What’s Wrong with Monetarism?

UPDATE: (05/06): In an email Richard Lipsey has chided me for seeming to endorse the notion that 1970s stagflation refuted Keynesian economics. Lipsey rightly points out that by introducing inflation expectations into the Phillips Curve or the Aggregate Supply Curve, a standard Keynesian model is perfectly capable of explaining stagflation, so that it is simply wrong to suggest that 1970s stagflation constituted an empirical refutation of Keynesian theory. So my statement in the penultimate paragraph that the k-percent rule

was empirically demolished in the 1980s in a failure even more embarrassing than the stagflation failure of Keynesian economics.

should be amended to read “the supposed stagflation failure of Keynesian economics.”

Brad DeLong recently did a post (“The Disappearance of Monetarism”) referencing an old (apparently unpublished) paper of his following up his 2000 article (“The Triumph of Monetarism”) in the Journal of Economic Perspectives. Paul Krugman added his own gloss on DeLong on Friedman in a post called “Why Monetarism Failed.” In the JEP paper, DeLong argued that the New Keynesian policy consensus of the 1990s was built on the foundation of what DeLong called “classic monetarism,” the analytical core of the doctrine developed by Friedman in the 1950s and 1960s, a core that survived the demise of what he called “political monetarism,” the set of factual assumptions and policy preferences required to justify Friedman’s k-percent rule as the holy grail of monetary policy.

In his follow-up paper, DeLong balanced his enthusiasm for Friedman with a bow toward Keynes, noting the influence of Keynes on both classic and political monetarism, arguing that, unlike earlier adherents of the quantity theory, Friedman believed that a passive monetary policy was not the appropriate policy stance during the Great Depression; Friedman famously held the Fed responsible for the depth and duration of what he called the Great Contraction, because it had allowed the US money supply to drop by a third between 1929 and 1933. This was in sharp contrast to hard-core laissez-faire opponents of Fed policy, who regarded even the mild and largely ineffectual steps taken by the Fed – increasing the monetary base by 15% – as illegitimate interventionism to obstruct the salutary liquidation of bad investments, thereby postponing the necessary reallocation of real resources to more valuable uses. So, according to DeLong, Friedman, no less than Keynes, was battling against the hard-core laissez-faire opponents of any positive action to speed recovery from the Depression. While Keynes believed that in a deep depression only fiscal policy would be effective, Friedman believed that, even in a deep depression, monetary policy would be effective. But both agreed that there was no structural reason why stimulus would necessarily counterproductive; both rejected the idea that only if the increased output generated during the recovery was of a particular composition would recovery be sustainable.

Indeed, that’s why Friedman has always been regarded with suspicion by laissez-faire dogmatists who correctly judged him to be soft in his criticism of Keynesian doctrines, never having disputed the possibility that “artificially” increasing demand – either by government spending or by money creation — in a deep depression could lead to sustainable economic growth. From the point of view of laissez-faire dogmatists that concession to Keynesianism constituted a total sellout of fundamental free-market principles.

Friedman parried such attacks on the purity of his free-market dogmatism with a counterattack against his free-market dogmatist opponents, arguing that the gold standard to which they were attached so fervently was itself inconsistent with free-market principles, because, in virtually all historical instances of the gold standard, the monetary authorities charged with overseeing or administering the gold standard retained discretionary authority allowing them to set interest rates and exercise control over the quantity of money. Because monetary authorities retained substantial discretionary latitude under the gold standard, Friedman argued that a gold standard was institutionally inadequate and incapable of constraining the behavior of the monetary authorities responsible for its operation.

The point of a gold standard, in Friedman’s view, was that it makes it costly to increase the quantity of money. That might once have been true, but advances in banking technology eventually made it easy for banks to increase the quantity of money without any increase in the quantity of gold, making inflation possible even under a gold standard. True, eventually the inflation would have to be reversed to maintain the gold standard, but that simply made alternative periods of boom and bust inevitable. Thus, the gold standard, i.e., a mere obligation to convert banknotes or deposits into gold, was an inadequate constraint on the quantity of money, and an inadequate systemic assurance of stability.

In other words, if the point of a gold standard is to prevent the quantity of money from growing excessively, then, why not just eliminate the middleman, and simply establish a monetary rule constraining the growth in the quantity of money. That was why Friedman believed that his k-percent rule – please pardon the expression – trumped the gold standard, accomplishing directly what the gold standard could not accomplish, even indirectly: a gradual steady increase in the quantity of money that would prevent monetary-induced booms and busts.

Moreover, the k-percent rule made the monetary authority responsible for one thing, and one thing alone, imposing a rule on the monetary authority prescribing the time path of a targeted instrument – the quantity of money – over which the monetary authority has direct control: the quantity of money. The belief that the monetary authority in a modern banking system has direct control over the quantity of money was, of course, an obvious mistake. That the mistake could have persisted as long as it did was the result of the analytical distraction of the money multiplier: one of the leading fallacies of twentieth-century monetary thought, a fallacy that introductory textbooks unfortunately continue even now to foist upon unsuspecting students.

