationary. They simply cause a run-up in debt. How that debt is serviced may be inflationary (printing money) or deflationary (higher taxes/lower benefits) or neutralised (through higher productivity growth).

    Chronic deficits only seem to be a real problem when there is a risk of default due to dwindling tax base. Combined with a home currency is pegged to an over-valued specie. This is the Greek problem.

    Its passingly strange how many of our modern woes in economic policy are simply the result of ignoring the wisdom accumulated by our elders: “pushing on a string”, “casino capitalism”, “taking away the punch bowl just as the party gets going” were all proverbial wisdom when I arrived as an economics undergraduate in the early eighties.

    Much the same can be said for the way we ignore the wisdom of our elders on matters of national culture. Interestingly, Keynes was decisively un-liberal in macro-economics, macro-ethnic and macro-eugenic policy. I guess he was just a silly old fool so we dont need to pay attention to him at all ever again.

    When the history of this era is written future students will wonder at the ability of liberal triumphalists to be oblivious to the obvious.

  25. Pr Q said:

    tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.

    Reckless monetary policy can cause much mischief, but good monetary policy is not much of a quick fix. Even its most enthusiastic proponent conceded that “long and variable lags” were the best it could do.

    Generally speaking, loose monetary policy can reliably cause price inflation in either goods markets (seventies) or asset markets (noughties). Quantitative easing being the latest case in point, see the run up of the Dow.

    Tight monetary policy can of course restrain inflation. But goods price inflation is not a pressing problem these days.

    Loose fiscal policy gets a lot of bad press but is rarely as bad as it seems. Chronic deficits are not inherently inflationary. They simply cause a run-up in debt. How that debt is serviced may be inflationary (printing money) or deflationary (higher taxes/lower benefits) or neutralised (through higher productivity growth).

    Chronic deficits only seem to be a real problem when there is a risk of default due to dwindling tax base. Combined with a home currency is pegged to an over-valued specie. This is the Greek problem.

    Its passingly strange how many of our modern woes in economic policy are simply the result of ignoring the wisdom accumulated by our elders: “pushing on a string”, “casino capitalism”, “taking away the punch bowl just as the party gets going” were all proverbial wisdom when I arrived as an economics undergraduate in the early eighties.

    Much the same can be said for the way we ignore the wisdom of our elders on matters of national culture. Interestingly, Keynes was decisively un-liberal in macro-economics, macro-ethnic and macro-eugenic policy. I guess he was just a silly old fool so we dont need to pay attention to him at all ever again.

    When the history of this era is written future students will wonder at the ability of liberal triumphalists to be oblivious to the obvious.

  26. @John Quiggin

    CBs don’t need to be independent for monetary offset to occur. In fact you can tell a very plusiable story where governments consolidate, to reduce debt say, and work with the central bank to ease monetary policy such that overall aggregate demand is maintained.

    I think the claim of MM is that central banks *can* offset fiscal contractions but in a imprecise manner. So when the sequester happened, which was an anticipated shock, the fed was able to keep job growth roughly stable with easier money. If the government slashed spending over night then it would be much harder to offset and output would probably dip for 6-12 months.

  27. Ikonoclast, Australia came out of the Great Depression earlier than most because of the fiscal discipline of the Premiers’ Plan.
    • The premiers’ plan required federal and state governments to cut spending by 20%, including pensions. It was accompanied by tax increases, and reductions in interest on bank deposits and government internal loans.
    • The plan was complementary to a 10 per cent wage cut of January 1931 and the devaluation of the Australian pound.

    The New Zealand government also cut everything that could be cut by 20%. NZ had the most rapid recovery of all western countries from the 1930s depression.

    By the mid-1930s, the unemployment rates in Oz and NZ were in mid-to-high single digits similar to the pre-1929 rates.

    MacLaurin (1936) dated the Australian economic recovery from the last months of 1932. It was to take another three years before the unemployment rate fell below 10 per cent — the rate during the 1920s.

    the data published in the 2001 yearbook of the Australian Bureau of Statistics graphed iat http://www.abs.gov.au/AUSSTATS/abs@.nsf/Previousproducts/1301.0Feature%20Article142001?opendocument&tabname=Summary&prodno=1301.0&issue=2001&num=&view= shows a rapid fall in the high twenties unemployment rate in 1932 to be below 10 per cent by 1937.

    Australian unemployment was 7.5 per cent in 1938, which is the long-term average for the period 1906 to 1929. The USA had an unemployment rate twice that in 1938 and was just coming out of a double dip depression caued by the new deal

  28. @Zac

    Sure, under some circumstances it makes sense for contractionary fiscal policy to be combined with expansionary monetary policy – a fiscal consolidation under normal cyclical conditions is one such case, as you say.

