Scott Sumner

0:12 Dan

Okay, today I'm talking with the excellent Scott Sumner. He previously taught economics at Bentley University. He was the director of the program on monetary policy at the Mercatus Center, and he writes one of the most popular economics blogs that I highly recommend called The Money Illusion, and also posts over at EconLog. Scott, welcome.

0:30 Scott

Thanks for inviting me, Dan. Glad to be here.

0:33 Dan

So first question, can reading fiction and watching films make you a better economist?

0:38 Scott

Oh, you've started off with a very hard question. Possibly in some ways, I think just having a broader life experience in general, reading a lot of things outside of economics, traveling, doing all kinds of different things can make you a better economist. I think it's hard to really pin it down, but if you expose yourself to a wide range of things in the arts and humanities and science and travel and literature and so on, you get a deeper understanding of the world and you're less likely to have an overly narrow view of certain issues. I find some economists from my perspective do have an exceptionally narrow reductionist view of certain kinds of issues, but it's hard for me to be very specific on that because it's. It's hard to draw a direct connection between a novel I might have read and economics. I think I've actually maybe benefited more from reading little bits of philosophy and things like that that have kind of expanded my ability to think about things in a different way. So that's something I would point to. I just did a blog post at EconLog yesterday, I guess it was, called the Wittgenstein Test. And it was based on a quotation from Ludwig Wittgenstein. And I use that quotation as an epigraph for my book, The Money Illusion. And those kind of things, you know, philosophical ideas that allow you to kind of look at things in a different way, open your mind to different methodological approaches and so on. I found those to be quite useful. And so I don't think I'm as narrow in the way I think about issues as I was when I was younger.

2:31 Dan

Yeah, it's funny you say philosophers over maybe fiction specifically, like, I guess, when you look back at the beginning of economics, it was kind of like more philosophical and less, you know, now it's much more mathematically rigorous. But like, for example, David Hume, like wrote a whole bunch of essays on economics, and philosophy was probably his main thing.

2:49 Scott

Yeah, that's right. I think specifically what I'm referring to with philosophy is the whole question of methodology and, you know, how do we know what's true, what to believe. And I think when I was in school, when I was young, I wanted to gravitate towards one single approach, like this is the way you figure out what's true. And, you know, you test a hypothesis or whatever. And as I've gotten older, I've realized that there's just a lot of pieces of evidence we bring to bear on what we should believe. And it's a mixture of empirical data, theory, even things like just metaphors about the world can be useful in kind of helping you achieve a deeper understanding of economic issues. So I don't believe any longer that there's only one approach to Truth. So in that sense, I'm sort of eclectic in my approach to methodology, I would say.

3:44 Dan

If a reader had to choose one and you were to make a recommendation, would you tell them to go read Knausgaard or Proust?

3:50 Scott

Well, that's a tough question. I mean, Proust has stood the test of time. Knausgaard might be more interesting to people of this generation because we can relate more. I found I could relate a lot to his life and when I read his magnum opus, My Struggle, I kind of felt like it was the first time I really recognized that other people experience life the way I do. Like we see other people from the outside, right? So we don't know whether what's going on in their interior perspective matches what's going on in our mind or whatever. And when we read literature, I think we get closer to that. But, you know, Proust was so far back in time that he was living in a very different world, whereas Knausgaard was living in a world that although is a different country from what I grew up in, it was still roughly the same time period and so on. And he had such an ability to make you feel like you were, you know, experiencing what he experienced that it was the first time I really felt I read something where I could say, yes, that's what life is like. Even though his life was very different from mine, like he's a different personality and so on, just the way he experienced things was presented in a way that made me feel less like I'm alone in the universe. I think it's called solipsism, this view that like you're the only one and everybody else is just as you see them on the outside. Now of course I've always known that's silly, but you know still to really know something at an intuitive level is different from knowing it intellectually. And when you read Knausgaard, do you know it at an intuitive level? At least it was for me.

Proust, uh, I read for the first time in my life only about a year or two ago, and it's a wonderful book, you know, maybe the greatest novel ever. So, uh, I would encourage people to read either one.

5:49 Dan

So I, I read the first two volumes of my struggle, like last year, I had the exact same response you did. It was like more visceral than anything I've ever read before. Um, but I have not yet read Proust. So good to know. It's got good reviews from you.

6:03 Scott

Well, yeah, and I think if I read Proust when I was young, I wouldn't have liked it. I wouldn't have been able to really understand it in the way I did when I was older. Now, this is not necessarily true for everyone. There's some readers that can appreciate very sophisticated literature when they're young. But for me, I didn't really have a very good understanding of society. And, you know, his book is so much about the interaction of people in fairly complex social situations. which when i was young i was a loner i didn't really have very many friends so i just didn't have any understanding of society at that level and much of that book would have gone right over my head if i'd read it when i was young so i think you know someone just starting out might want to start with now scarred for that reason it might be easier at a young age to absorbed that kind of thing as compared to a very complex society and one from like the I don't know 1890s or whenever it takes place.

7:04 Dan

Do you think that the best TV shows can ever compare to the best films?

7:08 Scott

Not really. Well obviously that's very subjective i should say that i think tv and film are different types of media tv is mostly like a writer's medium and film is sort of a director's medium and film i think is more about visual images and tv is more about dialogue so it really depends on what you're looking for and I'm a very visually oriented person. I like the visual arts more than the other arts. I find it easier to understand the visual arts more than music or poetry or things like that. So for me film is more appealing because at a visual level it's just a more impressive art form than TV. no matter how good the quality TV is. The writing in TV is often excellent and I understand why people that are interested in dialogue and stories and writing, I understand why they love quality TV shows and why they're bored by a lot of classic films which are often very slow moving and work at a visual level rather than a dialogue level. So it is to some degree a matter of taste but for me the peaks of filmmaking are just higher than the peaks of quality tv.

8:18 Dan

How would you recommend someone that is more used to absorbing dialogue from television or more modern movies get into these types of movies? Someone who's preparing to watch Tarkovsky for the first time or something; how would you recommend they reorient themselves to prepare for it?

