Market monetarist views are a mish-mash of the good and the silly that don’t belong together anyway

Market monetarism seems to be trending in the twittersphere and the blogosphere.  Before I ventured into these noisy arenas, I’d never heard of it.  After reading some of the outputs, I find myself struggling to understand it.  What the hell is it?  Why is it so popular?  Why does it have a name?  Most of us don’t go round declaring ourselves to be part of a school of thought, or coining terms to name ourselves.

Market monetarism [MM here on] has embraced some of the following claims or views.  This list might be incomplete, and it’s possible that contrarian positions by MMs have been stated on some points below.  So this critique risks doing some an injustice.  But in order to start somewhere:

1.  Monetary policy is never ineffective at stabilising inflation or the real economy, even at the zero bound.

2.  Fiscal policy is ineffective [at, see above...] always.

3.  Fiscal policy is effective [at...], but not desirable.

4.  Those New Keynesian models omit to model money, and so don’t capture why monetary policy is effective.

5.  If you look at New Keynesian models carefully, they show that monetary policy is effective, even at the ZLB, which demonstrates why it, and not fiscal policy, should be used for stabilisation purposes always.

6.  Unlike in NK models, monetary policy isn’t just about OMOs, or even buying long dated government securities.  Expansions of the money supply can be used to buy all sorts of assets.

7.  Societies should adopt nominal GDP targeting.

8.  [And/or] It follows from some combination of 1-6 that societies should adopt some form of nominal GDP targeting.

9.  The crisis was caused by inflation targeting.  Following a MM perspective, including a nominal GDP target, would have averted it.

10.  Fiscal policy is ineffective away from the ZLB because it prompts an offsetting monetary policy response.

One way of responding to these statements is to look at them solely through the lens of either a) theoretical models of money and the macroeconomy or b) the empirical literature on the efficacy of monetary and fiscal policy, via the identification of monetary and fiscal policy shocks.

To summarise what the mainstream canon has come up with so far.  In so far as we can tell what sensible stabilisation objectives for monetary and fiscal policy are, and assuming that we accept that prices are sticky, the use of both instruments in pursuit of them is, away from the zero bound, always effective and desirable.  If the economy is at the zero bound, but expected to be there temporarily only, then, with a qualification, the use of both instruments is again both effective and desirable.  The qualification here being that monetary policy means the manipulation of future interest rates.  If you don’t buy that prices are sticky, then monetary policy is not an effective instrument, nor is it desirable to induce fluctuations in inflation for their own sake.  If the economy is at the zero bound and not expected to escape, monetary policy [in the form of expansions of the money supply] are not effective, though they are probably harmless.  Fiscal policy is probably effective and desirable.

That summarises, probably, the pre-crisis theoretical literature.  The empirical literature studying economies away from the zero lower bound, which has grown from the recommendations of Sims and others about how to identify policy shocks, conforms to this, which is unsurprising, as the theory was engineered to match the empirics.  We know less, for obvious reasons, about the effects of policy shocks at the zero lower bound.

The post-crisis literature has begun to confront the intriguing facts emerging from the unconventional policy actions of central banks forced down to the zero lower bound.  These are that purchases of long-dated government securities or other, private sector assets, through the creation of reserves, lower yields on those securities.  Modifications of the pre-crisis theory change the story told above a little.  Monetary, fiscal and unconventional monetary policy are always effective and desirable away from the ZLB.  Unconventional monetary policy is always effective and desirable at the ZLB.  And so on.  Assuming there are no costs of conducting it.

We are now in a position to go back and look at some of the MM statements and respond to them.

1.  Monetary policy is never ineffective at stabilising inflation or the real economy, even at the zero bound.

Well, yes it is.  If the economy is expected to stay at the ZLB forever.  Or if a corresponding money injection is not expected to be permanent, and therefore is associated with interest rate not being expected to be any lower than normally, once the economy has escaped from the zero lower bound.

2.  Fiscal policy is ineffective [at, see above...] always.

This is false, both contrary to the theory and empirics, as stated above.  Versions of the theory which display Ricardian Equivalence  – the ineffectiveness of fiscal policy – are rejected by the data.  And common sense. [I can't borrow against my future earnings in unlimited quantities, so I am not indifferent to the timing of taxes and spending].

3.  Fiscal policy is effective [at...], but not desirable.

If this is an appeal to practical or institutional problems wielding fiscal instruments, then we are on to interesting territory.  But, I’d say that at the ZLB, they are dominated by the necessity of a stimulus, and the uncertainties surrounding the alternatives.

4.  Those New Keynesian models omit to model money, and so don’t capture why monetary policy is effective.

True.  But modifications of them to include roles for QE or credit easing which match the data don’t change the basic story – certainly that fiscal policy is always still effective.  Moreover, an expansion of money to purchase private assets is the sum of a conventional open market operation, which is ineffective in these models still, and a debt-financed purchase of private sector assets, which one might label fiscal policy anyway.

5.  If you look at New Keynesian models carefully, they show that monetary policy is effective, even at the ZLB, which demonstrates why it, and not fiscal policy, should be used for stabilisation purposes always.

This seems to be what David Beckworth was saying by tweeting links to Woodford and Auerbach and Obstfeld to me in our exchange.   Well, no.  NK models show what I already explained.  Monetary policy can work if the economy is temporarily stuck at the ZLB, sure.  But so can fiscal policy.  And both are desirable.  And anyway, it’s a bit odd to throw 4 and 5 at us.  We thought you didn’t like the model?!