    But, in the context of a deep recession, expansionary monetary policy alone won’t work fast – you need to use fiscal policy as well

    In the Depression, Sweden recovered faster than Australia & NZ, using both fiscal and monetary policy – almost the only country to do so.

  29. Jim Rose said:

    Australian unemployment was 7.5 per cent in 1938, which is the long-term average for the period 1906 to 1929. The USA had an unemployment rate twice that in 1938 and was just coming out of a double dip depression caued by the new deal…Australia came out of the Great Depression earlier than most because of the fiscal discipline of the Premiers’ Plan.

    Dear Jim,

    Your reference to Australian Great Depression, both in dimensions and cure, is wildly misleading. Australian Unemployment was at catastrophically high levels for the first half of the thirties. And the Premiers Plan, far from alleviating unemployment, greatly exacerbated the problem, prioritizing the servicing of loans to British banks over the care of Australias workers and war widows.

    The core of the Great Depression was the first half of the thirties, thats when most of the (in)action occurred. During that period Australia’s labour market suffered insults and injuries comparable to those of other countries in the Anglosphere, with the unemployment rate going from just over 10% in 1929, peaking at nearly 30% in 1932 before settling back closer to 10% by 1935. Here is the ABS summary:

    In 1906, unemployment stood at 6.7%, and fluctuated at around this rate (though it rose briefly to a little over 9% in 1915, and just over 11% in 1921) until 1929 when unemployment stood at 11.1%. The unemployment rate then increased rapidly to 19.3% in 1930, before reaching a peak of 29.0% in 1932, in response to the economic conditions of the Great Depression. This unprecedented high rate of unemployment persisted for two years, before the unemployment rate fell rapidly to below 10% by 1937. During World War II, unemployment in Australia reached a new low of 1.1%. This marked the beginning of a sustained period of low unemployment, with the unemployment rate generally remaining below 3% until the early 1970s.

    The Australian unemployment profile broadly fit the pattern of the UK, mainly because we followed the same disastrous policies of the orthodox Treasury View.

    And the “discipline” of the Premiers Plan was a pointless exercise in masochism designed to “please the markets” (in this case the Bank of England headed by the sinister figure of Sir Otto Niemeyer). Shades of ratings agency, c’est plus ca change.

    There is no evidence at all that Niemeyers program of leeching and cold showers did any good at all to the economic patient. Its true that Australian economy did recover during the second half of the thirties – some five years after the Premiers Plan. But this seems to have been a resource export-led recovery coming on the heels of a sustained devaluation of the currency. Together with some manafacturing protectionism and a steadily increasing rearmament program.

    That is hardly what one would call an orthodox scheme of measures.

    Of course the policy that really cured the Great Depression was the Second World War, which entailed a massive increase in government expenditure and control. All of which restored the labour market to full health for another 30 years. Nothing like an Arms Race to give an adrenaline hit to economic activity.

    In fact it was Hitler who, for all his faults, gets the prize for first successful Keynesian economic program. He stumbled onto the economic benefits of budget deficits through his rearmament program which caused Germany to climb out of Depression quicker than the Anglo powers. Keynes in the second edition of the General Theory goes out of his way to praise the Nazis for their robust economic policies.

    But then Hitler had to spoil it all by declaring war on everyone everywhere. Why cant people leave well enough alone?

  30. @John Quiggin

    Sure, and in the event of a ‘deep’ recession in all likelihood you would try both policies as a method of insurance. Model uncertainty (which is always high in macro) demands it.

    But ‘in the event of deep recessions try everything’ is a long way from monetary policy is ‘just pushing on a string’. Monetary policy may not be omnipotent, but it is far from powerless.

  31. Interest rates are the price of credit. I don’t think the price of credit should be manipulated. The goal of monetary policy ought to be to define the national unit of account in reference to a suitable stable proxy for value and then leave prices (including interest rates) to be determined through market dynamics.

  32. @John Quiggin

    I’m not sure lack of formal independence = no ability to act independently (the board structure was pretty similar to now, AFAIK, and how pleased was the govt with the rate hikes of ’94?), but I was pretty young at the time. But even if they were acting in perfect harmony, that surely means interest rates were being set given the fiscal stance so there is still a tradeoff.

