Clark Johnson has written what will become a Market Monetarist Classic

As I have written about in an earlier post I am reading Clash Johnson’s book on the Great Depression “Gold, France and the Great Depression”. So far it has proved to be an interesting and insightful book on what (to me) is familiar story of how especially French and US gold hoarding was a major cause for the Great Depression.

Clark Johnson’s explanation of Great Depression is similar to that of two other great historians of the Great Depression Scott Sumner and Douglas Irwin. Both are of course as you know Market Monetarists.

Given Johnson’s “international monetary disorder view” of the Great Depression I have been wondering whether he also had a Market Monetarist explanation for the Great Recession. I now have the answer to that question and it is affirmative – Clark Johnson is indeed a Market Monetarist, which becomes very clear when reading a new paper from the Milken Institute written by Johnson.

One thing I find especially interesting about Johnson’s paper is that he notes the importance of the US dollar as the global reserve currency and this mean that US monetary policy tightening has what Johnson calls “secondary effects” on the global economy. I have long argued that Market Monetarists should have less US centric and more global perspective on the global crisis. Johnson seems to share that view, which is not really surprising given Johnson’s work on the international monetary perspective on the Great Depression.

Johnson presents six myths about monetary policy and the six realities, which debunk these myths. Here are the six myths.

Myth 1: The Federal Reserve has followed a highly expansionary monetary policy since August, 2008.

Johnson argues that US monetary policy has not been expansionary despite the increase in the money base and the key reason for this is a large share of the money base increase happened in the form of a similar increase in bank reserves. This is a result of the fact that the Federal Reserve is paying positive interest rates on excess reserves. This is of course similar to the explanation by other Market Monetarists such as David Beckworth and Scott Sumner. Furthermore, Johnsons notes that the increase that we have seen in broader measure of the money supply mostly reflects increased demand for dollars rather than expansionary monetary policies.

Johnson notes in line with Market Monetarist reasoning: “Monetary policy works best by guiding expectations of growth and prices, rather than by just reacting to events by adjusting short-term interests”.

Myth 2: Recoveries from recessions triggered by financial crises are necessarily low.

Ben Bernanke’s theory of the Great Depression is a “creditist” theory that explains (or rather does not…) the Great Depression as a consequence of the breakdown of financial intermediation. This is also at the core of the present Fed-thinking and as a result the policy reaction has been directed at banking bailouts and injection of capital into the US banking sector. Johnson strongly disagrees (as do other Market Monetarists) with this creditist interpretation of the Great Recession (and the Great Depression for that matter). Johnson correctly notes that the financial markets failed to react positively to the massive US banking bailout known as TARP, but on the other hand the market turned around decisively when the Federal Reserve announced the first round of quantitative easing (QE) in March 2009. This in my view is a very insightful comment and shows some real Market Monetarist inside: This crisis should not be solved through bailouts but via monetary policy tools.

Myth 3: Monetary policy becomes ineffective when short-term interest rates fall close to zero.

If there is an issue that frustrates Market Monetarists then it is the claim that monetary policy is ineffective when short-term rates are close to zero. This is the so-called liquidity trap. Johnson obviously shares this frustration and rightly claims that monetary policy primarily does not work via interest rate changes and that especially expectations are key to the understanding of the monetary transmission mechanism.

Myth 4: The greater the indebtedness incurred during growth years, the larger the subsequent need for debt reduction and the greater the downturn.

It is a widespread view that the world is now facing a “New Normal” where growth will have to be below previous trend growth due to widespread deleveraging. Johnson quotes David Beckworth on the deleveraging issue as well site Milton Friedman’s empirical research for the fact there is no empirical justification for the “New Normal” view. In fact, the recovery after the crisis dependent on the monetary response to the crisis than on the size of the expansion prior to the crisis.

Myth 5: When money policy breaks down there is a plausible case for a fiscal response.

Recently the Keynesian giants Paul Krugman and Brad DeLong have joined the Market Monetarists in calling for nominal GDP targeting in the US. However, Krugman and DeLong continue to insist on also loosening of US fiscal policy. Market Monetarists, however, remain highly skeptical that a loosening of fiscal policy on its own will have much impact on the outlook for US growth. Clark Johnson shares this view. Johnson’s view on fiscal policy reminds me of Clark Warburton’s position on fiscal policy: fiscal policy only works if it can alter the demand for money. Hence, fiscal policy can work, but basically only through a monetary channel. I hope to do a post on Warburton’s analysis of fiscal policy at a later stage.

Myth 6: The rising prices of food and other commodities are evidence of expansionary policy and inflationary pressure.

