Tuesday, November 3, 2015

Who should we listen to?

Scott Sumner asks the question, regarding macroeconomics: who should we listen to? He tries to suggest that we should assign a higher Bayesian prior probability to someone who has made several qualitative and ill-defined conditional predictions with a model only that person can use that are declared correct by the person who made them.

This is exactly who you shouldn't listen to.

You should assign a higher Bayesian prior to someone who makes quantitative predictions with well-defined conditions with a publicly available model that are declared correct by someone else.

What is particularly important is that other people can use the model. For example, the ITM equations and parameters are publicly available here:


Anyone can use them to make predictions or even build their own models.

No one can use Scott Sumner's model except Sumner himself. Here's his paper on monetary offset [pdf]. The model appears to be an AD-AS model, however the specifics depend on whether expansionary monetary policy is "effective", and there is no model of monetary policy effectiveness other than the ability to move exchange rates (#3, below), stock markets (#7, below) or successfully implement contractionary monetary policy (#8, below). So there is no evidence of effectiveness in terms of nominal (or real) output, the default metric of macroeconomics. These market moves also have not been large enough to be distinguished from noise (see e.g. here).

An additional issue is that Sumner does not describe how to produce counterfactuals with regards to monetary policy. We have no idea what would have happened in Sweden, the EU (#8, below), the US (#1, #2, and #4 below), Japan (#3, below) if monetary policy had been different. We must basically ask Scott if things would have been different, and if so, how different?

Sumner does not specify what the counterfactuals are with regards to fiscal policy (#2, below) and does not exactly specify exactly what constitutes fiscal policy. In fact, because it wasn't exactly specified there was a question as to whether dividends from GSEs constituted contractionary fiscal policy. Whether or not it does, this could not have been answered without hearing from Sumner -- again, we have to rely on Sumner himself to understand his model.

Sumner describes his model in terms of the "hot potato effect" and the "musical chairs model", neither of which contain any reference to productivity. Yet the Sumner's model has something to say about productivity (#9, below). How do we mere mortals extract this effect?

But Scott Sumner thinks we should listen to him. Well, we have to in order to know what his model says! Here's his list of predictions:
1.  Those who, at the time, thought that Fed policy was too tight in late 2008 (something that Bernanke has now admitted).
What is "tight"? Who cares about a single opinion (Bernanke)? Do we know for a fact that tight monetary policy had any consequence in 2008? What is the counterfactual?
2.  Those who correctly predicted that the contractionary effects of the 2013 fiscal cliff would be offset by monetary policy.
This one does not count.

We don't know the counterfactual (fiscal or monetary) here so there is no way to tell whether 2013 was more or less contractionary than the counterfactual. Most of the so-called contractionary fiscal policy was dividends from GSEs, so the actual deficit reduction was tiny compared to the noise in NGDP growth and therefore could not ever be empirically extracted from the data. The result was indeterminate.
3.  Those who correctly predicted that the BOJ could sharply depreciate the yen, if they wanted to.
How can we tell if the BOJ "wants" to do something? Do moves in the exchange rate correspond to changes in NGDP? How do we convert "fall in exchange rate" to "rise in NGDP"?
4.  Those who claimed Bernanke was wrong in claiming monetary policy was highly accommodative in the years after 2008.  A critique that has now been confirmed by Vasco Curdia.)
What is the counterfactual? Would more accommodating monetary policy resulted in higher NGDP? No recession? We don't know.
5.  Those who said the Fed’s predictions for real GDP growth were too high.
How "high"? How is this discernible given noise and errors in the data? The Fed's predictions of RGDP are actually ok given the fluctuations in the measurements:

Also, I got these right -- shouldn't we listen to me?
6.  Those who said that if we ended the extended unemployment benefits, the unemployment rate would fall back to the natural rate faster than the Fed expected.  (Note this is the opposite of the previous prediction, which makes the success of both predictions especially interesting.)
This one also appears to be incorrect.

The acceleration in hiring appears to actually be the result of hiring in the health care industry due to the implementation of Obamacare because the increased rate of hiring is confined to the health care industry.
7.  Those who first suggested that central banks could do negative IOR, and that markets would treat the policy as expansionary.
Did the markets move far enough to indicate something other than random noise? How big should the effect be?
8.  Those who predicted that Trichet’s contractionary monetary policy of 2010-11, in response to transitory price rises from oil and VAT, was a big mistake.  Ditto for those who made the same prediction about Sweden.
Is this a mistake? Do we know the counterfactual without the contractionary policy? No.
9.  Those who first spotted the fact that the UK’s problem was productivity, not jobs, and hence that fiscal austerity was not the problem.
Sumner's model has inputs for productivity?
10.  Those who predicted low interest rates as far as the eye can see.
What is "low"? "[A]s far as the eye can see" would be ok here (since it means indefinitely), but there is an implied conditional -- if the Fed creates an NGDP futures market and targets it, will rates rise? How far? What about a different policy? What will raise rates and by how much?


  1. Didn't Mark Sadowski's series of VAR posts address many of your issues with Scott Sumner's claims? Basically, a 10% expansion in the Fed's balance sheet leads to 1% more NGDP growth.

    He also looked at similar effects on exchange rates, the stock market and other variables of interest.

    1. Scott Sumner's model is that QE is expected to be taken away, therefore it does not generate inflation, so actually, that raises more questions.

