I do think the Fed is more agile, but the decisive factor is that the Fed is much stronger. If you want a metaphor. . .imagine I’m driving my car and my 6-year old daughter pushes the steering wheel to try to change direction. I’d simply push back more strongly.
Read the whole thing.
Also, you should read Scott’s post on bond market vigilantes.
The 1990s were a successful period for monetary policy. . .We can infer from stable 2% inflation that the actual interest rate stayed pretty close to the natural interest rate during the 1990s.
Scott is fond of saying “Never reason from a price change.” In Fantasy Intellectual Teams, if other players use that, his owner will score M points.
The way I understand this maxim is that prices are an endogenous variable that can be affected by many things. So you cannot safely draw inferences from a price change without knowing more about what went on.
If we generalize the rule to say that you cannot safely draw inferences from changes to endogenous variables, then Scott violates his own rule promiscuously. Take the quoted passage, for example. Can we safely infer that because inflation was stable that the interest rate stayed pretty close to the natural rate?
It sounds like Scott is providing an explanation for the low inflation of the 1990s, based on a concept called the “natural rate of interest.” But the natural rate of interest is something that we cannot observe. It plays a role in macroeconomics that is analogous to the role played by “systemic racism” in Critical Race Theory.
For Scott to convince me of monetary dominance, I would like to see him reason from an observable definition of loose money or tight money. Saying that an episode of slow growth in nominal GDP proves that monetary policy was tight is convincing to someone who already believes in monetary dominance, but not to a skeptic.
A few more remarks:
1. I think of inflation as determined by the behavior of paper wealth relative to real output. If wealth grows rapidly and persistently relative to real output, then eventually consumer prices will increase markedly. The sort of deficit spending we have undertaken in 2020 and 2021 has added a lot to paper wealth and nothing to output. So watch out.
2. I think that most of the time neither fiscal policy nor monetary policy has much effect on paper wealth.
3. My story for Japan is that before the government started creating lots of paper wealth, a lot of paper wealth got destroyed in the collapse of Japanese real estate and equity prices. So Japanese consumers were not flooded with wealth on net.
4. I think that the government can monetize a fair amount of debt and get away with it, as long as it looks as though it will collect enough future taxes to pay off bondholders. It’s when the government has no choice but to monetize that things get ugly. And it’s up to bond investors to calculate when the government is going to have no choice, and to try to sell their holdings before that perception becomes widespread. That is the sort of sovereign debt crisis that you really don’t want to go through.
>—“3. My story for Japan is that before the government started creating lots of paper wealth, a lot of paper wealth got destroyed in the collapse of Japanese real estate and equity prices. So Japanese consumers were not flooded with wealth on net.”
This is an excellent point (and analogous to how Fed money creation after the Great Recession replaced massive wealth destruction in the American shadow banking system) but it raises the question of why those bubbles didn’t cause more inflation when they were at their peaks.
I don’t have any really strong views on how to understand inflation. I think it is clearly the most poorly understood area of modern economics and so I appreciate this series focussing on the topic. My intuition is that demographics plays a bigger role than it is usually given credit for.
“Paper wealth” is the key that traditional economists are missing. I believe monetary policy can affect nominal paper-wealth, but not real paper-wealth. The problem is what’s real vs nominal can’t be observed in real-time. All wealth feels like real wealth until some point in time when such wealth tries to convert into goods & services. If too much nominal wealth was created, you will experience inflation. As long as the “velocity of wealth” (desire to spend wealth) remains low (as it does today), you can create vast amounts of paper wealth with no obvious repercussions.
If/when the velocity of wealth of increases, we test the system. We may find that we have less real wealth than we perceived. To keep inflation under control we will need to destroy previously created paper wealth. In theory, that’s doable. In reality, it may not be. Since nominal wealth is perceived as real: 1) it is politically very unpopular to have nominal wealth destroyed, 2) falls in nominal wealth may coincide with temporary falls in spending as the uncertainty “freezes” things- but since we don’t tolerate temporary falls in spending, nominal wealth essentially cannot be allowed to fall.