The money multiplier is not a structural supply-side variable, it is a reduced-form variable incorporating both supply-side and demand-side parameters, but Friedman and other Monetarists insisted on treating it as if it were a structural — and a deep structural variable at that – supply variable, so that it no less vulnerable to the Lucas Critique than, say, the Phillips Curve. Nevertheless, for at least a decade and a half after his refutation of the structural Phillips Curve, demonstrating its dangers as a guide to policy making, Friedman continued treating the money multiplier as if it were a deep structural variable, leading to the Monetarist forecasting debacle of the 1980s when Friedman and his acolytes were confidently predicting – over and over again — the return of double-digit inflation because the quantity of money was increasing for most of the 1980s at double-digit rates.

So once the k-percent rule collapsed under an avalanche of contradictory evidence, the Monetarist alternative to the gold standard that Friedman had persuasively, though fallaciously, argued was, on strictly libertarian grounds, preferable to the gold standard, the gold standard once again became the default position of laissez-faire dogmatists. There was to be sure some consideration given to free banking as an alternative to the gold standard. In his old age, after winning the Nobel Prize, F. A. Hayek introduced a proposal for direct currency competition — the elimination of legal tender laws and the like – which he later developed into a proposal for the denationalization of money. Hayek’s proposals suggested that convertibility into a real commodity was not necessary for a non-legal tender currency to have value – a proposition which I have argued is fallacious. So Hayek can be regarded as the grandfather of crypto currencies like the bitcoin. On the other hand, advocates of free banking, with a few exceptions like Earl Thompson and me, have generally gravitated back to the gold standard.

So while I agree with DeLong and Krugman (and for that matter with his many laissez-faire dogmatist critics) that Friedman had Keynesian inclinations which, depending on his audience, he sometimes emphasized, and sometimes suppressed, the most important reason that he was unable to retain his hold on right-wing monetary-economics thinking is that his key monetary-policy proposal – the k-percent rule – was empirically demolished in a failure even more embarrassing than the stagflation failure of Keynesian economics. With the k-percent rule no longer available as an alternative, what’s a right-wing ideologue to do?

Anyone for nominal gross domestic product level targeting (or NGDPLT for short)?

36 Responses to “What’s Wrong with Monetarism?”


  1. 2 JKH April 26, 2016 at 3:10 pm

    Excellent.

    Can you expand a bit on the changes you refer to here:

    “The point of a gold standard, in Friedman’s view, was that it makes it costly to increase the quantity of money. That might once have been true, but advances in banking technology eventually made it easy for banks to increase the quantity of money without any increase in the quantity of gold, making inflation possible even under a gold standard.”

  2. 3 Ilya April 26, 2016 at 3:38 pm

    Hi David,

    Do you have any model of the “money market” that does a good job of accounting for the reduced form variable for the money multiplier? Perhaps, there is some particular model that can help make these things clear.

    Thanks.

  3. 4 Henry April 27, 2016 at 4:49 am

    “………..what’s a right-wing ideologue to do?”

    Pretend all is at it should be.

  4. 5 Henry April 27, 2016 at 4:54 am

    ” Friedman famously held the Fed responsible for the depth and duration of what he called the Great Contraction, because it had allowed the US money supply to drop by a third between 1929 and 1933.”

    Why did 30% of the US money supply disappear?

    Because 30% of US banks and their deposits disappeared because of widespread debt defeasance.

    The slump was well underway before the money supply collapsed.

  5. 6 JP Koning April 27, 2016 at 6:36 am

    “On the other hand, advocates of free banking, with a few exceptions like Earl Thompson and me, have generally gravitated back to the gold standard.”

    David, do you still support some version of Earl Thompson’s gold rebate plan that targets a wage index? Do you prefer gold as the redemption medium or will anything do?

  6. 7 David Glasner April 27, 2016 at 12:37 pm

    Miguel, Thanks.

    JKH, Thanks.

    I am referring to various advances in the technology of record keeping and transferring balances between banks and accounts and the entire infrastructure supporting the access of holders of bank deposits and similar instruments to make payments or discharge debts in the course of making transactions. Does that help?

    Ilya, The model is basically the one laid out by James Tobin in his wonderful paper, “Banks as Creators of Money.”

    Henry, You think right-wing ideologues like the world as it is? Then what are they so angry about?

    Friedman’s point was not that a drop in the money supply could not happen, but that it could have been prevented. I am not endorsing his position, just trying to restate it. Friedman did not argue that the Fed caused the slump; he asserted that the Fed did not prevent it from deteriorating into a catastrophic depression.

    JP, The truth is that, despite having written a book about monetary reform, I have become pretty agnostic about monetary reform. I think that Thompson’s plan is ingenious – in fact he was a genius – but I see no chance of its ever being adopted. However, I saw no chance that Donald Trump would ever be nominated by a major political party to run for President. So what do I know? But given my estimate of the chances of its being adopted, I have spent very little time since writing the book over 30 years ago thinking about how it would work if it were implemented.

