The economy is cratering and there’s currently no sign that conventional fiscal policy will be initiated. So let’s appoint a monetarist to the Federal Reserve: I nominate Scott Sumner, no relation to this guy.
This is another way of saying that we need a guy at the Fed who won’t be afraid to vastly increase the money supply. Sumner wants to target nominal GDP growth, which is national output that has not been adjusted for inflation. His strategy is to keep pouring money on the economy until it cries uncle. (We can debate specifics as appropriate.)
I don’t think it will work. But it will do little harm and might be partially effective. Besides, we’ll learn something. No, there won’t be hyperinflation and 4-5% core inflation wouldn’t be an awful thing, though that won’t happen either.
Scott Sumner is a libertarian. That should endear him to Republicans. Aw, who am I kidding? They would vilify Mother Theresa if Obama appointed her. Still, if Congress gave explicit permission to the Fed to conduct unconventional monetary policy, it would help. A little. Permission is different than mandate.
You must know, of course, that the notion of a Federal Reserve existing at all is incompatibile with libertarian thinking.
That’s why we rolled our eyes at the Alan Greenspan mea culpas, and the associated “See! See! Libertarianism doesn’t work!” straw men once he self-identified with the group.
Controlling a fiat money supply violates Rule #1 of most libertarian playbooks, so the fact that he called himself a libertarian is a non-sequitur.
I’d like to believe Sumner’s right about the politics here. Mankiw might do the trick. We don’t need a QE3, more money thrown out there with no clear idea of how long it will last. We need instead a realistic, dependable target for Fed policy. Ideally, this would be an NGDP level target, but a core price level target would work as well. We need a predictable, certain rule with a “memory” of past failure, so that they compensate accordingly if they miss their target, instead of falling into a rut and missing their target year after miserable year.
It would work.
Paul Krugman calls this the plan to “credibly promise to be irresponsible”. But this credibility would be easy to maintain, if they set a target and created the proper assurances that they were fully serious about it, whatever it takes. Easily doable if the Fed has the president’s back-up. Even a hardcore Keynesian like Krugman uses models which show this would eventually work. The reason PK didn’t focus more on money originally is that he had no confidence (and rightly so, as it turned out) that the Fed would do their job. He defines “liquidity trap” very carefully, as the failure of conventional monetary policy. He decided that the Fed had no stomach for unconventional policy, so he focused instead on spending, based on the belief that government spending would work better politically. Whoops.
Mankiw is far and away the likeliest candidate I’ve seen proposed for the job. The party of no might still stop him, but he’s got the best shot of anyone else competent that I know. Sumner is a notable blogger – he’d get my vote, no question – but he is not so distinguished in professional circles.
Words do have meanings. But this word’s meaning is hardly as narrow as you believe.
Sumner studied at the University of Chicago under Robert Lucas, a Nobel prize winner and one of the most famous conservative/libertarian macroeconomists in the world. Lucas studied under Milton Friedman, who is likely the most well respected libertarian economist of all time. Sumner’s brand of monetarism is a direct offshoot of Milton Friedman’s. Historically, it has been the academic libertarian economists who focus on monetary policy, in opposition to the more Keynesian liberals who focus on government spending. “Printing money” is, in fact, the traditional approach for academic libertarian economists. The most famous academic work ever written about the Great Depression, by Milton Friedman himself along with Anna Schwartz, blamed the Fed for the Depression for not having created enough money to counter-act the downturn.
This might not be the most famous branch of libertarianism among lay readers, but it’s long been the most well-respected branch among actual economists. Chicago, for all its innumerable faults, is famous for a reason.
You may have noticed those small green pieces of paper floating around our shops. Everyone finds them to be really useful. Those are produced by the government/federal reserve. If you want to dissolve the government you are going to have to find a replacement for these little green pieces of paper, whether its little yellow pieces of metal or chickens.
What is the libertarian explanation for the Great Depression? Are Great Depressions acceptable?
