Why ECB purchases could be more stimulative, euro for euro, than UK or US QE.

A short post substantiating my tweet yesterday asserting this, which was picked up by the Guardian, but, all on its own, to those not swimming in this stuff, might look rather odd.

We could think of an ECB purchase of a package of bank loans (an ABS) in two steps. First, it agrees to buy a government security from the bank. Then, in step 2, it agrees to swap this for an ABS issued/held by the bank. In reality, of course, the purchase involves a single step, a straight swap of electronic reserves for the ABS.

However, thinking of the purchases in two synthetic steps highlights why these purchases might be more stimulative than the Fed/BoE asset purchases, which involved straight swaps of reserves for gilts. [Leave aside the earlier Fed purchases of agency debt, and the tiny amounts of corporate paper the BoE bought]. Unless you think the swap stage would have no stimulating effect on the bank, or a negative effect, the ABS purchase must be more stimulative. If one supposes that the value of the government securities is effectively underpinned by Draghi’s earlier promise to invoke ‘Outright Monetary Transactions’ (OMTs), then we presume that the private bank and its funders feel its balance sheet to be less risky if it dispenses with an ABS than a government security. (In the past I blogged that I thought that OMTs were an almighty bluff and was puzzled that markets had not called it. They don’t look like calling it any time soon, so this presumption seems fine.) Wholesale debt funding can now be sourced more cheaply, its equity price will rise, and it will feel able to extend new loans at lower cost, stimulating spending by households and companies dependent on that funding.

Actions like this were urged on the Bank in the early days of the crisis, both publicly, by former MPC member Adam Posen, for example, but also privately, by myself and others on the staff, precisely on the grounds that one would presume them to have a larger bank for buck using this logic. In that case there was less of a question surrounding the credit-worthiness of gilts either, so the conclusion that private asset purchases would be more stimulative was on firmer ground.

This said, as I tweeted, though more stimulative euro for euro, one would presume that the purchases will be on a significantly smaller scale than US/UK QE.  [At least, assuming that there is no subsequent round of straight purchases of government securities].

Draghi post mortem

Draghi’s press conference today left many questions hanging in my mind. Here are a bunch of disjointed responses, recapping on tweets earlier today.

Why didn’t he mention an amount in announcing the start of purchases of private sector assets? Is this because, actually, and as Frances Coppola has intimated, there won’t be a large enough quantity of eligible assets to make it sound like a policy that will really work?

It seems likely this announcement is coloured by what the German constitutional court would view as the ‘fiscalness’ of ECB policies. Buying private sector assets is ‘monetary policy’, in this topsy-turvy world. Doing familiar QE – buying government securities – is fiscal policy, and to be avoided. Note that in the UK, former Governor Mervyn King and others rejected buying private sector assets precisely because this would be seen as fiscal policy, which is properly the concern of the UK Treasury. In the end, these distinctions, as I have blogged in the past, are hard to make concrete.

One presumes that the inflation forecast was not conditioned on any asset purchase program. At a time like this, it would have been great to have one to compare including such a purchase program, so we would know not only it’s size, but the anticipated effects on the ECB’s goal variables. Then we could monitor what the ECB intended to do, and what it intended to do if the economy did not develop, or the purchases did not have the same effect, as anticipated.

It’s a real shame that Draghi feels forced to mention ‘structural reform’ at every turn. At one point he commented that monetary and fiscal policy alone cannot fix Europe. On the contrary, monetary and fiscal policy can fix what the ECB is mandated to care about, namely the possibility that inflation will stray forever below target (and, at a generous interpretation, that the output gap will be negative for a long time). Potential output is the concern of member states and the EU, not the central bank. In fact, as I and others have commented, seen through the model that the ECB itself uses to forecast, structural reform may be deflationary, since it increases output relative to potential, making the output gap more negative. Really all this does – aside from keeping the German ECB board members and politicians onside – is to inject negative noise that reduces confidence in future inflation and real activity in the Euro Area. Imagine the response if Mark Carney said ‘We can’t fix UK secondary education with monetary and fiscal policy alone: we need educational reform.’ Or ‘we can’t fix crime with monetary and fiscal policy alone: we need criminal justice reform.’ How silly it would sound. But this is not really much different from what Draghi said.

