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What Is "Monetary Policy" and How Effective Is It?: Daniel Kuehn Is Remarkably Patient with Scott Sumner

"Fiscal policy" changes the total stock of government liabilities while keeping the quantity of outside money and the relative distribution of government interest-bearing liabilities unchanged. "Monetary policy" changes the quantity of outside money while keeping the total stock of government liabilities and the relative distribution of government interest-bearing liabilities unchanged. "Banking policy" changes the relative distribution of government interest-bearing liabilities while leaving the total stock of government liabilities and the quantity of outside money unchanged.

Daniel Kuehn gets righteous on these issues:

Facts & other stubborn things: Scott Sumner really needs to stop this: I've said in the past that Scott Sumner is probably starting to do more harm than good in getting solid monetary stimulus, because he tries to make it look like the advocates of monetary stimulus are a small group of rebels that everybody else disagrees with…. Recently this came up with respect to Brad DeLong's record on monetary policy, and predictably Sumner ends up promoting a nonsense history of it all. He selectively quotes Brad twice to make him sound like he was saying something he wasn't.

The first is this post by Brad criticizing Gary Becker - not for supporting monetary policy but for criticizing fiscal stimulus. Brad alleges that "monetary policy has shot i's bolt". Pretty damning huh? Except the part that Sumner fails to quote is Brad saying this directly before the "shot it's bold" sentence:

The difference between now and 1982 was that back in 1982 the interest rate on Treasury bills was 13.68%--there was a lot of room for the Federal Reserve to cut interest rates and so reduce unemployment via monetary policy. Today the interest rate on Treasury bills is 0.03%--there is no room for the Federal Reserve to cut interest rates, and so monetary policy is reduced to untried "quantitative easing" experiments.

In other words, not that monetary policy broadly speaking is useless but that what you might call the interest rate mechanism is no longer in play. He is clearly using "monetary policy" to refer to traditional monetary policy. This is the old Krugman argument about monetary expansion in a liquidity trap: not that it's no good. Monetary policy is very desirable in a liquidity trap. But a major mechanism through which monetary policy usually works (the interest rate) is unavailable, so it is weaker, less predictable, and lots of credibility issues are introduced. This and the zero lower bound make fiscal policy much more viable. That's very different from Sumner's claim that Brad was discounting monetary policy. Very different. And all Sumner had to do was not selectively quote.

The next instance of selective quotation is this post by Brad on Cochrane. This one is really outrageous on Sumner's part. He quotes Brad saying we "can't do any more of it", and tells us that Brad is talking about monetary stimulus, which he is - but only of certain sort. Again let's look at what Sumner decided not to quote Brad saying:

I distinguish between policies of:

  1. Pure inflation--the government prints up a lot of money and spends it to expand the outside monetary base and the total nominal value of outstanding assets to drive the price level up and induce a flight from nominal assets to real commodities.
  2. Monetary stimulus--the central bank buys short-term safe government bonds for cash.
  3. Credit stimulus--the central bank or the finance ministry do other things to increase the capitalization or otherwise improve the functioning of financial intermediaries or to reduce the amount or improve the characteristics of the credit-market assets that the private sector must hold.
  4. Fiscal policy--the government borrows and spends.

I think I know how to analyze (1), (2), and (4). I think we shouldn't do (1) (at least not yet). I think we have done (2) and can't do any more of it and expect it to have any effect. I think we should do (3) and (4) in some linear combination--but I have a hard time thinking about (3) because I am Bear of Little Brain.

Gee! Number one looks an awful lot like what Sumner wants, doesn't it? And it looks an awful lot what we would call "monetary stimulus". Once again "monetary stimulus" is used to refer to traditional monetary policy working through the interest rate. If Sumner actually quoted all of what Brad said, it would have been clear that once again Brad is saying the typical interest rate mechanism of open market operations isn't working like it usually does. But he still has other monetary policies on his list - specifically his first policy!

Now, he does say we shouldn't do "pure inflation" just yet, because as before it's highly uncertain and there are important credibility problems for central bankers in doing this. But Brad doesn't rule the first suggestion out nor does he say that we "can't" do that one (the way we can't do traditional monetary stimlus). It is the same argument as before. It is the Krugman argument for Japan. Credible commitment to inflation by the Fed would be fantastic but it's going to be tough and would be a lot easier if we did fiscal stimulus as well.

Once again - that's very different from what Sumner is claiming Brad and other Keynesians think. And once again, if Sumner didn't quote selectively, this would be blatantly obvious.

Brad keeps it brief in his statements in the other two links Scott provides (here and here), but he specifically cites the zero lower bound in the first one (suggesting that he is once again only referring to traditional manipulation of the interest rate). In the second one he quotes Jacob Viner, and I find it interesting - and a cautionary tale about what to expect from less traditional policies out of the Fed. He's quoting Viner pointing out that the Fed couldn't keep up with private credit contraction, which suggests that the Fed was running into the same credible commitment problems that Krugman has warned against repeatedly.

It's one thing to say "we need to target NGDP". Yes, that would be lovely, Scott. Nobody is disputing that. I could just as easily say "we need to target 3% percent unemployment". No arguments there! But a particular NGDP level is a goal. It is not an instrument and it is not a policy lever. Because of credibility problems or other obstacles it's quite reasonable to say that your policy lever (open market operations, for example) or your instrument (short term rates or reserve requirements) might not achieve the policy goal. This was Viner's concern and it's the Keynesian concern now.

We have tried it. We are afraid it's not going to be as successful as Sumner hopes. And we are stressing this point because there is the option of fiscal policy which can help monetary policy get traction and actually assist in pulling us out of this.

Now Sumner may dispute that argument. He may choose to remain the monetary Pollyanna. That's fine - we need enthusiastic boosters. And that gives him something to legitimately argue about with the monetary Cassandras out there. It's true, Brad is not as sanguine about the Fed as Sumner. But it's really not helpful for Sumner to be promoting this idea that Keynesians are somehow anti-monetary-expansion. If you tell the public and policymakers that a major, mainstream faction of economists thinks expansionary monetary policy is bad or useless you are going to reduce the likelihood of expansionary monetary policy. I fear that's what Sumner is doing right now.

Daniel is correct.