A: Milton Friedman claimed that Ben Strong died and a lawyer replaced him as head of the Fed. As a result the Fed dallied while the economy burned from October 1929- March 1933. Their policy was correct – they lowered interest rates – but they didn’t do it fast or far enough. This framework is fortuitous for traditional conservatives: if monetary policy is effective, we don’t need big stimulus packages by Congress or the Executive.
So, yes, Sumner is a libertarian.
Counterplan. Actually Rogoff would be a better pick than Mankiw if we’re discussing qualifications. But Sumner is a true believer in monetary policy, which assures us of robust advocacy.
Should the Fed loosen a lot, even if it involves taking on a lot of assets? What about their balance sheet?
Would extra-loose monetary policy work? (My answer: no, but try it anyway. Partial effectiveness is better than ineffectiveness.)
Up next: Links to past discussions: Hellestal has posted some great stuff, IMHO.
Here are 2 unconventional monetary policy programs:
Since the middle of the last decade, the Fed has paid interest on excess reserves. They now pay 0.25%. Drop that to zero. Then charge a penalty rate – this will permit a negative interest rate. They did that in Sweden.
Disadvantage: Treasuries would be bid up to the point where their rates might even go negative. Money market funds might face solvency problems. So do all that carefully.
Announce a nominal GDP or price path and stick to it.
My response: It might work. But we don’t know because it hasn’t been tried. Thatcher and Volker did try making a credible announcement of a new pricing regime. Some thought that inflation could be broken without recession. They were wrong. I simply don’t believe that announcements by the federal reserve have anything more than a modest effect on housing or investment demand. Arguably, they have no effect at all. And as the gap between reality and target widens, that won’t tend to enhance Fed credibility. After all, if the gap becomes wide enough, that might imply an unacceptably high rate of near-term inflation, which would upset a lot of commentators.
Then again… such a policy could be backed by massive open market operations and other complementary measures. On a scale of 0 to 100, where 0 implies " Wholly ineffective" and 100 implies “No need for fiscal policy ever again”, I’d rank a full throated unconventional monetary regime at… 30. But it could be 5-10 and it could be 70. Heck, it could be 100 – which would be a dream for libertarians. We simply don’t know. Notwithstanding my concerns about pure announcement effects, I don’t think it’s zero.
PK isn’t the final arbitrator of course, but here is some substantiation for your characterization of his views. My concerns remain. If I was to be convinced of such an argument, I’d want more evidence of how Fed announcements work through housing markets and the like. Advocates of targeting may imagine investment managers getting worried of being caught out with insufficient capacity as the gap between trend and target grows. I think it’s more realistic to believe that the Fed would balk before taking inflation to 6% and back down again. At least the nominal GDP target is a little more forgiving.
I would welcome Mankiw, but he’s too much of a politician I fear to opt for full-throated unconventionalism in the absence of a deflation scare. Plus, I think the 2% inflation target is too low early on, and opens us up to deflation scares in the future. (I’m currently plotting an optimal rate of inflation thread, btw).
I’d prefer Sumner, but even better would be a 100 kilogram weight placed on the Fed’s accelerator. As for professional circles, I agree, but I’m guessing that a Congress that rejects Peter Diamond for insufficient experience doesn’t care. But if expertise were the issue, I’d choose Diamond, Rogoff and Blinder. And any libertarian who could shut the gold bugs up or at least placate them would be terrific. Zandi would be an interesting choice, though I seriously doubt whether he’s interested.
Hellestal: Do you think that the Fed has any legitimate balance sheet concerns? I don’t see how, but I hear rumblings about it from time to time. The other background noise involves money market funds and breaking the buck.
Hey IMM. I know your question was rhetorical but… what we had was the Free Banking Era: bank regulation was handled by the states. It got pretty ugly: we had periodic banking crises and lengthy depressions. (Tangent: Shiller has a dataset on stock prices from 1871 online: IIRC, you can see some of the pre 1900 extended bear market. Of course the stock market isn’t the economy…) But it’s interesting that economies can exist without bank regulation by a central authority, though the whole financial system evolves rather differently. Milton Friedman, for example, didn’t like free banking because it was vulnerable to contagion: banks runs could destroy financial institutions that were fundamentally sound, because of the inability of depositors to reliably evaluate their banks.
