My TLS review of Tim Congdon and market monetarism

by on October 23, 2012 at 6:52 am in Books, Economics | Permalink

A version of my review can be found here.  Excerpts:

The economist Scott Sumner stated the case against fiscal policy another way on his blog The Money Illusion. Sumner noted that no one believes fiscal policy (unlike monetary policy) could be used to target a price inflation rate of say 4 per cent a year. The implication is that fiscal policy is not very effective in managing overall demand in an economy, so why should we so trust it as a tool of crisis management?

I still haven’t seen a good answer, or for that matter a bad answer, to that argument.  And:

Does the market monetarist movement hold all the answers? Not quite. It’s worth trying to keep the broader monetary aggregates at robust levels of growth, but what happens when this is not possible? The danger is not so much Keynes’s liquidity trap – considered a mythical beast by many, including this author – as the private sector’s reluctance to lend, such as followed the partial collapse of financial intermediation in 2008. Those credit relationships are being repaired only slowly, and so private investment will lag until trust is repaired. In the meantime, the authorities could prop up the monetary aggregates by printing more currency, but that’s not nearly as useful as trust-based expansions of bank lending and private investment. In other words, undoing the damage from a credit collapse is not always easy.

Read the whole thing.  You can buy Tim Congdon’s book here.  Here is my final take on the book itself:

Money in a Free Society doesn’t have all the answers, it is perhaps overlong, and it could have been more focused on remedies rather than devoting so much space to a long history of Keynesian thought in the United Kingdom. Nonetheless, it is a bracing and largely accurate take on what has gone wrong, a wake-up call for those who think they know all the right answers, and a medicine against the strands of political correctness that have been encircling and indeed strangling the macroeconomic debate.

Merijn Knibbe October 23, 2012 at 7:01 am

Isn’t a liquidity trap situation very much the same thing as the private sector’s relutance to lend, when the nominal interest rate can not go down further? In the Eurozone we’re not yet in that situation as nominal interst rates paid by households and companies are still high (let alone real interest rates). But that’s not the point, here.

Andrew' October 23, 2012 at 7:41 am

The underlying premise of all these theories is “we have no idea, but according to the current data stream now is the time to do it double-time” which is why I don’t get why there isn’t more humility built into them.

david October 23, 2012 at 5:05 pm

The status quo isn’t very humble either.

Saturos October 23, 2012 at 8:04 am

Credit failure doesn’t stop you from hitting an NGDP target. See 1933.

Saturos October 23, 2012 at 8:13 am

And Sumner favors the Friedman of the 90’s and 00’s, not the pre-70’s Friedman. It’s the 90’s Friedman who advocated that Japan start printing money to get out of its “liquidity trap”.

Orange14 October 23, 2012 at 8:06 am

Tyler – I just finished reading the review and thought it was generally a good overview though I do disagree with some of the premises that you state. I’m not sure that the statement about lending is quite correct. Certainly one can see in the housing area large amounts of lending going on right now with respect to original purchases and refinances. If one has a good credit score and a down payment, there is no problem in getting a loan these days (and of course interest rates are at record lows). With respect to commercial lending, many companies are sitting on very large amounts of cash and don’t need to borrow at all (unless it is to get more money at low interest rates). When I look at the 10-Ks that accompany proxy statements of my equity holdings I see every single company in excellent financial shape. One can also see that certain sectors of the US economy are doing quite well as things bounce back from the recession (bank profits, certain segments in retail, commercial real estate, housing construction and remodeling related industries).

If one looks at where the employment problem comes from, it’s clear and has been amply documented that much of it is a result of layoffs at the governmental levels (mainly state and local) and that private sector employment has actually done better than might be expected (growth here has been better under Obama than Bush). The demand side of the equation vs. the supply side seems to be where the debate is focused and the two schools seem to be quite entrenched (I’m more sympathetic to the demand side problems and would refer interested readers to what Dean Baker said over the weekend: http://www.cepr.net/index.php/blogs/beat-the-press/what-krugman-said-with-a-not-so-small-addendum It’s difficult to look at these numbers and say with any degree of certitude that if we only increase supply that all will be good. I don’t think that helps at all.