6.  Unlike in NK models, monetary policy isn’t just about OMOs, or even buying long dated government securities.  Expansions of the money supply can be used to buy all sorts of assets.

True.  But we dealt with this.  And it didn’t amount to concluding that fiscal policy wasn’t desirable.  And repeating my smug semantics, we saw that we could even call this fiscal policy if we were so minded.

7.  Societies should adopt nominal GDP targeting;  8.  [And/or] this follows from some of 1-6.

Well, in some model set ups, nominal GDP targeting is the right thing to do, but in many, in fact one might say usually, it is not.  Even in the general case where it is not, Woodford has advocated it as a means to managing expectations of short rates, so that people get the idea that the inflation undershoot has to be followed by an inflation overshoot, for which a reasonable approximation is that people get the idea that a nominal GDP growth undershoot is followed by a nominal GDP growth overshoot [as is the case with a nominal GDP levels target].  So there is something to NGDP targeting.  But it is really only a special case that emerges occasionally.  That’s not to say that what central banks actually do matches what is more generally supported in theory either.  Who knows what they do precisely, for that matter.   However, there is no result screaming out there to justify a major change in frameworks.  [The Bank of Canada used this argument in favour of rejecting Price Level Targeting].  And the most mysterious thing about the interest in nominal GDP is the strange, magical, mythological jump from money to nominal GDP.  Formally, the interest in nominal GDP targeting is, so far, a non-sequitur as regards the MMs worries about NK treatments of money.  The fact that views 7 is grouped with the others undermines them as a ‘movement’.  Where, in the literature, we do find support for nominal GDP targeting, it’s not because of any of 1-6.

9.  The crisis was caused by inflation targeting.  Following a MM perspective, including a nominal GDP target, would have averted it.

There are BIS-like claims that inflation targeting caused the crisis, through its alleged neglect of financial stability concerns, and asset prices.  These are debatable.  [Answer:  it would have been too costly to avert the crisis with tight interest rates].  But the MM claim I am aware of relates to a different point, to do with the fact that the Fed was insufficiently stimulative, and would have been more so had it appreciated the efficacy of monetary policy even at the ZLB even more than it did, and sought more energetically to generate a boom to make up for the slump.  I think this argument has more to it than the others.  But mainstream New Keynesian macro would say it differently.  Policy might have been better had we already had in place a prescription for a future, post recession inflation overshoot, which would have managed expectations in such a way as to make the initial undershoot less severe.  And, anyway, although some would not agree with me on this, the fact that inflation stayed pretty close to target indicates to me that demand-side policy was doing not far short of what it should do.

10.  Fiscal policy is ineffective away from the ZLB because it prompts an offsetting monetary policy response.

It’s true that away from the ZLB a fiscal expansion would prompt a partially-offsetting monetary contraction, but, this wouldn’t make it ineffective [referring to NK theory and VAR studies of historical policy] or undesirable [referring to theory here].  You can find fiscal instruments [eg the sales tax] that under some settings can be wielded in such a way as to be identical to monetary policy.  But in general, it isn’t, and from this flows the statement that begins this paragraph.

As a retort to each and every one of these points, MMs, or anyone else for that matter, could say ‘I don’t like your models, I’m talking about the real world’.  [This has been the flavour of some of the MM critiques].  Well, I’m not claiming that these models are right.  But they are relevant.

First, MM claims often make use of them, not always correctly, misunderstanding what is in them and their implications for the desirability of fiscal policy.

Second, many MM claims might persuade others that there is a competing theory, but there isn’t.  There is a competing body of thought in the academic literature that seeks to tell better stories about why people hold money, in the work of the ‘new monetarists’ like Wright and Williamson and Lagos.  But this literature is not a theoretical foundation for MMism.  We don’t know all that much yet about what such models would advocate for central bank or fiscal policy design.  To some extent, the modelling difficulties involve preclude building a model that is sufficiently realistic in other ways to address questions discussed in the NK literature.  Addressing these questions is also obscured by the mission of new monetarists to junk the assumption of sticky prices, since they view this assumption as superficial, and question-begging, and don’t like our habit of taking the empirical literature in favour of it at face value.  Many of those models for this and other reasons would see business cycles as efficient, not to be ironed out by any policy instrument.  These are positions that would seem, superficially, to conflict with the MM optimism about the usefulness of monetary policy to avoid booms and busts.

Third,if the MMs want to claim to be speaking about the real world, they need to rebut the overwhelming evidence in the empirical literature on monetary and fiscal policy.  And replace it with a competing empirics.  And interpret it through the lens of a coherent world view, ie, a theory.  MMs have neither a competing theory, nor a competing empirical canon.

 

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54 Responses to Market monetarist views are a mish-mash of the good and the silly that don’t belong together anyway

  1. Nick Rowe says:

    Tony: Welcome to our world!

    What a long list of questions! Let me start with just a couple:

    Why does it have a name? Well, Paul Krugman noticed that there were a bunch of us that seemed to have some things in common, and he called us “quasi-monetarists”. Which wasn’t a bad name, but we thought that since we were going to get named anyway (because we did tend to have things in common), we might as well choose our own name. Since “New Monetarism” was already taken by Steve Williamson, we decided on “Market Monetarism”. But it is hard to define exactly what is and is not a necessary or sufficient MM belief. It’s more of a family resemblance than a strict school of thought with a loyalty oath and membership list. But like all such names, it can be useful, provided you don’t expect it to have a perfectly precise meaning.

