Lorenzo´s Socratic dialogue on NGDP Targeting

Lorenzo from Oz suggested the following “Socratic dialogue “on NGDP targeting in a comment to my previous post – I think it is so good it need to be repeated:

Q: What has caused more damage; entrenched inflation (the 1970s) or massive deflation (1929-32)?
A: Deflation. But that is not what we face.
Q: What has caused more damage; entrenched inflation (the 1970s) or unexpected disinflation during a leveraging crunch (2008-?).
A: But inflation is evil.
Q: Why is inflation bad?
A: Because it distorts private decisions.
Q: Does it do that making basic parameters for judgement unreliable?
A: Yes.
Q: So it is about creating a clear and reliable framing for private decisions?
A: Yes.
Q: So, a central bank should provide a reliable framework for private decisions?
A: Yes.
Q: So it is about framing expectations in a credible way?
A: Yes.
Q: So, what is more important to people, expectations about income or expectations about prices?
A: [Some obfustication]
Q: So, should not a central bank seek to credibly generate expectations about income?
A. [Some more obfustication]
Q: In a highly leveraged age with many wages set by contracts operating across time and a range of “sticky” prices, which is more important to people, expectations about money income or “real” income?
A. [Even more obfustication]
Q: So, would not a clear target about aggregate income (aka NGDP aka Py) create a framework to anchor expectations in what people actually care about?
A: [Meltdown]

PS off to Vilnius, Lithuania today – nice city and nice people. I am among other things having a presentation about 1931 vs 2011 – and more important about whether 2012 will bring the same horrors as 1932 (My answer is – I fear so, but it is not too late to avoid).


Adam Posen calls for more QE – that’s fine, but…

Adam Posen who sits on the Bank of England’s Monetary Policy Committee (MPC) has a comment in on New York Times’ website.

Adam Posen is known to favour aggressive quantitatively easing in the present situation and in his piece he argues strongly that both the ECB and the Federal Reserve should follow the lead from the BoE and step up aggressive QE.

Posen rightly criticize the Fed, the BoE and the ECB with being too reluctant to do the “right thing” and in many ways his comments resembles my own critique of policy makers as being “Calvinist” in their thinking.

Posen is also right in arguing that more definitely is needed in both Europe and the US in terms of easing monetary conditions, but I have often argued that Market Monetarists are not in favour of discretionary policies (See here and here). We want to see QE within a proper framework of NGDP level targeting and not discretionary monetary “stunts”. The experience with both QE1 and QE2 in the US shows that unless is anchored within a proper framework then the impact on NGDP expectations are likely to be relatively short-lived.

I think that there might be some disagreement among Market Monetarists here and I guess that for example Scott Sumner would be happy to take whatever we can get, while I personally is more skeptical. If QE is done in an ad hoc fashion outside of a clearly defined policy framework then I fear it will undermine the longer-term arguments for NGDP level targeting. Some are already arguing that QE did not work – I think QE works very well if it is done within a proper framework, but how can we convince the skeptics?

That does of course not mean that I would vote against more QE if I for example was on the BoE’s MPC or the FOMC (there is no chance that will ever happen…). And it is quite obvious that the ECB need to ease monetary policy right now and rather aggressively – even within ECB’s present framework.

Anthony Evans seem to share my concerns about QE without a proper framework. See Anthony’s comment here and here.

See also Marcus Nunes and Scott Sumner on Adam Posen’s comment.

PS Theoretically I also disagree quite a bit with Posen as it seems like he think that the monetary transmission mechanism works primarily via lower bond yields. It’s basic MM knowledge that successful monetary easing (increased NGDP expectations) will increase bond yields. See my previous comment the transmission mechanism here. Even though I am skeptical about Posen’s call for ad hoc monetary easing I in fact think that monetary policy with the help of the Chuck Norris Effect is much more powerful than Posen seems to think.