This doesn’t even get into the inter-generational point. If all wealth is claims on the same set of future goods/services, pushing up the ratio of wealth:gdp simply brings wealth forward with all sorts of political repercussions as it massively benefits some age cohorts over others.
I worry that we are actually pretty bad at measuring real GDP while we are at it. As the number of goods with extremely low marginal cost increases, I suspect the GDP factory model breaks down harder and faster. I am mostly pondering out loud here, but so long as people are trading money for near zero marginal cost goods and then sitting on the cash (i.e. not spending it on goods with much greater than 0 MC) it seems like you can increase the amount of money without changing prices a great deal, until the MC of those low MC goods increases. As soon as people stop sitting on the cash and start trying to purchase higher MC goods, then I would expect prices to skyrocket.
Put another way, I worry that inflation hides behind demand for goods with very flat supply curves. As soon as demand shifts away from those to goods with “normal” supply curves, all that inflation is suddenly revealed.
I wish more economists thought hard about “I see X = Y; what possible combination of variables might cause X = Y, and how do I know which might be doing it?” Observational equivalence is way under rated within the macro profession, especially.
You shouldn’t let Scott get away with declarative statements like ‘we had stable 2% price inflation during the 1990s’, you only get this result if you are allowed to select a definition of inflation. Consumer prices for example ran between 1.5% (1998) and 5.5% (1990) during the 1990s with only 3 years between 1.5 and 2.5%. If you use the trimmed mean pace rate then you also don’t have stable 2% inflation, you have falling inflation in the first years of the decade from ~4% down to 1.6% in 1998. PCE consumption less food and energy is likewise also not stable, starting at over 4% and dropping to under 1% at the low (annualized).
The 90s being a stable inflation environment was selected ex post- Texas sharpshooter style. The average ended up looking OK, and then that average was used to project forward as ‘the new normal’ as if the Fed has predicted and expected that range of inflation going in. However the Fed was not expecting the great moderation, it was a surprise to them and they were at a loss to explain it at the time. It was only after it persisted for a while that they started to take credit for it and claim that they could control inflation this way going forward… which was shortly thereafter demonstrated incorrect by the GFC and the following low inflation decade.
“Can we safely infer that because inflation was stable that the interest rate stayed pretty close to the natural rate?” Yes, that will be true by the definition of ‘natural rate’. Since the natural rate is unobservable, no observation can upset this inference. Your complaining about it suggests misunderstanding on your part.
Where is the money-printed money from the Fed going? It’s not inflation, not yet.
The prior inflation post on Tyler is relevant, where he is only technically correct when he says about how smart folks (like me) are wrong:
The latest example is the claim that current inflationary pressures are somehow being “captured” or “locked up” in asset prices,
The pressure of more money is not trapped (Tyler tech right), it’s being invested by the rich in assets (Tyler’s spirit wrong) because
a) they don’t want to spend/consume it to buy more stuff, and
b) in comparing ROIs of alternatives, including non-monetary benefits, they choose to put more of their own savings glut cash into assets. Including art, jewels, crypto, but especially Blue Chip stocks and housing in nice, low-crime low-poverty areas.
Tyler mentions Weimar & Venezuela (tho not Zimbabwe) – where there were shortages of consumables. My new
“Grey’s Hyper-inflation Law” – no hyperinflation without shortages of food.
I’m certain Tyler is wrong for US & Japan when he says:
If for instance equity prices are very high relative to food, people will sell equities and buy more food,
Today equity prices are very high relative to food, but nobody is selling equities to buy more food – because there is plenty of cheap food. I’m pretty sure both Weimar and Venezuela had higher relative prices of food – because there were shortages of food. A failure of the economic system to produce enough food. And hungry people sell equities for food. That’s something needed for actual hyperinflations. Functioning Market economies since WW II haven’t generally failed to produce enough food.
The Casey Mulligan article seems more an excellent argument against UBI, with the virus stimulus as a semi-proxy for Universal Income.
President Biden’s $1.9 trillion Covid-relief package is being sold as an effort to “get America back to work.” It will do the opposite. We estimate that between five million and eight million fewer Americans will be employed over the next six months if the bill passes.
