Ryan Avent explains Market Monetarism (really!)

Scott Sumner referenced this Economist post by Ryan Avent “Stabilise that certain something“. I highly recommend a careful read of Avent right now – for an easy to follow explanation of the power of market monetarism. That doesn’t mean that Scott Sumner’s descriptions are inadequate – but I think you’ll find Ryan’s exercise illuminating. Motivational snippets: 

(…)  there’s a small but meaningful chance of disaster in lots of places around the world, and so the typical investor is skittish:

Is it any wonder that the marginal investor or business would prefer to hold Treasury bonds or sit on cash? And that sort of disengagement can make economic pessimism self-fulfilling.

This dynamic is clearly important. And it is one of the things that makes the Scott Sumner approach to monetary policymaking so elegant and attractive.

At its heart, the Federal Reserve ostensibly makes policy on what you might call an “inflation-targeting plus” basis. That is, the underlying assumption is that the central bank can best facilitate macroeconomic stability by maintaining low and stable inflation, but the Fed also has a “maximum employment” mandate that functionally serves to get the Fed to do more to support the economy when unemployment is high and upside risks to inflation are low. (It’s questionable whether the Fed has stuck to even this modest formulation; instead, it often behaves as though the employment mandate doesn’t exist, and its only goal is keeping medium-term inflation expectations between 1% and 2%.)

One can envision an alternative policy approach, however. In this approach, the economy has some level of potential supply or potential output, which is the product of all sorts of factors. Whether that supply is fully used, however, comes down to how tightly economic actors are grasping their dollars. That factor is a question of demand , which is just all of the money spent in an economy. The Fed’s job, as steward of the economy’s money, is managing demand. And in practice, that job amounts to coordinating expectations across the economy so that it doesn’t find itself in a rut of self-fulfilling economic pessimism. 

Now in practice, one has to nail this model of the economy to a support structure of policy tools. You need to discuss indicators of demand (nominal output or income or spending are good options). You need to talk about measures of expectations for those variables (Mr Sumner would like to create a nominal GDP futures market). And you need to set benchmarks for the stabilisation process (say, a level of NGDP corresponding to 5% annual growth) and set expectations for which policy levers will be used to push the economy toward the benchmark.

And at each of these points, critics will complain about the inadequacy of the new regime. In particular, they’ll ask how, exactly, mechanically, a particular policy lever translates into changes in that fuzzy variable demand . They’ll try very hard to break monetary policy down into an entirely mechanical process, in which the Fed makes x purchases in order to adjust a certain rate by y basis points, thereby raising investment by z percent. And it’s certainly possible to work through all those details and demonstrate how the Fed can use its toolkit to change the value of a dollar and thereby influence the public’s propensity to spend it. But that exercise will often make the process much harder than it needs to be and may well lead monetary policymakers to mistake their actual job for another one. Their actual job is to coordinate expectations for stable demand growth, and the easiest way to accomplish that will often be to convince everyone that they’re serious about coordinating expectations for stable demand growth.

This seems like a lot of hocus pocus to many critics, but it’s more or less straightforward economics. If someone who entirely controls the supply of something publicly declares that it is determined to see that something trade at a certain price, it isn’t going to need to go out and mechanically engineer that price because there will be instant money to be made by private actors anticipatorily doing that job for the monopolist.

So go read Ryan Avent for the full exposition. Enjoy.