Are you guys whooshing me? That’s the definition of a reserve requirement. And no, from a “money creation” standpoint, there is no difference between a bank and a guy. Banks are just groups of guys.
I see one person saying banks create money by lending, and that the amount loaned is not limited by the reserve requirement, since reserves can be made up after the fact. I see another poster who I think has shown before has a lot of credibility on this, basically agreeing, with some qualifications that the reserve requirement does affect how much is loaned, though not in a directly regulatory way… Then I see another poster (you) directly contradicting all of this, and I don’t know anything about that poster’s credibility or sources. So naturally, I ask where that person gets his information from.
I am not an economist, but here is a short refutation and here is a longer one.
The basic refutation is that just because inflation is not currently a danger does not mean it never will be.
It’s just timing. The bank is covering the reserve requirement in one way or another; it’s not kiting checks.
I would normally interpret the “conventional story” (the reserves first model of money creation) as the infinite series model of money creation. Not just outside cash being deposited in a bank one time, but rather the entire chain of cause-of-effect that is presumed to happen after that, with the money lent out and deposited again and again in ever-decreasing fractions.
On a system-wide level, that’s just not the way it works.
I mean, sure, if someone found ten thousand cash in their attic that had been forgotten for thirty years, and subsequently deposited it in the bank, then you could have at least a few steps of the conventional story actually happening. The bank would have 10k bucks more in reserves and deposits. That might rightly spur them to make a loan for a new car. It’s possible. But this sort of thinking doesn’t properly scale up. Suppose a news report announced that lots of folks in previous generations stored cash money in their attics. A grand hunt is launched. Millions of dollars are found and deposited. Some new loans are made…
…until the Fed decides the economy is heating up too much, and takes millions of dollars back out.
The conventional story can be sort of correct from time to time on a small level. But not on the big level. The flow of money through the economy is regulated from the top. I have a fairly strong belief that I believe I can back up with fairly strong evidence that the central bank largely determines the nominal income (nominal GDP) in an economy. All those little steps will add up to the number the central bank chooses. The exact “mechanism” for that is a layered argument that takes some time to lay out, but the 101 version should be: the central bank determines NGDP, and banks will lend enough for the number to reach the target.
Frankly, I think that’s a much more useful and much more honest 101 version.
If you want this cleared up, we need to backtrack. From the OP:
This is true.
A new loan most often results in a new deposit somewhere in the banking system – though not necessarily at the same bank! The loan check from Bank A might result in a new checking balance in Bank B after it’s deposited. But from the perspective of the banking system as a whole, new loans mean new (broad) money, minus whatever amount was taken in physical cash.
Tom Tildrum responds but only quotes the first sentence, not the second.
This is true.
It’s also an equivocation, or something close to it. Tom is referring to the monetary base here, “government money” in the OP’s terms, which is not the same definition that LinusK was using. But still, the statement is absolutely true when properly interpreted. If a bank makes a new loan, they must have the “money” (the government money, meaning the cash reserves) on hand to pay out that loan in the highly probable event that the loan check is deposited at a different bank. As he later specifies, no bank can be kiting checks. They demand cash. Of course, over time a successful bank will also be receiving checks from loans made by other banks.
The response:
This is true.
It’s also an equivocation, or something close to it. This time the tricksome word is “lend”. Tom was talking about a newly created loan whose check would likely be deposited elsewhere. Linus shifts to discussing all the loans on the balance sheet together. The sum total of loan assets for any given bank should exceed the cash reserve assets they have on hand. Cash basically does not pay interest but loans do. A profitable bank will want most of its balance sheet loaded up with assets that safely pay a nice return rather than assets that gather dust. So a sensible bank will want to be “lending” more (have more loans as assets) than it has cash reserves.
So. Same words to describe different things: “money” as base money or broad money, “lending” as a newly created loan or all the loans counted collectively. More than half of disputes in these kinds of threads are between people who would agree on the point at issue, if they understood each other’s language.
Not 100%, of course. There are still genuine disagreements after the language has been sharpened.