    Why NGDP (level path targeting)? In my case, it was mostly the data. I used to think that targeting 2% inflation was (at least approximately) the best monetary policy. Then the facts changed, and I changed my mind. Here is my post where I explained (to David Andolfatto) why I changed my mind: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/09/for-david-andolfatto-why-i-switched-from-it-to-ngdplt.html (And here is my old post that contains the graphs that lead me to change my mind: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/01/the-bank-of-canadas-success-and-failure.html )

    More later.

  2. Nick Rowe says:

    “1. Monetary policy is never ineffective at stabilising inflation or the real economy, even at the zero bound.

    Well, yes it is. If the economy is expected to stay at the ZLB forever. Or if a corresponding money injection is not expected to be permanent, and therefore is associated with interest rate not being expected to be any lower than normally, once the economy has escaped from the zero lower bound.”

    Sure. But why should we assume that the economy will be expected (with certainty) to remain at the ZLB forever? Forever is a very long time. Certainty is awfully certain. Equivalently (it amounts to the same assumption), why should we assume that a central bank cannot make a monetary injection that is (at least partly, with some non-zero probability) permanent (or at least permanent enough to outlast the duration of the ZLB)? Will the banknotes all self-destruct, and will the central bank’s printing press break down permanently so that those old worn out banknotes can never be replaced? Do we know this for certain?

    “2. Fiscal policy is ineffective [at, see above...] always.

    This is false, both contrary to the theory and empirics, as stated above. Versions of the theory which display Ricardian Equivalence – the ineffectiveness of fiscal policy – are rejected by the data.”

    This has got nothing to do with Ricardian Equivalence. (I think I’m the only MM who even toys with the idea of Ricardian Equivalence, but I don’t really believe it, because I often support Buchanan, or sometimes Samuelson 58, against Barro.)

    It’s the simple explanation of monetary policy offset. If fiscal policy changes to increase AD the central bank will take offsetting action to reduce AD by the same amount (plus or minus the central bank’s mistakes) to bring NGDP or inflation or whatever back to the central bank’s implicit target. It is an empirical hypothesis about central bank behaviour. (It probably wouldn’t work if the central bank was fixing the exchange rate, regardless of fiscal policy or anything else, for example.)

    Gotta go shopping with daughter. Baksun.

  3. Hypo MM this way for me please:

    1. Say we find it is possible to put NGDP on a level target (NGDPLT) of say 5% for the next 30 years.

    2. We do this by some kind of monthly recalibration, increasing or decreasing asset buys / sales that occurs without human decision making. A futures market that predicts 1-3-6 coming months and the machine targets the prediction. And acts based on the predictions.

    3. Assume this means, we can predict with some high % (say 95%) assurance, that NGDP will be within +/- .1% on any given month in next 30 years.

    4. Overtime, the accuracy increases because even in the face of massive shocks, market participants learn the machine is brutal cold and unrelenting in ensuring that by any means necessary it will aim for next months, 3 months, 6 months level target.

    ——

    Ok, are you saying that IF we could do this, it’s not worth it, doesn’t mean get us much?

    Or are you saying this can’t be done?

    • Tony Yates says:

      1) it can’t be done.
      2) strong weight of theoretical evidence is that it wouldn’t be a good idea anyway.
      3) any remotely automated system like this would likely lead to great instability, which is what normally happens when you put a rule into a model for which it wasn’t designed, or in this case a rule that does ok in a model, but it turns out that the model is not a good approximation to the real world.

  4. Nick Rowe says:

    Third comment (my first is stuck in moderation, probably because it contained a couple of links):

    “The fact that views 7 is grouped with the others undermines them as a ‘movement’. Where, in the literature, we do find support for nominal GDP targeting, it’s not because of any of 1-6
    …..
    But mainstream New Keynesian macro would say it differently. Policy might have been better had we already had in place a prescription for a future, post recession inflation overshoot, which would have managed expectations in such a way as to make the initial undershoot less severe.”

    It would be possible to agree or disagree with 7 (NGDPLT) independently of 1-6. The two sets don’t have to go together. But there is a relation between them, as you hint in that second bit I have quoted above. You recognise there that Price Level Path Targeting has stronger “automatic stabiliser” properties than Inflation Targeting, and these automatic stabiliser properties would be especially important to help keep off the ZLB. For a given nominal interest rate, a higher expected future price level would increase current demand. But it is also true that for a given nominal interest rate, a higher expected future real income level would increase current demand. Why not just add those two effects together, and say that, for a given nominal interest rate, a higher expected future NGDP level would increase current demand? Let’s face it: our knowledge of the Short Run Phillips Curve isn’t very good. We don’t understand its slope very well, plus that SRPC may shift around, when there are supply shocks. By committing to a higher future level of NGDP, we avoid having to figure out (or expect ordinary people to figure out) the slope and position of the SRPC, and decompose that into a higher level of P or a higher level of Y. It doesn’t matter. NGDP=PY will be higher either way, so one or the other or both automatic stabiliser mechanisms will work, if we follow NGDP level path targeting.

    “And, anyway, although some would not agree with me on this, the fact that inflation stayed pretty close to target indicates to me that demand-side policy was doing not far short of what it should do.”

    Yep. I for one would strongly disagree with you on that. To my mind, the fact that the Bank of Canada kept inflation (especially core inflation) pretty close to target, ***and Canada still had a recession, because all the (other) standard symptoms of recession were there*** was the death-blow to inflation targeting. To my way of thinking, that was not supposed to happen, but it did happen. What the heck is the use of IT if, even when the Bank hits (roughly) the inflation target, ***we still get a recession***! IT was the guard dog that didn’t bark, to warn us of the recessionary burglar; while the NGDPLT guard dog barked load and clear. (The UK IT dog was even worse than the Canadian IT dog, but at least your dog had the excuse of a financial crisis; our IT dog didn’t even have that excuse.)

