Immigration is saving the US economy – some telling graphs

Apparently monetary theory is not sexy – or at least when I write about something else than monetary issues then I get more comments and activity on my blog than when I focus on what I really care about (monetary policy as you know…)

Recently I wrote a piece on why I think the best immigration policy is “Open Borders” and that got a bit of attention and interestingly enough some of my readers who normally tend to agree with me – disagreed with me.

I do not exactly seek controversy (some would say I do), but I simply have to write another post on immigration. Bloomberg chief economist Mike McDonough yesterday shared some very interesting graphs on Twitter on the demographic outlook for Japan, China and the US.

The graphs are extremely telling – while Japan and China are facing sharply declining work age populations in the coming decades the US is likely to more or less maintain its present demographic structure.

Demographics

Joe Weisenthal at the Businessinsider explains how this is possible:

The best looking, really, is the US, which has a nice evenly distributed population. The shape of the pyramid isn’t changing much, in part because our immigration policy keeps the population from getting too old.

Joe is of course right – the US is still attracting people from all around the world to come to the US to work and live and my bet (and hope) is that that will continue to be the case in the future. Immigration is part of the American success story and will continue to be so for decades to come.

PS I am in London today speaking at the CAMP Alphaville. I am on a panel on “Central banks and their jedi mind tricks”  (they stole that title from Matt O’Brien) with Lorcan Roche Kelly, Josh Ryan-Collins and Paul Woolley. The Session starts at 12.30pm London time (so I better get moving…)

HT Niels Westy

 

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Sticking to its Knitting: Central bankers should forget about “financial stability”

These days central bankers seem more concerned about “financial stability” than ever before – and even more concerned about financial stability than nominal stability. These things go in cycles. After 1929 central bankers became terribly concerned about financial stability. Then again in the 1990s after the Mexican crisis in 1994 and the Asian crisis in 1997 and then after the bursting of the “IT bubble” in 2001.

But should central bankers really concern themselves with “financial stability” as a monetary policy goal? The great David Laidler gave the answer in a paper 10 years ago – This is from the abstract to “Sticking to its Knitting”:

It has become painfully evident that low inflation is not, in and of itself, sufficient to guarantee overall stability to the financial system. The bursting of the high-tech stock market bubble of the late 1990s in North America is sufficient evidence of this, but there were echoes here of the collapse of Japan’s bubble economy at the beginning of the decade, and even of the stock market crash of 1929 that marked the onset of the Great Depression of the 1930s. All of these episodes occurred at time when inflation was low and stable. At the same time, the Bank of Canada’s success in controlling inflation has been matched in many countries, to the point that monetary policy appears almost routine.

This combination of circumstances has led to a new interest in financial stability among central bankers, and a debate is beginning about what they might do to enhance it. No serious commentator is suggesting that inflation targeting should be abandoned for more ambitious goals, but there are those who suggest that existing regimes ought to be modified at least to the point of taking more notice of asset price behaviour, and others who argue that, sometimes it might be appropriate to trade off a little short term inflation stability in order to pre-empt financial market problems before they become acute.

This Commentary argues that monetary policy makers should think several times before becoming more ambitious in their goals. It notes that central banks already have all the powers they need to prevent financial market collapses getting out of hand in the wake of asset-price bubbles. In their role as lenders of last resort, they can and should be ready to provide ample liquidity to markets in such circumstances, measures which the Bank of Japan failed to take in the early 1990s. The Bank of Canada should stick to the single basic task of targeting inflation, while always holding lender-of-last-resort powers in reserve.

The Riksbank’s Stefan Ingves and the Bank of England’s Mark Carney should read David’s paper before talking more about macroprudential instruments and credit bubbles.

HT David Laidler

PS Tomorrow I will be speaking at the Financial Times’s CAMP Alphaville conference. See the programme here.

Milton Friedman’s answer to a student at the “CEPOS Akademi”

This morning I had the pleasure of doing a presentation on “Milton Friedman, Market Monetarism and the Great Recession” (and a bit on internet-Austrians) for a group of clever young students at the CEPOS Akademi in Copenhagen. CEPOS Akademi is essentially the Danish Free Market think tank CEPOS’s summer university.

Obviously I had told the students that at the core of the euro crisis is monetary policy failure and that monetary policy in the euro zone remains deflationary and that the solution is quantitative easing within a rule-based framework – preferably nominal GDP targeting.

One of the students asked me a question that I have heard before: “If the solution is this simple why didn’t the ECB not do the right thing yet?” 

I tried to answer the question as good as I could drawing Public Choice theory and “construction failure”, but as I was driving home in a taxi I opened a small pamphlet from the Institute of Economic Affairs that I had in my bag.

In the pamphlet Money, Inflation and the Constitutional Position of the Central Bank an article by Milton Friedman – The Counter-Revolution in Monetary Theory – has been reprinted.

On page 70 the answer to the student’s question popped up.

This is Milton Friedman – not on the euro crisis (for obviously reasons) but on the Great Depression, but the story is the same:

As it happens, this interpretation of the depression was completely wrong. It turns out, as I shall point out more fully below, that on re-examination, the depression is a tragic testament to the effectiveness of monetary policy, not a demonstration of its impotence. But what mattered for the world of ideas was not what was true but what was believed to be true. And it was believed at the time that monetary policy had been tried and had been found wanting.

In part that view reflected the natural tendency for the monetary authorities to blame other forces for the terrible economic events that were occurring. The people who run monetary policy are human beings, even as you and I, and a common human characteristic is that if anything bad happens it is somebody else’s fault. In the course of collaborating on a book on the monetary history of the United States, I had the dismal task of reading through 50 years of annual reports of the Federal Reserve Board. The only element that lightened that dreary task was the cyclical oscillation in the power attributed to monetary policy by the system. In good years the report would read ‘Thanks to the excellent monetary policy of the Federal Reserve…’ In bad years the report would read ‘Despite the excellent policy of the Federal Reserve…’, and it would go on to point out that monetary policy really was, after all, very weak and other forces so much stronger.

The monetary authorities proclaimed that they were pursuing easy money policies when in fact they were not, and their protestations were largely accepted.

This is of course the exact same discussion we are having today about the Great Recession. When in doubt – read Friedman.

PS Friedman tells the same story in this Youtube video.

PPS the head of the CEPOS Akademi and my friend Niels Westy took this picture of me during the “show” today.

Westy

 

 

 

The optimal immigration policy – just open the borders

My blog is mostly about monetary policy matters. However, if I one day would stop writing about monetary policy I think there are two other topics I would focus on. The one is on the need to end the global war on drugs and the second is immigration reform.

My view on immigration is pretty clear. Free trade is good – whether we talk about goods, capital or labour. It is that simple really.

Given my pro-immigration views I was very happy to read a new blog post by University of Chicago professor John Cochrane on the issue of “The optimal number of immigrants”. Cochrane rightly concludes that there, however, is not such a thing as the optimal number of immigration. This is Cochrane:

What is the optimal number of imported tomatoes? Soviet central planners tried to figure things out this way. Americans shouldn’t. We should decide on the optimal terms on which tomatoes can be imported, and then let the market decide the number. Similarly, we should debate what the optimal terms for immigration are – How will we let people immigrate? What kind of people? – so that the vast majority of such immigrants are a net benefit to the US. Then, let as many come as want to. On the right terms, the number will self-regulate.

Econ 101: Figure out the price, set the rules of the game; don’t decide the quantity, or determine the outcome. When a society sets target quantities, or sets quotas, as the U.S. does now with immigration, the result is generally a calamitous waste. With an immigrant quota, an entrepreneur who could come to the U.S. and start a billion dollar business faces the same restriction as everyone else. The potential Albert Einstein or Sergey Brin has no way to signal just how much his contribution to our society would be.

Cochrane in his post comes up with a number of interesting suggestions for immigration reform. He for example has an interesting suggestion for how to avoid that immigrants misuse social services. Here is Cochrane’s suggestion:

Immigrants would pay a bond at the border, say $5,000. If they run out of money, are convicted of a crime, don’t have health insurance, or whatever, the bond pays for their ticket home. Alternatively, the government could establish an asset and income test: immigrants must show $10,000 in assets and either a job within 6 months or visible business or asset income. 

But the best part of Cochrane’s post is on the impact of immigration on natives’ salaries:

You might fear that immigrants compete for jobs, and drive down American wages. Again, this is not demonstrably a serious problem. If labor does not move in, capital – factories and farms — moves out and wages go down anyway. Immigrants come to work in wide-open industries with lots of jobs, not those where there are few jobs and many workers. Thus, restrictions on immigration do little, in the long run of an open economy such as the US, to “protect” wages. To the extent wage-boosting immigration restrictions can work, the higher wages translate into higher prices to American consumers. The country as a whole – especially low-income consumers who tend to shop at Wal-Mart and benefit the most from low-priced goods – is not better off. 