  7. 8 Henry April 27, 2016 at 2:47 pm

    “You think right-wing ideologues like the world as it is? Then what are they so angry about?”

    Firstly, you’ll have to excuse my poor attempt at humour.

    They’re angry they’re not in full control. They’re angry because the neoliberal agenda has been frustrated to some extent by Obama even though neoliberalism has success after success not only in the US but in the UK and Europe also. Neoliberalism’s ascendancy is almost complete. They’re avaricious little buggers – enough is never enough, whether it’s wealth or political power.

  8. 9 Nanikore April 27, 2016 at 4:28 pm

    David, some of the concerns people have had with a gold standard, if I remember correctly, are the stability of the price of gold – it would be prone to fluctuations in gold output and supply which I guess they fear might affect money supply, relative prices and exchange rate pegs (?) – and that its supply comes from highly controversial sources such as Freeport Moran’s grotesque operation – a massive hole on the side of the Cartensz Pyramid in Indonesia’s New Guinea (illegally annexed in the 1960s.) These operations and similar ones in Africa are associated with human rights and environmental abuse unimaginable in say Europe or the US. What is your view on those concerns?

  9. 10 Scott Sumner April 28, 2016 at 7:36 pm

    David, In my view the K-percent rule was only a small part of monetarism, and 90% of Friedman’s ideas in monetary economics still hold up quite well. Of course Friedman’s views evolved away from the K-percent rule later in his life.

    It’s not accurate to claim that the (M2) money supply was increasing at double digit rates for most of the 1980s, only in 1983 and 1984 when there was a sharp one time fall in V due to sharply lower inflation, which is consistent with Friedman’s model. Of course I agree that the K-percent rule is a bad policy, but given that it has not been tried I don’t think you can say the 1980s proved it doesn’t work.

    There are other free banking fans who do not favor going back to the gold standard, such as George Selgin.

    I’m not quite sure I understand the thrust of this post. Much of Friedman’s empirical work was devoted to explaining why both V and the money multiplier have often been highly unstable, particularly during the 1930s. Was his explanation wrong? It seemed pretty reasonable to me.

  10. 11 Benjamin Cole April 30, 2016 at 10:00 pm

    Great blogging.

    Well, I am for NGDPLT, and sending in the helicopters to get there! As a first resort too, not as a last.

    Why do central bankers prefer the feeble, incremental and ineffectual to Chuck Norris in action and promise?

    Times have changed. Sheesh, not even helicopters

    Send in a few waves of B-52s.

  11. 12 David Glasner May 2, 2016 at 7:50 pm

    Henry, I am mystified by the term “neoliberalism,” which I talk to be meant as a term of abuse inasmuch as I don’t know of any public official or politician – certainly no one in America — who refers to himself in that way and I have no idea whom specifically it is meant to refer to. I certainly have seen or heard nothing from any of angry the Americans that qualifies as liberal in any old or new sense of the term.

    Nanikore, I am sorry but I have never heard any discussion of the gold standard that refers to any other conditions of the production that you mention. I have no familiarity with those issues, so I can’t comment on them except to point out that the existing stock of gold is now perhaps 50 times the total annual output of gold, so it would be unlikely that the conditions of production in one gold producing area, however deplorable, would have more than a negligible effect on the value of gold.

    Scott, I agree that from a theoretical standpoint, the k-percent rule was not an important part of Monetarism. But I think it was very important to important Friedman to be able to offer an alternative rule to the gold standard and to be able to argue that it was more consistent with liberal or libertarian principles than the gold standard, from which Friedman was trying to wean the next generation of libertarians and free-market conservatives. Friedman’s views on the k-percent rule didn’t evolve; he simply had to acknowledge failure after a sufficiently long period of crying wolf.

    You are right that growth in M2 tapered off in the mid-1980s after growing by 9% in 1982, 12.1% in 1983 and between 8 and 9% in 1984, 1985 and 1986. But M1 grew by 9% in 1985, 13.5% in 1986 and 11.7% in 1987 before slowing down to 4% growth in 1988, so Friedman had plenty of ammunition for his inflation scare mongering. I don’t agree that the k-percent rule was not tried,

    I think Volcker and the Fed made every effort to follow it in the early 1980s, but found that to have done so would have caused a collapse and a financial panic. The recovery from the 1981-82 began very soon after Volcker announced that they would no longer try to achieve their targets for the monetary aggregates.

    My view is that the k-percent rule was flatly inconsistent with Friedman’s empirical work on the instability of the money multiplier and velocity. So that just makes it worse for Friedman.

    Benjamin, Thanks. But I thought that you wanted to cut the military budget.

