All posts for the month December, 2011

Guest post: Why we need the European Central Bank as Lender and Owner of Last Resort

THIS IS A GUEST POST By Arash Molavi Vasséi

Why we need the European Central Bank as Lender and Owner of Last Resort

This post summarizes a short policy note where I argue that the only feasible as well as incentive-compatible solution to the current sovereign debt crisis in the Eurozone involves the European Central Bank (ECB)

  • as a Lender of Last Resort to the Eurozone’s core countries like France, Austria, Finland, and The Netherlands, and
  • as the Owner of Last Resort to the European banking system, thereby setting the stage for haircuts on the debt of potentially insolvent peripheral Member States like Greece, Italy, Spain, and Portugal.

The arguments for a credible commitment of the ECB to an unlimited swap line, promising to swap central bank liabilities for sovereign bonds with the aim to reduce liquidity premia, are well-known. So I won’t repeat them here. I will rather focus on the second part of my argument, on the ECB as an Owner of Last Resort. As far as I am aware of, the idea is new. I guess the idea is fundamentally flawed in a way that I cannot see. This is the reason I wrote it down and why I thank Lars for making it available to a wider audience. Note, however, that I am full aware that the implementation of the idea is neither politically feasible, not is it legal (see the conclusion). My arguments are just concerned with economic admissibility.

The ECB as Owner of Last Resort

There are few economist who would deny that a haircut on sovereign debt is an incentive-compatible solution; the extremely serious downside is the risk of a breakdown of the European banking sector and global contagion.

But there is a solution. First, the European Banking Authority (EBA) should come up with serious stress tests, that is, predicting the impact of realistic haircuts on peripheral sovereign debt and of a Europe-wide recession on each Systemically Important Financial Institution (SIFI) in Europe. In a next step, the ECB should step in as the Owner of Last Resort and recapitalize each such SIFI according to the EBA’s projections. In contrast to its role as Lender of Last Resort, the ECB would swap central bank liabilities for preferred stocks, i.e., senior equity securities that carry no voting rights and, thus, prohibits the ECB from getting involved in the SIFI’s business models.

There are clear advantages of the ECB engaging as the Owner of Last Resort:

1. The most important reason why the ECB should engage in the recapitalization of the European banking sector is the same as usual: it can create unlimited amounts of central bank liabilities and, thus, unlimited amounts of premium-quality capital. The ECB as an Owner of Last Resort thereby avoids the vicious circle that any other realistic recapitalization scheme would trigger: if Member States like France and Germany are supposed to finance heavy haircuts on peripheral sovereign debt, their own solvency could be endangered, respectively; this would suggest even higher default probabilities and potentially higher haircuts on sovereign debt. In turn, Member States would have to get involved in a second recapitalization-scheme, which would endanger their solvency and credit ratings even further; the feedback loop would continue until the entire Eurozone eventually collapses.

The same is true for any other limited fund like the EFSF, which is eventually backed by France and Germany (IMF-financed recapitalization would in addition endanger U.S. ratings; neither the Obama administration, nor the Republican presidential candidates show any interest in increasing IMF-funds; also China refuses to support the EFSF). By contrast, the ECB cannot become insolvent. That such a situation is considered in its constitutions is only due to the fact that it is designed by lawyers, obviously unaware of the basics of central banking: what makes a central bank so special is that the unit of account in a at system is defined in terms of its liabilities, and that its liabilities are the used to redeem contracts. The monopoly producer of the means of final settlement just cannot get bankrupt, for bankruptcy happens if you lack the means to settle your obligations. Unconstrained by its constitution, any central bank can shield its equity capital against losses.

2. The approach is incentive compatible: it rescues banks, but punishes their owners. Given the increased quantity of SIFI-stocks, the share of profits generated by such financial entities that could be distributed to the private sector diminishes. In short, recapitalization is a blow to the return on capital invested, reducing the value of each stock in circulation as well as the value of newly issued stocks. This is why banks hate it, and why they negotiate insufficient haircuts. Thus, recapitalization by the ECB must be mandatory to avoid resistance by the SIFI’s managements – who are obliged by law to protect the interests of private shareholders.

3. The approach avoids deleveraging processes that otherwise will accompany the revision of the the EU’s Capital Requirement Directive (CRD IV), which implements Basel III (in fact, CRD IV goes beyond Basel III). By cutting well-established credit lines to profitable companies, banks increase their capital ratio, respectively, by reducing the denominator. By contrast, the ECB as Owner of Last Resort would increase the numerator, leaving no rationale to deleverage. The consolidated balance sheet of the European banking system would lengthen instead. This ensures that (1) bank lending to the so-called “real economy” and (2) the transmission mechanisms of monetary policy remain intact.