The balance sheet stuff is a red herring, based on a false analogy between the central bank and private banks. The Fed’s operations in the current environment tend to work on a “buy high, sell low” principle. Bond prices are sky high, and so the Fed pays top dollar for the assets when they inject more money into the system. Later, when time comes to hoover up those dollars back out of the markets, bond prices will be lower. The assets won’t be worth as much, so the Fed will be unable to hoover as many dollars back out as they initially pumped in.
This will leave a mark on the balance sheet, but I don’t see cause for concern. The Fed’s “liabilities” include currency in circulation, which is a little bit ridiculous in modern fiat money terms. Today it’s just an accounting fiction to make the columns balance out. The economy requires a certain amount of currency to function efficiently, and it’s not especially relevant if the Fed’s assets dip below their liabilities, as long as they manage to reduce the money supply to non-inflationary levels. The Fed simply cannot become insolvent in the same way that a private bank can. I can imagine a slew of ignorant editorials from the WSJ opinion page about this – in fact, I would bet a lot of money on it – but I would think the vast majority of institutional investors wouldn’t be stupid enough to believe it.
After all, they can build up their assets again over time by declining to remit extra revenues back to Treasury, as is standard procedure now. This will be a revenue drain to Treasury, but it would only happen with economic recovery, at which point much more serious budget discussions will be necessary anyway.
As for the money market, I don’t know a whole lot about it. Selling a lot of Treasuries to soak up those dollars will reduce the price of those Treasuries. The money markets invest in safe assets – that’s the whole point of the thing – and so of course they use Treasuries as one safe harbor. A big sell-off from the Fed would reduce the value of the money market funds. This could plausibly lead to them breaking the buck, and lead to another run. But really, there’s no reason to assume that the sell-off would happen so quickly, catching the markets off-guard. It could easily be a gradual process, for which everyone would be well prepared. Anyway, they’ve dealt with such a run before, and I think a proper winding-down policy could deal with it again without much disturbance. The money market concern seems valid, but in the end not any real hindrance to the plan.
I’m going on a business trip, so I’ll be out for the next three days or so.
Hellestal -
Agreed. Furthermore, in the unlikely event that the Fed ran low on assets, it could still contract the economy via the discount window and reserve ratio. I understand that the latter has been arguably phased out in recent years, but it could be re-introduced.
All-treasury money market funds might have to close or reorganize if 90 day treasuries consistently paid negative rates. So arguably the Fed might have to phase in penalty rates on excess reserves.
He may be a libertarian, but not what people today call a libertarian, and definitely not the type of libertarian that Republicans like to embrace. The Republican position is that we cut spending, not increase it. It seems they just had this little debate over it recently…
BigT: Hold on. We’re talking about monetary policy, not fiscal policy. Monetary policy involves the Federal Reserve’s setting of short term interest rates. Fiscal policy involves taxes and spending. Scott Sumner isn’t advocating a stimulus package, AFAIK. He’s advocating looser monetary policy.
Milton Friedman wrote the classic libertarian work Free to Choose: he also basically founded the school of monetarism, which crashed and burned in the early 1980s (due to Goodhart’s Law). His framework calls for robust monetary policy, a formulation which makes spending adjustments during recession unnecessary. Sumner operates in the updated version of monetarism, which involves targeting inflation (or in his case nominal GDP) rather than the money supply.
The point: this is mainstream libertarianism. The other sorts of libertarians come from the Austrian School, which has been pretty fringey stuff since about 1965. That said, there are plenty of hard-money conservatives without an underlying coherent economic model, such as Glenn Beck, Ron Paul, etc. I think of them as Mellonists or liquidationists.
Does any conservative on this board want to vilify Milton Friedman or say he wasn’t really a libertarian?
What would you have instead? You’re not all goldbugs, are you?