      Between 1980 and 2000, the monetary base grows about 470%. That would imply by the 10:1 measure that NGDP should grow 47%. But NGDP grows 360% during that time. A 1.3:1 ration.

      Between 1980 and 1990 the monetary base grows about 210%, The 10:1 measure would mean NGDP grows 21%, but it grows 210% (a 1:1 ratio).

      That means monetary policy seems to be getting less effective over time. Scott Sumner doesn't think that is true.

      Its effectiveness suddenly goes from about 1 - 1.3 to 1 to 10 to 1 in 2009. That seems very much like the liquidity trap argument. Scott Sumner wouldn't like that at all.

      So is it just excess reserves that leads to more output (therefore monetary policy works differently before vs after 2009)? Scott Sumner wouldn't agree with that.

      Overall Sadowski's argument is that we have to double the base (100% increase) to get 10% NGDP over 5 years. (I think it was inflation in the original posts.) Therefore we'd have to double it every 5 years to maintain 2% NGDP growth. So over the next 50 years, the base would grow 1024 = 2^10 times, while NGDP would grow 20% = (1.02)^10. The base would be 4 quadrillion dollars while NGDP would be 22 billion dollars.

    2. "Its effectiveness suddenly goes from about 1 - 1.3 to 1 to 10 to 1 in 2009. That seems very much like the liquidity trap argument. Scott Sumner wouldn't like that at all."

      I won't speak for Scott Sumner. My take is that there is certainly a form of liquidity trap going on; dollar for dollar, monetary injections have less impact (i.e. velocity slows down rapidly at each injection). However, I think Scott Sumner rightly claims that the velocity does not fall exactly in sync with increases in the base. Even in a liquidity trap, injections have an effect. Ergo, monetary policy can be effective.

      As for the relationship between growth and the base, Sadowski looked at impulses from a baseline. If I understand, the model essentially starts from the hypothesis there would be some baseline NGDP growth without injections. Then, adding or subtracting to the base (in the current macro environment) has an effect of 10:1.

      By the way, I think this kind of empirical analysis is useful to establish a rule of thumb, but lacks, for example, an understanding of the mechanics that brought us into the liquidity trap or how/when it can be escaped. You entropy-based model, in my opinion, is much better, from that point of view.

      That said, what is the IT model prediction for the relationship between injections to the base and NGDP? Also, I understand that it allows for phase transitions out of its take on "secular stagnation". Is that right? How does this work, exactly? I am quite curious.

    3. Hi LK,

      I have no problem with the claim that "dollar for dollar, monetary injections have less impact", but at that point it becomes semantics about the liquidity trap, monetary offset and fiscal policy. Saying monetary policy has less impact and saying an economy is in a liquidity trap are just a difference in degree, not kind.

      You said

      "However, I think Scott Sumner rightly claims that the velocity does not fall exactly in sync with increases in the base."

      First, I think Sumner considers the equation of exchange (an particularly velocity) to be a definition:


      "[MV = PY] means V is PY/M. And that’s all it means."

      So it's not really an explanation, but rather a name for the mis-match between PY and M. He does go on in that post to describe an interpretation of 1/V = k as the fraction of NGDP held as cash balances. But again, that is just an accounting identity (definition).

      You asked:

      "That said, what is the IT model prediction for the relationship between injections to the base and NGDP?"

      The monetary base has a direction relationship on short term interest rates in the IT model; it's described in the paper:


      Increases in physical currency (monetary base minus reserves) appears to have a direct relationship with NGDP


      where the difference appears to derive from labor market fluctuations:


      "Also, I understand that it allows for phase transitions out of its take on 'secular stagnation'. Is that right? How does this work, exactly?"

      Secular stagnation is not directly related to the "phase transitions" (although a phase transition may get you out of secular stagnation). I referred to the changes as both phase transitions and monetary regime changes. They would find a reasonable description in terms of expectations. Nick Rowe has used the analogy of driving on the right. In the US and Canada, we drive on the right because of expectations anchored by the government. A 'phase transition' would occur if expectations changed and everyone started driving on the left. That is one way to look at monetary regime change in the IT model -- a certain set of expectations hold and then the central bank changes the way it conducts monetary policy and expectations change.

      This is not a well-understood aspect of the IT model (I don't know what constitutes a monetary regime change). 'Phase transition' is just a name for an apparent effect. I think of them as monetary regime changes because they seem to coincide with major changes in monetary policy in the UK and the US (and a less significant change in Switzerland).

      Regarding secular stagnation itself, it is a result of entropy -- ignorance about the micro states of the economy. If I don't know how each dollar of money is allocated against each dollar of NGDP, then I must assume ignorance and therefore a maximum entropy allocation (distribution). If you do this, there are more ways a large economy can be organized as a collection of many low growth states than a small economy (which has a higher probability to be organized as a few high growth states). Therefore, large advanced economies tend to have slower growth on average than small developing ones.

  2. Excellent blogging. You could square Sumner's circle by pointing out Sumner is setting up a series of strawmen (as is his wont) that represent wrong views, with only his view (#10) being the correct one. Sumner is entertainment, but in a world where people don't want to do hard science (and that includes me, I've made much more money in business than in science, and I have several degrees in science) Sumner is a convenient 'brand name' to identify NGDPLT with, hence his blog gets read more than this one, though this one is more scientific by far.


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