Emphasis added. I’m sympathetic to the view expressed in the underlined sentence. Most broad measures of money tend to be more hassle than use. But it’s still technically wrong.
The most commonly used definitions of broad money, like the M1 or the M2, rely on bank deposits. Simply put: bank deposits are defined to be money, and my debt is not. For one obvious point, my IOU is not nearly as negotiable as a bank’s for strict legal reasons. My debt is not regulated by the government as a kind of money, so it’s not fair to call it proper money. Summing up the distinction as “just groups of guys” isn’t right.
So it seems like your main beef with the standard story is the misuse of the terms “reserves” and “reserve requirement”.
Fractional- reserve banking is an accepted term to describe the current banking system. It is also a useful way to describe how commercial banks are at any particular time unable to fulfill all of their contractual obligations to their depositors.
If you were somehow able to explain how fractional-reserve banking and 100% reserve banking were the same, I would agree that it was a myth. You did not, it is not a myth. At best you have an issue with the semantics of the standard story. I disagree that it is misleading.
I also fail to see how currency is a liability on the government anymore.
There are a number of differences between them. From your point of view, the most important difference is that if there was a true bank crisis - like the one that almost happened in 08/09 - it would be like the bad old days, when banks simply disappeared. They closed their doors and went bankrupt. What that would mean to you is that any checks written off your account would not work. If you went to your bank’s ATM, it would not give you money (Federal Reserve Notes - government money). The bank’s doors would be locked, and customers couldn’t get in. Any money you had on deposit at a commercial band - commercial bank money - would disappear.
Your employer’s checks - your paychecks - would bounce. The only money you would have is the currency (government money) you had in your possession. When people talked about financial system going over the “cliff”, that’s the cliff they were talking about.
The dough would not spend the same, if there was a genuine bank crisis. There wasn’t a bank crisis in 08/09, because the Fed and the Federal government stepped in and stopped it.
Commercial banks are susceptible to bank crises. They happened repeatedly in the 19th century. The last one was in 1929. The Federal Reserve is not susceptible to that kind of crisis. It can’t go bankrupt, like a commercial bank, because it can, if it wants, “print” unlimited amounts of dollars. Commercial banks lack that ability.
You seem to be hung up on pointing out that the Fed cannot undergo a panic. No version of the standard story I am aware of suggests that the Fed is susceptible to that kind of crisis. The problem with fractional reserve banking isn’t that there is no mechanism for the Fed to save us from banking panics. Quickly, one problem with fractional reserve banking is that it needs to be saved from such crises.
There are political issues with the banking panics of the 19th century that mimic the moral hazard of today’s system if you would like to get into that old chestnut.
Thank you, Hellestal, for drawing something coherent from my remarks, and I agree with your corrections as well.
Some of this is pedagogy. The money multiplier story is useful for understanding how the Fed’s high powered money translates into a superproportional increase in loan activity.
There’s a rough analogy with the aggregate supply/aggregate demand story. In the standard view, aggregate demand slopes downwards because the money supply is held fixed and lower general price levels correspond to greater purchasing power. This is ok in a narrow sense. But if you want the student to read the business press intelligently, it would be better to speak in terms of inflation rates rather than price levels. Personally, I tend to think of Fed behavior more in terms of them manipulating the short term interest rate than with the mechanics of purchasing bonds (dumping money) or selling bonds (absorbing money). But that’s me.
FTR, I don’t share that belief. I don’t rule it out either. I think it downplays the monetary transmission mechanism, which operates via housing and cars. It also operates through expectations, but that process isn’t well understood once you get beyond participants within the financial markets. Liquidity traps certainly exist I say (I can point to examples), but whether they can invariably be overcome with sufficient monetary stimulus alone is an open question because it hasn’t been tried.
I don’t have a problem with nominal GDP level targeting though. Done with a reasonable degree of prudence it has little downside. Which is frustrating, frankly. But my best guess is that fiscal policy (including automatic stabilizers) won’t be revealed as irrelevant. For one thing their effects are more evenly distributed throughout the economy, rather than being focused on a couple of admittedly large sectors.
This is not a “scholarly article”. It’s written for the general public. The author, Warren Mosler, is not an academic. He was a Hedge Fund owner, who made so much money he retired to the US Virgin Islands. Now he does things like write about MMT and fund MMT projects at UM-KC (sort of the headquarters of academic MMT work, at least in the US.) He is one of the more influential MMTers. He has no advanced degree, although he has a couple of honorary ones. His web page is here: Mosler Economics. His Wikipedia page is here.
More importantly his book, The Seven Deadly Innocent Frauds of Economic Policy is here. It’s free/pdf. It’s one of the first books I read on MMT, and was the most influential to me. One of the reasons is it’s not academic in tone. It’s easily accessible.
Professor James K Galbraith wrote in the introduction:
The Seven Deadly Innocent Frauds doesn’t suffer from that problem.
There’s also a NY Times article about him here.
Responding to the last bit:
IOUs, at least in theory, can function like money. If Abe signs an IOU to me, and I sign it over to Bill, and Bill signs it over to Cate, the IOU is functioning like money.
One problem is that, in practice, IOUs rarely work that way. (I’m lucky to get my money from Abe, Cate’s chances are less, and Cate probably wouldn’t accept the IOU in the first place.)
Another problem is if you’re interested in knowing things like the quantity of money, the likelihood of inflation, the chances of a banking crisis, or what the Fed’s policies should be, counting, or trying to count, the number of IOUs is not very helpful.
Commercial bank deposits, on the other hand, can be counted, are counted, and enjoy special protections that Abe’s IOUs do not. And knowing the amount of bank deposits can be helpful.
That document is goddamn fascinatin’.
Question for anyone knowledgable, concerning his account of treasury securities. He says that to pay back the debt to China is just to reduce their security account by the amount of the debt and to add to their reserve account by the same amount plus interest.
Okay, but this invites a question. Well, my first question was why would China buy treasuries in the first place, but I guess it’s to get that interest. But my second question, which I don’t know the answer to, is why does the US sell the treasury securities? What’s in it for us if China (or anyone else) takes money we’ve placed in their reserve account, and moves it over to this other account that earns interest?
The popular picture would say that means we don’t have to pay them back for a while, or something? But on Mosler’s picture that of course can hardly be a cocnern.
Pedagogy is problematic if it makes students believe things that aren’t true, and then later lazily declines to disabuse them of the deliberately-instilled mistake.
Or put it another way. Some people will eventually find a nifty website with weird explanations and think, “The economists have been lying to us! We must find a different guru and start two dozen threads on the topic!” Maybe I am somewhat more sensitive to this problem than you are, but I would prefer if economists told it right from the beginning, or as right as possible as befitting the level. That doesn’t seem like much to ask, and I can’t do it by myself. People who become overenthusiastic about a BrandNewPerspective will make mistakes later on. I have evidence to back me up on that.
Economists should teach their students more clearly. It’s difficult to get most academic types interested in topics that don’t directly affect their job and tenure and promotion prospects, but still. This is important.
To whatever extent it’s okay – and I have serious doubts on that, as well – it’s okay because the idea is built upon, not abandoned.
At the intermediate level, IS-LM adds interest rates to thoughts on aggregate demand. For the truly ambitious, Mundell-Fleming adds exchange rate effects. The first foundation stone is used as a support for the ideas that follow. The same can’t be said for the infinite series of money. It’s touched on and then abandoned. Undergrads will never have any further exposure. Even worse, the wrong idea is later reinforced rather than corrected: one possible approach to IS-LM relies on a primitive loanable funds model. That’s just not he way it should be done.
It’s not overwhelming/indisputable/undeniable. It’s not a 99.99999% lock. But honestly, the new evidence that comes in all the time (like the ECB operations in January) is all pointing the same direction. The evidence is very strong and getting stronger every year. Every new piece we pick up points the same direction as all the previous pieces. There could be some deeper trick here, but that’s becoming less and less likely.
The excuses of the skeptical are slowly getting devoured. You should not be surprised if that continues.
It is not yet time to rewrite the 101 textbooks in my preferred way. Genuinely it is not. But I’m becoming more and more convinced that that time is coming.
I spent a bit of time explaining the monetary transmission mechanism to you personally and it mostly bounced off. That’s not a criticism. This isn’t easy and there’s no particular reason for any of it to have sunk in. But nothing is downplayed. I used the the transmission mechanism to explain why the central bank has the control that it has. In my view, to understand the mechanism is to acknowledge why the central bank can steer the nominal economy. You can disagree with that but you can’t claim that it’s ignored to an unhealthy extent. The issue is that when many different pieces are moving at once, the best way to understand the net effect is to actually look directly at the net effect rather than pretend that we can separate all the elements when we can’t see any of their individual effects.
But the next clause is more strange.
No, it doesn’t.
That might be the most bizarre economic claim I’ve ever seen you make. It’s like you plucked it out of the 1980s. Economists used to think that thirty years ago (the 80s were weird) but looking at the sum of the evidence, there’s no reason to believe that housing or autos are always, or even normally, the main transmission mechanism. They are just one part among many. Everyone who holds cash is part of the transmission mechanism.
If you think you’re relying on a recent Krugman piece to justify that statement, then you should reconsider. You’re misreading Krugman, or you’re misreading the evidence he cited, or possibly both.
Can I ask which document you’re talking about?
Of course.
It’s essentially the only way the system could even work. In ye olden days, they printed paper for all this and the current computer system mimics that old one.
Yes. Interest-bearing securities have a better return than securities that return nothing. (And the reason they held dollars specifically is for trade and to influence their currency.)
Interest-bearing securities are lower velocity. They don’t move as fast.
Example: Suppose Mr Adams has a million bucks in cash. Cash just gathers dust. It doesn’t do anything by itself. Every day that Mr Adams holds the cash is another day that he gives up the opportunity of a larger return. No good. The cash wants to move. It wants to melt into the markets. It wants to be spent, rather than gather dust. So Mr Adams spends it, and the flow of money increases. Mr Adams goes out and buys other shit, and that is somewhat inflationary.
In contrast, Ms Bertrand holds a million dollars worth in bonds that pay 3%. Ms Bertrand can make a conscious decision to sit on those securities and still be content that the wealth is working for her. She doesn’t step into the markets, doesn’t buy anything else, doesn’t increase the flow of money with any new purchases. She sits and waits.
The government taxes and spends. When the tax revenues are insufficient to meet the spending, then that deficit must be financed in some manner. One possible method is to print 0% cash and use that. Another possible method is not to create new cash but rather to borrow already-existing cash from the markets, and print up an interest-bearing security. (Or with a computer, these are the two different accounts you’re talking about.) Damn good reason for that. When governments finance their spending with newly created cash, the cash moves. It moves faster and faster. It doesn’t sit still. It hits the markets directly, getting passed around like a hot potato and prices increases. Prices become “unanchored”. Higher prices tomorrow mean an even bigger incentive to spend today. The velocity increases even more, the flow is even faster. Which pushes up prices again. Vicious cycle. This has happened to more than a few governments in history.
When governments finance their spending with bonds that pay a yield, then the people who buy those bonds are much more likely to brood on them, happy as hens. It doesn’t move. They sit and do nothing and the securities don’t flow through the markets like cash can and will.
One of the reasons (though not the most important reason) why inflation is so muted even though the Fed has created more than three trillion new dollars is that the Fed has decided to pay a quarter point to banks on that cash if the banks keep any cash in excess of their legal reserve requirement. If the Fed stopped paying that quarter point, banks would have 0% cash on their books rather than 0.25% cash on their books. They’d be wondering if there were something more productive they could be doing with that money. The cash would be tempted to move.
I would guess the popular picture is that the government doesn’t have enough tax money, so the government must borrow.
But of course, that’s ridiculous. The government has printing presses. (Or more than one account that they can manipulate.)
But if you just tell people “The government has printing presses” then nearly everyone immediately stumbles onto the right answer. Yes, the government has printing presses. But it’s nearly always a terrible idea to use them for the specific purpose of financing government spending. This is why, legally, the power to make zero-interest money is strictly separated by Act of Congress from the power to issue new bonds. Then then Treasury can concentrate directly on finding “money” that they have legal power to create. They find the money by taxing or by borrowing, not by printing. They don’t (generally) worry about the economy as a whole when they make this decision.
