Arnold Kling on U.S. Monetary Policy

His tentative policy views jumped out at me as expressing what has been rambling around, incompletely formed, in my mind.

Let me offer some multiple choice questions.
1. What should be the stance of U.S. monetary policy?

a) The Fed is out of ammunition (.0001)
b) The Fed needs to worry about hyperinflation, so it should not attempt any further expansion. (.0499)
c) The Fed should be trying to expand the money supply, and if anything, a little more inflation would be a blessing (.95)

The numbers in parentheses are my estimate of the probability that the answer is correct.

Scott Sumner and Ken Rogoff, two economists with different perspectives but who have been right more often than wrong about the current situation, both favor (c). So do I.

Answer (b) sounds like something out of the Tea-Party fringe. But it is indistinguishable from current Fed policy, which is to note that the economy is weaker than anybody would like, and therefore no policy change is required…

Answer (a) strikes me as nuttier than anything that has come out the Tea Party fringe. The Fed cannot be out of ammunition as long as it can buy stuff by printing money. Conceivably that could happen if the cost of printing money were higher than the value of the stuff that you can buy with it. But we are nowhere near that point. And it’s hard to get to that point in an era where printing money can be accomplished by moving bits on a computer network.

I’m just old enough to remember my parents stressing out badly over inflation in the 1970s (seeing your mom nearly in a panic in the grocery store over how to buy food for her family is not good for a child’s psyche), so I take inflation concerns seriously. But I am confident that the Fed is at least as concerned as I am about inflation, so a little short-term increase won’t necessarily lead to serious long-term problems. I’ll never get my Real True Austrian card from the Mises Institute for saying so, but I can live with that.

2. What should be the stance of fiscal policy in the U.S. and other countries that still enjoy the confidence of the world’s investors?

a) Tighten up fiscal policy to keep investor confidence. You are going to need it. (.60)

b) Loosen up fiscal policy to stimulate growth. (.10)

c) Stay the course. (.30)

Everyone who has an opinion on this is well dug in. Nobody is changing any minds. My weights show that I am worried about the long-term fiscal outlook. I am skeptical of the Keynesian idea that more deficit spending would be stimulative, but I am not so sure of myself as to consign the idea to the same trash heap where I would throw “The Fed is out of ammunition.”

Agreed. I’m exceptionally dubious of the value of fiscal policy, but I’ve been going over it and over it here on this blog because I’m not confident enough in my skepticism to flat out say it can’t be right. And if I was in the President’s cabinet, where the need to do something–for God’s sake do something!–is overwhelming, I don’t know that I’d have the courage to argue against fiscal policy.

But I also agree that clearly the Fed is not out of ammunition, despite the repeated bleating about the zero-bound on interest rates. So I’d like to see some more aggressive Fed action. Admittedly, though, given that the Fed has already engaged in some unusual monetary policy actions, I may be engaged in the same kind of behavior as the Keynesians I’ve criticizes, arguing that “of course my favored approach works; we just haven’t done enough of it yet.”

But this is Kling I’m citing here. If he’s right about the crisis revealing changing patterns of sustainable specialization and trade, which I suspect he is, are we both wrong in urging more monetary policy action?


About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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16 Responses to Arnold Kling on U.S. Monetary Policy

  1. I think for question (2), you could get the positive effects of both (a) and (b) by scaling back the war on terror (and the war on crime, the war on drugs, etc.), reforming entitlements, and reinvesting a proportion of the savings in something like infrastructure that lifts all boats (forgive the pun). As it is, we have too much paying people to interfere in the (economic) activity of others. Why not kill two birds with one stone?

  2. James Hanley says:

    At a glance the report you cite focuses on the short term. I have no problem with the argument that cuts in spending are contractionary in the short run. What I do have a problem with is that no one ever seems interested in looking past the short term. “Oh, but we have to solve the short term problem now, then when the economy is stronger we’ll deal with the long-term issues.” Really? We haven’t seriously dealt with the long term issues in close to forever now (and I’m including the Clinton era, when we still essentially were focused on a political-economic system based on debt-induced growth). In good times we feel like the problem’s solved and no one wants to hear that there’s more to be done. Focusing on the short term is just treating symptoms.

  3. Lance says:

    Isn’t it possible that the chaotic (using the mathematical definition which basically means non-determinIst ) system that is the world “economy” is likely to react in unexpected ways to stimulus, and that “stop fucking with it” might be a valid approach.

    By not “fucking with it”, I mean to only do things that are known in the long term to be beneficial, such as limiting deficit spending and practicing restraint with the money supply.

    I may be wrong but after having read many of your posts these past months you seem to be of the general opinion that if left alone markets will largely self-regulate.

    Why not give the markets a chance?

    Before someone claims that I am a vicious and heartless anarchist I hasten to remind them that I am not calling for lifting the many checks and balances on our financial system which is policed by the SEC, Justice Department etc.

  4. James K says:

    Lance: That’s actually a very Hayekian approach.

  5. To Nitpick, Lance, the systems of chaos theory are deterministic. The market may be deterministic as well, but for all practical purposes we have a poor understanding of its details – so poor that it is effectively non-deterministic. Just like the Internet emerges from individuals pursuing their own self-interest regardless of what Google or Facebook or Microsoft or the Chinese government may desire, so does the economy emerge from individuals pursuing their own self-interest regardless of what Paul Krugman or the Fed or Wall Street or the Chinese government may desire. .

  6. D. C. Sessions says:

    What I do have a problem with is that no one ever seems interested in looking past the short term.

    You obviously weren’t reading radical economists like Krugman and DeLong ten years ago.

  7. Lance says:

    Chris Carr,

    You are correct, chaotic systems are determinisitic. I should have been more precise in my definition.

    While the individual non-linear equations that define a chaotic system may be deterministic the sensitivity of the system to initial conditions renders the time dependent outcomes of such systems wildly unpredictable. And when you throw in the vast number of variables inherent in an entire economy the situation is even more hopeless.

    This is actually worse than being non-determinsitic, or stochastic, in that no general statement of the probability of obtaining a specific outcome is possible.

    James Hanley,

    I have only peripherally encountered Hayek and von Mises but your remark triggered a Google search that has me intrigued. I’ll have to investigate further.

  8. Lance, I’m not really sure what the prevailing conceptions of the economy are vis-a-vis deterministic chaos, emergence, stochasticity, etc., but this classification of systems has been fascinating to me for several months now. Can anyone point me in the right direction to read more about this topic?

  9. Lance says:

    Chris Carr,

    A casual Google search of “economics and chaos” leads to a Wikipedia page that plays both sides of the fence.

    It states that modern econometrics, a discipline that leaves me underwhelmed, claims to have dismissed the possibility that macro-economics is limited by deterministic chaos, and of course a “criticisms” section that counter-claims that it is so limited.

    Of course if econometricians (for lack of a better term) admitted that macro-economics was chaotic they would have to close shop and find new jobs, so it is hardly surprising that they deny any such possibility.

    I have not spent anytime investigating the issue but I frankly don’t see how such a complex system of multiple linear and non-linear underlying equations, not to mention a vast number of random variables, could not be chaotic.

    Another Google listing is,

    Nonlinear Dynamics and Chaos Theory in
    Economics: a Historical Perspective

    Artem B. Prokhorov
    EC 816
    December 13, 2001

    His conclusion is fuzzy and drags everyone from Mandelbrot to Karl Popper into the mix in a very unsatisfying and vague “who knows” kind of statement.

    “Finally, the inseparability of determinism and stochasticity evident from
    nonlinear research in economics is consistent with the philosophical tradition
    of duality in questions of free will and teleology. Even if we knew all the
    dependencies of the universe there still would be a place for randomness
    for a complex regular rule is the randomness itself.”

    Teleology for Christ’s sake?

    I’m beginning to regret looking into this whole mess.

  10. Lance says:

    Thanks Christopher,

    Totally worth the read even though the article, at least the one to which I linked, peters out in mid sentence after many amusingly interesting, yet meandering, paragraphs..As if the author were, I don’t know, bullshitting?

    I was hooked when in the first few paragraphs appeared the words “perspicuous” and “procrustean” in the same sentence.

  11. The take-away message of that piece on bullshit is that liars have enough respect for the concept of the truth to make falsifiable statements, but bullshitters avoid making falsifiable statements precisely because they disrespect the very concept of truth. A corollary to this is that extreme elements on the political right tend to lie, since something like “the holocaust never happened.” is a falsifiable statement. The political left’s more extreme elements on the other hand tend to bullshit in the sense that they “criticize” while simultaneously dancing around offering any alternatives. It’s an interesting theory.

  12. James Hanley says:

    1. I really meant the general political debate, particularly among actual politicians and the chattering classes (of which we are, undeniably, members) don’t focus on long-term solutions. Policy analysts and economists collectively were not really who I was referring to, although I obviously did not specify that at all in my comment–I could and should have been more cautious.

    2. Ten years ago I had not heard of Brad DeLong, but I was reading Krugman’s pop econ books, which I still unhesitatingly recommend. Is there anything specific of theirs from a decade ago that you’d point me to? But if all you mean is that they were criticizing Bush fiscal policy, then yes I’m aware of that, and am in general agreement with them. I will note, however, that Keynesian stimulus is explicitly a short-term policy, so their focus right now is on the short-term. If one thinks such stimulus is not only helpful but necessary, that’s justified. If one thinks stimulus is helpful but not necessary, that focus is more questionable.

    Hayek is worthwhile, von Mises considerably less so.

    Re: Randomness. Just think of the economy as a Darwinian system. There are lots of more-or-less random mutations, some of which provide a competitive advantage and most of which don’t.

  13. Lance says:

    Christopher Carr,

    I took a slightly different message away from the essay, that bullshitters are not disrespectful of the truth, as are liars, but are willing to obfuscate and equivocate to reach their goal while maintaining that they haven’t violated the “truth”.

    Also I think the author has a respect for skillful bullshitting as an art and a tool.

    As I said, I think he is wryly engaging in a bit of bullshitting himself.

  14. Lance, I like your reading too!

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