8:41 Scott

Right, so I would say two things on this. I think it's a mixture of nature and nurture, I guess would be the way I would put it. So I can't speak for everyone. I think that, you know, some people have what I might call a relatively balanced mind, where they can be equally good at absorbing material from different fields, you know, a Tyler Cowen, someone like that. For me, my mind is very unbalanced. I'm very strong in visuals and weaker in the linguistic side. So some things come very easy to me and some are very difficult. So I think it's partly innate. On the other hand, Making the effort to try to learn things does improve your appreciation over time. So there's a lot of films that I would not have appreciated when I was younger that just making the effort to watch a lot of classic films over time has sort of educated my mind to learn how to see what i'm watching or how to interpret or understand what i'm watching and i don't mean understand in this sort of verbal sense of explaining the intricacies of the plot but understand at a more intuitive level what the director is doing often in a way that you really can't put into words. So that's why it's so hard for me to explain, you know, you mentioned Tarkovsky. Well, what makes Stalker or Solaris or one of those films so great? It's really hard to put into words because he's working at a very visual level. There's very little dialogue in a lot of his films. So I think you can learn it to some extent, and it probably helps to start with things that are easier because they're more entertaining. So for instance, if you watch the classic films of Alfred Hitchcock, he's a very entertaining filmmaker, but also a great artist.

So it's a less painful way to learn about cinema than a very difficult, esoteric, you know, art film that comes out more recently. So, you know, people like Hitchcock, Kubrick's another one who makes films that are entertaining but also very artistic. and I think that those two directors work very strongly at a visual level especially so you probably learn more from watching their films about cinema than you'd learn from watching other great films like The Godfather or Casablanca which have a more traditional visual style so they don't have the sort of trademark style of the director to the extent that a Hitchcock film does or we'll take a modern example a Wes Anderson film like if you put a Wes Anderson film on within 30 seconds you know you're watching a Wes Anderson film. There's other directors where you don't really know who the director is. It's just, is this a good movie or not? Is it a good story? Does it have good actors? Like no one pays attention to who directed the latest James Bond movie or something like that typically. Right. So it's, but I think if you have a director with a really strong style like Hitchcock or Kubrick, who also makes films that are entertaining, it's, it's a way to learn about style.

11:59 Dan

Got it. The question for you, I've noticed that you mentioned you're both a fan. I love your posts on Joseph Conrad. You also talk a bit about liking Werner Herzog. And I want to quote one of the views that you've mentioned you believe Conrad holds and sort of your speculation about him, which is the theme that he has is that “the universe is cold and meaningless. Most people live by comforting illusions, fairy tales, but look for meaning anyway.” And Herzog carries a lot of these themes. He really kind of views nature as dark. What is it about both of these two, one of your favorite movie makers and one of your favorite writers and these themes that attracts you to them?

12:39 Scott

That's hard to say. Like I definitely, when I read Conrad and he's a writer I read when I was young, I just connected with his worldview in a lot of ways. And that may be because I already had similar views, or maybe he was sort of convincing me as I was reading, maybe some of each. So yeah, the whole question of meaning. I guess the way I look at things, meaning isn't really out there. It's something you sort of generate internally. And I think that's the way he looked at things as well. I can't say as much about Herzog because now I can't really remember the dialogue. With Herzog, I remember the visual images in his film more than the dialogue i i know he has a very mesmerizing narration to his documentaries you know his vocal style and so on but conrad is someone who i think looked at the world in a very clear-eyed way without a lot of illusions. I mean, there's a long time ago, so it's silly to bring up politics, but if you wanted to bring that up, you might say he didn't have a lot of illusions of either the left or the right. So his books can be considered a critique of both sides of the ideological spectrum. He saw through a lot of illusions that people had. And so I feel like, you know, I observe a lot of people with similar, uh, with sort of illusions that he thought they had. And maybe that comes from reading him, or maybe I was just predisposed to look at people that way. You know, I suppose at some level it's a non-religious view of the world. People that are deeply religious probably do believe the meaning is out there. And they're not just generating it internally, but they're looking for something that's really out there. That's fine, and that may be a better way to live in fact, but that's just not the way I look at the world.

14:29 Dan

Yeah, yeah. You noted that Robert Louis Stevenson is overlooked, even though he's praised by like Borges, Proust, Nabokov, all these writers said he was fantastic. How efficient do you think the opinion of modern popular art is?

14:43 Scott

Right, so I should say I'm not really qualified to say he's a great writer. I like Stevenson a lot, and the reason I believe he's a great writer is exactly what you said all these other great writers say he is. So I don't think my skill at literary criticism is strong enough where my opinion has much, you know, validity. But in terms of your question about why is he overlooked, I think it's because the kind of stories he told are kind of out of fashion. So he was writing popular stories. You know, you think of books like Treasure Island, which is viewed as a child's story, or even Kidnapped. And I think the writers that are taken more seriously today are those that deal with more, less sort of escapist literature, if you will. Now I don't think all his books are escapist by any means, you know, he did a number of different types of novels, but also he was such a good writer that what he did seemed almost effortless and like if I were comparing him to Conrad When you read Conrad, you have a feeling that he's really struggling to get the words out that convey what he's feeling very, very deeply. Whereas Stevenson just seems to write almost effortlessly. That's the impression I have. And so the one that's really struggling with, you know, deep emotional issues in some sense seems like a weightier you know more serious writer than someone who's effortlessly producing entertaining stories but obviously these great writers that really love stevenson see something in his skill that i can't really explain in words like i don't really see how to me it's all magic he creates this wonderful effect in his books i don't see how he does it but they're able to see what makes stevenson better than other writers of popular stories for you know teenage boys and so on and all I know is I see the effects, the effects it has on me as a reader.

16:47 Dan

So you've noted before that like really great writers, it seems like sometimes or oftentimes they're maybe mildly depressed and your speculation is maybe they're just seeing reality too clearly. Do you think optimists or really happy people can make good art or is pessimism going to typically be a better trait for someone who's trying to write or make films?

