Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 20 July 2014

What annoys me about market monetarists

I missed this little contretemps between Nick Rowe and Paul Krugman. Actually this appears to be a fuss over nothing. The main point Paul was trying to make, it seemed to me, was about how far the Republican base were on monetary policy from anything reasonable, and so what he called the neomonetarist movement did not have much chance with this group. By implication, neomonetarism was something more reasonable, although he had well known problems with its ideas. So a sort of backhanded compliment, if anything.

Nick responded by pointing out that what he called neofiscalists (those, like me, who argue for fiscal stimulus at the Zero Lower Bound (ZLB)) hadn’t done too well at finding a political home recently either. Which, alas, is all too true, but I think we kind of knew that.

What interests me is how annoyed each side gets with each other. Following my earlier posts, I will use the label market monetarist (MM) rather than neomonetarist. It seems to me that I understand a little why those in the MM camp get so annoyed with those like me who go on about fiscal policy. Let me quote Nick:

“We don't like fiscal patches that cover up that underlying problem. Because fiscal policy has other objectives and you can't always kill two birds with the same fiscal stone. Because we can't always rely on fiscal policymakers being able and willing to do the right thing. And because if your car has alternator trouble you fix the alternator; you don't just keep on doing bodge-jobs like replacing the battery every 100kms.”

I’ll come back to the car analogy, but let me focus on the patches idea for now. In their view, the proper way to do stabilisation policy outside a fixed exchange rate regime is, without qualification, to use monetary policy. So the first best policy is to try every monetary means possible, which may in fact turn out to be quite easy if only policymakers adopt the right rule. Fiscal policy is a second best bodge. MM just hates bodgers.

As I explained in this post, the situation is not symmetric. I do not get annoyed with MM because I think monetary policy is a bodge. I have spent much time discussing what monetary policy can do at the ZLB, and I have written favourably about nominal GDP targets. But, speaking for just myself, I do get annoyed by at least some advocates of MM.

Before I say why, let me dismiss two possible reasons. First, some find MM difficult because there does not seem to be a clear theoretical model behind their advocacy (see this post from Tony Yates for example). I can live with that, because I suspect I can see the principles behind their reasoning, and principles can be more general than models (although they can also be wrong). Second, I personally would have every right to be annoyed with some MMs (but certainly not Nick) because of their debating style and lack of homework, but I see that as a symptom rather than fundamental.

To understand why I do get annoyed with MM, let me use another car analogy. We are going downhill, and the brakes do not seem to be working properly. I’m sitting in the backseat with a representative of MM. I suggest to the driver that they should keep trying the brake pedal, but they should also put the handbrake on. The person sitting next to me says “That is a terrible idea. The brake pedal should work. Maybe try pressing it in a different way. But do not put on the handbrake. The smell of burning rubber will be terrible. The brake pedal should work, that is what it is designed for, and to do anything else just lets the car manufacturer off the hook. Have you tried pressing on the accelerator after trying the brake?”

OK, that last one is unfair, but you get my point. When you have a macroeconomic disaster, with policymakers who are confused, conflicted and unreliable, you do not obsess over the optimal way of getting out of the disaster. There will be a time and place for that later. Instead you try and convince all the actors involved to do things that will avoid disaster. If both monetary and fiscal policymakers are doing the wrong thing given each other’s actions, and your influence on either will be minimal, you encourage both to change their ways.

MM agrees that fiscal stimulus will work unless it is actively counteracted by monetary policy. Nick says we can't always rely on fiscal policymakers being able and willing to do the right thing. But since at least 2011 we have not been able to rely on monetary policymakers in the Eurozone to do either the right thing, or consistently the wrong thing. So why is anyone with any sense saying that austerity is not a major factor behind the second Eurozone recession? That is just encouraging fiscal policymakers to carry on doing exactly the wrong thing, in the real world where monetary policy is set by the ECB rather than some MM devotee.


  1. Simon, nice follow up to the car analogy.

    I'm personally a fan of the MM theory because it's easy for a layman such as myself to understand, it's intuitively appealing, and also I think it would be great if it were actually true (for several reasons). However it does seem to me that there's a tendency for some fo the arguments in favor of it to go like this:

    "OMOs and non-traditional monetary policies would work like the textbook theories say they should, if only the central bank had more X."

