David Laidler: “Two Crises, Two Ideas and One Question”

The main founding fathers of monetarism to me always was Milton Friedman, Anna Schwartz, Karl Brunner, Allan Meltzer and David Laidler. The three first have all now passed away and Allan Meltzer to some extent seems to have abandoned monetarism. However, David Laidler is still going strong and maintains his monetarist views. David has just published a new and very interesting paper – “Two Crises, Two Ideas and One Question” – in which he compares the Great Depression and the Great Recession through the lens of history of economic thought.

David’s paper is interesting in a number of respects and any student of economic history and history of economic thought will find it useful to read the paper. I particularly find David’s discussion of the views of Allan Meltzer and other (former!?) monetarists interesting. David makes it clear that he think that they have given up on monetarism or as he express it in footnote 18:

“In this group, with which I would usually expect to find myself in agreement (about the Great Recession), I include, among others, Thomas Humphrey, Allan Meltzer, the late Anna Schwartz, and John Taylor, though the latter does not have quite the same track record as a monetarist as do the others.”

Said in another way David basically thinks that these economists have given up on monetarism. However, according to David monetarism is not dead as another other group of economists today continues to carry the monetarist torch – footnote 18 continues:

“Note that I self-consciously exclude such commentators as Timothy Congdon (2011), Robert Hetzel (2012) and that group of bloggers known as the “market monetarists”, which includes Lars Christensen, Scott Sumner, Nicholas Rowe …. – See Christensen (2011) for a survey of their work – from this list. These have all consistently advocated measures designed to increase money growth in recent years, and have sounded many themes similar to those explored here in theory work.”

I personally think it is a tremendous boost to the intellectual standing of Market Monetarism that no other than David Laidler in this way recognize the work of the Market Monetarists. Furthermore and again from a personal perspective when David recognizes Market Monetarist thinking in this way and further goes on to advocate monetary easing as a respond to the present crisis I must say that it confirms that we (the Market Monetarists) are right in our analysis of the crisis and helps my convince myself that I have not gone completely crazy. But read David’s paper – there is much more to it than praise of Market Monetarism.

PS This year it is exactly 30 years ago David’s book “Monetarist Perspectives” was published. I still would recommend the book to anybody interested in monetary theory. It had a profound impact on me when I first read it in the early 1990s, but I must say that when I reread it a couple of months ago I found myself in even more agreement with it than was the case 20 years ago.

Update: David Glasner also comments on Laidler’s paper.

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Eichengreen’s reading list to European policy makers

Barry Eichengreen provides a Summer reading list for European policy makers in his latest article on Project Syndicate. Here is Eichengreen:

“Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States belongs at the top of the list. At the center of their gripping narrative is a chapter on the Great Depression, anchored by an indictment of the US Federal Reserve Board for responding inadequately to the mounting crisis.

Friedman and Schwartz are generally seen as reproving the Fed for failing to react swiftly to successive waves of bank failures, first in late 1930 and then again in 1931 and 1933. But a close reading reveals that the authors reserve their most scathing criticism for the Fed’s failure to initiate a concerted program of security purchases in the first half of 1930 in order to prevent those bank failures.

That is a message that the European Central Bank’s board members could usefully take to heart, given their announcement on August 2 that they were ready to respond to events as they unfolded but were taking no action for now. Reading Friedman and Schwartz will remind them that it is better to head off a crisis than it is to rely on one’s ability to end it.”

So true, so true…if just European policy makers had read and understood “Monetary History” then we would not be trapped in this crisis.

There are a couple of other titles on Eichengreen’s reading list, but in my view he forgets a very important book and that is his own “Golden Fetters”. Anybody who would like to understand the international monetary perspectives of the Great Depression should read “Golden Fetters”. And if you understand that you have a much better idea about the international monetary sources of the present crisis. Read Eichengreen’s “Golden Fetters” and replace “gold standard” with “dollar standard” everywhere and then you will get a pretty good idea about why we are still in this crisis. In the Great Depression it was excess demand for gold (from Europe) that caused the crisis. Today it is excess demand for dollars, which is causing the crisis. European policy makers should especially concentrate on what Eichengreen has to say about the mistakes made by European policy makers in 1931-32.