4. Finally, and closely related to point 3, the ECB as Owner of Last Resort would back the possibility to implement significantly higher capital requirement over a horizon of ten to fifteen years. Research shows that high capital requirements are not detrimental to economic growth (See for example here). Instead, they ensure that systemically relevant institutions climb down the “Efficient Frontier” such that a lower return on capital invested is compensated by reduced risk. Ask yourself: Of all possible investments possibilities, why should systemically relevant institutions be the hotbed of relatively less risk averse or even risk-loving investors? All it needs is that the ECB injects more capital than projected by the EBA such as to ensure capital ratios around twenty or even thirty percent. In the aftermath of the crisis, the ECB would sell its  preferred stocks during a period of ten to fifteen years, while commercial banks are prohibited to buy back these papers.

Conclusions

To contain the crisis, the ECB should act as a Lender of Last Resort, that is, it should credibly commit itself to an unlimited swap line as described above. However, to resolve the crisis the ECB should also act as an Owner of Last Resort with respect to the European banking sector and, thereby, set the stage for haircuts on the debt of potentially insolvent peripheral members of the Eurozone.

Of course, there is little hope that Germany will ever support such unconventional measures. It already brought France and Italy into line: they all announced not to seek for ECB intervention to rescue the Eurozone from a deepening sovereign debt crisis. But the problems with my proposal root deeper: it seems not only politically infeasible, but is clearly illegal. As an adherent to the Rule of Law, I feel highly uncomfortable with my own suggestions. Yet, I am not aware of an economically admissible solution to the sovereign debt crisis in the Eurozone that also conforms to law, including those measures I am opposed to. Given that the current legal framework does not support any feasible solution, and given that we do not have the time to adjust the legal framework, we will break the law anyway. Actually, we broke it already.

Perhaps is this the major lesson of the political project to impose a common currency on a non-optimal currency area: any attempt to implement a political vision in contradiction to economic regularities is not only doomed to fail, but also undermines the fundamental ingredient to a free and prosperous society: the Rule of Law.

—–
Note:
I am grateful to Arash for this very insightful comment on crisis resolution for the euro zone. We are facing an extremely challenging situation in Europe at the moment and if we do not move swiftly to resolve the crisis we could be heading for a disastrous outcome. I therefore welcome any discussion of this is issue and I would happily accept guest posts from other economists with an input to how to solve the crisis (please mail me at lacsen@gmail.com)

Finally I should say that I think that Arash’s ideas are very helpful in the terms of solving this crisis. That does not mean I agree with everything, but on the other hand there is certainly a lot of what Arash is saying that I agree 100% with. Furthermore, there is no doubt that the concept of Owner of Last Resort is theoretically very interesting and in my view the idea deserves more attention by other researchers.

Lars Christensen

10 Comments
by Lars Christensen on December 4, 2011  •  Permalink
Posted in Arash Molavi Vasséi, euro crisis, Guest post, The euro
Tagged , , ,

Posted by Lars Christensen on December 4, 2011

https://marketmonetarist.com/2011/12/04/guest-post-why-we-need-the-european-central-bank-as-lender-and-owner-of-last-resort/

David Eagle on “Nominal Income Targeting for a Speedier Economic Recovery”

I am continuing my mini-review of the research done by Dale Domian and David Eagle. The next paper in the “series” is a truly excellent paper on an empirical investigation of the impact of different monetary policy targets (inflation targeting, Price Level Targeting and Nominal Income Targeting) on the speed of recovery in the US economy.

Here is the abstract of the paper “Nominal Income Targeting for a Speedier Economic Recovery”:

“Using panelled time-series event studies of U.S. recessions since 1948, this paper studies the speed at which the unemployment rate recovers from a recession. This paper identifies recessions (such as the 1990s and 2001 recessions) as ones consistent with inflation targeting, whereas other recessions are more consistent with nominal-income targeting. We then find that the unemployment recovery time is significantly faster for those recessions consistent with nominal-income targeting than for those recessions consistent with inflation targeting. We then discuss the theoretical superiority of nominal income targeting from a Pareto-efficient micro foundations standpoint. Also, by studying the time path of nominal aggregate spending, we find definite empirical evidence of the “let bygones be bygones” property of inflation targeting.”

The paper is extremely innovative in its method. The characteristics of the three types of targeting are used to identify what type of targeting the Federal Reserve (implicitly) has used during different recessions since World War II.

It is then shown that in those recessions the Fed has targeted nominal income the recovery was speedier than in those periods when the Fed targeted inflation.

