Don’t forget the ”Market” in Market Monetarism

As traditional monetarists Market Monetarists see money as being at the centre of macroeconomic discussion. To us both inflation and recessions are monetary phenomena. If central banks print too much money we get inflation and if they print to little money we get recession or even depression.

This is often at the centre of the arguments made by Market Monetarists. However, we are exactly Market Monetarists because we have a broader view of monetary policy than traditional monetarists. We deeply believe in markets as the best “information system” – also about the stance of monetary policy. Even though we certainly do not disregard the value of studying monetary supply numbers we believe that the best indicator(s) of monetary policy stance is market pricing in currency markets, commodity markets, fixed income markets and equity markets. Hence, we believe in a Market Approach to monetary policy in the tradition of for example of “Manley” Johnson and Robert Keheler.

In fact we want to take out both the “central” and “banking” out of central banking and ideally replace monetary policy makers with the power of the market. Scott Sumner has suggested that the central banks should use NGDP futures in the conduct of monetary policy. In Scott’s set-up monetary policy ideally becomes “endogenous”. I on my part have suggested the use of prediction markets in the conduct of monetary policy.

Sometimes the Market Monetarist position is misunderstood to be a monetary version of (vulgar) discretionary Keynesianism. However, Market Monetarists are advocating the exact opposite thing. We strongly believe that monetary policy should be based on rules rather than discretion. Ideally we would prefer that the money supply was completely market based so that velocity would move inversely to the money supply to ensure a stable NGDP level. See my earlier post “NGDP targeting is not a Keynesian business cycle policy”

Even though Market Monetarists do not necessarily advocate Free Banking there is no doubt that Market Monetarist theory is closely related to the thinking of Free Banking theorist such as George Selgin and I have early argued that NGDP level targeting could be see as “privatisation strategy”. A less ambitious interpretation of Market Monetarism is certainly also possible, but no matter what Market Monetarists stress the importance of markets – both in analysing monetary policy and in the conduct monetary policy.


See also my earlier post from today on a related topic.

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  1. George Farnon

     /  January 13, 2012

    What makes market monetarism preferable to free banking? Is it simply political feasibility?

  2. George, I think that is a very good point. That said, for I am certainly not talking for other Market Monetarist bloggers on this point. Scott Sumner has never advocated Free Banking neither has Marcus Nunes or Nick Rowe. The story is different for David Beckworth, Bill Woolsey and myself.

    • George Farnon

       /  January 13, 2012

      Well luckily it was your opinion I was after! MM seems to me to be the second-best solution, so arguments like the above are important. Afterall Bagehot’s lender of last resort was his second best solution to no central bank. Yet he is only ever remembered as the guy who justified the CB’s role as LOLR. Excellent blog by the way.

      • George Farnon

         /  January 13, 2012

        I emphasize I meant “MM seems to me to be the second-best solution” as a good thing, as I see the best solution to be an impossibility in the
        medium term.

  3. I am uncomfortable with the rule/discretion distinction as the primary division in central bank policy. First, the more important distinction is explicit/implicit. Central banks are much more effective if they are explicit about their policy target.

    So, you can have an explicit target with discretion or an explicit target with a rule. I am uncomfortable with the latter since it seems to be both more open to “gaming” and problematic if there are institutional or other changes.

    A rule is of the form “the Bank will act as the rule determines”. First, that presumes the optimum rule is already known so, in a real sense, retards learning in the system beyond learning how to operate the rule. Second, it can actually result in de-stabilising expectations if circumstances become such that acting as the rule requires will result in sharply diverging results from previous experience. A target can be adaptive in a way that a rule is not.

    So, yes to explicit anchoring of expectations; no to rule-based roboticism in central banking.

    The ECB has a target that does not respond to circumstances while running an “artificial gold standard“: a sort of bastardised roboticism that anchors expectations about price but destabilises expectations about spending (i.e. NGDP) and debt.

  4. Benjamin Cole

     /  January 15, 2012

    Free banking? I think sovereign nations need to control the money supply. It is part of being a sovereign, part of taking on huge debts in wars etc. And yes, if need be, paying off debts with printed money. (BTW, I am actually for a much smaller USA military, but there are WWII type situations).

    I won’t even get into counterfeiting, or bank runs. Lender of last resort.

    Right now, I actually support the federal government running deficits simply by printing money, rather than borrowing. In a way we did that with QE. If the Fed just sits on the balances for a few decades, it amounts to the same thing.

    What would be the argument against the Fed buying debt and just sitting on it? If you say “inflating,” explain why moderate inflation would be harmful, and 2) Where is the effing inflation–we are all but deflating right now.

