Alexander Douglas — Apologising to Simon Wren-Lewis and Nick Rowe

This is probably going to be my last post on the philosophy of economics. Some recent events have led me to reassess my priorities.

I’m not abandoning politics or economics. I would just rather use this blog to write about the history of logic, and philosophy more generally. That fits my title better anyway. I’ve also come to the unwelcome conclusion that I’m quite bad at economics, whereas my career trajectory at least suggests that I’m not a terrible historian of philosophy.

What I’d like to do here is concede how much I now think I was wrong about and how much Simon Wren-Lewis was right about. A lot of this also applies to Nick Rowe, who has also been kind enough to engage with me over the last year or so.

First, I think that Wren-Lewis was probably largely right about MMT. His complaints were directed against the hard core of MMT supporters online, not the actual developers of the theory. He had two complaints:

MMT seems obsessed with the accounting detail of government transactionsThis seemed to lead to ideas that I thought were standard bits of macroeconomics

Now I think both complaints are quite fair, again if applied to the MMT fan base onlinerather than to Mosler, Kelton, Wray, Mitchell, Tcherneva, and the rest of the proper MMT theorists. In the blogosphere, I would add that they don’t apply to people like Eric Tymoigne, Brian Romanchuk, and Neil Wilson.…

Origin of Specious
Apologising to Simon Wren-Lewis and Nick Rowe
Alexander Douglas | Lecturer in Philosophy at Heythrop College, London

Alexander Douglas — More on MMT and the mainstream

Alex gets some notice and responds.

Origin of Specious
More on MMT and the mainstream
Alexander Douglas | Lecturer in Philosophy at Heythrop College, London

Simon Wren-Lewis and Nick Rowe on MMT

Finally, we are getting some good discussion going. I hope everyone on all sides will take a deep breath and focus on outcomes rather than "winning."

Simon Wren-Lewis has taken the time to put up a long post on his POV.

Mainly Macro
MMT and mainstream macro
Simon Wren-Lewis | Professor of Economics, Oxford University

SWL cites Nick Rowe, who one of the early birds in engaging with MMT. Nick has blog up in response to a recent Alex Douglas post. Alex responds in the comments there.

Worthwhile Canadian Initiative
Chartalism and stock-flow consistency
Nick Rowe | Professor of Economics at Carleton University in Ottawa, Canada, and a member of the CD Howe Institute's Monetary Policy Council and the Centre for Monetary and Financial Economics

David Glasner — There Is No Intertemporal Budget Constraint

Somewhat wonkish, but if you have been following the debate that Nick Rowe started, you may find it interesting.

Uneasy Money

There Is No Intertemporal Budget Constraint

David Glasner | Economist at the Federal Trade Commission

Ramanan — Nick ROKE, Thrift, And Hoarding

On the difference between saving and hoarding.

The Case for Concerted Action
Nick ROKE, Thrift, And Hoarding
V. Ramanan

Simon Wren-Lewis — Austerity: Nick Rowe's not so silly question

Ralph Musgrave alerts us to the Simon Wren-Lewis moving in the direction of agreeing with MMT on using fiscal policy to address economic contraction at the zero bound where monetary policy is unable to turn the economy around. While MMT disagrees about the relevance of fiscal versus monetary policy in general rather than only in special cases like the zero bound, the ball is moving down the field.

Be sure to read the comments, too. Good stuff there, too.

The basic principle is from Keynes, as MMT points out and Ralph reminds there: "Take care of unemployment and the budget will take care of itself." 

Simon Wren-Lewis is a budget balancer over the cycle and believes that while fiscal policy should be used in troughs, the deficit be addressed later through appropriate policy to reduce it.

According to MMT, if fiscal policy is used in the first place, then the troughs are shallower and the subsequent recovery reduces the deficit automatically by increasing tax receipts and reducing the automatic stabilization that the previous contraction had engaged.

Mainly Macro
Austerity: Nick Rowe's not so silly question
Simon Wren-Lewis | Professor of Economics, Oxford University

Brian Romanchuk — Monetary Impotence And The Triumph Of The Fiscal Theory Of The Price Level

There has been an ongoing debate about how monetary policy interacts with the zero bound on interest rates. Paul Krugman has recently posted an article,"The Simple Analytics of Monetary Impotence (Wonkish)", in which he gives a simplified Dynamic Stochastic General Equilibrium (DSGE) model which he says demonstrates something about monetary policy when at the zero bound. When I look at the model, it appears that there are internal contradictions to his suggested solution. Instead, it appears that the model solution is determined by the Fiscal Theory of the Price Level (FTPL). When it comes to DSGE models, it appears that all roads lead to the FTPL….

