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A Question for the Market Monetarists

Although my work on the "Productivity Norm" has led to my being occasionally referred to as an early proponent of Market Monetarism, mine has not been among the voices calling out for more aggressive monetary expansion on the part of the Fed or ECB as a means for boosting employment.*

There are several reasons for my reticence. The first, more philosophical reason is that I think the Fed is quite large enough–too large, in fact, by about $2.8 trillion, about half of which has been added to its balance sheet since the 2008 crisis. The bigger the Fed gets, the dimmer the prospects for either getting rid of it or limiting its potential for doing mischief. Besides, a keel makes a lousy rudder.

The second reason is that I worry about policy analyses (such as this recent one) that treat the "gap" between the present NGDP growth path and the pre-crisis one as evidence of inadequate NGDP growth. I am, after all, enough of a Hayekian to think that the crisis of 2008 was itself at least partly due to excessively rapid NGDP growth between 2001 and then, which resulted from the Fed's decision to hold the federal funds rate below what appears (in retrospect at least) to have been it's "natural" level.

My third reason for hesitating to endorse proposals for doing more than merely sustaining the present 4-5 percent NGDP growth rate is the one I consider most important. It is also one that has been gaining strength since 2009, to the point of now inclining me, not only to keep my own council when it comes to arguments for and against calls for more aggressive monetary expansion, but to join those opposing any such move.

My third reason stems from pondering the sort of nominal rigidities that would have to be at play to keep an economy in a state of persistent monetary shortage, with consequent unemployment, for several years following a temporary collapse of the level of NGDP, and despite the return of the NGDP growth rate to something like its long-run trend.

Apart from some die-hard New Classical economists, and the odd Rothbardian, everyone appreciates the difficulty of achieving such downward absolute cuts in nominal wage rates as may be called for to restore employment following an absolute decline in NGDP. Most of us (myself included) will also readily agree that, if equilibrium money wage rates have been increasing at an annual rate of, say, 4 percent (as was approximately true of U.S. average earnings around 2006), then an unexpected decline in that growth rate to another still positive rate can also lead to unemployment. But you don't have to be a die-hard New Classicist or Rothbardian to also suppose that, so long as equilibrium money wage rates are rising, as they presumably are whenever there is a robust rate of NGDP growth, wage demands should eventually "catch down" to reality, with employees reducing their wage demands, and employers offering smaller raises, until full employment is reestablished. The difficulty of achieving a reduction in the rate of wage increases ought, in short, to be considerably less than that of achieving absolute cuts.

U.S. NGDP was restored to its pre-crisis level over two years ago. Since then both its actual and its forecast growth rate have been hovering relatively steadily around 5 percent, or about two percentage points below the pre-crisis rate.The growth rate of U.S. average hourly (money) earnings has, on the other hand, declined persistently and substantially from its boom-era peak of around 4 percent, to a rate of just 1.5 percent.** At some point, surely, these adjustments should have sufficed to eliminate unemployment in so far as such unemployment might be attributed to a mere lack of spending.

And so, my question to the MM theorists: If a substantial share of today's high unemployment really is due to a lack of spending, what sort of wage-expectations pattern is informing this outcome?

That the question badly needs an answer is evident from statements like the following recent one (attributed to a writer for Credit Suisse), that very much beg it:

With the low-hanging fruit of lower interest rates and debt service costs already having been harvested, restoration of margins is achieved mainly through keeping a lid on labor costs. To break this pattern, nominal GDP needs to grow considerably faster to foster strong gains in both labor income and profits. It’s hard to see where such growth will come from in the short term, with slowing global growth and fiscal restraint becoming stiffer headwinds.

If NGDP growth is inadequate, as the statement suggests, why is it necessary to "keep a lid on labor costs"? Can it really be the case that NGDP (and equilibrium wage rate) expectations continue to race ahead of reality, even when that reality involves what would normally be considered a perfectly respectable, if not excessive, growth rate of overall spending? How can this be?

I should admit that my puzzlement in part reflects my personal experience. Here at UGA we haven't had any raises for five years running. I know professors elsewhere with similar experiences. We are, bless our hearts, helping to eliminate the spending "gap," and doing so despite the lower NGDP path. So who the heck isn't helping, and why should the rest of us put up with, much less root for, a more bloated and dangerous central bank for their sakes?

