Mian-Sufi vs. Scott Sumner and John Taylor

They write,

What we are witnessing is the limit of what monetary policy alone can do. Sometimes there is a tendency to assume that the Fed can “target” any inflation rate it wishes, or that it can target the overall price level – the so-called nominal GDP targeting. The evidence suggests that the Fed may not be so omnipotent.

Pointer from Mark Thoma. A couple of comments.

1. This seems like an argument against Scott Sumner’s view that monetary policy was too tight in 2008. That is, I take them as saying that there was nothing that the Fed could have done. Scott Sumner would insist that the Fed lacked the will, not the way.

2. Mian and Sufi offer a chart showing that core inflation was below the Fed’s 2 percent target almost the entire period starting in 2000. This seems like an argument against John Taylor’s view that monetary policy was too loose in 2004-2006.

3. I believe that in 2007 the Fed folks thought that inflation was rising, in part because they looked at oil prices, not just core inflation.

4. Mian and Sufi entitle their post “Monetary Policy and Secular Stagnation.” I still want to see an economist reconcile a belief in secular stagnation with a belief in Piketty’s claim that the return on capital is going to exceed the growth rate of the economy on a secular basis. For the record, I believe neither.

10 thoughts on “Mian-Sufi vs. Scott Sumner and John Taylor

  1. Thankfully, we got a nice natural experiment since The Fed did the utmost of conventional options rather than adding in extraordinary measures…

  2. The transcripts from the September 2008 Fed meeting are incredible. The meeting was the day after the Lehman failure. Their head trader explained that the market was pricing in a 25bp reduction in the Fed Funds rate, but that the 25bp forward price was a reflection of a barbell shaped set of expectations, “it’s really not about 25 versus zero. It’s really about zero versus 50 or maybe even 100 as you look out longer term. Either the financial system is going to implode in a major way, which will lead to a significant further easing, or it is not.”

    The Fed left rates at 2%, expecting to the next change to be a rise, due to inflationary pressures. The analogy isn’t whether they drove the Titanic into an iceberg. The analogy is that they were out on the deck taking an axe to the lifeboats.
    5 year inflation implied from TIPS was 2% the month before, was down to 1% at the meeting, and hit -1% in October.
    Surely, statement number 1 above can be taken as a given at this point.

  3. Although to get to #2, you have to ignore other metrics such as asset prices and credit growth, which long ago the Fed (McChesney Martin, at least) saw as relevant indicators for deciding what to do with the punch bowl.

    In any case, my unsolicited suggestion for your next project (I read your book this weekend – very persuasive) is a proposal for how the Fed should operate. Do your “anti-modernist” views mean that we should have something closer to Martin’s discretionary approach? Or, maybe you don’t see it as mattering, but a suitably provocative straw man for a better monetary policy framework might liven up your debates with Taylor & the NGDP people. Just a thought.

    • The effects of asset and credit growth should seep through inflation metrics. You would be overweighting shared factors if you adjusted monetary policy according to all three categories. Other pundits argued that the CPI treatment of contemporaneous housing costs is biased by the existing stock of homes, and that the survey method for imputed rent mischaracterizes market prices.

      • There’s quite a lot of evidence that they don’t seep through core inflation. In the housing boom, it was just the opposite – we bought cheap stuff from China which drove down core inflation, and China invested the proceeds in dollar assets, which helped to inflate our asset and credit bubbles. Owners’ equivalent rent, which is a huge portion of CPI, isn’t based on house prices and didn’t pick up the house price boom either (maybe that was your second point…)

  4. “Mian and Sufi entitle their post ‘Monetary Policy and Secular Stagnation.’ I still want to see an economist reconcile a belief in secular stagnation with a belief in Piketty’s claim that the return on capital is going to exceed the growth rate of the economy on a secular basis. For the record, I believe neither.”

    I agree that this is an important tension, and that these views are difficult or impossible to square. (For the record, I also believe neither – I think the ZLB is important, but “secular stagnation” is a much more implausible step beyond.) It is strange that a fairly large number of people seem to believe both.

    One way to reconcile the two is to say that Piketty’s return on capital includes the equity premium (and other premia for privately held businesses, etc.), whereas the secular stagnation idea of a perpetual ZLB deals with only the riskfree rate. If the equity premium is large, it’s possible that Piketty’s return on capital is high but the equilibrium real rate is low. (Indeed, this is the only way to make sense of Piketty’s use of a 5% real rate of return – far beyond the average riskfree rate in the postwar era, which after taxes has been roughly 0%. It is impossible to earn much return on capital without absorbing some aggregate risk. On that note, since I think we would all be better off if the equity premium was lower, I find it hard to get too angry at rich shareholders who perform the service of absorbing aggregate risk.)

    Regardless, the “secular stagnation” hypothesis is in dire need of some cogent back-of-the-envelope estimates, and I don’t think it holds up very well. A long-term fall in the average real interest rate from, say, 2% to -1%, would be absolutely extraordinary. It would imply massive increases in the valuation of long-lived, inelastically supplied assets like land, and massive increases in the quantity of long-lived, elastically supplied capital like structures.

    Just to illustrate how extreme the implications can be, consider the following (sloppy) calculation. The BEA’s average depreciation rate for private structures is currently about 2.5%. A decline in the real interest rate from 2% to -1% implies a decline in user cost r+delta from 4.5% to 1.5%, of a factor of three. If the demand for structures is unit elastic (as economists, unjustifiably from an empirical standpoint, tend to assume with Cobb-Douglas functional forms), this would imply a threefold increase in the steady-state quantity. Since structures are already 175% of GDP, this would imply an additional increase of 350% of GDP, more than doubling the overall private capital stock and nearly doubling national net worth. The transition to this level would require such an extraordinary, prolonged investment boom that we would not face slack demand for many, many years.

    (There are many things wrong with this calculation, but even an effect a fraction of this size serves my point, especially when you keep in mind that land values would be skyrocketing as well. The bottom line is that proponents of secular stagnation have not yet contended with some of the basic numbers.)

  5. Arnold,

    “I still want to see an economist reconcile a belief in secular stagnation with a belief in Piketty’s claim that the return on capital is going to exceed the growth rate of the economy on a secular basis. For the record, I believe neither.”

    I’m very curious about this claim. 5-year treasuries are around 1.75%. Let’s say 5 year BBB corporate bonds yield an average of 4%. Equities must be yielding at least 6% given the S&P PE of 19 and some expected growth. I don’t see how the weighted expected return on capital could be less than 5% probably more. And factoring in all the less high grade capital I’d bet the average is closer to 7 or 8%.

    As for nominal growth, lets assume 2% real + 2% inflation for 4% total. How can you possibly get that low for the return of capital? You’d have to assume an average capital risk premium of 4%-2% = 2%, which is the risk premium on BBB corporate bonds! Or, if you assume a more reasonable 4% risk premium, then the natural nominal risk free rate would have to be 0% over five years. In which case we are in big trouble because rates are way too high.

    • I am looking forward to seeing how Piketty has done this projection, but I think he is looking for an after tax return on capital, which helps to explain how r can be lower than g.
      Also, some BBB corporate bonds default, which has to be taken into account…