  12. 13 Henry May 3, 2016 at 4:33 am

    David,

    You used the term “right-wing ideologue” in your post, and I presume you were referring to Friedman. Then you asked what are “they” so angry at, having gone from “ideologue” to “ideologues”. You seemed to have gone from Friedman to apparently those on the right side of US politics, and saying they were all angry. It seems you have gone to the broad swathe of the US population that is supporting people like Trump, I say that because these people are the ones that seem to be angry – but I’m not sure whether you mean this, anyway I took a punt. (Of course there are those on the left who are also angry, but they are hardly right wing ideologues.) Then I introduced the term “neoliberalism”, focussing more on your term “right wing ideologues” (than the angry part, which suggested the broad mass of right side political supporters). So focussing on the right wing ideologues part led me to neoliberals. I find the two terms interchangeable. I can’t see why you have a problem with this. Perhaps this is not a common term in the US (I’m not from the US by the way, so I’ll take your word for it) but it is certainly a well used term in Europe (I don’t come from there either).

  13. 14 Henry May 3, 2016 at 4:49 am

    On the question of free banking, the very term suggests it is a system that would arise naturally in an economy (presumably in a laissez faire economy) without the promotion of a government, because I presume its benefits would outweigh its costs. If this is the case, why has such system not arisen in any major world economy? Is Bitcoin about to change this? What has changed in world monetary affairs such that many are now saying Bitcoin and its like will subsume fiat money? Presumably if one currency can arise then others could as well? Would such a system be different from a gold specie standard? What happens to monetary policy – does it disappear?

  14. 15 Henry May 3, 2016 at 5:12 am

    A couple of other questions.

    Will Bitcoin only be useful as a means of exchange?

    Given it seems to fluctuate wildly in value, what are the implications for a store of value function?

    And given its wild gyrations, what are the implications for its use as a numeraire, a means of account? How would economic performance be measured? Will it be relevant to ask the question even?

    If ever there was Uneasy Money, Bitcoin surely would be it.

  15. 16 Oliver May 3, 2016 at 6:25 am

    Interesting post!

    You write in response to JKH’s question:
    I am referring to various advances in the technology of record keeping and transferring balances between banks and accounts and the entire infrastructure supporting the access of holders of bank deposits and similar instruments to make payments or discharge debts in the course of making transactions. Does that help?

    You seem to be implying that the ability of banks to net and settle debts among themselves without involving the central bank has loosened the tie between the amount of gold held by the CB and the amount of banks money created? Are you not invoking a kind of money multiplier here? The same multiplier you suggest is at the root of the monetarist confusion?

    Can you sketch a chain of causation somehow connecting real output, nominal output, credit and base money and possibly income?

    And as for NGDPLT. I’ve seen all sorts of economists from all sorts of schools endorse it in theory which makes me a bit suspicious. It sounds too good to be true. Are you endorsing it? Or is your claim that this is the new k-percent rule?

  16. 17 David Glasner May 3, 2016 at 2:27 pm

    Henry, Actually I was not referring to Friedman who was more than just a right-wing ideologue, but Friedman was trying to get right-wing ideologues to give up on the gold standard by making the case that a k-percent rule did exactly what they wanted from a gold standard while avoiding problems that the gold standard created. He ultimately had to abandon the k-percent rule, and that left right-wing ideologues with no place to go but back to the gold standard, because the Taylor rule is way too complicated for right wing ideologues to handle, although it is a handy club with which to bash the Fed when they get the opportunity. But you are right that the term “right-wing ideologues” is nearly as vague as neoliberalism, though to my American ear it is much more familiar. I find neoliberalism a bad term with which to describe right-wing ideologues because except for the libertarians, right wing ideologues are highly allergic to any association with liberalism in any shape or form.

    Free banking in some form has been practiced in a number of historical episodes, most notably Scotland and Canada and possibly in the United States, though it is open to debate whether what is called free banking in the Civil War period was sufficiently unregulated to be considered free banking. One reason why banking has usually been heavily controlled is because the state has almost always considered the coining of money to be a sovereign prerogative and there are arguments why control over the money issue is helpful to a sovereign by providing an effective means of raising revenue in an emergency without having to go to the legislature or the nobility to levy explicit taxes. A classic example of this was the creation of the Bank of England in 1694 when the new monarch was faced with an invasion by the French to restore the Stuart dynasty to the throne. See Macaulay’s discussion in the History of England. As I have written in earlier posts, I regard the bitcoin as a bubble not as a viable fiat currency because, unlike a fiat money issued by the state, it is not acceptable for discharging tax obligations. For some reason the markets have not yet correctly priced the bitcoin at its true value of zero.

    Oliver, I don’t know what you mean by money multiplier. By money multiplier I mean a structural relationship between base money and the amount of money created by banks. I deny that there is such a structural relationship because the actual relationship between base money and the amount of money created by banks depends on the public’s demand for bank money, so the relationship between the amount of money created by banks and the amount of base money is a reduced form relationship not a structural relationship. Monetarists implicitly treat the money multiplier as a structural relationship not a reduced form, though they implicitly acknowledge that it’s a reduced form, they assume that in practice it can be treated as if it were a structural relationship. Otherwise, they could not have come up with the idea of a k-percent rule.