The very innovative methods in my view clearly should inspire Market Monetarists to adopt these methods in future research to test and demonstrate the merits of Nominal Income Targeting.

Furthermore, David Eagle demonstrates in a numbers of his papers that Nominal Income Targeting (NGDP targeting) is Pareto optimal. Hence, contrary to most Market Monetarists who focus on the macroeconomic advantages of NGDP Targeting Dr. Eagle demonstrates the microeconomic advantages and has a clear welfare perspective on NGDP Targeting. I think this is a tremendous strength in his (and Domian’s) research. Eagle’s and Domian’s research in many ways remind me of George Selgin’s argument for the so-called Productivity Norm.

I certainly hope that Eagle and Domian will continue to pursue research in this area (and the related area of Quasi-Real Indexing) and I hope that the future will lead to exchange of ideas between Eagle and Domian and the Market Monetarists. Maybe one day they might even join the “club”.

4 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in David Eagle, George Selgin, Inflation Targeting, MM Research agenda, Monetary institutions, NGDP Targeting, Nominal Income Targeting, Productivity Norm, Quasi-Real Indexing
Tagged , , , , , ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/david-eagle-on-nominal-income-targeting-for-a-speedier-economic-recovery/

Jacques Delors: “Euro doomed from start”

“The euro project was flawed from the start and the current generation of European leaders has failed to address its fundamental problems, Jacques Delors, the architect of the single currency, declares today” – this according to an interview in the Daily Telegraph.

This is from the Telegraph:

“Jacques Delors, the former president of the European Commission, claims that errors made when the euro was created had effectively doomed the single currency to the current debt crisis. He also accuses today’s leaders of doing “too little, too late,” to support the single currency.

The 86-year-old Frenchman’s intervention comes the day after France and Germany took another step towards the creation of a full “fiscal union” within the European Union and David Cameron insisted that Britain must remain a major player in Europe. Mr Delors, who led the commission from 1985 to 1995, played a central role in the process that led to the creation of the euro in 1999. In his first British newspaper interview for almost a decade, he says that the debt crisis reflects a threat to Europe’s global role and even basic Western democratic values.

Mr Delors claims that the current crisis stems from “a fault in execution” by the political leaders who oversaw the euro in its early days. Leaders chose to turn a blind eye to the fundamental weaknesses and imbalances of member states’ economies, he says.

“The finance ministers did not want to see anything disagreeable which they would be forced to deal with,” he says.

The euro came into existence without strong central powers to stop members running up unsustainable debts, an omission that led to the current crisis. Now that the excessive borrowing of countries such as Greece and Italy has brought the eurozone to the brink of disaster, Mr Delors insists that all European countries must share the blame for the crisis. “Everyone must examine their consciences,” he says.”

HT “Enzo the Kenzo”

——
Update: Scott Sumner as an excellent comment on who is to blame for the euro crisis. Scott’s conclusion: The “victims” (Greece, Spain, Italy) are to blame themselves for overly loose fiscal policies, but “Enough blaming the victims. Now let’s start blaming some villains. If the ECB keeps NGDP growing at 4% after 2008, it’s likely that Greece would be the only country in crisis right now. The others would certainly still have structural issues worth addressing, but nowhere near as severe as the problems they current face.”

3 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in euro crisis
Tagged ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/jacques-delors-euro-doomed-from-start/

A simple housing rescue package – QRI Mortgages and NGDP targeting

This is from Eagle’s and Domian’s paper “Quasi-Real-Indexed Mortgages to the Rescue”:

“With the U.S. Federal Government owning so many mortgages through its bailout of Fannie Mae and Freddie Mac, there may be a unique opportunity for the government to provide a principal break to mortgage holders in return for converting the mortgages to QRIMs. Based on a old January 2009 estimate, the principal reduction would be about 7.8%. With a principal reduction of 7.8% and QRIM payments being 22% below traditional mortgage payments, we are talking about approximately 30% reduction in the monthly mortgage payments relative to the traditional mortgage payment.

Some readers might consider this a government give away. However, if the central bank was trying to target nominal aggregate demand (nominal income targeting), then the fact that nominal GDP is 7.8% below its target means that the central bank will be trying in the future to get nominal GDP back up to its nominal GDP target. To do so, the central bank will need to increase nominal GDP 7.8% in addition to the long-run growth rate in real GDP and the “targeted” inflation rate of 2.5%. Thus, if the central bank was committed to a nominal-GDP target, then if the central bank meets its target eventually, then nominal GDP will recover which means that through quasi-indexing, the principal will also recover.”

I am certainly no expert on the US housing market, but to me this seems like a great idea for a US housing rescue package.

——–

Note:

QRIMs are Quasi-Real-Indexed Mortgages which “index mortgage payments to one and only one of the two causes of inflation. That cause is aggregate-demand-caused inflation. QRIMs share an advantage of its cousin Price-Level-Adjusted Mortgages (PLAMs) in that the initial mortgage payments are smaller than with conventional mortgages making the mortgages more affordable.”  

3 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in David Eagle, NGDP Targeting, Nominal Income Targeting, Quasi-Real Indexing
Tagged , , , , ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/a-simple-housing-rescue-package-qri-mortgages-and-ngdp-targeting/

Quasi-Real indexing – indexing for Market Monetarists

This morning when I was looking for something else on the internet I by coincidence came across Dr. David Eagle’s website. Dr. Eagle is an Associate Professor of Finance at the Eastern Washington University.

I regret to say that I had never heard of David Eagle before and I have never seen any of his research before and I had never heard about an idea that he has developed with Dr. Dale L. Domian a Professor of Finance in the School of Administrative Studies at York University. The idea is what Eagle and Domian call Quasi-Real Indexing (QRI).

I am quite delighted, however, that I have now come across Eagle’s and Domian’s research and I am happy to share some of it with my readers. I think their work on QRI will be of interest Market Monetarists and QRI could be a interesting and useful supplement to NGDP targeting.

The idea behind QRI is that normal inflation indexing of wage contacts, bonds etc. is imperfect as it does not differentiate between the causes of inflation. Hence, it is crucial whether inflation is caused by demand or supply shocks. A parallel discussion to this is George Selgin’s discussion of the so-called productivity norm, which also argues that one should differentiate between the causes of inflation (or deflation).

Here is Eagle and Domian (from the abstract in a recent working paper: “Immunizing our Economies against Recessions – A Microfoundations Investigation”)

“We find that, instead of using derivatives or expensive fiscal stimuli, we can achieve recession protection through indexing wages, mortgages, bonds, etc., to changes in nominal GDP but not to aggregate-supply-caused inflation. This type of indexing we call, “quasi-real indexing.”

Hence, the idea is to shield economic agents from swings in nominal GDP. This can be done as Market Monetarists argue with NGDP targeting (something Eagle and Domian agrees on and support), but also with QRI.

Here is a bit more on QRI (from another paper “Unsticking those Sticky Wages To Mitigate Recessions Without Expensive Fiscal Stimuli”):

”The conventional form of inflation indexing, also known as cost of living adjustments (COLAs), is based on price changes no matter what the cause… there are two and only two determinants of inflation: (1) aggregate demand as measured by nominal GDP, and (2) aggregate supply as measured by real GDP. QRI is linked to only one of these causes — nominal GDP, but not to real GDP. Because QRI is based on a cause, not the price level itself. QRI is proactive; if the price level is sticky as most economists believes, then QRI can respond to changes in nominal GDP prior to the price level being affected by those changes.”

I think this makes quite a bit of sense – and it is pretty much how Market Monetarists think.

Everything Eagle and Domian write on the topic of QRI seems to be a bit of a gold mine for Market Monetarists thinking and their modelling could be helpful in the further theoretical development of Market Monetarism. See here for example:

”Many economists may criticize QRI because it only responds to aggregate-demand-caused inflation and not to aggregate-supply-caused inflation. They may cite the almost universally accepted goal in monetary policy and macroeconomic policy of minimizing an objective function involving inflation (or the price level) and output gap (or unemployment or output). In fact, this objective function has been institutionalized into the legislative mandate for the Federal Reserve… However, that objective function, which is an ad hoc assumption of economists, has blind economists from what microfoundations says should be the objective of monetary and macroeconomic policy. Later in this paper, we present Pareto-efficiency arguments why we should only adjust for aggregate-demand-caused inflation and not for aggregate-supply caused inflation. At this point in the paper, realize that at one time medical science considered all cholesterol as bad; now they consider there to be both good cholesterol and bad cholesterol. Up to now, economists have considered any inflation above the targeted inflation rate to be bad inflation. Our view, supported by microfoundations involving Pareto efficiency is that unexpected aggregate-demand-caused inflation (or deflation) is bad but aggregate-supply-caused inflation (or deflation) is necessarily for the economy to efficiently handle the lower (or higher) supply.”

This is exactly what Market Monetarist are saying – and this discussion gives an excellent input to for example the discussion of the Taylor rule versus NGDP targeting.

There are many aspects of QRI and as I state above I have only become familiar with the topic today so I will not go in to it all in this post. However, as I see it the (for now) small literature seems very interesting and the QRI could sheet a lot of light on the advantages of NGDP targeting and it also seems like QRI could be helpful in crisis resolution in both Europe and the US. In that regard Eagle’s and Domian’s papers on QRI linked bonds seem especially of interest.