P.S. (added 3:15 on July 8): There's been a lot of loose talk, it seems to me, about how curing unemployment calls, not merely for raising the level or growth rate of actual NGDP, but for raising NGDP growth rate or level expectations. Well, if I'm an employer, I might well welcome, ceteris paribus, the news that demand for my output is going to go up. But suppose I am an employee. How should I respond to the changed expectation? Does it not give me grounds for holding out for a faster rate of wage increases than I would have been inclined to insist upon otherwise? Does it not, in other words, cause me to delay a needed adjustment to my schedule of wage demands? And does it not, to that extend, hurt rather than foster recovery?

*My former student, David Beckworth, has on the other hand been one of the more prominent proponents of greater monetary easing. Though we disagree, I'm damn proud of him.

**Link added at 7:30 on July 8.

  • Bill Stepp

    Doesn't the emphasis on NGDP (which Rothbard would call a "monstrous" concept–see his essay "The Fallacy of the Public Sector") overlook the coordination problem emphasized by Hayek and other Austrians? When Easy Al drove the Fed Funds rate toward 1%, setting in motion a chain of economic events that led to the boom and bust, which played out over a decade and is still going on, truth be told. The pattern of sub-market interest rates led to malinvestments in real estate, banking and related sectors, and filtered through to most of the economy. Stock, bond, and commodity markets boomed, as did private equity and even the art market.
    Keynesians overlook the microeconomic aspects of macroeconomics. ("Macro is monstrous!") The market monetarists seem to give it short shrift too.

    • Lee Kelly


      Market monetarists do not 'overlook' the coordination problem emphasised by Hayek. However, they consider it a secondary concern. The unraveling of malinvestment and redeployment of resources to more sustainable ends has been frustrated by lingering monetary disequilibrium. Once the nominal problem is resolved, whatever remains is presumably the natural rate of unemployment. At that point, the instincts of most market monetarists are shared with other advocates of the free market: deregulation, low taxes, free trade, open markets, political devolution, etc. Monetary policy offers no panacea, but to the extent that our problems stem from monetary disequilibrium, only monetary policy is in a position to help.

      George's criticism is that market monetarists, like myself, are straining credulity when arguing, in July of 2012, that there remains a shortage of money. Yes, total nominal income (NGDP) remains well-below its pre-2008 trend, but surely expectations have adjusted by now? Maybe wages were too high relative to total nominal spending back in 2009, but 3 years of stagnant wage growth must have made up the difference by now? Even if we continue to advocate an NDGP level target for monetary policy, there is no reason to return to a 5% growth path–why not 2% or 3% instead?

      The longer this goes on, market monetarists either need a bloody good explanation for how the shortage of money has persisted for so long, or they need to bite the bullet and accept that the problem is more real and less nominal than they thought. This doesn't, of course, imply that malinvestment remains the major problem either. In fact, Austrians face a similar dilemma with their story the longer high unemployment persists. There could be other, hitherto unnoticed, reasons for these theoretically uncooperative facts.

      • George Selgin

        Lee, thanks for supplying a very welcome and correct summary of my view. And Bill, much as I, too, have reservations regarding excessive reliance upon aggregates in macroeconomics today, my reservations regarding Rothbardianism in all of its manifestations have at last, and after much severe provocation, come to outstrip them!

      • Bill Stepp

        Lingering–lingering?–monetary disequilibrium is the work of central monetary-planners-cum-bankers, including Comrade Bernanke, whose QE and related disasters have left the US economy in a ditch. Saying that monetary disequilibrium can be righted by only monetary policy is like saying that only a bartender can help a drunk. What a drunk needs is the alcoholic equivalent of laissez-faire–to stop drinking.
        What the economy needs is laissez-faire–an end to the Fed and free banking, which would automatically solve the money supply shortage you mention in the third paragraph.

        I disagree with the market monetarists about coordination being a secondary concern. In a free bannking system markets would coordinate and unemployment would be at its natural rate, whatever that is.
        When central monetary Soviets tinker with interest rates, that discoordinates the economy up and down the structure of production. I don't think the MMs get that, although I could be mistaken. (If you have a cite to their literature expounding this, I'd be grateful.)

        George, I have my share of disagreements with Rothbard too, especially in money and banking (and with his mythical copyright stamp), but mostly I agree with him on other essential issues–justice and property rights, the nature of the criminal entity known as the State, war and peace, and many others. So on most of the Big Issues, I'm a Rothbardian. And N.B. to be a Rothbardian is to be an abolitionist. So end the Fed already! Freedom and laissez-faire in money and banking!