17:08 Scott

Yeah, that's another hard question. So, I'm sure there have been some great artists that were happy optimists. I mean, Stevenson probably, at some level. I don't know, that's a hard question. There's this concept of what used to be called melancholia, I think it's called depression today, that's throughout history been associated with intellectuals. in general, not just, you know, artists. And, you know, whether the association is correct or not, there's been a perception that people that are intellectuals are more inclined to be melancholic or depressed. Maybe that's because they have a harder time finding meaning because they see a lot of things as illusionary. You know, a lot of the things in life that provide the greatest meaning, I think, are things that are in some sense illusions, right? You think of a child on, I don't know, Christmas morning looking at the presents under the tree. So, for them, the world is kind of magical, right? And as you get older, you see the world more clearly. and you don't have the same kind of euphoric feeling maybe on Christmas morning that a child would have. They're seeing in some sense an illusionary world in their mind, right? On the other hand, you can still find meaning, but I think it becomes a little bit harder. And so maybe it's harder for an intellectual to see life as having meaning than it is for just an average person. I'm not sure.

18:43 Dan

So it seems like you're in some of your posts a bit of a cultural pessimist. You kind of talk about how after an art form has expressed its most potent ideas it sort of like runs out of steam and you know for painting you cite you know abstract expressionism is kind of like this final frontier where all visual representation is gone and it's all ideas. What, in your view, would need to change in society for us to start making more interesting or great art again? Or do you think it's a dead end and really there is an expiration date for each form of art?

19:17 Scott

Well, we're certainly not at the end. So here's one point I would make. Over time, the low-hanging fruit gets picked, right? So artists make the obvious masterpieces. And then other art, and this is not my theory, this is a theory that's been kicked around a lot, the anxiety of influence. Artists want to have their own style, they want to create their own style, right?

19:43 Dan

Yeah, Harold Bloom.

19:45 Scott

So it becomes harder and harder as more things have been done. And when technology opens up a new field, it's like people entering a new country where there's all this land that is waiting to be harvested. And over time, then the low-hanging fruit gets plucked and it becomes harder and harder so you have to find something new for artists to express themselves in in order to have the field continue to have energy right so when i was young like in music for instance popular music invented some new styles like you know rock and roll and and other styles in the 60s and there was a flourishing of new ideas that came out of that and then they kind of ran out of ideas and rock and roll became stale and then you know A lot of modern poetry and literature is more difficult than literature, you know, 19th century painting. Many people have trouble understanding abstract painting who like figurative painting. And film, I think, the classic period kind of probably peaked around, say, the 1970s or so, and then film became more and more difficult. Or even, you know, the 50s to the 70s in that period. And people say well why don't they make movies like the godfather anymore well that's been made it's sort of like saying well why doesn't someone go out and invent another light bulb edison invented it already you know you have to invent more difficult things now i mean edison invented i think dozens of consumer products as far as i can recall right in his lab but he was working with kind of an open field electricity had just been mastered and so there was like this opportunity to invent all these electronic appliances once they're invented you need some other fundamental underlying technology to get a new wave of invention you know we've had that in you know biotech computer chips and so on and i think the arts are kind of similar you have to have a new field open up so a lot of people think film was the most important art form of the 20th century and it's not because film is better than literature or symphonic music or anything like that it's that it was a relatively new art form in the 20th century so it opened up a lot of possibilities for invention whereas the novel and the symphony and so on had been around for a few hundred years and most of the great ideas or the easy great ideas had already played out.

I should say I don't want to appear too much of a pessimist there still are great movies being made and also great novels even in the 21st century I've read a lot of really excellent novels so I mean there's such complex art forms both the novel and film you can do so many things with it right that And I may be wrong, but just thinking off the top of my head, they seem to me much more complex than say, sculpture, right? Like how many ways can you do a sculpture of a human figure? It seems sort of limited, the possibilities, but it seems like there's just so many ways to do a film and so many ways to write a novel that even if some of the low hanging fruit has been plucked, it's certainly not, they're not dead art forms by any means.

23:34 Dan

Yeah, yeah. I mean, I think Tyler has a post talking about how, in his view anyways, you look at some of the writers of the last 20 years, like early 21st century, you have Sebald, Bolaño, Ferrante, I think his claim is like, these aren't actually so far behind the 20th century or 19th century greats.

23:55 Scott

Exactly, right. No, I think there's been a number. And you mentioned Overlooked. I'm reading a guy named Gene Wolfe.

24:04 Dan

Oh, yeah.

24:04 Scott

And he seems overlooked to me. I don't actually read much science fiction. But in reading his novels, they just seem to be at a much higher level in terms of, you know, literary artistry or whatever, than any of the other science fiction I've read. So I'm not quite sure why he's not more well known. But yeah, Bolano and Max Sebald and all those people. I love those writers.

24:30 Dan

I was gonna say Gene Wolfe has like a cult following, but it seems like it doesn't quite fit into tradition. He's like too literary for the typical like hard sci-fi. And then for whatever reason, like literary people don't take sci-fi seriously.

24:43 Scott

Yeah, I think that's right. He sort of falls in between the two.

And I think both sides should take more seriously. yeah but he's a little bit some of his books are a little bit difficult so if you're used to just very straightforward narrative that's easy to follow it could be frustrating to read him but yeah he's a wonderful writer

25:04 Dan

In your post on retirement, you note that some of the biggest mistakes in your life were doing things for money, like being a landlord or writing a principles of economics textbook. Assuming there are many other people out there like you who feel the same way, do you think that it's possible that the U.S. is approaching a post-scarcity economy where we'll see a lower supply of people who are willing to do jobs that lack meaning?

25:26 Scott

Yeah, I mean, assuming that everything goes well with, you know, like, if we assume the economy continues to grow, and if we assume AI does what people think it's going to do eventually, then we'll have enormous increases in productivity probably over the next hundred years or so. And we already live in a world where most people don't want to do jobs like go out in the field and pick fruit in the hot sun, right? Or, you know, those kind of difficult jobs, or work in a coal mine. But there'll be more and more jobs like that because so many jobs will be mechanized and, you know, robots will do many repetitive jobs. And, um, so yeah, people will, I mean, people are kind of insatiable in terms of their desires, right? No matter how good you make a person's life, they always want more, not necessarily more money, but more something, more meaning, more whatever it is that drives them. And so, uh, future improvements in technology that allow us to not do things we don't want to do will, I think, push people more and more towards jobs where they feel it has meaning. You know, I guess that's a good thing. I'm not sure we'll actually be any happier. I have this kind of hedonic treadmill theory that, you know, every time we improve things, we just expect more. So maybe we're not actually any happier, but I still think it's worth doing in case I'm wrong. And I also believe that we're probably happier living in a society where you're free to pursue your dreams, even if your dreams don't make you happier. Does that make sense?