I sincerely hope that my fellow Market Monetarist bloggers will have a look at Eagle’s and Domian’s interesting work on QRI and finally I would like to quote an appeal from David Eagle’s website posted on February 26 2009:

“I write this internet note with the hope that it gets to someone with influence. That someone could be a state or other local legislator struggling with how to cut their budget. That someone could be an administrator with a federal government trying to find some way to help their economy get through the current financial debacle. That someone could be working in a bank with the task of figuring out a way to refinance mortgages to avoid foreclosures and make it more affordable for homeowners to stay in their houses. That someone could work for a firm who is struggling to meet payroll in this time of lower demand for their product. That someone could even be President Obama as he struggles with many of these issues on the macroeconomic level. All these people are looking for ways to either better deal with the current recession or help others better deal with the current recession. I write this note, because I have a solution, a cheap solution, although the solution involves a major change in how businesses, governments, workers, lenders, and borrowers deal with each other. The solution is quasi-real indexing, a type of inflation indexing Dale Domian and I have designed.
Many of you will be skeptical and will ask, “What does inflation indexing have to do with the current recession?” A quick economic lesson will answer this question for you. Remember the debate between the Keynesian economists and the classical economists in the 1930s during the Great Depression. The classical economists criticized Keynesian economics by arguing that in the long run, prices and wages will adjust to return real output to its normal level. In response, John Maynard Keynes said, “In the long run, we all are dead!” The essence of Keynesian economics is that prices and wages are sticky, especially in the downward direction. Inflation indexing can then be very relevant if that indexing causes prices and wages to adjust very quickly.

However, the current recession makes this indexing really relevant. If most contracts were quasi-real indexed, then the current financial crisis would not be having such a negative effect on the overall economy.

Why is the financial crisis having such a negative effect on the economy? Because the financial crisis has caused nominal aggregate spending to decline. This can be explained relatively simply with one equation, N=PY, where N is the level of nominal aggregate spending, P is the general price level, and Y is real GDP. When N decreases, either P or Y must decrease. Prior to Keynesian economics, the classical economists thought that the decline in N would be felt by a decline in P, with no effect on Y. However, in the 1930s during the Great Depression, John M. Keynes challenged that premise, by arguing that in the short run, prices and wages would be sticky, which means that a drop in N will lead to a drop in Y. Even Milton Friedman and the Monetarists would not argue with this statement, but Friedman put the blame for the drop in N during the Great Depression on an over 30% decrease in the money supply between 1929 and 1933.

The important lesson to learn from the above paragraph is that a drop in nominal aggregate spending (N), as is occurring today, impacts the real output (Y) because prices and wages do not adjust much in the short run. This is where quasi-real indexing can help. If wages and some prices were quasi-real indexed, they will immediately respond to changes in nominal aggregate spending, one of the major causes of inflation. This is one of the advantages of quasi-real indexing over traditional inflation indexing — quasi-real indexing responds almost immediately to changes in nominal aggregate spending, rather than waiting for the price effects to occur.

A second advantage of quasi-real indexing is that it does not filter out the inflation caused by aggregate-supply shocks. Why is this advantage? Realize that 30 years ago, medical professionals thought that all cholesterol was bad. Now, they have come to recognize that some cholesterol is good while other is bad. Our research indicates that aggregate-supply-caused inflation is actually good; only aggregate-demand-caused inflation is bad. Quasi-real indexation filters out the bad inflation while leaving the good inflation intact. When all wages, prices, mortgages, bonds, and other contracts are quasi-real indexed; the economy becomes immune to fluctuations to nominal aggregate spending. In this sense quasi-real indexation immunizes an economy against recessions caused by drops in nominal aggregate spending. It also protects workers, employers, lenders, and borrowers from the uncertainties caused by unexpected changes in nominal aggregate spending. Hence, quasi-real indexation improves the economic efficiency of an economy.

One concern in the current economy that is contributing to the financial crisis are mortgages. An objective of the Obama administration is to help households refinance their mortgages in such a way to make them more affordable for people to stay in their homes and avoid foreclosure. Quasi-real mortgages can do just that. Realize that quasi-real mortgages are a lot like Price-Level-Adjusted Mortgages (PLAMs), except quasi-real mortgages do not have the defect of increasing monthly mortgage payments when aggregate-supply-caused inflation occurs. The initial payment on both quasi-real mortgages and PLAMs is significantly lower than with a fixed-nominal-rate, fixed payment mortgage. The literature on mortgages calls this effect the “tilt” effect. For example, the initial payment on a 7.2%, fixed-rate, fixed-payment 30-year, $200,000 mortgage is $1357.58. However, the initial payment on a 3.6%, quasi-real 30-year, $200,000 mortgage is $909.29, which is over 30% less than under a traditional mortgage.