    Will NGDPLT be the *perfect* monetary policy target? Of course not (unless we rig the model’s parameter values to make it perfect). Nobody knows (and probably will never know) the perfect monetary policy target. But it’s simple, and better than IT (and better than PLT), and we can’t think of anything obviously better.

    And fiscal policy has got other jobs to do, like build the right number of schools to match the number of kids, and get tax rates smoothed to minimise distortions and get intergenerational equity etc. We don’t want fiscal policy trying to do 2 jobs at once while monetary policy twiddles its thumbs. Sure, if you think it’s a good idea on micro grounds to build lots of bridges while real interest rates are low (it probably is), then go right ahead. But don’t let the central bank off the hook. Failures of Say’s Law are an inherently monetary exchange phenomenon (that’s where the failure of NK to incorporate money properly really matters). When Say’s Law fails empirically (as it does in a recession) that tells you the monetary institutions have failed. We shouldn’t be messing around with Heath Robinsonian fiscal patches. We should fix the monetary institutions that caused the underlying problem. When you diagnose magneto trouble, you don’t buy a new battery, you fix the magneto. Yep, we (or at least I) get radical at this point! Bad fiscal policy is not the root of the problem. Say’s Law can’t fail in a barter economy, no matter how bad fiscal policy is. Bad monetary policy/institutions is what causes failures of Say’s Law.

    • Tony Yates says:

      I don’t follow much of this, Nick, sorry. Probably requires a chat, a beer, and some pen and paper!

    • philippe101 says:

      “Say’s Law can’t fail in a barter economy”

      Let’s say you have a barter economy where all the land is owned by a small group of people. If that group of people decided to hoard the land and not employ people to work on it, that would create unemployment, right?

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  6. Nick Rowe says:

    One more go:
    “And, anyway, although some would not agree with me on this, the fact that inflation stayed pretty close to target indicates to me that demand-side policy was doing not far short of what it should do.”
    To MM ears, that sounds a bit like saying:
    ‘And, anyway, although some would not agree with me on this, the fact that the price of gold stayed pretty close to target indicates to me that demand-side policy was doing not far short of what it should do.’

    If we get recessions despite keeping on the gold standard, that suggests the gold standard is no good.
    If we get recessions despite keeping on the CPIdot standard, that suggests the CPIdot standard is no good.

  7. Nick Rowe says:

    I can’t resist one more go, sorry!

    A thought-experiment. Suppose you were in charge of monetary policy, and the economy was humming along normally. Suddenly you get the evil urge to force the economy into a ZLB/Liquidity Trap. Could you do it? Of course you could. Simply announce your intention to tighten monetary policy enough to get the economy into a ZLB/LT, and then follow through to make your announcement credible.

    You don’t need any exogenous shock at all to get the economy into a ZLB/LT. But if there were a shock, and you responded to that shock in the wrong way, or failed to respond in the right way, the result would be exactly the same. It wasn’t the shock that put the economy into the ZLB/LT, it was bad monetary policy. Unless you have run out of paper and ink.

    And where’s the irreversibility? If you can put the economy *into* a ZLB/LT, you can get the economy *out of* a ZLB/LT. Simply do the opposite, and make the opposite announcements. (With a new central banker, if need be.)

    • Tony Yates says:

      Dynamic systems with state variables and path dependence can throw up lots of examples where you can’t simply reverse trajectories, because values of state variables at the starting point are different [at each ends of the trajectory]. That’s the general point. The text in my post is just a wordy version of the maths of either RE or perfect-foresight sticky price model with MIU. You can argue the model isn’t insightful about the real world, but the model is what it is.
      PS thanks for engaging with my critique. My next posts on MM will be better as a result.

      • Nick Rowe says:

        Thanks Tony. And thanks for engaging with us. You got us mostly right. The only small bit you got totally wrong was the bit about Ricardian equivalence, which plays no role in our thinking.

        And you were right about NGDP targeting being a bit separate from the other stuff. In my own case, for a long time I was basically on board with all the other MM stuff, but was sitting on the fence about IT vs NGDPLT. I didn’t want Canada to change from IT, if it didn’t have to (small-c conservatism, “it ain’t broke so don’t fix it”, it’s not good to change the rules, just when people have finally learned how to play by those rules). Then I looked at the data (you can only really *see* the data when someone draws you a good graph) and jumped right down off the fence.

        It’s not easy finding the right words for my view on fiscal policy. It’s not so much a rigid opposition to fiscal policy per se. It’s more of a moral hazard thing. I don’t want to let monetary policy off the hook. If good Samaritan F helps out lazy M by doing part of the job that M should be doing, then M will just get even lazier. F should stick to her knitting, which is important in it’s own right, and kick M’s rear end.

      • Nick Rowe says:

        Dumb question: what is “MIU”?

        Another thought-experiment: suppose you took an economy at the ZLB, and then suddenly wiped everyone’s memories of how it had gotten into that mess, but kept all the real state variables exactly the same. Unemployment would be higher than normal, but so what? If the central bank immediately announced some sensible monetary policy going forward, why couldn’t all expectations, inflation rates, interest rates etc., immediately jump to the new sensible equilibrium path?