        • Lee Kelly


          Lingering. NGDP fell sharply in 2008 and remains well-below trend. Of course, prices and wages did not continue to rise along the old NGDP growth path, but neither have they completely adjusted to the new. In other words, albeit a rather crude aggregate analysis, there appears to be a lingering shortage of money (i.e. an excess demand for money). 'Lingering' is the perfect word to describe it. However, the longer our unemployment situation persists without significant improvement, especially as price and wage growth continues to stagnate, the more difficult it will be for market monetarists to explain why unemployment remains high.

          Anyway, I agree that free banking is preferable to central banking. But so long as we have a central bank, then we are in the unfortunate position of trying to figure out what the least bad monetary policy is. Personally, I think an NGDP level target (maybe 3%) would be a good way to have central banks approximate what a free banking system would do automatically. I don't like this situation, but when life gives you lemons then you make lemonade.

          • Bill Stepp


            If slavery were still a legal institution, would you be trying to "make lemonade" of it, or would you be joining me and other libertarian heirs of Garrison, Phillips, Spooner et al. in denouncing it and calling for its abolition?
            The fact is neither you nor anyone else knows what the right "NGDP" level target (whatever that is) should be. Indeed, no one can accurately even measure it, for Rothbardian reasons.
            A socialist, top-down central bank cannot come close to approximating what a free banking system does. To think that it can is to go over to the socialist dark side, and to abandon economics.

            To get in touch with my inner Friedman, one of the problems with the NGDP HOGWASH is that it's a measure of the symptom, like the temperature of a person. The market coordination process is the causal agency, which is interfered with by the State, resulting in the infection–the business cycle and the unemployment of land, labor, and capital. The idea is to understand the infection and its cause. Market monetarists are obsessed with the symptom, the temperature of the sick person. No wonder they want the Fed entity to try to ape the market. It can't be done, and they're efforts are doomed to failure.

            Instead of making slavery more efficient, why not advocate abolishing it? Ditto for the Fed.

          • Lee Kelly


            Yes, if slavery were still a legal institution, then I would be trying to make the best of it I could. That doesn't prohibit me from also supporting its abolition, but there is no reason to make lives worse in the meantime. I mean, do you want central banks to pursue bad monetary policy? Would you be complaining if they created a hyperinflation? Absent free banking, wouldn't it would be better if central banks didn't unexpectedly half the money supply? This more-free-market-than-thou attitude is just juvenile.

            And no, I don't know the right level of NGDP, but I have good explanations for why having NGDP on a stable growth path would be the least bad monetary policy for microeconomic coordination. I don't know what the right level of NGDP is, but there are reasons to suspect that it is too low at the present time. If you wish to be a critique, you need to do more than wave your hands about and say that nobody knows, because the alternative is not going to be free banking but whatever else central banks do instead. Why is that better than the suggestions of market monetarists?

            Also, NGDP is not a measure of the symptom. There is nothing in, say, the Austrian business cycle theory which demands that an inflationary boom be followed by a deflationary bust. While the fall in NDGP in 2008 was, undoubtedly, causally related to the housing bubble, that doesn't mean it was an inevitable consequence nor a natural part of the process of unwinding past malinvestment. This is just a common mistake that Austrians make.

  • BillWoolsey

    If you support level targeting then reversing any deviation from a two decade growth path seems reasonable.

    Of course, we know that there really was an explicit growth path target during the period, but that still is the key reason.

    When you support growth path targeting, you can't look at the growth rate during some particular period. So, for example, if nominal GDP is below trend, it should be growing faster than trend to get back to that trend.

    The supposed "too low, too long" period was one where nominal GDP was below trend and catching back up. The actual excessively rapid growth was during the bubble, where nominal GDP really did rise above its trend growth path.

    Now, if you actually look at wages outsides, they have pretty much kept on growing at the previous trend, and the growth path of the GDP deflator has only slightly decreased.

    Of course, it is possible that this is due to a decrease in the growth path of potential output and labor supply. (Those unemployed people don't really want to work. They are lying.) But I doubt that.

    I sometimes wonder if inflation targeting doesn't create inertia.

    If you assume prices always clear markets, and only a deviation of inflation from its expected level causes an output distortion, then this doesn't make sense.

    Only if a lower growth path of nominal GDP leads to a lower growth path of prices does it lead to less production and employment.

    But if instead prices are set based on expectations, and everyone believes the central bank will keep them rising, and they do continue rising.. well, there is a puzzle of course. Pay less, charge less, and gain market share. Why doesn't that happen?

    • BillWoolsey

      Well… I was wrong.
      The obvious (and obviously imperfect) measure of nominal wages are 2.5% below the trend of the great moderation (beginning of 1985 to end of 2007.) This is average hourly of all nonsupervisory and production employees. It is growing well below trend.

