I was reading Scott Sumner's recent post about Neo-Fisherism and I had an epiphany about Market Monetarism.
I have consistently taken issue with the likes of Sumner because of what I view as his confusion of policies and the results of policies, or rather his confusion of policies and observations. Case in point would be the post I was just reading, in which Sumner says
Sumner regularly flaunts this view by suggesting that a central bank can, for example, set the interest rate and set the exchange rate at the same time. This is where my epiphany comes in. What's really going on is that there are multiple equilibria. A cut in the nominal interest rate can either occur through an increase in the money supply (ceterus paribus) or a negative shock to money demand (ceterus paribus), but which occurs in a given scenario? Obviously it's almost always a combination of both -- the monetary base is rarely constant and neither is money demand, but absent the presence of a more complete model, what I just outlined has many possible equilibria.
Sumner's solution to this problem is, rather than more completely specify the model, to simply choose the equilibrium that is consistent with the facts and assert that the central bank is responsible for bringing that equilibrium about. Do I think this approach is valid? Not exactly. Nevertheless I am much more sympathetic to it than what I previously perceived from Sumner. Furthermore even some full models exhibit multiple equilibria -- like New Keynesian models in which the Taylor Principle is not followed -- meaning that Sumner's approach to, e.g., Neo-Fisherism, while not as 'correct' as a more analytical description of the possible equilibria is at most equally egregious to Cochrane's dubious equilibrium selection.
To put this in terms more conducive to Sumner's typical line of reasoning, low interest rates can either be consistent with high NGDP or low NGDP. In his view the central bank chooses which equilibrium prevails and that equilibrium selection is the 'stance' of monetary policy. I personally don't think that assuming central banks are capable of equilibrium selection without explicitly modeling it is a good thing, but at least it's better than just assuming central banks are capable of pegging whatever nominal variable to whatever they want regardless of the circumstances.
I have consistently taken issue with the likes of Sumner because of what I view as his confusion of policies and the results of policies, or rather his confusion of policies and observations. Case in point would be the post I was just reading, in which Sumner says
But how did the Swiss authorities make sure this decrease in interest rates had a contractionary impact? The answer is simple; they did a simultaneous, once and for all, massive appreciation in the SF.This idea that the exchange rate is just something that the SNB can set (while setting interest rates) is terrifyingly stupid from a conventional viewpoint. In general monetary policy can be seen through one of two lenses: 1) the central bank sets the monetary base and everything else is endogenous or 2) the central bank sets the short term risk free interest rate and everything else (including the monetary base) is endogenous.
Sumner regularly flaunts this view by suggesting that a central bank can, for example, set the interest rate and set the exchange rate at the same time. This is where my epiphany comes in. What's really going on is that there are multiple equilibria. A cut in the nominal interest rate can either occur through an increase in the money supply (ceterus paribus) or a negative shock to money demand (ceterus paribus), but which occurs in a given scenario? Obviously it's almost always a combination of both -- the monetary base is rarely constant and neither is money demand, but absent the presence of a more complete model, what I just outlined has many possible equilibria.
Sumner's solution to this problem is, rather than more completely specify the model, to simply choose the equilibrium that is consistent with the facts and assert that the central bank is responsible for bringing that equilibrium about. Do I think this approach is valid? Not exactly. Nevertheless I am much more sympathetic to it than what I previously perceived from Sumner. Furthermore even some full models exhibit multiple equilibria -- like New Keynesian models in which the Taylor Principle is not followed -- meaning that Sumner's approach to, e.g., Neo-Fisherism, while not as 'correct' as a more analytical description of the possible equilibria is at most equally egregious to Cochrane's dubious equilibrium selection.
To put this in terms more conducive to Sumner's typical line of reasoning, low interest rates can either be consistent with high NGDP or low NGDP. In his view the central bank chooses which equilibrium prevails and that equilibrium selection is the 'stance' of monetary policy. I personally don't think that assuming central banks are capable of equilibrium selection without explicitly modeling it is a good thing, but at least it's better than just assuming central banks are capable of pegging whatever nominal variable to whatever they want regardless of the circumstances.
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