    Now if you ask "Well how much X do they have exactly, and how much do they need?" A typical response is along these lines:

    "Obviously if they had enough X then OMOs would work, but OMOs are not working as expected, so X is deficient"

    Do you see how the circularity here precludes us from testing this theory of X? It doesn't matter too much what X is ("expectations," "effective CB communications," etc.). Now they might *seem* like they're improving their argument if they go on to say

    "Well, I know it's a problem with X since country A didn't have any problem. So clearly if there are problems in country B, then lack of X is the reason."

    But again, there's really no concrete independent (outside the circle of logic) measure of X here with which to test the X theory.

    In contrast, here's a very succinctly stated theory, from which a set of simple low-parameter count macro models can be derived, which so far demonstrates good agreement with the empirical data over a host of different economies and decades, compares favorably with existing models, makes several specific, testable predictions, and which offers a straight forward measurable and quantitative explanation for why country A's response to monetary policy is not like country B's.

    Plus, the author of this theory, has stated that he's not interested in adding "epi-cycles" to patch up his theory the evidence indicate that it's failed.

    A couple of "hard core" falsifiable hypothesis, a few more auxiliary hypotheses, some low-parameter count models derived from them and a set of resulting testable predictions: it almost seems like science, doesn't it? :D

    1. Brilliant observation... if you can't define something, you can't measure it!

    2. Uh oh "epi-cycles". I think that Ptolemaic astronomy was sound science, because Ptolemaic astronomers added no epicycles for over a millenium. I ask for any evidence that they did -- historical evidence including references to primary sources.

    3. Robert, thanks for the link. I recall your comment at Noah's on this (and his responses). But regardless the history, I think it's clear what the author's intended meaning was.

  2. Here's what annoys me: the MMers casually and repeatedly overstate their case against fiscal policy.

    If central banks had fixed NGDP targets, you would see a non-zero real GDP response to fiscal stimulus. The monetary offset in that regime would only be *partial.*

    And if central banks had fixed inflation targets, you would see an even larger real GDP response to a given fiscal stimulus.

    And ... in real life, central banks have neither of these. Instead they have hand-wavey ruminations that only kinda sorta approximate those things, with aggressive monetary responses in recent years when growth and or inflation expectations threatened to go negative, but insufficient responses to prevent us from seeing years of below target inflation and growth.

    Some MMers claim, very oddly, that this somehow indicates central banks want inflation and/or growth below their stated targets.

    But all one has to do is read the minutes of the meetings to see that instead what is motivating them is irrational fear of future inflation, financial instability or some other punishment from the bond gods for years of low rates. Unless you believe that all that discussion is conspiracy to mask true intent, it should be clear central banks *ARE NOT* achieving their targets.

    Other more realistic MMers instead claim that, well, if they really wanted to the central banks *could* achieve their preferred targets for inflation and growth, and therefore ... somehow ... fiscal policy should not be used.

    The notion that central banks could achieve their targets is a very arguable one (I happen to believe it too), but still doesn't acknowledge the fact that even in an NGDP targeting regime fiscal policy still matters (!), and more importantly, that in the real world we live in the dang fiscal multiplier sure as heck isn't zero.

    1. What if the problem is that wage levels for one particular industry need to fall so that employment can be restored to acceptable levels? How will fiscal policy or even monetary policy help?

    2. which particular industry is that?

    3. ST,

      "If central banks had fixed NGDP targets, you would see a non-zero real GDP response to fiscal stimulus. The monetary offset in that regime would only be *partial.*

      And if central banks had fixed inflation targets, you would see an even larger real GDP response to a given fiscal stimulus."

      Could you explain why that is please?

    4. James,

      You can think of both type of monetary regimes as dampeners of the economic cycle.

      In a fixed inflation regime, monetary policy offsets fiscal policy (and any other shock) only to the extent necessary to keep inflation fixed. In an NGDP targeting regime, monetary policy produces a higher offset, by essentially moving the effective inflation target counter to any shock. Neither though produces a complete offset to the *real* effect of the shock or fiscal actions.

      The precise numbers depend on your models of how sensitive RGDP is to marginal inflation at any given output gap and how expectations fit in ... but I don't think that changes the principle here.

  3. And another thing ... you'll often hear lectures from MMers who try to explain the existence of a monetary policy offset, as if they were the only ones aware of it and its mere existence somehow negated the value and efficacy of fiscal policy.

