Then How Do You Explain Zimbabwe? Unlearning Econ Looks at Market Monetarism

     I'm glad to see Unlearning is back-he had taken a hiatus back in May. I just realized he's back-actually he's been back since June. I guess I got discouraged as his hiatus was on top of WOJ's-who's been gone since March.

     http://bubblesandbusts.blogspot.com/

    I thought for some reason that Unlearning could be gone a long time too. Anyway I'm glad he's around as there is so much econ to unlearn, so little time. For an example of what I mean-in terms of what must be unlearned-see this 

    http://diaryofarepublicanhater.blogspot.com/2013/08/keynesianism-and-sumners-contempt.html

    Unlearning has a very important post where he questions Market Monetarism. It's the kind of critiques that are really needed-whether you buy into MM or not; I certainly have reservations. For me this theory that all you need to do is stabilize the NGDP level over time and we've solved the business cycle is very enticing because of it's seeming simplicity and intuitiveness. Yet as we've known at least since Kant, intuitiveness isn't proof of truth. 

    I came across this piece by Unlearning at just the right time as it was just after I read a piece at Sumner about fellow MMer Nick Rowe's post about Monetarism. Nick's piece is interesting. However, one thing he said that kind of raised my eyebrows was this evoking of hyperinflation:

   "Consider the following claim by Nick:

Empirically we observe that if you don’t let the money supply explode to infinity the economy won’t explode into hyperinflation either; and if you don’t let the money supply implode to zero the economy won’t implode to zero either. Empirically we know that monetarism is at least roughly true. But theoretically we don’t know why it is true. We don’t understand the strong dark force that makes monetarism at least roughly true.

    "This makes me a bit uneasy.  Is it really true that all hyperinflations involve huge increases in M?  Maybe, but I could easily imagine one that didn’t.  Suppose the Confederate government was expected to collapse within a few weeks in 1865. Even if they hadn’t printed a lot of money, wouldn’t prices have soared in terms of Confederate money, as the demand for that sort of money plummeted?"

     http://www.themoneyillusion.com/?p=22964

     I'm glad Sumner questioned this because I had the same question. It's certainly not true that hyperinflation is always the product of 'wild eyed (Keynesian) money printing.' In the worst hyperinflation in history-Weimar Germany-it was the effect of the Treaty of Versailles and the steep war debts Germany was forced to pay back. b

     If anything, though, even this doesn't go far enough in explaining hyperinflation. Unlearning does it in his piece on MM-it hasn't nothing to do with Keynesian fine tuning that 'goes too far.' As he points out, this is actually boilerplate for MMers as:

     "they seem to believe history shows that “no central bank has ever failed to create inflation” (and therefore NGDP). This presumably refers to the multiple instances of hyperinflation the world has seen, with the implication that they were caused by loose monetary policy. This idea is false. Without exception, hyperinflation occurs during times of mass political instability, where populations lose trust in a currency and political system and reject it outright. That the manifestation of this is superficially similar to what we call inflation is irrelevant."

     http://www.pieria.co.uk/articles/examining_the_case_for_ngdp_targeting

     This specious argument is the fallback for Market Monetarists when their 'hot potato' explanation for how an increase in the money supply increases NGDP. Unlearning, starts this debate in the right way by beginning with these two questions regarding NGDP targeting:

     A). Is NGDP the main driver of the economy?

     B).  Can the Central Bank control NGDP?

   I'm glad he looks at A as most Market Monetarists begin with B, never even asking the obvious begging question-why NGDP? Why is this the best measure?

    As he says, there are 4 possible answers to these two questions. 

    1. If A and B are both yes then of course NGDP targeting will prevent demand shortfalls massively stabilizing future shocks. 

     2. If A is true but B isn't-the CB can't adequately control NGDP-then pure monetary NGDP targeting won't work although a combination of policies might. This is an argument Steve Randy Waldman over at Interfluidity has made. 

     http://www.interfluidity.com/v2/4388.html

     3. If B is true but not A then at most NGDP targeting will turn a recession into stagflation

    Interestingly enough, Sumner has often evoked stagflation as what we would have had if the Fed had done what he thinks it should have back in 2008 and 2009. He argues that this would be a 'feature not a bug."

    http://www.themoneyillusion.com/?p=14924

    4. Neither A or B is true in which case we get nothing-it won't work though it may prop up the stock market and financial sector a little. 

    My best guess is that it's 2 or 4; if NGDP is the major driver of growth then I still doubt the Fed can successfully control it all by itself. On the other hand, 4 is very possible. As stated above, I appreciate that UL asks the question of just how much NGDP actually drives growth. It's certainly at least open to some doubt. Certainly there's no reason we have to believe that it's the main driver as MMers don't normally explain it but rather just presume it. 

    "If market monetarism is correct about the importance of nominal income, NGDP should drive changes in RGDP. I once pointed out that this is far from the case – it certainly wasn’t in the recent crisis – and the response was that it is expectations which drive both RGDP and NGDP. However, this argument is also empirically false."

