This is a must read. I'm just at the top at page 2 and already I love this paper. I will quote from this paragraph which so far as I'm concerned, already makes it.
"The recent financial crisis and its aftermath have created a problem for orthodox theory. That problem is: How does monetary policy affect the money supply, commercial lending, and nominal GDP? In the last 5 years (August 1, 2008 to August 1 2013) had increased the monetary base by 292% on the grounds of providing "liquidity" to the market and "stabilizing" the price level. Yet according to orthodox theory, the expansion of the monetary base should have done far more than stabilize the price level. It should have led to a significant increase in the price level. Meltzer (2013)"
This is at variance with what Mark Sadowski said in a recent discussion where he suggested that monetary policy works how Sumner says it does because if we hadn't had this almost 300% expansion of the MB we would have had outright deflation.
http://diaryofarepublicanhater.blogspot.com/2013/11/id-like-to-welcome-mark-sadowski-to.html
Joshua therefore asks exactly the right question. However, this next half of the paragraph is even more important and impressive:
"Economists have offered a variety of explanations for this anomaly from a liquidity trap (Krugman 2013) to sterilization of reserves by paying interest on them (Meltzer 2013) to not controlling expectations of future nominal GDP growth (Sumner 2012). In spite of the reputations of these esteemed economists, we find such varied justifications unpersuasive and other evidence that recent history is not an anomaly at all."
http://bubblesandbusts.blogspot.com/2013/11/empirical-evidence-for-endogeneity-of.html?showComment=1384615053068#c5178670672417007776
As this should show, this paper is vitally important and more than worth the price of admission. Josh is light years ahead of recent literature in that he mentions the IOR justification and Sumner. Any analysis that failed to mention these would be woefully incomplete. For IOR is one of the first alibis you're going to hear when you broach this subject, and Sumner has been working feverishly for 4 years to explain it. I'll say it again: Thank God for Joshua Wojinlower.
http://diaryofarepublicanhater.blogspot.com/2013/11/josh-wojinlowers-upcoming-paper-on.html
I mean we need precisely this kind of analysis. As you know, I've been one of the more determined skeptic of Market Monetarism. The funny thing is that Sumner hasn't been very smart-I came into it with an open mind but the more he attacked me in strident and snarky terms for honest questions-accusing me of either being 'dishonest' or 'ignorant of economics'-to ignorant to blog about it-the more he's kind of exacerbated my skepticism. If he could have tried being a little nicer I'd probably be considerably less skeptical of it-though no doubt if I don't get answers that make sense to me, I'm not going to stop.
However, in a way I've been easy for Sumner to dismiss with my rather admittedly whimsical style-Mark Sadowski once described it as 'histrionic.'
http://diaryofarepublicanhater.blogspot.com/2013/10/mark-sadowski-may-be-great-wonk-but-he.html
http://diaryofarepublicanhater.blogspot.com/2013/10/mark-sadowski-and-my-apparent-war-with.html
The funny thing is that I never considered myself in a war with MM. I still don't necessarily-I'm just looking for answers-answers Sumner is either unable or unwilling to give. Josh's work on the topic is welcome as he's much less easy to dismiss than a guy who calls his site Diary of a Republican Hater and has no formal training in economics. Josh's work is the excellent work of an academic economist and I look forward to the lively discussion that no doubt will ensue.
With the very bold claims that Sumner has been putting out there, it's time that someone showed him the respect-of disagreeing with him in an academic paper. If Josh had ignored Sumner his paper would be much less exciting than it is.
"The recent financial crisis and its aftermath have created a problem for orthodox theory. That problem is: How does monetary policy affect the money supply, commercial lending, and nominal GDP? In the last 5 years (August 1, 2008 to August 1 2013) had increased the monetary base by 292% on the grounds of providing "liquidity" to the market and "stabilizing" the price level. Yet according to orthodox theory, the expansion of the monetary base should have done far more than stabilize the price level. It should have led to a significant increase in the price level. Meltzer (2013)"
This is at variance with what Mark Sadowski said in a recent discussion where he suggested that monetary policy works how Sumner says it does because if we hadn't had this almost 300% expansion of the MB we would have had outright deflation.
