Answering questions on “Quora” about Market Monetarism

I recently signed up for Quora. According to Wikipedia Quora “is a question-and-answer website created, edited and organized by its community of users.”

I am not a frequent user of Quora but drop by from time to time and tonight I ran into this question:

Why do some market monetarists advocate fiscal austerity?

That one I obviously had to answer and here it is:

The short answer is the Market Monetarists do not advocate fiscal austerity. What MM’ers are arguing is that monetary dominates fiscal policy. Hence, IF fiscal policy is tightened then it will not necessarily have an negative impact on aggregate demand – or nominal GDP – if the central bank for examples targets inflation or the nominal GDP level. This is known as the Sumner Critique.

The view that monetary policy dominates fiscal policy in the determination of nominal spending in the economy makes Market Monetarists less fearful fiscal austerity than for example keynesians. Furthermore, Market Monetarists are highly skeptical about discretionary policies – both monetary and fiscal – and that leads Market Montarists to advocate rule based fiscal and monetary policy.

In addition most of the leader Market Monetarists thinkers are libertarian or conservative and as such highly skeptical about a large public sector and as a result many Market Monetarists therefore would welcome cuts in public spending. That, however, is not at the core of Market Monetarist thinking.

Finally for most Market Monetarists fiscal austerity is simply about simple arithmetics – in the long run governments cannot spend more money than they bring in. Therefore, for countries that are unable to access the global capital markets – such as Greece – there is no alternative to austerity.

I have written numerous blog posts on these issues on my blog The Market Monetarist. See some of them here:

“Conditionality” is ECB’s term for the Sumner Critique

In New Zealand the Sumner Critique is official policy

Policy coordination, game theory and the Sumner Critique

The Bundesbank demonstrated the Sumner critique in 1991-92

The fiscal cliff is not the end of the world

Cato Institute on US military spending and the fiscal cliff

The fiscal cliff is good news

The fiscal cliff and the Bernanke-Evans rule in a simple static IS/LM model

The fiscal cliff and why fiscal conservatives should endorse NGDP targeting

There is no such thing as fiscal policy – and that goes for Japan as well

There is no such thing as fiscal policy

Leave a comment


  1. Benjamin Cole

     /  December 27, 2012

    Excellent post.

    But I wonder…could QE become a permanent monetary policy? Then what would be fiscal austerity?

    The next stage for monetary policy might be perma-QE.

    Think Japan. How many years of QE will it take for them to have a robust, moderate inflation economy solidly entrenched?

    In general, I am for a much smaller government, but only if we have robust economic growth.

    • Benjamin,

      I fundamentally think that QE is a terrible term as it sounds like central banks are doing something different from what they traditionally have done. The fact is that central banks have to monetary policy tools. One is to change the money base and the second is signaling – telling the market what it intent to do with the money base in the future.

      QE is just an increase in the money base. In that sense QE has always been “permanent”.

      The problem with the kind of QE that central banks have been doing for the past 4 years that it has been tremendously ad hoc in nature. As a result the impact has been smaller than hoped.

      We need to move away from the ad hoc’ish monetary policy towards a rule based framework – that is a strong emphasis on the signaling part of monetary policy.

      While I think that a rule based monetary policy is strongly necessary I also think that the major central banks of the world have lost a lot of credibility. Therefore to reestablish credibility any switch to a rule based monetary policy – for example NGDP level targeting – likely needs to be accompanied by massive “QE” to signal to the markets that the central banks mean business. However, once credibility is reestablished a much less aggressive increase in the money base is needed.

  2. Suvy

     /  December 28, 2012

    I agree with almost everything in this post, I just want to add one comment about the role of fiscal policy. There is a role for fiscal policy because fiscal policy can be used to produce more. Printing money cannot be used to increase production. Usually, producing more would take away resources from the private sector, but when you have 12 million people unemployed and are stuck in a depression, spending money on things like infrastructure may make sense. However, it may add to the fiscal deficit/government debt and that is not a good thing. I think the major thing is that governments shouldn’t run deficits during the “boom times”, if you will. It just doesn’t make sense and is horrible policy. You save money in the booms and spend money on things like infrastructure in the busts.

    I think spending money on things like infrastructure and public works is much better than spending money on things like stupid wars, unnecessary defense, and transfer payments like social security. All of those things do not help the productive capacity of a country in the long run and do not add to the capital stock, they just take from one group and give to another–in some cases, they destroy capital, like unnecessary wars.

  3. Benjamin Cole

     /  December 28, 2012


    Maybe in Denmark, cynicism is not the rule.

    Sheesh, I just do not think Americans place a lot of faith in DC these days.

    “Re-establish credibility?”

    1. The Fed can’t command credibility. It is a federal agency. The public is very cynical. It may be even more skeptical of an opaque, bankers-friendly federal semi-agency.

    2. No one understands the Fed. The public is uneducated. Worse, even people who understand the Fed disagree on the effects of its actions See Wiliamson, vs. Krugman, vs. Sumner, vs. Richard Fischer etc.

    Monetary policy has to work without convincing the public of anything.

    (Side note, how credible is the Fed when a Richard Fischer runs around saying they are risking an inflationary volcano? And he is part of the Fed! What is the public to make of this?)

    Greenspan ran monetary policy without any public understanding of what he did. He mumbled. So monetary policy can be successful without credibility.

    If the Fed has no credibility now—after 30 years of crushing inflation—when would it have credibility?

    That said, I agree with you that the Fed should be transparent, accountable, provide clarity as to intentions. Those are democratic ideals.

    It should be responsive to elected leadership—that is also a democratic ideal.

    Despite all this, I really enjoy your blog, and agree with you on 90 percent of what you say!

    • Benjamin,

      You are right – Danes tend to be less cynical about public officials than Americans. In that sense, however, I am not a Dane. I studied too much Public Choice theory to have a blind trust in government officials.

      In terms of credibility we have to define it as the central bank saying what it want to achieve and then delivering. In recent years most of the major central banks in world have failed to say even what they want to achieve.

      It might be that the wider public is complete ignorant of monetary policy, but financial market participants are certainly not and that is the important thing in terms of the economy and the monetary transmission mechanism.

      To illustrate this lets assume that the Fed tomorrow announces that it will bring back the NGDP level to the pre-crisis trend level by the end of 2013 and will conduct unlimited QE to achieve that. Lets then assume that the average Joe is completely ignorant about, but financial market investors are not. Investors would know that NGDP level targeting would boost stock markets and weaken the dollar – so they would jump on these trades even before the Fed would do any QE.

      The average Joe would not notice what the Fed is saying, but would notice stock prices spiking. That would truly make him more likely to increase consumption and feel more secure about his job security. Similarly exports would get a boost from a weaker dollar. In this environment property prices would certainly also rise.

      Said in another way even if we assume an ignorant public, but fairly rational investors then signaling in the terms of clearly defined monetary policy targets would clearly have a strong impact on the economy.

      And suspected that you like my blog…thanks. And thanks for you input.

  1. Market Monetarism…ainda desconhecido no gigante adormecido « De Gustibus Non Est Disputandum

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