     The story that expectations drive both NGDP and RGDP fits the 1999 stock market crash but not 2008 where a drop in RGDP preceded both,

    "It seems to me that market monetarists have completely forgotten how 2008 had actually happened. Few people – economists, politicians, households, bankers, and everyone in between – foresaw the crash. Lehman Brothers certainly didn’t. Yet as the financial sector found that the ‘assets’ in which it had invested so heavily were worth less than the paper they were written on, the credit markets froze up, and banks stopped lending, consumers stopped spending and businesses stopped investing and hiring. It was only after this stark realisation (or ‘Minsky Moment’) that expectations, markets and income dropped, and hence the drop in NGDP was a symptom, rather than a cause, of the crisis."

    It's certainly true that MMers have forgotten how 2008 happened-if they ever noticed. I mean the worries of September 2008 were real-the fear that the financial system would implode with LIBOR rates spiking through the roof, 'breaking the buck', and fear of 'contagion.' None of this seems to be on Sumner's radar at all. If pushed he might admit that, yes, all this happened but still it can be ignored as it was all merely an epiphenomenon. Here he is remembering his thinking in 2007:

    "I got very worried in December 2007 when the Fed cut rates less than expected, stocks plunged, and nominal rates in the Treasury market fell from 3 month to 30 year maturities.  I wasn’t concerned so much about the economy, which seemed to revive a bit when the Fed reversed this mistake in January, but rather what worried me was the fact that most economists seemed to assume that rates were falling because of easy money, whereas the bond market was clearly signaling it was tight money that was depressing bond yields.  Markets respond to the unexpected part of the announcement.  I thought the Fed had learned a lesson.  I was wrong.  BTW, I don’t doubt that monetary shocks often do move interest rates in the “right” direction, but the point is that we can’t count on that being true, and it’s least likely to be true when we most need it to be true—when we are in unfamiliar territory."

     http://www.themoneyillusion.com/?p=915

     His belief is that no matter what happens in the real economy, it can't possibly drive the business cycle. Recessions and depressions are by definition always and everywhere a monetary phenomenon according to him and his MM. 

      Ultimately, MMers deny that the financial system matters at all. As UL notes, most mainstream economists seem to admit that the Post Keynesians are right about how the financial system works, it just doesn't matter.

      "Endogenous money – the idea that banks don’t really work in the way that is implied by mainstream economics - has been endlessly debated in the blogosphere. In my experience, it is generally conceded by mainstream economists that endogenous money proponents have the mechanics right, but market monetarists, as well as other mainstream economists, argue that this doesn’t matter from a monetary policy point of view. I believe this is a huge mistake."

        The trouble is that if you except that 85% of the money supply is endogenous then you realize why the Fed can't effectively control the money supply. In addition banks don't 'lend out' money but create it by creating money as credit when loan applicants qualify.

      "The idea at the heart of NGDPT is that if you load up the financial system with enough money, banks will ‘lend out’ at least some of this money. However, endogenous money proponents point out that banks do not ‘lend out’ money; they create new money as credit when the prospective loan looks good enough, and when they have a strong enough financial position. Since bank’s balance sheets are in tatters after the financial crisis, and any level of increase in reserves will simply not change this fact, monetary policy has become largely impotent."

      Sumner has argued that the trouble with endogenous money proponents-aka MMTers, etc.-is that while they know a lot more about the financial system than he does, this knowledge makes them less able to understand the monetary system. 

      "I wasn’t able to fully grasp how MMTers (“modern monetary theorists”) think about monetary economics (despite a good-faith attempt), but a few things I read shed a bit of light on the subject.  My theory is that they focus too much on the visible, the concrete, the accounting, the institutions, and not enough on the core of monetary economics, which I see as the “hot potato phenomenon.”  This is the idea that the central bank controls the total quantity of money, but each individual controls their own personal “money supply.”  So if the Fed injects more money into the economy, something has to give to equate money supply and demand.  Initially there is too much money in circulation, and people pass the excess balances to one another like a hot potato.  This process drives up NGDP, until the public is willing to hold the new quantity of money."

        http://www.themoneyillusion.com/?p=10178

        Finally, it's easy to see why Sumner takes such umbrage Friedman being called-by David Glasner no less-a Keynesian and someone who modeled based on IS-LM. 

      http://diaryofarepublicanhater.blogspot.com/2013/08/on-friedmans-keynesianism-sumner-just.html

      Consider what he says about IS-LM:

      "Postscript:  I share Milton Friedman’s preference for looking at lot’s of issues from a partial equilibrium perspective (a model for interest rates, another model for NGDP, another model to partition NGDP into prices and real output, etc.)  I’m sure if he were alive today he could have done a much better anti-IS-LM piece.  BTW, I am now planning an important post on Friedman and Schwartz’sMonetary History, which will complement this post.  It will evaluate Krugman’s critique of F&S.  I have mixed feelings about that critique, and I think that in discussing the issues raised by Krugman you will get a much better idea of where I am coming from.  It should be ready by later in the week, after I finish grading and taxes."

    "PPS.  The architect Christopher Wren is buried in a simple tomb in the basement of St. Paul’s Cathedral.  I belive the inscription reads “If you seek a monument, look around you.”  I’m not trying to compare myself to that great man, but I suppose I could say something similar about my blog, which is almost entirely an implied critique of the IS-LM way of thinking about monetary economics."

     http://www.themoneyillusion.com/?p=915