    The primary purpose of monetary policy is prosperity–it matters little if we inflate, stay even or deflate if prosperity is the result. How would we prosper with free banking? By digging more gold out of the ground?

    By deflating–have you checked out Japan lately?

    This is what is koo-koo about most monetarists–they are actually Theo-Monetarists. They start with the faith and belief that inflation should be zero, and work forward from there.

  5. Benjamin,

    I think you mix up Free Banking and the gold standard. A proper Free Banking system is actually much closer to NGDP level targeting than to a gold standard. In fact in for example David Glasner’s book on Free Banking it is hard to see the difference between the two.

    Ideally I think that monetary policy should be 100% separated from both banking and the funding of governments. Whether that is with Free Banking or an independent central bank with a clear NGDP level targeting rule is less important.

    I am also skeptical about QE without rules as it is likely to be much less effective than if it is conducted inside the framework of clearly defined NGDP level targeting. Even though QE2 obviously had some positive effects in the US I think it would have been a lot more effective had the Fed announced a clear target on NGDP.

    Therefore, there is a big risk that just arguing for the Federal Reserve to print money in the case of the US we just end up discrediting NGDP targeting. Printing money is a tool to ensure credibility of a certain NGDP target, but it is certainly not an aim in itself. The money base should have the size that ensures a given NGDP level target – nothing more or nothing less. Given that NGDP it too low at the moment the US money base should be increased (assuming a constant level of money-velocity).

    Furthermore, I am pretty certain that IF the Federal Reserve tomorrow announced that it would do everything in terms of printing money to ensure that NGDP would return to it pre-crisis NGDP 5% growth path (increasing NGDP 10-15% from the present level) then the Fed would probably have to do very little “money printing”. A sharp “automatic” increase in money-velocity (as money demand picks up) would do most of the job (its here the Chuck Norris effect and expectations come into the picture).

    Concerning some monetarists fear of inflation I am not sure that there are many monetarists that explicitly express a fear of inflation in the US. I can only really mention Allan Meltzer. What you probably is thinking about are Conservative/right wing New Keynesian economists like John Taylor. Taylor however never was a monetarist. That said, is there an (irrational) fear of inflation among some conservative economists in the US? Obviously and that is problematic, but I actually think that the way of thinking about economics in general is a much bigger problem.

    Many US economists today seem to thing that there actually is an liquidity trap and that monetary policy therefore is inefficient. As Market Monetarists we know that that obviously is wrong. However, we will not convince anybody that we are right by screaming “print money!”. Rather we must convince the economist profession (and policy makers) that the liquidity trap is nonsense. By doing so the objection to “printing money” to achieving a given NGDP target will become much smaller.

    Finally, the key economic problem in the US and the euro zone right now is deflationary monetary policies. However, if we fixed that problem (and it is actually very easy to do – announce a clear NGDP level target and promise to do as much QE necessary to achieve it) then we wouldn’t have to think much about monetary policy anymore. When monetary policy is conducted within a clear NGDP targeting framework the only policy discussions should be about supply side policies to increase real GDP growth.

  6. Benjamin Cole

     /  January 15, 2012


    When I say the Fed should engage in QE, I mean within a transparent target NGDP program.

    Objections? Well, we are still here in self-created monetary quicksand, so if anyone has objections to pumping up the money supply, I think they can be safely hooted off the stage.

    Remember—the goal of macroeconomic policy is prosperity, not zero inflation.

  7. Benjamin, then we are in agreement. I think we are often misunderstood because we do not stress the rules based part of our argument.

    Furthermore, I am also interested in the wider implications of the discussion. There is no doubt that monetary policy is too tight in both the US and in the euro zone, but that is hardly the case in a number of Emerging Markets country – one that for example comes to mind is Turkey which might need tighter monetary policy. That is why I am eager to discussion monetary policy and theory from a wider perspective.

    In terms of macroeconomic policy objectives I think that the objective of monetary policy should be to be “neutral” – hence, not distort the allocation of capital, labour and consumption. Therefore, monetary policy should ensure that money supply equals monetary demand. That is not the case at the moment in the US and the euro zone where there is excessive money demand. If monetary policy is “neutral” then the free agents can be free to pursue there goals in life and that surely would tend to create prosperity.

  1. Boettke’s important Political Economy questions for Market Monetarists « The Market Monetarist
  2. Markets are telling us where NGDP growth is heading « The Market Monetarist
  3. Wrap-up: My Free Banking related posts « The Market Monetarist
  4. Remembering the “Market” in Market Monetarism | The Market Monetarist

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