  8. GreenTeaIceCream says:

    Rebuttal 10 should be amended to note that market monetarists seem to focus upon monetary effects on demand. The sales tax example is a supply side boost, which would probably incorporate into the market monetarist model as an adjustment in the proportion of RGDP to inflation for a given NGDP level.

    Rebuttal 1 may be simply semantics. Monetary policy should effect changes in expectations to work, so it would be tautological to note that ineffective monetary actions are ineffective.

    • Tony Yates says:

      I’m not sure the sales tax thing is a supply-side boost, in the sense that, in certain circumstances, it’s exactly the same as monetary policy, in which case, unless we decide to label both as involving ‘supply’, it can’t be. Distinguishing ‘supply’ from ‘demand’ in GE/DSGE can sometimes be hazardous anyway.

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  10. Daniel says:

    The qualification here being that monetary policy means the manipulation of future interest rates.

    Neat trick you pulled there. If I didn’t know better, I’d say it’s circular logic.

    How about this – monetary policy means managing the supply and demand for base money.

    Suddenly, your reasoning is revealed to be based entirely on assuming the conclusion.

    • Tony Yates says:

      You don’t understand modern monetary macro; work through eg walsh’s account of MIU, then you’ll get what I mean. These models are not the be all and end all but there is nothing circular about them. They make question-begging assumptions about why money is valued, but these are tricky to better.

      • Daniel says:

        Yeah, sure I don’t. The qualification here being that modern monetary macro means the circular logic employed by proponents of the liquidity trap theory.

      • Tony Yates says:

        What you say is false: work through one of these models, and you will see. There’s nothing circular at all, though there may be lots false about them. Liquidity trap follows simply from asserting that money has non-pecuniary value of a particular form, that agents are optimising, probably also that there is a representative agent, and a representative firm. Before you make these seemingly radical and triumphant denouncements, take the time to read what you are criticising so that they are well aimed. Right now you are not debating the topic seriously.

  11. Don Geddis says:

    Daniel vs. Tony Yates: Tony, the “circular” part is that if you start with an axiom that what monetary policy “is”, is manipulation of interest rates, then in that case you may well build all sorts of models that lead to all sorts of conclusions. But MMs don’t accept that axiom about what monetary policy “is”. Instead, they believe that monetary policy is about “supply and demand of base money”.

    So naturally, when you say “our models built on top of this interest rate axiom lead to the following conclusions”, MMs would respond with: “Who cares what your models conclude? Your obvious mistake was making the initial assumption that monetary policy is about interest rates. It’s no surprise that your conclusions from that faulty assumption would be mistaken.”

    You say: “Liquidity trap follows simply from…” But you seem so blind to your axiom assumption that you can’t see that any ZLB obviously requires that interest rates be fundamental in your model (since the whole “problem” is that you want to lower interest rates, but they’re already at zero, and you have no power to lower nominal rates below zero). But if monetary policy ISN’T about interest rates, then the ZLB isn’t a real thing either.

    Interest rates are the price of credit, not the value of money. Those are different things. Monetary policy is (or, at least, should be) about stabilizing the value of money.

    • Tony Yates says:

      Nope.
      I’m not assuming monetary policy ‘is’ interest rate policy; interest rate changes or money injections are duals. Except at the zero bound, when interest rate cuts are obviously not possible, and I am talking about money injections.
      Your final statement is right; but the models are talking about are predicated on the objective that one tries to stabilise the value of money (or, equivalently, the price level, ie the exchange rate between money and goods), not stabilise the interest rate.
      You’re right that the models might not have anything to say about the real world; this is dealt with in my post. I mention them because i) if you want to mount a competing world view about how monetary policy works, you have to lay out a model and 2) MM protagonists frequently invoke the same models in support of their policies, but, in the instances I have seen, make incorrect statements about them.
      ‘I’ am actually not assuming anything; these models go back to Sidrauski, Brock and Clower in the late 1960s. ‘They’ make particular assumptions about how the non-pecuniary value of money fluctuates as the quantity of real balances change. Typical is the assumption that real balances are like other goods, that as their quantity increases, non-pecuniary returns [meant to capture the liquidity benefits of money], diminish. Just like the third Mars bar is less satisfying than the second. It is this property alone that generates the zero bound to nominal interest rates, and the inefficacy of monetary policy [here money injections] in the senses described in my post. So, initial assumption is about the functional form of the non-pecuniary returns to holding real balances with respect to their quantity. The conclusions drawn by ‘them’, are about the efficacy or otherwise of money injections. So I / ‘they’ are not assuming A to conclude A. There may be falsehoods, but no circularity. You and Dan are obviously both really interested in monetary economics. It baffles me why you haven’t taken the trouble – I reckon you would only have to give up a day’s work – to work through step by step just ONE of these models to see how they work, what you don’t like about them, what is meant by the statements in my post, and how you think the world would be better described. That way you could offer a serious challenge to mainstream monetary macro.

      • Daniel says:

        “Mainstream” monetary macro has already been falsified by Abenomics (among others) which succeeded in creating inflation despite being at the so-called ZLB. Or the Swiss currency peg (which Keynesians said wouldn’t work).

        Any talk of “unconventional” monetary policy is circular logic, pure and simple. Last time I checked, there was no law of nature that says a central bank’s sole allowed instrument is interest rates. Keynesian mental blocks are just that, and have more to do with anthropology than economics.

        (as an aside

        http://theviewfromhell.blogspot.ro/2012/10/old-money-evolutionary-economics-and.html

        turns out people have a very hard time grasping the “fiat” part of fiat money. Keynesians are just as guilty of this as the goldnuts)

        Keynesianism (aka “the dark age of macro”) is dead. It only made sense in a fixed exchange rate regime.

