All posts for the month February, 2012

I am blaming Murray Rothbard for my writer’s block

I have promised to write an article about monetary explanations for the Great Depression for the Danish libertarian magazine Libertas (in Danish). The deadline was yesterday. It should be easy to write it because it is about stuff that I am very familiar with. Friedman’s and Schwartz’s “Monetary History”, Clark Warburton’s early monetarist writings on the Great Depression. Cassel’s and Hawtrey’s account of the (insane) French central bank’s excessive gold demand and how that caused gold prices to spike and effective lead to an tigthening of global monetary conditions. This explanation has of course been picked up by my Market Monetarists friends – Scott Sumner (in his excellent, but unpublished book on the Great Depression), Clark Johnson’s fantastic account of French monetary history in his book “Gold, France and the Great Depression, 1919-1932” and super star economic historian Douglas Irwin.

But I didn’t finnish the paper yet. I simply have a writer’s block. Well, that is not entirely true as I have no problem writing these lines. But I have a problem writing about the Austrian school’s explanation for the Great Depression and I particularly have a problem writing about Murray Rothbard’s account of the Great Depression. I have been rereading his famous book “America’s Great Depression” and frankly speaking – it is not too impressive. And that is what gives me the problem – I do not want to be too hard on the Austrian explanation of the Great Depression, but dear friends the Austrians are deadly wrong about the Great Depression – maybe even more wrong than Keynes! Yes, even more wrong than Keynes – and he was certainly very wrong.

So what is the problem? Well, Rothbard is arguing that US money supply growth was excessive during the 1920s. Rothbard’s own measure of the money supply  apparently grew by 7% y/y on average from 1921 to 1929. That according to Rothbard was insanely loose monetary policy. But was it? First of all, money supply growth was the strongest in the early years following the near-Depression of 1920-21. Hence, most of the “excessive” growth in the money supply was simply filling the gap created by the Federal Reserve’s excessive tightening in 1920-21. Furthermore, in the second half of the 1920s money supply started to slow relatively fast. I therefore find it very hard to argue as Rothbard do that US monetary policy in anyway can be described as being very loose during the 1920s. Yes, monetary conditions probably became too loose around 1925-7, but that in no way can explain the kind of collapse in economic activity that the world and particularly the US saw from 1929 to 1933 – Roosevelt finally did the right thing and gave up the gold standard in 1933 and monetary easing pulled the US out of the crisis (later to return again in 1937). Yes dear Austrians, FDR might have been a quasi-socialist, but giving up the gold standard was the right thing to do and no we don’t want it back!

But why did the money supply grow during the 1920s? Rothbard – the libertarian freedom-loving anarchist blame the private banks! The banks were to blame as they were engaging in “pure evil” – fractional reserve banking. It is interesting to read Rothbard’s account of the behaviour of banks. One nearly gets reminded of the Occupy Wall Street crowd. Lending is seen as evil – in fact fractional reserve banking is fraud according to Rothbard. How a clever man like Rothbard came to that conclusion continues to puzzle me, but the fact is that the words “prohibit” and “ban” fill the pages of Rothbard’s account of the Great Depression. The anarchist libertarian Rothbard blame the Great Depression on the fact that US policy makers did not BAN fractional reserve banking. Can’t anybody see the the irony here?

Austrians like Rothbard claim that fractional reserve banking is fraud. So the practice of private banks in a free market is fraud even if the bank’s depositors are well aware of the fact that banks do not hold 100% reserve? Rothbard normally assumes that individuals are rational and it must follow from simple deduction that if you get paid interest rates on your deposits then that must mean that the bank is not holding 100% reserves otherwise the bank would be asking you for a fee for keeping your money safe. But apparently Rothbard do not think that individuals can figure that out. I could go on and on about how none-economic Rothbard’s arguments are – dare I say how anti-praxeological Rothbard’s fraud ideas are. Of course fractional reserve banking is not fraud. It is a free market phenomenon. However, don’t take my word for it. You better read George Selgin’s and Larry White’s 1996 article on the topic “In Defense of Fiduciary Media – or, We are Not Devo(lutionists), We are Misesians”. George and Larry in that article also brilliantly shows that Rothbard’s view on fractional reserve banking is in conflict with his own property right’s theory:

“Fractional-reserve banking arrangements cannot then be inherently or inescapably fraudulent. Whether a particular bank is committing a fraud by holding fractional reserves must depend on the terms of the title-transfer agreements between the bank and its customers.

