David Beckworth on recent The Economist article

David Beckworth responds to MMT criticism of the NGDP-targetting policy proposal he embraces based on lack of a transmission mechanism from reserves to bank deposit through bank loans. He claims that there is a different transmission mechanism operative — nominal expectations.

The real critique, then, is whether a change in  nominal expectations can really affect current spending decisions by firms and households.  I have an earlier post that shows inflation and nominal GDP expectations (as proxied by a survey of forecasters) do in fact influence spending decisions.  Josh Hendrickson and I also show in this recent working paper that shocks to inflation expectations cause households to adjust their portfolios in the manner outlined above.  Finally, as shown by Gautti Eggertson, a sudden change in nominal expectations was also key to FDR's 1933-1936 recovery.  If the MMTers (and Austrians) could come to accept this evidence, then we could truly have a deficient aggregate demand lovefest.  

Read it at Macro and Other Market Musings
The Market Monetarist, MMT, and the Austrian Lovefest
by David Beckworth

My comment at Beckworth's place:

Yes, I know neoliberals assert that the transmission mechanism is expectations and confidence, which they presume the central bank can use to manage economic behavior in aggregate. However, this is not an economic explanation that is empirically testable, but rather a pseudo-psychological one that has no basis in either psychological or sociological findings. It is a superstition that Paul Krugman has rightly lampooned as analogous to the tooth fairy.

Why would someone rationally expect something when there is no actual way to accomplish it in sight? It is like trying to rob someone with a toy pistol, hoping the victim doesn't notice it is just a toy. The Fed has been trying to stoke inflation through ZIRP and QE without success. Now people in aggregate are going to expect that inflation will rise because the Fed says to expect so? Please explain to me why anyone should expect that in light of what the Fed cannot do through monetary policy, which is its purview.

Expectations could perhaps work if the Fed were to threaten to do something it hasn't done, and the only actual policy gun the Fed has is the interest rate. That is already taking out the floor.

Afterthought: See Bill Mitchell's I am looking for the tooth fairy too

for an MMT critique of the fairy superstition in another context. See also Bill's Inflation targeting spells bad fiscal policy.

UPDATE: The debate continues at Macro and Other Market Musings. I can't find now to link to specific comments there so I am including them for the record here.


 David Beckworth said...
Tom Hickey:

"However, this is not an economic explanation that is empirically testable, 

I am sorry you haven't taken the time to actually read the literature and are thus making this misinformed claim. Again, take a look at Gautti Eggertson paper I linked to above and the reference found therein. Or at my working paper with Josh Hendrickson. There is plenty of evidence and expectations is a core part of modern macro for good reason. I was hoping for a more meaningful exchange with MMTers.

"...

Paul Krugman has rightly lampooned as analogous to the tooth fairy. 

Here too you apparently haven't read the material closely.

Krugman is actually one of the strongest advocates for the the Fed committing to shaping the future path of nominal expectations. He has a famous paper in 1998 where he shows the way out of a liquidity trap is for a central bank to promise higher inflation going forward. He has blogged about this many times too. 



The confidence fairy that he torn apart has to do with the view that austerity will create more confidence. This is a different topic altogether.
January 1, 2012 8:12 AM

 Tom Hickey said...

David, correlation is not causation. What is the transmission mechanism from expectations (psychological) to behavior (real)? 

REH involves assumptions that are questionable in the light of findings in other social sciences.



OK. I was exaggerating on Krugman and the confidence fairy, but I think there is a close connection. And I think PK is as wrong was other monetarists are about inflationary expectations being a sound basis for monetary policy. I just don't but it as an actual transmission mechanism.



Look at the folks at Zero Hedge going long all sort of inflation hedges due to a misunderstand of what QE would do. Sure, they fell into the expectations trap, and many got burned. Bill Gross got his butt handed to him on tsy shorts, just as the MMT-based traders had predicted. (BTW, Mosler's bank had a three year average of 67.77% ROE.) But the neither firms nor consumers in aggregate caught the expectations bug, and the Fed is still fighting "deflationary expectations."

Now that the Fed has shot off all its big policy guns and used up its ammo, people are going to get inflationary expectations from what exactly?



The point that the MMT'ers make is that the way out through fiscal policy is clear, should politicians actually understand the potential of fiscal policy based on sectoral balances and functional finance, and compromise enough for the good of the country to use it.



This kerfuffle is essentially between monetarists and fiscalists, and I don't see any making nice as a way to fix it. MMT'ers claim that we need to debate the merits based on a correct understanding of monetary economics wrt the existing monetary system in general and the specifics of different countries. But you know that already from what commentators here have said previously and in interaction with Scott Sumner. 

Your guys criticize the MMT'er's for not being open to your pet ideas, but you seem resistant to looking at anything the MMT'ers say about monetary operations that calls your position into question.

MMT shows clear and actual transmission mechanisms that don't have to be "proved" though dubious correlation studies that don't show directly how psychological states translate into aggregate behavior. I think that it is a weak argument in the face of argument that show how transmissions occur directly in terms of actual and therefore observable monetary and fiscal operations. In my view it is magical v. scientific thinking, regardless of the sophistication of the models. Let's look at operations.

January 1, 2012 4:13 PM

Noah Smith — Harrison & Kreps 1978: The power of irrational expectations

So what does that say about macro? Since the late 70s, nearly all of the models used by macroeconomists have been "rational expectations" models. "Rational expectations" is the idea that people don't make systematic mistakes when predicting the future. If you think that sounds a bit silly, you're not alone, but I kid you not when I say that rational expectations absolutely dominates modern macro.

But if expectations aren't rational in financial markets, why should they be rational in the economy as a whole? The answer is that they shouldn't. This is why Thomas Sargent, who won the Nobel Prize this year and who helped develop the theory of rational expectations, calls himself a "Harrison-Kreps Keynesian." Keynes, though he is usually associated with the idea of fiscal stimulus, was a professional stock speculator, and perceived clearly the irrationality of the markets in which he participated; Sargent is merely recognizing that financial market irrationality, which was formalized by Harrison and Kreps, is a huge hint that rational expectations is not going to get the job done in macro either. 

Read the whole post at Noahpinion

Harrison & Kreps 1978: The power of irrational expectations

by Noah Smith

(h/t Keven Fathi via email)

Some good comments too.

Smith points out that Keynes was a trader. Unlike many academic economists he was familiar with how financial markets actually operate based on trader psychology. He understood "uncertainty" based on personal experience with skin in the game. He also was aware of the many factors that affect traders in addition to those studied by academics when they consider markets. This shaped his views on macro that make the Keynesian approach to macro different from the approach based on rational expectations modeling.

I would suggest to traders and those interested in the cognitive-affective aspects of trading, along with the biases involves, that they take a look at Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Biases by Michael M. Pompian ((Wiley Finance, 2006).