Chuck Norris on monetary policy #1

In the coming time I will pay tribute to the great Chuck Norris by analyzing the monetary policy implications of some well-known facts and quotes from the great hero. These “facts” all come from

“Chuck Norris does not earn money,he prints it”

Well Chuck, so does central banks and that is why we can always avoid deflation, increase inflation and get whatever growth rate of nominal GDP we would like. But not even Chuck can increase real GDP growth in the long run by printing money. Not even Chuck can defeat the long run vertical Phillips curve.


Japan’s deflation story is not really a horror story

Many economists – including some Market Monetarists – tell the story about Japan’s economy as a true horror story and there is no doubt that Japan’s growth story for more than 15 years has not been too impressive – and it has certainly not been great to have been invested in Japanese stocks over last decade.

Some Market Monetarists are explaining Japan’s apparent weak economic performance with overly tight Japanese monetary policy, while others blame “zombie banks” and continued deleveraging after the bubble in to 1990s. I, however, increasingly think that these explanations are wrong for Japan.

Obviously, Japan has deflation because money demand growth consistently outpaces money supply growth. That’s pretty simple. That, however, does not necessarily have to be a problem in the long run if expectations have adjusted accordingly. The best indication that this has happened is that Japanese unemployment in fact is relatively low. So maybe what we are seeing in Japan is a version of George Selgin’s “productivity norm”. I am not saying Japanese monetary policy is fantastic, but it might not be worse than what we are seeing in the US and Europe.

The main reason Japan has low growth is demographics. If you adjust GDP growth for the growth (or rather the decline) in the labour force then one will see that the Japanese growth record really is not bad at all – especially taking into accord that Japan after all is a very high-income country.

Daniel Gros, whom I seldom agrees with (but do in this case), has done the math. He has looked Japanese growth over the last decade and compared to other industrialized countries. Here is Gros:

“Policymaking is often dominated by simple “lessons learned” from economic history. But the lesson learned from the case of Japan is largely a myth. The basis for the scare story about Japan is that its GDP has grown over the last decade at an average annual rate of only 0.6% compared to 1.7 % for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6 % qualifies as a lost decade…According to that standard, one could argue that a good part of Europe also “lost” the last decade, since Germany achieved about the same growth rates as Japan (0.6%) and Italy did even worse (0.2 %); only France and Spain performed somewhat better…But this picture of stagnation in many countries is misleading, because it leaves out an important factor, namely demography…How should one compare growth records among a group of similar, developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population represents an economy’s productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ…When one looks at GDP/WAP (defined as population aged 20-60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population…The difference between Japan and the US is instructive here: in terms of overall GDP growth, it was about one percentage point, but larger in terms of the annual WAP growth rates – more than 1.5 percentage points, given that the US working-age population grew by 0.8%, whereas Japan’s has been shrinking at about the same rate.”

So it is correct that Japanese monetary policy was overly tight after the Japanese bubble bursted in the mid-90ties, but that is primarily a story of the 90s, while the story over the last decade is primarily a story of bad demographics.

We can learn a lot from Japan, but I think Japan is often used as an example of all kind of illnesses, but few of those people who pull “the Japan-card” really have studied Japan. Similar for me – I am not expert on the Japanese economy – but both the monetary and the deleveraging explanations for Japan’s low growth during the past decade (not the 90ties) I believe to be wrong.

The Great Depression as well as the Great Recession are terrible examples of the disasters that the wrong monetary policy can bring and so is the Japan crisis in the mid-90s, but we need to make the right arguments for the right policies based on fact and not myth.

PS in Daniel Gros’ comment on Japan he makes some comments on the effectiveness of monetary policy. He seems to think that monetary policy is impotent in the present situation. I strongly disagree with that as I believe that monetary policy is in fact very effective in increasing nominal income growth as well as inflation. The liquidity trap is a myth in the same way the Japan growth story is a myth.

”Recessions are always and everywhere a monetary phenomena”

At the core of Market Monetarist thinking, as in traditional monetarism, is the maxim that “money matters”. Hence, Market Monetarists share the view that inflation is always and everywhere a monetary phenomenon. However, it should also be noted that the focus of Market Monetarists has not been as much on inflation (risks) as on the cause of recession, as the starting point for the school has been the outbreak of the Great Recession.

Market Monetarists generally describe recessions within a Monetary Disequilibrium Theory framework in line with what has been outline by orthodox monetarists such as Leland Yeager and Clark Warburton. David Laidler has also been important in shaping the views of Market Monetarists (particularly Nick Rowe) on the causes of recessions and the general monetary transmission mechanism.

The starting point in monetary analysis is that money is a unique good. Here is how Nick Rowe describes that unique good.

“If there are n goods, including one called “money”, we do not have one big market where all n goods are traded with n excess demands whose values must sum to zero. We might call that good “money”, but it wouldn’t be money. It might be the medium of account, with a price set at one; but it is not the medium of exchange. All goods are means of payment in a world where all goods can be traded against all goods in one big centralised market. You can pay for anything with anything. In a monetary exchange economy, with n goods including money, there are n-1 markets. In each of those markets, there are two goods traded. Money is traded against one of the non-money goods.”

From this also comes the Market Monetarist theory of recessions. Rowe continues:

“Each market has two excess demands. The value of the excess demand (supply) for the non-money good must equal the excess supply (demand) for money in that market. That’s true for each individual (assuming no fat fingers) and must be true when we sum across individuals in a particular market. Summing across all n-1 markets, the sum of the values of the n-1 excess supplies of the non-money goods must equal the sum of the n-1 excess demands for money.”

Said in another way, recession is always and everywhere a monetary phenomenon in the same way as inflation is. Rowe again:

“Monetary Disequilibrium Theory says that a general glut of newly produced goods can only be matched by an excess demand for money.”

This also means that as long as the monetary authorities ensure that any increase in money demand is matched one to one by an increase in the money supply nominal GDP will remain stable (Market Monetarists obviously does not say that economic activity cannot drop as a result of a bad harvest or an earthquake, but such “events” does not create a general glut of goods and labour). This view is at the core of Market Monetarist’s recommendations on the conduct of monetary policy.

Obviously, if all prices and wages were fully flexible, then any imbalance between money supply and money demand would be corrected by immediate changes prices and wages. However, Market Monetarists acknowledge, as New Keynesians do, that prices and wages are sticky.

PS I inspired Nick Rowe to do a post on ”Recessions are always and everywhere a monetary phenomena”. Now I am stealing it back. Nick, I hope you can forgive me.

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