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Don’t forget the ”Market” in Market Monetarism

As traditional monetarists Market Monetarists see money as being at the centre of macroeconomic discussion. To us both inflation and recessions are monetary phenomena. If central banks print too much money we get inflation and if they print to little money we get recession or even depression.

This is often at the centre of the arguments made by Market Monetarists. However, we are exactly Market Monetarists because we have a broader view of monetary policy than traditional monetarists. We deeply believe in markets as the best “information system” – also about the stance of monetary policy. Even though we certainly do not disregard the value of studying monetary supply numbers we believe that the best indicator(s) of monetary policy stance is market pricing in currency markets, commodity markets, fixed income markets and equity markets. Hence, we believe in a Market Approach to monetary policy in the tradition of for example of “Manley” Johnson and Robert Keheler.

In fact we want to take out both the “central” and “banking” out of central banking and ideally replace monetary policy makers with the power of the market. Scott Sumner has suggested that the central banks should use NGDP futures in the conduct of monetary policy. In Scott’s set-up monetary policy ideally becomes “endogenous”. I on my part have suggested the use of prediction markets in the conduct of monetary policy.

Sometimes the Market Monetarist position is misunderstood to be a monetary version of (vulgar) discretionary Keynesianism. However, Market Monetarists are advocating the exact opposite thing. We strongly believe that monetary policy should be based on rules rather than discretion. Ideally we would prefer that the money supply was completely market based so that velocity would move inversely to the money supply to ensure a stable NGDP level. See my earlier post “NGDP targeting is not a Keynesian business cycle policy”

Even though Market Monetarists do not necessarily advocate Free Banking there is no doubt that Market Monetarist theory is closely related to the thinking of Free Banking theorist such as George Selgin and I have early argued that NGDP level targeting could be see as “privatisation strategy”. A less ambitious interpretation of Market Monetarism is certainly also possible, but no matter what Market Monetarists stress the importance of markets – both in analysing monetary policy and in the conduct monetary policy.

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See also my earlier post from today on a related topic.

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“Should we replace Mervyn King with a robot?”

Sean Keyes at MoneyWeek has an article on Market Monetarism. To me he seems to understand MM better than most journalists. Here is Keyes:

“What they (Market Monetarists) imagine is a world without central bankers. A world where monetary policy is managed by machines. Where Keynesian stimulus spending and wrenching business cycles are a thing of the past…It’s all got to do with something called NGDP”

That surely sounds good to me – central banks’ discretionary behaviour replaced by a clear NGDP level rule.

Keyes also understands that monetary policy is not about interest rates:

“Currently the Bank of England steers the economy by adjusting interest rates to hit a target inflation rate of 2% (as measured by the consumer price index). This worked well enough during the ‘great moderation’, a golden, self-congratulatory 25 year period for macroeconomists and central bankers when inflation (by mainstream measures at least) was low and recessions were mild.

But since 2008 their interest rate lever has stopped working. 0% rates have not been sufficient to spur spending and growth. So what’s the solution?

Market monetarists say that central banks should instead target a given rate of nominal gross domestic product (NGDP) growth instead of a given rate of inflation. NGDP is simply the sum of all spending in the economy in a year – it’s what you’d get if you didn’t bother to adjust GDP for inflation. A central bank might pick a target of, say, 5% NGDP growth, consisting of 2.5% desired inflation plus the 2.5% long-run trend growth in output. But how would it work in practice?”

My American readers should of course realise that Keyes is British – that’s why he is talking about the Bank of England. But so far so good.

Keyes does not mention the Chuck Norris effect (he really should have, but ok he is forgiven…). But he got it right on expectations and central bank credibility:

“Well, say the market monetarists, imagine two possible states: an optimistic state where the people expect good times, prosperity and growth; and an otherwise identical but pessimistic state where the people are uncertain and fearful about their economic future. The citizens in the optimistic state will invest, borrow and spend freely which will lead to prosperity; uncertainty and fear in the pessimistic state will lead to self-fulfilling stagnation.

However, the poorer world could become the richer one, with a collective change of mindset. Here is where our market monetarist central bank comes in. Its role is as the great persuader. It creates those expectations of prosperity.    

To change minds, the market monetarist central bank must be credible. Let’s say that the Bank of England is not perfectly credible, in that its board of governors is divided between policy hawks (those who want to tighten monetary policy) and doves (those who want to loosen it). People might reasonably doubt its commitment to reflating the economy. How would the Bank of England persuade the economy back to health?

First the Bank would need to set an explicit target for NGDP growth. It would have to promise to buy unlimited quantities of assets (using newly created money) to achieve this target. As it set about its task, month by month, trillion by trillion, people would come to accept its commitment to the policy and begin to spend in the expectation of future inflation. The expected numbers would drive the real numbers. Spending would rise and the real resources of the economy would be fully employed, which would achieve the Bank’s 5% NGDP growth target.”

But the best part is that Keyes acknowledges that Market Monetarism is the not the monetary version of vulgar keynesian “stimulus”, but rather that Market Monetarists believe in rules rather than discretion and in general distrust the central planing elements in “modern” central banking:

“And this is where we get to the ‘market’ part of market monetarism (MMT for short). Ultimately, the logic of MMT leads to a world without central bankers.

If a market for NGDP futures were established (ie enabling investors to bet on where they thought economic growth was heading), then the central bank could simply conduct whatever monetary policy directed the NGDP futures price towards the stated NGDP growth target.

In the end, the NGDP futures markets could replace central bankers. In this world, monetary policy could be managed by a computer, conducting whatever policy nudged NGDP futures markets onto the target. In fact, saying that monetary policy is managed by a robot isn’t quite accurate – really it’s being managed by the markets, which is what advocates of scrapping central banks altogether often say is what should be happening.

It’s an appealing vision. The western world is stuck for solutions, and desperate. Sumner offers an easy answer, and in practice we suspect it’d be a lot harder to implement. But if you must have a central bank, then increasing the market’s role in setting rates, and shrinking the influence of politics, and fallible human central bankers, on the process, can only be a good thing.”

But oops…MMT? Keyes, that is something completely different. MM is short for Market Monetarism. MMT is “Modern Monetary Theory” and that is certainly not Market Monetarism. Other than that little mistakes Keyes’ article is a good little introduction to Market Monetarist thinking.

Keyes article is yet another prove that Market Monetarism increasingly is being recognized in the broader financial media and maybe soon central bankers around the world will also start listening.

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