Did Market Monetarists Accurately Predict Low Inflation?

David Beckworth stated on Twitter that Market Monetarists “knew all along inflation would not be a problem”.  It’s true.  The Market Monetarists have long been predicting low inflation and even deflation.   See this 2009 piece by Scott Sumner titled “Deflation is our Biggest Worry – Not Inflation”.  So yes, the Market Monetarists nailed this one, right?  Not so fast.

If you read the actual 2009 article you see the reasoning behind the thinking:

“Banks kept the Fed’s cash
Other economists point to the Fed’s large injections of cash into the banking system as an inflationary “time bomb.” But last October the Fed began a policy of paying interest on those extra bank reserves in order to keep interest rates from immediately falling to zero. Unfortunately, this caused banks to hoard the money, which is why prices have fallen over the past 12 months despite the Fed’s large injections of cash.”

Sumner followed that up a few weeks later with an even clearer explanation:

“Ohanian points out that the Fed has done a lot already, having increased bank reserves from $40 billion to $900 billion. But this liquidity injection was not what it seems — indeed, if it was, we’d now have hyperinflation. In reality, the Fed completely neutralized the injection by starting a new policy of paying interest on reserves, causing banks to simply hoard these “excess reserves,” instead of lending them out. The money never made it out into the economy, so it did not stimulate demand.”

This is obviously a misinterpretation of the money multiplier and it’s based on an incorrect causal understanding of bank reserves and the lending process.   More recently, there’s been some revisionist history on this concept.  Obviously, the 2009 Scott Sumner believed in the Money Multiplier and the myth that banks “lend out” reserves.  But since the Bank of England demolished that myth the story changed.  2014 Scott Sumner says the Money Multiplier is still valid, but simply represents a ratio instead of a causal relationship in the lending process.

So I don’t think the victory flag can be so triumphantly waved here.  I don’t doubt David’s claim that the Market Monetarists thought the Fed was too tight and that they weren’t doing enough to generate high inflation.  In fact, I think David is undoubtedly correct there.  But it’s also crystal clear that some other components of the reasoning for low inflation were based on a total misunderstanding of how modern banking works.  And so the conclusions were right, but not entirely for the right reasons.   And this again, proves why understanding the modern monetary system is so important.  



Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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3 years 1 day ago

I gave up trying to explain to Scott Sumner how banks work. Was boring talking to a brick wall. Nick Rowe is a different matter, though. He has some brilliant ideas and is prepared to listen and discuss alternative views.

3 years 22 hours ago

I’ve found the same to be true with David Beckworth. Great guys, the two of them. Very open-minded and smart thinkers. I’ve become a big fan of both.

Fed Up
2 years 11 months ago

Cullen and Frances, thoughts on these:

1) lower interest rates are mostly about more debt? Yes/No

2) monetary policy is only about buying assets? Yes/No

3) the hot potato effect can end immediately if a bond is bought from Apple, Warren Buffett, or a retirement fund? Yes/No

4) NGDP targeting can have some of the same problems as price inflation targeting? Yes/No

3 years 18 hours ago

Definitely agree about David, too.

3 years 4 days ago

Beckworth via twitter discussion: “MMs would say expected path of monetary base influenced econ outlook & thus endogenous money creation.”

3 years 4 days ago

If prediction is right then it is because of expectations, if prediction is wrong then it is because of failure to communicate.

This is just pseudo-science, how could it be proven wrong?

3 years 4 days ago

Nick Rowe still essentially clings to the old money multiplier myth by conflating reserves and deposits/receivables into one big “base money” category. His note about how, when bank A makes a loan which generates a deposit at a different bank (B) that results in both the deposit and reserve moving from A to B, so “let’s cut to the chase”.

3 years 4 days ago

Why don’t they just put their hands up and say: “oh, we got that one wrong, we misunderstood the causal relationship of reserves to loans”.

There’s no shame in that. Everybody gets things wrong. I certainly misunderstood plenty about finance and monetary mechanics over recent years. How else does one learn?

The alternative, loyally sticking to you ideology, just terminates in endless arguments that require stealthily adjusting the goalposts so that you can maintain a false accuracy. Nobody gains anything from that, it only serves to polarise.

2 years 11 months ago

People admitting when they are wrong is a big problem across disciplines, and in life in general. The best conclusion I’ve come up with so far is that people get so attached to their ideas that the ideas become part of their identity. This is most apparent with religions and political ideologies. As a result people often defend ideas, really defend themselves, as fierecly as you would defend your life from a wild animal attacking you in the woods. It’s like a self-preservation mechanism. And lurking in the background consciousness is a feeling that others will think: “If you have been so wrong about ‘X’ for so long, how can anyone trust anything you say?” … Ultimately we are social creatures and most of us deeply want to be liked and appreciated by others, so we defend against whatever threatens our social status.

It’s such a shame.