      The chain weighted GDP deflator is about 2% below the trend of the greater moderation.

      Anyway, it looks like that measure of wages has responded to the high unemployment by shifting to a lower growth path, and at least relative to all prices, that implies a slightly lower growth path of real wages too.

      Of course, this is nothing like the 14% nominal GDP gap.

      Prices and wages would need to fall to a much lower growth path for real expenditures to recover to the growth path of the great moderation.

  • Rob R.

    Do you think it is possible that the large but falling levels of household debt in the US and globally have prevented any real recovery from taking hold ? Other things being equal 3 1/2 years of reasonable NGDP growth should have eliminated he effects of a 9% drop back in 20008. But sharp drops in household debt in those years unmatched by new lending has led to constant downward pressure on AD. Even though various government programs have successfully kept NGDP growing not far below trend this has never translated into a sustainable recovery because there is still a strong tendency for savings out of income (to pay down the debt) not being matched by any new lending.

    If this analysis is correct then the options are bleak: Years of recession where NGDP growth is achieved only by money pumping; Debt forgiveness and the associated moral hazard; inflating away the debt; or (probably best of a bad set) stop NGDP pumping and allow deflation and bankruptcy to stabilize AD naturally.

  • George Selgin

    Rob says: "sharp drops in household debt in those years unmatched by new lending has led to constant downward pressure on AD [recovered NGDP growth] has never translated into a sustainable recovery because there is still a strong tendency for savings out of income (to pay down the debt) not being matched by any new lending."

    But what does it mean to speak of "downward pressure on AD" and a failure of saving "to be matched by new lending" when NGDP is growing at a fairy steady pace? Surely if by "aggregate demand" we mean demand for goods and services generally, then nominal income and aggregate demand are not two things connected by a loose causal joint but two names for the very same thing, to wit: P x y. In that case, to say that there's downward pressure on AD or that savings are being hoarded rather than invested is to suggest that NGDP is shrinking, or at least that the growth rate of NGDP is declining, neither of which is in fact the case.

  • Lars Christensen

    George, Thanks for challenging us. I got an answer to you:

    • George Selgin

      Lars, I'm very grateful for your remarks, to which I have now responded on your site. I encourage followers to have a look at that exchange.

  • Rob R.

    My ideas in this area are not fully formed so I apologize if I am not stating them well. However could it not be the case that NGDP would be shrinking due to high levels of savings out of income if it were not for the injection of new money by the CB?

    My understanding of what MMs are saying is that as the result of things that happened in 2008 money became overvalued with the result that people are hoarding it and because of nominal rigidities we need to increase the money supply to reduce its value again to get spending back on trend. They seem to assume that once money has been appropriately revalued everything will be back on track and in equilibrium. We will get positive interest rates and a normal unemployment rate.

    The flaw I see with this logic is that if there is a strong tendency for savings out of income (to pay back debt) then even after the initial money pumping the economy will not be in equilibrium because savings will still have a tendency to exceed borrowings and hence NGDP to fall (were it not for money creation). More money creation will be needed to keep NGDP on target (which is what I mean by the recovery not being self-sustained) . Eventually with this model debt would be paid down sufficiently and/or demand for loans would return but this could take many years during which I would predict the economy would stay in recession. For these reasons (which I have admitted are not fully formed) I question a policy of heightened NGDP targeting as the best policy.

    • Rob R.

      To clarify: I understand that when MMist talk about a 5% NGDP target they mean a 5% increase in the money supply adjusted for any changes in the demand for money, but that demand for money will be constant in normal times. I am saying that they will have to increase it by 5% plus the excess of savings over borrowings during the period of debt repayment and that will make it hard to build a sustained recovery.

  • BillWoolsey


    It is the demand for money relative to real income, rather than money demand. Most market monetarists really don't make any assumption about what will happen to the demand to hold money (even relative to real income) in normal tmes.

  • F.A. Hayek, in real time during the Great Depression, stated [paraphrasing] that monetary policy has its limitations.

    Since a fiscal limit exists, then surely a monetary limit exists as well.

    Quantitative easing and Keynesian deficit spending plans were theories developed and/or studied in hindsight in environments of low public and private debt. To deploy, simultaneously, Keynesian deficit spending and QE in an environment of hyper-debt had only been tried once in a modern advanced economy: Japan. The results are abysmal.

    Further, “democracy” unfortunately has yielded rent seeking galore since the mid 1930‘s. That the rent seeking economies of Adam Smith’s time shrunk and dissipated. However, rent seeking has returned to vogue over the last 80 years. Hence a built in drag regarding rent seeking occurs and surely the drag accumulates.

