I have asked Alex Salter to give his perspective on the ongoing debate about “Central banking is (not) central planning” in the blogosphere.
David Glasner also has a new comment on the subject.
But back to Alex…
……………
Guest blog: Central banking – between planning and rules
Alex Salter
asalter2@gmu.edu
I’ve been reading about the central banking vs. central planning debate on the blogosphere; the more I think about it the more interesting it becomes. Whether central banking is a form of central planning depends on what exactly the central bank does. There are two broad scenarios. In the first, the central bank is following some sort of rule or trying to hit a target. This can be a Taylor rule, inflation target, NGDP level target, or anything else. In this case the central bank is trying to provide a stable economic setting so that individuals can effectively engage in the market process. If this is what the central bank is doing, I don’t think it makes sense to call it central planning. All the central bank is trying to do is lay down the “ground rules” for economic behavior. If this is central planning, you could just as easily say any institution such as property rights or the rule of law is central planning too. This obviously isn’t a useful definition of central planning!
However, a central bank may be engaging in a type of central planning if it tries to bring about a specific allocation of resources. For example, if the central bank thinks equities prices should be higher for some reason, and they start purchasing equities, you could make an argument that this is a type of central planning. If the central bank explicitly tries to monetize the debt and acts as an enabler for the nation’s treasury department, you could also say this is a form of central planning. It’s still not 100% clear, since presumably the central bank is not using coercion or the threat of coercion to get market participants to behave in the way it wants; there’s voluntary assent on the other side of the agreement, even if that voluntary assent is a response to warped incentives.
In closing: if a central bank is trying to create a specific framework in which agents can operate, it’s not central planning, it’s rule setting. If on the other hand the central bank is trying to allocate specific resources, it may be a form of central planning. In either scenario, the usual knowledge and incentive problems still apply.
Marcus Nunes
/ October 25, 2011AS Very good. Nice, simple and straightforward, with just the usual “doubts” mentioned. Yes, a Central Banks main function is to deliver macro stability. The micro stuff is the “purview of the political branch”.
Blake Johnson
/ October 25, 2011I think the view of Glasner among others that central banking is not central planning because it does not consist of “One plan” for the whole economy is too strong.
If you read about the history of central banks, IE Vera Smiths Rationale of Central Banking or Selgin’s Theory of Free Banking, or even Selgin’s work on British Mint’s, it becomes clearly that a monopoly on the issue of currency has been a key tool for governments to coercively redirect the resources of society towards the ends they desire. In particular, large loans from central banks or debasement of the currency by mints allows governments to tax consumers by reducing the value of their money holdings, and then to use the proceeds from those taxes to purchase goods, often for war, which affects the allocation of resources significantly.
While central banks may often attempt to merely set the monetary “ambience” to allow for market transactions, history has shown that they can and will take an active role in what should be viewed as central planning. The sovereign debt crisis in Europe is a good example of this, as was the extension of lender of last resort powers to certain non-bank financial institutions within the US.
Lars Christensen
/ October 25, 2011Blake, while I do not think central banking is central planning as Kurt Schuler argues I do agree with you that there is a risk of a slippery slop in central banking – and the US and European examples you highlights are clearly good examples of this.
That is also why I argue that Market Monetarists (and others for that matter) should be critical of the central planning elements in Fed’s QE and ECB’s different interventions in particularly the European fixed income markets.
Alex Salter
/ October 25, 2011@Blake: I agree with what you’re saying, but not your conclusion. It’s true that governments have often tried to redirect the flow of resources in ways which are beneficial to its agents. One of the ways it can do this is central planning. However, there are other ways of interfering with the market process which do not qualify as central planning. Your points are a good example of this.
