Scott Sumner Faces Off With Joe Stiglitz

    It's not surprising Sumner went after Stiglitz's recent essay as it wholly cuts his own monetary and fiscal worldview to the quick. Let's get to some of the juice of what Stiglitz said:

    "Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy. Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the origins of the Depression. The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply—in other words, had done what the Fed has done today—a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s."

      See Stiglitz's paper http://www.vanityfair.com/politics/2012/01/stiglitz-depression-201201#

      See Sumner           http://www.themoneyillusion.com/

       For Stilgitz to say that, "Forget monetary policy. Re-examining the cause of the Great Depression—the revolution in agriculture that threw millions out of work—the author argues that the U.S. is now facing and must manage a similar shift in the “real” economy, from industry to service, or risk a tragic replay of 80 years ago."

      Simply the sentence forget monetary policy is fighting words. Because monetarist that Sumner is Stiglitz is cutting him wholly to the quick. For Sumner as any monetarist-market or otherwise-the sun rises and sets on monetary policy. According to him fiscal policy is always a bad idea as a loose fiscal policy will inevitably be followed by a tightening of monetary policy and so it cancels itself out. More Sumner adds that fiscal policy worsens our budgetary situation-this concern about deficits I see as a canard but this is Sumner's view-stimulus by the Fed is inherently superior to same thing out of the Treasury as the latter puts us at risk of "rising borrowing costs." What I can never get out of guys like Sumner is why are our current borrowing costs so low? Truth is the U.S. Treasuries are the safest investment in the world according to the market.

     However we won't digress on this point too much yet. Again, to say 'forget monetary policy' is fighting words for Sumner. After all right now he has been the popularizer of a monetary method that sounds to many Keynesians as well-Krugman, Delong, Ygelesias-as promising. Some MMTers have also said it sounds promising though others feel that it isn't so much. If I understand it-I've been trying-MMT seems to imply that many things that the Treasury currently does, the Fed should actually do. Again I could digress on this intriguing topic.

    Let's stick to the Battle Royale of Sumner-Stiglitz. Listen to Stilgitz twist the knife on Sumner:

   "Monetary policy is not going to help us out of this mess. Ben Bernanke has, belatedly, admitted as much. The Fed played an important role in creating the current conditions—by encouraging the bubble that led to unsustainable consumption—but there is now little it can do to mitigate the consequences. I can understand that its members may feel some degree of guilt. But anyone who believes that monetary policy is going to resuscitate the economy will be sorely disappointed. That idea is a distraction, and a dangerous one."

    If monetary policy is a dangerous distraction this wholly discounts Sumner's project-it's a distraction and a dangerous one, while Stiglitz isn't speaking personally about Sumner he has been at the forefront of the current debates that suggest that monetary policy will indeed resuscitate the current economy.. An important place to start is what Stiglitz says caused the current Lesser Depression. He argues-this far most monetarists starting with Bernanke himself wouldn't deny-that the previous historical event to compare the current crisis to is the Great Depression.

   However what caused the Great Depression and the current Lesser Depression. Stiglitz-basing this on work he has done with Bruce Greenwald-goes to a wholly different place than Sumner-Bernanke-Friedman or any monetarist interpretation. Indeed he doesn't see the banking crisis of the early 30s as the "Efficient Cause" at all:

     "Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy."

    No, Stiglitz's narrative of the cause of the Depression is decidedly different. The trouble was not-nor is now-a failure of monetary policy but a fundamental change in the real economy: 

    "For the past several years, Bruce Greenwald and I have been engaged in research on an alternative theory of the Depression—and an alternative analysis of what is ailing the economy today. This explanation sees the financial crisis of the 1930s as a consequence not so much of a financial implosion but of the economy’s underlying weakness. The breakdown of the banking system didn’t culminate until 1933, long after the Depression began and long after unemployment had started to soar. By 1931 unemployment was already around 16 percent, and it reached 23 percent in 1932. Shantytown “Hoovervilles” were springing up everywhere. The underlying cause was a structural change in the real economy: the widespread decline in agricultural prices and incomes, caused by what is ordinarily a “good thing”—greater productivity."

   Actually Stiglitz places this underlying weakness of the economy as paradoxically enough, a long term rise in productivity in the agricultural sector.

   "At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.'

   Sumner quotes this paragraph then answers this way: "Interesting, but this has been going on for 120 years.  So why was the economy booming in 1929, and flat on its back in 1932?  And why doesn’t Stiglitz discuss what happened to the incomes for the other 80%, the people not in farming?  It turns out that their incomes also fell “between one-third and two-thirds,” indeed nearly 50% by the fourth quarter of 1932.   So nothing particularly interesting was going on in farming, and yet this somehow explains the far greater collapse in output in manufacturing, mining, and construction.  There may be a model there, but I don’t see it."

   Well Sumner may not see it, but the question is he trying to? If he would have read further he would have learnt that Stglitz does have an idea as to what happened to the remaining 80%:

   "What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes."

   "The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy."

    Stiglitz's point is that 20% of Americans had been in the farm sector-with their precipitous drop in income this put a major strain on effective demand across the country- "The cities weren't spared far from it." As manufacturers saw demand drop they had to lay off workers too. As to Sumner trying to shrug this analysis away by saying it had been going on for 120 years, while certainly many things had been happening "for 120 years" the fact remains that as Stiglitz shows in 1900 there was still a large portion of Americans in argiculture.

