Scott Sumner vs. Simon-Wren Lewis on Monetary vs. Fiscal Policy

     I'm always grateful when Keynesians of any stripe attempt to respond to Sumner because for the most part I think he's been underestimated by particularly the so-called New Keynesians-Wren-Lewis, Delong, Krugman, Noah Smith, et. al.

     In Sumner's relentless frontal attack on the use of fiscal stimulus he never gets tired of declaring 'the death of Keynesianism.' For the most part Keynesians themselves have been MIA which only emboldens him-kind of like what they say about terrorists.

     Krugman for his part has had very little to say about Sumner; presumably so as not to encourage him. I've found what little Krugman has said about him lately rather weak: basically Krugman argues that the Market Monetarists are wasting their time as they have no natural constituency. That depends on how you define natural constituency. True, the Tea Party House hardly seems open to any kinds of 'Monetarism' whether 'Market' or other. Nevertheless, Mr. Sumner has gotten a hearing in the conservative intelligentsia-on the National Review, by even Larry Kudlow who definitely speaks with some Washington Republicans and now Sumner even writes a regular column at Econolog.

     I don't know how you want to define constituency but Sumner doesn't define it as how many House Republicans he has on his speed dial; not unlike Keynes his target audience he claims is other economists. One of his favorite sayings-right

after 'the fiscal multiplier is roughly zero' is 'there is no such thing as public opinion.

     To a man he is only trying to reach economists so if he reaches them he has his constituency. As for a constituency that will support him, that's conservative economists and more broadly the conservative intelligentsia, and while I would agree they were slow to discover his virtues, they are noticing now. At the end of the day, Sumner understands that today's GOP is a somewhat more unreliable vehicle than the GOP that Milton Friedman rode in his day, so his agenda is not simply achieving Republican control-he hopes to be able to shape the thinking of economists and so their advice to policymakers in what economists call 'the Long Run.'

    Even though I think Krugman needs to do more to really call out Sumner I appreciate any attempts. I did convince Delong to write a piece awhile back. I thought some of his points were good but Sumner as usual just ignores the criticisms he can't answer and as his opponents are much less determined not much happens.

   http://diaryofarepublicanhater.blogspot.com/2014/01/sumner-vows-to-bash-anyone-standing-in.html

    His promise to 'bash anyone standing in my way' is real but at the end of the day Nkers have been slow to recognize this. When Krugman says things like 'People who believe like me and follow standard economics and the IS-LM model; we got a lot of things right in this Lesser Depression' Sumner will swoop in with his childish jibes about a 2013 bet he allegedly won-because growth didn't fall of a cliff there was nothing wrong with doing the sequester.

   In any case, Wren-Lewis's questions Sumner's attack on fiscal stimulus-the zero fiscal multiplier, full monetary offset, etc.-Sumner has at times 'suggested'-one thing that makes him so clever is he so rarely asserts these things merely 'suggests'-that the multiplier could even be negative-seems to me to be handicapped from the start-ie, harder for him to gain traction with.

    What strikes me with NKers is much less their disagreement with MMers but just how much they agree on. They all agree on Long Run Monetary Neutrality and all agree that in normal times monetary policy is superior to fiscal as a stabilization tool. This is why Sumner doesn't see his agenda as such a lift. Basically NKers-who could easily be called New Monetarists-ie, NMers-don't usually like fiscal stimulus either. Only at the ZLB does this change. I wonder with so much agreement how easy it will be for them to disagree effectively here.  Here is WL on the consensus  for monetary policy.

    Suppose there is a shortfall in aggregate demand associated with a rise in involuntary unemployment in a simple closed economy with no capital. Do we try and raise private consumption (C) or government consumption (G)? If the former, why do we prefer to use monetary policy rather than tax cuts?

If consumers have stable preferences over privately and publicly produced goods, then ideally we want to keep the ratio C/G at its optimal level. So if the aggregate demand gap is caused by a sudden fall in C, we will want to do something to raise C. As real interest rates are the price of current versus future consumption, the obvious first best policy is to set nominal interest rates to achieve the real interest rate that gets C to a value that eliminates the consumption shortfall. That is the basic intuition behind the modern preference to use monetary policy as the stabilisation instrument of choice: part of what I have called the consensus assignment.

       http://mainlymacro.blogspot.com.br/2014/08/filling-gap-monetary-policy-or-tax-cuts.html

      Nevertheless while WL prefers conventional monetary policy to fiscal normally, at the zero bound this changes. In reading WL's post I knew Sumner would quibble. One thing, of course, is that WL focuses on QE which is not Sumner's optimal unconventional monetary policy.

