Sumner, Apostle of the New Religion of Nominalism

     Sumner likes the idea that "nominalism" is on the rise. He'd like to see a whole revamping of textbooks-as has fellow Market Monetarist Lars Christensen argued for:

      "I’ve never liked the way textbooks treat macro.  They have an intro to money section with some basic accounting (MV=PY) and also the quantity theory of money (which 99.9% of students and 90% of economists think is somehow related to MV=PY.  It isn’t.)  There’s discussion of the German hyperinflation from a sort of hot potato perspective.  And then . . ."

      ". . . and then it’s all dropped.  Then we go into Keynesian chapters where NGDP = C + I + G + NX and money affects interest rates and inflation is caused by “overheating economies” (like Zimbabwe?)"

   "I always thought the “classical dichotomy” provided the natural framework for explaining macro to students.  There’s the nominal economy, and there’s the real economy.  We could explain the nominal economy with a monetary (hot potato) framework and the real economy by assuming nominal shocks have real effects due to sticky wages and prices.  What could be simpler?"

    "In this framework the AD curve is relabeled NE (nominal expenditure) and is a hyperbola.  Monetary theory explains why that hyperbola shifts northeast or southwest, and sticky wages and prices explain why the SRAS is upward sloping and the LRAS is vertical.  No need to throw out those early money chapters; you can tell students the “MV stuff” explains why the NE curve shifts left and right."

   "We would also de-emphasize “inflation shocks.” Recall that we should never “reason from a price change,” because inflation from the demand-side is a totally different phenomenon than inflation caused by supply shocks.  On the other hand we should always and everywhere reason from an unanticipated NGDP change, because those affect employment in predictable ways, regardless of whether they hit a healthy economy (1929) or an economy ravaged by debt problems (2008.)  They cause employment fluctuations.  Period, end of story."

     http://www.themoneyillusion.com/?p=20650#comments

     He praises part of an article in the Financial Times which seems to augur this age of Nominalism. However, he doesn't like another part in the article which he sees as a specious correlation between inflation targeting and a lower share of GDP for labor:

     "On the other hand, I was disturbed by this:

A significant change in monetary policy is under way around the world. From Abenomics in Japan, to the greater flexibility just afforded to the Bank of England with regards to pursuing its inflation target, and the Federal Reserve introducing an explicit unemployment target, it is clear that the days of inflation targeting are numbered.

The focus on lower inflation has lasted more than 30 years, resulting in three decades of falling inflation. In the US it dropped from 12 per cent in 1979 to below 2 per cent before the credit crunch hit. The policy also produced a 30-year bull market for bonds, as US Treasury yields fell from more than 15 per cent in the early 1980s to below 4 per cent by the mid-2000s.

However, this success in beating inflation has been achieved at the cost of a declining share of labour in national income.

It is not a coincidence that the share of labour in GDP peaks in the 1970s for both the US and the UK. Given that the largest element of costs was – and remains – labour, the fight against inflation amounted to a campaign to squeeze labour incomes.

     "Monetary contraction in 1981-82, and again in 1991, did temporarily raise unemployment.  But tight money has no long run effect on the share of national income going to labor, as wages and prices will eventually adjust to the new inflation rate.  And in the short run a contractionary policy can (sometimes) actually raise real wage rates (although) of course it reduces total real income earned by workers."

      "When two long run trends happen at the same time, don’t assume one causes the other."

     Yesterday he had another post criticizing Matt Ygelsias for thinking that Sumner's proposal for a consumption tax depends on an assumption of full employment. Sumner thinks that Yglesias confounds a "real" or "supply" issue of taxes with a nominal issue-demand. 

       "I absolutely do not assume the economy is at full employment when advocating consumption taxes.  And “financial saving” is a meaningless term, so I won’t comment on that.  Saving is saving; it is defined in all the textbooks as the funds that go into investment. (You are free to have your own definition.) There are actually three errors embedded in the Roth/Yglesias critique:

1.  There is no paradox of thrift, so saving doesn’t cause higher unemployment. Oddly, the most common error on this topic is exactly the opposite; most people think high saving/CA surplus economies steal jobs from low saving economies, a view that is equally wrong.  Periods of higher than normal unemployment are caused by either NGDP shocks (bad monetary policy) or bad supply-side policies (think France/Italy/Spain.)

2.  OK, most old-style Keynesians don’t agree with me on the paradox of thrift, but today even old-style Keynesians accept the natural rate hypothesis, which says than demand doesn’t affect the long run average level of output, just the volatility. So even if higher saving did cause high unemployment, it would have no bearing on long run decisions over what sort of tax regime to implement, which affect the level of saving, not the volatility.

3.  Now let’s say I’m wrong about both the paradox of thrift and the natural rate hypothesis.  Suppose that we are permanently at the zero bound and the central bank is too conservative to push unemployment all the way down to the natural rate, but instead targets an unemployment rate that is 2% above normal.  (Put aside the question of why wages and prices don’t eventually adjust. Let’s suppose there is some sort of “hysteresis” that keeps the unemployment rate fluctuating around a trend line 2% above normal.)  In other words, I’ll take the most extreme Keynesian assumption I can think of.  What then?  Even in that case a consumption tax is optimal.  Even if we are not at full employment.  That’s because what matters is not the level of saving but rather changes in the share of GDP that is saved.  And in the long run those net out to zero.

   "The day we start making long run optimal tax regime decisions based on their implications for the business cycle is the day we become a banana republic."

     http://www.themoneyillusion.com/?p=20641

      Interesting. I do notice that while he would throw away the textbooks, he'd keep the part that says S=I, ie, national income accounting.  In my last piece about Sumner, both Unlearning Econ and Greg took Sumner apart. What say you-or Woj, or anyone else-regarding this? I think this is an important issue to get a handle on.