27:05 Dan

It does. Yeah, yeah.

27:07 Scott

So what makes, I wrote this paper once on neoliberalism, and I argue that what makes the reported happiness rankings higher in the more neoliberal countries is The writer V.S. Naipaul has a wonderful quotation on that, you can probably find it somewhere in my blog, I've quoted it a few times on the phrase, the pursuit of happiness in the Declaration of Independence and how important that phrase is and what it meant to him. And it's something I think everybody should read. The fact that they use the phrase, the pursuit of happiness, not happiness is very important in his view. So I kind of feel like what we call happiness is actually the expectation of future happiness. In a weird way. Like I mentioned the child, you know, Christmas morning looking under the tree at the presents. The child's very happy because of the anticipation of future happiness. Maybe two days from now they're playing with their toy and they're bored.

28:27 Dan

That's my memory of Christmas, yeah. The beginning of a romantic relationship, I think people are often at their happiest at that point, right? At the beginning of a romantic relationship between two people. And part of it is the anticipation of all the good things that are going to come out of that relationship.

28:54 Dan

That's interesting. You wrote a post in 2018 arguing that we should deemphasize behavioral economics in favor of classical economics. But I also feel like sometimes to me that line is a little bit blurry. So I'm wondering where you view the boundary between a classical econ idea and a behavioral econ idea. And one example here would be people who are allergic to inflation for whatever reason. Sometimes you cite that, well, inflation can actually be good because people like the idea of their income going up and they really don't like the idea of it going down. Is that sort of idea a behavioral or a classical idea?

29:32 Scott

Yeah, that's a good point, and certainly my blog is called The Money Illusion, which is a behavioral idea, so it's ironic that I would make that claim in a blog titled after a behavioral concept. It's a concept that sort of implies a certain level of irrationality, not in a psychological sense, but in an economic sense, right? People who suffer money illusion confuse real and nominal variables. So, I think, you know, behavioral economics is correct probably about a few of their ideas, certain biases people have about, I don't know, saving, you know, present versus future and so on. But I do think that overall, the classical theories explain things better than many economists even believe. As you probably know, I've argued against the whole idea of asset price bubbles, which I don't think actually exist in any meaningful sense. And I'm a believer that the rational expectations hypothesis is very important in macroeconomics. And just in general I think that we have to be a little bit distrustful of our intuitions about people's behavior. So I did a blog post on how things tend to be more elastic than people believe. Like the demand for products is more elastic than you would think using common sense. Than even what I would think using my own common sense. And, you know, like if you ask people about addictive drugs, they say, well, the demand will be very inelastic because people are addicted. But in many cases, probably people's demand for addictive drugs is more unit elastic. Like imagine a drug addict that just has a fixed amount of money. Like a disability pension they spend all the money they have on you know whatever cocaine or something well their demand for cocaine is unilastic price goes up 10 their demand goes down 10 quantity demanded right i'll give you another example my father who is a smoker used to tell me that you know a higher tax on cigarettes isn't going to make people stop smoking. You know, he was really addicted to cigarettes. And later in life, my mom mentioned casually that when she was very young, she had smoked. And I said, well, why did you stop smoking? And she said, well, when your father and I got married, we thought we could only afford to have one smoker in the family. So, you know, my dad's intuition wasn't even consistent with his own family, right? But I also understand why my dad would say that because I kind of feel that way off an intuitive level. Like I just go into a grocery store, I grab an item, I don't even look at the price in many cases. So I can see why intuitively people think, oh, you raise the price five cents, that's not going to affect whether someone buys it. That is our intuition. But I feel like the world actually behaves much like what classical economic theory predicts assuming people behave rationally. And so we don't really need a lot of behavioral economics to explain what's going on. Again, if you don't believe in, if you don't agree with me on asset price bubbles, then you'd think we do need behavioral economics, right? To explain those. But if I'm correct and there are no asset price bubbles, then we don't need that either. And so I do think that behavioral economists are probably right about a few things and maybe even some of their policy ideas, like having adoption of the pension be the default option rather than having you had to sign up for a pension. You know, those might be good ideas, but I don't think behavioral economics will radically transform the field of economics in the way that a lot of people thought early on when it was having its first major successes. Now we're in the sort of backlash period where some of the stuff has not replicated. But even apart from that, I don't think it was really transforming the field in any major way. I think what happened is people outside the field of economics have a lot of resentment about what economists say about the world in many cases. We provide unpopular opinions when we talk about things like opportunity cost. And because we provide a lot of these unwelcome messages, people outside economics think there must be something wrong with economists. They have too narrow a view of human behavior. So when behavioral economics came along, it was welcomed by non-economists. Like, finally, someone's going to shake up the field and introduce a note of realism and fix the problems with classical economics. But it hasn't really changed the field that much at all. The things that annoyed people before, I think, still annoy them, right? And I think we're just unfortunately fated to be kind of unpopular in our advice on certain things.

34:16 Dan

Let's double tap into your idea on asset bubbles. Your idea, as I understand it, is basically like, well, if you look at the NASDAQ back in like 2002, it was at, you know, 1200, but today it's at 14,000. And so, you know, it's up 13x or something. And so the idea of the dot com bubble was technically correct. It was like, hey, technology is the next big wave. And now look at the top five companies, you've got, you know, Facebook, Amazon, Apple, Microsoft dominating the economy. You look at Bitcoin as well, like it actually fared incredibly well, even though it went through some ups and downs. But my question to you is like, at what level of aggregate do you need to make this claim? Even if you took in 2000, if you just take the Nasdaq, that's everything, that's the entire aggregate. But if you took a subset, even within tech stocks, you might miss the five names that I just mentioned, which carried the majority of the of the weight. And so at what level of aggregate can you actually speak about this rule on asset bubbles?

