Matt Nolan

A point on crowding out

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The idea of crowding out mentioned here appears to have made some uncomfortable.  On the face of it, people may feel that this sort of conclusion would mean that I agree with this sort of statement from Neil Ferguson (I don’t):

You can’t be a monetarist and a Keynesian simultaneously—at least I can’t see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.

And it might give the inference that I disagree with Sumner here (I don’t):

I hope other bloggers will adopt DeLong’s enlightened approach.  Then we might finally be able to have a sensible debate over fiscal policy, instead of a inane shouting match between intellectually bankrupt “paradox of thrift” arguments and empirically unfounded “crowding out” arguments.

When I mentioned crowding out in that context, I was merely saying “hey, increased government demand is increased demand” … I was arguing against the idea that is publically being taken from MMT (although I am sure the authors are being a bit more careful) that for some reason a higher deficit would lower interest rates, and the fact that in trying to make themselves seem different from the mainstream MMT authors appeared to be willing to let this mistaken view become accepted.

[Note:  The argument they seem to have is that, if you increase the deficit AND then expand the money supply to accommodate it, you can lower interest rates … this is a different issue again, and requires a bit more of a description regarding the impact on inflation, which mainstream economics does through the central bank reaction function and inflation/NGDP target]

I emailed James about the Neil Ferguson piece saying the following:

Look at this.  Yar, an increase in G-T increases the term structure of real interest rate relative to where it would be, which in turn suggest that the central bank will indicate policy that involves a higher nominal interest rate to meet its inflation target.  But in terms of “stimulus” it doesn’t mean they are fighting – just that eqm interest rates are higher.  The Fed isn’t trying to “make interest rates lower” it is trying to meet its inflation target in the face of a negative demand shock.

This is consistent with the idea that, outside of the ZLB on interest rates central banks do fully offset the “demand” implications of fiscal policy (making it an issue of efficiency vs equity when choosing the size, scope, and actions of government).  When at the ZLB, and faced with the central bank that refuses to do anything, the fact that the government pushes up the “inflationary non-accelerating interest rate” by increasing its deficit is the very mechanism by which the stimulus is seen as “effective”.

As Sumner says in the aforementioned post, the “multiplier” associated with the deficit can be seen as an estimate of central bank incompetence – although I prefer to use the term central bank “conservativism” in the face of uncertainty.

Matt Nolan

The exchange rate as a price

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Over on Rates Blog I’ve knocked up an entry on exchange rates.  In it, I spend a bunch of time just talking about “what an exchange rate is” – all with the aim of turning around and saying that given it is a price, we need to understand what it is telling us and why before we can go off and demand changes.

Effectively, the exchange rate is a symptom of things going on in the real economy – and policy needs to be focused on where these fundamentals may be hit by market and goverment failures, instead of a blanket criticism of the price.  I’d also note that there is a “barrier” to intervention in all this – we do need to actually have a fundamental understand of the issues before we put policy in place.  The persistently high real exchange rate is an issue that has caused some concern (*,*,*) – but “solving” any perceived problem here does not lead us to the conclusion of arbitrarily loosening monetary policy!

Note:  I suspect the comment section over there will look a bit like this – and so will hold off from reading till the weekend.

Update:  Scott Sumner covers similar ground by railing against “imbalances” as a concept – stop concentrating on the price, and start thinking about why the price has shifted.  Lars Christensen reiterates this before both of us.  In some sense, the Lucas Critique stemmed from this very idea.  I genuinely don’t understand why simply saying “let us think of why the price changed, and what the trade-offs are from this fundamental shift (and any policy to change it)” makes people so incredibly angry – but it does!  I have no social skills, and have a passion for discussing trade-offs, so I will never stop making this point – no matter how many nights in bars I have to put up with people yelling at me while I’m drinking my beer 😉