It is often claimed that the rise in commodity prices in recent years is due to overly loose US monetary policy. Johnson refute that view and instead correctly notes that commodity price developments are related to growth on Emerging Markets in particular Asia rather than to US monetary policy.

Johnson’s answer: Rate HIKES!

Somewhat surprise after conducting an essentially Market Monetarist analysis of the causes of the Great Recession Clark Johnson comes up with a somewhat surprising policy recommendation – rate hikes! In fact he repeats Robert McKinnon’s suggestion that the four leading central banks of the world (the Federal Reserve, the ECB, the Bank of Japan and the Bank of England) jointly and coordinated increase their key policy rates to 2%.

Frankly, I have a very hard time seeing what an increase interest rates could do to ease monetary conditions in the US or anywhere else and I find it very odd that Clark Johnson is not even discussing changing the institutional set-up regarding monetary policy in the US after an essentially correct analysis of the state US monetary policy. It is especially odd, as Johnson clearly seem to acknowledge the US monetary policy is too tight. That however, does not take anything away from the fact that Clark Johnson has produced a very insightful and interesting paper on the causes for the Great Recession and monetary policy makers and students of monetary theory can learn a lot from reading Clark Johnson’s paper. In fact I think that Johnson’s paper might turnout to become an Market Monetarist classic similar to Robert Hetzel’s “Monetary Policy in the 2008-2009 Recession” and Scott Sumner’s “Real problem is nominal”.


Update: Marcus Nunes and David Beckworth also comment on Clark Johnson’s paper. Thanks to both Benjamin “Mr. PR” Cole and Marcus Nunes for letting me know about Johnson’s great paper.

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  1. Benjamin Cole

     /  October 22, 2011

    I was also surprised about Johnson’s rate hike suggestion, but I think he means it within the context of sustained QE.

    I guess I also remain a Freidmanite in some regards; I think if we firehose enough money into the economy we get a recovery and then inflation—expectations may not be needed. Friedman did not speak about expectations to the Bank of Japan.

    Nevertheless, I think think transparent Fed targeting of explicit nominal GDP goals is helpful while conducting sustained QE.

  2. BC, I agree, but I think Friedman would support the expectation driven view of the world. However, I think that it key point is that any announcement of a NGDP target needs to be credible. So if the Federal Reserve announce for example to bring NGDP back to the trend level from prior to the Great Recession for example by the end of 2012 then it should at the same time announce that it would put a trillion dollars on Time Square every Friday until the market pricing the policy. Its really pretty simple…

    By the way such policy might not even be inflationary as most of the recovery might happen in RGDP.

  3. Benjamin Cole

     /  October 22, 2011


    The Chicken Inflation Littles are basically contending there is little competition in pricing well before full output.

    This is at empirical and theoretical variance with what we think and have seen. Unit labor costs in the USA have been flat to down for several years now. In my little corner of the world, no one is in “Fat City”—the real estate boom days in 2002-7, when people were looking hard for tradesmen to work on houses or commercial developments.

    I agree with you–and indeed, I think there is even a case to be made then when output rises, overhead costs are spread among a larger number of units, keeping costs under control.

    Add on Johnson: He mentions something about higher interest rates taking the starch out of commodities prices. I think he just wants rates up two percent while the QE firehoses are on, to cool off commodities. I don’t know if that will work; commodities are driven by global demand and speculators.

    In any event, I think I will put out congratulatory feelers to Charles Johnson, if I can locate him

    I have in mind a multi-author op-ed for the Wall Street Journal or New York Times. A signal piece, as it were.

  4. dwb

     /  June 25, 2012

    As BC notes above, i think that the call for rate hikes confuses cause and effects. yes, think rate rikes are the appropriate medicine… caused by higher real returns and inflation. The fed just needs to run the printing presses until the 10 yr is 4%.

  5. Philo

     /  June 26, 2012

    Johnson writes (in his Milken paper) that the dollar should not have been allowed to appreciate so much from July to October, 2008–from $1.60/euro to $1.25/euro; he agrees with Mundell that it should have been held in the low $1.40s/euro. He adds: “This result could almost certainly have been achieved through aggressive, coordinated interventions in the government-debt and foreign-exchange markets.” I would not quarrel with the main point, but I am surprised at the weakness of ‘almost certainly’: what does he think might have prevented this achievement? And I wonder at the term ‘coordinated’: I think he means the Fed would have had to coordinate its actions *with other central banks around the world*; but why does he suppose this would have been necessary? Is it not clear that the Fed could have kept the dollar from appreciating beyond $1.40/euro all by itself, regardless of the actions of other central banks (provided we limit our consideration to actions that were politically feasible for them)?

  1. Guest post – Keynes: Evidence for Monetary Policy Ineffectiveness? (Part 1, by Clark Johnson) « The Market Monetarist

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