Beckworth and Ponnuru: Tight budgets, Loose money

David Beckworth and Ramesh Ponnuru just came out with a new article on the economic policy debate in the US. Beckworth and Ponnuru lash out against both left and right in American politics. Let me just say that I agree with basically everything in the article, but you should read it yourself.

However, what I find most interesting in the article is not the discussion about the US political landscape, but rather the very clear description of both the Great Moderation and the causes for the Great Recession:

“The Fed did a pretty good job of stabilizing the economy. The result of its monetary policies was that the economy, measured in current-dollar or “nominal” terms, grew at about 5 percent a year, with inflation accounting for 2 percent of the increase and real economic growth 3 percent. Keeping nominal spending and nominal income on a predictable path is important for two reasons. First, most debts, such as mortgages, are contracted in nominal terms, so an unexpected slowdown in nominal income growth increases their burden. Also, the difficulty of adjusting nominal prices makes the business cycle more severe. If workers resist nominal wage cuts during a deflation, for example, mass unemployment results…During the great moderation, people began to expect spending and incomes to grow at a stable rate and made borrowing decisions based on it. But maintaining this stability requires the Fed to increase the money supply whenever the demand for money balances—people’s preference for cash over other assets—increases. This happened in 2008 when, as a result of the recession and the financial crisis, fearful Americans began to hold their cash. The Federal Reserve, first worried about increased commodity prices as a harbinger of inflation and then focused on saving the financial system, failed to increase the money supply enough to offset this shift in demand and allowed nominal spending to fall through mid-2009″

I wish a lot more people would understand this – Beckworth and Ponnuru are certainly not to blame if you don’t understand it yet.


UPDATE: See this interesting comment on Niskanen and Beckworth/Ponnuru by Tim B. Lee.


William Niskanen 1933-2011

William Niskanen passed away on October 26. I have always admired Niskanen a lot. He was a champion of liberty and a great economist.

Any student of Public Choice theory would know Niskanen’s classic Bureaucracy and Representative Government from 1971 and I still think of this as his greatest contribution to economic theory. However, as Bill Woolsey reminds us William Niskanen was also a long time proponent of nominal income targeting.

Niskanen first advocated nominal income targeting or rather targeting of nominal spending in his 1992 paper “Political Guidance on Monetary Policy”. Niskanen later elaborated on the subject in his 2001 paper “A test of the Demand Rule” and further in his 2002 paper “On the Death of the Phillips Curve”.

Marcus Nunes has an insight comment on “A test of the Demand Rule” here.

The Chuck Norris effect, Swiss lessons and a (not so) crazy idea

Here is from The Street Light:

“You may recall that in September the Swiss National Bank (SNB) announced that it was going to intervene as necessary in the currency markets to ensure that the Swiss Franc (CHF) stayed above a minimum exchange rate with the euro of 1.20 CHF/EUR. How has that been working out for them?

It turns out that it has been working extremely well. Today the SNB released data on its balance sheet for the end of September. During the month of August the SNB had to spend almost CHF 100 billion to buy foreign currency assets to keep the exchange rate at a reasonable level. But in September — most of which was after the announcement of the exchange rate minimum — the SNB’s foreign currency assets only grew by about CHF 25 billion. Furthermore, this increase in the CHF value of the SNB’s foreign currency assets likely includes substantial capital gains that the SNB reaped on its euro portfolio (which was valued at about €130 bn at the end of September), as the CHF was almost 10% weaker against the euro in September than in August. Given that, it seems likely that the SNB’s purchases of new euro assets in September after the announcement of the exchange rate floor almost completely stopped.”

This is a very strong demonstration of the power of monetary policy when the central bank is credible. This is the Chuck Norris effect of monetary policy: You don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target. (Nick Rowe and I like this sort of thing…)

And now to the (not so) crazy idea – if the SNB can ease monetary policy by announcing a devaluation why can’t the Federal Reserve and the ECB do it? Obviously some would say that not all central banks in the world can devalue at the same time – but they can. They can easily do it against commodity prices. So lets say that the ECB, the Federal Reserve, the Bank of Japan, the Bank of England and the SNB tomorrow announced a 15% devaluation against commodity prices (for example the CRB index) and that they will defend that one sided “peg” until the nominal GDP level returns to their pre-Great Recession trend levels. Why 15%? Because that is more or less the NGDP “gap” in the euro zone and the US.

The clever reader will notice that this is the coordinated and slightly more sexy version of Lars E. O. Svensson’s fool-proof way to escape deflation and the liquidity trap.

Is a coordinated 15% devaluation of the major currencies of the world (with the exception of RMB) a crazy idea? Yes, it is quite crazy and it could trigger all kind of political discussions, but I am pretty sure it would work and would very fast bring US and European NGDP back towards the pre-crisis trend. And for those who now scream at the screen “How the hell will higher commodity prices help us?” I will just remind you of the crucial difference between demand and supply driven increases in commodity prices. But okay, lets say we don’t want to do that – so lets instead do the following. The same central banks will “devalue” 15% against a composite index for stock prices in the US, the UK, the euro zone and Japan. Ok, I know you are very upset now. How can he suggest that? I am not really suggesting it, but I am arguing that monetary policy can easily work and all this “crazy idea” would actually do the trick and bring back NGDP back on track in both the US and Europe.  But you might have a better idea.

George Selgin on Bernanke and NGDP targeting

Bill Woolsey has comment on Fed governor Ben Bernanke’s comment’s yesterday regarding NGDP targeting.

Here is what Bernanke said:

“So the fed’s mandate is, of course, a dual mandate. We have a mandate for both employment and for price stability. And we have a framework in place that allows us to communicate and to think about the two sides of that mandate. We talked yesterday about nominal GDP as an indicator, as an information variable, something to add to the list of variables that we think about. And it was a very interesting discussion. However, we think that within the existing framework that we have, which looks at both sides of the mandate, not just some combination of the two, we can communicate whatever we need to communicate about future monetary policy. So we are not contemplating at this time any radical change in framework. We are going to stay within the dual mandate approach that we’ve been using until this point.”

George Selgin who is one of the pioneers of NGDP targeting – even though we all know George prefers Free Banking – has a comment on Bill’s blog. I think George’s comment make a lot of sense:

“Right. BB doesn’t get it: nominal spending isn’t an indicator to be used in helping the Fed to regulate P and y. It is itself the very thing the Fed ought to regulate. The idea that Py is some sort of composite of two more “fundamental” variables, where the Fed is supposed to be concerned with the stability of each, is a crude fallacy. Neither stability of y nor that of P is desirable per se. Stability of Py, on the other hand–which is to say stability of nominal aggregate demand–is desirable in itself.”

Right on George! (for those not schooled in econ lingo P is prices and y is real GDP and Py obviously is nominal GDP).

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