Central planning is one very specific type of action a political body can take to redirect resources, and it’s often the most extreme. A monetary authority which enables these political actors is certainly undesirable, but I don’t think we should call it central planning. Labels should map uniquely (or as much so as possible) to concepts; to call central banking a form of central planning inevitably obfuscates the analysis of past examples of obvious central planning. Also, just because it doesn’t qualify as central planning doesn’t make it desirable; indeed, almost all Market Monetarists decry a meddling central bank even while acknowledging it’s not a form of central planning.
adlai
/ October 26, 2011I think this merits more caution than I see being given. Hayek is careful to separate the means and the ends of social planning; these seem to be muddled here. The means is strictly the use of coersion to determine outcomes. The ends are irrelivant. In this context, clearly the fed is not a central planner, and any argument that it is plays with a loaded word in an inappropriate context.
adlai
/ October 26, 2011Sorry that was **central planning, not social planning
Jonathan Cast
/ October 26, 2011The monetary authority can certainly try to increase the relative price of wheat,[1] say, by buying large quantities of it; but I doubt its ability to do so, at least in the long run (assuming the wheat is purchased using newly created money). Agents who sold wheat to the monetary authority would now have more money, which would be spent on other goods, raising the prices of those other goods and reducing the relative price of wheat; furthermore, some agents who would have bought wheat at the old price will spend their money on other goods at the new price, again raising the prices of other goods. In the long run, in order for the monetary authority to raise the price of wheat by 20% with newly created money, it would need to create enough new money to raise the general price level by 20%, which would leave the relative price unchanged.
[1] Equities are more complicated because presumably the relative price of equities responds to the growth in expected real income, which is directly affected by the conduct of monetary policy.
Benjamin Cole
/ October 26, 2011Nice post. I can live with a central bank that targets NGDP.
Utopia and a better way I will hope for in my next life.
Blake Johnson
/ October 26, 2011I’ll try to address each response in turn.
@Lars: I think there is certainly some overlap to our views on central banking, and I’d like to acknowledge those first. I do not think that ALL instances of central bank behavior are a form of central planning. I think if central banks could be trusted to stick to a rule, such as NGDP targeting, it would fulfill the kind of institutional role that would allow for more or less stable conditions that should allow markets to function.
However, I think central banks objectives are not as clean cut as simply trying to match the supply of money with the demand for money. I think Sargent and Wallace’s paper “Some unpleasant monetarist arithmetic” is particularly relevant to this discussion. It seems to me that the European sovereign debt crisis is looking more and more like a case of central bank activity being held hostage by the fiscal policy of governments as Sargent and Wallace suggest. With many central banks taking on the objective of not just satisfying the demand for money, but also trying to minimize macroeconomic misery, namely via low unemployment and inflation, it does not seem like central banks can make credible commitments to a non discretionary policy.
@Alex: I think maybe we need to form a common understanding of what the definition of central planning is. I agree with Adlai, that it is the use of coercive means to determine outcomes (in this case the allocation of resources) as the definition for central planning.
I think the real issue here is to what extent does a government have to interfere with the allocation of resources for us to consider it to be an act of central planning? Does it have to go all the way to the traditional method of socialism/communism with government ownership of the all the means of production?
I think it can largely depend on what, if any, recourse consumers and producers have to opt out of the market. For instance, we are free to attempt to avoid the effects of an expansion of the money supply by the Fed by holding other currencies, or assets denominated in other currencies.
However, in countries such as Argentina in the 1970’s/80’s where the central bank was engaging in large amounts of inflation to finance fiscal policy, access to foreign currency was severely restricted. At this point, the only recourse people have to escape the confiscation of their wealth to be used in a manner determined by the government is to turn to black market banking in foreign currencies. I would argue that the Argentine central bank was indeed engaging in some form of central planning, and there are other cases which mirror it.
Alex Salter
/ October 26, 2011@Blake: I agree we need a proper taxonomy of central planning. I also agree that, if we decide there is a continuum of central planning, a central bank is significantly farther towards the planning end than ordinary market actors.
