I’m With Stupid
Via FT Alphaville, James Montier has an interesting piece castigating economists for their “interest rate idolatry”, their belief that central bank-set interest rates matter a lot for the economy and that therefore it is useful, at least conceptually, to think about the “natural” rate of interest that would lead the economy to full employment. There is no evidence that interest rates matter in that way, he says, and economists who talk about natural rates are simply engaged in groupthink.
In particular, he identifies three blind and/or stupid economists leading everyone astray: Janet Yellen, Larry Summers, and yours truly.
Well, it could be true; there’s plenty of stupidity in the world, and much of it imagines itself wise. But in my experience people who declare confidently that “economists don’t understand X” usually turn out to be wrong both about X and about what economists understand. As I wrote in one context, often what they imagine to be a big conceptual or empirical failure is just a failure of their own reading comprehension.
Let me also say that if you were going to look for economists who blindly repeat doctrine, without the intelligence or courage to challenge conventional wisdom, neither Janet Yellen nor Larry Summers would be top picks.
So Montier offers a lot of evidence that interest rates move a lot, which isn’t news to anyone, and then one argument he apparently thinks is a big thing economists don’t know — that business investment is basically unaffected by interest rates. Who would have suspected such a thing? Well, everyone. Here’s what I wrote some years ago:
Back in the old days, when dinosaurs roamed the earth and students still learned Keynesian economics, we used to hear a lot about the monetary “transmission mechanism” — how the Fed actually got traction on the real economy. Both the phrase and the subject have gone out of fashion — but it’s still an important issue, and arguably now more than ever.
Now, what you learned back then was that the transmission mechanism worked largely through housing. Why? Because long-lived investments are very sensitive to interest rates, short-lived investments not so much. If a company is thinking about equipping its employees with smartphones that will be antiques in three years, the interest rate isn’t going to have much bearing on its decision; and a lot of business investment is like that, if not quite that extreme. But houses last a long time and don’t become obsolete (the same is true to some extent for business structures, but in a more limited form). So Fed policy, by moving interest rates, normally exerts its effect mainly through housing.
But Montier seems to have forgotten about housing, which is actually a fairly common problem among certain kinds of econocritics.
And do interest rates move housing? Here’s the inverse of the Fed funds rate versus housing starts during the period when major moves in monetary policy were mainly driven by concerns about inflation (as opposed to bursting bubbles):
Looks like a relationship to me. And I would say that for many economists of a certain age, the events of the early 1980s were especially important in convincing us that monetary policy can matter a lot. Paul Volcker decided to tighten; interest rates soared, housing collapsed, and the economy plunged into a deep recession. He decided that the economy had suffered enough, rates plunged, housing surged, and it was morning in America.
Beyond that, the general proposition that money matters also rests on a lot of careful empirical work — in fact, on two styles of careful work. There’s the Romer-Romer narrative approach, which examines Fed minutes to identify “episodes in which there were large monetary disturbances not caused by output fluctuations”, and the Sims approach, which uses time-series methods. Both find that monetary policy does indeed matter.
Are there times when monetary policy — or at least conventional monetary policy — can’t do the job? Of course. Summers and I have been talking about the zero lower bound since the 1990s — he introduced the argument that the ZLB justifies a positive inflation target, I brought liquidity-trap analysis out of the mists and back into modern economics.
The bottom line here is that there’s plenty of real stupidity in the world; we don’t need to add to the cloud of confusion with a critique of imaginary stupidity.
krugman
