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Is Scott Sumner Reality Based ?

Scott Sumner wrote

If pressed, Keynesians will usually point to real interest rates as the right measure of monetary ease or tightness. By that criterion the Fed adopted an ultra-tight monetary policy in late 2008. Monetarists will usually say that M2 is the best criteria for the stance of monetary policy. By that criterion the ECB adopted an ultra-tight monetary policy in late 2008. And yet it’s difficult to find a single prominent macroeconomist (Keynesian or monetarist) who has publicly called either Fed or ECB policy ultra-tight in recent years. Maybe tight relative to what is needed, but not simply “tight.”

To me this means that he claims that US real interest rates have been high “in recent years”. Of course he also says “in late 2008” but suggests that the real interest rates then were a policy choice and that the policy continues.

In fact real interest rates in the US are extraordinarily low. The 5 tear real interest rate is negative. I think Sumner made a definite claim about published numbers which is definitely false.

Sorry I don’t know how to embed Fred graphs. Please click this link.

I added the chart for you — spencer

update: thanks spencer. Also I have added the link to Prof. Sumner’s post.

More after the jump.

I’d say he is crazy and delusional. Basically, I’m convinced that his methodolical a priori is that everything is determined by monetary policy. Since unemployment is high, he claims US monetary policy is tight. I think you quoted a declaration of religious faith and not a description of reality.

I don’t agree with Sumner’s claim about Keynesians. In fact Keynesians follow Taylor (a Republican hack and new Keynesian) and evaluate monetary policy by comparing the federal funds rate to the level given by a Taylor rule. The absolutely standard view among Keynesians is that the loosest possible monetary policy occurs when the federal funds rate is essentially zero. This explains why all Keynesians agree that US monetary policy has been very loose since the crisis began.

Note the careful qualifier “late 2008.” He has picked a cherry. In particular in late 2008 world financial markets were in a total panic with a desperate race for liquidity. This drove up the price of normal nominal treasuries and drove down the price of any asset with a thinner market (that is all other assets). This was not a shift in monetary policy (just as no Keynesians would call it a shift in monetary policy). It was also very brief.

The current 5 year real interest rate in the USA is negative. Real interest rates are extremely extremely low in the USA. But Sumner will not allow facts to weaken his absolute faith, so he decided to ignore all evidence from 2009, 2010 and 2011. He just talked about a brief spike about which neither the Fed nor any other entity could do anything.

He tried to write something which was technically true, but he slipped up. I quote with a totally fair elision

“By that criterion the Fed adopted an ultra-tight monetary policy in late 2008.
late 2008. … Fed … policy ultra-tight in recent years.” Late 2008 is not years recent or otherwise. It is part of one year. Sumner’s absurd claim is based on describing a few months over two years ago as “recent years”. Basically he claims that because real interest rates were briefly high years ago (during a panic) they are high now.

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More on Units and the Economic Cost of Spending Cuts

There is a new estimate of the effect of $ 60 billion spending cut on GDP and employment. Since this estimate was made by brilliant economist* Ben Bernanke aided by the staff of the Federal Reserve Board, it will get a lot of attention.

Bernanke said that a $60 billion cut along the lines being pursued by Republicans in the House of Representatives would likely trim growth by around two-tenths of a percentage point in the first year and one-tenth in the next year.

“That would translate into a couple of hundred thousand jobs. So it’s not trivial,” he said in response to questions from members of the House Financial Services Committee.

This sure seems to be completely different from Mark Zandi’s estimate of 700,000 jobs. I think there is some confusion about units of measure and, in particular about the unit the “job.”

How can that be ? Well the effect of a policy shock changes over time and so one can discuss the effect on person-years of unemployment. One can also discuss the maximum effect on unemployment, which, in practice means the effect measured in the month with the largest effect.

Bernanke explained his calculation. He calculated the effect on yearly GDP in 2012 then applied Okun’s law. Thus he calculated the effect on average employment in 2012. His estimate of job-years lost is around 200,000 in 2012 after 133,000 in 2011 and presumably some in 2013. There is no way to calculate the largest monthly difference between employment given Obama’s budget proposal and employment given the House Republicans budget from yearly growth rates.

I’m sure Zandi is talking about the largest monthly difference which I would guess he forecasts for late 2011 or early 2012.

I can do an Okun’s law calculation for Phillips et al. (the Goldman Sachs team). They predict that the cuts will cause third quarter GDP to be 0.75% lower. By Okuns law, that corresponds to roughly 500,000 fewer jobs (three eighth’s of one percent of the labor force).

They forecast that second quarter GDP will be 0.375% lower. That means that they forecast that growth from fiscal year 2010 to fiscal year 2011 will be reduced by
9/32 percent, that is roughly 0.3%. This is a larger effect than the Fed’s estimated effect on growth (I can’t tell how much larger as Phillips et al didn’t report a forecast for the 4th quarter). But 0.3% is 0.3%. I describe Phillips et al’s estimate as implying the loss of 500,000 job-quarters in the quarter of maximum impact. Using the same Okun’s law and the same Phillips et al forecast, Bernanke would say 200,000 job-years in fiscal 2011. The 2.5 fold difference is a matter of units of measure.

* This is not at all ironic. I think he is brilliant. Also and much more important, he is reality based. There are smart mathematicians who present themselves as economists but really study formal systems. Bernanke has brilliant thoughts about what really happened in the real world *and* he confronts them with the data.

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