Wages are difficult to reduce in a recession, but they really should come down for economic efficiency. One reason why workers may be reluctant to give in to wage cuts is because of their fixed obligations like mortgages, although if they refinanced with a quasi-real mortgage, that would be less of an issue. A second reason why workers may be reluctant to give in to wage cuts is because once their wage is cut, they may think it will be difficult to get their wage raised when the economy returns to normal. That is part of the reason that quasi-real indexing would work so well; quasi-real indexing would automatically increase wages when the economy (nominal aggregate spending) recovers. Also, if nominal aggregate spending increases too much, leading to high inflation, the quasi-real indexing will take care of that, usually before the inflation took place.

Furthermore, employers may try to bring down wages down or make other cuts so that they are prepared for even bleaker times. However, quasi-real indexing of wages would do those reductions automaticly when nominal aggregate spending falls, so there would be no need for employers to bring down the wages below where they otherwise should be. Also, employees may be more willing to accept these wage cuts in return for quasi-real indexing being there to protect them in the future when the economy rebounds.

In the past, I have been frustrated with the publication barriers put up by economic journals, which have prevented me from getting my ideas exposed. With this note, I am bypassing those journals (although Dale and I will still try to publish in those journals). I hope that someone in Cyberland will find our message and investigate and try to contact us. Dale and I are currently writing more papers to help communicate these very important ideas. However, our previous papers were written at a very high theoretical level; we are now trying to bring these papers down to earth, making them more readable to more people. When we get those papers in more polished forms, I will try to make them available on this web site.”

Well Dr. Eagle – now I done a bit to spread your idea, which I find intriguing and I am sure my fellow Market Monetarist bloggers will take up the idea as well and discuss it. I don’t think QRI will take us out of this recession – we probably need NGDP level targeting for that – but I am pretty sure that the QRI literature will help us understand the present crisis better and could be very helpful in the crisis resolution.

PS When I read about Dr. Eagle’s frustrations I am reminded of how Scott Sumner felt back in 2009.

—-

Eagle’s and Domian’s papers on QRI and NGDP targeting:

Immunizing our Economies against Recessions — A Microfoundations Investigation


Unsticking those Sticky Wages To Mitigate Recessions Without Expensive Fiscal Stimuli


Nominal Income Targeting for a Speedier Economic Recovery


Quasi-Real-Indexed Mortgages to the Rescue

Using Quasi-Real Contracts to Help Mitigate Aggregate-Demand-Caused Recessions and Inflations

Quasi-real Government Bonds — Inflation Indexing With Safety 

20 Comments
by Lars Christensen on December 3, 2011  •  Permalink
Posted in David Eagle, George Selgin, John Taylor, MM Research agenda, Monetary institutions, NGDP Targeting, Nominal Income Targeting, Productivity Norm, Quasi-Real Indexing, Scott Sumner
Tagged , , , , , ,

Posted by Lars Christensen on December 3, 2011

https://marketmonetarist.com/2011/12/03/quasi-real-indexing-indexing-for-market-monetarists/

Wauw! We have a Market Monetarist at the Telegraph

Here is Ambrose Evans-Pritchard at the Daily Telegraph:

“A near universal view has emerged that Europe’s crisis can only be solved by governments and fiscal policy, with varying views over the proper dosage of pain. I beg to differ. This is a monetary crisis, caused by a jejune central bank that aborted a fragile recovery by raising rates earlier this year, allowed the money supply to collapse at vertiginous rates in southern Europe, and caused a completely unnecessary recession — and a deep one judging by the collapse in the PMI new manufacturing orders in November…Needless to say, drastic fiscal austerity is making matters a lot worse. You cannot push two-thirds of the eurozone into synchronized fiscal and monetary contraction without consequences.”

Do I need to say I agree? I do of course – even though I am less worried about the fiscal austerity than Ambrose.

Ambrose continues:

“The eurozone economy is in imminent danger of crashing into deflation, bringing down the whole interlocking edifice of sovereign debt and distressed lenders. And bear in mind that Europe’s bank nexus — including the UK, Swiss, Scandies — is €31 trillion. Big stuff.

This crisis can be stopped very easily by monetary policy, working through the old-fashion Fisher-Hawtrey-Friedman method of open-market operations to expand the quantity of money, ideally to keep nominal GDP growth on an even keel.“

We already know that Ambrose is reading the Market Monetarist blogs – now we know he also understands and agrees (I kind of had an idea about that already…did he for example read this comment). Back to Ambrose:

“This does not solve the 30pc intra-EMU currency misalignment between North and South, of course, but it quite literally “solves” the solvency crisis for Italy and Spain. They would not be insolvent if the ECB had not driven them into depression by letting their money supply implode.

