What exactly is causing non-covidian recessions? Here is Nick Rowe’s answer:
In some ways, Nick and I basically agree. But I’ll answer the question a little differently. It’s not necessarily wrong to say that recessions are caused by hoarding money, or by high interest rates, or by a decrease in spending on C + I + G + NX, but I don’t find any of these explanations the most useful way of addressing the problem formulate.
In my upcoming book (July 16, 2021) I argue that if monetary policy X is the most sensible way to prevent recessions, recessions are caused by monetary policy X not being carried out. In particular, I believe the most effective way to prevent recessions (with the exception of the Covid recession) is to stabilize the 1-year growth expectations for NGDP at around 4% / year. In this sense, recessions are caused by a sharp drop in NGDP growth.
From an accounting perspective, NGDP is the monetary base times the base speed. So you could say that Nick describes the empirical fact that decreases in M * V are mainly due to decreases in V. And Nick would probably agree with me that the central bank’s job is to make up for any declines in speed by increasing the supply of money during those periods when the demand for money is increasing. (A lower speed corresponds to a higher demand for money.)
The basic monetary model of recessions is symmetrical, and therefore a falling NGDP could be caused by either increased money demand or decreased money supply. That begs an interesting question. Are recessions merely “failure of neglect”, periods in which the central bank does not take into account an increase in the demand for money, or are some recessions due to a decline in the growth rate of the (base) money supply.
Here is the rate of growth of the U.S. monetary base from 1918 to the mid-1960s:
The sharp decline in base growth appears to have lagged the 1920-21 recession, but that’s a bit misleading. This recession was quite mild in the first eight months of 1920, and therefore the (falling) supply of base money correlates fairly well with the decline in the NGDP during the brief but severe slump of 1920-21. Base growth was also in 1929-30 negative, although the speed also declined sharply this year. Base growth declined particularly sharply before and during the slump from 1937 to 1938. It also turned negative just before the 1949 recession, and the growth rate fell to around zero during the three Eisenhower recessions.
Of course, all of this is very unscientific. I’m pretty sure, in accounting terms, that the money demand shocks Nick is referring to played the bigger role. I am not advocating a simplified monetarist explanation of recessions. But I would make two additional points:
1. The various decelerations in policy base growth have been commission errors, not negligence.
2. To some extent, the accompanying slowdowns in speed were endogenous, due to the slowing economy, which was itself due to the slowdown in the growth of the monetary base.
The distinction between omissions and commission errors is rather fuzzy and, in my opinion, not particularly useful.
Here are the more recent dates:
Now the correlation appears to be weaker, although money supply growth slows slightly in some cases during recessions. Perhaps the most interesting case is 2007-08, where base growth slowed to near zero as we fell into recession before rising significantly in late 2008. I would like to address two points regarding the past period:
1. After the Fed began paying interest on bank reserves (IOR) at the end of 2008, the demand for base money increased significantly. The Fed has responded to this demand with various QE programs, which greatly boosted the growth rate of the monetary base.
2. Even without the IOR, the decline in market interest rates to close to zero would have led to a sharp increase in the demand for money, ie a sharp decrease in speed.
Of course, the decision to pay IOR is also a “commission mistake”. Thus, in early 2008, the Fed sparked the Great Recession with the Commission’s mistake of greatly reducing the growth of the monetary base, and worsened the recession in late 2008 with another Commission’s mistake – paying the IOR. That is not to say that these two mistakes fully explain the Great Recession; Missing omissions also played a large role. Rather, it is important to realize that the problem wasn’t just ellipsis.
Of course, it’s all just bookkeeping. You could also say that the recession was caused by the Fed, which allowed NGDP growth to plummet. Or that the recession was caused by the fact that the Fed did not introduce a regime with NGDP growth of 4%. Or that the recession was caused by the Fed failing to price one-year NGDP futures contracts at a level 4% above current (2008) levels.
PS. Nick lives in Canada, which has a more stable banking system than the United States and therefore a more stable demand for base money. During the Great Depression, the Canadian base fell much more than the US monetary base as it was not in a bank panic. For this episode, at least, the raw monetarist model works better for Canada than it does for the US. Was that a commission mistake? Or should we apologize to the BOC for having to reduce their monetary base below the international gold standard? On the second thought, I think I’m not going to blame the BOC for the Canadian base case in the early 1930s, as the Bank of Canada didn’t exist yet.