35:15 Scott

Well, that's, that's a very good point. So let's take the case of Bitcoin, for instance, you know, which is up like, say 10,000 fold or whatever. The problem here is if markets are 100% efficient, if the efficient market hypothesis is completely true, then in that kind of world, the overwhelming majority of potential bitcoins should go to zero. Because if you have one that goes from $3 to $30,000, You can afford to have a lot of others that go from three to zero and you're still outperforming the market, right? But you don't know which ones will go to zero and which ones will go astronomically higher. So in that kind of world, it makes sense that most of the speculative assets will ex post be overpriced and look like foolish investments. They'll look like bubbles but they'll actually be efficiently priced because we don't know which ones will be the next Amazon, Apple, Google, Facebook, etc. And this also feeds into people's sort of confirmation bias about people are very confident that they're right about bubbles existing. And think about the fact that if you predicted a hundred bubbles and 99 times you were correct, and the one time you were wrong was Bitcoin, it's only human nature to think you're usually right, right? Most of the time you see something as a bubble, it goes to zero or almost zero, let's say. So you're going to pat yourself on the back and think, yeah, I really understand bubbles. When I see them, I'm almost always correct. but in fact i would argue you'd be wrong because if you called everything 99 bubbles plus bitcoin a bubble and didn't invest in any of them and your neighbor invested in all 100 he or she would have dramatically outperformed you, right? Even if 99 went to zero, Bitcoin goes from $3 to 30,000. So it's still a tremendous investment. And so I think that the fact that most of these highly speculative things go, you know, end up like pet.com and so on, It tends to give people a certain confirmation bias that they've been right about bubbles when they weren't right at all. So they're not looking at the right way of thinking about the bubble hypothesis. Like people always ask me, well how would you test whether there's bubbles or not. And you don't test by looking at whether something went up and down because efficient markets will go up and down. The way you test is you try to figure out whether the bubble hypothesis is useful. If it's not useful, someone once said something like that which has no practical implications, has no theoretical implications. Something to that effect. I don't know if I got it right. Like it has to be useful in some way. Like, can someone point to a set of mutual funds that are run on the, the bubble theory, the theory that there are bubbles. So they buy everything that is underpriced according to bubble theory and they short everything that's overpriced according to bubble theory. And I know you can't short everything, right? But you can short some things. So, you set up a mutual fund and you invest on that basis. Does that mutual fund outperform an index fund? If those, as a class, like obviously you could get lucky, but as a class, if those bubble funds are outperforming index funds consistently, then yeah, bubbles exist and the bubble hypothesis is useful. But is it, is it useful to investors or is it useful to policymakers? So I talked about this in my book. There was a lot of talk about the housing bubble and how regulators should have, you know, done something about it. Well, regulators did do something about it. They encouraged it, right? Regulators were actually encouraging banks to make more loans to people that had previously had difficulty getting loans during the housing bubble. Mutual funds using bubble ideas don't outperform index funds, where regulators don't usefully use bubble information to regulate markets. And I just don't see how the bubble hypothesis is useful for anyone, either investors or policymakers.

39:53 Dan

Yeah, yeah, that that makes sense. I do want to hit on your most popular theory here, or your most popular idea on the importance of nominal GDP. You know, in your most recent book, you talk a bit about how what people have trouble with is actually like determining the stance of monetary policy. So traditional monetarists like Milton Friedman will talk about the money supply, sort of Keynesians will look at the interest rate, but market monetarists and what you view as the correct stance of monetary policy looks at the price of money to determine the stance. Do you mind just explaining what you get wrong if you're looking at just interest rates or the quantity of money?

40:37 Scott

Okay, so let me just say first there's no perfect definition of the stance of monetary policy. It's a question of which definition is the most useful. I think that I've written a lot on why interest rates are not useful. As you probably know, when inflation is very high, interest rates tend to be high. And yet it's kind of silly to argue that a monetary policy that produces hyperinflation is a tight money policy because it leads to high interest rates. The money supply, I think, is flawed because the velocity circulation can fluctuate over time. In my view, since there's so many different possible definitions, Another one is exchange rates, whether the exchange rate's appreciating or depreciating. It makes most sense to think about the stance relative to the goals of monetary policy. Like if you wanted to have 2% inflation, to me, the most sensible way to think about it is monetary policy is too expansionary if inflation is above 2% and too contractionary if it's below 2%. Now I happen to favor nominal GDP targeting at say roughly 4%, so that's the benchmark I would use. And then we're left with a problem that nominal GDP is measured with a long lag or delay, and so how do we know right now if it's too expansionary or contractionary? So for that I say what we really would like to have is some sort of market price we could look at that shows the market's expectation of future nominal GDP growth. And then that market price becomes the benchmark to judge whether monetary policy is expansionary or contractionary and you mentioned the price approach so the ideal policy would be if you had like a futures contract for nominal GDP you would just peg the price of that contract at four percent growth and that's sort of like what you're doing with something like a gold standard or fixed exchange rate system where you peg to a currency. But with the gold standard and the fixed exchange rate systems, you're fixing the price of something you don't really care about that much. And you hope that that will lead to good things in other areas, right? Like you hope a stable price of gold or a stable fixed exchange rate between the British pound and US dollar will produce good things for a particular economy but it might not. With nominal GDP targeting, if you have a futures price target with four percent growth, there's much more reason to believe that if the markets believe nominal GDP growth will be four percent, you'll get good outcomes. So nominal GDP growth is much closer to the thing we care about than is interest rates, the money supply, the foreign exchange rate, the price of gold, or any other variable that you could target with monetary policy. So why not target directly or more directly the thing we really care about?