Rothbard (1983a, p. 142) in The Ethics of Liberty gives two examples of fraud, both involving blatant misrepresentations (in one, “A sells B a package which A says contains a radio, and it contains only a pile of scrap metal”). He concludes that “if the entity is not as the seller describes, then fraud and hence implicit theft has taken place.” The consistent application of this view to banking would find that it is fraudulent for a bank to hold fractional reserves if and only if the bank misrepresents itself as holding 100percent reserves, or if the contract expressly calls for the holding of 100 percent reserves.’ If a bank does not represent or expressly oblige itself to hold 100 percent reserves, then fractional reserves do not violate the contractual agreement between the bank and its customer (White 1989, pp. 156-57). (Failure in practice to satisfy a redemption request that the bank is contractually obligated to satisfy does of course constitute a breach of contract.) Outlawing voluntary contractual arrangements that permit fractional reserve-holding is thus an intervention into the market, a restriction on the freedom of contract which is an essential aspect of private property rights.”

Another thing that really is upsetting to me is Rothbard’s claim that Austrian business cycle theory (ABCT) is a general theory. That is a ludicrous claim in my view. Rothbard style ABCT is no way a general theory. First of all it basically describes a closed economy as it is said that monetary policy easing will push down interest rates below the “natural” interest rates (sorry Bill, Scott and David but I think the idea of a natural interest rates is more less useless). But what determines the interest rates in a small open economy like Denmark or Sweden? And why the hell do Austrians keep on talking about the interest rate? By the way interest rates is not the price of money so what do interest rates and monetary easing have to do with each other? Anyway, another thing that mean that ABCT certainly not is a general theory is the explicit assumption in ABCT – particularly in the Rothbardian version – that money enters the economy via the banking sector. I wonder what Rothbard would have said about the hyperinflation in Zimbabwe. I certainly don’t think we can blame fractional reserve banking for the hyperinflation in Zimbabwe.

Anyway, I just needed to get this out so I can get on with writing the article that I promised would be done yesterday!

PS Dear GMU style Austrians – you know I am not talking about you. Clever Austrians like Steve Horwitz would of course not argue against fractional reserve banking and I am sure that he thinks that Friedman’s and Schwartz’s account of the Great Depression makes more sense than “America’s Great Depression”.

PPS not everything Rothbard claims in “America’s Great Depression” is wrong – only his monetary theory and its application to the Great Depression. To quote Selgin again: “To add to the record, I had the privilege of getting to know both Murray and Milton. Like most people who encountered him while in their “Austrian” phase, I found Murray a blast, not the least because of his contempt for non-Misesians of all kinds. Milton, though, was exceedingly gracious and generous to me even back when I really was a self-styled Austrian. For that reason Milton will always seem to me the bigger man, as well as the better monetary economist.”

PPPS David Glasner also have a post discussing the Austrian school’s view of the Great Depression.

Update: Steve Horwitz has a excellent comment on this post over at Coordination Problem and Peter Boettke – also at CP – raises some interesting institutional questions concerning monetary policy and is asking the question whether Market Monetarists have been thinking about these issues (We have!).

50 Comments
by Lars Christensen on February 11, 2012  •  Permalink
Posted in Austrian economics, Douglas Irwin, Federal Reserve, George Selgin, Gold Standard, Gustav Cassel, Larry White, Monetary institutions, New Casselian economics, Scott Sumner, Steven Horwitz, The Great Depression
Tagged , , , , , , , , ,

Posted by Lars Christensen on February 11, 2012

https://marketmonetarist.com/2012/02/11/i-am-blaming-murray-rothbard-for-my-writers-block/

Do we have a problem if it works?

Recently I have become more positive on the outlook for the European and US economies. It seems like the ECB has finally recognised that it need to ease monetary policy to avoid a deflationary disaster and judging from the development in broad monetary aggregates in the US there are signs that things are also moving in the right direction in the US economy.

If investors and consumers are jumping on the happy-go-lucky bandwagon then we might even see the money velocity in the US and the euro zone  begin to inch up. If both broad money supply growth is picking up and velocity would be inching upward then nominal GDP and inflation would also be accelerating and as any Market Monetarist will tell you expectations are key so the recovery could be very swift if market participants start to think that central banks are willing to accept as short-term pick up inflation to achieve a higher level of NGDP.

Lets be really optimistic and say that US inflation jumps to 5% in the coming half year and real GDP also increases to 5% (there are no signs that that is happening). That would give us 10% NGDP growth and we would finally be closing the “NGDP gap” and start to return to the pre-crisis trend. What would happen in that situation? Well, some of us would happy, but there is no doubt that the fears of “runaway inflation” would increase. As somebody asked me the other day “will you be able to stop inflation getting out of control if you have 2 years in a row with 5 or 7% inflation?” My answer was “Clearly!”, but I must also admit that I am more worried than that answer reflected.

Hence, in my view there is a real risk that if monetary policy is eased in the present “stealth” fashion then it will be much harder to anchor expectations – and more importantly it might be harder to get policy makers back to the idea that high inflation is bad. No, please do remember that we are not inflationists. Inflation is bad – at least demand inflation is bad.