One day I hope to write a book with the title “Green Fetters”, but it will never be as good as “Golden Fetters”, but the topic would be the same – the insane commitment to a failed monetary regime and its dire consequences for the global economy. If just only policy makers would learn a bit from history.

HT David Altenhofen

PS See also Eichengreen’s critique of the ECB’s and the Fed’s inaction here (In German).

Related posts:

Between the money supply and velocity – the euro zone vs the US

International monetary disorder – how policy mistakes turned the crisis into a global crisis

1931-33 – we should learn something from history

Recommend reading for aspiring Market Monetarists

Goodbye to a great monetary historian – R.I.P. Anna Schwartz

Yesterday, Anna Schwartz passed away in her New York City home at an age of 96. Anna Schwartz undoubtedly was one of the greatest monetary historians ever and her masterpiece A Monetary History of the United States, 1867-1960″ , which she co-authored with Milton Friedman was instrumental in changing how economic historians view the causes of the Great Depression.

Anna Schwartz’s analysis lead her to conclude that the Great Depression was caused by monetary policy failure. Or as Ben Bernanke said in 2002:

  “I would like to say to Milton and Anna: Regarding the Great Depression, you’re right, we did it. We’re very sorry, but thanks to you we won’t do it again.” 

There is no way around it – Monetary History is one of the greatest works of economics ever produced and surely one of the most important – if not the most important – book on monetary history ever written.

Somewhat unfairly Anna Schwartz never got the full recognition for her work that she deserved. How the Nobel Prize committee never awarded her the Nobel Prize in economics will forever be a puzzle.

It is a testimony to her hard work and intellect that she continued to work with Michael Bordo and Owen Humpage on a project on the history of government intervention in currency markets after breaking a hip in 2009 and having a stroke (See here and here).

While I did not agree with her analysis of the Great Recession – exactly because I agree with her analysis of the Great Depression – I will forever think of Anna Schwartz as one of the greatest monetary historians with an amazing intellect.

Anna Schwartz R.I.P.

——

For an overview of Anna Schwartz work see here.

Update: Read also George Selgin’s tribute to “Anna”

The ECB has the model to understand the Great Recession – now use it!

By chance I today found an ECB working paper from 2004 – “The Great Depression and the Friedman-Schwartz hypothesis” by Christiano, Motto and Rostagno.

Here is the abstract:

“We evaluate the Friedman-Schwartz hypothesis that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, we first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. We identify a monetary base rule which responds only to the money demand shocks in the model. We solve the model with this counterfactual monetary policy rule. We then simulate the dynamic response of this model to all the estimated shocks. Based on the model analysis, we conclude that if the counterfactual policy rule had been in place in the 1930s, the Great Depression would have been relatively mild.”

It is interesting stuff and you would imagine that the model developed in the paper could also shed light on the causes and possible cures for the Great Recession as well.

Is it only me who is reminded about 2008-9 when you read this:

“The empirical exercise conducted on the basis of the model ascribes the sharp contraction of 1929-1933 mainly to a sudden shift in investors’ portfolio preferences from risky instruments used to finance business activity to currency (a flight-to-safety explanation). One interpretation of this finding could be that households . in strict analogy with commercial banks holding larger cash reserves against their less liquid assets . might add to their cash holdings when they feel to be overexposed to risk. This explanation seems plausible in the wake of the rush to stocks that occurred in the second half of the 1920.s. The paper also documents how the failure of the Fed in 1929-1933 to provide highpowered money needed to meet the increased demand for a safe asset led to a credit crunch which in turn produced deflation and economic contraction.”

The authors also answer the question about the appropriate policy response.

“We finally conduct a counterfactual policy experiment designed to answer the following questions: could a different monetary policy have avoided the economic collapse of the 1930s? More generally: To what extent does the impossibility for central banks to cut the nominal interest rate to levels below zero stand in the way of a potent counter-deflationary monetary policy? Our answers are that indeed a different monetary policy could have turned the economic collapse of the 1930s into a far more moderate recession and that the central bank can resort to an appropriate management of expectations to circumvent – or at least loosen – the lower bound constraint.