In contrast, the legally separated central bank guides their decision to print or destroy money by the macro situation. Which is a good thing. The power to print zero-percent money (one of the computer accounts) is waaaaaay more important to the economy than the ability to issue the interest-bearing stuff (the other computer account).
What I’m making here is a fairly standard monetarist argument.
Some people tut-tut at this and have their niggling doubts. Obviously I can’t say this is absolutely true. But there’s a lot going for it, and more every year.
In another context, someone has written to me in response to reading some of Mosler’s Seven Deadly Frauds, (that’s the document I was referring to above, to answer your question) the following:
It looks like this friend of mine is saying that Mosler is right in a technical sense, but is saying things that are not actually relevant to anything important because they deal with a mere theoretical possibility.
What is your evaluation of this counter-argument?
Thank you for any feedback. And do you mind if I ask, Hellestal, are you an economist?
I need to see a central bank adopt a nominal GDP level target for me to… assess the evidence. Proof of the pudding etc. I would advocate such an experiment because a) it would do little harm and b) targets aren’t hard to drop if they don’t work. The Fed targeted M1, M2 and M3 for a while and simply stood by when those targets were missed.
Mostly perhaps, but certainly not entirely. I’ve kept the hot money post in the back of my mind for a while. (I’ve purchased Keen but alas haven’t gotten around to reading it yet.)
Somewhat. Also the housing bubble of the 2000s. I didn’t mention the pretty significant Keynesian multiplier effects as carpenters are hired, etc.
My understanding though is that it’s difficult to establish an econometric relationship between fixed investment and interest rates. Which is sort of frustrating. Heck, even the effect on corporate investment from stock prices isn’t too large, though it has been established. If you have an econometric cite suggesting something else, I’d like to see it. Admittedly I overlooked the effect on exports and imports via the exchange rate, which can be pretty substantial, especially if the downturn is localized to a particular country. I concede that I am skeptical of arguments that, say, rely on the effects of Fed policy on the expectations of the general public or the operators of small and even mid-sized businesses. I don’t rule them out: I just want to see detailed empirical evidence. That stuff bounces off somewhat.
I read the long article by Mosler (and will comment if anyone’s interested in my opinion), but want to mention one assertion that caught my eye.
Mosler claims that the 2001 recession resulted from the budget surplus during the Clinton Administration stifling investment. I thought the opposite: that the 2001 recession was at least in part a backlash to excessive private-sector investment, especially Internet related. Is Mosler’s claim reasonable?
The “conventional story” is more accurate and less confusing. You’re arguments are, in large, semantic and quibbling. Honestly, there is no need to bust something that really isn’t a myth.
You’re point 2 - The reserve requirement DOES restrict lending. I don’t know anyone who confuses loans with deposits but you’re clarification isn’t particularly necessary or clarifying.
You’re point 3 - Does anyone really think that the bank takes the exact “money” deposited and loans it out with rubber stamps that says “Loaned by Chase Manhattan?”
You’re point 4 - I don’t even get this one. You seem to be implying through some round about way that banks aren’t restricted by their deposits because they can always just buy free reserves from other banks (or the Fed in a pinch). Nevertheless the banking system as a whole does need deposits in order to loan.
As far as “commercial bank money” vs. “goverment money?” I don’t know even where to start with that.
I don’t know if this answer your question, but:
China manipulates its currency to keep its exchange-rate value low. They do that because it makes Chinese products cheaper in the international market. China has a lot of people, and those people need jobs. One way to create jobs for them is to create more demand for Chinese products in the international market.
When a Chinese company sells goods to, for example, America, it receives dollars in return. Those dollars must be exchanged for yuan before the Chinese company can use them to pay wages to workers, pay Chinese taxes, or take profits.
That exchange happens in the international currency exchange market. All things being equal, selling dollars to buy yuan drives up the price of yuan, and drives down the price of dollars.
