Simon Wren-Lewis and Nick Rowe Annoy Each Other…: Friday Focus for August 1, 2014

Simon Wren-Lewis and Nick Rowe annoy each other by arguing over whose position is more politically hopeless, as well as whether the right way to think of aggregate demand deficiencies is as:

• being always and everywhere and monetary phenomenon.
• being somewhat more complicated–usually but not always a monetary phenomenon.

I am going to wait and wait in only at the bottom, After both have had their say…

Start with Simon Wren-Lewis:

Simon Wren-Lewis: What annoys me about market monetarists: “The main point Paul [Krugman] was trying to make…

…was about how far the Republican base were on monetary policy from anything reasonable…. By implication, neomonetarism was something more reasonable, although he had well known problems with its ideas. So a sort of backhanded compliment, if anything. Nick responded by pointing out that what he called neofiscalists (those, like me, who argue for fiscal stimulus at the Zero Lower Bound (ZLB)) hadn’t done too well at finding a political home recently either. Which, alas, is all too true, but I think we kind of knew that…

Indeed. Nick Rowe starts:

Nick Rowe: Neofiscalist delusions?: “It seems I need to respond to Paul Krugman…

…The neomonetarist movement starts from an acknowledgement of reality: shortfalls of aggregate demand do happen, and they do matter, and we need an answer. Like the original monetarists, however, they reject any government role in the form of discretionary fiscal policy. Instead, they argue that the Fed and its counterparts can do the job all on their own if they really want to.

OK. That’s me…. But there’s absolutely nothing “neo” about that policy position. It’s the neofiscalist position that is new. What I call a “neofiscalist” is exactly the same as what Paul calls a “neomonetarist”, except at the Zero Lower Bound. When the central bank hits the ZLB, neofiscalists throw up their hands in despair, and call for fiscal policy to manage aggregate demand…. Is there any constituency for their ideas in the modern (US?) left-of-centre movement? Well, if we look at actual existing fiscal policy by an actual existing modern US left-of-centre government, I think the answer is “no”….

Yes, “conventional” monetary policy right now means keeping expected inflation constant at 2%…. So what? A century ago, “conventional” monetary policy meant keeping the dollar price of gold constant. If we had been targeting NGDP for the last 20 years, inflation targeting would seem far beyond “conventional” monetary policy. And which is riskier? Having the central bank hold “unconventional” assets? Having the central bank hold an “unconventionally” large balance sheet of both assets and liabilities? Changing the monetary policy target so central banks don’t need to do either of those things? Or having a government needing to make large changes in its debt liabilities that are unrelated to the other objectives of fiscal policy?… Targeting a fixed and pre-announced level-path for NGDP is no more “activist” than targeting inflation, or targeting the price of gold….

The neomonetarist home is with anyone who is prepared to think radically…. Neomonetarism is a radical position. We want to get to the root of the problem of insufficient aggregate demand. We see aggregate demand as a monetary phenomenon, that only makes sense conceptually in a monetary exchange economy. And we see insufficient aggregate demand (just like an inflationary surfeit of aggregate demand) as due to an underlying failure of monetary institutions…

And Simon-Wren Lewis continues:

What interests me is how annoyed each side gets with each other…. I will use the label market monetarist (MM) rather than neomonetarist. It seems to me that I understand a little why those in the MM camp get so annoyed with those like me who go on about fiscal policy. Let me quote Nick:

We don’t like fiscal patches that cover up that underlying problem. Because fiscal policy has other objectives and you can’t always kill two birds with the same fiscal stone. Because we can’t always rely on fiscal policymakers being able and willing to do the right thing. And because if your car has alternator trouble you fix the alternator; you don’t just keep on doing bodge-jobs like replacing the battery every 100kms…

In their view, the proper way to do stabilisation policy outside a fixed exchange rate regime is, without qualification, to use monetary policy. So the first best policy is to try every monetary means possible, which may in fact turn out to be quite easy if only policymakers adopt the right rule. Fiscal policy is a second best bodge. MM just hates bodgers…. The situation is not symmetric. I do not get annoyed with MM because I think monetary policy is a bodge. I have spent much time discussing what monetary policy can do at the ZLB, and I have written favourably about nominal GDP targets. But, speaking for just myself, I do get annoyed by at least some advocates of MM….

