Saturday, January 4, 2014

The "Test" of Market Monetarism

Scott Sumner's first post on Econlog was about the "test" of Market Monetarism.   Market Monetarists have generally taken the view that monetary policy, broadly understood, is able to keep spending on output on a target growth path regardless of fiscal policy.   In particular, fiscal austerity can be offset.

Sumner had already commented on Paul Krugman and Mike Konczal's prediction  that the fiscal austerity in 2013 would throw the economy into recession along with their statement that it would provide a test of the Market Monetarist claim that the Fed can offset the effect of such a contractionary fiscal policy.    Sumner has generally been of the view that the Fed would in fact provide a monetary offset.

My own view is that the Fed could do so, though what it would do was more uncertain.    Until the Fed targets a growth path of nominal GDP, I don't see that there has been a test of Market Monetarism.

Sumner claims that Market Monetarism passed the test with flying colors.   He says that nominal GDP growth was about the same in 2013 as 2012.

 NGDP grew by 3.8% between 2011:4 and 2012:4, and is growing by 4.0% so far during 2013 (the fourth quarter is also expected to be strong.)  That's not much better than 2012, but market monetarism wins even if the two numbers are about equal.

Konczal linked to the following graph:

Bob  Murphy commented on the debate and implies that it certainly looks like nominal GDP growth is especially low during 2013.    The data presented here is growth from one year before.  The data is quarterly, but only the year is on the horizontal axis.  

So, fourth quarter 2012 NGDP growth was extra low and third quarter 2013 NGDP growth was quite high.    
Admittedly, Sumner often follows the modern economic convention of focusing on growth rates.   In my view, the last five years has shown that a narrow focus on growth rates is a mistake.   Instead, it is important to look at levels.
Let's return to the typical Market Monetarist diagram:
Nominal GDP remained on a remarkably stable growth path during the Great Moderation.   The recession that began at the end of 2007 was nothing unusual, but then there was a substantial drop in nominal GDP, and rather than return to its previous trend, it seems to have shifted to a substantially lower growth path that has a slightly lower growth rate.   Focusing on the slightly lower growth rate ignores the real problem--the lower level of nominal GDP.  

The following diagram focuses on the Great Recession and snail-paced recovery.  
All of the focus on growth rates is really just the minimal fluctuations around this new trend.   The growth rate is 4 percent rather than the 5.4 percent of the Great Moderation.   (Sumner's 5 percent target adds the trend growth rate of potential output during the Great Moderation, 3 percent, with the 2 percent inflation target favored by modern central banks.   The actual trend was slightly more than 5 percent.)
Here is a close-up of the variation of nominal GDP from its new trend:
The largest deviations from this trend are .6 percent of nominal GDP.    During the third quarter of 2012, nominal GDP was .6 percent above trend.    By the second quarter of 2013, it was .6 below trend--a slightly more than 1 percent change.   And by the third quarter of 2013, it was almost at trend (.1 percent below.)   
Looking at Market Monetarist diagrams, it looks like fiscal austerity has a small (approximately 1 percent) negative impact on spending that lasted less than a year.  
In truth, I wouldn't expect much better if the Federal Reserve were explicitly targeting nominal GDP one year in the future.   But perhaps I should.
The problem is that the Fed's discretionary forward guidance with reference to the unemployment rate and inflation is not generating an adequate nominal recovery.   I think the economy needs a Reagan/Volcker recovery.   A year of 10 percent nominal growth.   And one year from now, that should be the start of a new target growth path.   While I would prefer 3 percent, the current 4 percent growth rate wouldn't be too bad.   In my view, it would be better than 5 percent much less the 5.4 percent of the Great Moderation.


  1. "Admittedly, Sumner often follows the modern economic convention of focusing on growth rates. In my view, the last five years has shown that a narrow focus on growth rates is a mistake. Instead, it is important to look at levels".

    Right you are:

    1. You have a long list of posts emphasizing the importance of levels. Good!

  2. His name is Bob Murphy, not Mark Murphy.

  3. Paul Krugman:
    “…Incidentally, these other factors are why I don’t take seriously the claims of market monetarists that the failure of growth to collapse in 2013 somehow showed that fiscal policy doesn’t matter. US austerity, although a really bad thing, wasn’t nearly as intense as what happened in southern Europe; it was small enough that it could be, and I’d argue was, more or less offset by other stuff over the course of a single year…”

    This is a testable claim. I will assume by "southern Europe" he means the GIPS. By "intense" I will assume he means the amount of fiscal austerity in any given year.

    Using one of Krugman’s favorite measures of fiscal austerity, the change in the cyclically adjusted primary balance (CAPB) from the IMF Fiscal Monitor, the CAPB increased by the following amounts in the US, the Euro Area, the GIPS as a whole (weighted by potential GDP using IMF estimates of potential GDP), Greece, Italy, Portugal and Spain in 2010 through 2013:


    Note that Greece, Italy and Spain started fiscal austerity in calendar year 2010 and the US, the Euro Area as a whole and Portugal started a year later. Note also that US fiscal policy was only less austere than the Euro Area as a whole in 2011. And finally note that 2013 was the first year that US fiscal policy was more austere than the GIPS, but that the intensity of its austerity in 2013 was as great as the fiscal austerity in the GIPS in 2012 which was the peak year for fiscal austerity for those nations as a group.

    Looking at the individual GIPS nations we see that the level of fiscal austerity in the US in 2013 was less than that in Greece in three out of four years, was greater than the worst year of fiscal austerity in Italy which was 2012, was greatly exceeded by Portugal only once in its one truly horrendous year of fiscal austerity which was 2010, and was slightly exceeded by Spain's worst year of fiscal austerity which was 2012.

    I am gratified that Krugman seemingly acknowledges that the US fiscal austerity of 2013 was greater than anything that the Euro Area has ever experienced as a whole. However, I think by objective measures, measures Krugman himself uses, the intensity of fiscal austerity that the US experienced in 2013 is also as intense as the worst year of fiscal austerity experienced in southern Europe as a whole.

  4. Bill, Krugman never claimed austerity would throw the economy into recession. All that matters is whether you believe that without austerity the economy would have grown faster or whether it was full offset.

    As Delong shows full offset would require the economy to recover 2/5 of the output gap in 2013. As this didn't happen there was not a full monetary offset. Mark the word 'full'

    Now we're talking-Delong vs. Sumner

  5. Why was 2013 a test of Market Monetarism?

    You claim that Krugman only said that given private expenditure, less government expenditure results in less total expenditure? Great. He can do arithmetic.

    All that is important is whether a central bank can provide for monetary offset despite the zero nominal bound.

    Whether QE3 _was_ a monetary offset that allowed the economy to continue the Fed wants it despite fiscal austerity or else it would have occurred anyway because the Fed decided it wanted a more rapid recovery and the fiscal austerity blocked it, is not so important.

    Sumner said that he expected growth in 2013 to be about the same as 2012. It was.

  6. But growth being the same in 2013 as it was in 2012 isn't monetary offset. Monetary offset would mean full neutrality in policy where the economy should 'naturally' close the output gap by about 2/5.

    This didn't happen so overall policy was contractionary-factoring both monetary and fiscal.