Saturday, 18 January 2014

Market monetarism is nonsense.

I’ve spend some time recently investigating Scott Sumner’s Market Monetarism (MM). That is, I’ve queried several of his pro-MM / anti-fiscal policy claims. In fact we’ve exchanged about 3,000 words.
I’ve no quarrel with what is perhaps the main element in MM, namely NGDP targeting. However NGDP targeting is not a new idea. Plus some central banks actually adopt some elements of NGDP targeting even when they don’t officially adopt the idea in full. E.G. the Bank of England over the last few years has let inflation stay above the 2% target because they thought the cause was cost push rather than demand pull. But other aspects of MM don’t stand inspection, so I’ve set out below five ways in which Sumner goes off the rails.

1. There is Sumner’s claim that the fiscal multiplier is zero because the central bank will always offset fiscal policy. I dealt with that point here.

2. Sumner doesn’t understand that monetary policy is DISTORTIONARY. (Search for “distortion” in the comments here.) That is, having the CB print money and buy assets (mainly government debt) channels money into the pockets of a relatively small section of the population: the asset rich. They then use the money mainly to buy close substitute assets, e.g. shares, and that helps explain the good stock market performance over the last year or so.

In contrast, the spending and income of the asset poor (i.e. Main Street) and by government is not much affected. Fiscal policy on the other hand can boost spending by ALL SECTONS of the population and by government (or at least it can aim to do that, and there’s no reason fiscal policy should not be reasonably successful there.)

The decision to boost government spending is of course a political one, but fiscal policy offers that option, whereas monetary policy does not.

3. Sumner falls for the old myth that fiscal policy is defective because funding fiscal stimulus involves the CB / government machine going into debt (and/or issuing more base money) and that debt or base will need to be clawed back via extra tax in the future.

However that idea flies in the face of the facts. For example, the federal debt in the mid1970s was about $1.5tr and in 2010 it was about $9tr. I.e. that $1.5tr was never repaid. What happened was that it was eaten away by inflation, plus economic growth reduces the debt/GDP ratio. In fact the very large debts that Uncle Sam had incurred at the end of WWII were never repaid: they were whittled away by inflation, plus economic growth helped cut the debt/GDP ratio.

But even if there were no inflation and no growth and the debt and/or new base money that funds fiscal stimulus is subsequently withdrawn via tax, what of it? The only SENSIBLE time to withdraw is when the economy is overheating, i.e. when the withdrawal is required so as to prevent excess inflation. I.e. the tax does not make anyone WORSE OFF. Quite the reverse: it makes them better off in that it prevents excess inflation.

4. On the subject of the latter taxes, Sumner claims that taxes are distortionary. (Search for “distortion” here.)

Well obviously they CAN BE (e.g. a tax on people over 6ft tall). On the other hand adjusting taxes on EVERYONE’S income (up or down) would be pretty distortion free.

5. In order to show monetary policy in a good light, Sumner’s comparison between the two policies is blatantly loaded in favour of monetary policy. I dealt with that point here.


P.S. (21st Jan 2014). For an explanation as to what Sumner means by “monetary offset” (in his own words) see this Mercatus article by him entitled “Why the Fiscal Multiplier is Roughly Zero”.

PS (25th July 2014). Later in 2014, two other articles appeared criticising market monetarism. One by Tony Yates and the other by Simon Wren-Lewis (entitled “What annoys me about market monetarists”).


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