It’s frustrating that he and other central bankers fling the word ‘anchored’ around when discussion inflation expectations. What does it mean? If expectations were always equal to target, would that be such a good thing? What if the economy suffered persistent under and overshoots of the target, through no fault of the central bank. Would we wish that private agents nevertheless assumed inflation expectations would always be at target, and suffer the forecast errors? Is this meant to refer only to the fact that longer term expectations are not at target, when the ECB itself expects inflation at that horizon to be at target? If so, then one needs a clearer discussion. We need to understand what the ECB is assuming about why private participants don’t share their own view. Is it that they use a primitive method of extrapolating past inflation to forecast the future? Or do the ECB think that private participants are guessing the economy is in a worse state than the ECB itself think? Or that policy instruments will not be used as has been promised, or will not have the effects the ECB are assuming? And how are the ECB assuming that this world view different from theirs will develop such that the ECB itself can still forecast inflation to be on target eventually?  Is the ECB assuming that everyone comes to share their own world view?  If so, how and why?  Or is the forecast projected on a policy loose enough to compensate for the fact that private expectations stay ‘too low’ and to bring inflation back to target nonetheless?

Draghi mentions that there was not unanimity on the Governing Council regarding this announcement [whatever this announcement amounts to]. Some wanted more stimulus, some less. But if so, what did they want? By how much did it differ in size and nature? How were these minorities outvoted? 1 person 1 vote, or was it weighted by GDP? Are any members allowed a veto on any issue? Do Executive Board members count the same as Governors of member state central banks?

That the ECB cut rates again caused me to reflect on the fact that the UK’s MPC had chosen back in 2008 that the floor of rates would be 0.5%, higher than both the Fed and the ECB. I wonder: does the fact that these other central banks have gone lower without disaster cause the MPC to reflect on whether, if they needed more stimulus from some source, they could cut rates themselves?

A mauling Minsky moment: comment on Martin Wolf

Martin Wolf’s call to arms is a stirring read, and I agree with much of its conclusions on the need for simple and very much tighter regulations on bank leverage.  However, I don’t agree with how they are reached.  Somewhat caricatured, the logic is:  1) as Minsky said, stability and financial systems breeds instability, which explains why our global financial system collapsed.  2)  It follows that we need drastically tighter regulations on bank leverage.

Minsky’s reading of economic systems was a stroke of creative, imaginative but informal genius.  But it’s highly conjectural.  It may be part of the story of the financial collapse that financial system stability is inherently destabilising, or it may not.  Just because intermediation was cheap and plentiful before it became expensive and scarce does not validate Minsky.  There are plenty of other preceding and coincident events which don’t fit.  To go through a few examples:  Technological advancement in intermediation and financial transactions, accompanied by deregulation:  innovation (the destabiliser) did not advance because over some prior (stable) period it hadn’t. (The regulatory story fits, which I’ll return to later).  Calomiris-like tales of political interference in the financial sector:  banks didn’t lobby Governments (destabilising) because previously they hadn’t.  According to that story, they always have and always will.  The export of savings ‘uphill’ from emerging Asia, (destabilising) looking and hoping for safe haven:  this happened because barriers to that capital export were lifted, not because for no other reason capital had been invested locally.  None of these competing narratives of the crisis have anything to do with Minsky’s hypothesis that stability breeds instability. The simplest model of bank runs, which many use as a metaphor for the closure of wholesale funding markets, Diamong and Dybvig, simply says:  runs can happen on healthy banks which borrow short to lend long.  It doesn’t say ‘runs happen because they didn’t happen previously’.