    For a sketch of the line of causation, you can read my book or for a good introduction to banking theory you can read James Tobin’s article “Banks as Creators of Money.” The only thing missing from Tobin’s article is an acknowledgment that the Fed can control the price level by suitable adjustment in the quantity of base money.

    I believe that NGDPLT is probably the best policy regime available at present, but I am doubtful that there is any perfect monetary system so I would not be surprised if, after NGDPLT were adopted, things did not turn out as I and other supporters hope it turns out.

  17. 18 Henry May 3, 2016 at 6:57 pm

    “I believe that NGDPLT is probably the best policy regime available at present..”

    Why? Because everything else (in monetary policy) has failed?

    I believe monetary theorists should get over themselves. Monetary policy is not the sole determinant of economic performance. Unfortunately, you would be led to believe this if you read what monetary theorists write. I personally believe monetary theorists are grasping at the NGDPLT straw because all the other straws dissolved in their hands. We’ll see how long this one lasts.

  18. 19 David Glasner May 3, 2016 at 7:24 pm

    Henry, The answer is not because everything else has failed — the possibilities are actually limitless — but because it makes good sense; it also has a long pedigree of first rate monetary theorists who either supported it or provided strong arguments in its favor. That doesn’t mean it’s right, just that there is reason to believe it’s right or close to being right. But then again, it might not be. The only way it won’t last is to give it a try, because there is no compelling conceptual criticism that can be made against it. So if it’s discarded, it will only be because it fails once it’s tried.

  19. 20 Henry May 3, 2016 at 11:35 pm

    “The answer is not because everything else has failed — the possibilities are actually limitless”

    Everything else that has been tried has ostensibly failed.

    “it also has a long pedigree of first rate monetary theorists who either supported it or provided strong arguments in its favour”

    I’m sure as anything that you know an appeal to authority counts for nothing. Look at the numbers that bowed to Friedman’s monetarism.

    “So if it’s discarded, it will only be because it fails once it’s tried.”

    It may well. However, my point is monetary theorists may proceed ad infinitum trialling this or that when the problem has nothing to do with monetary policy and all to do with the myriad other factors driving an economy.

  20. 21 David Glasner May 4, 2016 at 7:48 am

    Henry, Everything else that has been tried may have failed that doesn’t mean that NGDPLT is all that’s left. So I am saying that there are good arguments to be made for compared to other options that are available.

    You said:

    “I’m sure as anything that you know an appeal to authority counts for nothing. Look at the numbers that bowed to Friedman’s monetarism.”

    I wasn’t appealing to authority; I was responding to your assertion that all NGDPLT has going for it is that everything else has been tried. I am saying that it is an idea that has been around for a long time and good economists have made good arguments for it. I’m not saying that anyone is obligated to accept those arguments.

    You said:

    “[M]y point is monetary theorists may proceed ad infinitum trialling this or that when the problem has nothing to do with monetary policy and all to do with the myriad other factors driving an economy.”

    Well, I agree that anything is possible, but why would it be reasonable to assume that monetary policy has no effect on the economy? And what precisely is “the problem” that you think that monetary policy has nothing to do with?

  21. 22 Henry May 4, 2016 at 2:52 pm

    “….why would it be reasonable to assume that monetary policy has no effect on the economy?”

    I didn’t say that and I am not arguing that. My point is that monetary economists talk as if there is no other game in town, as if there are no other factors at the root of the poor performance of the world economy for a decade and more. This monetary fetishism is distracting. Central bankers have come to believe they are gods, yet they are bereft. Monetary theorists are flaying about looking for solutions when the causes are deeply structural – globalization, demographics, technological saturation (about to shift in the next few years, I believe, in a new wave of technology driven growth), collapsed oil prices and other fading commodity booms brought by oversupply. And of course, to the extent that cyclical factors are at play, the one other policy alternative, fiscal policy, has been eschewed. The slump and shock of 2008/9 has left the world economy with edeep vestigial negative expectations and in a classic Keynesian liquidity trap where monetary policy is largely ineffectual.

  22. 23 David Glasner May 4, 2016 at 6:23 pm

    Henry, You said that you didn’t say that monetary policy has no effect on the economy. And then you said: “Central bankers have come to believe they are gods, yet they are bereft. Why are they bereft if monetary policy has an effect on the economy? And you conclude by saying that the world economy is in a classic Keynesian liquidity trap where monetary policy is largely ineffectual. So which is it?

  23. 24 Henry May 4, 2016 at 7:40 pm

    OK, I have been a little sloppy with my words. I’ll try again.

    Monetary policy is effective under certain conditions mainly where there is a cyclical deficiency of demand, presuming you want to bring the economy to full output/full employment.

    Where the economy has suffered a debilitating shock and slump and is entrenched in a mire of deeply negative expectations, then it may not be effective (Keynesian liquidity trap).