http://diaryofarepublicanhater.blogspot.com/2013/11/id-like-to-welcome-mark-sadowski-to.html
Joshua therefore asks exactly the right question. However, this next half of the paragraph is even more important and impressive:
"Economists have offered a variety of explanations for this anomaly from a liquidity trap (Krugman 2013) to sterilization of reserves by paying interest on them (Meltzer 2013) to not controlling expectations of future nominal GDP growth (Sumner 2012). In spite of the reputations of these esteemed economists, we find such varied justifications unpersuasive and other evidence that recent history is not an anomaly at all."
http://bubblesandbusts.blogspot.com/2013/11/empirical-evidence-for-endogeneity-of.html?showComment=1384615053068#c5178670672417007776
As this should show, this paper is vitally important and more than worth the price of admission. Josh is light years ahead of recent literature in that he mentions the IOR justification and Sumner. Any analysis that failed to mention these would be woefully incomplete. For IOR is one of the first alibis you're going to hear when you broach this subject, and Sumner has been working feverishly for 4 years to explain it. I'll say it again: Thank God for Joshua Wojinlower.
http://diaryofarepublicanhater.blogspot.com/2013/11/josh-wojinlowers-upcoming-paper-on.html
I mean we need precisely this kind of analysis. As you know, I've been one of the more determined skeptic of Market Monetarism. The funny thing is that Sumner hasn't been very smart-I came into it with an open mind but the more he attacked me in strident and snarky terms for honest questions-accusing me of either being 'dishonest' or 'ignorant of economics'-to ignorant to blog about it-the more he's kind of exacerbated my skepticism. If he could have tried being a little nicer I'd probably be considerably less skeptical of it-though no doubt if I don't get answers that make sense to me, I'm not going to stop.
However, in a way I've been easy for Sumner to dismiss with my rather admittedly whimsical style-Mark Sadowski once described it as 'histrionic.'
http://diaryofarepublicanhater.blogspot.com/2013/10/mark-sadowski-may-be-great-wonk-but-he.html
http://diaryofarepublicanhater.blogspot.com/2013/10/mark-sadowski-and-my-apparent-war-with.html
The funny thing is that I never considered myself in a war with MM. I still don't necessarily-I'm just looking for answers-answers Sumner is either unable or unwilling to give. Josh's work on the topic is welcome as he's much less easy to dismiss than a guy who calls his site Diary of a Republican Hater and has no formal training in economics. Josh's work is the excellent work of an academic economist and I look forward to the lively discussion that no doubt will ensue.
With the very bold claims that Sumner has been putting out there, it's time that someone showed him the respect-of disagreeing with him in an academic paper. If Josh had ignored Sumner his paper would be much less exciting than it is.
"This is at variance with what Mark Sadowski said in a recent discussion where he suggested that monetary policy works how Sumner says it does because if we hadn't had this almost 300% expansion of the MB we would have had outright deflation."
ReplyDeleteBased on what?
"Yet, according to orthodox monetary theory, the massive expansion of the monetary base should have done far more than stabilize the price level. It should have led to a significant increase in the price level (Meltzer 2013)."
ReplyDeleteAlan Meltzer's recent statements concerning contemporary US monetary policy severely contradict much of what he has written about the Great Depression. And I seriously doubt that the period in question (1971-2008) is relevant to our current circumstances.
Have you read the paper? What period is relevant? Why is this period not relevant? Again have you read the paper?
ReplyDeleteI have the paper right in front of me.
DeleteThe Fed was never at the zero lower bound during 1971-2008. The monetary base was never the instrument of monetary policy during this time period.
Mike - Again, thank you for the high praise! I've been discussing the paper with Mark on my blog and found the comments very helpful. That is not to say I agree with the general Market Monetarists perspective, but that aspects of my disagreement need to be made clearer in future versions of the paper. For example, the paper's argument and evidence are against explanations for the recent "failure" of monetary policy that rely on a "money multiplier" relationship that assumes direct causality from the supply of reserves to increases in bank lending (such as sterilization through IOR). The paper's evidence, in my opinion, does not contradict theories that rely on the monetary base affecting NGDP through expectations, either of future monetary policy or macroeconomic outcomes. If MMers fall in this latter category, then my disagreements on the affect of QE lie elsewhere than in the differentiation between exogenous or endogenous money.
ReplyDeleteYour welcome Josh. I saw that Mark left some comments on your blog. I notice that one argument Mark made-and this is exactly the same argument Sumner has made is that they actually don't believe in the money multiplier either-Mark left a comment to that effect on your post to I notice. However, what this seems to really mean is that they don't believe that the money multiplier is stable in the short run-logically then they do believe it's stable in the long run which of course they do as the believe in long run monetary neutrality.
