The Sudanese Pound – another Troubled Currency

A couple of days ago I wrote about Steve Hanke’s new Troubled Currencies project. The project presently covers Argentina, Iran, North Korea, Syria andVenezuela. However, I think Steve now has to expand the list with the Sudanese pound.

This is from Reuters yesterday:

Sudan’s currency has fallen to a record low against the dollar on the black market since South Sudan started reducing cross-border oil flows in a row over alleged support for rebels, dealers said.

There is little foreign trading in the Sudanese pound but the black market rate is an important indicator of the mood of the business elite and of ordinary people left weary by years of economic crises, ethnic conflicts and wars.

The rate is also watched by foreign firms such as cellphone operators Zain and MTN and by Gulf banks who sell products in pounds and then struggle to convert profits into dollars. Gulf investors also hold pound-denominated Islamic bonds sold by the central bank.

On Wednesday, one dollar bought 7.35 pounds on the black market – which has become the business benchmark – compared to 7 last week, black market dealers said. The central bank rate is around 4.4.

The pound has more than halved in value since South Sudan became independent in July 2011, taking with it three-quarters of the united country’s oil output. Oil was the driver of the economy and source for dollars needed for imports.

Last week, South Sudan said it would close all oil wells by the end of July after Sudan notified it a month ago it would halt cross-border oil flows unless Juba gave up support for rebels. South Sudan denies the claims.

Flows had only resumed in April after an earlier 16-month oil shutdown following South Sudan’s secession.

Interesting it is not only Sudan that has a currency/inflation problem. The same has indeed been the case for South Sudan, which initially after it became independent in 2011 saw a sharp spike in inflation.

Paradoxically enough the cause of the spike in inflation in South Sudan was the same as in Sudan – an South Sudanese oil boycott of Sudan. Hence,  the cut in oil sales from South Sudan to Sudan caused a sharp drop in the South Sudanese government’s oil revenue. That led the government to effectively force the new South Sudan central bank to fund the revenue shortfall by letting the money printing press work overtime.

As far as I know it was initially considered that South Sudan should implement Steve’s favourite monetary solution for countries like Sudan and South Sudan – a currency board.

Even though I am no big fan of currency boards I would agree with Steve that it could be the right solution for countries with extremely weak institutions such as Sudan and South Sudan. Another possibility could simply be to just dollarize and completely give up having their own currencies. My favourite solution for South Sudan would be a currency board, but with a twist – the Sudan Sudanese pound should be pegged to the price of oil rather than to another currency. This of course would be a strict form of the Export Price Norm (EPN), while I think complete dollarization would be the best solution for Sudan. Needless to say both Sudan and South Sudan should get rid of all capital and currency controls.

Finally it should be noted that while inflation seems to be getting out of control in Sudan inflation in South Sudan has been coming down significantly over the past year.

PS While the monetary situation is getting worse in Sudan the situation in Egypt apparently is improving and the black market for the Egyptian pounds seem to be “vanishing” according to a blog post from Steve today.

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The Troubled Currencies Project

The always busy and innovative monetary thinker Steve Hanke has started a new very interesting project – The Troubled Currencies Project - as a joint project between Cato Institute  and Johns Hopkins.

Here is what Steve has to say about the project:

“For various reasons — ranging from political mismanagement, to civil war, to economic sanctions — some countries are unable to maintain a stable domestic currency. These “troubled” currencies are associated with elevated rates of inflation, and in some extreme cases, hyperinflation. Often, it is difficult to obtain timely, reliable exchange-rate and inflation data for countries with troubled currencies.

To address this, the Troubled Currencies Project collects black-market exchange-rate data for these troubled currencies and estimates the implied inflation rates for each country. The data and estimates will be updated on a regular basis.”

The project presently covers Argentina, Iran, North Korea, Syria and Venezuela.

I look very much forward to following the project in the future.



Argentina’s inflation might already have surpassed 100%

There is no doubt that the main monetary policy problem in world over the last five years has been overly tight monetary policy – particularly in the US and the euro zone. However, there are certainly also central banks of the world that have erred on the other side.

Hence, Iran is flirting with hyperinflation and the policies of the petro-socialist regime in Venezuela has sparked runaway inflation. Furthermore, there is no doubt that inflation in Argentina is increasingly getting out of control and that is the topic for this blog post.