      • Tony Yates says:

        Abenomics is a complex policy experiment, for one thing. And I can tell you haven’t really taken in much mainstream monetary macro [you haven't studied the basics of how it treats money] so take a look, and then come back and think about your claim that it’s falsified. At the moment, you are just hurling uninformed, sometimes nonsensical statements, and while you might find it entertaining, you won’t have any effect on the debate, as those participants who know what they are talking about see you for what you are. This isn’t a take that comment. It’s advice. Channel your enthusiasm into learning about what you hate and want to knock down. Macro is full of people who did that and eventually changed it.

      • Don Geddis says:

        interest rate changes or money injections are duals

        I have to admit, that I don’t believe you. Instead, I think this is an example of the source of the fundamental conflict between your worldview, and that of the MMs. You assume these are duals, and then you choose only to think about and talk about interest rates. And then you come to conclusions that MMs don’t agree with.

        The problem isn’t your logical chain of reasoning or your models. The problem is your underlying assumption about what to model.

        You already admit that, at the zero bound, money injections and interest rates are not duals. MMs would argue that there remain important distinctions between them at positive interest rates as well.

        You don’t get a free pass, on ignoring money, just because you assert that they are duals.

      • Tony Yates says:

        Quite right: don’t take it on faith: go read either Eggertson and Woodford’s papers, or Woodford’s Jackson Hole paper. Better still work through the same model described nicely in Walsh’s textbooks.
        I am not going to respond to other points you make: they are garbled, and not based on having understood the model you want to reject. It’s really interesting that you’re so fired up to reject it, and yet you don’t even know it, not even in broad outline.

      • Don Geddis says:

        interest rate changes or money injections are duals

        And, lest you think I’m just whining here, let me be concrete. Imagine a normal economy, humming along, with interest rates at 5%. Then the central bank performs some monetary action. Interest rates are now observed to be 3% instead. Do you know what happened to money injections?

        No. There are two opposite paths that lead to the same interest rate result. One is that the central bank provided additional stimulus, injected addtional money, and the resulting easing led to a lowering of interest rates. We would expect this to stimulate the economy going forward, probably a rise of both inflation and growth, and a lowering of unemployment.

        The other possible path is a tightening of money. The central bank could be engineering a recession, and causing future NGDP to drop below previous expectations. The new 3% rate is now a reaction to the lowered demand for credit, given the worsening economic climate.

        Saying that “nominal interest rates dropped from 5% to 3%”, doesn’t tell you what macroeconomic consequences to expect. Credit prices (“interest rates”) are a function of both credit supply and demand, and you need to know which curve changed, in order to interpret the consequences of any resulting nominal value. (Note that demand change merely because of credible statements issued by the central bank, without necessarily requiring any immediate change to the actual total supply of money.)

      • Tony Yates says:

        Your thought experiment makes no sense. Write down a model, solve it, then peturb it with a policy shock, then come back to me.

      • Daniel says:

        Am I the only one here who knows about the Fisher equation ?

        If nominal interest rates are the sum of inflation and real interest rates, a fall in interest rates could reflect a fall in inflation, or a fall in real returns. Or both.

        So it tells you NOTHING about the stance of monetary policy.

        Enough of a model for you, Tony ?

      • Tony Yates says:

        You don’t understand the Fisher equation.
        Again, have a look at just one monetary model, from start to finish.
        The Fisher relation is a statement about low frequencies. Eg, in monetary models with sticky prices, a contraction in the cb instrument [interest rates or money] would cause interest rates to rise, in the short run, and inflation to fall in the short run. Provided cb objectives don’t change, inflation and interest rates would return to base. Fisher correlations could only be induced by changing the objective of the central bank. ie if you raised the inflation target, or tilted the path of an NGDP or PLT target, in the short run you would need an interest rate fall [or money growth increase] and then in the long run both inflation and interest rates would rise.
        The CB can be prompted to move its instrument by other shocks, so not all movements in the interest rate qualify as the kind of experiment I am discussing: we are evaluating MM statements about the efficacy of non-systematic peturbations of the cb instrument.

      • Daniel says:

        Also, it just dawned on me that, indeed, we are starting from different assumptions.

        the objective that one tries to stabilise the value of money

        It is precisely this objective that Sumner & co are contesting.

        Since “sticky” wages caused pretty much all of the business cycles in recent history, what you want to do is keep wage inflation low and stable. Attempting to stabilise the value of money would require monetary tightening in the face of a negative supply shock – running smack into said stickiness, thus causing involuntary unemployment.

        And if “monetary offset” is difficult to grasp … well, maybe your models aren’t set up properly. Maybe they don’t deal with the central bank’s reaction function so well.

      • Tony Yates says:

        No to all this. You are confused on all accounts. Monetary offset is very clear, it just doesn’t hold in models where we try to work out what it would be optimal for the cb and govt to do. I’m not going to respond to any more of your comments.

      • Daniel says:

        Eg, in monetary models with sticky prices, a contraction in the cb instrument [interest rates or money] would cause interest rates to rise, in the short run, and inflation to fall in the short run.

        Except we had a monetary contraction in late 2008 and interest rates didn’t rise in the short run.

        So your “monetary models” were falsified.

        Ignore me all you want, but you can’t ignore the fact that reality flat out contradicted your models. Ignoring it won’t make it go away.

  12. Tony,

    I quite agree. I’ve been hammering away at MM for months now. It’s a mass of self-contradictions and nonsense, far as I can see.