    Regardless, it seems pretty arbitrary to pick the historical path of interest rates + more fiscal expansion as your preferred policy. If monetary policy is so ineffective (and arguably overshot, given the cash rate was back to 7.5% by the end of ’94), why not smaller rate cuts and even more fiscal expansion, or conversely why not bigger and earlier rate cuts? Again, do you prefer fiscal policy because of shorter lags, greater precision, or what, and can you defend it with anything more than “everyone knew it at the time” and a couple of Depression anecdotes (which is the mirror image of “The US and Japan ran huge deficits and still remained depressed” and “everyone [at Chicago] knows fiscal stimulus is useless”)?

    My understanding of the MM position is “multipliers are just estimates of central bank incompetence” i.e. unpredictable under bad policy and zero under good policy. (Although they might become predictable under predictable bad policy e.g. at the zero lower bound absent further action, or a general reluctance to move interest rates.)

    The success of inflation targeting in stabilising inflation makes me somewhat optimistic that a nominal income target, say, would be successful in stabilising nominal income (without thinking that either of them are actually good targets for Australia).

  33. As a general observation, a lot of people here seem to have a very mechanical view of demand management: figure out a multiplier m so if we are hit with a shock of size X we pull the fiscal or monetary lever by X/m to offset the shock, rather than shaping expectations (of future income, mainly) so that demand is more stable in the face of shocks in the first place.

  34. http://www.petermartin.com.au/2006/12/truths-about-australias-recession.html

    December 1, 2006

    Truths about Australia’s recession
    By Peter Martin

    “Australia’s Reserve Bank deliberately dragged its feet in moving to end the early 1990’s recession, according to its recently retired Governor Ian Macfarlane.

    In the latest of his Boyer Lectures, to be broadcast on Sunday, the former Governor says that the Bank decided to move slowly in ending the recession in order to grab a once-in-a-generation opportunity to turn Australia into a low-inflation economy.

    At the time Mr Macfarlane was an Assistant Governor under Governor Bernie Fraser.

    In the lecture he says that “in earlier recessions, all the policies and all the government rhetoric were pointed towards re-expanding the economy as quickly as possible and reassuring the public that all efforts were being made to cushion the blow”.

    But that in 1990, once it became apparent that Australia was going to have a recession “it was reasonably quickly realised that there was an opportunity to achieve something of lasting value out of the unfortunate events”…

    He says that while the bank did cut interest rates from 1990 it did it “in a measured fashion” in order to ensure that inflation did not rekindle.

    It was a new approach that the former Governor says had the support of the Government led by Prime Minister Bob Hawke and Treasurer Paul Keating.

    “It is significant that in March 1991, in the middle of the recession, the Government was prepared to announce a further phased reduction in tariffs, a move that would reduce inflation but do nothing to support the economy,” he said.

    In his lecture Mr Macfarlane is at pains to point out that the bank did not set out to create a recession in order to reduce the inflation rate. It merely took advantage of the opportunity that the recession presented it with.

    “The experience throughout the developed world… demonstrates an unfortunate but inescapable fact – no country with an entrenched inflation problem has significantly reduced inflation without it occurring in the context of a recession. While everyone would like to find a softer way of doing so, without incurring the unemployment costs of a recession, no-one has found such a way.”

    The former Governor says he finds it odd that in the United States the success of the Fed Chairman Paul Volcker in destroying inflation in early 1980’s is viewed positively while in Australia “the equivalent disinflation of the early 1990s tends to be viewed as a monetary policy mistake.”…”

  35. I don’t agree with market monetarists who don’t like fiscal policy, but I don’t agree with the “pushing on a string” meme either. This best approach is monetary and fiscal policy working in concert. See Abenomics and Japan.

  36. “My views on this issue were formed by the experience of the late 20th century, and in particular, the recession that began in 1990, following steep increases in interest rates. Having planned a “short, sharp, shock”, the RBA started cutting rates in January 1990.

    They didn’t go for 25 basis point moves in those days. Over the period to December 1992, rates were cut by more than 12 percentage points, from 17.5 per cent to 5.25 per cent. Over the same period, unemployment rose from 6 per cent to 10.9 per cent, a record for the period since the Depression. As I said in the previous post, tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.”

    1) Nominal interest rates are a terrible measure of monetary policy stance.

    The following is a graph of Australia’s nominal short term interest rates (blue), year on year CPI inflation rate (red) and real short term interest rates (green) from 1987 through 1996:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134407&category_id=0

    Year on year CPI inflation fell from 8.7% in 1990Q1 to 0.3% in 1992Q4. Since short term interest rates fell from 15.8% to 5.7% during this time period this means real short term interest rates only fell from 7.1% to 5.4%.