    Where there are other longer term secular factors at play, then monetary policy is probably not effective.

    Whether monetary policy is effective or not, it does not necessarily mean central bankers know what to do. It seems to me they have been floundering around (along with monetary theorists) trying to pull the world economy out of a slump and I would argue that the slump is partly due to secular/structural factors and partly due the shock of 2008, but the central bankers and monetary theorists are focussing purely on the effects of the 2008 shock and hence failing to get traction with the various policy manoeuvres that have been made.

    The central bankers attribute the Great Moderation of the 1990s to their prowess as monetary policy managers. However, I would argue that the 1980s and 1990s growth pattern is due largely to the commercialization of a range technological developments beginning with the introduction of the PC, then advances in mobile communications and then the internet. These developments had begun to reach saturation by the early 2000s. This growth impetus has waned and along with other structural factors has held back economic performance thru the last 15 years. I would argue that we are about to see in the next few years the commercialization of the emerging ensemble of technological developments. This will naturally drag the world economy on to a sound growth trajectory.

    And no doubt, the monetary theorists and central bankers will say it was all their doing.

  24. 25 David Glasner May 5, 2016 at 7:20 pm

    Henry, Thanks for your clarification. I have no problem with that the week performance of developed economies for the past number of years has largely been the result of secular trends in productivity that are largely independent of and largely impervious to monetary policy. But the fact remains that there was financial crisis and a sharp downturn in 2008-09, and that financial crisis and the downturn it seems to me were largely the result of a monetary policy that was aimed at reducing inflation when it should have been trying to avoid a contraction in total spending.

  25. 26 Henry May 5, 2016 at 10:38 pm

    “…financial crisis and the downturn it seems to me were largely the result of a monetary policy that was aimed at reducing inflation when it should have been trying to avoid a contraction in total spending.”

    I agree. But that policy was reversed (massive QE in the US, Europe and Japan). The US (where there was fiscal stimulus) is pulling out of the slump. Europe is floundering around by and large (fiscal stimulus is anathema). Japan likewise (beset by structural problems). So how effective has monetary policy been?

  26. 27 David Glasner May 6, 2016 at 11:58 am

    Henry, I agree that monetary policy was loosened, but the question is whether it was ever expansionary. You claim that since we are in a liquidity trap, monetary policy cannot be expansionary. Those of us who disagree claim that under an inflation targeting regime, monetary policy cannot be expansionary without raising the inflation target. Since inflation and inflation expectations have been falling steadily, the evidence does not clearly refute our position. You say that US fiscal policy accounts for the stronger US recovery, but US fiscal policy became increasingly contractionary after 2010, and the ECB raised interest rates in 2009, so that comparison does not necessarily work in favor of your position.

  27. 28 Henry May 6, 2016 at 4:13 pm

    David,

    “I agree that monetary policy was loosened, but the question is whether it was ever expansionary.”

    I can’t believe you said that. It actually speaks to my point – monetary policy has been ineffective. Are you saying massive QE was designed not to be expansionary?

    “..monetary policy cannot be expansionary without raising the inflation target….”

    What’s the point of raising the target from 2% from 5% if the 2% target hasn’t worked? It doesn’t make sense. Should we make the target 20%?

    “Since inflation and inflation expectations have been falling steadily, the evidence does not clearly refute our position. ”

    That is conveniently perverse logic. Maybe the notion of raising inflation expectations is fallacious or maybe when oil prices have collapsed along with a good many other commodity prices, it has nothing to do, directly, with expectations. Prices are falling because of supply side shocks, at least in part.

    “…but US fiscal policy became increasingly contractionary after 2010…”

    And the US economy continued to struggle (albeit in the desired direction) despite massive QE. Perhaps fiscal policy should have remained more stimulatory?

  28. 29 David Glasner May 7, 2016 at 8:07 pm

    Henry,You said:

    “I can’t believe you that. It actually speaks to my point – monetary policy has been ineffective. Are you saying massive QE was designed not to be expansionary?”

    I am saying that the mechanism by which monetary policy can be effective is by raising prices. If the monetary authority increases the quantity of money but promises that it will not allow prices to rise, and the promise is believed, then prices will not rise. This is a basic proposition in monetary theory. The Fed conducted QE (aka open market purchases) in 1932 to little effect. People were saying that monetary policy was ineffective. When FDR devalued the dollar in March 1933, he triggered a 10-15% rise in prices over the next four months and fastest increase in industrial output in US history and stock prices doubled. That seems pretty effective to me.

    “What’s the point of raising the target from 2% from 5% if the 2% target hasn’t worked? It doesn’t make sense. Should we make the target 20%?”

    Level targeting means targeting the price level not the inflation rate. I would raise the price level target allowing a rapid but shot term increase in the price level and then inflation would wind down.

    “That is conveniently perverse logic. Maybe the notion of raising inflation expectations is fallacious or maybe when oil prices have collapsed along with a good many other commodity prices, it has nothing to do, directly, with expectations. Prices are falling because of supply side shocks, at least in part.”

    The logic is what it is, I don’t know what’s perverse about it. I don’t understand what you mean by the notion of raising inflation expectations being fallacious. Do you think inflation expectations don’t exist? I agree that supply shocks have had a role in low inflation, but inflation was falling even before the collapse in oil prices. I also agree that my theory of how the economy works could be wrong, but I don’t think that there is conclusive evidence that it is.

    I am not saying that fiscal policy should not have been more expansionary, but that doesn’t mean that monetary policy was ineffective.

  29. 30 Henry May 8, 2016 at 6:04 am

    David,

    We are going to get bogged down in all sorts of petty and tedious detail, for instance, you said:

    “Level targeting means targeting the price level not the inflation rate. ”

    However, in your penultimate post you said,

    “Those of us who disagree claim that under an inflation targeting regime…”

    You were talking about inflation targeting not price level target.

    You said:

    “When FDR devalued the dollar in March 1933, he triggered a 10-15% rise in prices over the next four months and fastest increase in industrial output in US history and stock prices doubled. That seems pretty effective to me.”

    Effective yes, effective exchange rate policy, not monetary policy.

    You said:

    “……but inflation was falling even before the collapse in oil prices.”

    Yes I agree, it’s been in decline for decades, starting it’s decline long before the shock 2008.

    Which brings me to the main point I have been trying to make and that is that what we see happening in the world economy is the result of secular trends in addition to the shock of 2008. Monetary theorists and central bankers have been carrying on as if these secular trends are non existent or irrelevant and focused on monetary policy as panacea. And in the last decade or so a range of monetary “theories” has emerged each designed to replace the last “theory” because it had ostensibly failed so we see a plethora of weird and wonderful ideas proliferating – in other words monetary theorists as a class and central bankers have no idea what is going on and how to deal with it. And the latest of these ideas is NGDPLT, which is where this discussion started.

  30. 31 David Glasner May 8, 2016 at 12:49 pm

    Henry,In my original post I talked about NGDPLT. I assumed that you understood that LT stands for level targeting. I later mentioned inflation targeting, because that’s the current policy regime. It never occurred to me that mentioning two alternative monetary policy regimes in the same thread would unduly burden anyone’s cognitive ability.

    If you choose to call FDR’s devaluation of the dollar in 1933 exchange rate policy, that is your prerogative. I, and most other economists, don’t draw a sharp distinction between exchange-rate policy and monetary policy. The point of the policy, whatever you choose to call it, was, as FDR explicitly stated, to raise the US price level, having fallen by about a third from its 1926 level, back to the 1926 level.

    Inflation has indeed been falling gradually since it peaked in the early 1980s, but it was rising a bit before the 2008 crash which misled the Fed into tightening monetary policy in 2007 and keeping it tight until after the crash in 2008. Rising oil prices in 2010 and 2011 again led to inflationary fears that induced or threatened to induce monetary tightening. And as I have pointed out to you, NGDPLT has been around as a concept in one form or another since the 1920s. You keep saying that monetary theorists and central bankers act as if nothing else matters, but I don’t know where you get that idea from. Central bankers in particular seem very happy to minimize their responsibility for what has gone wrong with the economy. Monetary theorists hold central bankers to a somewhat higher standard than central bankers are willing to accept, but that doesn’t mean that they deny that there are structural and technological forces that matter as much as, or even more than, monetary policy for economic performance. So I have trouble understanding what it is about monetary theory and policy that you find so deeply offensive.

  31. 32 Henry May 8, 2016 at 4:39 pm

    “It never occurred to me that mentioning two alternative monetary policy regimes in the same thread would unduly burden anyone’s cognitive ability.”

    I am disappointed you have descended to this level of comment. It was clear you used the term inflation targeting. That’s what I was referencing. End of story.

    “I, and most other economists, don’t draw a sharp distinction between exchange-rate policy and monetary policy. ”

    I can understand that. However. Changing the level of interest rates, changing the supply of money, enforcing changes in the level of commercial bank reserve ratios, placing restrictions on commercial lending practice, is clearly monetary policy in action. Suspending the conversion of currency into gold, as FDR did, is monetary policy in action. However, increasing the price of gold, as the Roosevelt administration did, is not quite the same. It clearly is designed to directly impact the internal and external price levels in a the way “normal” monetary policy cannot do and does only indirectly via level/quantitative changes on money stocks/flows and expectations.

    “Central bankers in particular seem very happy to minimize their responsibility for what has gone wrong with the economy. ”

    Entirely agree. And of course they also want to claim credit for the Great Moderation.

    “but that doesn’t mean that they deny that there are structural and technological forces that matter as much as”

    Perhaps not. However, reading the interminable number of blogs and papers monetary theorists produce, you would think otherwise.

    “So I have trouble understanding what it is about monetary theory and policy that you find so deeply offensive.”

    I don’t find it offensive. It seems to me that it has proved largely ineffective in recent years.

