When central banking becomes central planning

The great thing about the blogosphere is that everything is happening in “real-time”. In economic journals the exchange of ideas and arguments can go on forever without getting to any real conclusion and some debates is never undertaken in the economic journals because of the format of journals.

Such a debate is the discussion about whether central banking is central planning, which has been going on between the one hand Kurt Schuler and on the other hand David Glasner and Bill Woolsey. Frankly speaking, I shouldn’t really get involved in this debate as the three gentlemen all are extreme knowledgeable about exactly this topic and they have all written extensively about Free Banking – something that I frankly has not written much about.

In my day-job central banks are just something we accept as a fact that is not up for debate. Anyway, I want to let me readers know about this interesting debate and maybe add a bit of my humble opinion as we go along. There is, however, no reason to “reprint” every single argument in the debate so here are the key links:

From Glasner:

“Gold and Ideology, continued”

“Central Banking is not Central Planning”

“Hayek on the meaning of planning”

“Central Banking and Central Planning, again”

From Schuler:

“Central Banking is a form of Central Planning”

“Once more: central banking is a form of central planning”

From Woolsey:

“Central Banking is Not Central Planning”

Initially my thinking was, yes, of course central banking is central planning, but Bill Woolsey arguments won the day (Sorry David, the Hayek quotes didn’t convince me…).

Here is Bill Woolsey:

“Comprehensive central planning of the economy is the central direction of the production and consumption of all goods services. How many cars do we want this year? How much steel is needed to produce those cars? How much iron ore is needed to produce the steel?…Trying to do this for every good and service all the time for millions of people producing and consuming is really, really hard. Perhaps impossible is not too strong of a word, though that really means impossible to do very well at all, much less do better than a competitive market system…Central banking is very different. It does involve having a monopoly over a very important good–base money. Early on, governments sold that monopoly to private firms, but later either explicitly nationalized the central banks, or regulated and “taxed” them to a point where any private elements are just window dressing…Schuler’s error is to identify this monopoly on the provision of an important good with comprehensive central planning. Yes, a monopolist must determine how much of its product to produce and what price to charge. The central bank must determine what quantity of base money to produce and what interest rate to pay (or charge) on reserve balances. But that is nothing like determining how much of each and every good is to be produced while making sure that the resources needed to produce them are properly delivered to the correct places at the correct times.”

Bill continues (here its gets really convincing…):

“Suppose electric power was produced as a government monopoly. That is certainly realistic. The inefficiency of multiple sets of transmission lines provides a plausible rationale. The government power monopoly would need to determine some pricing scheme and how much power to generate. And, of course, these decisions would have implications for the overall level of economic activity. Not enough capacity, and blackouts disrupt economic activity. Too much capacity, and the higher rates needed to pay for it deter economic activity…It is hard to conceive of an electric utility centrally directing the economy, but it isn’t impossible. Ration electricity to all firms based upon a comprehensive plan for what they should be doing. Any firm that produces the wrong amount and sends it to the wrong place is cut off.”

Central banking might not be central planning

Hence, there is a crucial difference between central planning and a government monopoly on the production of certain goods (as for example money). One can of course argue that if government produces anything it is socialism and therefore central planning. However, then central planning loses its meaning and will just become synonymous with socialism. Therefore, arguing that central banking is central planning as Schuler does is in my view wrong. It might be a integral part of an socialist economic system that money is monopolized, but that is still not the same thing as to say central banking is central planning.

But increasingly central banking is conducted as central planning

While central banking need not to be central banking it is also clear that during certain periods of history and in certain countries monetary policy has been conducted as if part (or actually being part of) a overall central planning scheme. In fact until the early 1980s most Western European economies and the US had massively regulated financial markets and credit and money were to a large extent allocated with central planning methods by the financial authorities and by the central banks. Furthermore, exchange controls meant that there was not a free flow of capital, which “necessitated” central planning of which companies and institutions should have access to foreign currency. Therefore, central banking during the 1970s for example clearly involved significant amounts of central planning.

However, the liberalization of the financial markets in most Western countries during the 1980s sharply reduced the elements of central planning in central banking around the world.

The Great Recession, however, has lead to a reversal of this trend away from “central bank planning” and central banks are increasingly involved in “micromanagement” and what clear feels and look like central planning.

In the US the Federal Reserve has been highly involved in buying “distressed assets” and hence strongly been influencing the relative prices in financial markets. In Europe the ECB has been actively interfering in the pricing of government bonds by actively buying for example Greek or Italian bonds to “support” the prices of these bonds. This obviously is not central banking, but central planning of financial markets. It is not and should not be the task of central banks to influence the allocation of credit and capital.

With central banks increasingly getting involved in micromanaging financial market prices and trying to decide what is the “right price” (contrary to the market price) the central banks obviously are facing the same challenges as any Soviet time central planning would face.

