Thursday, December 29, 2011

The Market Monetarist, MMT, and Austrian Lovefest

The Economist magazine has a new article on the rising popularity of Market Monetarism, MMT, and Austrian economics.  The article notes that all of these schools of thought have benefited immensely from the blogosphere and have each provided a critique of how macroeconomic policy has been conducted over the past few years.  It was an interesting article, though as Scott Sumner notes the piece is wrong in its implication that nominal GDP targeting requires significant activism by the Fed.  If implemented properly, nominal GDP targeting would require less activism since it focuses the Fed on a single, explicit mandate.  In the case of Scott Sumner's nominal GDP futures targeting, this approach would actually put the Fed on automatic pilot.  (It would also put many Fed economists out of work and make the Fed far less important, so do not bet on it happening!)

One point I want to stress here is that contrary to claims of some MMT advocates, the success of nominal GDP targeting does not depend on increased bank lending or on a naive belief in a simple money multiplier story where increased bank reserves lead to increased bank lending.  In fact, the MMT emphasis on bank lending being influenced by capital considerations, credit worthiness of borrowers, and the demand for credit is entirely consistent with the Fed using a nominal GDP target to manage expectations such that portfolios are rebalanced in a manner that sparks a recovery.  Here, bank lending responds to the improvement in current and expected economic activity brought about by nominal GDP targeting.  This is how I explained the process before:
The ability of the Fed to influence total current dollar spending does not depend on banks creating more loans. Rather, it depends on the Fed's ability to change expectations so that the non-bank public rebalances their portfolios appropriately.  Recall that a nominal GDP level target means the Fed makes an unwavering commitment to buy up assets until some pre-crisis nominal GDP trend is hit.  As Nick Rowe notes, just the threat of the Fed doing this would cause the public to expect higher nominal spending growth and higher inflation.  This change in expectations, in turn, would cause investors to rebalance their portfolios away from liquid, lower-yielding assets (e.g. deposits, money market funds, and treasuries) toward higher-yielding assets (e.g. corprate bonds, stocks, and capital).  The shift into higher-yielding assets would directly affect nominal spending through purchases of capital assets and indirectly through the wealth effect and balance sheet channels.  The resulting increase in nominal spending would increase real economic activity, improve the economic outlook, and thus further reinforce the change in expectations.
Bank lending would probably respond to these developments, but it would not be driving them.  It is interesting to note that FDR did something similar to nominal GDP level targeting in 1933 and it sparked a sharp recovery that lasted through 1936.  Bank lending, however, did not recover until 1935.  Bank lending, therefore, was not essential to that recovery.  That may be less true today, but in any event the key point here is that if bank lending does increase it would do so as a consequence of the improved economic conditions brought about by the change in economic expectations.
There is more here on how this transmission mechanism works. The real critique, then, is whether a change in  nominal expectations can really affect current spending decisions by firms and households.  I have an earlier post that shows inflation and nominal GDP expectations (as proxied by a survey of forecasters) do in fact influence spending decisions.  Josh Hendrickson and I also show in this recent working paper that shocks to inflation expectations cause households to adjust their portfolios in the manner outlined above.  Finally, as shown by Gautti Eggertson, a sudden change in nominal expectations was also key to FDR's 1933-1936 recovery.  If the MMTers (and Austrians) could come to accept this evidence, then we could truly have a deficient aggregate demand lovefest.  


  1. Neo chartalism sounds to me like an old Fried man´s article, that I comented here
    I think that is a very good idea, perphaps not very aceptable politically.
    On the other hand, I suspect MMT is pure monetarism disguised, as the article of Friedman is obviously, monetarist.
    So, the differences are not so scandalous.
    I wouldn´t like to close all the door to some elements of other schools that in the fundamentals are not so away from monetarism.
    I mean that reducing all the debate aboy monetary policy to the reasonably of NGDP objective is a little impoverishing.
    I am strongly attracted by the Friedman article and some coincidences with MMT, in the sense that fiscal and monetary policy wuld be coordinanted, both pursuing a credible objective of estability. I don´t see why not to analyse the pros and cons of an idea of which Friedman was pioneer.

  2. Hi - simple question - won't the Fed have to change their legal mandate to encompass buying all assets required to achieve that nominal GDP target?

    As I understand it the Fed can not buy multiple asset classes like equities and REITs.


