Thread by @eriktorenberg

Econ Twitter:

Tell me where the below is wrong or add nuance to some of the claims:

- Misconceptions around monetary policy
- Similarities btw 1929, 1990s (Japan), & 2008 & lessons learned
- Was post 1929 recovery b/c of or in spite of New Deal?
- Keynesian vs Austrian school

Misconception around monetary policy:

Interest rates are monetary policy.

Interest rates are affected by monetary policy, but they on their own don't provide a clear measure of the stance of monetary policy.

e.g People equate low rates w/ easy money & high rates w/ tight money

But in fact, easy monetary policies tend to result in high inflation

& that actually leads to very high interest rates

Other misconceptions flow from that misguided belief that interest rates are monetary policy—

e.g. That monetary policy is ineffective at zero interest rates

Mistake: "Reasoning from a price change":

Drawing conclusions from price or rates w/o thinking abt underlying reasons

Prices can be high for two reasons, demand can go up or supply can go down

And if prices are high, because supply went down, then yes, consumers will buy less.

But if prices are high b/c demand went up, then consumers will buy more.

Same w/ interest rates: they can change for many reasons.

One might be easy money.

Another might be b/c of changes in underlying economy, often due to a previous tight money decision which slowed economy

Another example of reasoning from a price change:

Wages are higher during prosperous periods.

Just like wealthy people tend to drive nicer cars.

But driving a Porsche doesn't make you wealthy, and artificially raising wage levels doesn't make it a prosperous period.

Bernanke as an academic agreed that interest rates nor money supply are good measures of the stance of monetary policy. (Instead, look at inflation & nominal GDP growth)

As head of fed he endorsed standard fed view that low interest rates were an accommodative monetary policy

Why does fed think this?

If you look at Great Depression or Japan in 90s, interest rates were ~zero.

Consensus view is they could have done so much more to to promote monetary stimulus and a rapid recovery

Some of it is an incentive problem:

It's cooler to do a lot of QE

The central banks that are actually doing the most stimulus appear to be doing the least because the stimulus creates enough economic growth where interest rates stay above zero & you don't have to do a lot of QE

Scott Sumner's recommended path is level targeting:

When inflation or nominal GDP fall below target, you promise to buy as many assets as necessary to get market expectations up to your target

Prefers GDP targeting over inflation targeting.

Similarities btw 1929 U.S., 90s Japan, and 2008 U.S.:

- Banking problems in all 3.
- Nominal interest rates fell ~0
- QE
- Deflation in 1929/1990, 0 inflation in 2008
- All caused by big drop in aggregate demand

How could we avoid bank failures?

Adopt Canadian system.

Like airplanes, after each crash Fed learns lessons & improves for the next one:

- after 1930s, don't allow deflation
- after WWII, don't bias towards too much inflation
- we've only had 3 recessions since 1982 (excluding today), had 8 recessions in previous 37 yrs before that

Why Stagflation in 70s?

Misunderstood Phillips Curve: we thought you could buy unemployment with higher inflation, but that only works temporarily. So ended up w/ higher of both

Interest rates were high, we thought money was tight, & we thought it wasn't monetary policy's fault

But in fact, interest rates were high because inflation was high

Real problem: We were printing money at too rapid rate that was generating inflation & ultimately pushing up interest rates

Learning: we had to raise interest rates by more than inflation to bring inflation down

Last major challenge to solve is how to keep unemployment from spiking during a recession.

(see another thread soon about COVID)

Was post 1929 recovery b/c of or in spite of New Deal?

Hard to say. Anytime you spend a ton on, say, military, you'll increase employment

You could argue National Recovery act (e.g price controls) inhibited the recovery

Dollar devaluation & nothing else could have done the job

Keynesianism & Monetarism go in and out of style:

During high inflation, monetarist ideas get popular.

During deflation & zero interest rates, Keynesian ideas win out.

In 1920s, we were printing money but weren't having much inflation bc ppl hoarded cash so ppl left Monetarism

Monetarism came back in 1960s to help keep high inflation under control.

Then long era of stability under New Keynesianism (synthesis of 2), until 2008, when we went to deflationary zero interest rate environment.

Old Keynesianism returns (fiscal stimulus over monetary policy)

Keynesianism has survived critics:

Critics said if you borrow a lot, you'd push up interest rates and crowd out private investment.

But stimulus efforts didn't result in high inflation, or some of the problems people worried about with QE

Analogy for thinking about Keynesianism v Austrian economics:

Consider business cycles as Grand Canyon:

Keynes approach is to fill in the canyons so that the ground is flat

Austrian way: look at flat land with mountains sticking up occasionally and do the mountains as excesses

Keynes: Business cycle is caused by periods of low activity, and you need to raise activity up to the strongest the economy can support. Booms are normal.

Austrian: Business cycle is caused by excessive exuberance & malinvestment. Booms are outliers and must be reset.

Two types of left wing economics:

1/ Statism & Nationalization

2/ Income redistribution.

Nordic countries have the latter not the former.

Venezuela has the former not the latter.

Austrians want to go back to the gold standard, but it's not feasible.

A big increase in the global demand for gold can mess things up.

/FIN

Learned this from reading & talking to Scott Sumner, Bryan Caplan and listening to EconTalk & Macro Musings

Example of this in action, by @shreyas

medium.com/@shreyasdoshi_…