The counterfactual monetary policy that we study temporarily expands the growth rate in the monetary base in the wake of the money demand shocks that we identify. To ensure that this policy does not violate the zero lower-bound constraint on the interest rate, we consider quantitative policies which expand the monetary base in the periods a shock. By injecting an anticipated inflation effect into the interest rate, this delayed-response feature of our policy prevents the zero bound constraint from binding along the equilibrium paths that we consider. At the same time, by activating this channel, the central bank can secure control of the short-term real interest rate and, hence, aggregate spending.

The conclusion that an appropriately designed quantitative policy could have largely insulated the economy from the effects of the major money demand shocks that had manifested themselves in the   late 1920s is in line with the famous conjecture of Milton Friedman and Anna Schwartz (1963).”

So what policy rule are the authors talking about? Well, it is basically a feedback rule where the money base is expanded to counteract negative shocks to money-velocity in the previous period. This is not completely a NGDP targeting rule, but it is close – at least in spirit. Under NGDP level targeting the central bank will increase in the money base to counteract shocks to velocity to keep NGDP on a stable growth path. The rule suggested in the paper is a soft version of this. It could obviously be very interesting to see how a real NGDP rule would have done in the model.

Anyway, I can highly recommend the paper – especially to the members of the ECB’s The Governing Council and I see no reason that they should not implement a rule for the euro zone similar to the one suggested in the paper. If the ECB had such a rule in place then Spanish 10-year bond yields probably would not have been above 7% today.

PS Scott Sumner has been looking for a model for some time. Maybe the Christiano-Motto-Rostagno model would be something for Scott…


 

Jason finds (one of) Friedman’s gems

Here is Jason Rave over at Macro Matters on “History’s Lessons”:

Continuing with the Monetary theme I’ve had going lately, following Lars Christensen’s post about “Free to Choose” I decided to re-read Friedman and Schwartz’s “A Monetary History of the United States”. I came across this gem again, just about as beautiful explanation of a recession I think there is. Because of the number of parallels the passage has with the current economic climate, I thought I would share the relevant text here. The passage is referencing the banking crisis of 1907 in the US.

I am very happy to have inspired Jason to read Monetary History. It is a true masterpiece and anybody interested in monetary history and theory should read it. Jason goes on to quote Friedman and Schwartz on the 1907 crisis:

“The business contraction from May 1907 to June 1908, though relatively brief, was extremely severe, involving a sharp drop in output and employment. Even the annual net national product figures show a fall of over 11 per cent in both constant and current prices from 1907 to 1908
(…)
From May 1907 on, the stock of money, seasonally adjusted, declined in every month until February 1908 – mildly until the panic, then sharply. From May to the end of September, the money stock fell by 2.5 per cent, from September to February by 5 per cent. Though mild, the decline before the panic is worth noting. It gives some evidence of unusually strong downward pressure, at least in the monetary field. Thanks to its strong upward trend, the stock of money typically rises during mild contractions, declining at most for an occasional month or two. There are only three subsequent contractions in which the estimated money stock in any month of the contraction was below its previous peak by a larger percentage than the 2.5 per cent decline from May to September 1907 alone.

…”The initial decline of about 2.5 per cent (from May to September 1907) reflected in part a decline in high-powered money by about 1 per cent…the rest of the initial decline reflected a fall in the ratio of deposits to reserves, as banks increased their high-powered money holdings by some 5 per cent despite the decline in total high-powered money…(also) although the absolute amount of both deposits and currency fell, deposits fell by 2 per cent, currency by 5 per cent.

