Robert Waldmann, WADR, Maybe You Really Should Calm Down

Responding to this recent post of mine, Robert Waldmann wrote a post of his own with a title alluding to an earlier post of mine responding to a previous post of his. Just to recapitulate briefly, the point of the post which seems to have provoked Professor Waldmann was to refute the allegation that the Fed and the Bank of Japan are starting a currency war by following a policy of monetary ease in which they are raising (at least temporarily) their inflation target. I focused my attention on a piece written by Irwin Stelzer for the Weekly Standard, entitled not so coincidentally, “Currency Wars.” I also went on to point out that Stelzer, in warning of the supposedly dire consequences of starting a currency war, very misleadingly suggested that Hitler’s rise to power was the result of an inflationary policy followed by Germany in the 1930s.

Here is how Waldmann responds:

I do not find any reference to the zero lower bound in this post.  Your analysis of monetary expansion does not distinguish between the cases when the ZLB holds and when it doesn’t.  You assume that the effect of an expansion of the money supply on domestic demand can be analyzed ignoring that detail. I think it is clear that the association between the money supply and domestic demand has been different in the USA since oh September 2008 than it was before.  This doesn’t seem to me to be a detail which can be entirely overlooked in any discussion of current policy.

Actually, I don’t think that, in principle, I disagree with any of this. I agree that the zero lower bound is relevant to the analysis of the current situation. I prefer to couch the analysis in terms of the Fisher equation making use of the equilibrium condition that the nominal rate of interest must equal the real rate plus expected inflation. If the expected rate of deflation is greater than the real rate, equilibrium is impossible and the result is a crash of asset prices, which is what happened in 2008. But as long as the real rate of interest is negative (presumably because of pessimistic entrepreneurial expectations), the rate of inflation has to be sufficiently above real rate of interest for nominal rates to be comfortably above zero. As long as nominal rates are close to zero and real rates are negative, the economy cannot be operating in the neighborhood of full-employment equilibrium. I developed the basic theory in my paper “The Fisher Effect Under Deflationary Expectations” available on SSRN, and provided some empirical evidence (which I am hoping to update soon) that asset prices (as reflected in the S&P 500) since 2008 have been strongly correlated with expected inflation (as approximated by the TIPS spread) even though there is no strong theoretical reason for asset prices to be correlated with expected inflation, and no evidence of correlation before 2008. Although I think that this is a better way than the Keynesian model to think about why the US economy has been underperforming so badly since 2008, I don’t think that the models are contradictory or inconsistent, so I don’t deny that fiscal policy could have some stimulative effect. But apparently that is not good enough for Professor Waldmann.

Also, I note that prior to his [Stelzer’s] “jejune dismissal of monetary policy,” Stelzer jenunely dismissed fiscal policy.  You don’t mention this at all.  Your omission is striking, since the evidence that Stelzer is wrong to dismiss fiscal policy is overwhelming (not overwhelming enough to overwhelm John Taylor but then mere evidence couldn’t do that).  In contrast, the dismissal of monetary policy when an economy is in a liquidity trap is consistent with the available evidence.

It seems to me that Waldmann is being a tad oversensitive. Stelzer’s line was “stimulus packages don’t work very well, and monetary policy produces lots of fiat money but not very many jobs.” What was jejune was not the conclusion that fiscal policy and monetary policy aren’t effective; it was his formulation that monetary expansion produces lots of fiat money but not many jobs, a formulation which, I believe, was intended to be clever, but struck me as being not clever, but, well, jejune. So I did not mean to deny that fiscal policy could be effective at the zero lower bound, but I disagree that the available evidence is consistent with the proposition that monetary policy is ineffective in a liquidity trap. In 1933, for example, monetary policy triggered the fastest economic expansion in US history, when FDR devalued the dollar shortly after taking office, an expansion unfortunately prematurely terminated by the enactment of FDR’s misguided National Industrial Recovery Act. The strong correlation between inflation expectations and stock prices since 2008, it seems to me, also qualifies as evidence that monetary policy is not ineffective at the zero lower bound. But if Professor Waldmann has a different interpretation of the significance of that correlation, I would be very interested in hearing about it.

Instead of looking at the relationship between inflation expectations and stock prices, Waldmann wants to look at the relationship between job growth and monetary policy:

I hereby challenge you to show data on US “growth”  meaning (I agree with your guess) mostly employment growth since 2007 to someone unfamiliar with the debate and ask that person to find the dates of shifts in monetary policy.  I am willing to bet actual money (not much I don’t have much) that the person will not pick out QEIII or operation twist.    I also guess that this person will not detect forward guidance looking at day to day changes in asset prices.