    The 1993 and 1999 versions of the Taylor Rule assumes that a real interest rate of 2% is the long run real neutral interest rate. Admittedly the Taylor Rule’s assumptions may not be applicable to Australia, but 5.4% is still a very high rate of real interest by any standards. The lowest that Australia’s real short term interest rates fell to in the early to mid-1990s was 2.3% in the second half of 1995.

    2) Even real interest rates are a very poor measure of monetary policy stance.

    One way of thinking about this is the Taylor Rule, which is simple rule for the appropriate level of the policy interest rate given the gap between inflation and the target inflation rate (say 2%) and the gap between unemployment and the natural rate of unemployment. The following is the 1999 version of a Taylor Rule for Australia (red) graphed along side the short term interest rates (blue) and the residual (green) from 1987 through 1996:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134410&category_id=0

    In constructing this Taylor Rule I’ve assumed the long run real neutral interest rate is 2% and that Australia’s natural rate of unemployment was 8% throughout this period. The OECD’s estimate of Australia’s NAIRU varies from 7.4% to 8.5% during this period, increasing from it’s low prior to the recession and peaking at its high when the unemployment rate peaked. Furthermore I’ve assumed an Okun’s Law coefficient of 1.8 based on Lawrence Ball’s recent estimates for Australia for 1980-1995 (“Okun’s Law: Fit at Fifty?”).

    Note that the residual increased from (-1.5%) in 1990Q1 to 9.8% in 1992Q4 and would not get close to 0% until mid-1995. Regardless of one’s opinion of the various parameters one thing is clear, by the standards of a simple rule monetary policy got much tighter, not easier from 1990Q1 to 1992Q4.

    And the policy rate never fell below 4.75% in the early to mid-1990s, so Australia didn’t have the excuse of the zero lower bound. Based on Ian Macfarlane’s recollections above, monetary policy was intentionally tight during this period as a means of reducing the inflation rate.

  37. @TravisV

    There’s a lot more when it’s released from moderation. In the meantime you can read it all in the comments on the most recent post on The Money Illusion (“Why would tapering hurt Indonesia?”) or in the comments on today’s links of Economist’s View (“Links for 08-27-2013”).

  38. @SJ

    Long term perhaps. However I’d be looking to setup a proxy for value similar in many ways to the bancor as proposed by Keynes. Perhaps an ECU style basket weighed with USD, EUR, CNY and Gold.

  39. I am rapidly losing interest in economics. The notion that you can do economics, especially mathematical economics, in a vacuum without considering class, government, law and force is a nonsense. Political economy is a different matter. Now that is a real subject. Economics as current bourgeois economics is piffle.

  40. Ikonoclast,

    I think you’re wrong. I think we can simplify macroeconomics to “Wages are sticky. Therefore, money matters. The central bank has to print enough money to ensure moderate NGDP growth. If it doesn’t, then people will resist nominal wage cuts and there will be mass unemployment.”

    No additional analysis involving class, government, law or force is necessary.

  41. Seems pretty self-evident, doesn’t it? I certainly do not remember as devastating a hit to “animal spirits” as we saw in 2008-2009, especially coming on top of the erosion of confidence in an economy already suffering from serious issues — the rapid loss of manufacturing, the outsourcing trend, erosion of labor influence, wage stagnation, health insurance cost explosion, college cost explosion, abandonment of defined-benefit pensions and employer sponsored health insurance — that was fairly obviously being propped up by the real estate bubble. On top of it all, despite the alleged positions of one of the parties as more populist in economics, both parties have been beholden to the money-providing elite that created the mess and, therefore, bereft of solutions.

  42. @TravisV

    Who cares whether wages are sticky in this situation (since 2008)? Suppose they were not sticky and employers were free to drop nominal wages as far as they wanted? What good would that have done when demand for what they can produce had plummeted — and promised to decline even more with everyone making still less income? If employers only needed so many workers to produce what was being demanded, they wouldn’t hire more just because they didn’t cost as much.

  43. @Mark A. Sadowski

    A case of traps for young players, I’m afraid. In those days, the CPI included mortgage interest rates, so raising (lowering) interest rates produced an illusory increase in measured inflation. The actual reduction was more like 3.5 percentage points, from 6 to 2.5.

    On the second point, it’s a semantic difference, not a real one. I’m using an absolute measure of the stance of policy, you’re measuring it relative to to the Taylor rule which (in my terminology) prescribes expansion when unemployment rises.