It’s also falsifiable, which should be a huge advantage in FIT. But I suspect it will be falsified, depending on the measuring process for “working”. Yet in the context of domination, it’s more Fiscal than Monetary, as Arnold is thought-arguing with Scott Sumner.
When the money is given to investors, they invest in assets. When given to consumers, they buy stuff – and if their buying is “enough” that causes price rises. Otherwise it just gives more profit to companies, and their rich investor owners who have … more money to invest. In assets.
Scott is correct in his conclusion:
Almost every major school of thought—monetarist, Keynesian, and Austrian, etc.—believe that monetary policy has a major impact on nominal variables.
This is not quite saying Monetary policy is dominant, tho it’s close.
Nor does this answer about where the printed money is now going
While Arnold doesn’t agree with all of Scott, he probably concedes that monetary policy is important, tho less dominant.
1) If wealth grows rapidly and persistently relative to real output, then eventually consumer prices will increase markedly. This seems to have been true in the past, but history has never had a real “savings glut”. We might have one now, which might mean that paper wealth (= wealth?) can keep growing faster than material (maybe not quite “real”, but at least tangible), without milk prices increasing faster than 2% (has been about 1.6% for last decade).
2) I’m sure both fiscal (who gets how much gov’t money, like Solyndra) and monetary (how much total money in economy) have major influences on both paper and real wealth. Arnold flat out wrong here.
3) Excellent point on Japan. I recall incredulously reading that Tokyo real estate in 1989 was more valuable than … the ENTIRE USA. When it crashed, the gov’t refused to let most banks fail, so they’ve been on slow working out for the last 3 decades … and more to come.
4) It’s when the government has no choice but to monetize that things get ugly. Maybe – tho I claim it is when the economy is failing to provide real food to real people at nominal prices that the people can really afford. If real economic failure gives the gov’t “no choice”, that confirms the statement. But if the economy is not failing, the gov’t will still have other choices?
Are the huge gov’t spending deficits going to cause inflation soon? We could use better “pundit” prediction markets.
Tyler is correct to ask any inflation hawk (like Arnold? nah; but also not a dove. Maybe Arnold is an inflation parrot? parakeet? pigeon? 50% no big inflation thru 2027)
Whenever someone tells me that much higher rates of price inflation are imminent, I ask a simple yet obnoxious question: “Have you shorted the long bond?”
Rich investors, and their highly paid financial advisors, currently don’t think big inflation is coming to the USA soon.
Prof. R.A. Werner shows {in his book, New Paradigm in Macroeconomics} that government spending will only increase nominal GDP if the government finances the spending by borrowing the {new} money from the private banking system or is financed by money created by the central bank. Government spending financed by borrowing from the public will have very little effect.
If not financed by borrowing from a bank or from the central bank, fiscal policy will be offset by falls in other components of aggregate demand. This is because the velocity of the real circulation is relatively constant.
‘ . . . whereby the coefficient for ∆g is expected to be close to –1. In other words, given the amount of credit creation produced by the banking system and the central bank, an autonomous increase in government expenditure g must result in an equal reduction in private demand. If the government issues bonds to fund fiscal expenditure, private sector investors (such as life insurance companies) that purchase the bonds must withdraw purchasing power elsewhere from the economy. The same applies (more visibly) to tax-financed government spending. “With unchanged credit creation, every yen in additional government spending reduces private sector activity by one yen. “ ‘
The empirical results for the Japanese case have been unambiguously supportive. The Japanese asset bubble of the 1980s was due to excess credit creation by banks for speculative purposes, largely in the real estate market. The apparent velocity decline is shown to be due to a rise in credit money employed for financial transactions, while the correctly defined velocity of the real circulation is found to be very stable. . . .
As for favouring private credit creation, he is in favour of this as, bank credit creation for “transactions that are part of GDP, has been identified as the main determinant of nominal GDP growth.”‘
http://eprints.soton.ac.uk/339271/1/Werner_IRFA_QTC_2012.pdf
See also? https://professorwerner.org/wp-content/uploads/2018/10/KK-97-Disaggregated-Credit.pdf