All posts for the month October, 2011

Guest blog: Central banking – between planning and rules

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.

15 Comments
by Lars Christensen on October 25, 2011  •  Permalink
Posted in Austrian economics, Guest blog, MM Research agenda, Monetary institutions
Tagged , , , ,

Posted by Lars Christensen on October 25, 2011

https://marketmonetarist.com/2011/10/25/guest-blog-central-banking-between-planning-and-rules/

Central banks cannot ”do nothing”

Central banks cannot ”do nothing” 

Some commentators have suggested that central banks should ”do nothing” in the present crisis, but even though that on the surface sounds appealing it is in fact nonsense to say a central bank should do nothing. Central banks in fact cannot “do nothing”. Let me explain why.

The first thing to ask is what “doing nothing” means. Often people talk about monetary policy as manipulating interest rates up and down and doing nothing is taken to mean that the central bank should keep interest rates “unchanged”. However, what we really are talking about is that the central bank is intervening in the money markets to keep the price of overnight credit fixed at a given level. So imagine the demand for overnight liquidity spikes for some reason then the central bank will have to increase liquidity to keep the market interest rate from rising. Hence, even a central bank that is “doing nothing” in the sense of keeping interest rates fixed might end up doing quite a bit. Central bank credibility might reduce the need for actual intervention to keep the interest rate fixed, but that does not change the principle that ultimately the central bank will have to actively manage things.

The story is the same for a central bank that has announce a fixed exchange rate policy. Here “doing nothing” is normally taken to mean that the central bank buys and sell the currency to ensure that the exchange rate indeed remains fixed. So again “doing nothing” might involve doing quite a bit – even though again credibility might indeed reduce the need to doing something on a daily basis, but even the most credibility fixed exchange rate regimes like the Denmark’s peg to the euro or Hong Kong’s peg to the dollar from time to time (quite often in fact) would require the central banks to buy and sell their currency.

In fact all central banking involve controlling the money base. The central bank can use different operational targets like interest rates or exchange rates, but the central bank is never doing nothing. George Selgin who (indirectly) inspired this blog post would of course say that if you want central banks to do nothing then you should abolish central banking all together, but that is not the purpose of this discussion.

An example of the fallacy that a central bank can do nothing is the debate about “quantitative easing” (QE). There is really nothing special about QE as it basically just means to increase the money base. This in someway is seen to be “dirty” or dangerous and it is getting a lot of attention, but some central banks are doing QE all the time, but it is getting no attention at all. Lets say a country has a fixed exchange rate policy and the demand for its currency for some reason increases – then the central bank will have to sell it own currency to curb the strengthening of the currency. But what does it mean to “sell the currency”? In fact that means to increase the money base. That is QE. So central banks with fixed exchanges could in fact be “doing nothing” and at the same time be engaged in QE on a massive scale – just ask the good people at People’s Bank of China about that.

“Doing nothing” in monetary policy is not really as simple as it is often made up to be. There is, however, another way of looking at things and that is to differentiate between rules and discretion.

NGDP Targeting is as close to “doing nothing” as you get

After the outbreak of the Great Recession a lot of central banks have been conducting monetary policy on a discretionary basis – jumping from one crisis to another without defining the rules of engagement so to speak. An obvious example is the Federal Reserve which have implemented QE1 and QE2 and even the odd “operation twist” without bothering to state what the purpose of these policies are and under which circumstances to scale them up and down. Interestingly enough the Fed has been criticised for doing what central banks do – “playing around” with the money base – but there has been little criticism the discretionary fashion in which US monetary policy has been conducted. Even most of the Market Monetarist bloggers have failed in clearly stating this (sorry guys…).

Imagine instead that there had been a NGDP level target in place in the US when the Great Recession started. A NGDP target would have been a clear rule for the conduct of US monetary policy. It would have stated that if NGDP expectations (either market expectations or the Fed’s own forecast) drops below a certain target then the Fed should take actions to increase the money base (without any restrictions) until NGDP expectations had returned to the target level. That likely would have led to a significant increase in the money base, but within a very clearly defined framework and the increase in the money base would have been completely automatic (as would have been the “exit” from the boost in the money base). Very likely there would not have been any debate about whether this increase in the money base or not if the NGDP target framework had been in place. In fact the Fed could have said it was “doing nothing” – even though that would as demonstrated above, but it would not have done anything discretionary. The real problem with QE is not that the money base is increase, but that is done in a completely random fashion without any clear framework. So the best thing the Fed could do was to very soon implement some rules of engagement – preferably a market based NGDP level target.

PS Those of my reader who are in favour of a true gold standard should know that the central bank can easily end of doing quite a bit of manipulation of the money base within the framework of a gold standard.

PPS Just came to think of it – why did nobody debate the increase in the US money base prior to Y2K (that was actually quite insane a policy) or after 911?

19 Comments
by Lars Christensen on October 25, 2011  •  Permalink
Posted in NGDP Targeting, Nominal Income Targeting, The Great Recession
Tagged , , ,

Posted by Lars Christensen on October 25, 2011

https://marketmonetarist.com/2011/10/25/central-banks-cannot-%e2%80%9ddo-nothing%e2%80%9d/

Brüning (1931) and Papandreou (2011)

Here is Germany Prime Minister Brüning in 1931.

Here is Greek Prime Minister Papandreou in 2011.

Brüning fled Germany in 1934 after the Nazi takeover in 1933.

5 Comments
by Lars Christensen on October 24, 2011  •  Permalink
Posted in euro crisis, The Great Depression, The Great Recession
Tagged , , , ,

Posted by Lars Christensen on October 24, 2011

https://marketmonetarist.com/2011/10/24/bruning-1931-and-papandreou-2001/

80 years on – here we go again…

The year is 1931. US president Hoover on June 20 announces the so-called Hoover Moratorium. Hoover’s proposition was to put a one-year moratorium on payments of World War I and other war debt, postponing the initial payments, as well as interest. This obvious is especially a relief to Germany and Austria. The proposal outrages a lot of people and especially the France government is highly upset by the proposal.

July 23, 1931. After finally gaining French support, President Hoover announced that all of the important creditor governments had accepted the intergovernmental debt moratorium. While the U.S. government rejected the notion that inter-Allied war debts and reparations were connected, the European governments adopted the stand that Allied debts and reparations would stand or fall together. The delay in action on the debt moratorium contributed to the closing of all German banks by mid-July. (From youtube)

Here are the historical pictures from the Paris conference in 1931.

80 years on – now we are again talking about European debts. This time things a different now it is now Germany who are in need of a debt moratorium, but Greece. And guess who is upset this time around??

6 Comments
by Lars Christensen on October 24, 2011  •  Permalink
Posted in Economic and monetary history, euro crisis, The Great Depression, The Great Recession
Tagged , , ,

Posted by Lars Christensen on October 24, 2011

https://marketmonetarist.com/2011/10/24/80-years-on-here-we-go-again/

Bennett McCallum – grandfather of Market Monetarism

Scott Sumner in a blog post today calls Bennett McCallum “the most respected NGDP advocate in the entire world”. I completely agree with Scott. McCallum’s work on “Nominal Income Targeting” (maybe out of respect for McCallum we should really call it that…) is second to none and everybody interested in the topic should read all of his work (I am getting there…). I am particularly impressed with Dr. McCallum’s work on Nominal Income Targeting in Small Open economies.

If I have time I one day hope to write an overview article of McCallum’s work…Until then take a look at McCallum’s recent paper on “Nominal GDP Targeting”.

See especially McCallum’s discussion about “level” versus “growth” targeting:

“From the foregoing it can be seen that one issue that arises in discussions of nominal GDP targeting is whether the targets should be expressed in terms of “level” or “growth-rate” measures. For an example of the distinction, suppose that the chosen rate of growth of nominal GDP is 4.5% per year. Suppose that in some year, however, the central bank misses that target by a full percentage point on the high side, yielding 5.5% growth consisting of (for example) 3.0 percent inflation and 2.5% real growth. Should the central bank strive for the usual 4.5% growth in nominal GDP again in the following year? Or should it decrease its growth target to 4.0%, aiming thereby to be back at the original path for the nominal GDP level at the end of the next year? In other words, should the nominal GDP targets be set in terms of growth rates or growing levels? In the latter case, the disadvantage will be that policy that decreases nominal growth below its usual target value may be excessively restrictive, whereas the former case leaves open the possibility of cumulative misses in the same direction for a number of periods, i.e., it permits “base drift” away from the intended path. My position on this issue has been that keeping with the target growth rates will, if they are on average equal to the correct value over time, be unlikely to permit much departure from the planned path and so should probably be preferred. This is not at all a universal point of view, however, among nominal GDP supporters.”

It is also interesting that McCallum in his paper acknowledges the work of the blogging Market Monetarists – particularly Scott Sumner – and hopefully the interaction between the Market Monetarists and McCallum will develop in the future.