  44. ZAC (namesake)

    “A proper atheortical evaluation of the evidence would look at multiple countries over multiple time periods”

    What would you be evaluating in an ‘atheoretical’ evaluation at ‘multiple countries’ over multiple time periods?

    Your statement seems to me to be a spurious assertion about a methodological problem because, if someone talks about ‘a recession’ or a ‘deep recession’ or ‘fiscal’ and ‘monetary policy’, it is quite obvious to me the author is talking in the context of macro-economic theoretical frameworks.

    “For example there is strong evidence that easing monetary policy (going off the gold standard) ended the great depression. Not too mention current evidence from Japan and the US on the effectiveness of monetary policy – even at the zero lower bound.”

    Really? Not all ‘countries’ (as defined by the local populations, rather than imposed by the legal notions of imperial powers) were members of the ‘gold standard’ club. Ignoring a large segment of the world’s population hardly seems to be an improvement on methodological grounds you suggest.

    Furthermore, if you look into details of the functioning of the ‘gold standard’ you will find it hardly ever worked exactly. Moreover, the ‘gold standard’ should not be confused with the ‘gold exchange standard’. And, while we are at it, the subsequent Bretton-Wood system with the US-dollar being convertible into gold, collapsed because DeGaulle called the US bluff. (The US effectively defaulted.) And the ‘Great Moderation’ collapsed on itself because the financial system (proverbial Wall Street Bankers and their associates, the rating agencies) built a huge delusion of ‘values’.

    My second question to you is: Are the financial contracts underlying these ‘great moderation values’ money or not?

    These financial contracts did affect quantities and prices, including relative prices, denominated in currency units.

    “I’ve read Keynes, but he is not the solution to all the worlds problems (he is after all 70+ years out of date!)”

    Quite right, there were major developments in both Walrasian and non-Walrasian equilibrium (solution concept) theory.

    My third question to you is: Why do you ignore these advances. In particular, why do you ignore ‘critical points’ in the time series, by focusing on “the current evidence” ?

    The only points in time of interest for questions about the stability of a system are ‘critical points’. (See for example the work by authors including, M.C. Blad, , M.C. Blad and C. Zeeman, M.C. Blad and A. Kirman, Malinvaud and Benassy and Malinvaud , V. Boehm – in no particular order, from the 1970s and 1980s).

    Empirically, you might not easily observe the critical points, unless you work with daily data.

    “Why does fiscal policy work when monetary doesn’t for example?”

    Fiscal policy can be directed to individuals and individual non-financial businesses. To the best of my knowledge, monetary policy has never been implemented via a helicopter from which notes and coins can be dropped into the corresponding locations.

    If one focuses only on aggregates of interest to the private and public financial managers, nominal GDP, then the selectivity advantage of fiscal policy over monetary policy (taking out critical points) is of no interest, because it doesn’t matter whether most of the people in a society are homeless or destitute in some other way as long as the ‘aggregate’ doesn’t drop in numerical value for two (or three? I can’t remember) consecutive quarters. (Why any economist wants to chase ever increasing real numbers – an abstract object – is a mystery to me. But I can understand very well why financial managers want to chase such numbers if their personal income and non-monetary welfare depends on it)

    I suppose the answer to your question “Why does fiscal policy work when monetary doesn’t for example?” ultimately depends on your notion of ‘deep recession’.

  45. @TravisV

    You want to talk about sticky wages and not talk about the systems and relations of ownership, production and labour in our society. An idea like sticky wages is empty of content without that context.

    You want to ignore the issue of force when force clearly determines who drills for oil where, who owns the fields and who gets the benefits. As an example there is the news headline;

    “Israel has given permission for an American based energy company to drill for oil in the Golan Heights, a plateau it captured from Syria in 1967. ”

    Now, I don’t want to start an Israel debate at all. That would be very derailing. This is merely to illustrate that force (one of the parameters of anlysis you rejected) conditions when, where and how markets, production and benefits all operate… and indeed who gets the work and wages… and who gets the profits.

    As I said, economics taken alone is all but meaningless. Political economy is the real subject perhaps twinned with biophysical economics to link it to the real physical world. All of this talk about economics that occurs as if the economy was free standing from both the biophysical world and from the world of politics, administration, law, custom, class, force, persuasion, exploitation and so on is just so much bumpf. There is no such thing as a value free “economic desision” or a value free “economic judgement”.

    The mere fact you are talking about wages without pondering why wage labour and capital ownership exist and what their existence might mean illustrates the paucity of all such analysis in economics which is blind to its own ideological premises and mistakes particular constructed historical and social conditions for universal, unchanging conditions.

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