Friday, February 14, 2014


I have the distinction of having made Brad DeLong's Thursday idiot rollcall. For the uninitiated, here's what being labeled an idiot by Brad DeLong means. From DeLong's vantage point, the world looks like this:
In DeLong world, there are in fact genuine crackpots in that large idiot set. There are also genuine crackpots in the small "friends of Brad" set. Having Brad put you in the large idiot set is really not informative.

But we should see what Brad has on his mind. Maybe he has a point? Brad's complaint regards this post of mine, where I discuss a New York Times article on Narayana Kocherlakota. The latter part of the post used this quote from Ed Prescott as a launching point:
It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed.
It was obvious to me that this would set some people off. Indeed, Prescott likes to say things like this for that purpose (though not for that purpose only). And, indeed, it set people off.

But, the point I wanted to make is that what Prescott said is not obviously kooky. For example, if we take the statement apart and ask what it means, we have to ask what exactly "monetary policy" connotes. Does this mean the systematic element of policy, or are these the "surprises" in monetary policy? Prescott's statement says that, since 1913, monetary policy was unimportant for the time series of employment and output. Does that mean that monetary policy could not have an effect on real variables? Prescott's statement certainly does not say that the Fed cannot control inflation, or that inflation does not matter. So, there are a lot of things to consider. I thought this could be thought-provoking, and commenters had some interesting things to say. I certainly learned something.

So, this is what DeLong says about Prescott's statement:
Everyone else simply says: "Prescott is wrong: that's not an established scientific fact at all."
I guess the problem DeLong is having here is with the words "established," and "fact." Those words make the statement seem grandiose. But if we were to be charitable to Ed, we might say that by "established" he means "the best evidence we have tells us," and by "scientific fact" he means "the fact is that the science tells us the following." But this is semantics, and is not very illuminating. Here's what one of my commenters said:
There is a very clear and uncontrovesial interpretation of what Prescott was saying: Milton Friedman was wrong in that, if you do an analysis of variance of which shocks explain most of U.S. GDP and inflation fluctuations, monetary shocks will explain a tiny fraction of either. This is not a radical, out of mainstream view, it is in fact what comes out of SVAR studies and of DSGE estimation. If you want to see for yourself, open Smets and Wouter's AER and look for the table with the analysis of variance.

What this doesn't mean (and this is where Prescott was too vague and open to attack), is that monetary policy is impotent if a Central Banker decides to use it in an unexpected way, or that monetary policy rules don't matter, since they may affect how macroeconomic aggregates react to real shocks. But if you want to know the source of fluctuations, you are better off looking elsewhere.
I thought that was pretty good.

So, here's a blog post of Brad's from 2010 in which he approvingly quotes Narayana Kocherlakota, as follows:
Why do we have business cycles? Why do asset prices move around so much? At this stage, macroeconomics has little to offer by way of answer to these questions. The difficulty in macroeconomics is that virtually every variable is endogenous – but the macro-economy has to be hit by some kind of exogenously specified shocks if the endogenous variables are to move. The sources of disturbances in macroeconomic models are (to my taste) patently unrealistic. Perhaps most famously, most models in macroeconomics rely on some form of large quarterly movements in the technological frontier. Some have collective shocks to the marginal utility of leisure. Other models have large quarterly shocks to the depreciation rate in the capital stock (in order to generate high asset price volatilities). None of these disturbances seem compelling, to put it mildly. Macroeconomists use them only as convenient short-cuts to generate the requisite levels of volatility in endogenous variables...
In my opinion, that's being too negative about what we actually know, but the point is that Brad seemed to agree with that. And what Kocherlakota was commenting on was the best available science, and he says the best available science doesn't tell us a lot about what is going on. My commenter above says that the best available science - the same science Kocherlakota is discussing - tells us monetary policy is not so important. So, we're at least talking about the same science here, which seems to conclude something that is not so far off what Prescott is claiming.

So, it seems Brad is not being entirely consistent. Asking questions is important. Good scientists should not cut off discussion by calling people idiots when what they're saying appears not to be entirely orthodox.


  1. Steve, I think Brad's reaction to your post is unjustified. Having said that, I think Prescott's statement in this case was over-the-top once put in the right context.

