Rush, Rush, Market Monetarists, Steven Horwitz is your friend

Do you remember the Canadian rock band Rush? Steven Horwitz does. Steven does not only like odd Canadian rock, but he is also a clever Austrian school economist. Reading Alex Salter’s guest blog (“An Austrian Perspective on Market Monetarism”) imitiately made me think of Steven.

Steven Horwitz identify himself as a Austrian economist in the monetary equilibrium (ME) tradition. Market Montarists like Bill Woolsey and David Beckworth in many way share the theoretical background for this tradition with dates back to especially Leland Yeager and to some extent Clark Warburton (who by the way both termed themselves “monetarists” rather than “Austrians”).

Steven has co-authored a paper on the reasons for the Great Recession with William J. Luther:

“The Great Recession and its Aftermath from a Monetary Equilibrium Theory Perspective”

Here is the abstract for you:

“Modern macroeconomists in the Austrian tradition can be divided into two groups: Rothbardians and monetary equilibrium (ME) theorists. It is from this latter perspective that we consider the events of the last few years. We argue that the primary source of business fluctuation is monetary disequilibrium. Additionally, we claim that unnecessary intervention in the banking sector distorted incentives, nearly resulting in the collapse of the financial system, and that policies enacted to remedy the recession and financial instability have likely made things worse. Finally, we offer our own prescription to reduce the likelihood that such a scenario occurs again by better ensuring monetary equilibrium and eliminating moral hazard.”

I find Steven’s and Bill’s paper interesting in many ways. One of the things that strikes me is how close it is to the “journey” towards Market Monetarism described so well by David Beckworth in his recent post. See my own “journey” here.

The story basically is the following: Monetary policy was overly easy in the US prior to the crisis, but that in itself was not the only problem. Equally important was (is) the massive extent of moral hazard not only in the US, but also in Europe. But while US monetary policy was overly loose prior to the crisis it became overly tight going into the crisis and that caused the Great Recession.

I will not review the entire paper, but lets zoom in on the policy recommendations in the paper. Steven and Bill write:

“…one thing policymakers can do is ensure that, when enough time has passed, market participants will return to an institutional environment conducive to the market process. This requires addressing two major problems moving forward: monetary instability and moral hazard…In our view, monetary stability means continuously adjusting the supply of money to offset changes in velocity. Given the current monetary regime, where such adjustments are in the hands of the central bank, they should be made as mechanical as possible. Discretionary monetary policy unnecessarily introduces instability into the system with little or no offsetting benefit. Instead, the Fed should commit to a policy rule. Given our monetary equilibrium view, we hold that the Fed should adopt a nominal income target. Although nominal income targeting would require price adjustments in response to changes in aggregate supply, these particular price changes convey important information about relative scarcity over time and would be much less costly than requiring all other prices to change as would be the case under a price-level targeting regime… Under a nominal income targeting regime, monetary policy would have the best chance to maintain our goal of monetary equilibrium, at least to the extent that central bankers can accurately estimate and commit to follow an aggregate measure of output. As imperfect as this solution would be, we believe it is superior to the alternatives available in the world of the second best, and certainly an improvement over the status quo of the Fed’s pure discretion in monetary policy and beyond.

…A monetary regime that stayed closer to monetary equilibrium would have likely prevented the housing bubble and subsequent recession. However, it is also important to weed out the moral hazard problem perpetuated—and recently exacerbated—by nearly a century of policy errors. Among other things, this means ending federal deposit insurance and credibly committing not to offer any more bailouts. The political consequences of such a policy are admittedly unclear. And the feasibility of credibly committing to refrain from stepping in should a similar situation result, having just exemplified a willingness to do precisely the opposite, does not look promising. Nonetheless, we contend that ending the moral hazard problem is essential to long-run economic growth free of damaging macroeconomic fluctuations.

…The absolute worst solution in terms of dealing with moral hazard would be to abolish these programs officially without credibly committing to refrain from reestablishing them in the future. If market participants expect the government will bail them out when they get into trouble, they will act accordingly. The difference, however, would be that the Deposit Insurance Fund—having been abolished—would be empty and the full cost of bailing out depositors would fall on taxpayers in general. If bailouts and deposit insurance are going to be offered in the future, those likely to take advantage of them should be required to pay into respective funds to be used when the occasion arises. Ideally, payouts would be limited to the size of the fund. But given that a lack of credibility is the only acceptable reason to perpetuate these programs, their continuance suggests that the resulting government would be unable to tie its hands in this capacity as well.”

Cool isn’t it? I think there is good reason to expect Market Monetarists and Austrians like Steven and Alex to have a very meaningful dialogue about monetary theory and policies.

PS If you want to identify some differences of opinion among Market Monetarist bloggers ask them about US monetary policy prior to the outbreak of the Great Depression. David Beckworth would argue that US monetary policy indeed was too loose prior to the crisis, while Scott Sumner would argue that that might have been the case, but that is largely irrelevant to the present situation. My own views are somewhere in between.

PPS Steve, you are right Rush is pretty cool. This is “The Trees”.

Leave a comment


  1. Lars
    I´m even more “radical” than Scott about the so called “too easy” MP in 2002-04. As I show in this post
    the period of “instability” goes from 1998 to 2004, first with MP too “expansionary”, then too “contractionary” and finally just right to get NGDP back on trend by late 2005, just in time for Bernanke to take over the helm. . It´s interesting to see the reasons for this instability, especially, given his position today, Krugman´s views back in 1997!

  2. Incidentally, my very first post in english was on that exact topic:
    In his blog David Beckworth wrote at the time:
    Update: Check out Marcus Nunes who makes an even stronger case using the above figure. He also looks at the 1965-1979 period referenced above. Finally, Marcus provides a nice Beckworth smackdown regarding my use of nominal spending trends.

  3. Alex Salter

     /  October 14, 2011

    Who is this ‘Axel Salter’ you speak of? 🙂

  4. Alex, Axel is now Alex;-)

  5. David Beckworth

     /  October 14, 2011


    Thanks for sharing their paper with us. I am just waiting for the Rothbardians to pounce all over them for selling out. One I time saw a commentator on Bob Murphy’s blog write something along these lines:
    Milton Friedman was a socialist.
    FA Hayek was a sellout.
    Rothbard all the way!

  6. David, I am sure that Bob will be angry. I will, however, be happy to host a guest blog from Bob on why the Austrians at GMU are not Austrians and why the Market Monetarists are wrong. I would like to see the debate.

  7. Just fyi: The song is called “The Trees.” Not “The Threes.” Or, if you’re making a joke, maybe I’m lame and don’t get it.

  8. Ben, you are surely not lame. Thanks for spotting it. I have corrected the typo, but the song is still great.

  9. Neo chartalism sounds to me like an old Friedman´s article, that I commented here
    I think that is a very good idea, perhaps not very aceptable politically.
    On the other hand, I suspect MMT is pure monetarism disguised, as the article of Friedman is obviously, monetarist.
    So, the differences are not so scandalous.
    I wouldn´t like to close all the door to some elements of other schools that in the fundamentals are not so away from monetarism.
    I mean that reducing all the debate about monetary policy to the reasonably of NGDP objective is a little impoverishing.
    I am strongly attracted by the Friedman article and some coincidences with MMT, in the sense that fiscal and monetary policy would be coordinated, both pursuing a credible objective of estability. I don´t see why not to analyse the pros and cons of an idea of which Friedman was pioneer.

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