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Saturday, November 2, 2013

Sumner on the Achilles Heel of MMT

      UPDATE: I see that Tom Hickey over at Mike Norman's economic blog had a post about this post so I've now written a follow-up post.

     As I observed in an earlier post, Sumner no longer even tries to engage any heterodox schools of economic thought but he used to. He agreed with me when I suggested that hes become much more hypersensitive over time:

      "Mike Sax, Yes, I’ve gotten more frustrated and testy over time. Partly due to seeing the same comments over and over again, and partly because I’m increasingly busy–too busy. But I agree that is a fault on my part."


     http://diaryofarepublicanhater.blogspot.com/2013/11/on-anti-gay-discrimination-chuck-hagel.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+DiaryOfARepublicanHater+%28Diary+of+a+Republican+Hater%29


      I was just looking at an oldie but goodie-some posts where he did engage MMT. Here he thought he found their flaw:


     "Suppose we pick a fairly “normal” year, when NGDP growth and nominal interest rates and unemployment are all around 5%.  It might be 2005, 1995, 1985, whatever.  The exact numbers aren’t important.  Now the Fed does an OMP and doubles the monetary base by purchasing T-securities.  They announce it’s permanent.  What happens?"



      "One MMT answer is that the Fed can’t do this.  It would cause interest rates to change, and they peg interest rates.  But the more thoughtful MMTers seem to be willing to let me do this thought experiment, as long as I acknowledge that interest rates would change and that it’s not consistent with actual central bank practices.  I’m fine with that. "

      "So let’s say they double the base and let rates go where ever they want.  I claim this action doubles NGDP and nearly doubles the price level.  MMTers seem to disagree, as I haven’t changed the amount of net financial assets (NFA) at all."
  
      "But here’s the Achilles heel of MMT.  Neither banks nor the public particularly wants to hold twice as much base money when interest rates are 5%, as that’s a high opportunity cost.  So they claim this action would drive nominal rates to zero, at which level people and/or banks would be willing to hold the extra base money.  Fair enough.  But then what?  You’ve got an economy far outside its Wicksellian equilibrium."

    "The MMTers like to talk about cases where large base injections did coincide with near zero rates—The US in 1932 or 2009, Japan in the late 1990s and early 2000s.  But those were all economies that were severely depressed and/or suffering deflation.  I find it hard to believe that you could cut rates from 5% to 0% in a healthy economy without triggering an explosion of AD, especially if the economy was already experiencing normal levels of NGDP, normal growth in NGDP, and normal unemployment levels.  The closest example might be the US after WWII, but remember that people (wrongly) expected deflation after the war, and by 1951 the Fed gave up on that policy due to rapidly rising inflation."


       However, why should we only debate 'normal'-ie, years we aren't in a really bad recession when the real debate is what we do in a really bad recession? Are MMTers denying that you would stimulate the economy by dropping interest rates from 5% to 0%. I don't know who is exactly. If anything they probably agree with that as many of them think we should always leave rates at 0%.

        It's obvious that in a recession of the magnitude of 2008 a huge expansion of the monetary base doesn't do much.  I recently wrote about a great post by David Glasner where he pointed out that Lucas' attempt to use Ricardian Equivalence to show fiscal stimulus can't work-the trouble is that even on Lucas' own terms ,RE only works if you assume a normal functioning economy. The same thing Sumner assumes here. 

      http://diaryofarepublicanhater.blogspot.com/2013/10/scott-sumner-vs-david-glasner-on-fiscal.html


      I see the smart econ blogger JKH who doesn't nominally consdier himself an MMTer agreed with me in the comments section of the above Sumner post both that MMT does think in a healthy economy MMTers would agree that a a big increase in the monetary base would drive interest rates from 5% to 0% and also confirms my understanding that the MMTers favor a permanent 0% interest rate set by the Fed. 

       "If the funds rate is at 5 percent and the Fed floods the system with reserves to the degree you suggest, and doesn’t pay interest on those reserves, there is no question that the funds rate will head for zero."

       "MMT might then go in a different direction. They might say that they would then prefer a policy that set the funds permanently at zero, which is an area where I think you and Nick have big problems with them, among others. They would say they can set the funds rate at zero permanently, if they so choose, and then regulate AD via tax policy. If they could do that successfully, then by definition and implication, they could affect the curve as well because they would obviously affect expectations for fed policy."
      

      

4 comments:

  1. Hmm, who cares what Sumner thinks about MMT? He is hopelessly lost.

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  2. Well maybe but a lot of people read him. What concerns me is his influence. Probably a lot more people know about Market Monetarism than MMT

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  3. All publicity is good publicity, as they say. So as an MMTer, I'm all in favour of Sumner standing on the roof top and screaming truths or falsehoods about MMT.

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  4. Exactly Ralph that's the spirit.

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