    Prescott made the remark in response to a question about the potency of monetary policy, and not whether fluctuations in money growth are behind the observed fluctuations in output! The answer to the latter does not require a fancy VAR analysis. Even looking at Figure 3.13 of your textbook raises questions regarding Friedman's view. Specifically, the behavior of M2 becomes not only less volatile after 1990 but in fact countercyclical. This indeed suggests that other shocks are driving fluctuations in output, and that after 1990 money growth is responding to these shocks. Having said that, it is also the case that the beginning of the Great Moderation corresponds to this break in the relationship between output and money. So while changes in money growth may not be important sources of output fluctuations, they may still be important as a remedy to whatever shocks are driving output fluctuations. Of course, it is too early to tell if this is the case, but it certainly is not an established fact that it isn't the case.

  2. "It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed."

    About Prescott, here I gotta side with Brad. All kind of sophistry and postmodern games cannot undo that Prescott's statement is a lie. The Great Depression and the Volcker disinflation are the clearest data points that illustrate that money is anything but neutral in the short-run.

    But while disagreeing with your bad defense of Prescott I consider your original post to be pretty good as you asked a fundamental question which is rarely asked (the dogma of central bank independence is also rarely questioned but at least more often that central bank existence).
    Even if the answer to this question would be the orthodox one, "we need CBs", the question was still useful as it made people think. I like to call such question Brechtian as Brecht also liked to ask fundamental question like "what does an actor do?".

    1. "The Great Depression and the Volcker disinflation are the clearest data points that illustrate that money is anything but neutral in the short-run."

      Great Depression: That's not clear. A lot depends on what we think "monetary" factors are. If you asked me, I would say that it's clear that financial factors, bank failures, and panics, were important, at least for propagation of whatever shock caused the Great Depression. Friedman and Schwartz make the case that things would have been a lot better if the Fed had done the right thing. But Cole and Ohanian argue, I think, that we don't need to even think about the financial stuff to explain what is going on. I don't agree with that, but that's the case they make.

      Volcker: Probably you're right, but again it's not obvious. Maybe Volcker brought inflation down, but the output decline was driven by other factors. Energy prices?

    2. "But Cole and Ohanian argue, I think, that we don't need to even think about the financial stuff to explain what is going on. I don't agree with that, but that's the case they make."

      If you don't agree with Cole and Ohanian's argument, why do you enlist it in support of Prescott's position?

      Parsing what you have written, you clearly state that you believe that financial/monetary factors were important for the Great Depression; that Friedman and Schwartz hold similar position; and that you disagree with Cole and Ohanian's argument. In other words, your views on the Great Depression are pretty mainstream.

      To summarize: you clearly disagree with Prescott's position on the merits, but can't seem to find in you what it takes to state it in clear words.

    3. Former U.S. President Harry S. Truman famously said: "Give me a one-handed economist! All my economics say, ''On the one hand? on the other.''

      Steve is simply being an economist!

  3. My impression is that Friedman&Schwarz is the mainstream view while the Keynesian 'liquidity trap so fiscal policy' arguments are not accepted by everybody and other arguments like e.g. Stiglitz' productivity shock in the agricultural sector argument seem highly dubious at best.

    About Volcker, sure, there was a supply side shock which brought output down but contractionary fiscal policy made the recession worse. Of course it was necessary to bring inflation expectations down and just like the Great Depression inspired discretionary public demand management the Volcker disinflation inspired rule driven demand management merely conducted via monetary policy.

    By the way, I don't wanna "overdefend" these orthodox positions. But I also don't wanna pretend that they have become orthodox for no good reason so when I encounter with an idea like Stiglitz' sectorial productivity story or Cole and Ohanian's decreased competition story which ignore the elephant in the room I am highly sceptical (not at least because productivity and competition change all the time and basic convexity arguments imply smooth output / factor input changes)

    I am pretty sure that the source is monetary/financial: in a hypothetical barter economy without imperfect financial markets recessions would be far less severe. If this is indeed the case Wicksell, Keynes and Friedman would have been right, money is not neutral in the short-run.

    1. correction: contractionary monetary policy made the recession worse

  4. The full Prescott quote:
    Edward C. Prescott, who won the Nobel in economic science in 2004 and is on the Minneapolis Fed’s research staff, said Mr. Kocherlakota was misjudging the Fed’s abilities. “It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed,” Professor Prescott, also on the faculty of Arizona State University, wrote in an email. Bond buying, he wrote, “is as effective in bringing prosperity as rain dancing is in bringing rain.” (emphasis mine)

    It certainly does sound as if Prescott is making the extreme claim his critics say he's making.

    That said, it is not good to call people "idiots", so this comment is not an endorsement of that.