Therefore, I think that even if nominal GDP growth starts to pick up I think is extremely important that we keep arguing in favour of NGDP level targeting. We don’t want “stimulus” to bring us out of the present mess. No, we want a monetary regime that ensures us against ever to get into this situation again. So yes, we should clearly argue for monetary easing now, but it is much more important that sound monetary regimes are implemented.

Lets say I had the choice between increasing euro NGDP with 15% right now but also maintain the overall present monetary regime in Europe (with all its faults) or have a monetary regime based NGDP level targeting (but from present levels) then I surely would prefer the later.

9 Comments
by Lars Christensen on February 9, 2012  •  Permalink
Posted in Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting
Tagged ,

Posted by Lars Christensen on February 9, 2012

https://marketmonetarist.com/2012/02/09/do-we-have-a-problem-if-it-works/

Selgin on Quasi-Commodity Money (Part 1)

George Selgin just send me his new paper on what he has termed Quasi-Commodity Money. George spoke briefly on this topic in his recent presentation at the Italian Free Market think tank the Bruno Leoni Institute. See my comment here on the presentation and my review on a related paper – “L Street – Selgin’s prescription for Money Market reform”

Over at Freebanking.org George is complaining that he does not have enough time for blogging. Unfortunately I am in slightly the same situation. Greece is on the verge of default and so it is busy, busy times in the financial sector and I have promised to write a paper on monetary explanations for the Great Depression for the Danish libertarian journal the Libertas magazine and also need to write a preview for the republished version of the Danish translation of Milton Friedman’s “Free to Choose” (Remember uncle Milt would have turned 100 this year). And then I need to review a couple of books for another magazine. So yes I share George’s frustration about not having enough time for everything. Therefore, I will not write a review of George’s paper today. However, I do promise to do that very soon as I know that what George has to say always is interesting and important.

Until then here is the abstract of George’s paper:

“This paper considers reform possibilities posed by a type of base money that has heretofore been overlooked in the literature on monetary economics. I call this sort of money ‘quasi-commodity money’ because it shares features with both commodity money and fiat money, as these are usually defined, without fitting the conventional definition of either; examples of such money are Bitcoin and the ‘Swiss dinars’ that served as the currency of northern Iraq for over a decade. I argue that the attributes of quasi-commodity money are such as might supply the basis for a monetary regime that does not require oversight by any monetary authority, yet is capable of providing for all such changes in the money stock as may be needed to achieve a high degree of macroeconomic stability.”

As I will not be reviewing the paper this week but hopefully next week I would like to hear what my readers make of George’s paper – I know I will probably be convinced that George’s concept is correct once I have read the paper, but will my readers be as well?

9 Comments
by Lars Christensen on February 7, 2012  •  Permalink
Posted in Free Banking, George Selgin, Quasi-Commodity Money
Tagged , ,

Posted by Lars Christensen on February 7, 2012

https://marketmonetarist.com/2012/02/07/selgin-on-quasi-commodity-money-part-1/

Is PIMCO’s Bill Gross a Market Monetarist?

This is PIMCO’s Bill Gross:

“The transition from a levering, asset-inflating secular economy to a post bubble delevering era may be as difficult for one to imagine as our departure into the hereafter. A multitude of liability structures dependent on a certain level of nominal GDP growth require just that – nominal GDP growth with a little bit of inflation, a little bit of growth which in combination justify embedded costs of debt or liability structures that minimize the haircutting of or defaulting on prior debt commitments. Global central bank monetary policy – whether explicitly communicated or not – is now geared to keeping nominal GDP close to historical levels as is fiscal deficit spending that substitutes for a delevering private sector.”

HT Cthorm

14 Comments
by Lars Christensen on February 6, 2012  •  Permalink
Posted in Reading recommendations
Tagged

Posted by Lars Christensen on February 6, 2012

https://marketmonetarist.com/2012/02/06/is-pimcos-bill-gross-a-market-monetarist/

Guest blog: NGDP Targeting is NOT just for Central Banks! (David Eagle)

Guest blog: NGDP Targeting is NOT just for Central Banks!

By David Eagle

Because of Lars Christensen’s blog on “Market Monetarism vs Krugmanism,” I am interjecting a new topic into my guest blog series.  I agree with the comments from JJA and Scott B. on Scott Sumner’s blog.  While some of the market monetarists do not believe in the effectiveness of fiscal policy, I think there is a great opportunity for those fiscal conservatives among us to openly welcome Keynesians to bring fiscal policy into the realm of NGDP targeting.  I agree with JJA that NGDP targeting should be the aim for BOTH monetary and fiscal policy.  In other words, both monetary and fiscal policy should target NGDP, although under normal times that responsibility should fall on the central bank.  Let me restate this very important statement: The role of fiscal policy in stimulating aggregate demand should also be governed by the NGDP target.  In other words, if NGDP is below target and the central bank says it needs help from fiscal policy to boost NGDP, then those in favor of using fiscal policy should advocate for fiscal stimuli.  However, when NGDP is at or above target, then the fiscal policy should be directed towards fiscal surpluses to make up for the previous deficit spending.  If the central bank and fiscal authorities were to agree on a NGDP target, then we would not have had the huge fiscal deficits that we did have preceding 2008.