Mises and Hayek convincing won the Socialist calculation debate back in the 1920s and the collapse of communism once and for all proved the impossibility of a central planned economy. I am, however, afraid that central banks around the world have forgotten that lesson and increasing are acting as if it was not Mises and Hayek who prevailed in the Socialist-calculation debate but rather Lerner and Lange.

Furthermore, the central banks’ focus on micromanaging financial market prices is taking away attention from the actual conduct of monetary policy. This should also be a lesson for Market Monetarists who for example have supported quantitative easing in the US. The fact remains that what have been called QE in the US in fact does not have the purpose of increasing the money supply (to reduce monetary disequilibrium), but rather had the purpose of micromanaging financial market prices. Therefore, Market Monetarists should again and again stress that we support central bank actions to reduce monetary disequilibrium within a rule-based framework, but we object to any suggestion of the use  central planning “tools” in the conduct of monetary policy.

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  1. “Market Monetarists should again and again stress that we support central bank actions to reduce monetary disequilibrium within a rule-based framework, but we object to any suggestion of the use central planning “tools” in the conduct of monetary policy”.
    Spot on!

  2. Benjamin Cole

     /  October 23, 2011

    Because man is given to irrational optimism (land booms etc), there is a need for central banks. Also, today we live in a global world–we might do things right, but what if our major trading partner collapses?

    That said, I agree with Nunes. There is a rules-based framework to keep NGDP headed towards a target.

    Trying to conduct monetary policy according to any ideological or partisan acid test just seems to flop. Yes, there is a element of government planning in having a central bank. So what.

  3. BC, I am not sure that we can proven that there has been any “irrational optimism” – or rather it is very hard to spot a bubble BEFORE it busts. And if the market can’t do it neither can a central bank. That is why we want markets to place a central role in monetary policy making – for example through NGDP futures.

    Furthermore, I think the the Free Banking theorist shares a lot of the views of the Market Monetarists. We have different different strategies, but for me this is a key theoretical debate. My Market Monetarism is not a political ideology and I have no particular political aims (even though I believe the world would be better if the Fed and the ECB adopted NGDP level targeting).

  4. Alex Salter

     /  October 24, 2011

    Great post, Lars. I think we can conclude central banking is not central planning. The monopoly provision of base money isn’t a strong enough argument for central planning. After all, any quantity of money (above some arbitrarily small amount, i.e. too little money with respect to money’s denominations) is “optimal” ex ante, since all prices, being listed in the monetary unit, will adjust to the total stock. Trying to fine-tune the economy doesn’t make the central bank a central planner either, but we should be wary of these actions due to the traditional incentive and knowledge problems that come with any attempt at social engineering.

    Of course, I still prefer free banking to central banking. Indeed, the justification for an NGDP target in my mind is that it forces the central bank to behave, in terms of macroeconomic stability, as closely to a free banking system as possible. Still, straw man arguments are not the way to discredit central banking. We should stand on the intellectual high ground; we already have plenty of ammo to work with without getting bogged down in semantics.

  5. Benjamin Cole

     /  October 24, 2011

    Yes, a bubble is only a bubble after the fact, you are right about that. But surely, man is given to herd investing, and that can lead to huge and sudden declines in equity or debt values after the herd changes direction. (I concur the last real estate bust was caused by Fed tightening).
    Also, as stated, we might be perfect here, but if the world stalls suddenly….you need a central bank to gun the money supply and hard.
    I am beginning to agree with you on the Free Banking theorists, but I remain very much a practical guy. If we can get a more-transparent Fed to target NGDP, and yes a futures market, probably we will get good results.
    Man is not only a rational animal, but a social animal. If we all know we have a stake in the central bank and smart and sober guys are running it, it makes for more stability. That is an ideal, but we only need good leadership, not perfect leadership.
    I find libertarianism an enchanting ideology, but the exceptions are many and varied, you end up being a “libertarian except for.” That becomes national defense, pollution, sexual harassment on the job, or FDIC insurance. I have a soft spot for national parks.
    I am not sure the general public will easily navigate a bust with free banking. You mean a bunch of self-serving private-sector bankers are in control of the money supply? Could lead to mayhem in the streets.

  6. Nick Rowe has demonstrated that it is deflationists who are the real command-economists–under their approach, the central bank ultimately ends up owning everything 🙂

    The most serious example of financial market central planning is the way the Japanese Ministry of Finance “managed” the Japanese financial system–ultimately disastrously. Another vindication of the economic calculation critique.

    But also an indication of how much ordinary central banking is not central planning.

  7. Lorenzo that is an extremely good and valid point. Nick is a very clever economist – I will have to have a look at his comments.

  1. Central Banking and Central Planning Once Again « Uneasy Money
  2. Browsing Catharsis – 10.24.11 « Increasing Marginal Utility
  3. Is Market Monetarism just market socialism? « The Market Monetarist
  4. Wrap-up: My Free Banking related posts « The Market Monetarist

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