In his latest post, Scott Sumner presented his view of macro, the overlapping of studies involving real and nominal.
It’s an interesting view. Though I am having trouble with his point on the study of nominal shocks that reads this way:
Disequilibrium macro looks at nominal shocks that cause changes in real variables, but only because of wage/price stickiness. Thus because prices are sticky, an increase in the money supply will temporarily cause higher real money demand, a lower real interest rate, and a lower real exchange rate. These changes occur even if there is no fundamental real shock hitting the economy. The effects are temporary, and go away once wages and prices have adjusted.
If wages and prices are sticky then an increase in the money supply will also cause a temporary rise in employment and real output.
And so what I want to do is break it down to test my understanding of what is being said here:
Disequilibrium macro looks at nominal shocks that cause changes in real variables, but only because of wage/price stickiness.
I understand this sentence as a classical explanation of the Great Recession. Suddenly tight money, for whatever the cause, whether it be excess and unaccommodated demand for money, or an actual change in the supply of money having the effect of reducing output and causing a bunch of unemployment.
The next part, however, I have a little bit of trouble wrapping my heard around:
Thus because prices are sticky, an increase in the money supply will temporarily cause higher real money demand, a lower real interest rate, and a lower real exchange rate.
Perhaps it is just the framing, because at least two of these are effects that happen in the very short run. Tighter money reduces the Wicksellian rate in the longer short term into the medium term depending on whether tighter money is the longer term expectation. At least, I recall that to be part of the core explanation as to why the nominal shock portion of the Great Recession persisted for so long when explained in terms of the difference between nominal and real interest rates – the Wicksellian rate was pushed so far below zero in the nominal shock that even the nominal ZLB was much too tight. Add to this the attempt to put a floor under nominal rates with IOR, and there was a real problem there of the Fed zigging when it should have been zagging.
I hate to be so bold here, but the next part of the statement appears a bit on the side of glib:
The effects are temporary, and go away once wages and prices have adjusted.
I suppose that in theory, this is true. Money is neutral. I have an issue with how this is put forward, though, because this depends on whether the change that brings about the disequilibrium is a one-time deal or one that is more ongoing in a succession of changes in one general direction as to never allow the adjustment process to complete before another shock is induced. It takes an accumulation of the same category of monetary errors in order to sustain disequilibrium in either direction, a point that many are all too familiar with when the topic of the Great Inflation comes up. But it seems like it is difficult for some to understand that the same sort of ongoing disequilibrium pendulum swings both ways and in either case, a desirable outcome is very unlikely. Many of us probably already understand that there is no such thing as a Great Inflation or a Lost Decade in the absence of an ongoing monetary policy problem and that these do leave some sort of long lasting scar.
If, for example, the Great Recession were the result of a onetime error of omission, not reducing interest rates when the last chance to do so presented itself, it would not have lasted as long as it did. But in all reality, there were many policy errors of omission, as well as errors of commission, such as IOR, in addition to failure to do enough remedy the situation in an ongoing fashion. Too tight money lasted for what felt like forever, and believe me, I had plenty of time on my hands to ponder the situation.
Obviously I am not in agreement that monetary policy has done as much as possible to unbreak the eggs without going overboard. The new “Greater Moderation” is governed by luck more than anything resembling stable and reliable theory, or lawfulness. Frankly, it sucks rocks now, and will really suck them much harder later. But no worries, the Fed critters have no fear of unemployment lines and soup kitchens.
By the way, if productivity takes a hit during a negative monetary shock as labor is reallocated to much less productive services, why are they not being allocated back, if money has no meaning in the longer run? Why did we go from aerospace to flipping hamburgers and not back again? Perhaps flipping burgers is more rewarding?
Just a little something to noodle on…