In looking at the Eurozone, one thing you didn’t comment on is how Germany has addressed part of their problem by going to shorter work weeks for everyone rather than lay offs. I think this has helped keep them in much better shape that other countries (though one can argue that Holland is doing OK in this regard as well or at least that’s what I hear from relatives living there).

Finally, it would be nice if we could to a randomized controlled trial of the two approaches and measure which one performs best. Unfortunately most of economics is retrospective, looking a historical data and trying to see what models fit the data best. Predicatively, it has always been difficult (doesn’t the old canard go, “economics is good at predicting the last recession?”). There will continue to be continuing discussion from both sides but with little resolution.

Saturos October 23, 2012 at 8:16 am

If Bernanke went on TV tomorrow and announced NGDP/cap level targeting at a 4% trendline starting from halfway to the peak – MMs predict unemployment coming down below 6% within 12 months. That would test our theory well enough. But of course it won’t happen. Also, the Fed board would have to genuinely support the policy, or it wouldn’t be credible.

Andrew' October 23, 2012 at 8:25 am

You would be asking them to admit they hadn’t done it already.

mark October 23, 2012 at 12:29 pm

“If one has a good credit score and a down payment, there is no problem in getting a loan these days (and of course interest rates are at record lows).”

But how much of those loans are simply being passed on to Fannie and Freddie etc (who in turn are backstopped by the Treasury which in turn is having its incremental debts monetized by the Fed)? I suspect a lot in which case I don’t think this proves much.

Rahul October 23, 2012 at 8:17 am

“Finally, it would be nice if we could to a randomized controlled trial of the two approaches and measure which one performs best”

Now, that is ambitious! Bravo!

Orange14 October 23, 2012 at 8:35 am

More born out of frustration in looking at historical data and confounding information.

louis s October 23, 2012 at 10:08 am

“no one believes fiscal policy (unlike monetary policy) could be used to target a price inflation rate of say 4 per cent a year. The implication is that fiscal policy is not very effective in managing overall demand in an economy, so why should we so trust it as a tool of crisis management?”

No one suggests using fiscal policy alone to deal with a crisis. It is not even a primary choice. But when monetary policy is exhausted, and private sector deleveraging unstoppable, we know the direction in which expansionary fiscal policy acts. And if we want to maintain a certain inflation target through the crisis, we still have monetary policy to use on top of the blunter tool of fiscal policy.

Scot October 23, 2012 at 10:26 am

Maybe someone here can help me understand the following: Monetary policy has not been as effective as some would have hoped because banks have been reluctant to lend. Couldn’t the Fed cut banks out and conduct monetary policy by issuing checks directly to households – a true helicopter drop? If you’re having trouble getting money out into the economy because there is a lack of trust on the part of the banks, why not handle it this way? Couldn’t you even keep doing it until you hit some nominal GDP target? It’s such a simple answer there must be something terribly wrong with it. Right?

mark October 23, 2012 at 12:36 pm

I think that this may not be something the Fed can legally do, notwithstanding Bernanke’s speech. But what you describe can more or less be accomplished in two steps by household-centric fiscal stimulus and the Fed monetizing Treasury’s resulting deficit. But that poses questions about Fed independence and, conversely, integrating the fisc and the central bank as MMT proponents advocate, which would have significant impact on inflationary expectations and conceivably financial markets generally, which are all tied to Treasuries in one way or another. So likely not going to happen except to avoid riots in the streets.

Scot October 23, 2012 at 1:17 pm

I was trying to think of a way to keep the Treasury out of it so that it would be true monetary policy instead of fiscal policy. When you start talking about tax-rebate checks, that’s where things get political. I was hoping there was an easy way for the Fed to stay above the fray but it sounds like that would be illegal. Maybe they could set up a facility to buy securities from individuals at above market prices? They’ve been happy to do that for the banks, right?

mark October 24, 2012 at 2:45 pm
Boonton October 23, 2012 at 12:41 pm

They could, however they would be giving up a lot of future control of monetary policy.

Consider what happens in standard monetary operations. The Fed goes into the market, buys a 3 month T-Bill, creates the money and beams it into the account of whoever they brought it from (a brokerage firm I imagine acting on behalf of some client who wants to sell T-bills). In 3 months time the T-bill will turn into cash. If the Fed does nothing the Treasury will either tax or borrow the money out of the private sector and pay off that 3-month T-bill. If the Fed wants to suck cash out of the economy because it decides it printed too much, it could sell the T-bill now or it just has to wait 3 months and let the t-bill turn into its face value.

Now consider what happens when the Fed starts buying different types of assets like a 30 year bond or a MBS. The Fed creates cash now to pay for the asset, but it won’t turn into cash for many years as the Fed collects coupon payments or interest payments on it. What happens if the Fed decides it printed too much cash and needs to get it out of the economy to prevent inflation? It can’t wait 30 years. It has to sell it in the open market, but what if the price of the asset has fallen dramatically? Then the Fed can only get rid of some of the cash it created. And if the market was afraid of rapidly increasing inflation the value of a bond that pays a fixed interest rate would fall dramatically!

So to go another step and imagine the Fed directly giving money to households or loaning it. Now the Fed has no way to pull back that money at all. Of course we’d also get into political problems. By law the Fed is now allowed to just create money, they must create money to buy something for equal value. So they can create $100 if they are going to buy a $100 bond. Just creating $100 to give it to someone is not allowed. Consider the political implications of the Fed creating billions of dollars and distributing it directly to favorite causes….no doubt Congress wants to preserve their monopoly on that! I suppose you could create an agreed upon system of a fair ‘helicopter drop’…perhaps a lottery type system where every unique social security # gets a payment.

Ryan October 23, 2012 at 10:53 am

When interest rates hit zero, fiscal policy + keeping rates at zero will increase demand without needing to rely on changing people’s expectations.

123 October 23, 2012 at 2:17 pm

I’m a market monetarist myself. Optimal fiscal policy can reduce the volatility of NGDP.

Tom October 23, 2012 at 3:24 pm

M3 is close, but the missing magic two words are: Net Worth.
“We’re not as rich as we thought” is pretty close, too.

How much money do decision makers have is the micro essence of monetary theory. Of those making $100 000/year, the ones with $200 000 in equity have a “lot less” than those with $400 000 in equity. And if one was a $400k equity owner in 2006, but a $200k equity owner in 2008, one’s spending will most likely be much less, and one’s saving more (assuming Life Cycle desire for about $400 000 at that age).

Neither monetary nor fiscal policy will do a good job at replacing the lost Net Worth.

But also, there are two big types of fiscal policy. Wasteful, Dem party supported gov’t spending programs (like Solyndra), often beloved by economists for their theoretical ability to be optimized is the Krugman-DeLong type. Or tax cuts, which allow tax payers to most efficiently choose to save more, pay down previously excess debt, and also buy more, yet which are demonized by the Dems.

Bush Tax Cuts were fairly successful in the bubble years at restoring growth. When has Krugman been calling for $1 tril in tax cuts? If he’s not, he’s not serious about fiscal policy, but instead is only serious about expanding wasteful gov’t.

Finally, the shorter work weeks of Germany is a good idea. The top 10% of gov’t workers should be moved to half-time, half-pay work schedules, to allow more advancement, encourage more early retirement or transfer out of gov’t work, and to allow hiring more entry level gov’t workers. From 100 workers, putting 20 into half time work is almost certainly better for the economy than firing 10 of them.

mpowell October 23, 2012 at 5:59 pm

An excellent example of political priors strangling any utility out of an economic argument.

rre October 23, 2012 at 4:47 pm

So rather than setting minimum capital requirements, maybe the Fed should set minimum lending mandates for banks.

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