Yes, I know there are lots of central bankers who say or think monetary policy cannot achieve these miracles. They are wrong. Of course it can. A whole generation of policy-makers have been side-tracked into cul-de-sacs like (Bernanke) creditism, or German religious theories of “expansionary fiscal contractions”. (By the way, I learned in Ireland last week that the country’s 1980s experience used as the poster child for that credo is based on false data. It does not validate the theory at all).

They have forgotten some basic lessons of economic history. As the Bank of England’s Adam Posen put it, policy defeatism has taken over.

I have no idea whether ECB chief Mario Draghi really believes the mantra he is constrained to utter by his masters. It hardly matters. But his insistence that this crisis must be solved by governments alone — “a new fiscal compact” as he called it today — is a derelection of duty.”

I have nothing to add. Lets just conclude that we have a Market Monetarist at the Daily Telegraph and it is a joy to read his comments.

—–

If you want to read some of my comments on the topic covered by Ambrose see below.

On “monetary policy defeatism”:
Adam Posen calls for more QE – that’s fine, but…
Gustav Cassel foresaw the Great Depression
“Our Monetary ills Laid to Puritanism”
Calvinist economics – the sin of our times

Fisher (and bit on Friedman):
Repeating a (not so) crazy idea – or if Chuck Norris was ECB chief
The Chuck Norris effect, Swiss lessons and a (not so) crazy idea
Irving Fisher and the New Normal
The Fisher-Friedman-Sumner-Svensson axis

—–

Update: David Beckworth also has a comment on Ambrose.

 

2 Comments
by Lars Christensen on December 2, 2011  •  Permalink
Posted in Ambrose Evans-Pritchard, euro crisis
Tagged ,

Posted by Lars Christensen on December 2, 2011

https://marketmonetarist.com/2011/12/02/wauw-we-have-a-market-monetarist-at-the-telegraph/

Selgin’s Monetary Credo – Please Dr. Taylor read it!

Ok, there is no reason to hide it – I love George Selgin or at least his thinking on monetary theory. George of course is the source to go to on Free Banking theory and history (ok, Larry White is also pretty cool…) and he is of course an expert and a true pioneer on nominal income targeting. His work on the so-called Productivity Norm should be standard reading for anybody with the slightest interest in monetary theory. And now George is out with a comment on NGDP targeting. It is primarily a response to John Taylor’s recent critique of NGDP targeting.

Here is Selgin:

“Thus Professor Taylor complains that, “if an inflation shock takes the price level and thus NGDP above the target NGDP path, then the Fed will have to take sharp tightening action which would cause real GDP to fall much more than with inflation targetting.” Now, first of all, while it is apparently sound “Economics One” to begin a chain of reasoning by imagining an “inflation shock,” it is crappy Economics 101 (or pick your own preferred intro class number), because a (positive) P or inflation “shock” must itself be the consequence of an underlying “shock” to either the demand for or the supply of goods. The implications of the “inflation shock” will differ, moreover, according to its underlying cause. If an adverse supply shock is to blame, then the positive “inflation shock” has as its counterpart a negative output shock. If, on the other hand, the “inflation shock” is caused by an increase in aggregate demand, then it will tend to involve an increase in real output. Try it by sketching AS and AD schedules on a paper napkin, and you will see what I mean.”

Damn, I would not like to be on the receiving end of a critique from Dr. Selgin! But he is of course ever so right…inflation is alway and everywhere a monetary phenomenon (as is recessions) and the problem with the economics of John Taylor and other New Keynesians (yes guys, he is a New Keynesian!) is that they see inflation fluctuations as basically non-monetary shocks or at least think that monetary policy should be used to “counteract” non-monetary shocks.

John Taylor and other New Keynesians therefore see monetary policy as responding either with rules (as Taylor prefers) or with discretionary monetary policy to “shocks”. However, fluctuations in nominal GDP, the price level and inflation are monetary phenonoma. Therefore, monetary policy do not need to “respond” to “shocks”. Monetary policy should not create the shocks in the first place and that is the purpose of NGDP targeting. As I have earlier tired to explain – NGDP is not a form of monetary “fine tuning”. It is in fact the direct opposite.

