The hawks should start advocating NGDP targeting to avoid embarrassment

Over the past six years the “hawks” among UK and US central bankers have been proven wrong. They have continued to argue that a spike in inflation was just around the corner because monetary policy was “high accommodative”. Obviously Market Monetarists have continued to argue that monetary policy has not been easy, but rather to tight in the US and the UK – at least until 2012-13.

The continued very low inflation continues to be an embarrassment for the hawks and looking into 2015-16 there are no indication that inflation is about to pick-up either in the US or in the UK.

That said, there might actually be good reasons for turning more hawkish right now – nominal GDP growth continues to pick up in both the UK and the US (I will ignore the euro zone in this blog post…)

The sharp drop in oil prices in recent months is likely to further push down headline inflation in the coming months. Central bankers should obviously completely ignore any drop in inflation caused by a positive supply shock, but with most hawks completely obsessed with inflation targeting a hawkish stance will become harder and harder to justify from an inflation targeting perspective exactly at the time when it actually might become more justified than at any time before in the past six years.

I would personally not be surprised if we get close to deflation in both the UK and the US in 2015 and maybe also in 2016 if we don’t get a rebound in oil prices, but I would also think that there is a pretty good chance that we could get 4-5% or maybe even higher nominal GDP growth in both the UK and US in 2015-16. And that would be a strong argument for a tighter monetary stance.

Hence, if strict inflation targeters would follow their own logic then they would be advocating monetary easing in 2015-16 in both Britain and the US, while those of us who are more focused on NGDP growth will likely see an increasing need for monetary tightening in 2015-16.

As a consequence if you are an old hawk who “feels” that there is a need for monetary tightening then you better stop looking at present inflation and instead start to focusing on expected NGDP growth.

But of course the idea that you are hawkish or dovish is in itself an idiotic idea. You should never be hawkish or dovish as that in itself means that you are likely advocating some sort of discretionary monetary policy. What should concern you should be the rules of the game – the monetary policy regime.

HAWKISH Market Monetarists

Over the past five years Market Monetarists have gotten a reputation for always being dovish in terms of monetary policy. The Market Monetarists have day-in and day-out been pushing for monetary easing in the US, the UK and the euro zone. So our reputation is correct in the sense that we – the Market Monetarists – in general have favoured a more dovish monetary stance both in the US and in Europe than has been implemented by central banks.

However, one might notice that the Market Monetarist bloggers have been surprisingly calm in recent months despite the sharp decline in inflation we have see in particularly Europe. Overall, we have obviously maintained that monetary policy in the euro zone is far too tight and that we are heading for deflation as a result of this. But the primary cause of the sharp decline in headline inflation in the euro zone has been lower commodity prices and to some extent also a result of an “austerity pause” (no indirect tax hikes).

Hence, Market Monetarists do not think a decline in inflation due a positive supply shock in itself should trigger interest rate cuts (or other forms of monetary policy easing). Remember Market Monetarists favour nominal GDP targeting and a supply shock will not impact nominal GDP – only composition of nominal GDP growth between inflation and real GDP growth.

As a result Market Monetarists actually tend to be somewhat less alarmed by the recent inflation decline in the euro zone than for example the ECB and in that sense you can argue that the Market Monetarists actually are more “hawkish” than the ECB presently is when it comes to the need for monetary easing in response to the recent decline in euro zone inflation. When Market Monetarists are calling for monetary easing in the euro zone it is hence for a somewhat different reason than the ECB.

Monetary policy remains overly tight in the euro zone and we are likely heading for deflation – even disregarding the recent supply side driven drop in inflation – and that is why we – the Market Monetarists are advocating monetary easing in the euro zone. Just a look at the dismail growth of nominal GDP in the euro zone – there is no better indication than that of the ECB’s failure to ease monetary policy appropriately. So we shouldn’t be too sad if the ECB moves to ease monetary policy – even if Market Monetarists think it is for the wrong reasons.

In 3-5 years the Market Monetarists will be among the biggest hawks

If we are lucky we continue to see supply side conditions improve both in the US and the euro zone in the coming years. I am personally particular optimistic about the outlook for the US economy, where I do expect a number of factors to give a welcomed lift to US potential growth. The end of the so-called commodity super cycle and fracking might hopefully to reduce oil prices. This is a positive supply shock to the US economy.

Furthermore, as I am optimistic that the US is in the process of ending two wars – the War on Drugs and the War on Terror. I will return to that issue in a later blog post, but I overall think that this is the direction we are moving in and that will be tremendously positive for the US labour supply (and public finances for that matter).

Finally, as the US economy continues to improve the present anti-immigration sentiment in the US will hopefully be reversed – after all Americans are more happy to welcome Mexicans to join the labour force when the economy is doing good rather than bad.

Add to that that US unemployment is still high so there is really no labour market constrains to growth at the moment in the US. So overall, I think we with a bit of luck could be in for a couple of years of fairly high real GDP growth driven by positive supply side factors. In such a scenario we could easily have 4% or even 5% real GDP growth for some years without any substantial pick-up in inflation. This would be very similar to mid-1990s.

Such a scenario would likely in 3-5 years time turn the Market Monetarist bloggers into proponents of Fed tightening – before most other economists would favour it. This would particularly be the case if the Fed overdo it on monetary easing in a scenario where positive supply side factors keep inflation low and hence we see a sharp pick-up in nominal GDP growth. This would of course be what Austrians call relative inflation.

So no, Market Monetarists are not always dovish. We advocate clear monetary policy rules and these rules sometimes leads us to advocate a dovish stance on monetary (as presently), but also to a hawkish stance if needed. For now I have no big fears that US monetary policy is becoming too easy, but if I am right about my “supply side optimism” then a Fed too focused on headline inflation might overdo it on the easy side down the road.

There is of course only one way to avoid such a monetary policy mistake – spell out a clear NGDP level targeting rule today.


PS The ECB today did NOTHING to avoid deflation in the euro zone. No comments on that other than the ECB missed yet another opportunity to do the right thing.

PPS My best guess is that Scott Sumner will be a ultra hawk on US monetary policy in 2018-9.

Forget about “hawks” and “doves” – what we need is a “monetary constitution”

Even though NGDP level targeting is becoming increasingly popular I am increasingly getting worried that people don’t really understand what Market Monetarists are talking about. The problem is that most observers and participants in the monetary policy debate continue to think about monetary policy in a highly discretionary way rather think about monetary policy in terms of rules.

Keynesian economists have traditionally been much less concerned about ensuring a rule based monetary policy so it is not surprising that they continue to think in terms of different positions in the monetary policy debate in terms of “hawks” and “doves”. However, a surprisingly large number of anti-keynesian free market oriented economists have also fallen into this trap of thinking about monetary policy issues in terms of “hawks” versus “doves”. They see themselves as “hawks” who should fight the keynesian “doves”. They tend to think that central banks only err on the inflationary side and never on the deflationary side and that the important thing therefore to always argue for tighter monetary policy.

However, the problem is not that central banks are always inflationary – they are not necessarily. Just look at the Bank of Japan or the ECB. The problem is that central banks are not ruled by a “monetary constitution”. There are no clear rules guiding the game and so they mess up things.

James Buchanan who sadly died earlier this week can hardly be said to have been a great monetary theorist (his monetary thinking was “old Chicago” – Frank Knight, Henry Simons and Lloyd Mints). However, that is not really important because what Buchanan taught us about monetary policy (and about everything else) was much more important. Buchanan was a constitutionalist. He was concerned about one thing and one thing only and that was how to define the rules the game – also in monetary matters. This to me is what Market Monetarism to a large extent is about (or at least should be about).

We want central banks to stop the ad hoc’ism. In fact we don’t even like independent central banks – as we don’t want to give them the opportunity to mess up things. Instead we basically want as Milton Friedman suggested to replace the central bank with a “computer”. The computer being a clear monetary policy rule. A monetary constitution if you like.

The problem with today’s monetary policy debate is that it is not a Buchanan inspired debate, but a debate about easier or tighter monetary policy. The debate should instead be about rules versus discretions and about what rules we should have.

Obviously Market Monetarists have been arguing in favour of monetary easing in both the US and the euro zone, but the argument is made within the framework of NGDP level targeting. We are not always “dovish”. In fact most of us would probably have argued that monetary policy in the US and in most Europe have been overly easy for the last 40 years. But that is besides the point. The point is that we really should not have a discussion about easier versus tighter monetary policy. We should debate the rules of the game – James Buchanan would have told us that.

I am not trying to say James Buchanan was Market Monetarist – he was not and I am sure he would not have liked that label. But I do think that Market Monetarists’ call for a rule based monetary policy is completely in the spirit of James Buchanan.

However, many of the economists who would normally be on the same side of the argument as Market Monetarists today see us as allies of the keynesians because they see the Market Monetarist call for easier monetary policy as meaning that we are keynesians – because they equate being keynesian with easy monetary policy and therefore if you are anti-keynesian you will have to be a “hawk”.

Take some of the “hawks” on the FOMC – for example Charles Plosser. Plosser of course academically comes from an economic tradition (Real Business Cycle theory) that should lead him to stress the importance of rules. However, over the last four years I have heard very little from Charles Plosser about the need for a rules based monetary policy. Instead Plosser has been speaking in the language of discretion. In that sense he has a lot more in common with the keynesian Federal Reserve officials of the 1970s than Market Monetarists have.

That said, Market Monetarists certainly have a problem as well. If somebody wrongly sees us as the monetary version of discretionary keynesian fiscalists like Paul Krugman then we have a problem. Then we need to explain ourselves. We need to explain that we want a monetary policy based on the constitutionalist thinking of James Buchanan. We don’t care about hawks and doves – the only thing we care about is limiting the central banks ability to mess us things by introducing clear and transparent monetary policy rules that limits the discretionary powers of the central banks. In that sense we have a lot in common with Austrian gold standard proponents despite the fact we strongly disagree on the causes of the Great Recession.

So concluding, Buchanan was right – we need a monetary constitution that limits the discretionary powers for central banks. Now lets discuss what that rule should be instead of the continued fruitless discussion about easier or tighter monetary policy and stop identifying yourselves as hawks or doves. The questions is whether you believe in a monetary constitution or not.

PS I use the term “keynesian” here in a certain way that I think that most of my readers understand and agree with. However, the New Keynesian traditions would certainly be as strongly against discretionary monetary policies as Market Monetarists. I would not place for example Paul Krugman in that New Keynesian tradition as he seems very happy to endorse all kind of discretionary shenanigans.

PPS The term “constitutionalist” is not meant to mean the US Constitution and it is not some fringe US populist tradition. It a form of economic thinking.

PPPS Market Monetarism of course is not just about NGDP level targeting and rules, but also about how to think about monetary theory – for example how to think about the monetary transmission mechanism. Hence, you are not automatically a Market Monetarist just because you favour NGDP level targeting and you can think as a Market Monetarist and not necessarily favour NGDP level targeting.

See this excellent lecture by James Buchanan about the Great Recession and Economists from 2011 (Buchanan was 91 at that time!). I disagree with some of his views of the specifics of the causes of the Great Recessions, but he fully agree with his view that the fundamental reason for the Great Recession was that the failure of the “rules”.

Related posts:

NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed
NGDP level targeting – the true Free Market alternative (we try again)


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