    
Debates over monetary policy should not be debates over QE.  The discussion should focus on what policy regime is optimal.  An optimal policy regime would probably not involve any QE at all. And even if it did, it would still be less inefficient than fiscal stimulus. That was my point.  (Remember that the “advance to consumers” must eventually be clawed back via distortionary taxes.)

One way of stimulating demand when interest rates are stuck at zero is to promise a combination of higher than ideal inflation and higher than ideal output in the future. (This can be done either explicitly or implicitly by using some form of target in the nominal level of something like nominal GDP. For those not familiar with how this works, see here.) The cost of this policy is clear: higher than ideal future inflation and output. Once again, these costs can be worth it because of the severity of the current recession, which is why nominal rates are stuck at zero. Whether these costs are greater or less than the cost of changing government spending is debatable: a paper by Werning that I discussed here suggests optimal policy may involve both.

Given that inflation doesn’t matter at all, it is hardly possible for it to be above or below “ideal” levels.  People who talk about the welfare costs of inflation are confusing inflation with NGDP growth.  There are welfare costs of excessive long run NGDP growth, primarily excess taxation of nominal returns on capital. But inflation by itself does not have important welfare costs.  The only possible inflation cost is the “menu costs” of price changes, but even that is unclear, given that nominal wage changes also involve menu costs.  Thus a NGDPLT policy minimizes both the “welfare cost of inflation” and the problem of suboptimal output fluctuations.  There is no trade-off. NGDPLT also reduces financial sector instability, relative to inflation targeting.  It’s a win-win-win policy.

     http://www.themoneyillusion.com/?p=27456

     Is Sumner claiming that fiscal stimulus will later be taxed back on a 1 to 1 basis from taxpayers? If so, evidently he's unselfconsciously assuming full Ricardian Equivalence. However, it's true that WL fails to notice Sumner's critique of the concept of inflation. Is he unaware of it? Sumner's premise is that NGDP targeting is superior to inflation targeting as there is what you might call 'good inflation' or 'bad inflation' or more precisely there is supply side and demand side inflation. NGDP targeting would prevent the CB from targeting the 'wrong' kind of inflation or for that matter the 'wrong' kind of deflation. When NKers like Krugman say we need higher inflation, Sumner's answer is that what they mean is higher demand side inflation or better yet, higher NGDP.

    Now by not noting this, WL kind of makes it easy for Sumner to dismiss him-in reality this is besides the point at issue here-whether or not unconventional monetary policy isthough  always and necessarily preferable to fiscal policy.

     In fact, as  Keynesian one probably could call for NGDP targeting and still ask for fiscal stimulus as part of the policy to meet this target. Krugman noted something like this a few years ago when he tentatively seemed to give NGDPLT his blessing.

    http://krugman.blogs.nytimes.com/2011/10/19/getting-nominal/?_php=true&_type=blogs&_r=0

    Here he seemed to accept that maybe an NGDP target might be politically acceptable-as most noneconomists suffer from what Nick Rowe calls the inflation fallacy. However, Krugman didn't touch on the point Sumner makes about supply side vs. demand side inflation. The selling point of NGDPLT is that the CB won't tighten like the ECB did in 2011 because of a temporarily spike in commodities-driving by the Japanese earthquake that year or the Fed tightening in 2008 because of the run up in the Summer of commodity prices-these were supply side spikes that had nothing to do with AD is the premise.

     However, none of this really effects the debate over fiscal vs. monetary. There's nothing to stop us from using fiscal policy to achieve a nominal target-just direct the CB not to 'offset' it-which is something that even if you listen to the words of Bernanke and the rest of the Fed, seems to have always been overstated.

     Sumner may say that unconventional policy should not be defined as simply QE but what else is really left? Simply expectations.

      The other argument Sumner makes that the NKers fail to respond to is that monetary policy is wrongfully conceived as changes in interest rates but that this is a Keynesian error. I think that the Krugmans, Delongs. and Wren-Lewises need to respond to this-and the supply side demand side of inflation point-to effectively engage Sumner's argument.