MMT-MM Smackdown: Scott Sumner vs. Dan Kervick

      For a long time I've been saying this is the grudge match we've been needing. Now we got it. Sumner wrote a post in response to a post Dan wrote last week that questioned Krugman's call for more inflation.

       http://www.themoneyillusion.com/?p=13846#comments

       Kervick's post

       http://neweconomicperspectives.org/2012/04/the-political-path-to-full-employment.html

        I read him originally at the above link but you can also see him at Naked Capitalism

        http://www.nakedcapitalism.com/2012/04/dan-kervick-contra-krugman-why-increasing-inflation-is-not-likely-to-increase-employment.html

        See Krugman here http://www.nytimes.com/2012/04/06/opinion/krugman-not-enough-inflation.html?partner=rssnyt&emc=rss

        Here is the original Krugman quote that Kervick takes issue with:

        “For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need. Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recovery.”

         Kervick argues:

       "I believe this is the wrong approach. The Fed’s ability to boost employment is very limited, well-intentioned citations of the Fed’s full employment “mandate” notwithstanding. Rather than looking to central bankers and the banking system to accomplish a task for which they are not really cut out, we should turn our attention back toward fiscal policy as the primary tool for bringing the country up to full employment and keeping it there. And rather than seeking engineered inflation as the mechanism for boosting spending and employment, we should implement the MMT job guarantee proposal to achieve full employment and price stability at the same time."

        "I believe this is the wrong approach. The Fed’s ability to boost employment is very limited, well-intentioned citations of the Fed’s full employment “mandate” notwithstanding. Rather than looking to central bankers and the banking system to accomplish a task for which they are not really cut out, we should turn our attention back toward fiscal policy as the primary tool for bringing the country up to full employment and keeping it there. And rather than seeking engineered inflation as the mechanism for boosting spending and employment, we should implement the MMT job guarantee proposal to achieve full employment and price stability at the same time."

       "Krugman’s two main arguments for the beneficial results of inflation are questionable. First, he argues that inflation will help reduce private sector debt overhang. But inflation only reduces debt overhang in a significant way for households who are fortunate enough to see their nominal wages rise along with the general rise in prices. In today’s economy, workers are frequently not so fortunate."

      "Suppose you work 40 hours a week for $1000 of take home pay, and you have a weekly debt bill of $500 and a weekly consumption bill of $500. So you work 20 hours for debt repayment and 20 hours for consumption. Now let’s suppose prices rise by 5%. Then the same basket of consumption goods you purchased before for $500 now costs you $525. Your debt bill, which is fixed in nominal terms, remains $500 per week."

      "Suppose also that your employer does not give you a raise, but chooses to take advantage of the inflation by keeping your nominal wages right where they were at $1000 per 40 hours. Then the result will be that you will have to decrease your real consumption by 4.7%. You will continue to work 20 hours for debt repayment and 20 hours for consumption, but now your consumption will be lower in real terms."

      "This worry about employers’ behavior is a real one. We don’t live in the old days of strong unions and the wage-price spiral that existed when economists like Krugman were cutting their teeth. We live in a permanent buyers’ market for labor characterized by persistently high unemployment and minimal worker bargaining power. As prices rise, many people’s nominal wages stay fixed or lag well behind the price level increase. Real wages go down and ordinary folks feel the sting of higher prices without the benefits on debt relief."

       "Doubts can also be raised about Krugman’s claim that people respond to inflation by increasing their propensity to spend their income. The idea is that in an inflationary environment, one is losing money just by holding money, so to the degree people expect higher inflation their incentive to spend rather than save increases. But while this behavioral response sounds plausible in theory, it might not be how people actually behave in practice. Instead, people worried about having to pay higher prices in the future and attempting to maintain a stable level of real expenditures over time might cut back on expenditures now to save for the expected higher prices."

       "Here’s a homework assignment for economics students out there. Explain Kervick’s argument using an AS/AD model. You will quickly see that it only makes sense if you assume the inflation was created by reduced AS. If it was caused by increased AD, then real GDP would have increased along with prices (assuming the AS curve is not vertical, and I can’t imagine an MMTer making that assumption.)"

       "Krugman is obviously calling for the Fed to create higher prices via more AD, not less AS."

      Sumner then reiterates an assertion he makes quite often: "Never reason from a price change." Indeed, the name of his post is "More reasons to stop talking about inflation."

