Washington, DC -- (ReleaseWire) -- 07/27/2015 --BENNETT: Scott Sumner is the Director of the Program on Monetary Policy at the Mercatus Center of George Mason University, as well as economist who teaches at Bentley University in Waltham, Massachusetts. His economic blog, The Money Illusion, popularized the idea of nominal GDP targeting which says that the Fed should target nominal GDP (real GDP growth plus the rate of inflation) to better "induce the correct level of business investment. Scott, welcome to Financial Myth Busting.
SUMNER: Thanks for inviting me.
BENNETT: Last Wednesday, Janet Yellen presented a monetary policy report to the House Financial Services Committee, and while she was there Wisconsin Representative Sean Duffy laid into her for ignoring a congressional subpoena regarding a leak from the Federal Reserve in 2012 when the minutes of a Federal Open Market Committee were apparently leaked to a firm that sells analysis to investors before they were released to the public. Can you give me some background about what's at play here, and the role of Congress in overseeing the Federal Reserve?
SUMNER: Well, I don't know the details of that particular case, other than what you described. I guess it was a difference of opinion, as to whether the Feds have to provide that information to Congress. You would think they would. I guess Janet Yellen said something about an ongoing investigation. I don't know about that, but I will say in general I do think there needs to be more accountability at the Fed. The way they've been set up, they're not really accountable, in terms of whether they're doing their job in an appropriate way. So I focus more on the monetary side: are they doing their monetary policy job, hitting the mandates given to them by Congress? And right now, there's so much mysticism surrounding the Fed that it's very hard for Congress to really hold them accountable, because people in Congress don't have expertise in that area—they don't even know what questions to ask—and the Fed can always shift the discussion to some other area, if they're uncomfortable in one question raised by Congress.
BENNETT: And they do.
SUMNER: So in other words, what I'd like to see is a specific target that the Fed has tried to achieve, like nominal GDP, and then you could evaluate whether they're achieving or not. If they're not, you could say, 'Hey, what's going on here? Why aren't we seeing the results that your mandate calls for?' And we just don't have that specificity right now with the Fed.
BENNETT: You have a very different view of the Federal Reserve policy than most do. I mean, some credit you as the reason Ben Bernanke deciding to engage in quantitative easing. You can let us know if that's true or not, but I know you've objected to the way this has unfolded. If you were Bernanke or Yellen, what would you have done differently?
SUMNER: First of all, my main difference is I diagnosed the problem differently way back in 2008 and 2009. I thought monetary policy needed to be more expansionary, and that struck a lot of people as crazy, because they looked at it through the lens of interest rates, which were pretty low. But I looked at it through the lens of, is nominal GDP—which is sort of like national income—growing at a slow and steady rate that's compatible with economic growth and low inflation? Historically, that's been about 5%, although today maybe 4% would be more appropriate. But instead, nominal GDP fell, so I actually argued they needed to be more stimulative. And then they started to do the QE programs that some people saw as being along the lines of what I was suggesting, although I don't think I had any personal influence on the Fed. But I think that people also miss the point that they had to do the QE because of earlier failures which allowed the economy to slip too deeply into recession in 2008 and 2009. If they'd had a more sensible target and been adhering to it all along, I don't think we would've had to do QE. And then more recently, by the way Europe has finally accepted the need to do that, and it's years later and of course, Europe got deeper into recession than we did, because they made even more serious mistakes over there.
BENNETT: Aren't we currently testing the limits of the quantitative easing approach? The Fed is continuing to expand the money supply, but the nominal GDP doesn't seem to be responding. Is it your conclusion that we're simply not being aggressive enough?
SUMNER: Well, there's several things here. I would say the main policy they enacted, which was at the end of 2012, actually was surprisingly effective. There was a letter of 350 liberal economists predicting a sharp slowdown in 2013, because of the so-called 'austerity', that is the reducing the budget deficit with some sequester of spending and cash increases. Well, it turned out the reduction in the budget deficit didn't slow the economy at all, and it was partly because the Fed offset that with QE. Now, this year the Fed is already talking about raising interest rates in a few months, so that's a signal that the Fed feels the economy's roughly where they want it to be right now. They wouldn't be raising interest rates later this year if they thought we were not growing as fast as they wanted. So I've always felt that, to some extent, our slow growth is because the Fed is sort of passive and accepting of this. This seems to be the new normal, in their view, and they haven't really pushed as hard as they could. But I think when they did push, it did have a marginal effect. If you compare the US to Europe, the effect of QE3, there was just a dramatic difference. Europe went into a double dip recession; they did not do QE until just this last year. In the US, where we did QE, we continued to grow. And fiscal policy was about the same in both places. All the difference was in monetary policy.
BENNETT: Do you think she should raise rates?
SUMNER: That's a hard question to answer, because I think it depends on the context. I've always felt that rates should be determined by the status of the economy. If the economy starts to grow more rapidly, yes, she should raise rates. But it should be conditional on the economy. If the economy is weak, that's telling you that the rates need to be low, and if you try to raise them before it's ready, as the Europeans did in 2011, they raised rates, they just went back into a double dip recession. So to me, I would compare it to somebody who's been in bed, maybe quite ill, for a couple of months. They start to feel better and they go out and play a round of golf, and then they discover they're actually not that healthy and they collapse on the golf course. So if we've been zero-bound because the economy's been so weak, it might seem like we're doing better, we can raise rates, and maybe we can; it's very possible that the rate increase later this year will be fine. But there is a risk it could push into a double dip recession. So on balance, I'd probably prefer they wait until next year to do it. But it's a tough call.
BENNETT: It is. Yellen points to very modest inflation as what she's saying is an argument in favor of continued accommodative monetary policy. Isn't she missing something? In a slow economy, don't producers drop prices until they find the market clearing level? In other words, absent any Fed intervention, who's to say prices wouldn't be lower, and that there is inflation in the form of so-called price stability?
SUMNER: Well, okay, but I think the argument here is the Fed has taken it as its job, and in a sense, Congress gave it the duty, of targeting inflation. One of the things that I would like to see is a more specific target. Because they have a 2% inflation target, and they also try to target unemployment, and so that breeds a lot of confusion as to what they're actually trying to do. With nominal GDP targeting, they would just have one target and it would be much clearer. But I think I would defend Yellen in this sense; if you really take seriously that their inflation target is 2%, then that's what they should be trying to do, regardless of what interest rates are. And I would say that there isn't really any natural rate of inflation in the absence of the Fed doing anything, because the Fed is always doing something. The analogy is if you're steering an ocean liner, you're always doing something, you have the steering wheel at some setting. And you can't just say, 'Well, let's let the ship naturally take its course.' You're almost forced to, in some sense, steer it, because you control the money supply. And if you control the money supply, you control the value of money, you control inflation, ultimately. We can quibble about whether 2% inflation should be their target, but if it really should be their target, I don't see how people can say the Fed is too expansionary, because we've been undershooting 2% mostly for the past seven years. So I look at outcomes; are they achieving the target they're aiming for?
BENNETT: Central to that approach towards central bank policy making is the premise that monetary policy can be highly effective in reviving a weak economy, even if short term interest rates are near. Maybe you can give us some insight on that. Can we really ever know what is genuine growth? You talk about targets, and I'm wondering if it's just merely re-inflating a bubble.
SUMNER: Yeah, so here's a couple of things on that. I'm focusing in my blog mostly on what economists call the demand side of the economy, the business cycle, the swings up and down in spending. But you raise a good point; in the long run, what's most important is the buy side, our productivity, our economic growth that's generated by the basic factors like investment, productivity, workforce growth, training. And that's the key stuff in the long run, and monetary policy can't fix that. There are some economists to the left of me that I think focus too much on the demand side, too much on just more spending, and forget that countries like Greece also have structural problems, supply side problems. And I think the US has actually had two problems since 2008. One is the monetary one, but another one is that our productivity and our workforce growth and so on are very substandard. In the previous hundred years, we'd had a trend growth of about 3% in real GDP. Now more and more people are marking that down in sort of defeatist way, like, 'Oh, it's only 2.5% or 2% or 1.5%.' And this sort of defeatism, I think, overlooks the fact that we can do policies that boost productivity, boost efficiency, boost labor force participation, and get that trend growth higher. And those policies are not printing money; those are much more fundamental policies. As far as bubbles, I don't think monetary stimulus creates bubbles. I know that's a controversial view. I think that the problems we've had, like in sub-prime mortgages, were really due more to bad regulation. But I think the central bank really has to focus on just keeping inflation low and smoothing out the business cycle, and the rest of the economy and policy makers have to focus on changing the structure of our economy and make it more efficient, make it more free market oriented and more competitive.
BENNETT: At the moment, we're in the most bizarre US and global financial situation I can remember. The markets are wildly volatile. You know, there just seems to be so much absurdity in the marketplace. All debt markets seem to have become speculative arenas, courtesy of central bank activity. How does one explain the incompetence currently barreling its way through the financial markets?
SUMNER: Growth is slowing. I think the slow growth is really the main reason for the low interest rates, and then I think that low interest rates—and in the 21st century, that's the new normal, low interest rates—those are explaining the high asset prices, the high stock prices especially, and in some markets, recovering housing prices, and so on. With interest rates so low, people are looking for return, and they're going into stocks and so on. So I think unless we can fix the low growth, low interest rate environment with stronger fundamentals, we're going to be stuck with this.
BENNETT: You don't think this is a free market, do you?
SUMNER: Well, no. I think that the stock market is a free market, but the government intervenes in many ways which are counterproductive, but I do think the stock market actually reflects the market view of what these assets are worth, when they can only earn almost zero on the bond market? I mean, your alternatives are so low in the bond market that why wouldn't people pay a lot of money for stocks?
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