I also agree that the degree to which individuals have to insulate themselves from a central bank’s actions can give us meaningful information. As I said in my post, I believe whether a central bank is a central planner largely depends on what actions they take. However, there are a few key things keeping me from labeling all central banking central planning:
1) Central banks are usually market actors. They conduct their operations in an already established and functioning network of trade relationships. Granted they aren’t restricted like other market actors since they can print money, but ultimately they operate through the market, rather than in place of it.
2) Transactions involving the central bank are usually voluntary, in the sense there is a willing trader on the other side of the transaction. There is no coercion or threat of coercion. Thus central bank operations are incentive-compatible.
3) Central banks usually do not attempt to bring about a specific allocation of resources. They inject liquidity and let market actors pursue whatever ends they find appropriate.
I think of central planning as specific interventions which violate all of the above. The shady area consists of instances where some but not all of the above are violated. I view central banks as a significant intervention, and certainly a source of uncertainty/discoordination if the historical record is any indication, but not necessarily a central planner. Again, there are exceptions (Argentina is a good example, even though what they had was technically a currency board, not a central bank).
Blake Johnson
/ October 26, 2011@Jonathan: I agree that central banks can not affect asset prices in the long run. I would point out that they only need to affect asset prices in the short-medium run to cause mal-investment in those sectors, and cause lingering damage to real output a la Austrian Business Cycle Theory. That would seem to be at least one plausible explanation of the housing boom, and one of the better ones at least in my humble opinion.
@Alex: I think given our expansion of the definition of central planning, our opinions are coming much closer on this subject. I have a two points to bring up in response.
1) I think the last sentence in your first point has bigger implications than you seem to acknowledge. The ability to simply print an irredeemable currency which is backed by legal tender laws can imply some rather large effects on market outcomes.
2) My critique of this point follows from my first point. Let us consider the incentives for any individual engaging in Open Market Operations with a central bank, for simplicity we will use the Fed and purchase of US treasuries. If the Fed offers a sum greater than the net present value of my T-bill, it behooves me to sell it to the Fed. The Fed is competing with other private buyers, but is not constricted by a hard budget constraint, they can simply print dollars at a near zero marginal cost. The more T-bills the Fed buys, the more the monetary base is increased, causing real returns on both T-bills in circulation and the real price paid on each T-bill to decrease. While it is in the interest of each individual to sell to the Fed, it may be welfare decreasing for each private actor once the Fed has purchased a sufficient quantity and forced inflation high enough. Note that I don’t think of this as being the standard result of OMO’s, but I think it may be useful as a limiting case where the standard utility maximizing properties of voluntary exchange might not hold. This would also most likely only work as a one shot wealth grab and was unannounced, as markets would adjust to higher inflation expectations if an announcement were made. I am also unsure as to what the amount of inflation would have to be for this to hold.
As for the Argentine situation, it was my understanding that the Currency Board was formed in 1991 as an attempt to reign in the hyperinflation of the 1970-80’s driven by government fiscal spending, and implemented by the Central Bank of Argentina.
Blake Johnson
/ October 26, 2011I think my second point needs to be qualified some. The marginal T-bill selling individual should be better off even after selling, but those who sold first would be worse off assuming they had not been able to spend their newly received money quickly enough. Even in this case, the person who receives their spent money simply bears the inflationary costs instead of the original T-bill holder.
This is why I shouldn’t mix weird models and 3 am blog posts.
Overall I agree with both Lars and Alex that central banks are not necessarily instances of central planning in theory. Whether or not in practice central banks will tend towards more institutional roles via rules such as nominal income targeting, or they will tend towards more interventionist roles in trying to determine the prices of specific assets, as Lars mentioned in his original post, remains to be seen.
Lars Christensen
/ October 26, 2011Blake, the is nothing wrong with having an obsession with monetary theory that keeps you up until 3am;-)
Njambi Mbugua
/ January 4, 2012I concur that the degree to which individuals have to insulate themselves from a central bank’s actions can give us meaningful information. central banks will tend towards more institutional roles via rules such as nominal income targeting, or they will tend towards more interventionist roles in trying to determine the prices of specific assets.