If Policy Won't Succeed, Does That Mean Policy Can't Succeed?

Includes: FXY, TIP
by: Scott Sumner

Early on I decided that it was very unlikely that Fed policy would rescue the economy. The markets predicted that Fed policy would remain suboptimal, and the markets are usually right. So what implications can we draw from this pessimism?

1. Some argue that the Fed is too hawkish to change its policy, and even if it did the new policy wouldn’t be credible. Thus we needed fiscal stimulus.

2. Of course Congress is much too deficit-phobic to enact effective fiscal stimulus, and the Fed’s 2% inflation target would neutralize it even if they did. So any sort of demand stimulus is futile.

3. Some argue that this means we should focus on structural changes, supply-side reforms like a simple, loophole-free consumption tax. But of course Congress is much too corrupt to ever do that, so there is no prospect of supply-side reforms.

4. Some argue that there’s no point in even getting out of bed in the morning. After all, life is just M iterations of N events with K degrees of intensity. Life has no meaning. In any case, we have no free will, so we are merely going to play out the motions that the atoms in our bodies are compelled to undertake according to the laws of physics plus quantum randomness.

Or . . .

Or we can pretend that the universe is charged with meaning. That our actions do make a difference, that my blogging might lead Richard Fisher to have a road to Damascus experience, where he wakes up one morning exclaiming “Yes, I see the light, Scott Sumner has been right all along.”

I’ve spent my life studying the Great Depression, so I fully understand that my crusade will likely fail, at least in the short run. If Keynes failed when he was alive, why should I expect to succeed? So why keep blogging? I suppose because if I stop blogging that means there is no hope for communicating with my fellow economists, indeed my fellow human beings. In that case there really would be no reason to get out of bed in the morning. I have to hope that someday, even if 100 years from now, these ideas will be accepted by the profession. And when that happens, the monetary-policymakers will surely follow, as they always do. The Fed has always stuck close to the consensus views of macroeconomists, and always will.

All this was triggered by a recent Tyler Cowen post sent to me by David Levey, which seems to confuse what will happen with what can happen:

4. The Fed, at least right now, is not able to make a credible commitment toward a significantly more expansionary policy for very long. Putting aside the more general and quasi-metaphysical issues with precommitment, just look at the key players. Bernanke leaves the scene in 2014 and is a lame duck at some point before then. Obama could be gone by the end of this year, and in any case is unlikely to be reelected with a thundering mandate. Romney’s actual views on monetary policy are a cipher. Either house of Congress could change hands. There is less public support for a consensus view of the Fed today than in a long time.

On this issue I feel Scott Sumner is insufficiently Sumnerian. He correctly stresses the role of expectations and credible commitments, but I still do not understand why he does not accept the implied pessimism in this, at least for May 2012. 2008-2009 was the time to act, in a Ludwig Erhard/Douglas MacArthur/Alexander Haig “I’m in charge now and we’re doing ngdp targeting try to challenge me in the chaos and confusion” sort of way.

Oh I do accept the implied pessimism, but I’m playing a much longer game.

Let’s return to this “quasi-metaphysical” issue of commitment. Paul Krugman has famously argued that the BOJ can’t inflate, because any commitment to inflate wouldn’t be believed. And why wouldn’t it be believed? Because everyone knows they don’t want to inflate, and would renege on any promises at a future date. OK, but what if they really changed their minds about the desirability of higher inflation? Krugman would argue that the markets would not believe them. Actually that’s wrong, as there’s all sorts of things they can do right now to show the “change of mind” (such as currency depreciation.) And it’s wrong because the markets know the “mind” of the central bank much better than the central bank knows it’s own mind. But let’s say he was right. I’d still say he was confusing can’t with won’t. The only solution to a central bank bound and determined to produce deflation is to change them (via change in attitude or change in mandate or change in personnel) into a central bank that isn’t bound and determined to produce deflation. It does no good to throw up one’s hands and say “they can’t because they won’t.” In legal terms that’s called “the insanity defense.” Have we reached the point where we are going to judge monetary policymakers “not guilty due to insanity?”

If I had to summarize my blog in one word, it would be “j’accuse.” (Or is that two words?)