43:30 Dan

And one question I have on this is, so picking 4% sort of makes sense in a world where we're like real growth is typically around, you know, one, one and a half, 2%. And then we're used to 2% inflation, that probably wouldn't feel too different from today. What would we do if real growth either due to technological breakthroughs went way up, say like 8% or something crazy, we started to really take off or went down to 0%. So look, we have deflation in some of the new products in the economy. When new technology products are invented, often the price falls over time, especially if you hold, you know, quality constant. So let's just suppose that you had a 4% nominal GDP target. And real GDP starts growing at 8% a year because of technological progress due to AI and robots and so on. So you'd have 4% deflation, right? Now normally we associate deflation with hard times, but that's because most deflation is not caused by rapid You can still have 4% growth in wages or maybe 3% if population's growing up at 1% a year, right? So people can still get the same raises they used to have. So you're not going to have a lot of unemployment. There's still enough money to pay all the workers and have full employment. And the workers are benefiting from the productivity growth in the form of seeing their pay go up at 3 or 4% a year and the price going down at 4% a year. So their real wages are rising very, very rapidly. Now, if you want to be a purist and say we must have stable prices, then, yeah, you'd have to raise nominal GDP growth to, say, 8% and people would get bigger, nominal pay increases, and they'd have stable prices, but the real wage would still be rising by the same amount. So deflation isn't really a problem in and of itself, it's historically often been a problem because it's been associated with falling nominal GDP. So people are interested in this, George Selgin wrote a very good book, Less Than Zero, I think it's called, and he explains the intuition behind this stuff much better than I can right here, but many of the problems that people associate with rising and falling inflation are actually more properly thought of as problems associated with rising and falling nominal GDP. So we kind of worry about the wrong things when we're worried about inflation. And if you ask the average person why they don't like inflation, they actually sort of give you quote the wrong answer in the sense that the answer they're giving you is looking at inflation as if it only affects prices and not incomes. But over time, inflation raises both prices and incomes. So I happen to think high inflation is a bad thing, but not really because it hurts shoppers in the long run. It's really a bad thing because it has other more insidious indirect effects in the economy. But if we're trying to reduce those negative effects that we associate with inflation, we could do so more effectively with stable nominal GDP growth rather than stable inflation. And just to give you a sense of that this isn't anything radical I'm saying the Fed kind of knows this at some level like if there's a huge price shock due to rising oil prices or something they'll generally allow the inflation rate to move up or down a little bit above or below their target rather than slavishly try to keep it at two percent because they know there's other things that are important beyond the rate of inflation and when they do allow some variation the inflation rate. They're kind of implicitly admitting that really it's nominal GDP that we should care about more. But for political reasons, they don't want to switch to nominal GDP targeting because it sounds bad. Like, oh, you're saying you're not trying to control inflation anymore? And, you know, it would sound like a radical switch that might be unpopular at first. So they take the safe course and just say they're targeting inflation, but quietly try to also stabilize nominal GDP growth.

48:09 Dan

Why is there so much institutional resistance against it? You talk about it a bunch, how you actually believe Ben Bernanke understood this very well. You know, he wrote papers on it before he was in the Fed. And then after the Fed, he even sort of admitted it. But like, when he's in the Fed, like he's in the chair, like he he wasn't able to make these decisions. What do you think it is that's putting up so much resistance?

48:32 Scott

Yeah, well that's a complicated question and in the particular example you mentioned, I actually think it was a mixture of partly that he didn't see things exactly as I did and partly that he sort of saw the problem to some extent but faced political resistance within the Fed. So I think there were times where Bernanke was trying to nudge the Fed to do more and he didn't want to make a move unless he had a pretty strong consensus because it would look Let me put it this way, it's very important that Fed policy be credible, that markets believe it will persist, that what you say you're going to do in the future, you actually do. And if you get your policy enacted by a 7 to 5 vote on the FOMC, the markets are not going to have any confidence that that policy will persist. So, Fed shares try to get near unanimity, and to do that, he had to be a little more hawkish than I think he preferred. So I think that's part of it, but I think also, especially in 2008, he didn't really see things exactly the way I did because I was I think focusing more on market forecasts like tip spreads and the bond market and I think he was focusing a little more on the actual inflation rate which had recently been above target in 2008.

49:51 Dan

So a quick question on that point: do you think that if the Fed decided to target nominal GDP and we had nominal GDP futures markets that sort of told the Fed whether or not it was on track, could you remove all people from the Fed and could this be run programmatically?

50:16 Scott

Because even nominal GDP targeting is only an approximation of the perfect policy, right? And I would argue for the United States it's a very close approximation but there's other countries where it wouldn't work very well. I often cite a place like Kuwait or, you know, a big oil producer where maybe half the GDP is oil. If you target nominal GDP then when oil revenues rise and fall through factors beyond your control, the international market, you have to make the non-oil part of the economy move in the other direction, which would be kind of destabilizing. So then you'd say, well, what Kuwait would want to do is actually target something like nominal domestic labor income. And that might actually even be better for the United States. But for the United States, targeting one or the other are going to lead to pretty similar outcomes. And so I usually just advocate nominal GDP targeting. But I think you'd want to have a Fed in case something came along like COVID, where maybe it's not appropriate right at that moment in time. Like during COVID, at least for a few months, it was appropriate for nominal GDP to fall. Like we weren't, we had like 14% unemployment for one month. And we shouldn't look at that and say, oh, we need to inject a lot more money into the economy to get those people back to work. We're literally sending them home because we didn't want, you know, COVID to spread, right? That's a very rare occurrence. We almost never get major swings in unemployment that are in some sense intentional like that. So I'm not saying it's a big problem for the United States, but if you didn't have a Fed at all and something came along like that where you needed to react, it'd be a problem. Also there are some questions about how to use market prices. There's some concerns people have about market manipulation. You know, I've argued that we should continue to allow a little bit of discretion and view these futures markets as guardrails. So I've talked about a system where the Fed, let's see, they sell short contracts at 5% nominal GDP growth and they buy contracts at 3% nominal GDP growth. And within those guardrails, the Fed is free to do whatever policy they want. That way, if they saw someone trying to manipulate the market, like one big trader going in and piling up trades on one guardrail or the other, they could safely ignore that, realizing, well, that's not the market, that's just, you know, one or two people trying to manipulate the market in some way. I don't think market manipulation would actually be that big of a problem. I mean, in theory, if it was a problem, it would also be a problem under like Bretton Woods or any kind of system of that sort, right? So I think that it's it's not something i worry about a lot but i would rather continue to have the fed there in case something went wrong and at least initially give them a little bit of flexibility to make sure the system is working well but yeah i mean theoretically it works kind of automatically and in much the same way that like Hong Kong has fixed their dollar to the U.S. dollar for 40 years in a row at around 7.8 Hong Kong dollars to one U.S. dollar. It's a really simple system, right? They just buy and sell at that rate to anyone who wants to trade them. And I don't know how many people they have at their monetary authority, but it can be a very, very stripped down central bank. They don't need thousands of researchers doing computer models of the Hong Kong economy, right? They're just fixing the exchange rate and letting the Fed determine their interest rates, basically. And, you know, if Argentina dollarizes, they could abolish their central bank, right? But there's still a central bank doing Argentine policy. It's the Fed, in that case. So, yeah, I mean, in theory, it could be completely automatic, but in practice, you'd have at least a skeleton staff there, making sure things go well.