However, unfortunately the central bank and fiscal authorities have not been following a mutually agreed upon and transparent NGDP target.  Because of the murky waters concerning what the central bank is doing, fiscal and monetary policy often work in different directions.  In particular, when the central bank targets inflation, it often is not clear what the central bank’s intentions are with regard to NGDP.  (Because I agree with Scott Sumner that we should treat NGDP and aggregate demand as the same concept, even a central bank targeting inflation should be transparent about what its intentions are concerning aggregate demand, i.e., NGDP; but alas central banks today are not that transparent.)  Because of these murky waters, politicians have often been able to pass politically desirable tax cuts and increased government spending under the guise of stimulating the economy (i.e., stimulating aggregate demand, i.e., stimulating NGDP), even though the central bank is content to let bygones be bygones and keep NGDP on its current track, but consistent with its future inflation target.

The Japanese Experience:

Take Japan, for example, where the Bank of Japan was under pressure to be more independent of the Japanese Government and be more like “western central banks” at maintaining price stability.[1]  Then came the 1990s and the Japanese Government followed Keynesian fiscal policy to stimulate the economy.  Meanwhile the Central Bank of Japan was determined to follow in Paul Volker’s footsteps of regaining credibility for maintaining price stability.  As Scott Sumner (2011) reported, the Bank of Japan actually pursued restrictive monetary policy at times when the Japanese government was trying to be expansionary with its fiscal policy.[2]  Because they were pulling the economy in two different directions, the result was (i) the Bank of Japan offsetting much of what the aggregate-demand effects of the fiscal stimuli, and (ii) the national debt in Japan skyrocketed from 51% of GDP at the beginning of the 1980s to over 220% now.  Then came 3/11/11, the day of the triple supply shock in Japan – earthquake, tsunami, and nuclear crisis.  In addition to their enormous national debt, now Japan faces the high costs of rebuilding.

Lack of Coordination between US Fiscal Policy and the Federal Reserve:

The United States I think is another example.  In 2003, the Bush administration passed tax cuts and kept them in place for a long time (they are still in place today).  These tax cuts were to stimulate the economy.  However, at the same time, the Federal Reserve was content to “let bygones be bygones” and let the NGDP base drift caused by the 2001 recession continue (see my guest blog that explains NGDP base drift).  As a result, if the tax cuts did have any stimulative effect, the Federal Reserve would have countered them with monetary policy.  On the other hand, if both the Federal Reserve and the Bush administration had agreed upon a NGDP target, and if that NGDP target was above where NGDP was at the moment, then the Federal Reserve could have tried to boost NGDP by using tools that Ben Bernanke said he had and that Scott Sumner believes he had.[3]  Also, as I will explain in a later guest blog, expectations has an important role to play.  If the public expects the central bank and fiscal policy to succeed in boosting NGDP up to its target, then they will be more inclined to spend more because of higher expected short-term inflation, helping the monetary and fiscal policy reach this goal.  Unfortunately, despite all the rhetoric about the transparency of inflation targeting (IT), IT is not as transparent as NGDP targeting.  I believe the ultimate in transparency for both monetary and fiscal policy is NGDP targeting.

The Two-Headed British Media:

Sumner (2011) reports an example in Britain of how the lack of transparency with regard to aggregate demand, i.e. NGDP, led to the British media simultaneously condemning both fiscal and monetary policy simultaneously:

“Recent events in Britain provide a perfect example of the confusion generated by drawing this sort of false dichotomy between monetary and fiscal policy. The government of Prime Minister David Cameron has been sharply criticized for its policy of fiscal austerity. The recovery from the recent recession has been even weaker in Britain than in the United States, and there are fears that budget cuts will lead to a double-dip recession. At the same time, the press has been highly critical of the Bank of England for allowing inflation to rise far above the 2% target. But these criticisms cannot both be correct: Either Britain needs more aggregate demand or it does not. If it needs more, then the inflation rate in Britain needs to rise even higher, because the Bank of England needs to provide even more monetary stimulus. If inflation is too high and Britain needs less aggregate demand, then [the British] should desire fiscal austerity that would slow the economy. The press seems to believe in some sort of policy magic whereby fiscal stimulus can create growth without inflation and monetary tightening can reduce inflation without affecting growth.” (brackets added after consultation with Scott Sumner)

If the British media is confused, then obviously the British public is confused.  If British fiscal and monetary policy both pursued a NGDP target, I believe the British media and British public would finally understand that it cannot criticize both fiscal and monetary policy under these circumstances.  As I said before, expectations plays an important part to boosting aggregate demand (NGDP), and I know no better way to guide the public expectations concerning aggregate demand than a credible and transparent NGDP target for both monetary and fiscal policy.

Summary: NGDP targeting for both fiscal and monetary policy:

In summary, if the central bank and those in favor of fiscal policy could agree on a NGDP target and then jointly pursue that target, our economies would be so much better today.  In particular, on the fiscal side, we would have no justification for the high federal government debt we have accumulated.  If fiscal policy followed a NGDP target, then over half the time we should have fiscal surpluses rather than fiscal deficits.  Also, a NGDP target is so much more transparent for both fiscal policy and monetary policy than the murky waters of inflation targeting that we face today.  With fiscal policy and monetary policy following a NGDP target, expensive fiscal stimuli could not be justified to stimulate the economy when NGDP is at or above target.

Reference:

Sumner, Scott (2011). “Re-Targeting the Fed,” National Affairs Issue #9.

[1] Ben Bernanke (http://www.federalreserve.gov/newsevents/speech/bernanke20100525a.htm) reported in 2010, “The importance of central bank independence also motivated a 1997 revision to Japanese law that gave the Bank of Japan operational independence.9 This revision significantly diminished the scope for the Ministry of Finance to influence central bank decisions, thus strengthening the Bank of Japan’s autonomy in setting monetary policy.”

[2] Scott Sumner states, “But the Japanese twice tightened monetary policy in an environment of zero inflation (in 2000 and 2006), so it would be hard to claim that they were trying to create inflation.”

[3] Sumner (2011, p. 4) states, ““But the Fed itself never claimed to be ‘out of ammunition,’ even after rates hit zero.  Indeed, Chairman Ben Bernanke has repeatedly stressed that the Fed still has many options for boosting demand, and he has proved the point with two rounds of ‘quantitative easing.’  Indeed, it is hard to see how a fiat-money central bank would ever be left unable to boost nominal spending.  That would logically imply it was unable to raise the rate of inflation – that is, to ‘debase the currency,’ which it can always do.  There is no example in history of any fiat-money central bank that tried to create inflation and failed.”

© Copyright (2012) by David Eagle

3 Comments
by Lars Christensen on February 6, 2012  •  Permalink
Posted in David Eagle, Fiscal policy, NGDP Targeting, Nominal Income Targeting, Scott Sumner
Tagged , , , ,

Posted by Lars Christensen on February 6, 2012

https://marketmonetarist.com/2012/02/06/guest-blog-ngdp-targeting-is-not-just-for-central-banks-david-eagle/

L Street – Selgin’s prescription for Money Market reform

Yesterday, I wrote a post on George Selgin’s latest presentation on monetary reform at the Italian think tank the Bruno Leoni Institute. In his presentation George essentially outlines a tree step strategy for the privatisation of the supply of money.

I described these three steps in my post yesterday, but I would like to take a deeper look at the first reform George proposes – reform of the way the US Federal Reserve controls the US money base and more concretely reform of the US money markets.

He outlines these reforms in his paper “L Street: Bagehotian Prescriptions for a 21st-Century Money Market”.

L-Street is of course a wordplay on Lombard Street – the book in which Walter Bagehot outlined the famous proposal for central banks to act as lender of last resort – and on the address of the US Federal Reserve in Washington DC.

George of course is the world’s foremost expert on Free Banking Theory, but in L-Street George takes a more practical approach to the monetary issue and assume that central banks at least for now is with us. That said, George also clearly states that he see money market reform as a step in the direction of Free Banking. However, this in no way central to the understanding of George’s proposals and I think that George’s reform proposals have a lot of merit on its own and should be of interest also to those you are not in favour of abolishing central banks.

Here is the abstract from George’s paper:

“In Lombard Street Walter Bagehot offered some second-best suggestions, informed by the crisis of 1866, for reforming the Bank of England’s conduct during financial crises. Here I respond to the crisis of 2008 by proposing changes, in the spirit of Bagehot’s own, to the Federal Reserve’s operating framework. These changes are aimed at reducing the Fed’s interference with the efficient allocation of credit, as well as its temptation to treat certain financial institutions as Too Big to Fail, during crises. More fundamentally, they seek to ground Fed operations more firmly in the rule of law, and to thereby make them less subject to the whims of committees, by allowing a fixed but flexible operating framework to serve the Fed’s needs during financial crises as well as in normal times.”