Besides, as a theoretical conjecture, it needs working through.  Before we accept Minsky’s verbal conjecture, what would an artificial economy do if you peopled it with agents with imperfect apprehensions of risk?  Would such artificial systems be characterised by a ‘stability is destabilising’ dynamic?  There are lots of counter-examples in models of less-than-rational expectations.  For example, heuristic models of inflation-forecasting, a field I know more about, often have multiple rest points.  These rest points are not necessarily inherently destabilising.  If shocks are small, they attract the system back.  If shocks are large, the economy might be sent off to another attracting rest point.  There is nothing inevitably cyclical about the volatility of systems like these.  If you hit these systems with shocks so that every now and then a large one arrives, then you will see repeated movements between the rest points.  But you would not describe such models as exhibiting a stability-is-destabilising dynamic.  You would describe them as exhibiting a ‘large shocks cause the economy to move from one rest point to another’ dynamic.  Models of learning would go by the opposite description.   In such models, stability is stabilising;  instability is destabilising.  What causes agents’ forecasting models and the system at large to explode is large shocks:  instability.  There are probably hundreds and hundreds of mathematical systems with potential lessons for economics that don’t fit with Minsky’s hypothesis.   If you follow Paul Krugman’s reasoning, the financial crisis, at least as manifest in spreads, is over and done with.  And it’s lasting consequences for demand and inflation are down to insufficiently stabilising fiscal policy.  There’s no room for a ‘stability is destabilising’ dynamic here.  The future would be bright if Governments simply spent more money raising the natural rate.

But suppose we accept the idea at face value.  One reading of it suggests that we restricting bank leverage as Martin Wolf urges won’t work by itself.  A long period of stability breeding complacency would presumably erode the support for these restrictions.  In a democracy like the UK’s, where by convention no Parliament can bind any of its successors, there would be nothing to stop this complacency leading to future regulatory relaxation.  Is this an argument for something that does bind future Parliaments?  It would be, if we found solid theoretical and empirical support for the stability breeds instability idea as the dominant cause of the crisis.  But we haven’t yet.

 

 

 

Blame the EZ crisis on Woodrow Wilson, not Germany

Paul Krugman and Simon Wren-Lewis characterise the Eurozone crisis as partly or wholly caused by German intransigence, the outcome of which is monetary and fiscal policy that is too tight, forcing an unnecessarily harsh fiscal and competitiveness adjustment on the Southern European countries. Taking the premise of this as true:

If we focus on monetary policy, one could just as well blame it on the Allied powers who enforced the Versailles Treaty on the defeated German nation at the end of World War 1. Indulging in some rather crude history: it was the impossibility of financing reparations that led to Weimar hyperinflation, and then Hitler’s take-over and subsequent determination to reverse German humiliation. And it was the experience of that hyperinflation that led Allied Powers to – with the presumed support of the German elite at the time – enshrine price stability in the constitutionally mandated framework governing the Bundesbank.  That same hyperinflation coloured the Bundesbank’s conservative post World War 2 monetary policy, and the coincidence of the apparent success of that, coupled with the years of monetary-anchor-wilderness faced by the other major economies, as they worked their way through various ways of operating fiat money systems, that meant that this same constitutional price stability provision was to be hard-wired into the EU Treaty.

No doubt this history also coloured other facts, like the location of the ECB within a 5 mins Chauffeur of the Bundesbank, (something that would rebound on the Bundesbank itself, as it struggled to staff junior posts in an institution so close to its more important protoge institution);  the predominance of German appointments in senior positions in the monetary policy functions of the new ECB;  the early emphasis on the ‘monetary pillar’;  the aversion to characterising monetary policy as being about stabilising not just inflation but real activity (which, although the rhetoric has softened, may still be colouring actual policy);  the asymmetry of the inflation target [and its reluctance to call it such] which specifies that inflation shall be ‘close to but below’ 2 per cent;  the fact that the ECB got to define its own objective, safely away from its coalition of political masters, an unusual example in public economics, where principals usually set their agents target, not the agent itself.

So, conjecture: don’t blame the Germans for the ECB’s conservatism. Blame Woodrow Wilson for acceding to the daft Versailles Treaty under pressure from the French premier Clemenceau. [If Keynes’ account in the ‘Consequences…’ is to be believed].  Since the EZ crisis blows back on the UK, US and of course French economies, this is a kind of karmic revenge for the overreaction of the drafters of the German ‘Basic Law’ from which the price stability clause derives.

In Mervyn King’s Ely lecture, he wrote that institutions – like independent central banks, and constitutional provisions for price stability – are a kind of social memory of past learning through experience.  Let’s hope that this is right, and that future monetary and fiscal institutions governing the Eurozone correct for some of the features above which we are learning have contributed to overly conservative monetary policy.