“Global Banking Glut and Loan Risk Premium”

David Levey has sent me a new paper by Princeton University economics professor Hyun Song Shin on “Global Banking Glut and Loan Risk Premium“. I have unfortunately not had the time to read the paper yet, but it looks quite interesting and I would like to share it with my readers.

Here is the abstract:

“European global banks intermediating US dollar funds are important in influencing credit conditions in the United States. US dollar-denominated assets of banks outside the US are comparable in size to the total assets of the US commercial bank sector, but the large gross cross-border positions are masked by the netting out of the gross assets and liabilities. As a consequence, current account imbalances do not reflect the influence of gross capital flows on US financial conditions. This paper pieces together evidence from a global flow of funds analysis, and develops a theoretical model linking global banks and US loan risk premiums. The culprit for the easy credit conditions in the United States up to 2007 may have been the “Global Banking Glut” rather than the “Global Savings Glut””

Overall, I think the global financial linkages are extremely important in understanding how the Great Recession has played out and Hyun Song Shin’s paper could help us understand these linkages. I am personally very interested in the impact of the European banking sector’s demand for dollar.


PS While the European crisis continues relentlessly it is hard to find anything positive of cheer you up. However, my colleague Antero Atilla – who long ago has realised that I am obsessed with monetary policy suggested a more fun youtube link today…have a look – it is all about money!

PPS The European crisis, business traveling and a bad flu is likely to keep me a bit away from blogging in the coming days.

Tilford and Whyte on the euro crisis

Simon Tilford and Philip Whyte have written an essay – Why stricter rules threaten the eurozone” – on the euro crisis for the normally strongly pro-European Centre for European Reform. I far from agree with everything in the report, but it is worth a read.

Here is the conclusion (for the lazy):

“When the euro was launched, critics worried that it was inherently unstable because it was institutionally incomplete. A monetary union, they argued, could not work outside a fiscal (and hence a political) union. Proponents of the euro, by contrast, believed that a currency union could survive without a fiscal union provided it was held together by rules to which its member-states adhered. If, however, a rules-based system proved insufficient to keep the monetary union together, many supporters assumed (as faithful disciples of Jean Monnet) that the resulting crisis would compel politicians to take steps towards greater fiscal union.

Initially, proponents of the euro seemed to have been vindicated. The euro enjoyed a remarkably uneventful birth, and a superficially blissful childhood. But its adolescence has been more troubled, lending increasing weight to the euro’s critics. If anything, a shared currency outside a fiscal union has turned out to be even less stable than the critics imagined. Common fiscal rules did not guarantee the stability of the system – not just (as North European politicians like to claim) because they were broken, but also because they were inadequate. The eurozone now faces an existential crisis – and EU politicians their ‘Monnet moment’. At root, the eurozone’s sovereign debt crisis is a crisis of politics and democracy. It is clear that the eurozone will remain an unstable, crisis-prone arrangement unless critical steps are taken to place it on a more sustainable institutional footing. But it is equally clear that European politicians have no democratic mandate in the short term to take the steps required. The reason is that greater fiscal integration would turn the eurozone into the very thing that politicians said it would never be: a ‘transfer union’, with joint debt issuance and greater control from the centre over tax and spending policy in the member-states.

Eurozone leaders now face a choice between two unpalatable alternatives. Either they accept that the eurozone is institutionally flawed and do what is necessary to turn it into a more stable arrangement. This will require some of them to go beyond what their voters seem prepared to allow, and to accept that a certain amount of ‘rule-breaking’ is necessary in the short term if the eurozone is to survive intact. Or they can stick to the fiction that confidence can be restored by the adoption (and enforcement) of tougher rules. This option will condemn the eurozone to selfdefeating policies that hasten defaults, contagion and eventual break-up. If the eurozone is to avoid the second of these scenarios, a certain number of things need to happen. In the short term, the ECB must insulate Italy and Spain from contagion by announcing that it will intervene to buy as much of their debt as necessary. In the longer term, however, the future of the euro hinges on the participating economies agreeing at least four things: mutualising the issuance of their debt; adopting a pan-European bank deposit insurance scheme; pursuing macroeconomic policies that encourage growth, rather than stifle it (including symmetric action to narrow trade imbalances); and lowering residual barriers to factor mobility.”