Officially inflation in Argentina is around 11%. However, anybody who has just a minimum of knowledge about the Argentine economy knows that the Argentine inflation numbers are as real as Mickey Mouse. Inflation in Argentina is not 11%, but much higher.

According to an alternative measure of inflation the so-called Congressional Index, which is a price index based on private surveys inflation is more likely around 24-25%.

But inflation is likely even higher than that. Surveys of inflation expectations indicate that inflation is running around 30%.

However, I think that it might be even worse than that. One thing that is strongly distorting all of these measures is the extensive price controls that have been put in place in recent years in Argentina. These controls undoubtedly have “helped” curb inflation. However, the underlying reasons for the sharp increase in inflation cannot be removed by draconian price controls. It might have postponed inflation from rising further in the short-run, but sooner or later the underlying inflationary pressures will be translated into actual inflation.

A Hankeian measure of Argentina’s near-hyperinflation

The world’s foremost expert on super high inflation and hyperinflation in my view is Steve Hanke. Steve has suggested to use black market exchange rates as a proxy for inflation when official data is none-existent or manipulated. Steve suggests using the black market exchange rate rather than the official exchange rate when capital and currency controls distort the official exchange rate (as is presently the case in Argentina).

This is Steve (his case is Zimbabwe):

The principle of purchasing power parity (PPP) should be able to come to our rescue. PPP states that the ratio of the price levels between two countries is equal to the exchange rate between their currencies. Changes in the exchange rate and the ratio of the price levels move in lock step with one another, with the linkage between the exchange rate and price level maintained by price arbitrage.

…But does PPP hold during periods of hyperinflation? If not, we cannot use changes in the Zimbabwe dollar/U.S. dollar exchange rate to estimate Zimbabwe’s inflation rate. There is a consensus among economists that, over relatively short periods of time and at relatively low inflation rates, the link between exchange rates and price levels is loose. But as inflation rates increase, the link becomes tighter.

In a study of the German hyperinflation of 1921–23, Jacob Frenkel  (1976) found that correlations between various German price indices and the German mark/U.S. dollar exchange rate were all close to one. Every 1 percent increase in the exchange rate was associated with a 1 percent increase in the price level. Frenkel’s empirical work strongly suggests that PPP holds when a country is hyperinflating. Additional evidence supporting the PPP principle during periods of very high or hyperinflation has been reported for a wide range of countries…

That PPP holds under conditions of very high inflation or hyperinflation should not be surprising. After all, under these conditions, the temporal dimension of price arbitrage is compressed and the long run effectively becomes the short run. For example, in July 2008, Zimbabwe’s inflation was 2,600 percent a month—equivalent to a 12 percent daily rate. That is per day—not per month, or per year. In these circumstances, arbitrage benefits per unit of time are relatively large and transaction costs can be overcome quickly. Accordingly, price arbitrage works to ensure that PPP holds.

Steve in his paper on Zimbabwe utilized PPP and the black market exchange rate to calculate the inflation rate in Zimbabwe. I have used the same method to make an estimate for Argentine inflation. The graph below shows the official price level and the price level implied by the black market rate for the Argentine peso against the US dollar (and the US price level).

Price Level Argentina

The graph is pretty clear – until  2007-8 the official price level more or less developed in line with the price level implied by PPP. However, ever since the price level implied by PPP has grown much faster than the official inflation rate.

This is a very a clear indication just how manipulated the official inflation data has become since 2007-8 and the graph also very clearly shows how steep an increase in prices we have seen in Argentina since early 2012.

Inflation might have surpassed 100%

There is no doubt that inflation has accelerated further in the last couple of months and this is clearly confirmed by my calculation of the PPP implied price level. Hence, over the past three months the PPP implied price level has increased by an annualized rate of 127%!

This is the reason why I would argue that it is likely that Argentine inflation already has surpassed 100% – maybe not on a year-on-year basis, but at least on a annualized basis over the last 3-6 months. This is not just high inflation, but rather an inflation rate that might very well turn into outright hyperinflation (more than 50% increase in prices per month) unless there is a dramatic change in economic policy in Argentina.

