Are we overly focused on nominal issues?

Here is Trevor Adcock in answer to my previous post on “Regime Uncertainty”:

“Real regime uncertainty could also cause a recession if the uncertainty was over policies that affect prices and wages. The New Deal policies that distorted prices and wages directly contributed about as much to the Great Depression as policies that affected them indirectly through nominal GDP shocks. I sometimes feel that Market Monetarists focus too much on the left side of the equation of exchange and not enough on the right side.”

Trevor surely brings up a valid concern. Sometimes it seem like all of us Market Monetarist bloggers run around with our hammer and scream “If just the central banks would target the NGDP then everything would be fine”. We so to speak spend a lot (all?) of our time talking about MV in MV=PY and there might be real worry that people think that we underestimate other problems.

Is that because we do not think that there are structural problems in the US and European economies? Certainly not. I think most of us think that both the US and the European economies face very serious structural challenges and that the structural problems clearly hamper long-term real GDP growth. In fact I think most of us are much more concerned about these issues than mainstream economists – particularly mainstream European economists. After all we are all Free Market oriented (that’s an understatement) economists.

However, I believe that the present crisis both in the US and Europe is 90% nominal and 10% real. The crisis is a result of monetary policy mistakes. So yes, there are supply side problems both in the US and Europe but these problems did not cause nominal GDP to drop 10-15% below the pre-crisis trend level. This is why we are running around with our hammer and scream about NGDP level targeting all the time.

Furthermore, there is an important political-economic perspective on the discussion of nominal versus real problems. History has shown than when misguided monetary policies create problems then opt for interventionist policies to fix these problems rather than by fixing the nominal problems. Just think about NIRA and Smoot-Hawley in the US during the Great Depression or capital controls in France, Austria and Germany in 1930s. Today European policy makers are trying to “fix” the problems with highly damaging proposals for a Tobin tax, a ban on short-selling of stocks, legal attacks on rating agencies etc. No European policy makers (other than a few extreme leftists) were advocating these ideas prior to the crisis. Said in another way the monetary induced problems have led policy makers to come up with high damaging proposals that will reduce long-term real growth and do little or nothing to solve the problems facing the US and European economies at the moment. Milton Friedman’s case for floating exchange rates was to a large extent build on this kind of argument.

In my view some libertarian and conservative economists particular in the US is overplaying the “supply side problems”-card and by doing so actually discredit their own reform proposals. Many US Free Market economists for example have argued that the Obama administration’s proposals for healthcare reform played a key role in postponing the recovering in the US economy. Sorry guys that just comes across as a partisan argument rather than a argument based on sound economic reasoning. And note I am not endorsing Obama’s proposals – I just don’t think that it had any major impact on the speed of the recovery in the US economy. I am no fan of socialized medicine, but the issue is largely irrelevant for the present crisis. When the Clinton administration in the 1990s had proposals that was a lot more interventionist than what the Obama administration has suggested it did not led to a drop in economic activity in the US. And why not? Well, at that time the Federal Reserve was doing its job and kept NGDP growth on track (there comes the hammer again…).

We could of course spend more time on criticising these damaging policy proposals. We could also talk about the massive demographic challenges facing many Europe economies or talking about the massive burden on the economy from high taxes. But just because Milton Friedman focused most of his research on monetary issues I don’t think that anybody would argue that he did not care about supply issues. Market Monetarists are no different than uncle Milt in that regard.

PS see also my related post Monetary policy can’t fix all problems.

Leave a comment


  1. Alex Salter

     /  February 14, 2012

    “I am no fan of socialized medicine, but the issue is largely irrelevant for the present crisis.”

    I don’t think it’s crazy to suppose a policy that will raise costs for businesses would lead those businesses to produce less going forward.

  2. Trevor Adcock

     /  February 14, 2012

    I think you misunderstood my point. I was suggesting that Market Monetarist don’t focus enough on micro-foundations. What is really the difference between disequilibrium in a market caused by a nominal GDP shock and disequilibrium caused by the government legislating price changes. Early New Keynesian economics got a lot of this right, it’s a shame they went on to forget it all.

    • Trevor Adcock

       /  February 15, 2012

      Certainly my reply was not very clear, as well. It made more sense when I was writing it.


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