  32. 33 Henry May 8, 2016 at 4:45 pm

    “…but it was rising a bit before the 2008 crash which misled the Fed into tightening monetary policy in 2007 and keeping it tight until after the crash in 2008….”

    And because it was working with rather than against secular disinflationary forces it had a significant impact.

  33. 34 David Glasner May 9, 2016 at 12:38 pm

    Henry, You said:

    “Changing the level of interest rates, changing the supply of money, enforcing changes in the level of commercial bank reserve ratios, placing restrictions on commercial lending practice, is clearly monetary policy in action. Suspending the conversion of currency into gold, as FDR did, is monetary policy in action. However, increasing the price of gold, as the Roosevelt administration did, is not quite the same. It clearly is designed to directly impact the internal and external price levels in a the way “normal” monetary policy cannot do and does only indirectly via level/quantitative changes on money stocks/flows and expectations.”

    Your distinction between changing the supply of money and other techniques that affect “money stocks/flows” and devaluation directly operating on “the internal and external price levels” is certainly a valid distinction, but why is only the former entitled to have the designation “monetary policy” bestowed upon it?

    You said:

    “I am disappointed you have descended to this level of comment. It was clear you used the term inflation targeting. That’s what I was referencing. End of story.”

    And I am disappointed that you are not carefully reading what I have been saying to you in response to your diatribes against monetary theorists, monetary policy and central bankers. Of course I used the term “inflation targeting.” I have also used the term “level targeting.” Both terms are relevant to a discussion of how to conduct monetary policy. Why is that hard for you to understand?

    This exchange about inflation targeting started when I pointed out to you that the recession starting at the end of 2007 and the financial crisis of 2008 could be attributed at least in part to a tightening of monetary policy in 2007 and 2008. The tightening continued even as the recession and unemployment were rapidly worsening. And the reason that monetary policy was kept tight for so long was because of exaggerated fears of inflation in 2007 and 2008. You responded by saying that monetary policy was reversed, becoming highly expansionary, thereby showing monetary policy to be ineffective. I responded by saying that, under the existing inflation-targeting regime, monetary policy could not be made significantly more expansionary without raising the inflation target. You rejected my response by asking:

    “What’s the point of raising the target from 2% from 5% if the 2% target hasn’t worked? It doesn’t make sense. Should we make the target 20%?”

    You also accused me of using “conveniently perverse logic” for suggesting that if inflation expectations have been falling, then monetary policy may not really have been as expansionary you believe it was.

    In reply to your question about raising the inflation target to 5% if the 2% target wasn’t being met and to your sarcastic query about a 20% inflation target, I pointed out that, under a level-targeting regime instead of the existing inflation-targeting regime, persistent undershooting of the price-level target would tend to raise expectations of future inflation (but only until the price-level target was achieved). Your response to my conceptual distinction between an inflation-targeting regime and a level-targeting regime was to accuse me of getting “bogged down in all sorts of petty and tedious detail,” because I had discussed the advantages of level targeting after having explained in a previous response that, if the inflation target is (credibly) raised, monetary policy can be expansionary even in a liquidity trap.

    Why is it “getting bogged down in all sorts of petty and tedious detail” to point out that, as a matter of basic monetary theory, a liquidity trap can be escaped by (credibly) raising the inflation target and then pointing out that a level target automatically adjusts the inflation target when the monetary authority misses its price-level target? Evidently, you failed to grasp what I had been saying, which is that a level-targeting regime is preferable to an inflation-targeting regime, which is precisely the tentative policy proposal with which I had concluded the post that started this thread and was precisely the point which got your diatribes against monetary policy, monetary theory, and central bankers under way.

  34. 35 Henry May 9, 2016 at 2:30 pm

    “……..but why is only the former entitled to have the designation “monetary policy” bestowed upon it?”

    I think there is more than a subtle distinction. If you don’t want to recognize that, that’s OK by me.

    “Your response to my conceptual distinction between an inflation-targeting regime and a level-targeting regime was to accuse me of getting “bogged down in all sorts of petty and tedious detail,””

    This is a silly thing to say David. I did not accuse you and was not accusing you of doing this. I was in effect admonishing myself in advance as it was I who was about to do just the that.🙂

    “….a liquidity trap can be escaped by (credibly) raising the inflation target and then pointing out that a level target automatically adjusts the inflation target when the monetary authority misses its price-level target?”

    For me this is just another assertion by a monetary theorist (I think I can call you that?). It just seems to me to be one of a plethora of many assertions/theories currently being offered by monetary theorists. (And, equally, my comment on the matter is also just assertion.) All I am arguing is that in the last few years, say since 2010, the US economy has struggled to gain momentum and it seems that the only policy at play was monetary policy. I would argue the reason for the apparent ineffectiveness of monetary policy is that the shock of 2008 was deep and powerful (and you assert above that this is surmountable) and that other secular/structural factors were working against monetary policy.


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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.

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