The failure of Fed’s operating framework

George’s starting point is a critique the Federal Reserve’s reliance on so-called primary dealers in its general operating framework. I find his discussion of the role of the primary dealers in events of 2008 very interesting and insightful and his discussion clearly illustrates that structural flaws in Fed’s operating framework seriously hampered the Fed’s role of an effective lender of last reserve. Furthermore, it gives a “micro perspective” on some of the issues discussed by market monetarists likely Scott Sumner who normally tend to have a more macro perspective on the crisis. These “explanations” in my views complement each other perfectly well.

Here is George:

“Further consideration suggests, however, that the apparent need for direct lending during crises stems, not from the inadequacy of open market operations as such, but from the inadequacy of the Fed’s particular rules and procedures for conducting such operations, including its reliance upon the primary dealer system. In particular the Fed, by depending upon a small set of primary dealers, and on two clearing banks, for its open-market operations, risks a breakdown in the monetary transmission mechanism when these agents themselves become troubled. Consequently the Fed may be compelled, not merely to engage in direct lending, but also to depart from Bagehot’s principles by bailing out insolvent firms when their failure threatens to cause a breakdown in its operating framework. The Fed’s reliance upon primary dealers and tri-party repos thus contributes to the notion of the “Systemically Important Financial Institution” (SIFI), official recognition of which, according to former Kansas City Fed President Thomas Hoenig (2011), poses a serious threat to the future of capitalism.”

I think George’s analysis fundamentally is right and it is also a good explanation why the Federal Reserve has been so preoccupied with saving (investment) banks rather than focusing on ensuring a stable nominal anchor for the US economy.

Market Monetarists including myself have tended to blame Fed chairman Bernanke’s Creditist views for the Fed’s intense focus on financial intermediation rather than on for example increasing nominal GDP. However, George’s discussion of the Fed’s operating framework also shows that the overreliance on the primary dealers in the day-to-day (and emergency) conduct of monetary policy basically “forced” the Fed in the direction of the Creditist position. Furthermore, as the system relied heavily on the primary dealers (and still do) the Fed basically had no other choice than to help bail out these institutions if it wanted to maintain its basic operating framework.

Selgin’s prescription: Abolish the Primary Dealer System

George’s solution to the problem of overreliance of the primary dealer system is simply to do away with it. Here is George:

“The most obvious operating system reform suggested by the crisis is to replace the primary dealer system with one in which numerous financial firms, and perhaps even some nonfinancial firm, take part in the Fed’s open market operations.

There are good reasons for the Fed to dispense with its primary dealer system even putting aside the dangers of relying upon it during crises. “In central banking terms,” as Chris Giles and Gillian Tett (2008) observe, despite its long pedigree the Fed’s primary dealer system “is decidedly old-fashioned,” having, as Bob Eisenbeis (2009: 2) explains, “evolved prior to the advent of electronics and computerization of the bid and auction process when institutions relied upon messengers to transmit paper bids to the [System Open Market] Desk.” Today, Eisenbeis goes on to observe, there’s no reason why a much larger number of qualified firms “could not take part in the daily Open Market transaction process through the System’s electronic bidding process.””

George continues:

“The Shadow Financial Regulatory Committee, of which Eisenbeis is a member, has recommended that the Fed take advantage of modern technology to adopt an approach similar to that of the ECB, which routinely conducts open-market operations “with more than 500 counterparties throughout the Euro Zone,” and which might deal with more than twice as many. Doing so, the committee maintains, “would increase the efficiency of the SOMA transaction process, lower costs, reduce dependence upon a geographically concentrated set of counter parties, and enhance the monetary policy transmission process” (Shadow Financial Regulatory Committee 2009). Electronic trading could also preserve the anonymity of firms seeking funds from the Fed.

Such improvements, it bears noting, would supply a rationale for doing away with the primary dealer system even if primary dealers’ soundness were never in doubt.

So far as outright open-market purchases are concerned there is no reason at all for the Fed to restrict the number of its counterparties, even by limiting participation in open-market operations to financial firms, since it doesn’t expose itself to counterparty risk in making outright purchases. The only risk it takes on is that connected with depreciation of the securities it acquires, which is of course a function, not of the counterparties it deals with, but of the securities it chooses to buy.”

I think George’s position makes a lot of sense and to me the main point in terms of the conduct of monetary policy must be that the central bank is as little dependent on any individual institution so the central bank will not be taken “hostage” of a single institution. That is effectively what happened during late 2008 and 2009.

The Fed as the market maker of last resort
Furthermore, Selgin suggests to get rid of the Federal Reserve’s “Treasuries only” policy for open–market operations and instead “broadening of the set of securities used in its temporary, if not in its permanent, open-market operations”.