Bond Economics
Monetary Impotence And The Triumph Of The Fiscal Theory Of The Price Level [wonkish]
Brian Romanchuk

See also, JKH, John Cochrane’s “Monetary Policy with Interest on Reserves”, at Monetary Realism

Brian Romanchuk — Should A Central Bank Care About Loanable Funds?

New Keynesian loanable funds and DSGE modeling following up on Lars Syll and Nick Rowe.

Bond Economics
Should A Central Bank Care About Loanable Funds?
Brian Romanchuk

Lars P. Syll — The loanable funds fallacy

Keynes and Minksy answer Krugman and Mankiw.

Lars P. Syll’s Blog
The loanable funds fallacy
Lars P. Syll | Professor, Malmo University

Winterspeak on bond vigilantes and NGDP targeting

The quote is from Nick Rowe. Winterspeak responds from the POV of monetary economics versus monetarism.

Hint: It's the transmission mechanism, as MMT proponents have been saying from the time that NGDP targeting was surfaced, not mention seeing bond vigilantes' faces in the clouds.

Winterspeak.com
"Japan looks even more unstable than the US"
Winterspeak

Michael Sankowski — The Distributional Consequences of Monetary Policy

Mike responds to a recent Nick Rowe post. Nice quote from Wynne Godley, too.

Read it at Modern Monetary Realism
The Distributional Consequences of Monetary Policy

by Michael Sankowski

What I would add to it is that cb's running a NAIRU-based monetary policy raise rates to quell inflation, which typically happens as they see wage pressure developing in addition to rising CPI. This provokes an economic contraction that increases the buffer of unemployed and reduces labor bargaining power, decreasing wage pressure.

Then to stimulate the economy when sufficient consolidation has taken place, the cb lowers rates to spur borrowing and spur a new cycle of investment and consumption.

However, as Mike notes the lowering of interest rates translates first into rising asset prices with the distributional effects he notes. The as consumer borrowing increases, price pressures increase, which then results in wage pressure in reaction. Then, the cycle is repeated.

So the outcome is higher asset prices at the beginning of the cycle, then increasing consumer indebtedness, and then falling real wages resulting in increasing worker demands for increased wages to keep up with inflation.

So, yes, monetary policy does have distributional effects. There are winners and losers. See if you can identify them.

Nick Rowe — From gold standard to CPI standard

I had always thought "Oh yeah, dropping gold changed everything". But other than making the basket much more representative and sensible, which matters massively in practical terms, did it really change things theoretically?

Read it at Worthwhile Canadian Initiative
From gold standard to CPI standard
by Nick Rowe

Edward Harrison ratchets it up a notch

Drilling down to the basic issues.

Read it at Naked Capitalism
Money, the financial system and the Federal Reserve

by Edward Harrison

John Carney — Paul Krugman vs. MMT

Brief summary of the state of the debate between Krugman-Rowe and Keen-Fullwiler, so far. No one seems to think that is just going to fade away.

Read it at CNBC NetNet
Paul Krugman vs. MMT: The Great Debate
by John Carney | Senior Editor

Scott Fullwiler on central bank policy, strategy and tactics

Scott posted this comment in clarification at Credit Writedowns.

Scott Fullwiler
3 April 2012 at 17:07

this is a good post, Ed, but this debate is muddled by a lack of definition of terms. More specifically, in the policy sciences there is a distinction made between policy, strategy, and tactics. Similar distinctions are found in business/management literature. Applying this to central banking, it goes a bit like this:

Tactics–can the central bank directly target reserve balances, monetary base, etc. 

Strategy–what sort of rules/discretion balance does the central bank follow in adjusting the target it has set tactically. How often? How big of an adjustment each time? 

By what criteria?

Policy–How does the macroeconomy work and what role can or should the central bank play in stabilizing it?

The debate between Krugman/Keen once it got to issues related to the money multiplier and loanable funds was about tactics–can banks individually or collectively create loans without regard to deposits or reserve balances? This is closely linked to an understanding of what banks are/do and hence Krugman’s view that they didn’t need to be included since inserting them didn’t change how one should view the money multiplier or loanable funds models. This is where I jumped in, because Krugman in my view was completely wrong on these points.