    But what they don't seem to recognize is that the whole premise behind fiscal policy, from its proponents, is that fiscal multipliers vary over time under different monetary regimes. When we are at full employment equilibrium, monetary authorities actually do offset fiscal policy, if not entirely then at least substantially. It's only at those times when we are below that full employment equilibrium that fiscal stimulus is warranted. By applying it countercyclically, fiscal policy balance in the long run but still have a net positive effect on output, increasing output during the terrible times without decreasing it during the good.

    In other words, it's only with the existence of that monetary offset, during the good times when we save for a rainy day, that fiscal policy makes long run sense. So yeah, we are aware of the offset, thanks!

  4. I don't think you are describing MM views fairly. I think many of them supported some fiscal intervention given the depth of the crisis.

    Traditional fiscal policy is slower and more difficult to implement than monetary policy since it requires finding public investment with not too negative returns. Monetary policy is rather quicker and it can leverage diffuse decision making which is likely to be more efficient.

    We are not in as much of an emergency any more so you need to start discussing how to make sure we have the tools to fight the next emergency.

    The real argument I think is really this: should we try to build a demand stabilization policy which minimizes the chances of needing to use fiscal policy?

    MMs argue that we both should try to achieve that and that if we do it properly there would be almost no cases in which fiscal policy would be useful for stabilization. Whenever they are correct in their forecast (there is no crisis deep enough to require using fiscal policy), we will only be able to judge in the future. Given that Krugman has argued for higher inflation targets, the aim of minimizing the need of using fiscal policy seems to be shared quite widely.

    I also find your criticism a bit weak for another reason: I don't really see any concrete proposal on how to improve the efficiency of fiscal policy. MMs are trying to expand the set of tools available to central bankers, they are trying to change the monetary framework in order to make it more potent. Is there any equivalent push by fiscal policy advocates? Fiscal policy seems an inherently limited resource and there seems to be no strong movement trying to face such limitation and somehow overcome them. MMs are trying to overcome the zero bound. I see no equivalent on the fiscal side: no institution to allow government to expand demand even when the government becomes unable to borrow.

    1. Let me take these paragraphs in turn.

      1) In Tony Yates account of what he sees as MM from what he has read (and Tony is no 'neofiscalist'), being against the use of fiscal policy is almost a defining characteristic of MM.

      2) How revealing - 'finding public investment with not too negative returns'.

      3) Try saying that in France or the Netherlands.

      4+5) No - there is no argument among mainstream macro academics about this, as you yourself note. I have said this many times. So why do you raise it?

      6) You are making the same mistake as Sadowski - you do not see it because you do not look. I have just written a paper that discusses how to improve the way fiscal policy stimulus packages are formulated at the ZLB. There is a lot of academic work on the stabilisation effects of various different types of fiscal policy.

    2. By not too negative returns, I meant that you should have a more lax cost benefit criteria when evaluating public investment in a recession since externalities are more likely to balance the costs than in normal times. It still leaves the issue that finding investment opportunities is hard (even for the private sector). I wasn't saying that all public investment has negative returns. I was trying to say that cost benefit analysis is quite complicated and that adding the wider implications seems difficult. I grant you I was a bit vague in my statement. You read much more into it though than I meant though...

      You might be right that I am not looking enough. It might also be true that monetary policy is more likely to satisfy our desire for a quick miraculous fix. But I read your blog all the time so I am trying to look as you say.

      But prediction markets for policy impact seem so attractive. They seem to be a way to increase the amount of information available to make decisions. They seem almost as useful as creating national accounts and statistics. Better policy seems likely with more information available. Adding a panel of experts seems a lot less powerful than this.

    3. Stopped reading after "being against the use of fiscal policy is almost a defining characteristic of MM".


      This is only the attitude of those who view MM as a conservative conspiracy. Great. So you maybe missed the boat a bit with MM (as did Yates BTW, so don't rely on his unfortunate analysis).

      Bottom line is that interest rates do not reflect stance of monetary policy, and that expectation targeting is optimal. Under MM preferred policy, the CB will simply adjust course of the MB if fiscal policy impacts AD expectations. Simple, right? Advocating against fiscal policy is entirely secondary and is a personal preference.

    4. Some fiscalists notably including our host have most definitely attempted to expand the set of tools considered by fiscal policymakers. The political debate of fiscal policy is a debate about deficit spending. It need not be so restricted as a balanced budget spending increase should stimulate. This is not a new argument, but it strikes me as being as novel as the most novel MM proposal.