If China doesn’t want that to happen - and it doesn’t - it must sell yuan and buy dollars to maintain the value of yuan within its target range.
The simplest way to do that is for the Chinese Central Bank to create yuan (out of nothing) and use them to purchase dollars. Once it owns dollars (and assuming they want to keep them - which they do) it has few options. One option is to keep the dollars in China’s account at the Fed. Another option is to exchange the federal funds for paper notes, and ship them to China. A third option is to purchase Treasuries.
The first option is free, but pays no interest. The second option - shipping bales of US currency to China - is not free, and still pays no interest. The third option is to move the dollars from China’s reserve account to its Treasury account, by purchasing US debt. The third option is not only free, it also pays interest. So the third option, from China’s point of view, is the best.
From the US point of view, we’re getting goods from China at an artificially reduced price. It’s as if China has instituted a national sale on all things Chinese. If you’re a consumer, a sale is a good thing: it means you’re paying less than what you’d otherwise have to pay.
That China is accumulating American dollars and/or Treasuries doesn’t really matter. Or rather, it does matter, but not in the way people normally think.
It doesn’t matter, because ultimately China can only do one thing with US debt: redeem it for dollars. Since the US government (specifically, the Fed) can create any amount of dollars at any time, paying China is not a problem. Furthermore, once China gets those dollars, it can only do a couple of things with them. One is to purchase American goods and services (which is the real way the US will “pay back” its debt to China). That, of course, will create jobs in the US, in the same way that Americans buying Chinese goods creates jobs in China.
Another option would be to sell the dollars on the FX market. That would (all other things being equal) increase the value of the yuan, and reduce the value of the dollar. In effect, it would put all things American on sale. Again, that would increase the demand, internationally, for the American products, which would represent a real way of paying back the debt.
The third option would be to ship bales of US currency to China, and bury them in a vault. That would be the equivalent of forgiving the debt.
Regardless of what China does, it’s not really a problem for the US, with some caveats. One is that if China is “removing” dollars from the US economy (by hoarding them, for example) it’s important for the Fed to make up for what China is doing. Specifically, it needs to create more dollars to replace the dollars China is hoarding. Another caveat is that if China decided to sell all its dollars and dollar-denominated assets at once, and exchange the dollars for yuan, it could cause a dramatic fall in the value of the dollar, and equivalent rise in the value of the yuan.
Of course, the Fed has it within its power, should it decide to do so, to counter the effect by creating dollars, and using them to buy yuan.
Why was it fascinating?
I ask for purely selfish reasons. I can be interesting in a classroom but it’s harder in writing. I have my moments, but still, this stuff can be pretty dry. Just… gears spinning. I have to wonder what he’s done to make it compelling.
So that I can violently mug him and steal the technique.
I agree entirely with this friend of yours. I was trying to make a similar argument at the end of my last post. The two functions are legally separated for a damn good reason: countries with weak institutional barriers between the power to tax and spend and the power to make new base money tend to suffer higher inflation. Without the barrier between the powers, the people in government who spend often succumb to the temptation of “printing money” to finance the spending instead of risking short-term political displeasure with higher tax rates. Borrowing is problematic, too, because of previous irresponsibility.
Happens all the damn time. The apparent MMT response of “Taxes can be raised!” is a copout. If governments were so willing and able to raise taxes in the first place, they never would have printed.
Institutional barriers will sometimes evolve in places where human reason is repeatedly shown to fail. This is one of the more obvious cases.
…yes?
I’m a PhD candidate. My undergrad back in the day was econ and I did some graduate work, too, while studying other things. Then went into the world. Now much later, I’m back to finish. I research. I’ll be teaching again soonish. You can assign to me whatever label seems most appropriate.
Ultimately, of course, arguments stand on their own terms. Reality doesn’t bend to any credential.
An analogy, based on recent post by Scott Alexander.
In nutrition they prefer human studies to animal studies. They like to randomize groups in order to control for confounders. They like long-term studies to see if any perceived effect persists.