It is monetary policy failure – stop the press NOW!

There is no doubt that Argentina’s super high inflation is caused by excessive money supply growth and that is obviously also the case in Argentina where President Cristina Kirchner’s populist government has been funding excessive growth in public finances by letting the printing press running overtime.

Hence, there is only one way of stopping the runaway inflation in Argentina and that is by stopping the printing press. Unfortunately it has hard to be optimistic that inflation will be slowed anytime soon when Argentina’s central bank governor don’t believe that there is a connection between money supply growth and inflation. We live in an age of central banker ignorance.

A modest proposal for post-Chavez monetary reform in Venezuela

Let’s just say it as it is – I was very positively surprised by the massive response to my post on the economic legacy of Hugo Chavez. However, as somebody who primarily wants to blog about monetary policy it is a bit frustrating that I attract a lot more readers when I write about dead authoritarian presidents rather than about my favourite topic – monetary policy.

So I guess I have to combine the two themes – dead presidents and monetary policy. Therefore this post on my modest proposal for post-Chavez monetary reform in Venezuela.

It is very clear that a key problem in Venezuela is the high level of inflation, which clearly has very significant negative economic and social implications. Furthermore, the high level of inflation combined with insane price controls have led to massive food and energy shortages in Venezuela in recent years.

Obviously the high level of inflation in Venezuela is due to excessive money supply growth and there any monetary reform should have the purpose of bringing money supply growth under control.

A Export Price Norm will bring nominal stability to Venezuela

Market Monetarists generally speaking favour nominal GDP targeting or what we also could call nominal demand targeting. For large economies like the US that generally implies targeting the level of NGDP. However, for a commodity exporting economy like Venezuela we can achieve nominal stability by stabilizing the price of the main export good – in the case of Venezuela that is the price of oil measured in Venezuelan bolivar. The reason for this is that aggregate demand in the economy is highly correlated with export revenues and hence with the price of oil.

I have therefore at numerous occasions suggested that commodity exporting countries implement what I have called an Export Price Norm (EPN) and what Jeff Frankel has called a Peg-the Export-Price (PEP) policy.

The idea with EPN is basically that the central bank should peg the country’s currency to the price of the main export good. In the case of Venezuela that obviously would be the price of oil. However, it is not given that an one-to-one relationship between the bolivar and the oil price will ensure nominal stability.

My suggestion is therefore that the bolivar should be pegged to basket of 75% US dollars and 25% oil price. That in my view would view would ensure a considerable degree of nominal stability in Venezuela. So in periods of stable oil prices the Venezuelan bolivar would be more or less “fixed” against the US dollar and that likely would lead to nominal GDP growth in Venezuela that would be slightly higher than in the US (due to catching up effects in Venezuelan productivity), but in periods of rising oil prices the bolivar would strengthen against the dollar, but keep nominal GDP growth fairly stable.

 EPN is preferable to a purely fixed exchange rate regime

My friend Steve Hanke has suggested that Venezuela implements a currency board against the dollar and permanently peg the Venezuelan bolivar to the dollar. However, that in my view could have a rather destabilizing impact on the economy.

Imagine a situation where oil prices increase by 30% in a year (that is not usual given what we have seen over the past decade). In that scenario the appreciation pressures on the bolivar would be significant, but as the central bank was pegging the exchange rate money supply growth would increase significantly to curb the strengthening of the currency. That would undoubtedly be inflationary and could potentially lead to a bubble tendencies and an increase the risk of a boom-bust in the economy.

If on the other hand the bolivar had been pegged to 75-25% basket of US dollars and oil then an 30% increase in the oil prices would lead to an appreciation of the bolivar by 7.5% (25% of 30%). That would counteract the inflationary tendencies from the rise in oil prices. Similar in the case of a sharp drop in oil prices then the bolivar would “automatically” weaken as if the bolivar was freely floating and that would offset the negative demand effects of falling oil prices – contrary to what happened in Venezuela in 2008-9 where the authorities tried to keep the bolivar overly strong given the sharp drop in oil prices. This in my view is one of the main cause for the slump in Venezuelan economic activity in 2008-9. That would have been avoided had the Venezuelan central bank operated EPN style monetary regime.