    However Scott Sumner seems to have toned down his more extreme MM views. He said recently “Since 2008, the UK has run extremely large budget deficits, bigger than the US as a share of GDP. Everyone agrees these are too large, and need to be reduced. But Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument…”.

    The idea that fiscal deficits are in any sense “fair” flatly contradicts his previous claims to the effect that fiscal policy is pointless because the central bank always “offsets” it.

    • Don Geddis says:

      a mass of self-contradictions and nonsense

      MM might be false. Or even technically true, but unhelpful. But it is not self-contradictory. If you’re going to make inflamatory statements like that, you should at least have the courtesy to back them up with some concrete facts.

      fiscal policy is pointless because the central bank always “offsets” it

      Sumner never once said that. You are reacting to a strawman of your own devising. What Sumner said was: if a central bank is targeting a nominal aggregate, then any deviations of the fiscal multiplier from the theoretically expected value of zero, are simply an estimate of the central bank’s incompetence. Or, to put it another way: given a competent central bank targeting a nominal aggregate, the fiscal multiplier is zero because of monetary offset, and therefore (demand-side) fiscal policy is pointless. (Note that supply-side fiscal stimulus is a completely different story, and fiscal policy can easily affect the mix between real growth and inflation, given that the central bank fixes NGDP growth.)

      But Sumner also says, that it appears that essentially all real-world central banks are indeed incompetent. And therefore, in the real world, fiscal policy has indeed had demand-side effects. But this isn’t something to be happy about. This should have caused intense criticism of the failures of the central banks, and it’s a shame that the criticism hasn’t materialized.

      • Tony Yates says:

        I don’t need to back anything up: I’m contrasting statements MMs have made with facts about monetary macro models that have so far been articulated. [That you could go and verify for yourself]. We can debate whether those models are interesting or not.

        Others have said exactly this about fiscal policy. And on your point about Sumner, the positive fiscal multiplier does not measure cb incompetence. In these same models, as I reported in the original post, jointly optimal monetary and fiscal policy is for both to be active in response to all shocks, at all times, whether at the ZLB or not. This is quite an old result, and not very surprising, based on the fact that mp and fp are similar, but not identical instruments. It’s not a matter of shifting an AD curve in and out. Once again, you can say ‘ok I don’t like this model, so I don’t accept the desirability of jointly active mp and fp’, but, if so, MMs need to explain what they don’t like about it and work through the implications of the new model. That has yet to be done.

      • Don,

        Re “self-contradictions” I’ve backed that accusation up with some quotes from Sumner here:

        http://ralphanomics.blogspot.co.uk/2014/07/scott-sumner-changes-his-mind.html

        Re your claim that all Sumner is saying is “if a central bank is targeting a nominal aggregate….”, strictly speaking you’re correct. However, the reality is (e.g. to judge from the quotes I set out at the above link) that Sumner has used his “nominal aggregate” point as a basis for throwing cold water over fiscal stimulus, over and over and over again.

        Moreover, while his “nominal aggregate” point is strictly speaking correct, it’s completely pointless and vacuous, and for the simple reason that it can be turned on it’s head. That is, one might as well say that that if the fiscal authorities are effecting stimulus in an accurate and competent way, then “monetary multiplier” is always zero: i.e. monetary policy is pointless.

  13. Pingback: TheMoneyIllusion » Tony Yates on market monetarism

  14. Nick Rowe says:

    Tony: “I’m not assuming monetary policy ‘is’ interest rate policy; interest rate changes or money injections are duals. Except at the zero bound, when interest rate cuts are obviously not possible, and I am talking about money injections.”

    For any reasonable model of a monetary economy, this isn’t quite right. If you know the time-path of M, you can solve the model for the implied time-path of the nominal interest rate i. But if you know the time-path of i, you cannot (generally) solve for the implied time-path of M. For example, if you double M at all points along the time-path, you get the same time-path of i (in most models). And the same would holds true, for example, with the time-path of the nominal price of (say) gold. Knowing the time-path of i does not pin down a unique time-path of the price of gold. So when Roosevelt wanted to loosen monetary policy, he simply announced a higher/rising price of gold, and it worked, despite nominal interest rates being at or near the floor. Announcing a rising price of gold will loosen monetary policy (increase expected inflation and/or expected real growth) while at the same time cause equilibrium nominal interest rates to increase, and the equilibrium marginal utility of real money balances to rise.

    If we (and by “we” I mean both economists and economic agents) think of monetary policy as setting a nominal interest rate, and letting the price of gold be market-determined, we get one result. The liquidity trap looks like a real trap, where you can’t loosen monetary policy. But if instead we think of monetary policy as setting the price of gold, and letting nominal interest rates be market-determined, we get a very different result. The liquidity trap is no trap at all, it is simply the result of announcing too low a growth rate in the price of gold.

    Sometimes, the way we think about the world has a real effect on what we can and cannot do. A central bank that is thought of as setting the price of gold can communicate things, and influence expectations, in ways that a central bank that is thought of as setting nominal interest rates cannot communicate. Only the latter central bank is struck dumb in a liquidity trap.

    (I am not a gold bug, and only used gold as my example because then I could use a real historical illustration, rather than having to invent one.)

  15. Nick Rowe says:

    Tony: ” In these same models, as I reported in the original post, jointly optimal monetary and fiscal policy is for both to be active in response to all shocks, at all times, whether at the ZLB or not.”

    Yes. Nearly all shocks will have an effect on the real interest rate r, for example. And it will generally be the case that optimal G is a function of r, and optimal T is a function of r. That result (or similar results) is not what is at issue. The question is how we interpret that result.

