Scott Sumner's 15 Minute Macro Economics Lesson

Scott Sumner has given us a 15 minute lesson on what is important in understanding the field of macroeconomics. After this discussion there is some interesting interaction with Fed VP Stephen Williamson, some insights from him and an economic rant. But first, in order to make sense of Professor Sumner's arguments, it would be helpful to look at the definition of macroeconomics:

Macroeconomics (from the Greek prefix makro- meaning "large" and economics) is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole...
Macroeconomists study aggregated indicators such as GDPunemployment ratesnational incomeprice indices, and the interrelations among the different sectors of the economy to better understand how the whole economy functions...
While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income). 
Professor Sumner has not always been willing to communicate with people outside the field. He is a glass tower kind of guy, from what I have seen. So, to give a 15 minute explanation of macroeconomics to a "really bright person" is certainly a move in a positive direction. Many economists do just that, all the time.

I am going to assume that my readers and myself could be really bright but are likely just above average like those children who lived in mythical Lake Wobegon. So I will try to extend the explanation of those 15 minutes.

So, to Sumner, there are three main branches of Macro:

1. Equilibrium Nominal 2. Equilibrium real 3. Disequilibrium sticky wage/price interaction

He goes on to explain the three:

Scott Sumner Famous at Bentley University, by Fogster at English Wikipedia

1. Equilibrium Nominal's important concepts:

A. Quantity Theory of Money

Definition: This means that the price level of goods and services reflects the amount of money in circulation.

B. Fisher Effect

Definition: The Fisher Effect states that the real interest rate equals the nominal interest rate minus the inflation rate. However, the concept is open to debate as we see from Investopedia.

C. Purchasing Power Parity

Definition: Purchasing power is clearly determined by the relative cost of living and inflation rates in different countries. Purchasing power parity means equalising the purchasing power of two currencies by taking into account these cost of living and inflation differences. For example, if we convert GDP in Japan to US dollars using market exchange rates, relative purchasing power is not taken into account, and the validity of the comparison is weakened. By adjusting rates to take into account local purchasing power differences, known as PPP adjusted exchange rates, international comparisons are more valid.

2. Equilibrium Real Macro looks at economic shocks that do not rely on wage price stickiness.

Definition: I can offer a definition here. This seems to be referring to shocks that happen that do not have to do directly with central bank policy regarding the money supply. These shocks could be changes in population, technology/robotics, government policy, war, choice, fear, etc.

3. Disequalibrium Nominal Macro looks at shocks that cause real variables to change, due to wage/price stickiness:

Definition: Monetary-disequilibrium theory states that output, not (or not only) prices and wages, fluctuate with a change in the money supply. To that degree, prices are represented as sticky. It is this “monetary disequilibrium,” that, the theory contends, affects the economy in real terms. Thus, changes in the money supply will result first in a change of output in the same direction, as distinct from merely a change in prices. Consequently, an increase in the money supply will induce workers and businesses to supply more, without being fooled into doing so. In a situation where the money supply contracts, businesses will respond by laying off workers. In this way, the theory accounts for involuntary unemployment. The disequilibrium between the supply and demand for money exists as long as nominal supply does not automatically adjust to meet the nominal demand.[4] Monetary-disequilibrium is a short-run phenomenon as it contains within itself the process by which a new equilibrium is established i.e. through changes in the price level.

So, that is basically macro economics in a nutshell. Scott Sumner, of course,  is famous worldwide for emphasizing the importance of tracking Nominal GDP as it can drop quickly, leaving central banks helpless, as in the Great Recession. Scott is among many who promote the economic school called market monetarism. NGDP is a leading indicator, but market monetarist solutions are often viewed as complex and unmanageable.

However, not all is settled regarding the study of the broader economy. Here are a few of the most contentious issues in Macro:

1. The Fisher effect. Scott Sumner believes in the money illusion. His blog is labelled TheMoneyIllusion. Is the money illusion as simple as Irving Fisher explained?

2. The failure of the economy is a surprise when things seem to be in equilibrium. That terrible reality unsettled economists during the Great Depression.

3. The role of derivatives and collateral in the new normal affects the economy in ways that macro economists rarely seem to understand.

4. The failure of capitalism and the Fed itself, in the repo markets, which affects GDP, as is asserted by Jeffrey P Snider.

5. In a related topic the failure of capitalism and Fed monetary policy in the badly damaged Eurodollar market is also explored by Jeffrey on Talkmarkets.

6. The argument over the neutrality of money. I personally don't believe that money is neutral. A lack of it affects GDP, and consumption. But the argument is debated at Wikipedia.

7. NeoFisherian economics. The Grumpy Economist discusses the argument regarding whether neo Fisherians are right or wrong about raising interest rates and the effect on inflation.

8. What are reasons why the natural rate of interest, R*,  keeps declining.

9. Is the economy inherently stable or inherently unstable? This is connected to number 6.

10. The Fed's role in liquidation of the economy seems harsh, unlike what we see from other central banks.

I hope this article would serve as a helpful road map in trying to make sense of most of the articles about economics out there in cyberspace. I share with you my rant on economics, from a guy happy to be just above average, which Professor Stephen Williamson of the St Louis Fed was so kind to publish on his blog: 

Prof, isn't the natural rate of interest falling because the people at the bottom simply do not have enough money? Jeffrey P Snider uncovers the Fed's phony recovery. It is a recovery to the New Normal, whoopee: Add to this the fact that the BOE helped out the small and medium businesses, leaving both retail and real estate much stronger after the crash, while the Fed just helped big business, destroying the job creators with a tightening of credit. Remember when small business had to be lucky enough to use credit lines from credit cards to survive? What kind of a recovery could be based on that. No, Prof, the Fed has failed. The Eurodollar market is smaller. Lending is slowing. Tax receipts are slowing. We could even be coming close to Edward Lambert's effective demand limit. The Fed's idea of potential GDP keeps going lower and lower and somehow people are perplexed about the R* going lower? Time for helicopter money, in my view. And it needs to be a controlled and brief helicopter money that Eric Lonergan argues for. It has to keep a lid on inflation, because as many know, there would be a collateral meltdown if interest rates shot up. But here we are, with the 10 year yield declining once again, and the R* will probably scrape zero someday as all these retail stores close. I think Snider has it right, the Fed pats itself on the back for a recovery that is dismal. Again, whoopee. And we have POTUS wanting to hurt the middle class in every way he can think of, from government layoffs, to destroying public education, to destroying social security and medicare, forcing people to try to save more when it is difficult for them. How many ways can Trump the chump keep the middle class from spending? I think the border tax should be the final straw. Add to all this the massive hiding of money from tax jurisdictions and we have a real problem down on main street prof. A real problem.
And even this rant is open for debate by others. So it goes in the land of macroeconomics. Oh, and please read Dr. Williamson's article as he speaks to topics like the equilibrium real interest rate, Fisher and the R* and he discusses the scarcity of collateral. Broaching this topic is a serious move forward by a man who ranks pretty high in the Fed hierarchy. I leave you with this juicy quote by the St Louis Fed Vice President:

For example, in this paper, if safe collateral is scarce, a reduction in the nominal interest rate also reduces the real interest rate - permanently. That's because the open market operation that reduces the nominal interest rate is a purchase of good collateral (same effect under a floor system with reserves outstanding).  

This article was first published by me on Talkmarkets:


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