I should stress that I have not done detailed work on what would be the “optimal” mixed between the US dollar and the oil price in a potential bolivar basket. However, that is not the important thing with my proposal. The important thing is that such a policy would provide the Venezuelan economy with an stable nominal anchor while at the time reduce the risk of boom-bust in the Venezuelan economy – contrary to what have been the case in the Chavez years.

Time to get rid of currency and price controls

The massively unsustainable fiscal and monetary policy since 1999 have “forced” the Venezuelan government and central bank to implement draconian measures to control prices and the exchange rate. The currency controls have lead to a large black market for foreign currency in Venezuela and at the same time the price controls have led to massive energy and food shortages in Venezuela.

Obviously one cannot fight inflation and currency depreciation with interventionist policies. Therefore, this policies will have to be abandoned sooner rather than later as the cost of these policies are massive. Furthermore, it is obvious that the arguments for these policies will disappear once monetary policy ensures nominal stability.

End monetary funding of public finances

A key reason for the high level of inflation in Venezuela since 1999 undoubtedly has to be explained by the fact that there is considerable monetary financing of public finances in Venezuela. To end high-inflation it is therefore necessary to stop the central bank funding of fiscal policy. That obviously requires to bring the fiscal house in order. I will not touch a lot more on that issue here, but obviously there is a lot of work to be undertaken here. A place to start would obviously be to initiate a large scale (re)privatization program.

A modest proposal for monetary reform

We can therefore sum up my proposal for monetary reform in Venezuela in the following four points:

1) Introduce an Export Price Norm – peg the Bolivar to a basket of 75% US dollars and 25% oil prices

2) Liberalize capital and currency controls completely

3) Get rid of all price and wage controls

4) Separate fiscal policy and monetary policy – stop monetary funding of the public budget

I doubt that this post will be popular as my latest post on Venezuela, but I think that this post is significantly more important for the future well-being of the Venezuelan economy and a post-Chavez regime should move as fast as possible to implement monetary reform because without monetary reform the Venezuelan economy is unlikely to fully recover from its present crisis.


Jeffrey Frankel has made a similar proposal for the Gulf States. Have a look at Jeff’s proposal here.


Update: Steve Hanke has a comment on his suggestion for full dollarization in Venezuela. Even though I prefer my own EPN proposal I must say that Steve’s idea has a lot of appeal given the obvious weakness of public institutions in Venezuela and a very long history (pre-dating Chavez) of monetary mismanagement.

Papers about money, regime uncertainty and efficient religions

I have the best wife in the world and she has been extremely understanding about my odd idea to start blogging, but there is one thing she is not too happy about and that is that I tend to leave printed copies of working papers scatted around our house. I must admit that I hate reading working papers on our iPad. I want the paper version, but I also read quite a few working papers and print out even more papers. So that creates quite a paper trail in our house…

But some of the working papers also end up in my bag. The content of my bag today might inspire some of my readers:

“Monetary Policy and Japan’s Liquidity Trap” by Lars E. O. Svensson and “Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rate” by Bennett T. McCallum.

These two papers I printed out when I was writting my recent post on Czech monetary policy. It is obvious that the Czech central bank is struggling with how to ease monetary policy when interest rates are close to zero. We can only hope that the Czech central bankers read papers like this – then they would be in no doubt how to get out of the deflationary trap. Frankly speaking I didn’t read the papers this week as I have read both papers a number of times before, but I still think that both papers are extremely important and I would hope central bankers around the world would study Svensson’s and McCallum’s work.

“Regime Uncertainty – Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War” - by Robert Higgs.

My regular readers will know that I believe that the key problem in both the US and the European economies is overly tight monetary policy. However, that does not change the fact that I am extremely fascinated by Robert Higgs’ concept “Regime Uncertainty”. Higgs’ idea is that uncertainty about the regulatory framework in the economy will impact investment activity and therefore reduce growth. While I think that we primarily have a demand problem in the US and Europe I also think that regime uncertainty is a highly relevant concept. Unlike for example Steve Horwitz I don’t think that regime uncertainty can explain the slow recovery in the US economy. As I see it regime uncertainty as defined by Higgs is a supply side phenomena. Therefore, we should expect a high level of regime uncertainty to lower real GDP growth AND increase inflation. That is certainly not what we have in the US or in the euro zone today. However, there are certainly countries in the world where I would say regime uncertainty play a dominant role in the present economic situation and where tight monetary policy is not the key story. My two favourite examples of this are South Africa and Hungary. I would also point to regime uncertainty as being extremely important in countries like Venezuela and Argentina – and obviously in Iran. The last three countries are also very clear examples of a supply side collapse combined with extremely easy monetary policy.

Furthermore, we should remember that tight monetary policy in itself can lead to regime uncertainty. Just think about Greece. Extremely tight monetary conditions have lead to a economic collapse that have given rise to populist and extremist political forces and the outlook for economic policy in Greece is extremely uncertain. Or remember the 1930s where tight monetary conditions led to increased protectionism and generally interventionist policies around the world – for example the horrible National Industrial Recovery Act (NIRA) in the US.

I have read Higg’s paper before, but hope to re-read it in the coming week (when I will be traveling a lot) as I plan to write something about the economic situation in Hungary from the perspective of regime uncertain. I have written a bit about that topic before.

“World Hyperinflations” by Steve Hanke and Nicholas Krus.

I have written about this paper before and I have now come around to read the paper. It is excellent and gives a very good overview of historical hyperinflations. There is a strong connection to Higgs’ concept of regime uncertainty. It is probably not a coincidence that the countries in the world where inflation is getting out of control are also countries with extreme regime uncertainty – again just think about Argentina, Venezuela and Iran.

“Morality and Monopoly: The Constitutional political economy of religious rules” by Gary Anderson and Robert Tollison.

This blog is about monetary policy issues and that is what I spend my time writing about, but I do certainly have other interests. There is no doubt that I am an economic imperialist and I do think that economics can explain most social phenomena – including religion. My recent trip to Provo, Utah inspired me to think about religion again or more specifically I got intrigued how the Church of Jesus Chris Latter day Saints (LDS) – the Mormons – has become so extremely successful. When I say successful I mean how the LDS have grown from being a couple of hundreds members back in the 1840s to having millions of practicing members today – including potentially the next US president. My hypothesis is that religion can be an extremely efficient mechanism by which to solve collective goods problems. In Anderson’s and Tollison’s paper they have a similar discussion.

If religion is an mechanism to solve collective goods problems then the most successful religions – at least those which compete in an unregulated and competitive market for religions – will be those religions that solve these collective goods problems in the most efficient way. My rather uneducated view is that the LDS has been so successful because it has been able to solve collective goods problems in a relatively efficient way. Just think about when the Mormons came to Utah in the late 1840s. At that time there was effectively no government in Utah – it was essentially an anarchic society. Government is an mechanism to solve collective goods problems, but with no government you have to solve these problems in another way. Religion provides such mechanism and I believe that this is what the LDS did when the pioneers arrived in Utah.

So if I was going to write a book about LDS from an economic perspective I think I would have to call it “LDS – the efficient religion”. But hey I am not going to do that because I don’t really know much about religion and especially not about Mormonism. Maybe it is good that we are in the midst of the Great Recession – otherwise I might write about the economics and religion or why I prefer to drive with taxi drivers who don’t wear seat belts.


Update: David Friedman has kindly reminded me of Larry Iannaccone’s work on economics of religion. I am well aware of Larry’s work and he is undoubtedly the greatest authority on the economics of religion and he is president of the Association for the Study of Religion, Economics and Culture. Larry’s paper “Introduction to the Economics of Religion” is an excellent introduction to the topic.

Hanke and Krus on “World Hyperinflations”

I just read an interesting piece on the escalation of inflation in Iran by Steve Hanke. Steve’s Iran piece is interesting enough, but in his article he has a reference a to his recent Cato working paper on “World Hyperinflations”. Nicholas Krus is co-author of the paper.

I haven’t read the paper yet, but the abstract certainly makes me want to read it:

“This chapter supplies, for the first time, a table that contains all 56 episodes of hyperinflation, including several which had previously gone unreported. The Hyperinflation Table is compiled in a systematic and uniform way. Most importantly, it meets the replicability test. It utilizes clean and consistent inflation metrics, indicates the start and end dates of each episode, identifies the month of peak hyperinflation, and signifies the currency that was in circulation, as well as the method used to calculate inflation rates.”

Even though some – especially some internet Austrians in US – worry about the danger of hyperinflation in the US and Europe I rather think that the risk in the euro zone and partly in the US is deflation than hyperinflation. However, there are countries in the world today where hyperinflation is a real risk. Steve of course gives the example of Iran. I would also be quite worried about inflation getting seriously out of control in Venezuela and Argentina.

So what is worse hyperinflation or (demand) deflation? Well, both are the result of serious monetary policy mistakes and both have devastating impact on the economies hit by it. Germany experienced both within a 10 year period from 1923-1933 and we know how that ended.

PS The 1923 German hyperinflation is documented in Adam Fergusson’s 1975 book “When Money Dies”.

Monetary disorder in Central Europe (and some supply side problems)

Last week we got GDP numbers for Q2 in both the Czech Republic and Hungary. Both countries plunged deeper into recession and as it is the case in most other countries in Europe the cause of the misery is monetary disorder. This is documented in two news pieces of research. One on Hungary by Steve Hanke and one the Czech Republic by myself.

Both pieces of research are actually more traditional monetarist in nature than market monetarist as the focus in both papers are on the lackluster growth in the broad money supply rather than on nominal GDP or on market pricing. However, the same analysis could easily have been conducted by looking at nominal GDP rather than the money supply.

Even though the two countries are similar in many ways – population size (around 10 million), economic development (transitional economies, middle income economies) and monetary policy regimes (inflation targeting and floating exchange rates) – there are also many differences such as the level of indebtedness (Hungary is high indebted and the Czech Republic have low levels of public and private debt).

I think both countries are highly interesting in terms of understanding the present global crisis. The Czech Republic is in a deep recession and is showing no signs of recovery and seems to be caught in a disinflationary trap. While many argue that the present global crisis is a “balance sheet recession” or a natural hangover after a too wild party that can hardly be argued for the Czech Republic. The country has quite low levels of private and public debt and the banking sector is quite healthy compared to most European economies. So it is hard to argue that the Czech recession is the result of too much debt or a bursting property market bubble. There is really only one cause: A failed monetary policy. I try to document that in the paper I have written in my day-job as head of Emerging Markets research at Danske Bank. Read the paper “Time for the CNB to take bold action” here.

I have for some time seen Hungary as the odd man out in Europe as Hungary’s main problem at the moment in my view is not monetary, but rather a deeper structural problem. Hungary has basically not seen any economic growth since 2006 and despite of that inflation has continued to run well above the Hungarian central bank’s inflation target of 3%. This to me is an indication of significant supply side problems in the Hungarian economy. The main supply side problem in Hungary is massive political uncertainty and a highly erratic conduct of economic policy. Hence, political uncertainty has dominated all economic decisions in Hungary for at least a decade. Hungary is probably the best example in Europe of what Robert Higgs has called “regime uncertainty”. Regime uncertainty basically mean that political and institutional uncertainty – such as uncertainty about tax rules – hampers investments and general entrepreneurial activity and therefore lowers productivity growth. Regime uncertainty therefore is a supply side phenomena. I strongly believe that this is at the core of Hungary’s lack of growth in that last 6 years. That said, I also agree that particular since 2010 monetary conditions have become tighter in Hungary and the monetary contraction has become especially nasty in the last six months of so.

In his new piece at Cato@Liberty Steve Hanke discusses particular the monetary developments in Hungary in the last couple of quarters. I especially like Steve’s discussion of the policy mix in Hungary – that is fiscal policy versus monetary policy:

“When monetary and fiscal policies move in opposite directions, the economy will follow the direction taken by monetary (not fiscal) policy – money dominates. For doubters, just consider Japan and the United States in the 1990s. The Japanese government engaged in a massive fiscal stimulus program, while the Bank of Japan embraced a super-tight monetary policy. In consequence, Japan suffered under deflationary pressures and experienced a lost decade of economic growth.

In the U.S., the 1990s were marked by a strong boom. The Fed was accommodative and President Clinton was super-austere – the most tight-fisted president in the post-World War II era. President Clinton chopped 3.9 percentage points off federal government expenditures as a percent of GDP. No other modern U.S. President has even come close to Clinton’s record.”

This is of course is two examples of the so-called Sumner critique, which I discussed in recent post on German monetary and fiscal policy after the German reunification.

I agree with Steve – the reason for lack of growth in the Hungarian economy is not due to fiscal tightening. It is due to supply side problems – massive regime uncertainty – and recently also due to an unwarranted tightening of monetary conditions.

So yes, the recent drop in economic activity in both the Czech Republic and Hungary is certainty due to a renewed monetary contraction, but while I think the “fix” is it pretty simple for the Czech Republic (ease monetary policy aggressively and soon) I am more skeptical that monetary easing alone will provide a lot of longer lasting help for the Hungarian economy. Hungary desperately needs to improve the general investor climate and implement real supply side reforms and most of all there is a need to reduce regime uncertainty. One might add that the tight monetary conditions in the Czech Republic likely is also creating supply side problems as the Czech government has reacted to the deterioration of public finances caused by low growth by sharply increasing taxes. Supply side problems and tight monetary policy is hardly a combination that gets you out of recession.

Friedman, Schuler and Hanke on exchange rates – a minor and friendly disagreement

Before Arthur Laffer got me very upset on Monday I had read an excellent piece by Kurt Schuler on about Milton Friedman’s position on floating exchange rates versus fixed exchange rates.

Kurt kindly refers to my post on differences between the Swedish and Danish exchange regimes in which I argue that even though Milton Friedman as a general rule prefered floating exchange rates to fixed exchange rates he did not argue that floating exchange rates was always preferable to pegged exchange rates.

Kurt’s comments at length on the same topic and forcefully makes the case that Friedman is not the floating exchange rate proponent that he is sometimes made up to be. Kurt also notes that Steve Hanke a couple of years ago made a similar point. By complete coincidence Steve had actually a couple of days ago sent me his article on the topic (not knowing that I actually had just read it recently and wanted to do a post on it).

Both Kurt and Steve are proponents of currency boards – and I certainly think currency boards under some circumstances have some merit – so it is not surprising they both stress Friedman’s “open-mindeness” on fixed exchange rates. And there is absolutely nothing wrong in arguing that Friedman was pragmatic on the exchange rate issue rather than dogmatic. That said, I think that both Kurt and Steve “overdo” it a bit.

I certainly think that Friedman’s first choice on exchange rate regime was floating exchange rates. In fact I think he even preffered “dirty floats” and “managed floats” to pegged exchange rates. When I recently reread his memories (“Two Lucky People”) I noted how often he writes about how he advised governments and central bank officials around the world to implement a floating exchange rate regime.

In “Two Lucky People” (page 221) Friedman quotes from his book “Money Mischief”:

“…making me far more skeptical that a system of freely floating exchange rates is politically feasible. Central banks will meddle – always, of corse, with the best of intentions. Nevertheless, even dirty floating exchange rates seem to me preferable to pegged rates, though not necessarily to a unified currency”

I think this quote pretty well illustrates Friedman’s general position: Floating exchange rates is the first choice, but under some circumstances pegged exchange rates or currency unions (an “unified currency”) is preferable.

On this issue I find myself closer to Friedman than to Kurt’s and Steve’s view. Kurt and Steve are both long time advocates of currency boards and hence tend to believe that fixed exchange rates regimes are preferable to floating exchange rates. To me this is not a theoretical discussion, but rather an empirical and practical position.

Finally, lately I have lashed out at some US free market oriented economists who I think have been intellectually dishonest for partisan reasons. Kurt and Steve are certainly not examples of this and contrary to many of the “partisan economists” Kurt and Steve have great knowledge of monetary theory and history. In that regard I am happy to recommend to my readers to read Steve’s recent piece on global monetary policy. See here and here. You should not be surprised to find that Steve’s position is that the main problem today is too tight rather than too easy monetary policy – particularly in the euro zone.

PS I should of course note that Kurt is a Free Banking advocate so he ideally prefers Free Banking rather anything else. I have no disagreement with Kurt on this issue.

PPS Phew… it was much nicer to write this post than my recent “anger posts”.


Related post:
Schuler on money demand – and a bit of Lithuanian memories…


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