But Krugman’s reply to me, and Rowe’s post, brought in strategy and policy–”the central bank must change the interest rate target by adjusting to events and expectations” which is about how the central bank should adjust its target (strategy) within the context of how the macroeconomy works and interacts with monetary policy (policy). This is a complete tangent and obfuscation of the point that was being discussed. It is not unimportant–to the contrary, obviously—but to throw it in at this point was not helpful.

The MMT view is that we need to understand how the tactics work to inform our strategy and even our understanding of how the economy works. Krugman tried to suggest understanding the tactics is irrelevant to these two. This is a very significant distinction between the approaches.

Further, in MMT, we keep these three (tactics, strategy, policy) separate when we discuss them. Neoclassicals generally don’t–so, when I say the central bank must set an interest rate target (tactics) but can move that target wherever it wants (the possibilities for strategy), Nick says no the cb must set a target that responds to the economy and thus must be endogenous (strategy in the context of view of macroeconomy). We end up talking past each other as I have not invoked yet at all how central banks “should” set strategy with regard to how the macroeconomy works. While we will disagree on the latter, in our view jumping to that without clarifying and setting a common language for tactics and strategy complicates the discussion unnecessarily.

 Note finally that the “short” vs. “medium” horizon distinction Nick makes isn’t at all the same as the tactics vs. strategy distinction. The central bank can change the interest rate target every day or even every minute (possiblities for strategy) but must still defend that target every day, every hour, and every minute (tactics).

Hope that makes some sense. And hopefully none of this is seen as a personal attack on Nick–I agree with you that Nick is one of the most stand-up guys in the blog world and one whose criticisms of my own views are to be taken seriously.

Best,

Scott

Mark Thoma gets drawn in

Read it at Economist's View
Classes of Macro Models: What Counts as a DSGE Model?

by Mark Thoma

Edward Harrison — Endogenous or exogenous money?

I think the real difference between what Nick Rowe is saying and what people like Scott Fullwiler and Steve Keen are saying is that Nick believes over the medium-term, central bank interest rate policy is endogenous. What I think Nick means is that Scott Fullwiler’s view is reasonably clear and straightforward in his view that central monetary policy is exogenous but that it only matters over a short-term time horizon because central bank interest rate policy adjusts endogenously over the medium-term to commercial bank and other economic variables such that it is really endogenous rather than exogenous. 

Further, I think Nick Rowe is saying that it creates an expectation of central bank interest rate policy merely by announcing its target rate and the market moves to accommodate that target, knowing the central bank is the monopoly supplier of reserves. In that sense the central bank has control. But what he seems to suggest is that the central bank policy rate cannot be determined independent of macroeconomic variables (like inflation specifically) and that central bank may be forced to change policy based on these, making it possible to treat the central bank policy rate as medium-term endogenous.

Read it at Credit Writedowns
Endogenous or exogenous money?

By Edward Harrison

I think that Ed has this essentially right, and I said something similar to that effect yesterday. It is clear that the Fed sets the FFR and discount rates exogenously, but obviously, it doesn't do this arbitrarily, as Fed minutes show. Economics conditions figure into Fed decision-making and to that extent the process is "endogenous." I don't see this as a controversial point. It's essentially about semantics. 

When PKE and MMT economists say that money creation is endogenous and the Fed setting of the interest rate is exogenous, they mean that credit extension is determined in the market place through demand, while the Fed operates independently in setting rates. In the US, the overnight rate is not set in the overnight market by banks competing for available reserves. When the Fed does not manage the rate by paying IOR, it carefully manages quantity to target price using OMO, the issuance of tsys having already served as the major drain of excess reserves.

Is this all the kerfuffle is about? I don't think so.

Paul Krugman takes the position that the cb can use either price (interest rate) or the quantity (base money) as policy tools. PKE and MMT economists object that under the existing monetary and financial arrangements, this is merely theoretical and would be impractical to implement as a tactic. Policy tools need to be consistent with operational realities, not just modeling. Interest rate setting is what the Fed has actually been relying as a policy tool for some time, once this was discovered.

PKE and MMT economists would say further that the model-based approach of orthodoxy is misleading about causation, whereas the operations-based approach shows causation clearly. Once this is understood, orthodoxy is often discovered to have the causation reversed. 