To understand why I do get annoyed with MM…. We are going downhill, and the brakes do not seem to be working properly. I’m sitting in the backseat with a representative of MM. I suggest to the driver that they should keep trying the brake pedal, but they should also put the handbrake on. The person sitting next to me says:

That is a terrible idea. The brake pedal should work. Maybe try pressing it in a different way. But do not put on the handbrake. The smell of burning rubber will be terrible. The brake pedal should work, that is what it is designed for, and to do anything else just lets the car manufacturer off the hook. Have you tried pressing on the accelerator after trying the brake?…

When you have a macroeconomic disaster, with policymakers who are confused, conflicted and unreliable, you do not obsess over the optimal way of getting out of the disaster. There will be a time and place for that later. Instead you try and convince all the actors involved to do things that will avoid disaster. If both monetary and fiscal policymakers are doing the wrong thing given each other’s actions, and your influence on either will be minimal, you encourage both to change their ways…. Nick says we can’t always rely on fiscal policymakers being able and willing to do the right thing. But since at least 2011 we have not been able to rely on monetary policymakers…

I am on Simon Wren-Lewis’s side, and am in fact even more on his side than he is. The way I like to put it is to move into a Walras’s Law framework and say that a deficiency in demand for and hence a general glut of currently-produced goods and services can be the result of any one of three things:

1. A shortage relative to demand of the stock of the liquid medium of exchange, with no fundamental mismatch in the supply and demand of either savings vehicles as a whole or of risk-bearing capacity.

2. A shortage relative to demand of the stock of safe assets, of which the stock of the liquid medium of exchange is an important component, because of the inability of private financial intermediaries to mobilize the risk-bearing capacity of society and do the risk transformation to match the profile of the assets they can create to the assets that safety-loving wealth-holders wish to hold.

3. A shortage relative to demand of savings vehicles as a whole, of which the stock of the liquid medium of exchange is an important component.

In the case of (1), conventional interest rate-based monetary policy works. Liquid cash is at a premium relative to longer-duration safe nominal assets–short term interest rates are high–and so the central bank can rebalance the economy and boost demand for currently-produced goods and services back to where it should be by swapping cash for longer-duration safe nominal assets.

In the case of (3), conventional interest-rate based monetary policy will not work. All savings vehicles are at a premium relative to currently-produced goods and services–all along the risk spectrum interest rates are low–but there are not enough positive net present value investments to satisfy current wealthholders’ desires to move purchasing power from the present into the future. Conventional monetary policy that swaps liquid cash for short-term safe nominal assets cannot help unless and until it summons the Inflation Expectations Imp and so makes interest rates at the zero interest rate lower bound consistent with the configuration of real interest rates across the risk spectrum that corresponds to the current Wicksellian natural rate. The neo-fiscalist question in such a situation is “why bother”? Why not just have the government borrow (through issuing either bonds or money) and spend? Yes, the better monetary policy rule might well have kept the economy from being wedged. But once the economy is wedged, what is the gain to circling Robin Hood’s barn and de-anchoring inflation expectations?

In the case of (2), the key shortage is not of the stock of the liquid medium exchange per se or an elevation of the entire risk spectrum of real interest rates above the Wicksellian natural rate because of the zero lower bound, but rather the inability of financial intermediaries to raise enough capital and trust to do the risk transformation. The consequence is safe interest rates at or below their first-best Wicksellian natural values and risky interest rates well above their first-best Wicksellian natural values. In this case a resort to monetary expansion–even if the economy is away from its zero interest-rate lower bound–provides incentives to invest too much of society’s wealth in long-duration assets, with the added complication that the financial sector has a difficult time distinguishing A valid long-duration asset from a Ponzi scheme because neither requires the investors be shown the money in any serious way. In (2), there is a case for fiscal policy–for the government as financial intermediary and mobilizer of risk-bearing capacity–even if the economy is away from the zero interest rate lower bound.

By ruling out (2) and (3)–or, rather, by claiming that there is nothing problematic either in the de-anchoring of inflation expectations, in incentives to create long-duration assets about de-anchoring inflation expectations, or in attaining policy credibility in the summoning of the Inflation Expectations Imp needed to solve (2) and (3) by monetary policy alone–I think that the neo-monetarists and the market monetarists do us no good service…

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