I’m going to make 4 arguments for ignoring Tyler’s advice and charging ahead with my Fed/ECB/BOJ bashing:

1. Public pressure is part of the policy process

2. Failure is a matter of degree

3. Educating the public

4. Playing the long game

Some people have pointed to Fed officials indicating (sotto voce) that they’d like to do a bit more, but there’s oh so much public pressure from the inflation hawks. This argument is apparently supposed to make me see that my crusade is futile. But it does just the opposite. If hawkish pressure is restraining the Fed from easing, then market monetarist and enlightened Keynesian pressure can push back the other way. No one can deny that reporters are increasingly pressing Bernanke at his press conferences on the obvious inconsistency between the Fed’s unemployment objective of 5.6% and inflation objective of 2%, with a policy that is currently expected to undershoot on both jobs and inflation. But there’s much more work to be done. We still need to educate roughly 50% of economists, and President Obama, and much of Congress, all of whom support more stimulus but think the Fed’s out of ammo.

Even if we don’t “succeed” perhaps we’ll cause the Fed to fail a little less badly. Tyler’s right that there are no longer $1 trillion bills lying on the sidewalk, as in 2008-9.

I still believe in a looser monetary policy, I just think that what we can get for that now is much much less (a fifth? a tenth?) of what we could have received in 2008-2009.

But that means there are still $100 billion bills lying around, well worth picking up. Heck, I’m old enough where I still pick up non-copper coins.

Some people say “yes, we see your point, but there’s nothing that can realistically be done at this point.” Actually, people don’t agree with me. Few agree that tight money caused the recession. Few agree that the fiscal multiplier is zero, although the idea is beginning to appear in unexpected places. Few agree with me that saving is not contractionary. Indeed here’s Tyler:

3. As banking and finance heal, debt overhang is less of an AD problem. The debt repayments get rechanneled into investment, rather than falling into a black hole.

Yes, saving can be deflationary under money supply or interest rate targeting, but that’s not Fed policy. Bernanke is targeting inflation at 2%, with perhaps some weight given to employment. Under inflation targeting saving is not contractionary, regardless of the weight given to jobs.

Many people wrongly think that monetary stimulus would hurt older people. Not so, Social Security recipients are protected via indexing, and those living off capital will do better is a healthy economy where returns to capital are higher. If part of the cause of our malaise is public pressure caused by false theories, then correcting those false ideas has real value.

And then there’s the long game. My hope is to get market monetarist ideas into the textbooks, where they might influence the next generation. (Soon I hope to be able to announce progress on that front.) I’m shocked when people say that there’s no hope of convincing the world’s central banks that NGDP targeting is a good idea. It was only a few decades ago that the economics profession convinced the world’s central banks that inflation targeting was a good idea. Furthermore, many central banks already do “flexible inflation targeting,” which is really close to NGDP targeting. Furthermore, until the interest rate hit the zero bound in 2008 the Fed has been doing something pretty close to NGDP targeting for 25 years. Furthermore the idea of a single target that addresses both sides of the dual mandate has great appeal, as both the left and the right now agree that the discretion associated with the Fed’s current approach to the dual mandate leads to undesirable policy uncertainty. Furthermore NGDP targeting has already been praised by lots of well known conservative economists and lots of well known liberal economists. And after all this we are to believe it can never happen? People need to use their imaginations a bit more. Change is the only constant in the world of central banking. Never say never.

Tyler also has this to say:

This will sound counterintuitive, but we should be debating real factors more and nominal factors less, all the more as time passes.

Circa 2012, monetary policy matters less every day. You might feel outraged by that reality, and by the policy omissions from the past, but still monetary policy matters less every day. That point follows from basic insights from Milton Friedman and Irving Fisher, or for that matter modern most mainstream neo-Keynesian models. By the way the labor force participation rate declined in the latest round of data, and will likely remain low for a good while, so I am not convinced by graphs which beg the question about the size of the output gap.

I also stress that I haven’t changed my views at all, not since 2008-2009, and not since my early column on Scott Sumner (someday I’ll do a post on why I wrote that column in terms of prices rather than ndgp). Same views, but I do see the clock ticking on the wall.

This entire point is hardest to grasp in a mental framework of “accumulated blame,” easiest to grasp within a disciplined, non-moralizing look at marginal products.

He doesn’t realize that he’s preaching to the choir (with me, not Krugman.) I recently wrote in the comment section that Tyler hadn’t changed his views. I have consistently argued that monetary stimulus becomes less effective as more time passes. I’ve gone from recommending we go all the way back to the trend line to (more recently) only 1/3 of the way back. I do occasionally post on supply-side issues, and agree that they are what really matters in the long run, what separates North and South Korea. But I have no special expertise in non-monetary areas of economics.

I only have two choices. Keep focusing on those $100 billion bills on the sidewalk, or give up blogging and go back to being an obscure prof at Bentley, playing out the string while watching contemporary Asian art films. M iterations of N events with K degrees of intensity. A blob of buzzing sub-atomic particles in a universe too perplexing to understand.

So what shall I do, Tyler?