And this is exactly why economists since the days of Adam Smith and David Ricardo have advocated free trade. And again – that goes for goods, capital and labour.

If you are interested in the economics of immigration then I suggest you take a look at the Open Borders website. My favorite immigration economist is George Borjas - despite the fact that he has been advocating restricting immigration in the US. Read Borjas’ brilliant book Heaven’s Door together with Julian Simon’s The Economic Consequences of Immigration into the United States. Then you will be well-equipt  to understand the main issues in immigration economics.

The Fisher-Hetzel Standard: A much improved “gold standard”

Anybody who follow my blog will know that I am not a great fan of the gold standard or any other form of fixed exchange rate policy. However, I am a great fan of policy rules that reduce monetary policy discretion to an absolute minimum.

Central bankers’ discretionary powers should be constrained and I fundamentally share Milton Friedman’s ideal that the central bank should be replaced by a “computer” – an automatic monetary policy rule.

Admittedly a gold standard or for that matter a currency board set-up reduce monetary policy discretion to a minimum. However, the main problem in my view is that different variations of a fixed exchange rate regime tend to be pro-cyclical. Imagine for example that productivity growth picks up for whatever reason (for example deregulation or a wave of new innovations).

That would tend to push the country’s currency stronger. However, as the central bank is keeping the currency pegged a positive supply shock will cause the central bank to “automatically” increase the money base to offset the appreciation pressures (from the positive supply shock) on the currency.

Said in another way under any form of pegged exchange rate policy a supply shock leads to an “automatic” demand shock. A gold standard will stabilize the currency, but might very well destabilize the economy.

Hence, the problem with a traditional gold standard is not that it is rule based, but that the rule is the wrong rule. We want a rule that provides nominal stability – not a rule, which is pro-cyclical.

Merging Fisher and Hetzel

Irving Fisher more than a 100 years ago came up with a good alternative to the gold standard – his so-called Compensated Dollar Plan. Fisher’s idea was that the Federal Reserve – he was writing from a US perspective – basically should keep the US price level stable by devaluing/revaluing the dollar against the gold price dependent on whether the price level was above or below the targeted level. This would be a fully automatic rule and it would ensure nominal stability. The problem with the rule, however, is that it not necessarily was forward-looking.

I suggest that we can “correct” the problems with Compensated Dollar Plan by learning a lesson from Bob Hetzel. Has I have explained in my earlier blog post Bob Hetzel has suggested that the central bank should target market expectations for inflation based on inflation-linked bonds (in the US so-called TIPS).

Now imagine that we that we merge the ideas of Fisher and Hetzel. So our intermediate target is the gold price in dollars and our ultimate monetary policy goal is for example 2-year/2-year break-even inflation at for example 2%.

Under this Fisher-Hetzel Standard the Federal Reserve would announce that it would buy or sell gold in the open market to ensure that 2-year/2-year break-even inflation is always at 2%. If inflation expectations for some reason moves above 2% the Fed would sell gold and buy dollars.

By buying dollars the Fed automatically reduces the money base (and import prices for that matter). This will ultimately lead to lower money supply growth and hence lower inflation. Similarly if inflation expectations drop below 2% the Fed would sell dollar (print more money), which would cause actual inflation to increase.

One could imagine that the Fed implemented this rule by at every FOMC meeting – instead of announcing a target for the Fed funds rate – would announce a target range for the dollar/gold price. The target range could for example be +/- 10% around a central parity. Within this target range the dollar (and the price of gold) would fluctuate freely. That would allow the market to do most of the lifting in terms of hitting the 2% (expected) inflation target.

Of course I would really like something different, but…

Obviously this is not my preferred monetary policy set-up and I much prefer NGDP level targeting to any form of inflation targeting.

Nonetheless a Fisher-Hetzel Standard would first of all seriously reduce monetary policy discretion. It would also provide a very high level of nominal stability – inflation expectations would basically always be 2%. And finally we would completely get rid of any talk about using interest rates as an instrument in monetary policy and therefore all talk of the liquidity trap would stop. And of course there would be no talk about the coming hyperinflation due to the expansion of the money base.

And no – we would not “manipulate” any market prices – at least not any more than in the traditional gold standard set-up.

Now I look forward to hearing why this would not work. Internet Austrians? Gold bugs? Keynesians?

PS I should say that this post is not part of my series on Bob Hetzel’s work and Bob has never advocated this idea (as far as I know), but the post obviously has been inspired by thinking about monetary matters from a Hetzelian perspective – as most of my blog posts are.

PPS Obviously you don’t have to implement the Fisher-Hetzel Standard with the gold price – you can use whatever commodity price or currency.

Scott Sumner’s Adam Smith Lecture

Last week Scott Sumner gave a lecture in London on the causes of the Great Recession and Market Monetarism. I had the honour of introducing Scott and you might me hear interrupting Scott near the end of the presentation. Scott made a lot more sense than I did.

Watch Scott’s Adam Smith lecture here.

Enjoy.

HT Sam Bowman

Bob Hetzel’s great idea

As I have promised earlier I will in the coming weeks write a number of blog posts on Robert Hetzel’s contribution to monetary thinking celebrating that he will turn 70 on July 3. Today I will tell the story about what I regard to be Bob’s greatest and most revolutionary idea. An idea which I think marks the birth of Market Monetarism.

I should in that regard naturally say that Bob doesn’t talk about himself as market monetarist, but simply as a monetarist, but his ideas are at the centre of what in recent years has come to be known at Market Monetarism (I coined the phrase myself in 2011).

Here is how Bob describes his great idea in his book “The Monetary Policy of the Federal Reserve”:

“In February 1990, Richmond Fed President Robert Black testified before Congress on Representative Stephen Neal’s Joint Resolution 4009 mandating that the Fed achieved price stability with five years. Bob Black was a monetarist, and he recommend multiyear M2 targets. As an alternative, I had suggested Treasury issuance of matched-maturity securities half of which would be nominal and half indexed to the price level.  The yield difference, which would measure expected inflation, would be a nominal anchor provided that the Fed committed to stabilizing it.

The idea came from observing how exchange-rate depreciation in small open economies constrained central banks because of the way it passed through immediately to domestic inflation. With a market measure of expected inflation, monetary policy seen by markets as inflationary would immediately trigger an alarm even if inflation were slow to respond. I mentioned my proposal to Milton Friedman, who  encouraged me to write a Wall Street Journal op-ed piece, which became Hetzel (1991).”

Bob developed his idea further in a number of papers published in the early 1990s. See for example here and here.

I remember when I first read about Bob’s idea I thought it was brilliant and was fast convinced that it would be much preferable to the traditional monetarist idea of money supply targeting. Milton Friedman obviously for decades advocated money supply targeting, but he also became convinced that Bob’s idea was preferable to his own idea.

Hence, in Friedman’s book Money Mischief (1992) he went on to publicly endorse Bob’s ideas. This is Friedman:

“Recently, Robert Hetzel has made an ingenious proposal that may be more feasible politically than my own earlier proposal for structural change, yet that promises to be highly effective in restraining inflationary bias that infects government…

…a market measure of expected inflation would make it possible to monitor the Federal Reserve’s behavior currently and to hold it accountable. That is difficult at present because of the “long lag” Hetzel refers to between Fed’s actions and the market reaction. Also, the market measure would provide the Fed itself with information to guide its course that it now lacks.”

In a letter to then Bank of Israel governor Michael Bruno in 1991 Friedman wrote (quoted from Hetzel 2008):

“Hetzel has suggested a nominal anchor different from those you or I may have considered in the past…His proposal is…that the Federal Reserve be instructed by Congress to keep that (nominal-indexed yield) difference below some number…It is the first nominal anchor that has been suggested that seems to me to have real advantages over the nominal money supply. Clearly it is far better than a price level anchor which…is always backward looking.”

The two versions of Bob’s idea

It was not only Friedman who liked Hetzel’s ideas. President Clinton’s assistant treasury secretary Larry Summers also liked the idea – or at least the idea about issuing bonds linked to inflation. This led the US Treasury to start issuing so-called Treasury Inflation Protected Securities (TIPS) in 1997. Since then a number of countries in the world have followed suit and issued their own inflation-linked bonds (popularly known as linkers).

However, while Bob succeed in helping the process of issuing inflation-linked bonds in the US he was less successfully in convincing the Fed to actually use market expectations for inflation as a policy goal.

In what we could call the strict version of Bob’s proposal the central bank would directly target the market’s inflation expectations so they always were for example 2%. This would be a currency board-style policy where monetary policy was fully automatic. Hence, if market expectations for, for example inflation two years ahead were below the 2% target then the central bank would automatically expand the money base – by for example buying TIPS, foreign currency, equities or gold for that matter. The central bank would continue to expand the money base until inflation expectations had moved back to 2%. The central bank would similarly reduce the money base if inflation expectations were higher than the targeted 2%.

In this set-up monetary policy would fully live up to Friedman’s ideal of replacing the Fed with a “computer”. There would be absolutely no discretion in monetary policy. Everything would be fully rule based and automatic.

In the soft version of Bob’s idea the central bank will not directly target market inflation expectations, but rather use the market expectations as an indicator for monetary policy. In this version the central bank would likely also use other indicators for monetary policy – for example money supply growth or surveys of professional forecasters.

One can argue that this is what the Federal Reserve was actually doing from around 2000-3 to 2008. Another example of a central bank that de facto comes close to conducting monetary policy in way similar to what has been suggested by Hetzel is the Bank of Israel (and here there might have been a more or less direct influence through Bruno, but also through Stanley Fisher and other University of Chicago related Bank of Israel officials). Hence, for more than a decade the BoI has communicated very clearly in terms of de facto targeting market expectations for inflation and the result has been a remarkable degree of nominal stability (See here).

Even in the soft version it is likely that the fact that the central bank openly is acknowledging market expectations as a key indicator for monetary policy will likely do a lot to provide nominal stability. This is in fact what happened in the US – and partly in other places during the 2000s – until everything when badly wrong in 2008 and inflation expectations were allowed to collapse (more on that below).

Targeting market expectations and the monetary transmission mechanism

It is useful when trying to understand the implications of Bob’s idea to target the market expectations for inflation to understand how the monetary transmission mechanism would work in such a set-up.

As highlighted above thinking about fixed exchange rate regimes gave Bob the idea to target market inflation expectations, and fundamentally the transmission mechanism under both regimes are very similar. In both regimes both money demand and the money supply (both for the money base and broad money) become endogenous.

Both money demand and the money supply will automatically adjust to always “hit” the nominal anchor – whether the exchange rate or inflation expectations.

One thing that is interesting in my view is that both in a fixed exchange rate regime and in Bob’s proposal the actual implementation of the policy will likely happen through adjustments in money demand - or said in another way the market will implement the policy. Or that will at least be the case if the regime is credible.

Lets first look at a credible fixed exchange regime and lets say that for some reason the exchange rate is pushed away from the central bank’s exchange rate target so the actual exchange rate is stronger than the targeted rate. If the target is credible market participants will know that the central bank will act – intervene in the currency market to sell the currency – so to ensure that in the “next period” the exchange rate will be back at the targeted rate.

As market participants realize this they will reduce their currency holdings and that in itself will push back the exchange rate to the targeted level. Hence, under 100% credibility of the fixed exchange rate regime the central bank will actually not need to do any intervention to ensure that the peg is kept in place – there will be no need to change the currency reserve/money base. The market will effectively ensure that the pegged is maintained.

The mechanism is very much the same in a regime where the central bank targets the market’s inflation expectations. Lets again assume that the regime is fully credible. Lets say that the central bank targets 2% inflation (expectations) and lets assume that for some reason a shock has pushes inflation expectations above the 2%.

This should cause the central bank to automatically reduce the money base until inflation expectations have been pushed back to 2%. However, as market participants realize this they will also realize that the value of money (the inverse of the price level) will increase – as the central bank is expected to reduce the money base. This will cause market participants to increase money demand. For a given money base this will in itself push down inflation until the 2% inflation expectations target is meet.

Hence, under full credibility the central bank would not have to do a lot to implement its target – either a fixed exchange rate target or a Hetzel style target – the markets would basically take care of everything and the implementation of the target would happen through shifts in money demand rather than in the money base. That said, it should of course be noted that it is exactly because the central bank has full control of the money base and can always increase or decrease it as much as it wants that the money demand  taking care of the actual “lifting” so the central bank don’t actually have to do much in terms of changing the money base.

This basically means that the money base will remain quite stable while the broad money supply/demand will fluctuate – maybe a lot – as will money-velocity. Hence, under a credible Hetzel style regime there will be a lot of nominal stability, but it will look quite non-monetarist if one think of monetarism of an idea to keep money supply growth stable. Obviously there is nothing non-monetarist about ensuring a stable nominal anchor. The anchor is just different from what Friedman – originally – suggested.

Had the Fed listened to Bob then there would have been no Great Recession

Effectively during the Great Moderation – or at least since the introduction of TIPS in 1997 – the world increasingly started to look as if the Federal Reserve actually had introduced Bob’s proposal and targeted break-even inflation expectations (around 2.5%). The graph below illustrates this.

BE inflation

The graph shows that from 2004 to 2008 we see that the 5-year “break-even” inflation rate fluctuated between 2 and 3%. We could also note that we during that period also saw a remarkable stable growth in nominal GDP growth. In that sense we can say that monetary policy was credible as it ensured nominal stability – defined as stable inflation expectations.

However, in 2008 “something” happened and break-even inflation expectations collapsed. Said, in another way – the Fed’s credibility broke down. The markets no longer believed that the Fed would be able to keep inflation at 2.5% going forward. Afterwards, however, one should also acknowledge that some credibility has returned as break-even inflation particularly since 2011 has been very stable around 2%. This by the way is contrary to the ECB – as euro zone break-even inflation on most time horizons is well-below the ECB’s official 2% inflation target.

While most observers have been arguing that the “something”, which happened was the financial crisis and more specifically the collapse of Lehman Brothers Market Monetarists – and Bob Hetzel – have argued that what really happened was a significant monetary contraction and this is very clearly illustrated by the collapse in inflation expectations in 2008.

Now imagine what would have happened if the Fed had implemented what I above called the strict version of Bob’s proposal prior to the collapse of Lehman Brother. And now lets say that Lehman Brothers collapses (out of the blue). Such a shock likely would cause a significant decline in the money-multiplier and a sharp decline in the broad money supply and likely also a sharp rise in money demand as investors run away from risky assets.

This shock on its own is strongly deflationary – and if the shock is big enough this potentially could give a shock to the Fed’s credibility and therefore we initially could see inflation expectations drop sharply as we actually saw in 2008.

However, had Bob’s regime been in place then the Fed would automatically have moved into action (not in a discretionary fashion, but following the rule). There would not have been any discussion within the FOMC whether to ease monetary policy or not. In fact there would not be a need for a FOMC at all – monetary policy would be 100% automatic.

Hence, as the shock hits and inflation expectations drop the Fed would automatically – given the rule to target for example 2.5% break-even inflation expectations – increase the money base as much as necessary to keep inflation expectations at 2.5%.

This would effectively have meant that the monetary consequences of Lehman Brothers’ collapse would have been very limited and the macroeconomic contraction therefore would have been much, much smaller and we would very likely not have had a Great Recession. In a later blog post I will return to Bob’s explanation for the Great Recession, but as this discussion illustrates it should be very clear that Bob – as I do – strongly believe that the core problem was monetary disorder rather than market failure.

Hetzel and NGDP targeting

There is no doubt in my mind that the conduct of monetary policy would be much better if it was implemented within a market-based set-up as suggested by Robert Hetzel than when monetary policy is left to discretionary decisions.

That said as other Market Monetarists and I have argued that central banks in general should target the nominal GDP level rather than expected inflation as originally suggested by Bob. This means that we – the Market Monetarists – believe that governments should issue NGDP-linked bonds and that central banks should use NGDP expectations calculated from the pricing of these bonds.

Of course that means that the target is slightly different than what Bob originally suggested, but the method is exactly the same and the overall outcome will likely be very similar whether one or the other target is chosen if implemented in the strict version, where the central bank effectively would be replaced by a “computer” (the market).

In the coming days and weeks I will continue my celebration of Robert Hetzel. In my next Hetzel-post I will look at “Bob’s model” and I will try to explain how Bob makes us understand the modern world within a quantity theoretical framework.

PS I should say that Bob is not the only economist to have suggested using markets and market expectations to implement monetary policy and to ensure nominal stability. I would particularly highlight the proposals of Irving Fisher (the Compensated Dollar Plan), Earl Thompson (nominal wage targeting “The Perfect Monetary System”) and of course Scott Sumner (NGDP targeting).

—–

Suggested further reading:

I have in numerous early posts written about Bob’s suggestion for targeting market inflation expectations. See for example here:

A few words that would help Kuroda hit his target
How to avoid a repeat of 1937 – lessons for both the fed and the BoJ
The cheapest and most effective firewall in the world

Sumner, Nunes and Christensen in London

Scott Sumner has been speaking at the Adam Smith Institute tonight. I had the honour to introduce Scott. Adam Smith Institute will surely post Scott’s presentation soon.

Here is, however, a historical picture. Three market monetarist bloggers and Adam Smith in a picture together: Scott Sumner, Marcus Nunes and myself.

Smith

Paul Krugman puts the IMF straight (and it is not what you think!)

This is from Market Watch:

The International Monetary Fund on Monday called on the U.S. to raise its minimum wage, but refrained from naming a specific level, saying that’s up to Congress.

In its annual review of the U.S. economy, the IMF said increasing the minimum wage and expanding the Earned Income Tax Credit would help raise the incomes of millions of poor, working Americans. Read the IMF’s review.

Christine Lagarde, the IMF’s managing director, told reporters an increase in the minimum wage — now $7.25 an hour — “would be helpful from a macroeconomic point of view.”

The fund’s recommendation will be well received by congressional Democrats and the Obama administration, both of which have been pushing for an increase to $10.10. The proposed increase has been hampered by an election-year stalemate over major policy issues. House Republicans don’t plan to take up a bill to increase it and Senate Democrats don’t have enough members to get it through their chamber.

Lagarde said the amount of an increase “needs to be decided by legislators.”

Frankly speaking I am somewhat shocked that the IMF would come up with this kind of policy suggestion, but it reminded me about what Paul Krugman once said about increasing the minimum wage (yes, yes he probably have another view today):

So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment.

This graph tells the same story.

minimum-wage

W eq is the equilibrium wage that would emerge in an unregulated labour market with no minimum wage. In such a market employment would be N eq.

W min is the minimum wage, which is higher than the equilibrium wage (W eq). In such a world the demand for labour will be only N2, while the supply of labour will be N1. The difference between the N2 and N1obviously is the level of unemployment caused by the minimum wage.

No more discussion of this topic should be necessary…

PS I deleted a lot of horrible things I wrote about French lawyers…

Follow me on Twitter here.

 

 

 

Belka-gate – the Polish version of the Sumner Critique?

A key Market Monetarist insight (it is New Keynesian insight as well…) is that budget multiplier is zero if the central bank says it is so. Or rather it the central bank targets inflation, the price level or nominal GDP then the central and will offset any shock – positive or negative – to nominal spending (aggregate demand) from changes in fiscal policy.

This means that the central bank – rather than the ministry of finance – has the full control of aggregate demand in the economy. No matter what the government does with fiscal policy the central bank has the instruments to fully offset this. This is the so-called Sumner Critique.

A major scandal involving the Polish central bank governor Marek Belka that has developed over the last couple of days is a powerful illustration of the Sumner Critique.

This is from Reuters:

A Polish magazine said on Saturday it had a recording of a private conversation in which the central bank chief told a minister the bank would be willing to help rescue the government from economic troubles on condition the finance minister was removed.

The weekly Wprost news magazine said it had a recording of a meeting in a Warsaw restaurant last July between central bank governor Marek Belka and Interior Minister Bartlomiej Sienkiewicz. It did not say who recorded their conversation, or how it had obtained the recording.

According to extracts of the audio recording posted on the Internet by the magazine, which have been heard by Reuters reporters, and were also emailed to Reuters by Wprost in transcript form, the minister sets out a possible future scenario in which the government could not meet its financial commitments and faced election defeat.

The man identified in the transcript as Sienkiewicz refers in vague terms to monetary policy action carried out elsewhere in Europe – an apparent reference to central bank stimulus.

“Is that precisely the moment for launching this sort of solution, or not?” Sienkiewicz asks Belka.

Belka replies, according to the transcript: “My condition would be the removal of the finance minister.”

The finance minister at the time, Jacek Rostowski, was removed last November as part of a cabinet reshuffle.

There you go. Central bankers have the power to control nominal spending in the economy. They might even have the power to have finance ministers removed. Never ignore the Sumner Critique.

PS the Polish central bank has said that the recordings are authentic, but that they have been manipulated and that Belka’s comments regarding the removal of the Finance Minister were taken out of context.

PPS It has been – and still is – my view that Polish monetary policy has been far too tight since early 2012. Maybe an explanation to the overly tight stance could be – and I am speculating – dissatisfaction with the Polish government’s fiscal stance.

PPPS for game theoretical based discussion of the Sumner Critique see my earlier posts here and here.

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