Friday, June 8, 2012

Murphy, Kuehn, and DeLong on Scott Sumner and the contingency of market monetarism on expectations

Although I just got up, I want to start with a line from Bob Murphy that I am nevertheless confident will still deserve the title "quote of the day" when I retire tonight: "I imagine when Scott eats at a Chinese place and opens the fortune cookie, he always exclaims, “Just as I’ve been saying for 3 years on my blog!”"

In all seriousness, Scott Sumner is a great blogger with great ideas, but some of us still have questions -first about his questionable critique of Keynesians, and then also about his policy positions.

Which brings me to a comment of mine on a DeLong posted that was then "hoisted" by him into the blog proper. I do think it needs a little clarification on my part.

Refering to this post by Brad, I write:


We have the confidence fairy. We need to start talking more about the "expectations fairy" in reference to market monetarists like Scott Sumner. Of course in the best of all possible worlds the expectations channel works great and we can talk about monetary policy with confidence even with a non-existent interest rate channel. But we don't live in that world and we can advocate monetary policy while still having reservations about its effectiveness. Sumner seems to interpret that as opposition. So let's talk more about the "expectations fairy".

Another way to say it is this: Krugman noted that what the central bank needs is to make a credible commitment to being irresponsible. There are legitimate questions about whether it is capable of credibly committing to being irresponsible.

Nobody questions whether Congress is capable of credibly committing to being irresponsible. It's practically a prerequisite for the job."

Some of the comments on that said we just need to redefine "responsible" and "irresponsible". Meh - they're making too much of a nice turn of phrase by Krugman. Everyone knows Krugman thinks that not being "irresponsible" is really what's irresponsible. It's a dig at the "Very Serious People". OK, I think all that's clear to most of us.

I think it's more important to clarify exactly what I mean by Congress being capable of being irresponsible in the way we require. Clearly they're not doing the right thing according to us either. So they're being irresponsibly "responsible" right now, when they ought to be responsibly "irresponsible".

The point is (and the point that DeLong made in the original post), is that Congress does not make exit plans the way the Fed does. With the Fed you always wonder about policy permanence, and when we're concerned about expectations (which, let me be clear - both the market monetarists and the Keynesians agree we are talking about when it comes to monetary policy right now), perceptions of policy permanence are critical. The Fed has spent decades building up a particular sort of credibility suggesting that exceptional monetary policy right now would not be permanent. And what you need to remember is that you should read that last sentence as "the Fed has spent decades building up a particular sort of credibility suggesting that exceptional policy right now would not be effective". Get that? When it comes to monetary policy, effectiveness is contingent on perceptions of permanence.

Back to Congress. Congress doesn't make exit plans, the closest thing to immortality is a government program, etc. etc. That's all part of it. Congress has not cultivated the same expectations as the Fed - and they haven't for quite good Jeffersonian reasons. Although Congress isn't always pretty, we don't want it to be a bunch of old white men sitting around a table in a board room in a marble building dictating things independently. That's central bank stuff. We want our legislature to be contentions, responsive, ridiculous, and democratic (but I repeat myself). There are costs to that, of course. But the cost of anything else would be much greater.

So they haven't cultivated the same expectations.

But you also have to think about what an "exit strategy" for fiscal expansion would have to consist of. It's trivial for the FOMC to tighten back up. But for Congress to tighten back up you would need to run large surpluses to eliminate any deficits you've created (not the case for the Fed - they just need to do another open marker operation). You'd have to cancel or cut back on projects to reel back in any demand you've added to the system (not the case for the Fed - again they just have to step into the bond market). Congress is not likely to do any of these things when conditions start to improve. They certainly aren't going to cancel things when revenue is coming in and times are good. As Clinton demonstrated, they may run surpluses in good times but it's not going to be enormous and it's probably going to be more a consequence of economic growth than any real reduction in public demand. You'll probably get a slowing of public sector growth (that's probably a good thing) so that in the long term the public/private balance stays reasonable. But overall fiscal policy has an expectation of permanence to it that the monetary authority has trouble getting. When the Fed makes open market purchases, it can just as easily make open market sales tomorrow, and everyone knows this. When the Congress runs a deficit, the money is out the door and they don't pull it back in.

Expectations of permanence is effectiveness.

We Keynesians like monetary policy. It's a very good idea. It's not perfect or a sure thing, though - maybe in the future when the Fed can generate a new set of expectations, but not now. So go ahead and do it, but there's a very strong case for fiscal policy as well.

1 comment:

  1. Did you know that it is possible to order fortune cookies with custom fortunes? I think Scott Sumner is going to get some fortune cookies.


All anonymous comments will be deleted. Consistent pseudonyms are fine.