    1. You should know the whole story here. I was contacted by the same NYT reporter, who asked to talk to me on the phone. I responded by telling him I would prefer to do it by email. He sent me a set of questions, some of which I answered. Judging from the Prescott quotes this journalist used, my guess is that the NYT guy asked Prescott the same questions. Basically, the piece was written with a particular narrative viewpoint, and the NYT guy chose what he thought were juicy quotes to fit into his narrative. So, it would be interesting to know what else Prescott had to tell him.

      The quote in bold you mention appears to refer to QE - i.e. purchases of Treasury bonds by the Fed. One can easily defend that statement. There really is no solid evidence that tells us that QE works, and no theory of QE has been used to measure the effects empirically. So, if Prescott says QE does not bring prosperity, that statment has as much merit as Ben Bernanke's claim that it does.

      So, he's making strong statements alright, but given what we know, these things are not outside the realm of possibility. So, the reaction to these things shouldn't be to say: Oh, that's so obviously a lie, what an idiot. You should be thinking about what things we think we know, and why, and what we need to find out to confidently tell Ed he doesn't know what he's talking about.

    2. I heard a certain economist called Prescott said money is not important. I wasted no time to reduce all my money to pieces. I wish he had said that earlier. Some economists have enlightening views. Really.

    3. This highlights what some people may be thinking. There are three statements:

      1. Money does not matter.
      2. Monetary policy does not matter.
      3. Monetary policy has not mattered much for real variables since the founding of the Fed.

      Prescott's claim is not (1) or (2), but (3). The commenter is saying that Prescott's claim is (1). But (1) and (3) are entirely different.

    4. That is interesting. Now I want to see the whole email interview...

      It is indeed very easy to use selective quotation to make people "say" anything you want.

    5. But (3) is hardly not controversial! See Volcker disinflation.

    6. Exactly. But we can't say everything that happened in that period is well understood, and that we can confidently break down the real output effects into what was caused by monetary policy, and what was caused by other factors.

    7. I would disagree with that statement. I would say that there is overwhelming evidence that monetary policy caused a major contraction (the Volcker disinflation), as well as convincing evidence that other contractions were caused deliberately by monetary tightening (e.g. the Romer and Romer evidence). I also have some trouble taking seriously anyone who ignores such a wealth of evidence.

    8. Noah,

      I tried to post the email conversation here, but it was way too long. See my last post.

    9. I'm pretty sure Ed Prescott isn't sitting around wondering whether a nutjob like Irineu de Carvalho Filho takes him seriously or not. And I'm also pretty sure that the rest of us don't care either.

  5. The role of monetary policy is to regulate the right quantity of money in the economy. At operational level, central bankers my choose to adopt several instruments from targeting money growth to defending an explicit inflation objective. So monetary policy is all about getting money in the productive and speculative sectors. I cannot see why you should be pushing around semantics. If monetary policy is not important in driving observed fluctuations in output, then money is irrelevant.

    1. Here's an example. We need a model, but you can take any model in which money matters for some fundamental reason. In such a model, money is important as a medium of exchange for, say, overcoming a double coincidence problem. If we did not have money, then we would have less exchange, and in a well-defined sense real output would be lower. So money matters. But it is also typical in such a model that money is neutral in a well-defined sense. In the long run, a level change in the money supply is neutral - there is no effect of money on real variables. So there is a well-defined sense in which monetary policy does not matter. The question is, how much does monetary policy matter in the short run, and what do we mean by short run. That's debatable.

    2. But neutral is not the same as superneutral.

    3. You bet. But I don't think Prescott would argue that long-run inflation doesn't matter.

    4. By the way, any thoughts on my first comment? Do you see a change in the cyclicality of M2 that coincides with the beginning of the great moderation?

    5. You have to worry about endogenous money. That was one argument of the RBC people - not really worked out completely, but the argument seemed to be that you could explain the behavior of monetary aggregates with technology shocks, working through the intermediation sector.

    6. Finn and Scott Freeman worked the idea out fairly completely in their AER paper. I miss Scott, he was a great economist and a great guy.

    7. Yes, I agree, but even though it is too early to tell, I do see the possibility of a structural break. Whether this is the result of policy regime changes is of course debatable. But I am not familiar with convincing explanations regarding what else could bring such a radical change.

    8. "I miss Scott, he was a great economist and a great guy."

      Me too. Sorry, I forgot about Freeman/Kydland.