Sumner vs. Delong on Monetary Policy

    Yesterday we took a look at Delong's piece about monetary policy during a liquidity trap.

     http://diaryofarepublicanhater.blogspot.com/2012/03/once-again-fiscal-vs-monetary-stimulus.html

     Not surprisingly Sumner had a rebuttal. To be sure, Sumner insists he wrote the post prior to seeing Delong's:

      "I wrote this post yesterday, before I had read Brad DeLong’s recent post. This post might be viewed as a rebuttal to DeLong. What DeLong sees as ultra-easy monetary policy is actually ultra-tight monetary policy."

      But did Delong claim to see ultra-easy money? It seems his main point is just that in a LT there's monetary policy can only do so much. Sumner's main area of attack on "liquidity trap" Keynesians is the idea that they are too focused on nominal interest rates as indicative of monetary policy being loose or tight.

      What they don't consider, according to Sumner, is unconventional monetary policy. Is this true though, has Delong simply never heard of quantitative easing? Of course not. Many critics of Monetarism argue that QE simply doesn't work. That's the MMT position for example. Sumner himself conceded QE2 for example may not have done much.

    But he argues its value is what it does in confidence and expectations. The MMT criticism is actually that QE2 did little to help things but simply boosted up asset prices-equities, commodities, etc while doing nothing for home prices. In other words, they assert, the little guy gets the worst of all worlds. It does little to re-inflate the economy in a way that would help him-houses, wages-while raising oil prices which hurt him at the pump.

    Delong says this about monetary policy in a liquidity trap:

    "the claim that monetary policy is non-distortionary is subject to question when the real interest rate that produces total spending equal to potential output is negative. In such a case, monetary policy works by artificially pushing the real interest rate r down well below its full-optimum level to compensate for other market failures. The relative overproduction of long-duration and underproduction of short-duration assets in the present is not small, and the claim of no first-order losses is not clearly relevant. "

     His claim that monetary policy can be distortionary in this context is important as this is the usual reason given why fiscal stimulus is undesirable-it's held to be distortionary.

     Actually, it was in a piece that Delong wrote a week ago that he gave a more comprehensive look at what he thinks about monetary vs. fiscal policy.

      I talked about it in depth here http://diaryofarepublicanhater.blogspot.com/2012/03/sumner-and-delong-is-fiscal-multiplier.html

     http://delong.typepad.com/sdj/2012/03/the-changing-multiplier-since-1925.html

      Delong makes the point that to Sumner's oft-repeated claim that the "fiscal multiplier is roughly zero" depends on the context of what monetary regime your under. Delong's point is that this is only totally true under the regime that he calls Monetary Dominance (MD). In the MD regime, monetary policy is completely vertical. The multiplier is zero. Delong argues that this was the regime that Clinton assumed he was working under when he passed his balanced budget package in 1993.

    However it is less true in other regimes.  For example even in a monetary regime based on the Friedman Rule about growth of the money supply (FR) the multiplier is not zero though it is very small-Friedman himself admitted this; his point is that it was not large enough to mater or even be worth talking about.

   The third monetary regime which need not preoccupy us is the gold standard regime. As I don't see this regime frankly coming back at any point, probably ever, it's more a historical point more than anything. However in a gold standard regime there is a moderate multiplier.

    The fourth monetary regime is important as it touches on Sumner's major criticism of the Keynesians-that they focus too much on nominal interest rates as being one and the same with monetary policy. Essentially his complaint is they don't consider unconventional monetary policy.

    Sumner's basic argument is that even hitting up against the zero bound, even here while conventional monetary policy won't be sufficient, unconventional policy will do the trick .

     Delong says of the fourth monetary regime:

     "Fourth in logical sequence is a central bank that targets the real rate of interest: call this the “constant monetary conditions” multiplier. This is the multiplier that would be estimated by cross-state fiscal-policy regressions in the United States, or cross-country fiscal-policy regressions in a monetary union, were there neither demand spillovers nor cross-jurisdiction factor mobility to bias the estimated coefficient one way or another."

   "Note that a monetary authority that targets the real rate of interest is likely to be pursuing a policy in which nominal interest rates are rather strongly procyclical. Inflation will surely rise with higher levels of real GDP. Risk spreads are likely to fall as well. Both of these must be compensated for by rising nominal interest rates if the monetary authority is truly going to pursue a policy that keeps the real interest rate constant. The multiplier μ under such a monetary policy rule is likely to be rather large: there is neither investment-based nor export-based interest-rate crowding out, since the purpose of the policy is to ensure that the interest rate does not move."

     This central bank tha targets the real rate of interest is essentially a traditional Keynesian central bank. It is perhaps this that Sumner has in mind when he claims that Keynesians are too focused on interest rates. In any case, in the Real Interest Rate regime (RIR) the fiscal mutliplier gets quite substantial.

       Of course the fifth and final monetary regime is the Zero Lower Bound (ZLB) monetary regime. Here Delong argues monetary policy can only do so much. However, in no regime is the band for the buck greater for fiscal stimulus.

      As for unconventional monetary policy, Delong says this:

      "Under all the other monetary policy regimes the monetary authority could, if it thought wise, shift the MP or LM curve to provide further monetary expansion. Under monetary dominance it would simply change its near-future real GDP target. Under the Friedman rule it would boost the money stock growth rate. Under a gold standard it could sell some of its own gold holdings or change the gold parity. Under a constant real interest rate regime it could change the target real interest rate."

     :But at the zero nominal lower bound the monetary authority’s available tools are much weaker, and active monetary policy seems likely to be of limited effectiveness. The monetary authority can promise higher inflation in the future—but how is it to make that promise effective and credible, especially in a political and technocratic environment averse to even moderate inflation? Quantitative easing to boost the money stock can always be reversed if the assets purchased by the monetary authority as it issues more cash are traded in thick markets. And if the monetary authority issues cash and wishes to demonstrate that the transaction will not be unwound by using the cash to purchase assets that cannot easily be sold off —bridges, highway interchanges, and the human capital of twelve-year-olds, for example—that looks a lot more like fiscal than monetary policy, albeit a fiscal policy conducted by the monetary authority."

     So in this last paragraph particularly, is I think the Delong answer to Sumner-he never goes out of his way to reply to Sumner directly or not often. While he admits that the monetary authority can promise future higher inflation how can it make that credible "especially in a political and technocratic environment averse to even moderate inflation?"

    On this he's certainly right. Even if the Fed can raise inflation by future expectations this is a "political and technocratic environment averse to even moderate inflation." Of course the fact is that the political and technocratic environment is just as hostile to even moderate fiscal stimulus and mild budget deficits.

   As to QE it too lacks credibility as it can always be reversed. On the other hand while there are further things the Fed can do but:

   "And if the monetary authority issues cash and wishes to demonstrate that the transaction will not be unwound by using the cash to purchase assets that cannot easily be sold off —bridges, highway interchanges, and the human capital of twelve-year-olds, for example—that looks a lot more like fiscal than monetary policy, albeit a fiscal policy conducted by the monetary authority."