Scott Sumner: evaluation

Transcript context

…This is a point where I think I disagree with you, even though I agree with much of what you’ve said up until now. I worry that by attributing the decline in real GDP to a decline in nominal GDP, that it’s on the verge of being tautologous. Not a literal tautology, given prices don’t move that much — that you’re explaining a thing by itself, and I think it would have been quite possible for real GDP to fall by a few percent. If we had stabilized the growth path of nominal GDP, we would have had price inflation of, say, 5 percent, which I would have greatly preferred to what we did, to be clear. I think it’s one reason why central banks are reluctant to institute your kind of advice, because they know they’ll be blamed for a price inflation rate of 5 percent. Do you see what I’m saying? I see what you’re saying, but I think that, in a way, your instincts that it’s almost tautological reflect the fact that you sort of buy into what I’m saying about the interrelationship between real and nominal shocks. We both know that they’re not necessarily at all closely correlated, right? In 2008 and 2009, Zimbabwe had a recession and a hyperinflation at the same time. Their nominal and real economies are going in dramatically different directions. We also know that real and nominal variables are radically different variables. When our instincts tell us that there’s something tautological about the correlation between real and nominal GDP in the United States, it’s because our instincts have recognized the fact that, in fact, most of the US business cycle is due to nominal shocks interacting with sticky wages. If that hypothesis is true, that model of the business cycle is true for the United States but not for Zimbabwe, then what it’s telling us is that if we can control nominal GDP growth, probably the path of real GDP will also be more stable. Now, it’s possible that we do succeed in stabilizing nominal GDP growth, and we find out it doesn’t help. But there’s an awful lot of circumstantial evidence to support my claim, because we observe, for instance, in the United States that when nominal GDP is more volatile, so is real GDP. That’s one thing we know. We also know that some of the volatility of nominal GDP comes from very clear monetary policy mistakes that have been made at various periods of time that can be clearly identified. When we see this show up in similar movements in real output, there’s just a strong presumption that there’s a causal relationship there. Financial markets also seem to treat it like there’s a causal relationship. Financial market responses to Federal Reserve policy shocks seem to reflect a view in the financial markets that these things are important for the real economy. I think my view would be, when you get a very bad recession, it’s typically the combination of negative nominal shocks and significant negative real shocks, often to credit markets. The negative real shocks are not just an epiphenomenon or result of the nominal problem mixed with sticky wages. You have both happening, and the credit market problems don’t just go away if you do your nominal job. Then you get back to these situations where you’ll need a fairly high rate of price inflation to stabilize the growth path of nominal GDP. You just think credit market shocks are not that important? Like what Charles Kindleberger wrote, you wouldn’t really agree with that economic history? Or how should I frame your view here?…

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