Or say George explains: “We shall have no real progress in monetary policy until monetary economists realize that, although it is true that unsound monetary policy tends to contribute to undesirable and unnecessary fluctuations in prices and output, it does not follow that the soundest conceivable policy is one that eliminates such fluctuations altogether. The goal of monetary policy ought, rather, to be that of avoiding unnatural fluctuations in output–that is, departures of output from its full-information level–while refraining from interfering with fluctuations that are “natural.” That means having a single mandate only, where that mandate calls for the central bank to keep spending stable, and then tolerate as optimal, if it does not actually welcome, those changes in P and y that occur despite that stability“

Any Market Monetarist (in fact anybody with interest in monetary theory and policy) should remember these words. So lets repeat them (in a shorter version) and let us call it Selgin’s Monetary Credo:

“The goal of monetary policy ought to be that of avoiding unnatural fluctuations in output…while refraining from interfering with fluctuations that are “natural.” That means having a single mandate only, where that mandate calls for the central bank to keep spending stable, and then tolerate as optimal, if it does not actually welcome, those changes in P and y that occur despite that stability“

So one more time – the goal of monetary policy is NOT to fine tune the economic development, but to avoid creating “unnatural” fluctuations in nominal spending and prices.

I have often been critical about the call for “monetary stimulus” from some Market Monetarists as it has lead many to think that we are in favour of activist monetary policies. We are not in favour of activist policies, we are in favour of “Selgin’s monetary credo”!

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See my earlier overview of the Market Monetarist response to John Taylor’s critique of NGDP targeting here.

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Marcus Nunes also has a comment on Selgin as do Scott Sumner.

10 Comments
by Lars Christensen on December 1, 2011  •  Permalink
Posted in George Selgin, MM Research agenda, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Selgin's Monetary Credo
Tagged ,

Posted by Lars Christensen on December 1, 2011

https://marketmonetarist.com/2011/12/01/selgins-monetary-credo-please-dr-taylor-read-it/

Market Monetarism comes to Hong Kong

Dr. Yue Chim Richard Wong Professor at the University of Hong Kong has an excellent comment on Market Monetarism on his great blog. Dr. Wong is a specialist among other things on the Hong Kong property market and a well-known economics commentator in Hong Kong.

In his comment “Easy Money, Tight Money, and Market Monetarism” he explains the background for Market Monetarism and explain the key theoretical insights and policy recommendations from Market Monetarism. It is an excellent introduction to Market Monetarism – to some extent a parallel description to my own working paper on the foundation for Market Monetarism.

Dr. Wong has some interesting observations about the main Market Monetarist thinkers/bloggers:

The Market Monetarist blogger are “(a)n assorted group of economists, mostly of the free market persuasion, (who) have joined Sumner in developing and elaborating the subtle logic behind NGDP targeting and they continue to debate the new Keynesians and old Monetarists…”

Dr. Wong continues: “The amazing fact about the group is that most of the members are relatively junior in the economics profession and are concentrated in the teaching universities. For me this was an absolutely delightful finding. I have always wondered if the pressure to publish research in ever more specialized and compartmentalized fields in the major research universities is an unqualified healthy outcome for academia.”

This I think is a very interesting observation. Scott Sumner spend more than 20 years teaching without anybody in the economics profession really noticing his important research (I did!). But once he started blogging he became the main force behind the creation of a new economic school. A school I am proud to belong to – Market Monetarism.

There is no doubt that Dr. Wong is highly sympathetic to Market Monetarism and in that regard I don’t think it is a coincidence that Wong has his PhD from the University of Chicago as is the case for Scott Sumner. To me the link to the University of Chicago is key to the intellectual development of Market Monetarism.  It is, however, not today’s University of Chicago, but the 1960s and 1970s when Milton Friedman still was a professor at the University. Friedman retired in 1977. The economic and monetary theory that Friedman was teaching at the University of Chicago was policy oriented and “practical”. Contrary to the focus at most universities where students spending most of their time with advanced mathematically models with little or no relevance to the real world – and if the models are relevant the students and professors alike often don’t realise it themselves and the policy conclusions are often not spread to a wider audience.

Scott Sumner, David Beckworth and the other Market Monetarist bloggers have made monetary theory accessible to policy makers, market participants, commentators and journalists. This in my view is the real achievement of Market Monetarism and I am happy to say that Dr. Wong now is helping spreading the word.

PS Dr. Wong write comments in both English and Chinese. He writes a weekly political economy column for the Hong Kong Economic Journal.

 

1 Comment
by Lars Christensen on December 1, 2011  •  Permalink
Posted in David Beckworth, MM Research agenda, Reading recommendations, Scott Sumner
Tagged , ,

Posted by Lars Christensen on December 1, 2011

https://marketmonetarist.com/2011/12/01/market-monetarism-comes-to-hong-kong/

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