  3. Rates-of-change in monetary flows (our means-of-payment money X's its transactions rate-of-turnover), on one side of the equation, are mathematically equivalent to rates-of-change in nominal gDp on the other side. However the level and/or rate-of-change in the FFR has no such connection. The only connection is, as Sumner points out: high interest rates are prima facie evidence of an easy money policy & low interest rates are prima facie evidence of a tight money policy. Unfortunately the monetary transmission tool utilized since 1965 has been thru the manipulation of short-term interest rates.

    There's little debate that consumers were tapped out as a result of Greenspan's housing bubble (the principal cause of the Great-Recession per MMT'ers), it is equally clear the the Federal Reserve suffocated the money market by contracting liquidity precipating a banking crisis.

    I.e., the FED failed to counteract the 2 year decline in the rate-of-change in nominal gDp using its policy target the FFR. I.e., there is absolutely no controversy in saying the FED was responsible for an overly restrictivve money policy which ultimately lead to economic collapse.

  4. David,

    It seems that that the paradigm for Market Monetarism is to stabilize AD while interfering as little as possible with market processes.

    The suggested policy however (buying assets until NGDP returns to trend) seems high-risk and potentially inflationary.

    Why not just have a sales tax that the government varies to maintain stable retail sales and that is allowed to go negative if the NGDP forecasts move below trend ? It could even be combined with interest rate policy to maintain the correct balance between consumer and investment goods.

  5. Luis H Arroyo said..."Neo chartalism sounds to me like an old Fried man´s article, that I comented here
    I think that is a very good idea, perphaps not very aceptable politically.
    On the other hand, I suspect MMT is pure monetarism disguised, as the article of Friedman is obviously, monetarist."

    Forgetting the issue of whether Neo-Chartalists are correct or not, This is certainly not true. Read the academic Literature. they are anti-monetarist. They think that when a banks make a loan, they create a deposit (more accurately they credit the deposit account of the borrower or the deposit account of the person/corporation/ the borrower is paying), not that a deposit creates a loan (as it does in monetarism and the money multiplier theory).

  6. Yes, I know neoliberals assert that the transmission mechanism is expectations and confidence, which they presume the central bank can use to manage economic behavior in aggregate. However, this is not an economic explanation that is empirically testable, but rather a pseudo-psychological one that has no basis in either psychological or sociological findings. It is a superstition that Paul Krugman has rightly lampooned as analogous to the tooth fairy.

  7. Rob,

    I will have to think more about your sales tax idea (send any links with further info).

    Regarding the risk of NGDP targeting, the key is that it is NGDP level targeting. That is, the Fed would have to both loosen and tighten around a long-run trend path. And if taken seriously it would actually anchor long-run inflationary expectations.

  8. Macro Musings,

    The Fed would probably not need to buy up all asset classes in practice, but yes it would add to add to its efficacy it could threaten to buy up all asset classes.

  9. Tom Hickey:

    "However, this is not an economic explanation that is empirically testable,

    I am sorry you haven't taken the time to actually read the literature and are thus making this misinformed claim. Again, take a look at Gautti Eggertson paper I linked to above and the reference found therein. Or at my working paper with Josh Hendrickson. There is plenty of evidence and expectations is a core part of modern macro for good reason. I was hoping for a more meaningful exchange with MMTers.

    "...Paul Krugman has rightly lampooned as analogous to the tooth fairy.

    Here too you apparently haven't read the material closely. Krugman is actually one of the strongest advocates for the the Fed committing to shaping the future path of nominal expectations. He has a famous paper in 1998 where he shows the way out of a liquidity trap is for a central bank to promise higher inflation going forward. He has blogged about this many times too.

    The confidence fairy that he torn apart has to do with the view that austerity will create more confidence. This is a different topic altogether.

  10. Re: Negative Sales Tax.

    This was something I thought of while reading The Economist article on heterodox economics viewpoints. I assumed that this is not a new idea but so far (via Google) I have not found any discussion on it.

    A sales tax that is allowed to go negative would seem to be a simple way to implement a stable AD policy in a way that is politically acceptable. It would not be (obviously) inflationary and the idea of directly influencing sales via this policy tool would be easy to explain to non-economists. It would have a very direct transmission mechanism between policy and target (retail sales forecast).

    The main downside I can think of are that it would be distortionary between spending on capital v consumer goods , and between different consumer goods depending upon their "elasticity" in the face of changes in the demand of money. Also when the sales tax went negative it would involve money creation to fund it, but this should balance out over the course of the business cycle.

    I am sure that there must be other factors that I am missing here that would rule this idea out from practical consideration - and I would definitely welcome your (or others) views on that.

  11. David, correlation is not causation. What is the transmission mechanism from expectations (psychological) to behavior (real)?