Cue angry comments from proper financial and monetary historians…

Core blimey, Governor

This post recaps on today’s tweetstorm about core inflation, which follows Paul Krugman’s blog on the topic.  It’s late on Friday, productivity levels are falling, and I can defend not doing my bit for my co-authors on my revise and resubmit.

1.  In sticky price models, theory tells us that the optimal inflation rate is one weighted by the stickiness of prices.  So if it could be proven that food and energy are more flexible than other prices, that would legitimate the Fed dropping these prices from the core rate.

2.  By the same token, equal prominence should be given to nominal wages in formulating policy.  If prices were entirely flexible, and  nominal wages sticky, the central bank should be given a nominal wage inflation, not a price inflation target.

3.  Another defensible argument is that some shocks to inflation may come and go more quickly than monetary policy can respond, given, ahem, the long and variable lags between interest rate changes and changes in inflation.   Looking through such shocks may often wind up looking like excluding some prices from the headline index.

4.  It’s also defensible to formulate a core index on grounds of measurement error.  There are two kinds we can envisage.  One is that our statistics agency has the correct concept of price, but simply measures it with random noise induced by sampling.  It has long been known [see for example work by Svensson and Woodford] that optimal policy indicators should weight component variables by how well they are measured.  A similar argument was made by Bryan and Cecchetti in the early 1990s when they argued for the ‘trimmed mean’ inflation rate.  A second kind of measurement error is that the statistics agency simply has a concept of price that is not appropriate for monetary policy purposes.  (This doesn’t mean that the price is necessarily ‘wrong’, since it may do perfectly well for achieving some other policy goal.)  Responding to this kind of measurement error would hopefully amount to surgically removing the offending component index, and replacing with one more in conformity with what theory or common sense tells you should go in.  And this process might resemble constructing a core inflation index.  A classic example of this genre is that the theory consistent measure looks for an aggregate of nondurable goods.  Yet CPI weights the prices of many goods which provide services over a long period.  Ideally we would figure out the service flow and substitute this in place of the price of the computer, or car, or whatever.  [Although my Windows 8 computers struggle to provide a service flow over multiple periods].

5.  These arguments have to be weighed against the costs of the central bank, or authority which defines the mandate, appearing to choose and change the goalposts to suit itself.  If there is a strong feeling that something is inflation in the populace, it may be costly for the authorities to entirely disregard controlling that, since it may undermine the credibility of their actions in this and other spheres of public policy, and may unhinge expectations of the true measure of inflation, aggravating the problem of controlling it.  Lorcan Roche Kelly responded to my tweetstorm by pointing to ‘CPI flat‘, a joke index of the prices which, when aggregated, amount to the same number each month.  This is not such a joke.  It reminds me of a long period in the early 2000s when the ECB were continually pointing to above target inflation as being due to ‘price level shocks’, as though these were mysterious things that had nothing to do with the ECBs own actions.  ‘Price level shock’ madness haunted the corridors of the BoE too, in the early days of post-crisis high inflation, before the MPC made more conscious and honest reference to an explicit choice to tolerate higher inflation on account of moderating the recession.

 

On raising the inflation target to combat secular stagnation

Tim Harford’s FT article responds to the recent ebook on secular stagnation – the tendency for weak demand to depress equilibrium real interest rates – circulated by VoxEU.  He deduces that raising the inflation target would help combat or avoid it.

Well – at least through the lens of modern macro – yes and no.  First, raising the inflation target now might well not help at all.  With the reliable and conventional tool of interest rates at their zero floor, and fiscal room for stimulus argued by some to be minimal, or at least politically limited by those with this view, there would be no means to achieve a higher inflation target.  At least, if you are sceptical that QE has any great effect beyond signalling the future path of central bank rates.  [A view held by Barro, Sims, Woodford, Cochrane and many others, though one that is controversial.]  If this was the case, raising the inflation target could be self-defeating, since it would set up the central bank to fail, and the credibility of monetary and other public macroeconomic policies could suffer as a result.

In this sense, raising the inflation target is something we should consider as a step to take to reduce the probability of interest rates having to hit the zero bound again in the future, ie as a preventative measure, rather than a cure for future ills.