Here is George:

“In particular, there are good reasons for having the Fed engage in temporary purchases of some of the private market securities it has traditionally accepted as collateral for discount window loans, provided that it subjects those securities to “haircuts” sufficient to both protect it against potential credit risk, while otherwise adhering to the classical rule of supplying credit only on relatively stiff terms.”

This proposal is similar to what Willem Buiter and Anne Seibert have called “the central bank as market marker of last resort”.

While I have a lot sympathy for this proposal I also think it is very important to stress that if the central bank acts as market maker of last resort then that does not mean that the central bank should try to manipulate the relative prices of financial assets. Sometimes it seems like especially the Fed has been trying to do exactly that. What George is suggesting is rather that the Federal Reserve expands the type of collateral that it will accept in the conduct of market operations. Here the condition for sufficient haircuts of course is key. Central banks should not be in the business of doing subsidized lending.

To avoid that open market operations lead to a distortion of relatively prices of financial assets Selgin suggests an auction system for liquidity:

“The procedure I have in mind, if only in the crudest of outlines, combines a set of reverse (single price) auctions for particular securities, with prospective counterparties allowed to submit multiple (but mutually-exclusive) bids involving different securities, with a multiple-yield (discriminatory price) auction that determines which securities the central bank actually ends up purchasing. The Fed would first have to decide what security types are eligible, favoring those for which holdings are sufficiently dispersed to provide for competitive bidding, and (to further discourage adverse selection) indicating maximum values of total and individual security purchases that it is prepared to make from a single participants. The list of such securities could be compiled, and regularly updated, using reports regularly submitted by prospective counterparties as one requirement for eligibility. Next the Fed would announce the total value of an intended purchase, along with reference prices (reflecting risk-based “valuation haircuts”) for particular securities. It would then hold simultaneous reverse (single-price) auctions, with descending prices expressed as reference-price percentages, for each security type, allowing individual counterparties to take part in any or all; but before actually completing any purchases it would first rank offers from the various auctions according to the percentage of the security reference prices involved, and then accept offers starting with those entailing the lowest percentage, progressing to higher percentages until the predetermined aggregate purchase is completed.”

George rightly conclude that if the Fed would act as market maker of last resort as he suggest the Fed would no longer need to act as a traditional lender of last resort through the so-called Discount Window and he therefore suggests that the Discount Window should be abolished. Fine with me, but don’t do it before you are sure that the other reforms suggested are working.

One can conclude that if the Fed moved in the direction of becoming market marker of last resort and got rid of the Discount Window then the Fed could effectively control the money base without any reliance of any particular institution and it would mean a minimum of distortion of relatively prices in the financial markets. This would be a huge step forward in the direction of a more market based monetary system.

Bernanke should have a look at Selgin’s prescriptions

Overall, I think that George Selgin’s L-street reforms make a lot of sense and if implemented likely would make the framework for conduct of US monetary policy a lot more transparent, but most important it would greatly insure against the kind of ad hoc policies measures that the Fed has had to resort to after the outbreak of the crisis in 2008.

In addition to Selgin’s proposal for L-street reform he also proposed NGDP targeting and finally the privatisation of the supply of money based on what he terms a “Quasi-Commodity Money” standard in his Bruno Leoni Institution presentation. As far as I understand George is in the process of finalizing papers on these two topics as well. I am surely looking forward to reading (and maybe reviewing) these papers as well.

PS To my American readers on this Super Bowl Sunday – Football is a sport where you kick the ball with your FEET and you are not allow to pick it up in the hands…anyway enjoy the game.

Update: See a presentation of Selgin’s reform ideas here.

Update (April 6 2012): Scott Sumner also comments on George’s paper here.

11 Comments
by Lars Christensen on February 5, 2012  •  Permalink
Posted in Ben Bernanke, Federal Reserve, Free Banking, George Selgin, MM Research agenda, Monetary institutions, Reading recommendations
Tagged , , , ,

Posted by Lars Christensen on February 5, 2012

https://marketmonetarist.com/2012/02/05/l-street-selgins-prescription-for-money-market-reform/

George Selgin outlines strategy for the privatisation of the money supply

I have earlier argued that NGDP targeting is a effectively emulating the outcome under a perfect Free Banking system and as such NGDP level targeting can be seen as a privatisation strategy. George Selgin has just endorsed this kind of idea in a presentation at the Italian Free Market think tank the Bruno Leoni Institute. The presentation is available on twitcam.

You can see the presentation here. You need a bit of patience if you are not Italian speaking, but George eventually switch to English. The presentation lasts around 45 minutes.

I will not go through all of George’s arguments – instead I recommend everybody to take a look at George’s presentation on your own. However, let me give a brief overview.