      Sumner also took issue with Dan quoting him disapprovingly with regards to a recent Tyler Cowen post:

     "Yes, there are some people who still believe America’s workers are overpaid! In a recent post, Scott Sumner approvingly quotes Tyler Cowan, who has argued both against public sector hiring and for lower real wages. Cowan said, “the greater the number of protected service sector jobs in an economy, the more likely those citizens will oppose inflation. Inflation brings the potential to lower real wages, possibly for good.” Sumner then argued that Cowan’s considerations are a strong argument for favoring monetary policy over fiscal stimulus."

    Sumner comes back with this:

     "My post said nothing about wages, and I certainly didn’t endorse lower wages. (Although you wouldn’t know that by clicking on the link, because it doesn’t link to my post. I wonder why?) I was arguing that we shouldn’t aim for a higher inflation rate, but rather for higher NGDP. I thought MMTers also favored higher NGDP, I guess at least one does not."

      UPDATE: Dan says it was a mistake that the link wasn't working and it should work now.

      Dan does reply in the comments section:

      "How does this address my point about real wages Scott. My point was simple. If consumer prices go up while the nominal wages for a given class of people stay where they are, then there real wages go down. That point is independent of the cause of consumer price increase, and holds even if prices rise due to a boost in AD and GDP. Are you saying that people’s nominal wages will rise automatically along with prices and GDP?"

       "Dan, The effect of inflation on real incomes completely depends on whether it’s demand or supply side inflation. “Never reason from a price change.” If it’s higher aggregate demand, then any rise in prices occurs precisely because AD shifted right, which means real incomes also rise (Unless SRAS is vertical.) Are you assuming SRAS is vertical?"

         So who wins this argument? I will leave it for you to decide for now for I'm not entirely sure what I make of it all. I haven't really fully decided.  My feeling is that in a quick recovery, inflation is at least associated with it. Depressions and deep recessions like 1932 and 2008 are associated with deep asset deflation like Fisher and Minsky talk about.

        In 2009 we saw deflation and deep deflation in 1929-32. Certainly during this recessions we have heard way too much worry about inflation-Kervick is right that Krugman is right about criticizing the inflation hawks. However he argues:

        "working people have already suffered enough. It is absurd to support lower real wages for working people as a tool for getting to lower unemployment. The real incomes of workers have been falling for years, while the ratio of CEO to worker pay in America is now in the hundreds, and massive amounts of the nation’s productive wealth are skimmed off the top of our economy by a bloated and wasteful financial sector in the American plutonomy. If there is another approach to full employment – one that does not place the burden of assisting unemployed workers on the backs of employed workers who are struggling themselves – we should take it."

       I do agree that people have suffered enough. Still the people who would suffer something of a nominal wage cut actually have been suffering far less. Indeed, the point about sticky wages is that during a downturn employers are much less likely to cut the wages of current employees than to stop hiring new ones. In a way this talk about "public sector" employees is a misnomer-Cowen actually spoke not of public sector but "service sector"  workers which is badly named if he really means public sector service sector. Really higher inflation would cut the wages of private sector workers just the same, many of them with very high wages.

    

      Keynes too, for that matter argued-against the classical economists-that it is not illogical that workers are much more likely to fight nominal cuts than real wage cuts. Kervick's real point is that we should to the MMT idea of a Job Guarantee (JG) an interesting idea that I basically agree with-I'd like to see a return of the old Public Works Administration (PWA).

     The MMT proponents of the JG though seem to worry about inflation more than is called for-we have very little history of inflation in this country anyway. The 70s were a misnomer-the only time in our history we've seen meaningful peacetime inflation.

     The JG is an interesting proposal that I would recommend further reading on. They actually have their own "fiscal" rule-the JG itself-as the parallel to Monetarism's monetary rule. However the JG is a rule only to the extent that the wage paid to workers employed under JG are paid a flat wage that is not indexed to inflation-to avoid the Minsky style wage-price spiral. In the proposals I've read about, the wage paid to workers hired under JG-the government is the Employer of Last Resort (ELR) is $8. This wage is of course not very high-though somewhat higher than the official minimum wage of $7.25. It would not rise with the rate of inflation but would rise based on the fiscal rule-maybe every 5 to 10 years.

     http://www.levyinstitute.org/pubs/wp_706.pdf

    Again there is maybe too much concern about inflation. And I still believe that inflation is in some way a positive phenomenon either as cause or effect. After all was not America's greatest populist William Jennings Bryan a great inflationist?  Ultimately what makes things hard is not the natural rising cost of goods but when we don't have the jobs with healthy wages to pay for it.


    There are not many times in history that deflationary periods-where the cost of goods is falling that would therefore be assumed to be a positive for working people have not been deeply troubled economic times. Sumner makes the point that one example is the 20s-which he says buttresses his point that what matters is whether inflation/deflation is demand or supply based, If it's demand based then deflation is bad and inflation is good.