Note too that as a preventative measure it won’t entirely eliminate the bad consequences of secular stagnation.  In the long run monetary policy can’t do this.  As Tim notes in his post, low equilibrium real rates are ultimately determined by supply and demand.  Higher inflation will lead to longer time higher levels of the central bank rate, making more room for larger interest rate cuts, and, repeat, making it less likely that policy gets trapped again at the ZLB and the real side of the economy suffers from the recessionary traps associated with being stuck there.  But long run higher inflation won’t – a few minor details glossed over – do anything to raise long term growth or equilibrium real rates.

So, in sum, higher inflation isn’t a good cure for today’s ills, and would only be a partial solution to the unattractive features of longer run secular stagnation.  I’m personally in favour of raising the target at some point.  Indeed, as I blogged before, I’ve urged that we consider setting up a body to conduct low-frequency reviews of the appropriate inflation target, to respond to low-frequency changes in real rates.  But not now.  And we shouldn’t hope for too much for it, and not lightly dismiss the costs associated with it in potentially unhinging expectations of nominal stability.

What I thought John Cochrane would have said about legislating a Taylor Rule for the Fed

John Cochrane recently responded on his blog to the news that Congress were going to debate that the Fed be required by legislation to choose a monetary policy rule, and stick to it, justifying when and why it departs from it.

His post surprised me somewhat.    It seemed relatively favourable to the idea.  Not entirely convinced.  But raising practical questions like:  what would go in the rule, what would be left out?  What about macroprudential policy?  Putting on the table the distinction between instrument rules [schemes that stipulate directly what should be done with the interest rate] and targeting rules [jargon to describe schemes for evaluating the outcomes of policy, where the policymaker is left to decide how best to do its job].

Cochrane has written quite a lot that bears on how much weight we should put on the literature that extols the benefits of Taylor-like rules in the sticky-price macro model.

One theme, in his  Journal of Political Economy paper, is:  the benefits claimed for rules like the Taylor Rule are much less reliable than you might think, because they are based on arbitrary and very unconvincing procedures for picking out one particular equilibrium in the sticky price model from the many possible.

Another theme, that he has developed in his blog,  focuses on policy recommendations for escaping the zero bound that emerge from the sticky price model.  The basic idea is:  at the zero bound, the sticky price model throws up some mighty strange results.  Rather than forcefully recommending the prescriptions that rely on them, these strange results should cause us to wonder whether the model isn’t itself wrong.

Key prescriptions are that the central bank should engage in forward guidance, lowering the future rate when it can’t push today’s interest rate any lower.  And implementing a fiscal stimulus on the basis that the multiplier is so large in these models when monetary policy is stuck at the ZLB.

The results that Cochrane [rightly in my view] says are weird, are what protagonists have dubbed the ‘paradoxes’.  Like the paradox that if you reduce potential output, by destroying capital, or force workers to work part-time,  you can increase inflationary pressure, so much so that the economy escapes the zero bound and output  increases.  [There are other exotic results too, like the fact that if you fix interest rates for protracted periods, these models can go from generating huge inflations to huge deflations as you extend the period of fixed rates out just one more quarter].

So, to recap, I was expecting John Cochrane to say that it was way too early to start legislating on the basis of a literature that used dodgy logic to select equilibria, and threw up so many paradoxes at the zero bound.  [And I would have agreed with him].

Bailey and Carney punch the Bank for International Settlements below the belt

Mark Carney (Governor of the BoE) and Andrew Bailey (Head of the Prudential Regulatory Authority within the BoE) were sharply critical of recent warnings by the BIS that central banks were fueling another crisis by keeping rates too low.   Carney said:  “It’s a report that’s made in a vacuum though, the vacuum of Basel, a world where a central bank doesn’t have a mandate… a world where a central bank is not accountable to Parliament and through Parliament to the people, to achieve specific targets.”  Bailey:   “It’s an interesting commentary from an institution that doesn’t have policy obligations.”

As I wrote in earlier posts, I agree with the substance of these Bank of England remarks, that tightening policy now would be ill-advised.  But, two concerns.

First, these remarks come close to reading like this:  ‘the BIS see clearly what would be in society’s best interests in the long run, but unfortunately we have these local political masters who have set us inflation targets that we need to hit, and doing that means we can’t do what’s right.  What a pity we can’t do the right thing.’