If you study rats, you can easily randomize groups and study for a long time. You get an effect out of the data and you’re damn sure it applies to rats. You’re wondering if the effect is more general. You do a short-term study on people, properly randomizing the groups and strictly controlling for the variable at interest. But carefully looking over everyone’s shoulder for every meal is hella expensive so you can’t do it long. You get the same effect. Confirmation that the effect works in humans, but the question is open whether it persists. So you do a cheaper version of a long-term study with self reporting. You get the same effect again. But proper randomization of groups is basically impossible now. That means there’s a dangerous possibility of confounders.
Does the effect actually exist?
If all the research has been professionally done, the intellectually responsible answer at this point is “yes, probably”. Now maybe the effect doesn’t generalize to humans AND the perceived short-term effect is an aberration that wouldn’t persist AND the perceived long-term effect is the result of some damn confounder. Maybe each study is flawed and each flaw somehow manifests in the same way. It’s possible. But if we’re looking at the data so far, and the types of research that have been done, then it’s clear which way the wind is blowing.
Someone could be sitting on the sidelines saying, well, there hasn’t been One Study to Rule Them All. There is no single human study with properly randomized groups over a long time period so hey, they’re still undecided on the effect. They want every star to align for them to express any degree of conclusion. Overconfidence is a sin and it’s nice to avoid it.
But refusing to be moved by the available evidence is also a sin. It’s not Bayesian. Even if the perfect experiment hasn’t been done, we should still be leaning in one direction.
To be clear, I’m not saying something like NGDP targeting should be treated on the same level as hypothetical research above. It’s not there yet. But I am saying that waiting for the One Study to Rule Them All to finally make up our mind is an empty excuse. Even if we don’t get the perfect natural experiment, we are getting lots of little natural experiments that chip away at the edges, and not now but eventually, if the trend continues, that should be enough for any honest observer to start leaning in the obvious direction. NGDP wasn’t picked out of a hat. We’re not open to the idea based on total randomness. We’re open to the idea because it fits what we see in the evidence. The edges that have already been exposed seem to match up with it. If we chip away at a few more places, then that should be enough to express at least some measure of confidence that it would be superior policy.
Some of the people who posit the ineffectiveness of interest rates argue the bubble of the 2000s is another example of how interest-rate policy doesn’t work. The relationship breaks down completely in the data.
There’s a reason Krugman cut twenty years out of his dataset, including everything after 2000, in order to make his argument. He had to dump the data that contradicted the correlation. He took some heat for this. To defend his previous assertion and emphasize again the strong correlation, he decided to… dump even more data.
His reason:
His argument here is that the data that supports his point should be used to support his point, and the data that doesn’t support his point should be ignored.
And I sort of agree with him, though his argument is so terrible it makes me shake my head. I mean, come on. “It’s not that hard to know which eras we’re talking about”? Really? Really? Maybe if you’re a genius it’s not hard to know. For the rest of us, this takes quite a lot of work.
I ran the numbers myself. The correlation in the brief moment in the 1980s that he cited in his graph runs close to -0.5, exactly like he wants. And yes, that’s important. Housing can be important. But the correlation for the entire data set runs a positive 0.1, opposite of his favored window. What you can argue, then, is that housing is sometimes disproportionately important in certain strange situations: where interest rates are fluctuating wildly in a time of relatively high inflation. (This relates to the Fisher effect: The interest rate swings are so volatile, and inflation so high, that the rate changes are moving much faster than inflation expectations. That means most of the interest rate swing is “real”, which will have a disproportionately large effect on housing when rates spike upward.)
What we should say: housing can be a disproportionately important transmission mechanism of monetary policy in certain circumstances.
What we should not say: Housing is always disproportionately important, and that the cause-and-effect relationship from a three year window should be presumed to be a “natural experiment” whose causation applies more broadly: equally important in the rest of the many decades of data, even though the effect does not appear in the rest of the many decades of data.
Those multiplier effects are just as hard to pin down as any other transmission mechanism. Too many variables, too little data to isolate them. The assumptions behind the multipliers could just as easily go the opposite direction.
Your understanding is right.
Even the housing relationship only shows up in specific circumstances.
Yes.
Yes.
Yes.
I don’t have what you want yet.
Another five or ten years might be a different story.