The subsequent decline in the money stock from September 1907 to February 1908, on the other hand, has all the earmarks of an active scramble for liquidity on the part of both the public and the banks. The stock of high-powered money rose by 10 per cent over that five-month period, yet the money stock fell by 5 per cent. As in 1893 the public’s distrust if the banks…(was) reflected in the combination of a rise in currency in the hands of the public, this time by 11 per cent, and a decline in deposits, this time by 8 per cent. The two together produced a decline in the ratio of deposits to currency from 6.0 to 5.0. At the same time, the banks sought to improve their capacity to meet the demands of the public by raising their currency holdings… The result was a decline in the ratio of deposits to reserves from 8.2 to 7.0. Taken by itself, each of the changes in the deposit ratios would have produced a decline of 7-8 per cent in the stock of money and, together, of nearly 14 per cent. The actual decline was kept to 5 per cent only because of the accompanying 10 per cent rise in high-powered money”

Jason then draws a very interesting parallel:

The similarities in the process of deleveraging and the flight to liquidity between then and over 100 years later are striking. I think what’s more important to remember for the current crisis and policy response is what Friedman and Schwartz gone on to describe as the post crisis response of economic agents;

“The deposit-currency ratio rebounded rapidly and within less than a year seems to have resumed it’s earlier trend. The deposit-reserve ratio resumed its rate of rise after 1908 but at a lower level rather than at the level of the earlier trend… The experience of the panic apparently raised the liquidity preference of the commercial banks for a considerably longer period than it did that of their depositors. The same contrast in the behaviour of the two ratios is noticeable after the monetary crises of 1884 and again after the troubled period of 1980 to 1893. We shall see it occurs again after the panic of 1933.”

Given the fact that Euro zone M3 is currently growing at a below trend rate (see here), and given last night saw the third record high level of overnight deposits held with the ECB at EUR827.534 billion, I’d imagine a similar dual speed deposit ratio recovery is prevalent in the currency bloc as we speak (stay tuned for some statistical analysis of this). This has important implications for policy. That is, if depositors regain confidence in banks more rapidly than banks do in depositors and the economy, the problem is bottlenecks in the willingness to lend on the part of banks due to permanent increases in the demand for money. Thus the ECB and other central banks should be doing all they can to meet this demand, as I have argued here and here, and should continue to flood the market with cheap money until they do so (were they not constrained by inappropriate inflation targets).

Despite being written over 50 years ago about events over 100 years ago, Friedman and Schwartz’s economic documentation is still incredibly applicable to events occurring this very minute.

So what Jason basically conclude is that the ECB’s actions since December basically is what Friedman would have suggested. I of course fully agree that Friedman would have advocated increasing the money base to avoid a collapse in nominal spending. However, I would also stress that a key weakness in ECB’s policies is the lack of a clear statement of the real purpose of these operations. The ECB needs to be much more clear on it’s nominal target. In the dream world the ECB would formulate a clear NGDP level target, but we all know that that is never going to happen.

Lorenzo on Tooze – and a bit on 1931

The other day I was asking for comments on Adam Tooze’s book  “Wages of Destruction”. Now our good friend “Lorenzo from Oz” has answered my call. It turns out that he already back in 2009 wrote a review on the book on his excellent blog Thinking Out Aloud.

Here is Lorenzo’s wrap-up:

“Tooze’s book is genuinely revelatory. The purposiveness of Nazi policy, the fears and aspirations that drove it, the limitations it laboured under are all made clear. Hitler was, from first to last, a wilful gambler who knew himself to be such. He was also a consummate political game player who attracted and used people of genuine talent for a purpose that was horrific. That the Nazi economy was a loot economy was not happenstance but the nature of the beast. Genghis Khan with a telephone indeed.”

So far every single review of this book I have read has been positive – I am still hoping to find some time to read it – until then I highly recommend that you all have a look at Lorenzo’s review of the book.

PS I continue to think that we can learn a lot about the present crisis by studying history. Yesterday I spend some time in the company the Danish central bank governor Niels Bernstein and Polish central bank governor Marek Belka. Dr. Belka brought up the year of 1931. Dr. Belka of course spend time at the University of Chicago in 1980s so he full well understand monetary policy and monetary history. I hope that Dr. Belka will educate his European colleagues about monetary history (he yesterday also referenced Friedman’s and Schwartz’s “Monetary History”). See what I earlier have written on the “Tagic year 1931″.

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