Second, there is an element of this:  ‘you shouldn’t take seriously their views, because their minds are not concentrated by the reality of having a real job to do.’

I doubt anyone at the BoE holds the first view, but it’s a dangerous one to allow to be read into your utterances.

The second I think was intentional and misjudged.  It could be read as an attempt to devalue all independent commentary.  Not a policymaker?  No right to comment, since you are other-wordly.  Presumably academics, journalists, employees of the IMF would fall into the same bracket.   In fact, who would be qualified, outside the BoE itself?   An organisation like the BoE, with so many important powers, and with such imperfect systems holding to account, is in a delicate situation.  It must be seen to welcome scrutiny and challenge, however daft.  The more defensive and undermining it is of its critics, the more likely it runs the risk of corroding the political consensus around its independence.

Besides, the BoE is part owner of the BIS.  Collectively, central banks [ultimately through their governments] have agreed to tolerate a role for the BIS as an independent commentator on central bank policies.  There are good reasons to do it.  One might hope that if there were market failures in monetary or financial economic research, the BIS could act as a focal point for thinking and funding.  The BIS’s independent commentary could potentially be a force for good in orchestrating better global coordination for monetary policy, and averting self-defeating competition between countries over financial regulation.  This independent commentary, even if sometimes unsound or unwelcome, may, in the long term, bolster the independence of member institutions.  Local political regimes may be just a tiny bit less tempted to interfere if there appears to be an expert functioning community, of which the BIS is a part, evaluating what their central banks are doing.

If Carney and Bailey don’t want independent commentary, they should work behind the scenes to get an agreed change to the BIS’ mandate with other owners.  If that’s not an option, they should simply combat arguments they don’t like with economics, and not resort to near-smear-tactics.

 

 

 

Why Civil Service Department Heads should have one eye on future governments

A document listing the desired attributes of a future leader of a Ministerial Department has caused a storm in the UK.  One of its recommendations is that a candidate be able to “balance ministers’ or high-level stakeholders’ immediate needs or priorities with the long-term aims of their department, being shrewd about what needs to be sacrificed, at what costs and what the implications might be”.

Some Tory politicians, sensitive to their current lack of legislative progress in this department, and looking for scapegoats, have complained that the civil service is acting unconstitutionally in choosing its leaders for their capacity to face down their incumbent ministers.

Well, here is an amateur argument for why that characteristic IS constitutional.  The constitutional feature we all learn about at high school in the UK is that no single Parliament should be able to bind future Parliaments.  This principle is obviously routinely flouted.  Since every penny of spending committed today deprives a future Parliament of the same discretion.  Every piece of land built on cannot be restored to its prior state…. And so on.  But here lies the salvation of that controversial document.  Department heads – known in the UK as ‘permanent secretaries’ [a misnomer, since they are not permanent, though usually longer-lasting than their political bosses] – faced with demands for splurges in spending, or drastic changes in current capacity that might constrain future capacity, might reasonably object on the grounds that future Parliaments cannot be unduly bound.

The tradition that future Parliaments be not unduly bound is question-begging, of course.  Why should that be a good feature of a democracy?  The soundest reason I can see is that as yet unborn or not independent generations want to have the same say in their own affairs as we had in ours.

If you haven’t already clicked through to the offending document, it’s worth doing so just to absorb the tone of the final section headed ‘The X-Factor’, which, I forecast, will provide much enjoyment and study for those immersed in the sociology of the cult of ‘leadership’ in the modern age.

Postscript:  it occurs to me that there is a contrast between HMTs view of the function of a perm sec and that of Francis Maude.  HMT asked Nick Macpherson to step outside his role as immediate facilitator of Coalition policies and offer independent advice.  Maude objects to criteria for selecting perm secs on the basis that they can formulate benevolent but independent views about what should be done.  Our hypothetical Maude might comment that NM only intervenes when instructed to do so, so NM’s contribution isn’t an act of constitutional subordination or independence.  However, if that were the case, then the SNPs charge that NMs views can’t really be taken seriously, since they would not have been aired if they had not agreed with the Government’s, would be valid.

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.