For example, the "money multiplier" based on required reserves and "lending reserves" is seen as an accounting residual rather than as a cause, since operationally banks don't extend credit by lending either reserves or deposits — loans create deposits and obtaining reserves to settle and to meet the RR are a cost rather than a constraint. The spread between what a bank charges to make a loan and what the cost of the loans will be to the bank is determined by several factors including the cost of obtaining reserves.

So far a lot of what has gone down is people talking past each other. It was probably necessary to lay down the groundwork first, however. Hopefully, this discussion will now move forward to zero in on key issues.

One area that needs exploration is the interest rate. Monetarists make certain assumptions about the interest rate and inflation that PKE and and MMT economists challenge. Warren Mosler has observed, for example, that higher interest payments are actually economically stimulative, and that lower interest have the opposite effect. Therefore, he recommends setting the overnight rate to zero and using fiscal policy based on the sectoral balance approach and functional finance to address price stability.

Travis Fast — Hubris leads to incompetence: the Rowe & Krugman edition

This is one of those very unfortunate situations where good people make bad decisions, probably in haste. It's an occupational hazard in blogging, often to be overlooked, but one should admit it when one has jumped the shark, as Krugman clearly did. He obviously trusted ordinarily competent Nick Rowe to have it right. But there is always a risk in not consulting the source, and Professor Krugman fell victim to this freshman error.

Read it at
Relentlessly Progressive Political Economy
Hubris leads to incompetence: the Rowe & Krugman edition

by Travis Fast

(h/t Travis for providing the link in the comments)

Nick Rowe — "Monetary policy is just one damn interest rate after another"

Nick apparently conflates monetary policy with monetary operations. No one doubts or denies that the cb sets its target rate and changes it as deemed appropriate with a view to monetary policy, and in the US, the Fed's mandate is to maintain production consistent with full employment and price stability. So the Fed does have explicit economic criteria for setting monetary policy. 

If this is what one means in holding that monetary policy is "endogenous," OK. But that is using "endogenous" in a different sense than Post Keynesians use it. Post Keynesians hold that the interest rate is exogenous in that it is set by the central bank as monopoly supplier of reserves rather than as a market rate. Of course, change in the economy influence changes in the rate. But what adjustment in the rate actually do and how they do it is non-trivial, and there is apparently considerable disagreement over this.

Regardless of the monetary policy it chooses to implement, the cb uses monetary operations as tools. These are the means of implementing monetary policy to achieve policy goals. The principal tool is price — the overnight interest rate. The cb sets price and lets quantity float within the band that achieves this price while settling all accounts seamlessly. That is how a monopolist acts, and the cb holds a monopoly over reserves and access to them since it owns and controls the spreadsheet only which they alone reside.

The cb conducts monetary policy by setting the target rate exogenously, although obviously not arbitrarily. No one ever claimed that. The target rate changes with economic conditions, and many factors may be involved in establishing such conditions. Central banks maintain elaborate forecasting models for this purpose.

The cb uses monetary operations to implement monetary policy. Chief among these operations is setting the overnight rate and managing reserve quantity to hit its target through OMO. That is to say, if the cb permits reserve quantity to expand without limit, then the overnight rate will go to zero. So the cb has to limit quantity available in order to hit the target, since insufficient reserves will drive up the rate and excess reserves will drive it down. 

Issuance of government securities is also an interest rate management operation in that this alters the composition and term of government liabilities, draining excess reserves to reduce the need for OMO intervention.

If it chose, the cb could simply pay IOR at the target and then excess reserves would become irrelevant. Or government could eschew monetary policy in favor of fiscal policy and set the overnight rate to zero.

Read it at Worthwhile Canadian Initiative
"Monetary policy is just one damn interest rate after another"
by Nick Rowe

There are always interesting comments at Nick's place and he is good at responding to them.

Stephen Gordon: What A Balance Sheet Recession Looks Like

Stephen Gordon at Worthwhile Canadian Initiative has some charts up illustrating the balance sheet recession.

This is what a balance-sheet recession looks like, and it's not pretty

Nick concludes with:

"The US data go back to 1952, so I was able to check the last time the real, per capita value of US housing equity was at its current level. Even after looking at all of these graphs, the answer astonished me: 1978. Nineteen seventy-freaking-eight."

And it isn't over yet.