I claim that the null that nothing special happened the day QEIV was announced or any of the 4 plausible dates of announcement of QE2 (starting with a FOMC meeting, then Bernanke’s Jackson Hole speech then 2 more) can’t be rejected by the data. This is based on analysis by two SF FED economists who look at the sum of changes over three of the days (not including the Jackson Hole day when the sign was wrong) and get a change (of the sign they want) whose square is less than 6 times the variance of daily changes (of the 10 year rate IIRC).  IIRC 4.5 times.  Cherry picking and not rejecting the null one wants to reject is a sign that one’s favored (alternative) hypothesis is not strongly supported by the data.

I think that the way to pick out changes in monetary policy is to look at changes in inflation expectations, and I think that you can find some correlation between changes in monetary policy, so identified, and employment, though it is probably not nearly as striking as the relationship between asset prices and inflation expectations. I also don’t think that operation twist had any positive effect, but QE3 does seem to have had some. I am not familiar with the study by the San Francisco Fed economists, but I will try to find it and see what I can make out of it. In the meantime, even if Waldmann is correct about the relationship between monetary policy and employment since 2008, there are all kinds of good reasons for not rushing to reject a null hypothesis on the basis of a handful of ambiguous observations. That wouldn’t necessarily be the calm and reasonable thing to do.


15 Responses to “Robert Waldmann, WADR, Maybe You Really Should Calm Down”

  1. 1 Marcus Nunes February 17, 2013 at 2:40 pm

    David, maybe Waldman is “blind”, for there is lot´s of evidence on MP and employment. For example:


  2. 2 maynardGkeynes February 17, 2013 at 7:25 pm

    The purpose of monetary policy was to stimulate the housing market, which would have created employment, but when that didn’t work, what we got was the booby prize of pumping up the stock market, which Bernanke then claims as a victory. Ha! No wonder he is so popular on Wall St, and an object of derision, if not contempt, almost everywhere else.


  3. 3 Christiaan Hofman February 18, 2013 at 4:09 am

    Also, the actual announcement of monetary policies were preceded by long times of expectations of those announcements. And as the effect of monetary policies under current conditions goes mostly, if not exclusively, through expectations (of inflation), as you and many other economists are arguing, those expectations maybe almost as relevant as the announcements themselves. So not seeing much direct effect of the announcement would not be very surprising, even if they do work, because they were fully expected. Personally, I think an announcement to do the exact opposite (monetary tightening) actually *would* have made a clear effect on the asset prices, because it was not expected. But luckily we have not tested that.


  4. 4 maynardGkeynes February 18, 2013 at 5:31 am

    What effect on asset prices? Look at the evidence. When it’s only affecting financial assets (largely the stock market and gold), and missing real assets (like housing), something else is going on that has little or nothing to do with monetarism, or at least the “beneficial” monetarism of Friedman. No, this looks to me like what you would expect to see when there has been a wealth transfer from one group of wealth holders to another, in this case, savers to Wall St, and banks. That is why it has not worked to create jobs, and probably never will.


  5. 5 W. Peden February 18, 2013 at 5:32 am

    Christiaan Hofman,

    One could look at the 2010 tightening by the ECB. That didn’t work well.


  6. 6 Diego Espinosa February 18, 2013 at 8:57 am

    You cite the link between inflation expectations and asset prices as evidence that monetary policy is ‘working”. How strong is the (recent) link between asset prices and rgdp growth and unemployment? Presumably there are two causal drivers: the wealth effect and Tobin’s Q.

    Tobin’s Q seems to be having a weak effect. That is, as the stock market has rallied strongly, yet business investment ex-structures has plateaued. Further, the volume of equity IPO’s is still depressed.

    On the wealth effect, the payroll tax cut expiration offers a nice experiment. Stocks are up but middle class disposable income will take a hit. If the wealth effect is material, we should see spending accelerate in coming months. (So far, the evidence points in the other direction).

    Lastly, if the drop in real yields from 2010-2012 reflected a steady increase in market “pessimism”, then its hard to see how, in equities and HY, Fed policy has driven a steady increase in market optimism.


  7. 7 Hellestal February 18, 2013 at 5:38 pm

    One other point to note is that the Fed has not made any open announcements to target something like NGDP growth, which would work more strongly to shape expectations than the previous QE attempts, since QE might be seen by the markets as a temporary (and therefore weak) measure.


