“Synthesizing State and Spontaneous Order Theories of Money”

I have been traveling quite a bit recently and have had a bit of a hard time finding time for blogging. I really wanted to blog about why I think that there is a very serious risk that the Swedish Riksbank might hit the Zero Lower Bound soon and is totally unprepared for this.

I also want to blog more about the recent major changes in Czech monetary policy and finally I want to blog about development economics and particularly about my view of Nina Munk’s fantastic new book – “The Idealist” – about Jeffrey Sachs and why all kinds of central planing is insane (some thing Sachs apparently has failed to understand).

But I have no time or energy for all that now. Instead I think you should read this paper “Synthesizing State and Spontaneous Order Theories of Money” – by the two young and clever economists Will Luther and Alex Salter. Here is the abstract:

What role does government play in determining the medium of exchange? Economists weighing in on the issue typically espouse one of two views. State theorists credit government with the emergence and continued acceptance of commonly accepted media of exchange. In contrast, spontaneous order theorists find little need for government, maintaining that money emerges and continues to circulate as a result of a decentralized market process. History suggests a more subtle theory is required. We provide a generalized theory of the emergence and perpetuation of money, informed by both approaches and consistent with recent theoretical and empirical advances in the literature.

Enjoy!

Hopefully I will get back to blogging in the coming days…

PS Will and Alex you are both very clever economists, but you need to work on your marketing credentials - “Synthesizing State and Spontaneous Order Theories of Money” is not a sexy title for a paper. I am happy I know your qualities so I will read your paper anyway and I am sure my readers will do so as well.

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Remembering the “Market” in Market Monetarism

A couple of days ago the young and talented George Mason University economist Alex Salter wrote the following statement on his Facebook account:

I wish market monetarists would put relatively more emphasis on the “market” bit.

I agree with Alex as I believe that one of the main points of Market Monetarism is that not only do money matters, but it equally important that markets matter. Hence, it is no coincidence that the slogan of my blog ismarkets matter, money matters” and it was after all me who coined the phrase Market Monetarism.

Paul Krugman used to call Scott Sumner a quasi-monetarist, but I always thought that that missed an important point about Scott’s views (and my own views) and that of course is the “market” bit. In fact Alex’s statement reminded me of a blog post that I wrote back in January 2012 on exactly this topic.

This is from my post “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.

Interestingly enough Alex himself has just recently put out a new working paper – “There a Self-Enforcing Monetary Constitution?” -
that makes the exact same point. This is the abstract from Alex’s paper:

This paper uses insights from monetary theory and constitutional political economy to discover what a self-enforcing monetary constitution — one whose rules did not require external enforcement — would look like. I argue that a desirable monetary constitution (a) institutionalizes an environment conducive to economic calculation via an unhampered price mechanism and (b) enables agents acting within the system to uphold the rule even in the presence of deviations from ideal knowledge and incentive assumptions. I show two radical alternatives to current monetary institutions — a version of NGDP targeting that relies on market implementation of monetary policy and free banking — meet these requirements, and thus represent self-enforcing monetary constitutions. I ultimately conclude that the maintenance of a stable monetary framework necessitates branching out from monetary theory narrowly conceived and considering insights from political economy, and constitutional political economy in particular.

I very much like Alex’s constitutional spin on the monetary policy issue. I strongly agree that the biggest problem in the conduct of monetary policy – basically everywhere in the world – is the lack of a clear rule based framework for the monetary system and equally agree that NGDP targeting with “market implication” and Free Banking fulfill the requirement for a monetary constitution. Or as I put it in my 2012 post:

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.

…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 an “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.

Hence, Alex and I are in fundamental agreement, but I also want to acknowledge that we – the Market Monetarists – from time to time are more (too?) focused on the need to ease monetary policy – in the present situation in the US or the euro zone – than to talk about “market implementation” of monetary policy.

There are numerous reasons for this, but the key reason is probably one of political realism, but there is also a serious risk in letting “political realism” dictate the agenda. Therefore, I think we should listen to Alex’s advice and try to stress the “market” bit in Market Monetarism a bit more. Afterall, we have made serious inroads in the global monetary policy debate in regard to NGDP level targeting – why should we not be able to make the same kind of progress when it comes to “market implementation” of monetary policy?

Alex Salter’s (friendly) critique of Market Monetarism

Alex Salter just sent me his latest working paper “Not All NGDP is Created Equal: A Critique of Market Monetarism”. I haven’t read the entire paper yet,  but Alex is always writing interesting stuff – including as a guest blogger at this blog – so I want to share it with my readers already.

Here is the abstract:

Market Monetarism, with its policy rule of NGDP targeting, has in common with free banking that both seek to avoid monetary disequilibrium. One might conclude that these are different approaches to achieving the same end. The purpose of this paper is to show that the proximate ends are in fact conceived differently: Stable NGDP as an object of choice by a central bank is different from NGDP as the emergent outcome of the market process. Furthermore, well-known insights on knowledge, the pricing process, and the institutional context of economic activity suggest that this difference has important implications.

I don’t have time to write a reply to Alex’s paper today, but hope to get back to it soon – or maybe some of my co-Market Monetarist bloggers might. But please have a look – it might be a critique of Market Monetarism, but coming from Alex it is always meant as a friendly critique.