Dear Mario and Ben – monetary policy is getting tighter and tighter by the minute

On the first page of the Market Monetarist bible it says that we can observe whether monetary policy is getting tighter or looser by watching the markets. From a US perspective US monetary policy is getting tighter when the US dollar strengthens, stock prices drop, bond yields drop and commodity prices fall. Guess what folks – monetary policy is getting a lot tighter today!

Is this what we need?

Insufficient powers of (European) central banks

Here is Ben Bernanke and Harold James (1991) on “Insufficient powers of (European) central banks”:

“An important institutional feature of  the interwar gold standard is that, for a majority of the important continental European central banks, open market operations were not permitted or were severely restricted. This limitation on central bank powers was usually the result of the stabilization programs of the early and mid 1920s. By prohibiting central banks from holding or dealing in significant quantities of government securities, and thus making monetization of deficits more difficult, the architects of the stabilizations hoped to prevent future inflation. This forced the central banks to rely on discount policy (the terms at which they would make loans to commercial banks) as the principal means of affecting the domestic money supply. However, in a number of countries the major commercial banks borrowed very infrequently from the central banks, implying that except in crisis periods the central bank’s control over the money supply might be quite weak.”

I wonder whether Ben Bernanke is having the same unpleasant feeling of déjà vu as I am having and what he plans to do about – because apparently nobody in Europe studied economic history.




“Incredible Europeans” have learned nothing from history

The conservative Partido Popular won the general elections in Spain over the week and PP leader Mariano Rajoy will now become Prime Minister in Spain. That makes it three – that is the number of new Prime Ministers in Southern European countries in a couple of weeks.

So the European crisis continues and as in 1931 this is to a large extent a political crisis and policy makers seem unable to learn much from the past. Here is Scott Sumner for you:

“The events of the last few years have caused me to radically revise my views of the Great Depression.  Not in terms of the causal factors, those have been amply confirmed.  Falling NGDP does create domestic and international financial turmoil—no doubt about that.  But I used to think people were stupid back in the 1930s.  Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”?  I used to wonder how people could have failed to see the real problem.  I thought that progress in macroeconomic analysis made similar policy errors unlikely today.  I couldn’t have been more wrong.  We’re just as stupid as they are.”

I am only quoting, but find it hard to disagree. One thing is to agree with with Scott Sumner (I am used to that), but agreeing with Paul Krugman is slightly less normal for me, but here he is (and I agree):

“I had some hopes for Mario Draghi; he has just done his best to kill those hopes. In his view, it’s all about credibility, defined thusly:

Credibility implies that our monetary policy is successful in anchoring inflation expectations over the medium and longer term. This is the major contribution we can make in support of sustainable growth, employment creation and financial stability. And we are making this contribution in full independence.

Unbelievable. Right now, the ECB has too much credibility on the inflation front; the spread between German nominal and real interest rates, which is an implicit forecast of the inflation rate, is pointing to disastrously low medium-term inflation“.

Draghi also seems to suffer from a variation of the “Gold Standard mentality”. Anybody who have studied the Great Depression should find recent European events surreal. Day-by-day history repeats itself. It is tragic.

If there is any European policy makers out there reading this – you should take a look at events of 1931 – try not to repeat anymore of events from that tragic year. You could start reading my comment on 1931.

PS I wonder if Mariano Rajoy know how Spain avoided the Great Depression 80 years ago…(hint: Spain was not on the gold standard).

PPS I have been thinking – FX policy is the responsibility of EU Finance Ministers rather than of the ECB. You can draw your own conclusions.

PPPS Tyler Cown also has a comment on the European crisis.

PPPPS Ambrose Evans-Pritchard has a comment on Spain that is unlikely to cheer up anybody.

Taylor fires at NGDP targeting – the Market Monetarists fire back

John Taylor has a comment on NGDP targeting. Let’s just say he is not a fan of NGDP targeting.