    The comparison to today is clear. We have seen a similar move from manufacturing to service. According to Stiglitz there are 4 major service sector industries:

    "Of four major service sectors—finance, real estate, health, and education—the first two were bloated before the current crisis set in. The other two, health and education, have traditionally received heavy government support. But government austerity at every level—that is, the slashing of budgets in the face of recession—has hit education especially hard, just as it has decimated the government sector as a whole. Nearly 700,000 state- and local-government jobs have disappeared during the past four years, mirroring what happened in the Depression. As in 1937, deficit hawks today call for balanced budgets and more and more cutbacks. Instead of pushing forward a structural transition that is inevitable—instead of investing in the right kinds of human capital, technology, and infrastructure, which will eventually pull us where we need to be—the government is holding back. Current strategies can have only one outcome: they will ensure that the Long Slump will be longer and deeper than it ever needed to be."

     For Stilgitz we never did have enough fiscal stimulus during the Depression certainly not after 1937 when FDR got seduced by the budget hawks. WWII finally generated the spending we needed though he is careful to say that military spending is not the preferred route. While no one should disagree with that he does acknowledge that only war may be enough to get us to follow through with the level of fiscal commitment he believes is necessary.

     The greatest fiscal investments in U.S. history were always a result of war-the Civil War, WWI, WWII, to a lesser extent Korea in the 50s and Vietnam in the 60s. Of course the kind of wars we get involved in today-Iraq, Afghanistan, Libya-don't require the total mobilization of these previous wars.

      I by no means necessarily agree with Stiglitz on everything here but it is a bold an interesting thesis that deserves serious consideration. I'm not sure about some of his criticism of FDR's stimulus:

     "The Agriculture Adjustment Act, F.D.R.’s farm program, which was designed to raise prices by cutting back on production, may have eased the situation somewhat, at the margins. But it was not until government spending soared in preparation for global war that America started to emerge from the Depression. It is important to grasp this simple truth: it was government spending—a Keynesian stimulus, not any correction of monetary policy or any revival of the banking system—that brought about recovery. The long-run prospects for the economy would, of course, have been even better if more of the money had been spent on investments in education, technology, and infrastructure rather than munitions, but even so, the strong public spending more than offset the weaknesses in private spending."

    If anything you can argue that based on Stiglitz's thesis, FDR may have sought too much in the early days to give agriculture what it wanted rather than expanding to the new manufacturing sector-Henry Wallace in the early years honestly believed that the goal was to create conditions for most Americans to always work on farms.

    Overall what Stiglitz talks about is very important. I'm not here to categorically choose Stiglitz of Sumner in this dispute but I will say that at the very minimum the monetarist view of someone like Sumner may be a little one sided. In his world, "real economy" phenomenon like a productivity boom that displaces workers simply doesn't exist. He shows no awareness of them and if he is he can only presume that they are deriviative phenomena that monetary policy will seamlessly fix.

   I certainly agree with Stiglitz's overall description of the economy in recent years-between the rise from productivity that started to accrue in the mid 90s, exacerbated by globalization and outsourcing, millions of American workers have become displaced. From what I understand there are some new jobs that have started to develop since 2009. They are kind of manufacturing jobs even but require background in things like science and engineering-fields that the U.S. has bee very weak on lately. So clearly a major investment in education is in order.

   If Stiglitz feels like too many of us have "drunk the koolaid" in focusing on monetary policy I guess the answer is that "Nature abhors a vacuum" as there is no fiscal stimulus on offer anyway with the current most unproductive of Congresses where else can one go? All one can do is demand better politicians, but this won't come about till at best in 13 months.

   Overall my tendency is to think that monetary policy is not irrelevant-look at the fine work of someone Stiglitz likely would appreciate, Eccles-but that a Scott Sumner exaggerates it as he hopes to be able to get us even in principle eschew any fiscal stimulus, ever. I remember a recent exchange I had with him when he claimed that if Benjamin Strong had lived the Depression would never have happened. Such a view must be an exaggeration. I tend then to agree mostly with an Eggertsson who gives a place to both.
To be sure Sumner is trying to insist monetary policy is always the answer, fiscal stimulus is always misguided: "For the 247th time the fiscal multiplier is roughly zero."

    "Everyone seems to agree that the fiscal multiplier is zero when we aren’t at the zero bound.  The issue being debated is whether this is also true when rates are near zero.  I say yes, most Keynesians say no."

    Then he adds the snarky: "PS.  When I say “everyone seems to agree,” I of course mean everyone but Joe Stiglitz."

     Yet I agree with the comment by o. nate: "Maybe Stiglitz’s story isn’t the whole story, but couldn’t it be part of the story? Differences in marginal propensity to spend and/or increased demand for leisure and/or savings by those with increased real incomes, plus other structural rigidities, could conceivably lead to effects along the lines of those Stiglitz proposes. You can hardly fault him for not spelling out in detail all of his assumptions in an article for a non-specialist publication."

      I don't think Sumner's story is the whole story either-though he thinks it is-but I think it may well be "part of it." The trouble is the agenda of monetarism is to rule out fiscal stimulus in principle, ever. No Scott, even if you have said it 247 times you haven't convinced me.

      On the other hand you could argue that Stiglitz's understanding of Fed policy at least in this paper may be too narrow. When he says:

      "Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy."

      You can argue that he construes Fed policy too narrowly here. Just because the Fed funds rate is zero doesn't necessarily mean he has been ultra aggressive if you understand Fed policy as more than anything driving expectations.

    If you do see it as mostly this then you can point out that when Greenspan tightened by raising rates in 1994 and 1995 it didn't succeed in slowing down the 90s bubble nor did his tightening between 2004-2006 when he raised it 17 straight times in a row succeed in stopping the real estate bubble. But the monetarist answer is that there's much more to Fed policy than merely this. At best I'm still content that both have a part of the story though I'm not convinced that either has wholly ruled out other parts of the story.