Market monetarism is not (primarily) about NGDP targeting
By Scott Sumner
I was very excited to read about a new San Francisco Fed study that supported one key tenet of market monetarism. A number of commenters seemed confused as to why it was a big deal. To see why, we need to consider what market monetarism is all about.
I think it’s fair to say that my blogging is associated with the proposal for NGDP level targeting. It’s true that I favor that policy, as do many other market monetarists. But I also think the Fed did a pretty good job during 1983-2007, without an explicit NGDP target. And I believe that it’s quite possible that a closely related policy, such as targeting total nominal labor compensation per working age adult, might be slightly better.
In fact, market monetarism is mostly about another set of ideas:
1. Expected NGDP growth is the best measure of the stance of monetary policy.
2. Monetary policy causes changes in NGDP.
3. Market indicators are better than structural models at predicting NGDP growth.
4. A fiat money central bank never runs out of ammunition.
5. Interest on reserves is contractionary, negative IOR is expansionary.
6. Market interest rates are not a reliable indicator of the stance of monetary policy.
7. Interest rate targeting doesn’t work well at the zero bound, and hence interest rates are not a reliable policy tool.
8. Fiscal stimulus is usually offset by monetary policy when the central bank is targeting NGDP (except for supply-side effects.)
Of course this is just my list, and not all market monetarist agree with each and every point. But notice that NGDP targeting is not on the list. I don’t see it as a core idea, although I freely concede that it’s a part of the appeal of MM.
Why was the San Francisco Fed paper such a bombshell? Not because they suggested the Wicksellian equilibrium interest rate might be negative 2.1%. As some commenters pointed out, others have made similar claims. Instead the real breakthrough was that the SF Fed paper conceded that this meant policy was actually contractionary (and by implication had been contractionary since 2008.)
When we claimed that money was very tight in 2008-09, people thought we were crazy. Almost everyone else (liberal, conservative, Keynesian, Austrian, old monetarist, etc.) thought policy was expansionary, and that the recession was caused by the financial crisis. If money was tight in 2008-09, then it’s quite plausible that the Great Recession was caused by Fed policy, not financial turmoil.
Much of market monetarism is basic textbook economics, which has been forgotten by the rest of the profession (with a few exceptions such as Robert Hetzel.) Low interest rates don’t mean easy money. Monetary policy is still highly effective at zero rates. An inflation targeting central bank will generally offset the impact of fiscal stimulus. We used to teach this stuff to our students back in 2007.
Another EC101 idea is that there is nothing wrong with trade “imbalances.” The current account deficit represents the gap between domestic investment and domestic saving, and there is no reason to expect that gap to be zero for a household, a small town, a big city, a province or a country. It’s simply not a problem. Except most economists seem to have convinced themselves that “imbalances” are a problem. Tyler Cowen has a new post today, which quotes someone pushing back on this bizarre conventional wisdom. Here is the Martin Sandbu quote he provides:
In an integrated regional economy like Europe’s, it is improbable that every country is able to offer just the right investment opportunities to match the country’s own savings. Countries that want to save more than they invest need to find a productive outlet for their savings. Countries that can productively invest more than they are willing or able to save must find funds from the outside. And so long as the fund that flow across borders are invested well, such flows can benefit lenders and borrowers alike. Indeed, large asymmetries are not only compatible with efficient economic development but they can be vital for making it happen: Norway’s current account deficit reached 14 per cent of GDP in the late 1970s, but the capital is imported enabled it to build up one of the world’s largest oil industries.
Paul Krugman made a career out of defending EC101, back in the 1990s (now he tends to do the opposite.) Here’s Krugman back in 1996:
(ii) Adopt the stance of rebel: There is nothing that plays worse in our culture than seeming to be the stodgy defender of old ideas, no matter how true those ideas may be. Luckily, at this point the orthodoxy of the academic economists is very much a minority position among intellectuals in general; one can seem to be a courageous maverick, boldly challenging the powers that be, by reciting the contents of a standard textbook. It has worked for me!
And the same is true of market monetarism; we are mostly trying to defend basic textbook ideas that have been almost completely abandoned by the rest of the profession. We have to get back to a place where it’s not “bizarre” to claim that a big fall in AD might have been caused by tight money.