      Relative to current policy, fiscal stimulus does not require finding investment projects at all. The reason is that there have been sharp cuts to current spending in the name of austerity in many countries (I am thinking of the US and Italy). A discussion of whether to lower the direct benefit required to fund below that used in cost benefit analysis in 2006 is not at all related to the current debate. Spending as if nothing unusual had happened in 2008 would be a huge shift towards expansionary fiscal policy. The current debate is whether to stick with extraordinary public spending cuts or to return to the fiscal status quo ante.

  5. Simon’s “car going downhill” analogy doesn’t strike me as a good defence of fiscal. The analogy implies we try fiscal because we’re desperate and prepared to try ANYTHING.

    I suggest a better and very simple defence is this. Using monetary policy ALONE is blatantly DISTORTIONARY. E.g. QE stuffs money into the pockets of the asset rich, whereas fiscal can distribute stimulus very widely, for example into health, education, increased state pensions and/or simply leaving more money in household pockets by reducing taxes.

    1. I do not think that this is what Simon is getting at in his car analogy. He provides it not as a defence as fiscal intervention as first-best policy - in which case the analogy would indeed be bad. Rather, he points out that in case of an utter urgency you throw the kitchen sink at it, and not start to quibble about secondary shortcomings - be it neofiscalists or neomonetarists. This is to demonstrate the non-symmetric nature of the debate: while neofiscalists are all for trying monetary policy in absence of (expansionary) fiscal policy, even if having doubt about its effectiveness, neomonetarists use their doubt of the effectiveness of fiscal intervention as an argument to dismiss it altogether. Fair or not, I think that's what the analogy is getting at.

  6. Another thing that annoys me about MMers (Grrrr): they don't seem to get the point that the inflation targeting versus NGDP targetting argument IS SEPARATE from the monetary versus fiscal argument. That is, one can perfectly well target NGDP using FISCAL policy.

  7. I believe that many market monetarists support monetary solution to make the NGDP targeting regime robust. It's mostly about getting "institutional safeguard" against sadomonetarists.

    Car analogy is very unfortunate because it implies that the monetary policy wouldn't work. This kind of arguments might strengten sadomonetarts. It would be more helpful to come up with analogies where fiscal solution is more efficient.

    1. The car is the Eurozone. ECB policy has not and is not working. Yet MM says there is nothing wrong with continuing austerity!

    2. I guess this is what most market monetarist would recommend for Eurozone:

      Either it would work or the existing stock of EZ government debt would be exhausted. In any case it would help to defeat sadomonetarism.

    3. I think you miss my point. Their recommendation to fiscal policy makers in the Eurozone is carry on with austerity. Given that the ECB, and not they, are in charge of monetary policy, that is simply irresponsible.

    4. If the issues are structural, then QE will simply serve to maintain the status quo which delays the badly needed reform. If the medicine is structural reform (liberalize labor markets, reduce govt participation in the economy etc.), QE will not solve the problem.

    5. the medicine is not structural reform. Tat way of thinking has plunged countries in the eurozone into depression.

  8. Personnally, I am rather on the side of the market monetarists. I agree with Simon that at the ZLB there are few objections for budgetary stimulus. But we should not lose sight of where the real problem comes from: it is bad monetary policy that brings the economy at the ZLB in the first place. I also attritube most of the Euro crisis to a totally unwarranted tightening of monetary policy between early 2011 and mid 2012. I therefore agree with the market monetarists who critize Simon Wren-Lewis for emphasizing fiscal austerity as cause of the Euro crisis, and not monetary policy.

    More broadly, I think Japan until 2013 demonstrates what happens when you emphasize budgetary sitimulus without getting monetary policy right. After a first bout of budget stimulus, any attempt to tighten budgetary policy crashes the economy. The deficit can not be lowered and public debt continues to spiral upwards. More importantly, private investments remain subdued despitre ultra-low interest rates. This is not what I would describe as a healthy economy.

    Conclusion: at the ZLB, the priority is to loosen monetary policy. Budgetary policy must be run to support that effort. Not the other way round.

    1. Reminds me of the question is the zebra a black donkey with white stripes or is it a white donkey with black stripes. I really don't think there is a practical difference in implementing expansionary fiscal policy supported by expansionary monetary policy or expansionary monetary policy supported by fiscal policy. I think its hair splitting. At the end of the day, either way, its a donkey!

    2. I do not agree. Take Greece for example. Real interest for households, corporates and the government are around 8% (6% nominal and 2% deflation). I do not know of any advanced economy which would not be in a depression with such high real interest rates. Would a loosening of budgetary policy in Greece address that problem? To a limited extent I believe. Would monetary policy be able to address that problem? To a very large extent I believe. That is the difference of focus between monetary and budgetary policy.

  9. Fiscal policy can and does pull an economy in an opposite direction from monetary policy (think austerity - money supply expansion) even when both should be pulling in the same direction. Locking fiscal policy in the tool shed leaves economists trying to fight economic downturns with only monetary policy which is not the sharpest tool in the shed. At the ZLB, fiscal policy has a much stronger effect than the weak monetary policy effects we have witnessed. The tendency is for monetary policy to be swamped by fiscal policy. Away from the ZLB, monetary policy gets more traction. The bottom line: Monetary policy, no matter how good, cannot overcome truly bad fiscal and regulatory policy.

    In this latest recession, we have witnessed the massive failure of over reliance on monetary policy. Macroeconomic policy in the future will have much greater focus on creative new regulatory policies for managing economies and expansion of fiscal policies, especially automatic stabilizers. Monetary policy will still be useful for fine tuning, but major shocks are best addressed by fiscal and regulatory policy.
    -jonny bakho

  10. I am almost certain of what Professor Rowe's reply will be. When the driver pushed the break pedal down a little(QE) it led to a (small) decrease in speed so the pedal seems to be working fine. In this situation, why would you want to use the handbrake when you haven't even really tried using the apparently functional brake pedal?

    Mind you I'm not really a MM'er myself, I'm just trying to move the discussion along. Though I liked the blogpost I got the impresison that it didn't quite address the point that Rowe was trying to make.

    1. I think you miss a crucial part of the analogy. The MM is in the back seat and is not driving. They have no control over what monetary policy is. In that context, arguing that austerity is no problem is irresponsible.

    2. Actually I think MMs might say something like this:

      "Well clearly pushing the brake pedal down is not sufficient: the driver also has to do a good job of signalling his intentions to the car. I've been in other cars where pushing down the brake pedal worked just fine, so clearly there's something missing in this car, and that is a communication problem from driver to car. Maybe the car just thinks the depression of the pedal is temporary. Things would be different if Chuck Norris were driving this car. Braking a car is 99% communicating the proper expectations to the car." If you question how this theory of communicating expectations can be tested, you're likely to hear "Well it's easy: you'll know that they've been communicated properly when pressing down the brake pedal works.'

      Now I'm fine with introducing another necessary ingredient in the mix (other than just pushing down the pedal), but can it please be something that's independently observable, so we can test if the hypothesis is false? For example, the brake fluid level? If we test the hypothesis and find the brake fluid level adequate, then there's no excuse for not moving on to the handbrake.

    3. This comment has been removed by the author.

    4. True enough. However IF (big if) Professor Rowe and the others are correct in saying that monetary policy can fix any AD deficiency by itself, they are on strong ground when they say that economists should put their focus on convincing central bankers rather than Prime ministers/the Chancellor.

      For this reason I believe that it would be good to have a discussion about possible reasons for doubting the effectiveness of monetary policy below the ZLB.

    5. Hugo, my comment at the top includes an example of a falsifiable hypothesis on this subject.

  11. Krugman agrees:

    I wouldn't put it as strongly as Krugman does in the U.S. context. Obama had a good, "eclectic" advisor in Christina Romer, but the Obama administration wasn't as good as Krugman lets on. At one point Romer says Obama pointed out to her that "monetary policy had shot its wad*" and she pointed out he was wrong. Geithner said in a heated debate that fiscal stimulus was "sugar" and she said no it was antibiotics.

    Bush nominated Bernanke but today's Republicans appear to be as Krugman describes them.

    And I disagree with bahko above. Monetary policy could overcome bad fiscal and regulatory policy, it's just not desirable because of distributional issues.

    * as in shot from and old-timey musket gun.

  12. Simon, I love this post. I could not possibly agree more. Your handbrake analogy is perfect.

    I cannot understand why Keynesians don't support the MM ideas of a NGDP level target and a prediction market to guide OMO's to hit the target. Why is Krugman always mocking them for "having no home" when the center-left could be a perfect home for MM? There's nothing right-wing about MM. MM would benefit everyone.

    And likewise, I cannot understand why MM's oppose fiscal action at the ZLB, where yes, monetary offset could (in theory) nullify the demand stimulus of fiscal action, but it probably won't, because the CB probably will not tighten because we're in a demand depression for crying out loud and Janet Yellen clearly understands that. Sure, in an MM world, fiscal policy would probably not be effective, but we're not *in* an MM world. Surely the MM's can grasp that?

    Meanwhile, the real enemy is all the RBC and Austrian and two-and-twenty idiots who claim that what's happening today isn't happening because their theories say it can't be happening and therefore reality is wrong, up is down, the sky is green, and we should raise interest rates, which would involve monetary contraction that would be bad for almost everyone.

    It seems to be all about people who care more about their ideas than making the world better.


    Kenneth Duda
    Menlo Park, CA

    1. While I agree with your third paragraph completely, I think you are a bit unfair on the second. I support a NGDP target, as does Mike Woodford. The situation is not symmetric.

    2. Mr Duda, I can't help but wonder why you would write that
      "Keynesians don't support the MM ideas of a NGDP level target".

      Prof. Wren-Lewis who is undoubtedly a keynesian writes in this very blogpost that he has in the past "written favourably about nominal GDP targets". Paul Krugman, the other Arch-Keynesian, has also been supportive of the idea. For example when Christina Romer called on Bernanke to adopt a nominal gdp target, Krugman's response was "I'm all for it". Admittedly he seems to be on the fence about adopting a NGDP target for the long term. Both of them appear to be more concerned with with picking apart neo-classical views and ending the current recession than building a system for for the period that comes after which is why they haven't been talking about the NGDP issue all that often.

      I'm not sure either of them has written much about a prediction market for OMO's but I very much doubt that either would oppose it.

    3. Does fiscal policy impact inflation? Yes. Unemployment? Yes.

      Conveniently, the CB targets both. If fiscal policy pushes inflation and unemployment above and below the CB's target, respectively, a competent CB contracts the money supply, and vice versa. That is all. No speak of the preferred course 1) expansionary fiscal and monetary contraction, 2) contractionary fiscal and monetary expansion, or 3) somewhere in the middle.

      That ^ is fiscal offset. The principle doesn't not claim austerity is optimal, rather that it is not problematic if given a competent CB. And regarding the 'they' who claim Europe *should* undertake austerity? 'Could if .... ' would be more appropriate.

    4. Minor type there ^ that I missed in the proof: Final paragraph should read: "The principle doesn't claim ... "

  13. The problem is much deeper than people realize.
    Fiscal and monetary policies are both ineffective against the true problem... which is a declining demand for labor, weak real wages and low labor share.
    The car itself is actually working well. The problem is that we are stuck in a traffic jam on the highway. Everyone is going slow. And everyone is trying to get to the same destination.
    Neither the brakes, nor the handbrake will work. The solution is not to stop the car. Even all the cars around you on the road (other countries) are having the same problem. Even if you managed to stop the car, someone would crash into you from behind.

    The solution is to get off the highway and take an alternative route... an alternative economic system.

    1. Easy money policies allows corporations to replace labor with machinery. That would explain why labor participation is dropping and why demand isn't picking up despite massive amounts of QE
      However, an increase in interest rates now would be disastrous for the US govt as higher rates would test its solvency. Something must give soon otherwise the Japanization of the US is imminent!

  14. We ought to get a lot of "fiscal policy" because high unemployment rates and low interest rates mean that the costs of a myriad of projects drop and would be executed by sensible cost benefit analysis. Of course states and local governments are constrained by borrowing limits and nothing is rarer that Congress being sensible about applying cost benefit analysis. Therefore there is a lot more need for monetary policy than would otherwise be necessary. If we had "market fiscal-ism" the ZLB would probably never be observed.

  15. Simon,

    am I right in thinking that the main way monetary policy is supposed to work at the ZLB is by creating expectations of looser than normal monetary policy in the future, which somehow changes people's consumption and investment behaviour in the present?

    1. Nick Rowe says that "Monetary policy is 99% expectations,..."

      Here's an alternative view. Also check out the author's 1st comment below.

    2. James that is the argument made by Krugman in the case of Japan in the 90s and enthusiastically embraced by Woodford discussing the US in recent years.

  16. I think that this debate is really getting repetitive. As some of the other people said, the analogy is clearly not accurate as it ignores great deal of actual experience that was never even discussed by fiscalists. So I will repeat both:

    1) During 2011 In the middle of the crisis ECB has actually risen interest rates from 1.0% to 1.5%. Using your analogy they pulled the pedal to the metal and yet you and Krugman blame that the passenger did not pull the handbrake?

    2) UK austerity and the infamous MM "test". UK had sharp austerity accompanied by easier monetary policy. As it turns out instead of a crash as fiscalists predicted UK economy increased - despite ZLB.

    There are other examples - for instance the success of Abenomics etc. So there are clear examples that brakes work and yet and again we have a group of economists spending disproportionate ammount of time criticizing a completely different agent for not doing enough.

  17. Ah civility. I admire it from afar. Your post is surprisingly diplomatic given the title. I think your analogy is excellent. I suppose you should have clarified that you too are in the back seat, since you are not in a position to make fiscal policy (actually maybe the trunk (boot in English English)).

    I comment to add a few notes. First "We don't like fiscal patches that cover up that underlying problem" is also an argument based on analogy. Rowe's use of "patches" and "cover up" are dead metaphors. No one thinks of cloth patches sewn on clothing or a covering with a sheet or paint or something when they use those words as he did. But the argument, such as it is, relies entirely on the assertion that fiscal policy is like a patch or a layer of paint over a rusted spot in that the patched economy is and remains different from a properly fixed one. The analogy is doing the work in that sentence.

    In contrast "kiling two birds with one stone" is quite frankly an analogy. The argument depends entirely on the implied assertion that fiscal policy is like a stone -- a solid object which is in one place and one place only. The argument that one shouldn't attempt "catching two fish with one net" wouldn't work. It is, however, exactly equally valid. Of course it is still silly, fiscal policy is much more complicated and contains many more holes than any net.

    The repeated efforts to argue by analogy tend to suggest to me that the analogies are
    bearing the weight of the argument. Not there to explain reasoning but themselves the reasoning.

    Now models. How strange. I find myself right here defending formal theory. I think it would be a good thing if economists developed and tested hypotheses. A very serious problem with principles is that they are flexible enough that they can't be rejected by the data.

    My problem with macroeconomic research at least since 1973 (more exactly since 1937) isn't that it is formalized. My problem is that something is called a hypothesis, tested, rejected, and then accepted as the standard benchmark model. To use your terms, it isn't the insistence on internal consistency, but the indifference to external inconsistency.

    I do not recall a case of a MM giving a hostage to fortune -- making a prediction the failure of which would force a confession of error. This might just be a statement of my ignorance, since I don't read much written by MMs

    1. Robert, I don't read much by MMs except what they write on blogs (and maybe that's the bulk of it?). But I can second your observation in your final paragraph ... I think... if I'm understanding "hostage to fortune" correctly. However, that is not a characteristic unique to MMs, is it? Not to excuse it at all.

  18. We seem to be painting the MM ideas as being scattered throughout this spectrum:

    1. Fiscal policy can be powerful in many(all?) situations. However, under the current monetary regime, central banks can be even more 'powerful' on the downside, by snuffing out any fiscal-led recovery. A change in monetary regime would either a) help the economy make progress in the face of stupid fiscal policy, and/or b) actually incentivize better fiscal policy because bondholders know that, with NGDP level targeting, the only way to defend their assets from inflation is to lobby politicians for positive growth.

    2. Monetary policy can operate independently of fiscal policy. Fiscal policy doesn't matter. In fact, fiscal policy shouldn't be used even in an emergency.

    3. "Economic policy" generally should only have a monetary policy component, there should be no fiscal policy (shutdown the government permanently).

    I get the feeling that many MMers are more like (1), acknowledging the power of fiscal policy to do good. But also its power to do bad, and therefore the need for monetary policy to be 'more powerful' than the bad fiscal policy. But some people with an agenda try to redefine perceptions of MM to suit their agenda. Right wings nuts, aided by extremely scientific and rational (and selfish) bondholders, want to pretend MM is about (3). Equally, left wingers are so scared of (3) that they fall for the right wing propaganda that MM equals (3)


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