Selgin on Sumner 1

George Selgin's response to Sumner's essay on Cato Unbound was very supportive. It should be no surprise.

Like Sumner, Selgin is a monetary disequilibrium theorist, with some unique twists. Selgin edited The Fluttering Veil, Essays and Monetary Disequilibrium which is a collection of essays by Leland Yeager. When I bought it, some years ago, I looked through to make sure I had read all the essays included and then it sat on my shelf. With the start of the crisis, I began a review and began to see how much of my analysis of the crisis is right there in chapter one, "A Cash Balance Approach to Depression," an article written in 1956, the year I was born.

However, it is Selgin's own Theory of Free Banking that is must reading. His argument that the demand for reserves in a free banking system generates a market process that stabilizes nominal expenditure is an important contribution to both the monetary disequilibrium and free banking traditions.

Selgin comes out of the "Austrian" tradition, and this shows in his comment. He gently criticized Sumner for failing to consider how an expansive monetary policy in the early part of the decade helped cause the housing boom, the end of which initiated the crisis. My understanding of Sumner's view is that monetary policy was too expansive during the middle of the decade, as shown by excessive growth in nominal GDP. Sumner, however, puts little weight on this as being a cause of the financial crises. Lending against overpriced homes to people who can't afford to make payments is likely to cause problems, even if there were no monetary policy mistakes. Further, monetary policy mistakes provide no excuse for lending against overpriced real estate to people who cannot afford to make the payments. That isn't to suggest that policy mistakes that create excess nominal expenditure growth are harmless. (Sumner and I pretty much agree on the above, I think. I am more likely to see what happened in the housing market as a speculative bubble than Sumner.)

Selgin's view that a higher trend rate of nominal expenditure growth is will lead to malinvestments is suggested as well. Selgin favors very slow growth in nominal expenditures, and so a deflationary trend for the price level. Sumner's view is that while the trend growth rate of nominal expenditure does have negative interactions with the tax system, he tends to be dismissive of arguments about malinvestment. My view is similar to Sumner's, though I prefer a 3% growth path for spending as opposed to the 5% growth path that he has been advocating.

I take concerns about malinvestment seriously, but see them as being associated with shifts in policy regimes as well as possible consequence of policy mistakes where the monetary authority and entrepreneurs make the same errors. Regardless, Selgin, Sumner, and I all agree that productivity changes (often called "supply-side shocks") should result changes in the price level, and so deviations from the trend inflation rate. Roughly, the growth path of nominal incomes remain unchanged. (It was Selgin's arguments that long ago convinced me that generating fluctuations in nominal expenditure to stabilize the price level in the face of supply shocks is a mistake, and that stable nominal expenditure is the better alternative. )

Selgin agrees with Sumner that engineering a disinflation during the fall of 2008 would have been very poor timing, when the banking system was already stressed because of the subprime mortgage crisis. For that reason, I had adopted Sumner's call for a return to a 5% growth path of nominal expenditure. However, as Selgin suggests in his comment, I am now inclined to accept fait accompli, and favor reflation back to what would have been a 3% growth path and carrying on from there with price level stability.