Scott Sumner Cries Out
By Arnold Kling
He wants the Fed to do whatever it can to try to get prices headed up rather than down. His best argument:
What do we have to lose?: We can get rid of interest on bank reserves (and consider a penalty rate), set an explicit nominal target, and engage in quite substantial quantitative easing using indexed bonds (and perhaps a few foreign government bonds) without incurring much risk at all. And even if we have to eventually move more heavily into assets more exposed to U.S. inflation risk (long term T-bonds) I don’t see how those risks are any worse that what we are now doing at the Fed. Isn’t a risky policy that has a good chance to boost AD superior to a risky policy that has little chance of achieving that goal?
Pointer from Tyler Cowen, who is much more enthusiastic than I am about Sumner’s ideas.
I don’t buy the monetarist story here. Sumner’s thesis is that causality runs from slow money growth to slow GDP growth to financial collapse. I believe the causality runs in exactly the opposite direction.
In the old days, a monetarist would pick a definition of the money supply, plot its growth rate, and predict GDP a few quarters ahead. Those of us who were skeptical were always on the lookout for folks who would change their choice of money measure every few years to demonstrate better fits with the data.
But the real problem came when the movements in money were contemporaneous with or lagged behind the movements in GDP. Milton Friedman famously said that there were “long and variable lags” between changes in money growth and changes in the growth rate of nominal GDP. I remember at some point one of his opponents (I want to say Franco Modigliani, but I would not swear to it) asked sarcastically if the long and variable lags had become long and variable leads? That latter quip is the one that I would throw back at Sumner.
I’m describing myself these days as the world’s only libertarian Keynesian. In any case, I don’t go for the notion that you can just pour money all over the economy and generate a recovery. I think that we have shifted out of a regime with a low risk premium and into a regime with a high risk premium. I think the only way out is for profits to increase, which would lead gradually to business expansion, rehiring, and more overall economic activity. See Would Keynes Have Supported the Stimulus Bill?