Matt Nolan

On MMT: An ideology wrapped in a strawman

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Note:  PP on twitter asked for a post on MMT, and asked me to try to avoid making it technical.  I attempted to do that at much as I could – however, I was forced to use words like endogenous, as it was the cleanest way of trying to get across the point that by using supply and demand savings and investment are jointly determined … and the interest rate is set as the price.  The very idea that economists only think the causal chain goes only one way or the other is patently ridiculous – and does not represent economists, no matter how much people keep saying it does.  So try to keep that point in the back of your head until at least the end of the post if you read it 😉

I have nothing inherently against modern monetary theory, its proponents, or the value judgments involved.  But my impression is that MMT theorist view central bank independence and the framing of government policy as an ideological device to “shrink government” and so have decided to create a “strawman” mainstream economics to attack, rather than directly admitting they want a larger state (and the trade-offs involved in that).  For me this simply lacks transparency!

So how does MMT differ from mainstream economics.  Well in the words of Bill Mitchell (who I choose because he is clear, both here and on his blog – which is a good thing!) it comes from economists accepting three false premises:

  1. A government has to borrow to spend
  2. There is a fixed supply of savings at a point in time
  3. Governments crowd out investment for that fixed supply of savings, pushing up interest rates

Supposedly all three of these are in the core of economics, and they are all wrong.  Huzzah.

Ok, so if that is MMT then I’m not sure who in the world they are actually arguing with.  The government can print money, and this is in any graduate macro book, so that doesn’t hold as a premise.  Savings and investment are determined by supply and demand, they aren’t a “fixed thing”, so that isn’t a premise in mainstream economics (Sidenote:  Why do people keep saying “savings determines investment” or “investment determines savings” – I’ve never heard economists talk like this … remember the money multiplier is a ceteris paribus example, not a description of the causal device).   Crowding out is actually a premise – but it comes from government demand pushing up demand for underlying goods and services … because government demand for things is just like the demand of any institution.

Let me restate these premises in terms of what the mainstream actually has:

  1. A government can finance spending through taxation, selling bonds, or issuing money.  In the end, prices and expectations adjust such that someone pays for government consumption and investment.  More specifically the government has to match spending to taxes over time for a certain inflation target!
  2. Savings and investment are determined endogenously by demand and supply factors in the economy, where the “price” is the REAL interest rate (perhaps I should use the world natural/fundamental here) – as savings and investment are factors that are involved with transferring consumption (the thing we really want) over time due to technology, the rate of return on investment, our time preference, etc etc
  3. Additional government demand for goods and services will push up the price of those goods and services and push up the REAL interest rate in the economy … remember the real interest rate is a price, when the government is trying to push up investment of consumption this increases the demand for these given an underlying PRODUCTION FUNCTION, crowding out private investment and consumption … the real interest rate rises as investment/consumption demand has been pushed up and the lift in relative prices has to occur in a way that makes private agents defer consumption/investment in terms of the quantity of goods and services.  No amount of hammering the S=I identity in the face of fiat currency changes this 😉

These premises actually sound pretty good to me!

I remember my dad used to say “it isn’t money that matters when we think about people, it is the actual good and services that are made and consumed”.  He didn’t take the same point out of it I did, but I think on this statement he was right – we need to actually think about goods and services, capital, and labour here.

Now there are MMT people who claim they do (back to Bill again) – that they have a production function (which seemed to be a bit missing earlier) and they have a Phillips curve (tells us how this production function and prices pressures relate through time).  This is good, these two things are necessary!

But if that is what they are doing, then their inherent model IS the mainstream model.  The three “fallacies” that they mention don’t actually exist – and that third point they list down is WRONG … there is crowding out.  Instead their argument is that the “optimal size of government” is larger than they hear other people saying … which is both an empirical and subjective question that people have already written (and should continue writing) countless books on.

Yes, people should discuss this, and discuss trade-offs.  But misinterpreting mainstream economics and pretending to offer an alternative in order to sell your view as not being “subjective” (which all policy conclusions are) is both misleading and irritating for people who view themselves as part of the mainstream.  Personally I like the idea of “changing the frame” to think about issues – but to me that is just a good way of researching, rather than a sign of a militant revolution inside economics 🙂

A much better critique of MMT (albeit more technical) can be found here.

Matt Nolan

Why is Nick Rowe so incredibly clear on monetary policy?

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Here read this:

Yes, if the central bank raises or lowers interest rates, this will affect financial markets. But I thought we had gone beyond thinking of monetary policy in terms of raising or lowering interest rates. Or buying or selling bonds in an open market operation. Or raising or lowering the money supply. Or raising or lowering the exchange rate. Those aren’t monetary policies.

Targeting 2% inflation is a monetary policy. Keeping the money supply growing at 4% per year is a monetary policy. Keeping the exchange rate fixed at $0.95US is a monetary policy. Targeting “full employment” (at least, trying and failing) is a monetary policy. Following the Taylor Rule is a monetary policy. Targeting a 5% level-path for NGDP is a monetary policy.

Yes.  Exactly.  When monetary policy rules are analysed by economists this is clearly kept in mind – but when it comes to discussing it to the public we feel compelled to “tell a story” that involves whatever people are interested in.  And this confusion, although it may not have caused the crisis, hasn’t helped matters.

And why is he so clear on it, he understands the way that policy has been framed differs from the truth of what monetary policy is as a targeted rule:

OK, this is probably the weirdest post I have ever written. I am going to argue that interest rate targeting is not what central banks really do; it’s a social construction of what they really do. Interest rate targeting is not reality, it’s a way of framing reality.

That was weird enough, but I’m now going to get really weird. The failure of monetary policy is not caused by anything central banks are actually doing; it’s caused by central banks’ way of framing what they are doing, and by the rest of us accepting that same framing. The current recession was caused by those (and that includes especially central bankers themselves) who think that central banks use an interest rate as the control instrument. It’s the framing of what central banks do that caused the mess, not anything central banks are actually doing. The social construction of reality is what dunnit!

Monetary policy is about expectations, and using rule based policy to help manage these expectations, take advantage of any perceived tasty looking trade-offs, and deal with “time inconsistency”.

Interest rates, exchange rates, asset prices, are all factors that help give us information about the stance of monetary policy (relative to some prior belief, or some set of expectations).  But monetary policy is about the rule, and being clearer about this rule and what it means instead of making “neat little (partial) causal stories, that only work part of the time” is a good way to go.

Don’t get me wrong – I believe strongly in the intertemporal substitution justification for active monetary policy.  But the interest rate can only be interpreted with prior assumptions around a bunch of other things, and that point is often lost.

Matt Nolan

Overhyping nothing: The NZ context for the UK FSA speech

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Via Bernard Hickey I saw this speech by Adair Turner about monetary policy in the UK.

Let us give it some context – the UK has had their cash rate at virtually zero for some time, and many analysts over there have been screaming hyperinflation and showing that they do not understand the purpose of credibility, independence, and expectations management for a central bank in the slightest.  With these concerns in mind, Turner has come out to try and open up debate a little more, and make it a bit more intelligent.

This is good.  However, I think that Bernard Hickey is misinterpreting these points when he comes back to looking at NZ.  However, as I agree with him that we should discuss these issues I am going to briefly point out here how I can:

  1. Agree with Adair Turner
  2. Disagree with the inferences Bernard Hickey seems to be aiming at.

Let’s go.

Read more

Matt Nolan

NZ NDGP graphs – add your own comments!

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As a starting point – thank you Statistics New Zealand for all your tasty data.

First a graph of the deviation of per capita NGDP from its 1994-2011 trend (took out the 1991-1993 period due to the structural changes taking place) – comparing the last ANZSIC 1996 data (Dec 2011) to the September ANZSIC 2006 data:

datarevision

Then a graph of deviations in NGDP from trend and the UR (unemployment rate):

NGDPUR

The same things will case NGDP to shift and the UR to shift, in opposite directions.  In that way this is unsuprising.  Make of it what you will in the NZ context, given your implicit model of the economy – in fact, feel free to mention it in the comments.  I will be sitting out of this one at present.