If Scott Sumner is the father of Market Monetarism then Bennett McCallum is the grandfather – even though some of us might disagree with McCallum’s position in the level vs growth debate.

——–

Update: Steve Walman at Interfluidity has a post on “The moral case for NGDP targeting”.

Update 2: David Beckworth suggests that Bennett McCallum is the godfather of Nominal Income Targeting. I can accept that…even though grandfather seems a bit more friendly;-)

Update 3: Scott Sumner also has an comment on McCallum’s paper. And here is a comment from Marcus Nunes as well.

6 Comments
by Lars Christensen on October 24, 2011  •  Permalink
Posted in McCallum, McCallum-Christensen rule, NGDP Targeting, Nominal Income Targeting
Tagged , , ,

Posted by Lars Christensen on October 24, 2011

https://marketmonetarist.com/2011/10/24/bennett-mccallum-grandfather-of-market-monetarism/

“Graph man” Nunes is having a look at the Plucking Model

In a recent post I highlighted Milton Friedman’s so-called “Plucking Model”. Marcus Nunes – also known as the “Graph man” among friends have been taking a look at how US data fits Friedman’s model. Marcus “Graph man” Nunes’ post is very educational – please have a look.

2 Comments
by Lars Christensen on October 23, 2011  •  Permalink
Posted in Economic and monetary history, General economic theory, MM Research agenda
Tagged , , ,

Posted by Lars Christensen on October 23, 2011

https://marketmonetarist.com/2011/10/23/graph-man-nunes-is-having-a-look-at-the-plucking-model/

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.

11 Comments
by Lars Christensen on October 23, 2011  •  Permalink
Posted in Austrian economics, Economic and monetary history, Free Banking, General economic theory, MM Research agenda, Monetary institutions, Monetary policy
Tagged , , , , , ,

Posted by Lars Christensen on October 23, 2011

https://marketmonetarist.com/2011/10/23/when-central-banking-becomes-central-planning/

Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed

I always enjoy reading whatever George Selgin has to say about monetary theory and monetary policy and I mostly find myself in agreement with him.

George always is very positive towards the views of Milton Friedman, which is something I true enjoy as longtime Friedmanite. I particular like George’s 2008 paper “Milton Friedman and the Case against Currency Monopoly”, in which he describes Friedman’s transformation over the years from being in favour of activist monetary policy to becoming in favour of a constant growth rule for the money supply and then finally to a basically Free Banking view.

I believe that George’s arguments make a lot of sense I and I always thought of Milton Friedman as a much more radical libertarian than it is normally the perception. In my book (it’s in Danish – who will translate it into English?) on Friedman I make the argument that Friedman is a pragmatic revolutionary.

To radical libertarians like Murray Rothbard Milton Friedman seemed like a “pinko” who was compromising with the evil state. Friedman, however, did never compromise, but rather always presented his views in pragmatic fashion, but his ideas would ultimately have an revolutionary impact.

I there are two obvious examples of this. First Friedman’s proposal for a Negative Income Tax and second his proposal school vouchers. Both ideas have been bashed by Austrian school libertarians for compromising with the enemy and for accepting government involvement in education and “social welfare”. However, there is another way to see both proposals and is as privatization strategies. The first step towards the privatization of the production of educational and welfare services.

Furthermore, Friedman’s proposals also makes people think of the advantages if the freedom of choice and once people realize that school vouchers are preferable to a centrally planned school system then they might also realize that free choice as a general principle might be preferable.

In a similar sense one could argue that Scott Sumner and other Market Monetarists are pragmatic revolutionaries when they argue in favour of nominal GDP targeting.

Why is that? Well, it is a well-known result from the Free Banking literature that a privatization of the money supply will lead to money supply becoming perfectly elastic to changes in money demand. Said, in another way any drop in velocity will be accompanied by an “automatic” increase in the money, which effectively would mean that a Free Banking system would “target” nominal NGDP. Hence, as I have often stated NGDP targeting “emulates” a Free Banking outcome. In that sense Sumner’s proposal for NGDP targeting is similar to Friedman’s proposal for school vouchers. It is a step toward more freedom of choice. Scott therefore in many ways also is a pragmatic revolutionary as Friedman was.

There is, however, one crucial difference between Friedman and Sumner is that, while Friedman was in favour of a total privatization of the school system and just saw school vouchers as a step in that direction Scott does not (necessarily) favour Free Banking. Scott argues in favour of NGDP targeting based on its own merits and not as part of a privatization strategy. This is contrary to the Austrian NGDP targeting proponents like Steve Horwitz who clearly see NGDP targeting as a step towards Free Banking. Whether Scott favours Free Banking or not does, however, not change the fact that it might very well be seen as the first step towards the total privatization of the money supply.