ReplyDeleteI think that one thing your paper hasn't made clear enough yet is why you don't think IOR is a persuasive explanation of the lack of impact of expanding the MB. Unless I missed it-I have read the entire paper.
ReplyDeleteMike, I can't speak for Josh, but I think that in order for IOR to have an "impact" on the MB, the added money needs to circulate. It's one thing to increase the MB, it's quite another when it does not increase the velocity of money. If it's not "multiplying" it's not having any impact. Well, it is, but what it's doing is the same as QE: It's creating an excess demand for money. I'd like to hear what Josh, or anyone else thinks about this.
ReplyDeleteWhile I'm certainly not an expert on MM, I think it's true that a "money multiplier" is no longer necessary for their theory to hold. Changes in interest rates and the money supply only matter to the degree they affect expectations of future NGDP. Given rational expectations, future expectations will be correct on average and therefore the Fed can control the growth or level of NGDP.
ReplyDeleteTurning to the effect of IOR, I appreciate the comment that our position is not clear enough. I'll try to briefly explain here. Typically the claim that IOR inhibits the effect of QE is argued on the basis that banks are encouraged not to lend out reserves. This notion that banks lend out reserves implies that causation runs from the MB to bank lending. In other words, a "money multiplier" exists.
The point of our paper is to argue that the quantity of reserves are not and have never been a constraint on bank lending decisions (the price may be). Expanding the quantity of reserves will therefore not alter the ability of banks to make loans, regardless of whether or not IOR exists. The goal of QE is to raise NGDP expectations and thereby encourage greater demand for loans. Since IOR represents a subsidy to banks, it could actually lower the markup necessary to provide loans to creditworthy borrowers.
Josh,
ReplyDeleteSome would argue that banks cannot and do not lend out reserves. My question is, does paying interest on reserve increase the base money? (M1, M2). As you note, the quantity of reserves are not and have never been a constraint on bank lending decisions (the price may be.) Would it be safe to assume that lending is constrained by the price being too high right now? (That seems wrong.) Or, is it the fact that the risk premium is too low? It would seem your assumption that IOR's could actually lower the mark up necessary to provide loans to creditworthy borrowers compounds the problem related to the risk premium question. The market seems to be doing quite well under current policy, the broader demand side and labor side of the economy, not so much. Or is it the case that once again, I'm totally in the dark?
nanute,
DeleteI am one of those who "would argue that banks cannot and do not lend out reserves" beyond the interbank Federal funds market. Focusing solely on the action of paying interest on reserves, the policy does increase base money (M0 or MB) by the amount of interest paid. The increase in base money, however, will not alter the price of reserves for depository institutions. Whether or not M1, M2, etc rise, fall or stay the same depends on whether the securities being exchanged for reserves were initially held by the depository institutions or other private sector agents.
In my opinion it's misleading to "assume that lending is constrained by the price being too high right now." Banks can always increase lending if they are willing to reduce rates or accept greater credit risk. Lending for the sake of lending, even when unprofitable, is not a path to prosperity. That being said, it's possible that regulations are raising the cost of lending, which could be positive or negative.
I also doubt that the risk premium is a typical consideration of banks when making loans. My understanding is that banks set the price of loans as a markup to average unit costs, adjusting for credit and maturity risk, then attempt to meet all creditworthy demand for loans at that price.
You not a bifurcation in the economy between the financial markets and goods/labor markets. In my opinion this is largely due to the type of borrowers and purchases being made. Financial markets have been rising dramatically for several years, initially bolstered by earnings due to federal deficits, now by increasing enthusiasm. For investors, which tend to be wealthy and have relatively little debt compared to assets, the opportunity for profit continues to appear significantly higher in financial markets than in production of real goods. Therefore it's not surprising investors are borrowing significant sums to speculate on financial assets. In the "real" world, household debt remains a significant burden for a large percentage of households near the bottom of the wealth/income distribution. These households continue to face credit constraints not in place before the crisis, which compounds the problem of weak domestic consumption growth. Without growing demand for goods, companies have little incentive to invest in capital or labor. Hence we seen strong financial markets combined with slow growth in output and employment.
Hopefully this response answers at least one of your questions. It's a very complex subject that I can't even claim to fully understand, but it helps to try and talk/type through the plausible logic and gain other opinions.