54:12 Dan

Do you think with NGDP targeting, It could make us lazier in other areas if we sort of could just trust the Fed to keep 4% growth going each year. So for example, regulations that might boost growth or fiscal policies that wouldn't be good.

54:29 Scott

I just I think exactly the opposite. One of the reasons I like the idea so much is I think it will encourage pro-growth regulations and in fact i would argue that one of the reasons that the so-called neoliberal reforms occurred in the say mid eighties to early two thousands is nominal GDP growth became much more stable and in that environment people that say oh we need to subsidize this to create jobs or bail out this industry to create jobs or or whatever their argument is much weaker because if nominal GDP is only going to be X amount next year And if you bail out, you know, General Motors, so it doesn't go bankrupt, people will spend more on GM cars, but they'll spend less on other products. You're not net creating any jobs. And that becomes very, very clear. Historically, whenever nominal GDP has fallen very sharply, Other economic policies get much worse, much more inefficient. In the Great Depression we had some really inefficient policies, the National Recovery Act. When Argentina had a big drop in its nominal GDP in the late 90s and early 2000s, they swung away from free market policies towards really inefficient statist policies. And whenever you have a big drop in nominal GDP, Or maybe some cases high inflation like the 70s when we had price controls. You get very inefficient policies because people are blaming the wrong thing. You know, they're attributing the problems to things that aren't really the underlying cause. The underlying cause is unstable nominal GDP, but in the Great Depression I think it's because capitalism doesn't work. or in The Great Inflation they think, oh there's greed-flation, we need price controls because companies are greedy. So they look for scapegoats and they come up with really bad microeconomic policies that are anti-growth. So I think stable nominal GDP growth creates an environment where it's much easier to argue for sound microeconomic regulations and other policies.

56:29 Dan

Yeah, that's that's really good perspective. So zooming out on monetary policy a little bit, if you take some countries in terms of GDP that are maybe in the second tier, mid tier, like Italy or Spain, and they're trying to become an economic powerhouse, what is the relative importance of monetary policy compared with some other factors that like development economists typically cite like geography, culture or other institutional factors?

56:53 Scott

Well, for long-run economic growth, monetary policy is way down the list, I'd say. Unless it becomes very dysfunctional, then it becomes a big problem. But if you look at the Eurozone, the countries did very, very differently during the crisis of the 2010s. And that's because some of the countries were just better governed in terms of economic policy. They were all under the Euro system. They all had the same monetary policy in a sense. So in a monetary sense, like Germany and Greece were both like two states within the United States. and so you wouldn't say that like i don't know massachusetts is doing better than west virginia because of monetary policy you'd look at other factors right and so i would say monetary policy is not that big a factor in terms of long-run growth this is what's called the natural rate theory that you know nominal or monetary shocks only have short run effects on real variables in the long run you go back to the natural rate I basically think that's true with a proviso that really extreme mistakes can have very long lasting consequences so you can argue that the tight money that led to the Great Depression contributed to World War II like there's a pretty strong argument you can make that's the case. Just to give you an example, in 1929, the Nazi party, which had been around for years, was still very, very small. Not polling well at all in elections in 29. In 33, it took power. And the growth of the Nazi party was almost certainly heavily due to the Great Depression. and hyperinflation can also have, you know, big impacts on society. So I don't want to be a purist and suggest that it doesn't matter at all in the long run, but I do think that in general it's, you know, regulatory policies, tax policies, housing policies, immigration policies, trade, all these various things, the legal system,

58:57 Dan

What are some reasons why the equilibrium rate of interest seems to have been trending downwards for 40 years in most developed countries?

59:10 Scott

Well, I thought I knew, but then it's been trending upward the last couple of years. Yeah, so I'm a little less confident. I mean, the first place it trended downward was Japan. So that makes you look in terms of things like demographics, you know, slowing population growth, aging population. But there may be kind of a cycle there where the population ages a certain amount and people save more, like a 50 or 60 year old might save more than a 20 year old, but then 80 years old you're dissaving. So the demographics may be complicated. Also along with that on the investment side, and just parenthetically, obviously more saving would put downward pressure on interest rates, but investment If there's slower population growth, you're not going to have as much of GDP going into building new housing, roads, factories, and so on. You have more of a steady state society. Now, interestingly, if you have a shift towards more saving and less investment, the effect on quantity is ambiguous because the two, in a supply and demand diagram, the two lines are moving in opposite directions. So the price of credit falls sharply, the interest rate falls sharply, but the quantity of savings investment might not actually change that much as a share of GDP. People might be trying to save more, invest less, so interest rates have to fall until savings equals investment, at least at a global level, and find a new equilibrium. And that possibly is what happened. We also had less inflation somewhat over time but you mentioned real interest rates I guess but that does raise the puzzle of why real interest rates have risen a lot in the last few years. Certainly the over stimulus in the economy created an overheated economy and that's part of the story but it's probably not the whole story so I'm not sure maybe the the demographic thing that I mentioned that the savings pattern might reverse as you get more people into a very old age category where they're pulling money out of their savings in retirement. That's possibly part of it.

61:20 Dan

Have you heard of this wild paper? I talked about this on another episode with the guests. Basically, they argue that if AGI, like really advanced AI, were to come in a relatively short time frame, you would expect the interest rate to go up. And it wouldn't matter if it was