Taylor’s comments have provoked the Market Monetarists bloggers to fire back at Taylor. See the comments from:

Scott Sumner
Nick Rowe
Marcus Nunes
Bill Woolsey

I don’t have a lot to add, but I would note that it seems like Taylor wrongly thinks that NGDP targeting is discretionary. I have already commented on that common misperception.

See my comment “NGDP targeting is not a Keynesian business cycle policy”

PS To me actually the worst thing about the Taylor rule is that it has created the very damaging misconception that monetary policy is about controlling interest rates. Interest rates is NOT the price of money – it is the price of credit.

Capital controls are always wrong – also in Iceland

I have long had a interest in the Icelandic economy and my views on the Icelandic boom-bust are well know.

Iceland has come quite well through the crisis – and there is a moderate recovery underway in the economy and the debt situation has clearly been stabilised. However, there is one area where I continue to see a serious problem and that this capital controls. In the wake of the crisis the IMF more or less forced the Icelandic government to introduce draconian capital controls.

Now two Icelandic economists Ragnar Arnason and Jon Danielson have written a excellent comment on the website Voxeu.org about the capital control. You should read the comment for yourself, but here is a bit of the conclusion:

“Thus, in our view, the imposition of capital controls was both unnecessary and unjustified. Without them, the exchange rate might have temporarily fallen even further in a worst case scenario, in which case a surgical intervention in the form of a temporary tax on short capital outflows would have been a sufficient policy response. 

Instead, the IMF forced the Icelandic government to impose draconian capital controls of a type last seen in developed economies in the 1950s, causing significant short-term and long-term economic damage. The capital controls were initially touted as a temporary measure, but now three years after the event it looks like they are there to stay, and as the domestic economy adapts to their presence, they will be increasingly costly to abolish. After all, the last time Iceland imposed capital controls in the 1930s, they lasted until 1993.

The capital controls have resulted in an intrusive licensing regime, with government permission required for foreign travel and those emigrating prevented from taking their assets with them. Both are direct violations of the civil rights of Icelandic citizens and Iceland’s international commitments as a democratic European country.

Our hope is that other countries facing a similar situation will have the good fortune of receiving better advice from the IMF.”

Lets just say it as it is – I agree with every single word.


Pedersen on Price Level Targeting

My good colleague Jens N. Pedersen has today successfully defended his master thesis at the Department on Economics at the University of Copenhagen.

 Jens’ thesis should be of interest to Market Monetarists.

 Here is a bit from the introduction of Jens’ thesis “Price Level Targeting –  Optimal anchoring of expectations in a New Keynesian model”:

 “The recent experience of the Financial Crisis has highlighted the potential drawbacks of a policy targeting the changes and not the level of the prices. When the zero lower bound on the nominal interest rate binds, the inflation target presents a lower constraint on the real interest rate because inflation expectations are anchored at the target. Following the crisis, a number of major central banks have been forced to keep the policy rate close to zero and in the mean time use unconventional tools to keep monetary policy effective. Price level targeting, however, presents the optimal way of anchoring expectations by increasing inflation expectations in a deflationary environment and vice versa. This improves monetary policy in general and in a zero interest rate environment, which keeps the conventional interest rate operating procedure effective. This thesis attempts to study, how the central bank can optimally utilise the expectational channel, when setting monetary policy, by announcing a price level target. The investigation will take on both a theoretical and an empirical stand point. The theoretical part of the thesis revisits the arguments for and against adopting price level targeting. The empirical part of the thesis attempts to evaluate the optimality of monetary policy by inspecting the statistical properties of the price level.”

I am grateful to Jens for always challenging some of my views on monetary policy and Jens is always an excellent sparring partner not only on monetary issues but also on such interesting subjects as sportometrics and fine dining.

So dear readers please have a look at Jens’ excellent thesis. And to Jens – Congratulations! It is well-deserved and you can truly be proud of your thesis.



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