    I would interpret that result in this way: “Fiscal policy should stick to it’s microeconomic objectives, and leave the management of aggregate demand to the central bank. But we should recognise that both G and T ought to respond to r. And the central bank should take into account the actual changes in G and T (whether optimal or not) when it manages aggregate demand.”

    It’s like a principal with two agents (monetary and fiscal) and two objectives (macro and micro). It is better to assign each agent a separate target, for which he is solely responsible for hitting, than to assign joint responsibility to one or both of those targets. That way you can hold one agent accountable for hitting his target, even if the other agent gets it wrong. It’s a form of decentralisation of decision-making in an interdependent economy.

    (My simple principal-two agent model is complicated in the real world by the fact that it is hard to specify a microeconomic target for a fiscal agent, so the principal might wish to retain direct control over fiscal policy himself.)

  16. Nick Rowe says:

    Take an existing macro model off the shelf. That model will (usually) have an endogenous implied time-path for P(t) and Y(t), and their expectations. So that model implicitly contains an implied time-path for NGDP and its expectation. Now assume the central bank communicates policy in terms of that time-path for NGDP.

    It’s exactly the same model, in terms of the equations describing the equilibrium conditions, but it has a very different interpretation. For example, if the central bank loosens monetary policy, which means announcing higher future NGDP, that will (usually) imply a higher nominal interest rate.

    MM is more about interpreting existing models differently and interpreting the existing data differently. Monetary policy is 99% expectations, so how monetary policy is communicated is 99% of how it works. And market prices (especially asset prices) are the main source of information we have on how that communication is being received.

  17. Sam Gray says:

    Tony,

    This is a great post, thanks.

    You said “So there is something to NGDP targeting. But it is really only a special case that emerges occasionally.”

    To quote Scott Sumner: “Interest rate targeting could be compared to a steering mechanism that works fine except when you need it most; it locks up in rough weather.” http://econlog.econlib.org/archives/2014/02/the_ecb_is_stee.html

    • Tony Yates says:

      I’m not advocating interest rate targeting at all. Using the interest rate or money supply as the instrument, to carry out optimal policy. In these models, this means setting out what’s in their utility function, and using the instrument to maximise it, given how individuals go about solving their own problem. This very rarely leads to a policy that is equivalent to NGDP targeting. They are only models of course!

  18. Tom Brown says:

    Tony, would it be fair to say that one of your main frustrations with MM is that it appears to lack a mathematical model? Would you like to see MMism spelled out in a coherent and complete set of model equations?

  19. Tom Brown says:

    Tony, what are your thoughts on this? (Scott Sumner’s response):

    http://www.themoneyillusion.com/?p=27068

    • Tony Yates says:

      I’ll respond at some point…

      • Tom Brown says:

        Tony, re: MM models: in the post Scott writes the following in his post:

        “If someone bothered to write down the MM model (at least my version of it), the model would be as simplistic as the Keynesian cross.”

        Which I took to mean that nobody (including Scott) has bothered. However, when I asked him if Jason (I give you the link above to Jason’s model) is the 1st person to have bothered (Jason gave him the link) then Scott replied:

        “Tom, I sketched out the outlines of such a model a few years back.”

        So I either misinterpreted Scott’s 1st statement, or the 2nd statement is stating that a sketch exists, which perhaps is different than a complete model? I’m not sure… but still, I don’t have the link to Scott’s sketch, just to Jason’s model, which Jason created a year ago.

        Jason approaches the problem from a very different direction (from within his information transfer framework), but still he arrived at much the same conclusion as Scott about the Keynesian cross similarity:

        http://www.themoneyillusion.com/?p=27068#comment-357150

        Also, Scott is confused by Jason’s model (not a surprise, since Jason approaches the subject from his unique viewpoint) and asks him this:

        “Jason, Why do you assume a fixed relationship between P, NGDP, and MB?”

        Jason will probably answer Scott (he usually does). But I’m afraid to really answer that Scott would have to digest the general (not econ specific) information transfer model, which Jason won’t be able to convey in a line or two of comments. But then again, I’m not an expert on Jason’s theory, so perhaps that’s wrong.

        I’m interested because I personally have never seen an MMist write out the equations for their model and present it, but then again, I’m an avid MM blog reader the last couple of years, but that still doesn’t make me an expert on MM. I’m a fan of Jason’s blog, but I wasn’t aware that he had created what he thought could serve as equations for an MM model (Scott’s model in particular) almost a year ago. But I highly doubt that Scott will accept Jason’s model as “Scott’s model.” I guess we’ll see!

        So, AFAIK, still no MM sanctioned model… although if you do respond to Scott you might ask about that “sketch” he says he made some years back.

  20. Benjamin Cole says:

    Well, lots of good stuff here, but it all comes down to this:

    When in recession, a central bank should print a lot more money, and should aim to steer well clear of zero inflation in the future.

    Inflation in the 3 percent range is fine.

    Prosperity, not price stability, is the first goal of macroeconomics. A peevish fixation on price stability is a form of dementia. Even measuring inflation is a subjective art.

    MM is a good platform to manage monetary policy, provided the targets are not set too low.

  21. Pingback: Insure Against Central Bank Incompetence: My Reply To The New Keynesian Strikeforce - True Investment Research

  22. Pingback: The Jefferson Tree | Scott Sumner still promotes market monetarism.

  23. Shahbaz Rao says:

    give your point of view weather fiscal or monetry policy is better to control the inflation or deflation be sepecific

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