61:59 Scott

Yeah, I mean, I shouldn't even comment on that because I don't know enough about AI to have a good sense of how it will affect the economy. There does seem to be something about the modern economy so far that is more information oriented, in some sense seems less capital intensive than the economy I grew up in, which was, you know, a lot of heavy industry, car factories, steel mills and things. And it's more about ideas. That, I kind of thought for a while, was one of the reasons why maybe interest rates were falling. Not as much capital was needed for the new firms coming along. I don't know if that theory is right, but then with AI, I suppose that at some point, if AI becomes extremely powerful, it might again require a lot of physical capital. And so if we actually had the technology to produce this kind of world, environmental cleanups, there's so many things you could do if AI got to the point where you had robots that could just cheaply do a lot of things that are very expensive today. So yeah, I mean, I could see in that world, there'd be another burst of physical investment and demand for capital. I guess I'm a little bit skeptical about how fast this is going to come along, but people that know more about it than me tell me I'm wrong, that it's going to come very fast. And so I don't know. It's just, you know, during my life, you know, I've seen a lot of predictions that the computer revolution would speed up real economic growth and it didn't really, it probably prevented it from slowing even more than it did. And that's something I think people often overlook. You know, when you talk about, oh, GDP growth is only one or 2% as if that's a terrible thing. Well, we're already a rich country and many of our industries really plateaued. So, if you look at the growth in, say, commercial airliners, right? I mean, the plateauing of that technology is just absolutely astounding for someone in my age group. Maybe not for a young person like you, but like, you know, you go from the Wright Brothers to the 747 in the 1960s. That was only 60-some years. From that first plane to the 747 and I feel like today the airplanes are pretty much the same 60 years later yeah they're better electronics and fuel efficiency I get all that so they are but they're not like progressing at the phenomenal rate that they were so all of those technologies based on electricity internal combustion engine all that stuff plateaued after the 70s and without the computer revolution growth would have probably slowed even more yeah I always wonder

64:59 Dan

I wonder this a lot because I've heard the analogy of like Microsoft Excel right and you take like an insurance company where you could actually like imagine an entire skyscraper or like a 15 story building as like a spreadsheet where you have people doing hand calculations to understand like actuarial tables or like make these calculations and it just makes no sense that now each of those offices or chairs in that same building, someone has like the power at their fingertips of what the entire building used to do. And they're running these calculations all the time. Like, it doesn't make any sense to me that growth wouldn't like just take off and go, you know, kind of exponential. So I'm always very puzzled by this.

65:40 Scott

Well it's just, I have a hard time explaining it. I know during my career in academia it seemed like every improvement they just asked us to do more and more silly things that we didn't have to do when we didn't have so much technology at our fingertips, right? It just seems like the demands got greater. There was so much more effort put into evaluating whether teaching was working and annual reports and investigations into this and that, that if we didn't have all this technology and we were busy with our just old style of teaching, we wouldn't have done these things at all. And I wonder how many jobs there are in these modern office buildings that wouldn't even have existed when we didn't have so much labor to do all these sort of tangential talked about how we have like way, way more support personnel for education relative to teachers than we used to have in the past. That's kind of a luxury of wealth, right? We're a richer country so we can afford that. But if we didn't, if we hadn't done that, and then all those people that are support personnel for the teachers could be out producing other goods and services.

And we would still measure the output of the educational system the same way. There'd still be a classroom of students being taught by a teacher and those people out doing something else would mean our GDP would be higher. So we've sort of chosen to do a lot more labor into education, health care and things where it's not clear we're getting much measurable extra output from it, you know, or maybe human resource departments in corporations or whatever, you know, wherever all this extra labor is going, it's producing stuff that is kind of hard to measure as output.

67:36 Dan

Yeah, that's a really, really interesting perspective. Maybe all those Excel spreadsheets aren't as useful as they might first appear. One last question here to wrap up. Are you aware of any global macro hedge funds or anybody that trades in the markets that cites a strategy specifically based on your theory of market monetarism?

67:58 Scott

I would say I'm not particularly aware of it other than occasionally, you know I've been blogging since 2009 and I've done a lot of traveling and I give talks and I meet people. So I do meet a number of people that read my blog and once in a while people tell me thanks you know i've invested based on your blog and uh sometimes in the comments section people say that i i mean i don't take it too seriously because i'm not really offering investment advice and i'm not claiming to provide something that'll make people rich and it may be just confirmation bias on their part but you know a few people have told me that they've benefited from certain things i've said probably the thing they benefited from most was during the 2010s, I was kind of a little bit of a pessimist about the economy and bearish on growth and where interest rates and inflation were going. basically just by looking at the markets, right? So I could see the markets were not predicting any high inflation from QE. They thought interest rates would stay low for a long time. So I think some of the people that told me they benefited from what I said probably were just basing their personal finance decisions on the assumption that maybe interest rates will stay lower than people think for a while. Now, if that's what they were doing, that wouldn't have worked well in the last couple of years, of course. So, it might have been just luck. But anyway, you know, my view of economics is economists can't actually predict asset prices and business cycles also. So I have this phrase, good economists don't forecast, they infer market forecasts. And if people ask me what I think is going to happen, I usually try to just remember what the markets are thinking is going to happen and tell them that. so in that sense i don't think i'm necessarily providing any uh... great advice but uh... i mean i have had wall street firms call me in you know to give a talk and you know pay me for giving a one hour talk so maybe they think there's some value in just sort of the broad perspective i'm providing about monetary policy obviously in believing markets are efficient That's something I believe at kind of the macro level, like for the average person, they can't beat the market, but someone has to make the market sufficient. And those Wall Street firms that hired me to go talk to them are in the position of not just taking market prices, but having to think about what market prices make sense. So they're part of the internal structure of the market trying to become efficient. And so it would be silly for them to just assume market efficiency and not spend any effort trying to have their own view on things, right? If everyone did that, then markets would not be efficient in the first place. So I guess from that perspective, maybe there's some small benefit from market monetarism.

You'd probably be better off asking some people on Wall Street if they've gotten any benefit out of it. But yeah, a few people have told me that. It's an interesting question. I'm kind of skeptical about people that have claimed to do well in investing based on their ideas. I think a lot of people are very selective. People often talk about how John Maynard Keynes was a successful investor. which is sort of true but you know initially he started out and made investments and went bankrupt and was bailed out by his rich father and then did it a second time and was very successful. Well I didn't have a rich father so I'm kind of resentful when people talk about how astute John Maynard Keynes was as an investor, right? You know, I think that there's some bias in people who... I'm very distrustful of people that claim to have forecasted all sorts of things accurately because I think they tend to forget their mistakes. You know, people that predicted the 2008 crisis, some of them had been predicting crises for a long time and were often wrong. And one guy I think that was very successful shorting the market, made a billion dollars, but then was an unsuccessful investor after. So, you know, some of it's just luck. I think people should be very skeptical of stories they hear about a particular person being very successful as an investor.

72:20 Dan

That's a great place to wrap up. Scott, you've been so, so generous with your time. I had a ton of fun here talking with you today. So thanks for coming on the show.

72:28 Scott

Well, thank you. I enjoyed it.