All posts in category Policy futures

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 is “markets 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?

About these ads
3 Comments
by Lars Christensen on May 8, 2013  •  Permalink
Posted in Alex Salter, James Buchanan, MM Research agenda, Policy futures, Prediction markets
Tagged , ,

Posted by Lars Christensen on May 8, 2013

http://marketmonetarist.com/2013/05/08/remembering-the-market-in-market-monetarism/

Ben maybe you should try “policy futures”?

My readers will know that I think that the Federal Reserve has taken a step in the right direction with its latest policy action. I do think that the fed finally after four years of failure is moving towards a more rule based monetary policy. However, it is certainly far from perfect and there is still a lot of risks involved.

The Minutes from the latest FOMC meeting was published yesterday and it is clear that the FOMC is well-aware that it needs to address it’s communication problem. That’s positive. However, it is also clear that the fed still don’t have a proper communication policy in place and even though we are moving towards a more rule based monetary policy it still not completely clear what the rule is and it is not entire clear how it should be implemented. We are still far away from Milton Friedman’s ideal of having a computer control monetary policy. However, I think that the fed should move in the direction of that ideal and it could start the journey toward this goal by introducing what we could call “policy futures”.

It is obvious that the fed is aware that there is problems with the present forecasting set-up within the fed. The key problem is one that every central bank in the world is facing – should the central bank forecast that it will fail? That is effectively what the fed has been doing so far when it is saying that it expect a fragile and weak recovery.

Scott Sumner has suggested that monetary policy should be “pegged” to a NGDP future, which would mean that the money base is increased or decreased continuously as market expectations for future level NGDP changes. This is basically the Friedman ideal of a computer – or rather the market – controlling monetary policy. However, a less radical plan where futures are “just” used for policy guidance and forecasting is also possible and that is what I suggest that the fed should look at.

There are some very clear advantages of using the market to forecast. First of all the fed would not have to know the “real model” of the US economy. Second the forecasts would be unbiased. Third the fed would have real-time forecasts of its policy variables.

It is pretty clear that the fed is now moving towards some kind of Evans rule where changes in the money base is a function of unemployment and inflation. We don’t know fed’s reaction function, but a version of the Evans rules could take the following form:

(1)    ∆b = α(U-U*)-β(π-πT)

Where ∆b is the change in the money base, α and β are coefficients, U is unemployment and U* is the fed’s unemployment target or the structural unemployment, π is inflation and πT is the inflation target.

There plenty of reasons to be skeptical about the fact that the fed is so clearly targeting real variables (employment/unemployment). However, by using policy futures it might be possible to greatly reduce these risks.

I imagine that the fed set up a futures or an options market on for example inflation, employment/unemployment and obviously NGDP on different time horizons.

Let’s say that the fed has the target of reducing unemployment to 6%, but also want to maintain long term price stability (keeping inflation around 2%). If structural unemployment is higher than 6% then that would obviously not be possible – and if the fed tried to push unemployment below 6% then inflation would explode. A policy future would greatly help assess this risk.

Hence, the fed could issue a put option that would be knocked in if unemployment dropped by 6% and inflation was below 2 or 3% at some future date – for example January 1 2013. Such an option would give an assessment about whether it is likely that the fed will hit it’s policy objectives. If the market assess that structural unemployment is above 6% then that would be reflected in the pricing of the put option.

If the fed issued a number of different policy futures and options on the key policy objectives it could get the markets’ assessment of whether it is on the right track in terms of fulfilling it’s monetary policy objectives or not by cross-checking the pricing of different policy futures.

Such policy futures could also greatly help the fed in it’s communication with the markets and it would probably also be much easier to get consensus on the FOMC about the possible risk to monetary policy.

The fed would very easily be able to set up such policy futures markets, but the informational gains would in my view be tremendous. The only “problem” would that the fed would need fewer economists to do forecasting…

Related posts:
Yet another argument for prediction markets: “Reputation and Forecast Revisions: Evidence from the FOMC”
Benn & Ben – would prediction markets be of interest to you?
Prediction markets and government budget forecasts
Central banks should set up prediction markets
Markets are telling us where NGDP growth is heading
Scott’s prediction market
Robin Hanson’s brilliant idea for central bank decision-making

6 Comments
by Lars Christensen on October 5, 2012  •  Permalink
Posted in NGDP Targeting, Policy futures, Prediction markets, Scott Sumner
Tagged , , ,

Posted by Lars Christensen on October 5, 2012

http://marketmonetarist.com/2012/10/05/ben-maybe-you-should-try-policy-futures/

Follow

Get every new post delivered to your Inbox.

Join 402 other followers

%d bloggers like this: