Tuesday, April 23, 2013

Battle of the Keynesians: Krugman versus Meltzer (As reported by a Keynesian)

Brad DeLong has a blow-by-blow:

It really does seem as if Allan Meltzer does not understand the basic economics of money demand--does not understand that the short-term safe nominal interest rate is the opportunity cost of holding cash balances. And not understanding that makes it impossible to think coherently about nearly any issues in monetary economics…

Paul Krugman:

Trap Denial: OK, probably going on too much about this, but I want to return briefly to the issue of puzzled economists, specifically Allan Meltzer.

Four years ago Meltzer and I effectively had a debate about the effects of the rapidly expanding Fed balance sheet. He (and others) warned of inflation ahead; I (and others) said that we were in a liquidity trap, so that the Fed’s bond purchases would basically just sit there. So here we are four years later, the huge expansion of the Fed’s balance sheet has not, in fact, led to inflation. And Meltzer is puzzled by the fact that all those bond purchases just sat there:

Since late 2007, the Fed has pumped more than $2 trillion into the U.S. economy by buying bonds. Economist Allan Meltzer asked: “Why is there such a weak response to such an enormous amount of stimulus, especially monetary stimulus?” The answer, he said, is that the obstacles to faster economic growth are not mainly monetary. Instead, they lie mostly with business decisions to invest and hire; these, he argued, are discouraged by the Obama administration’s policies to raise taxes or, through Obamacare’s mandate to buy health insurance for workers, to increase the cost of hiring.

He made a monetary prediction; I made a monetary prediction; his prediction was wrong. Therefore, it must be because of Obamacare!

And, of course, if ObamaCare was causing structural problems and reducing aggregate supply, that would make inflation not undershoot but overshoot Meltzer's forecast. What we have here on Meltzer's part is simply badly-prepared word salad.

Actually, Krugman and Meltzer are both wrong, Meltzer less so than Krugman. Meltzer is correct in saying that government regulations are stifling the economy. They are. The number of sectors that are free from government regulation are getting smaller and smaller.

Where they are both wrong is that they fail to understand that the monetary base is not the money supply. If the Fed prints high-powered money and it ends up as excess reserves, the money is not in the system. It is back at the Fed just sitting there.

Here's the monetary base:

Here's the chart on excess reserves.

A significant portion of what the Fed has printed has simply ended up back at the Federal Reserve  as excess reserves.The result has been erratic money supply growth---which does a lot to explain the erratic moves in the economy.

In other words, more significant than DeLong's claim that  Meltzer doesn't understand price theory, is the sad fact that it appears Krugman, DeLong and Meltzer don't seem to understand that rather than a focus on the monetary base, the real focus should be on the erratic money supply growth. 

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