Sumner’s proposal the implementation of NGDP futures could in a in similar fashion be seen as a integral part of the privatization of the money supply.

Friedman famously paraphrased the French Word War I Prime Minister George Clemenceau who said that “war is much too serious matter to be entrusted to the military” to “money is much too serious a mater to be entrusted to central banker”. Scott Sumner’s proposal for NGDP targeting within a NGDP futures framework in my view is the first step to taken away central bankers’ control of the money supply…but don’t tell that to the central bankers then they might never go along with NGDP Tageting in the first place.

For Scott own view of the Free Banking story see: “An idealistic defense of pragmatism” – he of course might as well have said “A revolutionary defense of pragmatism”.

———–

Update: I just found this fantastic quote from George Selgin (from comment section of Scott’s blog): ‘I only wish…that Scott would draw inspiration from Cato the Elder, andend each of his pleas for replacing current Fed practice with NGDP targeting with: “For the rest, I believe that the Federal Reserve System must ultimately be destroyed.”’

22 Comments
by Lars Christensen on October 23, 2011  •  Permalink
Posted in Austrian economics, Free Banking, MM Research agenda, Monetary institutions, NGDP Targeting, Reading recommendations
Tagged , , , , , , , , ,

Posted by Lars Christensen on October 23, 2011

https://marketmonetarist.com/2011/10/23/scott-sumner-and-the-case-against-currency-monopoly-or-how-to-privatize-the-fed/

Chuck Norris on monetary policy #3

Yet another other great “fact” from www.chucknorrisfacts.com

“TARP didn’t have to be passed to kickstart the economy. All that the President needed to do was to ask Chuck Norris to roundhouse kick it”

Well, it is entirely correct – TARP really didn’t do anything to “kickstart” the US economy. Just look at the US stock markets – the ultimate forecasting tool for NGDP expectations. It kept dropping until the Federal Reserve called in Chuck Norris in March 2009 and initiated quantitative easing of monetary policy – the monetary version of a roundhouse kick.

Leave a comment
by Lars Christensen on October 22, 2011  •  Permalink
Posted in Chuck Norris
Tagged , ,

Posted by Lars Christensen on October 22, 2011

https://marketmonetarist.com/2011/10/22/chuck-norris-on-monetary-policy-3/

Do you remember Friedman’s “plucking model”?

Clark Johnson’s paper on the Great Recession has reminded me of Milton Friedman’s so-called “Plucking model” as Johnson mentions Friedman original 1966 paper on the Plucking model. I haven’t thought of the Plucking model for some time, but it is indeed an important contribution to economic theory which in my view is somewhat under-appreciated.

At the core of the Plucking model is that the business cycle is asymmetrical. If you studies modern day textbooks on Macroeconomics it will talk about the “output gap” as it is something we can observe in the real world and a lot of econometric modeling is done under the assumption that real GDP move symmetrically around “potential GDP” over time.

The idea in the Plucking model is, however, that the business cycle really can’t be symmetrical as no economy can produce more than at full capacity. Hence, all shocks in the model will have to be negative shocks – or shocks to the potential GDP. Simply expressed negative shocks are demand shocks and positive shocks are supply shocks – and Friedman assumes that the demand shocks dominates.

A numbers of older and relatively new research confirms empirically the the Plucking model, but for some reason it is not getting a lot of attention.

A key implication of the Plucking model is that there is not correlation between the extent and the size of the “boom” prior to a crisis and how fast the recovery is afterwards. The implication of this is that the idea of “The New Normal” where we will have to have lower growth in the coming years because of “overspending” prior to the crisis simply does not find support in economic history.

Here is a recent interesting paper that finds empirical support for the Plucking model – including for the period covering the Great Recession.

Needless to say – Austrian business cycle fanatics do not agree with the conclusions in the Plucking model…

More research on the Plucking model would be interesting and it would be interesting to see how Market Monetarists can learn from the model.

5 Comments
by Lars Christensen on October 22, 2011  •  Permalink
Posted in Austrian economics, Economic and monetary history, MM Research agenda, The Great Recession
Tagged , , , ,

Posted by Lars Christensen on October 22, 2011

https://marketmonetarist.com/2011/10/22/do-you-remember-friedmans-plucking-model/

« Older Posts
Newer Posts »