    Moreover, the “promised” yet unfunded social welfare state, which has morphed into a dystopia via politicos through the mechanism of government , is an accumulating drag.

    Hence returning to trend, although an appealing proposition, may be a much more difficult trick to pull off in an environment of hyper debt, rent seeking vogue and social welfare state dystopia becoming proverbial boat anchors.

    Finally, F.A. Hayek stated on many occasions that the best your could expect from macroeconomics is to identify a pattern. But the pattern is a snap shot in time and the pattern can change quickly in another time. Therefore, the prior trend, however it occurred, can change just as quickly to another pattern and is one pattern somehow, someway more true then the other pattern?

  • Bill Stepp

    Before I get arrested for practicing medicine without a license, let me clarify my medical analogy. The symptom is the fever, the disease is the cause of the fever, for example influenza or measles. Austrians study the economic equivalent of the disease–the business cycle. NGDP is a measure of the symptom–the fever. If the market monetarists don't study the microeconomics of the business cycle, I don't see how they can understand it. NGDP is no substitute for this.

  • Bill Stepp


    There is a case for bad monetary policy insofar as that would get everyone to support the abolition of the Fed. Call it more short-term pain for long-term gain.

  • Lars Christensen

    Bill, I strongly disagrees with that position. Rarely will bad policy lead to the right policies being implemented. Often bad policy will lead to other bad policies. In the 1930s an insane commitment lead to the adoption of capital controls and protectionism – and brought Hitler to power in Germany. In Greece bad policies lead neo-nazi and hardcore communists being elected to the Greek parliament. The failed monetary policies of the Fed and the ECB is leading politicians on the left and on the right to call for more government involvement in the economies rather than less.

    I would rather argue that a successful implementation of a NGDP level targeting regime could be the first step towards a free banking system. See my blog post on that here:

  • Bill Stepp


    Bad policies can lead to bad policies, as in the '30s, but that result was not preordained. After all, bad policies in the '70s led to better policies in the '80s with better economic outcomes.
    Re: your comment about Friedman, he should have advocated the abolition of the income tax, and the full privatization of schools. He also advocated patent monopolies, which should be abolished.
    On most issues I think Rothbard had better arguments than Friedman. He certainly did on the income taxes, schools, and patents.

  • Lars Christensen


    I think you are completely wrong about Friedman. Friedman was advocating exactly that – abolition of the income tax and privatization of school. Just read Free to Choose or Capitalism and Freedom. He states that quite clearly. However, he then goes on to suggest reforms that will move society in the direction of a more free society. The Negative Income Tax and School Vouchers were never Friedman's ultimate policy goal, but strategies to move closer to a truly free society.

    Furthermore, in my view Friedman did a lot more for spreading freedom around the world that Rothbard ever did. George actually had a excellent discussion about this topic on this blog some time ago:

    By the way if you think that the "wrong policies" will lead us in the right direction – then you should also advocate protectionism, increase minimum wages, higher income taxes, nationalization of banks etc. I doubt that you are willing to go in that direction…And I am sorry if I misread you comments.

    PS my Rothbard have had great influence on my own view of the world, but Rothbard only influenced my political views and never my economic thinking.

  • Bill Stepp


    It's been too long since I read Friedman's books for me to remember his exact arguments, but as I recall he skated lightly over the idea of abolishing taxes and privatizing schools, whereas Rothbard was quite clear about his goals.
    I don't recall Friedman ever advocating anarchy either. I'd advocate increased protectionism (like outlawing free trade entirely), an increased minimum wage (to say $1,000 per hour), higher income taxes (say a 100% marginal rate), etc. so that the advocates of statism could clearly see the logic of their arguments.

    Rothbard's exposition of microeconomics and capital theory in Man, Economy, and State were far better than Friedman's in his book Price Theory. Rothbard was a better economist in my view even if his views on money and banking were inferior to Friedman's. Rothbard understood action, subjectivism, and market coordination better than Friedman, who was very mainstream in his economics generally.

  • Lars Christensen


    And no, Friedman never advocated anarchy (David has obviously been doing that for a long time now). However, he never allied himself with extremist leftists as Rothbard did in the 1960s or with an anti-immigration protectionist like Pat Buchanan as Rothbard did in the 1980s.

    Not to tire everybody with our discussion – which is regularly being repeated in difference forms – I will end it here. Not because I do not accept your arguments – they are completely valid and fair. However, we all have heard all this before. I mean no disrespect.

    For those interested in this debate I think the should take a look at, read George's comment as I noted above and David Friedman's blog: