"One of my goals in the previous post is to get people to think about my message in a different way. I’d rather people not think of me as calling for the Fed to stabilize NGDP (although obviously I am calling for that) but rather to see me as calling for the stabilization of its inverse—i.e. 1/NGDP. Obviously those two goals are identical from a purely mathematical perspective."
"Macro is basically composed of three fields:
1. Long run RGDP growth.
2. Nominal macro variables in the long run (P, NGDP, i, E, etc)
3. Business cycles.
"Money is all of part two, and half of part three. That means monetary economics is half of macro. It’s also far and away the more interesting half. The real side is a long, boring and random list of factors that affect RGDP (capital, labor, technology, good governance, natural disasters, etc. Monetary economics is an interesting, counterintuitive and elegant structure that fits together wonderfully, using concepts like money neutrality and superneutrality to generate the QTM, the Fisher Effect, PPP and lots of other models filled with beautiful symmetries."
Evidently he feels that he needs to clarify certain things. In the first link above, "These Money Illusions", he explains a bit more of why he calls his blog The Money Illusion. No doubt, it calls to mind Irving Fisher to mind first and foremost.
"In 1928 Irving Fisher wrote a whole book entitled “The Money Illusion,” full of delightful examples. He was referring to the tendency of people to confuse real and nominal variables, or perhaps it would be more accurate to say people tend to see nominal variables as being in some sense “real.” I still recall when we got no pay increase back in 2009, a year of minus 1% inflation. My colleagues at Bentley greeted the anouncement very differently from when we got a 4% increase during a year of 3% inflation. I see money illusion everywhere I look, so I didn’t need much convincing."
"Another form of money illusion is confusion about the nature of monetary policy. The liquidity effect is actually just an epiphenomenon, and yet most people see it as not just a side effect, but rather as monetary policy itself. And “most people” includes the Fed. For this reason, policy is often perceived as being ineffective at the zero bound, unless perhaps longer term rates can be lowered via QE. In fact, in the long run more money lowers the value of money (value in terms of the share of NGDP which can be bought with each dollar) for exactly the same reason that more apples lowers the value of apples. (Admittedly the problem of expectations is more complicated in the money market.)"
"These two forms of money illusion have some interesting parallels. In both cases the problem becomes much more severe at the zero rate bound. For psychological reasons that are quite frankly irrational, both workers and central banks behave bizarrely at the zero bound. Workers start being much more resistent to wage cuts necessary to restore labor market equilibrium. And central banks become much more resistent to monetary policy steps needed to keep NGDP on track. Their superstitious fears of the number zero (which after all is a foreign concept borrowed from the Islamic world) causes them to behave in ways that are both personally and socially destructive."
It's certainly an interesting idea of drawing an equivalence between workers and central banks, but is it justified? Sumner rounds out to the third money illusion-besides that of workers and central banks-economists:
"There’s a third form of money illusion, to which economists are also subject. Economists have just as much trouble as the Fed does in identifying the stance of monetary policy. Because they think ultra-tight money is actually ultra-easy money, then are often not able to perceive the impact of very tight money. This means that they find some other explanation for economic distress, such as financial instability. Fisher said the business cycle is nothing more than the “dance of the dollar.” Fisher defined monetary policy in terms of the price of money (1/P), not the rental cost of money (i.) Because modern economists see tight money as high interest rates they confuse cause and effect, not understanding that financial distress is a symptom of a monetary policy-induced recession, not the cause."
Sumner got into it a little with Stephen Williamson again the other day. Williamson was saying he doesn't think sticky wages has much to do with our problems that it's due to a loss in wealth. He then referred to Prescott's H-P. The Real Business Cycle Theory (RBC) takes things a whole different way again with their attempts to put trends aside. Sumner does mention them as the 'long boring side of real factors."
Still he does hold out the rather Utopian vision of finally eliminating the business cycle:
"It breaks my heart to think about all the garbage we force our students to learn in macro. Is inflation good or bad for growth? They leave the course not having a clue. If only we’d teach a simple monetary model of NGDP determination, and then a simple W/NGDP model of business cycles, using the sticky wage assumption. They might actually be able to understand that model. Of course if our politicians understood the model then they never would have allowed the Fed and ECB
So in a way victory in Sumner's terms if when we have nothing to do in economics but look at these long, boring, random,, real factors? I won't get into a blow by blow evaluation of everything Sumner said here-from this don't infer agreement.
I will suggest that he is very different from Keynes who suggested that there's nothing "irrational" about workers, even his fellow professors at Bentley, fighting no nominal wage increase in 2009-which was in the middle of a recession. Let's consider what he said one more time:
"I still recall when we got no pay increase back in 2009, a year of minus 1% inflation. My colleagues at Bentley greeted the announcement very differently from when we got a 4% increase during a year of 3% inflation. I see money illusion everywhere I look, so I didn’t need much convincing."
According to Keynes this is not irrational. Sumner in his debate with Williamson had said that money illusion is his only concession away from rational expectations:
"I don’t know why people have money illusion, and it’s certainly a bizarre thing to put into a model. But it’s there."
"I seem to recall that Steve Williamson shares my preference for rational expectations models and the EMH. Money illusion is one of my few concessions to the behavioral economists. I wish it weren’t there—it makes our models much uglier and it causes enormous human suffering. But wishing it weren’t there doesn’t make it go away. ”The world is as it is.” Between mid-2008 and mid-2009, NGDP fell about 9% below trend, while wages kept chugging along at roughly trend. That’s a really big problem. Although unemployment has since fallen from 10% to 8.2%, wages still haven’t entirely caught up to that massive demand shock."
Finally, all this talk about money illusion, stick wages, and NGDP shocks leads me to a conversation I had with Woj-who writes the excellent post "Bubbles and Busts." It is certainly a real treat if you haven't gotten a chance to see it. I find it a great resource in the short time since I discovered it.
In a previous comment, Woj had said he still can't figure out if Sumner believes that nominal changes have real effects. I answered that Sumner believes they have only short term effects. I've read enough of Sumner by now that I feel confident enough to say that.
Then I added that I seem to remember Sumner recently in a few posts about stagflation really going off the rails. He seemed to suggest that a 5% NGDP target would have dropped inflation but made no decrease in real growth.
Woj then provided me a link to where he wrote about this very subject. Then I realized that i had read that post and that's where I first noticed that Sumner in this example ignores the fact that nominal changes do have short term real effects. Of course the question of whether they have long term effects is another question all together. Suffice it to say, Sumner doesn't believe this, nor does Nick Rowe, However, interestingly, David Glasner does believe it has even long term effects, though he too is a Market Monetarist and in fact, he's more even than any mere Market Monetarist as he actually believes in the idea of Free Banking.
He's a very interesting thinker and very tough to pin down exactly. As is Stephen Williamson. My take on SW is that you can learn a lot from him but he's also a bit of a schmuck, quite honestly! Here is Sumner forgetting about short term real effects of monetary policy:
"In a recent post I pointed out that during the 1970s we had normal (3.2%) growth and that 100% of the high inflation was due to NGDP growth being much higher than 5%, indeed about 10.4% on average between 1970 and 1980. So even during the 1970s, inflation would have been only around 1.8% under NGDP targeting. I think Karl Smith accepts that argument. But he also claims:
The 1970s were definitely an era of stagflation"He later defends this statement by pointing to the relatively high levels of unemployment during that decade. I had thought the word ‘stagflation’ meant high inflation plus slow output growth (due to slow growth in AS.) Karl seems to think it means high inflation plus other bad things, like high unemployment.
"Rather than arguing over semantics, I’d rather focus on the important issue; what does the 1970s tell us about NGDP targeting?"
Rather than arguing over semantics! I like that one. Yeah, by the way I say 2+2=5. You disagree? Well, anyway, let us not argue about semantics.
It's rather surprising that such a prominent economist as Sumner doesn't know what stagflation means-it means high inflation and high unemployment, period. While often high unemployment and low RGDP comes together it's not the same thing, in fact, in the late 70s you did see some pretty healthy RGDP with elevated unemployment. The 70s was a very strange time in virtually any way you care to look at it, particularly economically, but also socially, culturally, and politically
By the way please see two good pieces at Woj about Sumner and also about the vexing problem of monetary neutrality.
Last week I wrote about Bill Mitchell's post on the Great Moderation. What I found very interesting is that he disputed the Great Moderation as the admirable achievement the mainstream profession-recall Bernanke's eulogies to Milton Friedman, You were right, we did it, but thanks to you we'll never do it again.
He made the argument that Volcker's disinflation had a long term negative effect on trend output. This flies totally in the face of SW's admiration for the H-P filter-which argues that trends are not real, and that there's no way we can have any effect on long term RGDP-indeed as the quotes above show, it also is totally at variance with Sumner who does generally believe in short term real effects from nominal changes-though as we saw in the stagflation piece, he can forget sometimes-agrees with Lucas and Prescott, et al. that there are no meaningful effects on RGDP in the long term.
There's not much question if you look at it empirically that in the short term, the Volkcer disinflation (VD) slowed down output. Sumner might well concede that but he would not concede that it had long term effects. On this on an intuitive level I agree with Mitchell, though I also want to be able to put my arms around it on more than just intuition. What I'm basically saying is that I think Mitchell is right though I can't really explain it properly yet.
For Mitchell's excellent, thought provoking piece, please click here