  8. 8 Robert Waldmann February 19, 2013 at 6:39 pm

    I haven’t really read this post (just skimmed it). I note your question on breakevens and stock prices. I haven’t 2 through to which are, at legasti, sincere.
    1) I don’t think that stock prices tell us much about anything. In particolar they have a low correlation with future GDP and employment growth IIRC. I through this question was settled in 1987.
    2) I don’t think that monetary policy has much effect on expected inflation (except through past inflation). I note that event studies (in the huge Woodford paper) show Tony effects 3 out of 4 (or 4 out of 5) have the expected sign.
    3) I think breakevens are vero well explained by lagged inflation, lagged core inflation and lagged changes in the price of petrolem. I don’t see any effects of shifts of monetary policy in this graph

    4) I also think that in the early 80s that monetary policy shifts affetterà expected inflation via high interest ratea caused high unemployment which caused low inflation which caused low expected inflation.

    5) I am not convinced that any model developer altre the * adaptive* expectations augmented Phillips curve is as empirically successful.

    Are you sure that we don’t disagree all that much ?

    I promise this comment is sincere and not exaggerated.


  9. 9 maynardGkeynes February 19, 2013 at 7:37 pm

    When the Fed’s stated policy is to juice equity prices, that makes using stock prices as a leading indicator of the real economy a fool’s game. This is so obvious that I am reluctant even to post the point, except that it seems to be both Bernanke’s and UM’s main piece of evidence that current monetary policy is working. I find this remarkable, and not in a good way.


  10. 10 David Glasner February 21, 2013 at 9:10 pm

    Marcus, Thanks for the link. Great stuff! I really do need to read your book!

    maynardGkeynes, So would you be happier if stock prices were at the level they were at in March 2009 (when QE was first announced with the S&P 500 at about 650)?

    Christian, Good point.

    maynardGkeynes, Excuse me stocks are not just financial assets, they are claims of ownership on businesses that own real stuff: land, buildings, factories, machines, etc.

    W. Peden, No it didn’t; not well at all.

    Diego, I think the reason that Tobin’s Q is having a weak effect is because entrepreneurial expectations of future demand are still pessimistic. This seems to be changing very slowly, but I am beginning to feel that we may be about to turn a corner, except that the Fed seems to be losing its nerve and the ongoing fiasco that is known taking place in Washington may be having a depressing effect.

    Hellestal, Point well taken.

    Robert, The transmission seems a bit garbled, but I will respond as best I can. I agree that stock prices are not good predictors of the future, but sometimes they are right. At any rate, since 2008 there has been a very close correlation between expected inflation and stock prices, a correlation not predicted by the simple theory of finance, and not observed previously. That requires an explanation. Event studies, as some of my commenters have pointed out are difficult to perform, because it is not always clear when the event takes place, inasmuch as the announcement of a new policy may be anticipated before the announcement (or it may not).

    Thanks for the link, I will have to look at it more closely before commenting.

    I agree with your point 4.

    I meant that we don’t disagree that much about the effect of fiscal policy at the zero lower bound. We obviously do disagree about whether monetary policy is effective.

    I trust you.

    maynardGkeynes, Why do you think that the Fed is more successful at juicing equity prices now than in it was in the 1970s?


  11. 11 maynardGkeynes February 21, 2013 at 11:04 pm

    @ DG: My first candidate would be Regulation Q, Reg Q had been imposing low and often negative real interest rates on demand deposits throughout much of the 1960s and 1970s, when inflation began to pick up significantly. Such demand deposits constituted a huge swath of the investible funds of the era. (Remember, mm funds did not exist at the time,) Reg Q would have muted the marginal impact of changes to the FF rate on equity prices to a significant degree. In effect, equities were already being juiced by the low, and often negative real interest rates imposed by Reg Q on savers. True, equity prices were quite low in this period, but in all probability they would have been even lower had it not been for Reg Q.


  12. 12 maynardGkeynes February 22, 2013 at 7:27 am

    Addendum/clarification of above comment — I was actually referring not just to demand deposits, but to Regulation Q’s imposition of maximum interest rates on various other types of bank deposits, such as savings accounts and NOW accounts. Both impacts of Reg Q were significant in this regard.


  1. 1 Robert Waldmann, WADR, Maybe You Really Should Calm Down | Fifth Estate Trackback on February 19, 2013 at 5:06 pm
  2. 2 Some Popperian (and Kuhnian!) Responses to Robert Waldmann | Uneasy Money Trackback on March 1, 2013 at 9:38 am
  3. 3 Some Popperian (and Kuhnian!) Responses to Robert Waldmann | Fifth Estate Trackback on March 1, 2013 at 1:21 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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