Guest post: Thoughts on Policy Uncertainty (Alex Salter)

Even though I think the primary economic problem in the US and in Europe at the moment is weak aggregate demand due to overly tight monetary policy I certainly do not deny the fact that both the US and the euro zone face other very significant problems. Among these problems are considerable “regime uncertainty”. In fact I believe that regime uncertainty is the key economic problem in a number of countries such as Venezuela, Argentina and Hungary. I have in earlier posts (see links below) argued that regime uncertainty primarily should be seen as supply side phenomena. However, regime uncertainty can also be seen as a demand side problem.

In today’s guest post the young and talented Alex Salter discusses a framework in which to discuss regime uncertainty or policy uncertainty – both as a supply side and a demand side phenomena. I think Alex’s discussion is highly relevant  and is quite useful in understanding regime uncertain conceptually .

Enjoy Alex’s guest post.

Lars Christensen.

Guest post: Thoughts on Policy Uncertainty

By Alex Salter, George Mason University

There’s been some talk lately about policy uncertainty and its effect on economic activity.  It’s important to pin down just what economic effects we’re talking about here.  In particular, we need to decide whether policy uncertainty (also called ‘regime uncertainty’ by economist Robert Higgs, who was talking about it before it was in vogue) is a demand-side or a supply-side phenomenon.  I’ve seen arguments for both sides.

Here’s my take on it: In the short-run it’s a demand phenomenon.  But it has long-run supply consequences.

Policy uncertainty stems from uncertainty with respect to the future structure of property rights.  If I’m not sure what regulatory policy, tax liability, etc. for various economic activities will look like, then there’s a real option value to holding off on investing in an enterprise (Avinash Dixit has some really interesting papers on this).  This, of course, means lower investment spending than there would be otherwise.  The standard Aggregate Demand-Aggregate Supply (ADAS) framework provides a quick-and-dirty way of looking at this.

First off, let’s work in growth rates instead of levels.  I think it makes the analysis easier.  The AD curve is given by.  This is the dynamic form of the familiar quantity equation,.  The little g denotes growth rates.  Note that the AD curve shows all combinations of inflation and real income growth that map to a constant level of nominal income growth.

AS is, as usual, broken down into short-run and long-run components.  SRAS is a standard Lucas supply curve, which is an increasing function of inflation expectations.  LRAS depends on the real productive capacity of the economy; it is vertical to reflect long-run monetary neutrality.

In the short run, policy uncertainty manifests itself as reduced investment expenditure.  Assuming a constant level of money supply growth, this is essentially a negative velocity shock, and hence a negative AD shock, as shown below:

The economy, initially in long-run equilibrium at point a, moves to point b, below its long-run potential growth rate.

Ordinarily, the reduction in money flows throughout the economy would put downward pressure on prices, leading to disinflation (or outright deflation if the shock is big enough).  The SRAS curve would shift down as the economy adapted to the new expenditure pattern, bringing us back to long-run equilibrium with the same growth rate as point a, but lower equilibrium inflation.

However, this is not the whole story.  Policy uncertainty, by hampering investment spending, has lowered the rate of capital formation relative to what it would have been in the uncertainty-free counterfactual.  The old long-run growth rate, given by the position of the LRAS curve, is no longer sustainable due to this reduced rate of capital accumulation.  The long-run effects of policy uncertainty are reflected in a reduced potential growth rate for the economy, represented by an inward shift of the LRAS curve:

As I have drawn it, the inward LRAS shift meets the transition down AD’ (reflecting larger income growth relative to inflation growth over time, still yielding a constant level of nominal income growth).  The result is long-run equilibrium at point c.  Again, real income growth is permanently lower because regime uncertainty, by hampering capital formation, has reduced the economy’s real productive activity vis-à-vis the no-uncertainty world.

This is obviously an oversimplified (and overaggregated!) model, but I think it captures the short-run/long-run distinction well enough for the purposes of getting our thinking straight.  There are all sorts of bells and whistles you could add to this.  For example, you could look at what happens after the uncertainty plays out (property rights become better-defined, either at a permanently “stronger” or “weaker” level).  The new equilibrium would be different depending on how you model actor expectations (rational, adaptive, etc.)  The grad students out there might want to spice things up by examining this in a Ramsey-style model and playing with the dynamics.

Now that we’ve got our terminology squared away, we can proceed to the really interesting questions—namely, how regime uncertainty plays out at the micro level, with the accompanying distortions in relative prices (and thus resource misallocations).  There are all sorts of political economy implications to work through as well.

—-

Related posts:

Regime Uncertainty, the Balkans and the weak US recovery
Papers about money, regime uncertainty and efficient religions
”Regime Uncertainty” – a Market Monetarist perspective
Monetary disorder in Central Europe (and some supply side problems)

“Synthesizing State and Spontaneous Order Theories of Money”

I have long been impressed with the young guard at George Mason University. Now two of them – Alex Salter and Will Luther – is out with a new Working Paper – “Synthesizing State and Spontaneous Order Theories of Money”. It is very interesting stuff and I highly recommend it to anyone who is interested in monetary theory. Here is the abstract:

“What role does government play in determining the medium of exchange? Economists weighing in on the issue typically espouse one of two views. State theorists credit government with the emergence and continued acceptance of commonly accepted media of exchange. In contrast, spontaneous order theorists find little need for government, maintaining that money emerges and continues to circulate as a result of a decentralized market process. History suggests a more subtle theory is required. We provide a generalized theory of the emergence and perpetuation of money, informed by both approaches and consistent with recent theoretical and empirical advances in the literature.”

PS Will is now an Assistant Professor at Kenyon College, while Alex is a PhD fellow at GMU.

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