99 – Edward Nelson on Money, its Role within Monetary Policy, and the Monetarist Legacy

Episode Summary

Executive Summary: Ed Nelson traces his path into macroeconomics and argues that money still matters in theory, empirics, and policy—though less visibly than before. He defends nominal GDP targeting’s robustness, reassesses Friedman’s enduring influence, explains why money aggregates and the monetary base remain useful, and offers a nuanced view of QE, the Fed’s balance sheet, and modern central banking.

Main Topics: Nelson’s path into macroeconomics (Priority: 3/5): He describes how Australian high school economics, university courses, and early policy exposure led him to macroeconomics and monetary economics, eventually culminating in PhD training at Carnegie Mellon. Australia as a monetary-policy case study (Priority: 4/5): Nelson and Beckworth discuss Australia’s long expansion, avoiding the zero lower bound, and how the Reserve Bank of Australia’s policy credibility and higher interest-rate buffer helped during the global financial crisis. Nominal GDP targeting and McCallum’s influence (Priority: 5/5): Nelson explains his support for nominal income targeting, especially McCallum’s emphasis on operational simplicity, robustness to supply-side uncertainty, and instrument-rule design. Milton Friedman’s lasting impact (Priority: 5/5): The conversation argues Friedman remains deeply influential through the ideas that inflation is a monetary phenomenon and that monetary policy determines the long-run inflation rate, even if monetary targeting itself faded. Does money still matter? (Priority: 5/5): Nelson says yes—especially in the long run. He distinguishes short-run endogeneity under interest-rate policy from the enduring role of money growth, money demand, and the quantity theory in explaining inflation. Empirical relevance of money aggregates and the monetary base (Priority: 4/5): They examine whether better measurement (Davisia aggregates) improves money-demand relationships and whether the monetary base still has informational value after the crisis, reserve changes, and regulatory shifts. QE, balance sheets, and portfolio effects (Priority: 4/5): Nelson defends QE as non-self-defeating and consistent with asset-price/portfolio-balance channels, while acknowledging that permanent versus temporary balance-sheet effects remain important and controversial.

Key Arguments: Nominal GDP targeting is attractive because it is operational and robust to uncertainty about aggregate supply and the output gap. McCallum’s version of nominal income targeting was designed to work across different supply-side specifications, making it less fragile than rules based on estimated gaps. Friedman’s greatest legacy is not monetary targeting itself, but the now-standard view that inflation is a monetary phenomenon and that monetary policy sets long-run inflation. Self-identifying monetarists are rare today, but many mainstream macro and central-bank ideas still reflect monetarist doctrine implicitly. Money-demand equations are not invalid in modern models; they are often redundant in the short run under an interest-rate instrument, but still matter for long-run inflation determination. The quantity theory remains relevant: in the long run, money growth anchors inflation, even if short-run models emphasize interest rates and Phillips-curve dynamics. Broad monetary aggregates may be more stable and informative than narrow ones, and Davisia measures can improve short-run money-demand relationships. The monetary base remains worth studying, but its relationship to broader aggregates has become noisier because of interest on reserves, reverse repos, crisis-driven reserve demand, and regulation. QE likely worked through asset-price and term-premium channels; it was not simply canceled out by reserve demand or made irrelevant by its eventual normalization. A retail-focused aggregate like Davisia M2 is preferable to very broad wholesale aggregates, because money demand should be grounded in household and transactions-based theory.

Data Points: Scott Sumner proposal: Nominal GDP futures market - Opening pitch for Mercatus-sponsored research project tied to forecasting nominal GDP. Show history: Weekly Macro Musings podcast - Beckworth introduces the podcast and guest. Career timeline: Late 1980s - Nelson says his Australian high school economics exposure was in the late 80s. Australia recession record: No contractions since the early 1990s - Beckworth notes Australia’s unusually long expansion. Great Recession policy constraint: Zero lower bound avoided - Discussion of Australia’s higher inflation and higher natural rate giving more room to cut rates. Friedman paper anniversary: 50th anniversary - Reference to Friedman’s 1968 Presidential Address and related recent papers. FOMC transcript release lag: 5 years - Nelson describes responsibilities of the FOMC Secretariat. Missing money period: Around 1973 - Nelson references Goldfeld’s breakdown in the short-run M1 demand relationship. Fed policy horizon example: 2010 deflation forecast missed - Nelson says Phillips-curve equations were predicting deflation in 2010, but it did not occur.

Pivotal Quotes: "I think that the consensus that inflation is a monetary phenomenon, it can be controlled by monetary policy, should be targeted by monetary policy, and that I think that's a very enduring part of Friedman's influence." — Ed Nelson: Explaining Friedman’s lasting impact on modern central banking and macroeconomics. "So Ben really emphasized Let's get away from fragile estimates of the output gap. Let's get away from the environment in which he was working." — Ed Nelson: Describing McCallum’s motivation for nominal GDP targeting. "I would say that in the long run, the central bank can't control interest rates because the interest rate is ultimately a real variable since percent terms." — Ed Nelson: Arguing that money growth, not interest-rate setting alone, anchors long-run inflation.

Implications: Listeners should come away seeing money as diminished in day-to-day policy debates but still central for long-run inflation, policy robustness, and balance-sheet analysis. The transcript favors careful measurement and rules-based frameworks over gap-based discretion.