    REH involves assumptions that are questionable in the light of findings in other social sciences.

    OK. I was exaggerating on Krugman and the confidence fairy, but I think there is a close connection. And I think PK is as wrong was other monetarists are about inflationary expectations being a sound basis for monetary policy. I just don't but it as an actual transmission mechanism.

    Look at the folks at Zero Hedge going long all sort of inflation hedges due to a misunderstand of what QE would do. Sure, they fell into the expectations trap, and many got burned. Bill Gross got his butt handed to him on tsy shorts, just as the MMT-based traders had predicted. (BTW, Mosler's bank had a three year average of 67.77% ROEthree year average of 67.77% ROE.) But the neither firms nor consumers in aggregate caught the expectations bug, and the Fed is still fighting "deflationary expectations."

    Now that the Fed has shot off all its big policy guns and used up its ammo, people are going to get inflationary expectations from what exactly?

    The point that the MMT'ers make is that the way out through fiscal policy is clear, should politicians actually understand the potential of fiscal policy based on sectoral balances and functional finance, and compromise enough for the good of the country to use it.

    This kerfuffle is essentially between monetarists and fiscalists, and I don't see any making nice as a way to fix it. MMT'ers claim that we need to debate the merits based on a correct understanding of monetary economics wrt the existing monetary system in general and the specifics of different countries. But you know that already from what commentators here have said previously and in interaction with Scott Sumner. Your guys criticize the MMT'er's for not being open to your pet ideas, but you seem resistant to looking at anything the MMT'ers say about monetary operations that calls your position into question.

    MMT shows clear and actual transmission mechanisms that don't have to be "proved" though dubious correlation studies that don't show directly how psychological states translate into aggregate behavior. I think that it is a weak argument in the face of argument that show how transmissions occur directly in terms of actual and therefore observable monetary and fiscal operations. In my view it is magical v. scientific thinking, regardless of the sophistication of the models. Let's look at operations.

  12. Tom,

    This is a great point. I personally have called Monetary Policy a Rube Goldberg machine for the last several years.

    The transmission mechanism is best described in a post I wrote here.

    Even if you take monetary policy in the best case scenario, the fact it relies on real estate as it's primary transmission mechanism to the rest of the economy makes it problematic.

    In fact, using real estate as the primary transmission channel for any policy is probably the worst way possible to moderate action in the economy.

    Here's a quote that will help to illuminate this problem:

    "It’s a huge problem. Even when the real estate markets are functioning properly, there are vast, gigantic, huge problems with the monetary transmission mechanism:

    real estate transactions are costly
    real estate transacations are bulky they are huge relative to incomes
    real estate transactions take lots of time
    real estate transactions are extremely geographically dependent
    real estate transactions aren’t easily reversible

    Monetary policy forces us to push on what is the slowest moving, bulkiest, costly, and yet geographically limited area of the economy as our stimulus policy tool!

    Ok some snark: I wonder why monetary policy takes 12-18 months to see impact? Why in the world would this be the case? I can’t figure it out – must be magic or incomplete markets or a breakdown of the EMH."

    The good thing about fiscal policy is there is no need for correlation studies. You can measure the effect directly.


    You should know that I think highly of your work. I've quoted your work several time, in particular the note that the U.K. probably targets NGDP at 5.3% growth.

    This didn't really result in a golden age of growth and prosperity for the UK, at least in comparison to the rest of the world. It doesn't seem to be that much of a difference, because when it was really needed in 2008, they dropped the ball entirely.

  13. "Regarding the risk of NGDP targeting, the key is that it is NGDP level targeting. That is, the Fed would have to both loosen and tighten around a long-run trend path. And if taken seriously it would actually anchor long-run inflationary expectations."

    I think my concern is not so much whether it would work in a stable economy but how it would work when the staring point is a deep recession where demand for money is very high. In this scenario a lot of asset purchasing may be needed before NGDP returns to trend. If demand for money then also returns to trend then there is a truck load of money moving back into circulation that will need to be withdrawn quickly to avoid inflation. I worry that this cannot be done without either provoking another recession or causing the CB to lose it nerve and drop the target and allowing inflation to take-over.

  14. I don't understand why trading up prices on old investments (equity or bonds)results in real economic improvement.

    The only direct positive effect of bidding up these financial assets is that they can improve one's ability to gain loans at a favorable rate via the banker's perception of a larger capital base. That effect can expand credit, which can result in new productive investment.

    Even new or secondary equity offerings seldom raise fresh capital anymore.