Basically George see a three step procedure for the privatisation of the money supply and how to go from the present fiat based monetary monopoly to what he calls a Free Banking system based on a Quasi Commodity Standard. Often Free Banking proponents tend to start out with some kind of gold standard – or at least assume that some sort of commodity standard is necessary for a Free Banking system to work. George does not endorse a gold standard. Rather he favours a privatisation strategy based on a NGDP targeting rule.

Essentially George spells out a three step procedure toward the privatisation of the money supply.

The first step (and this is especially directed towards the US Federal Reserve) is to move towards a much more flexible system provision of liquidity to the market than under the present US system where the Federal Reserve historically has relied on so-called primary dealers in the money market. George wants to abolish this system and instead wants the Fed to control the money base directly through open market operations. I fully endorse such a system. There is no reason why the monetary system and the banking system will have to be so closely intertwined as is the case in many countries. A system based on open market operations would also do away with the ad hoc nature of the many lending facilities that have been implemented in both the euro zone and the US since 2008.  George is essentially is saying what Market Monetarists have argued as well and that is that central banks should be less focused on “saving” the financial sector and more focused on ensuring the flow of liquidity (and yes, that is two very different things). George discusses these ideas in depth in his recent paper “L STREET:Bagehotian Prescriptions for a 21st-century Money Market”. I hope to return to a discussion of this paper at a later point.

The second step – and that should interest Market Monetarists – is that George comes out and strongly endorses NGDP targeting – or as George puts it a “stable rule for growth of aggregate (nominal) spending” and argues that central banks should do away with discretion in the conduct of monetary policy. George directly refers to Scott Sumner as he is making this argument. George’s preferred rate of growth of nominal spending is 2.5-3% – contrary to Scott’s suggestion of a 5% growth. That said, I am pretty sure that George would be happy if the Federal Reserve implemented Scott’s suggested rule. George is not religious about this. I on my part I am probably closer to George’s view than to Scott’s view, but again this is not overly important and practically a 5% growth rate would more or less be a return to the Great Moderation standard at least for the US. It should of course be noted that there is nothing new in the fact that George supports NGDP targeting – just read “Less than zero” folks! However, George in his presentation puts this nicely into the perspective of strategy to privatise the supply of money.

In arguing in favour of nominal spending targeting George makes it clear that it is not about indirectly ensuring some stable inflation rate in the long run, but rather “stability of (nominal) spending is the ultimate goal”. I am sure Scott will be applauding loudly. Furthermore – and this is in my view extremely important – a rule to ensure stability of nominal spending will ensure that there is no excuse for ad hoc and discretionary policy. With liquidity provision based on a flexible framework of open market operations and NGDP targeting the money supply will effectively be endogenous and any increase in money demand will always be met by an increase in the the money supply. So even if a financial crisis leads to a sharp increase in money demand there will be no argument at all for discretionary changes in the monetary policy framework. (Recently I have been talking about whether pro-NGDP targeting keynesians like Paul Krugman are saying the same as Market Monetarists. My argument is that they are not – Paul Krugman probably would hate the suggestion that monetary discretion should be given up).

Market Monetarists should have no problem endorsing these two first steps. However, the third step and that is the total privation of the supply on money will be more hard to endorse for some Market Monetarists. Hence, Scott Sumner has not endorsed Free Banking – neither has Nick Rowe nor has Marcus Nunes. However, I guess Bill Woolsey, David Beckworth and myself probably have some (a lot?) sympathy for the idea of eventually getting rid of central banks altogether.

This, however, is a rather academic discussion and at least to me the discussion of NGDP targeting and changing of central bank operating procedures for now is much more important. That said, George discusses a privatisation of the money supply based on what he calls a Quasi Commodity Standard (QCS). QCS is inspired by the technological development of the so-called Bitcoins. I will not discuss this issue in depth here, but I hope to return to the discussion once George has spelled out the idea in a paper.

Once again – have a look at George’s presentation.

HT Blake Johnson

8 Comments
by Lars Christensen on February 4, 2012  •  Permalink
Posted in Bill Woolsey, Blake Johnson, David Beckworth, Federal Reserve, Free Banking, George Selgin, Gold Standard, Marcus Nunes, MM Research agenda, Monetary institutions, NGDP Targeting, Nominal Income Targeting, Reading recommendations, Scott Sumner
Tagged , , ,

Posted by Lars Christensen on February 4, 2012

https://marketmonetarist.com/2012/02/04/george-selgin-outlines-strategy-for-the-privatisation-of-the-money-supply/

Glasner on Austrian economics

Here is David Glasner – great as always:

“I had just started getting interested in Austrian economics – while my contemporaries were experimenting with drugs, I was experimenting with Austrian economics; go figure! I sure hope no permanent damage was done”

This from a great comment on the 1920-21 US Recession.

 

2 Comments
by Lars Christensen on February 3, 2012  •  Permalink
Posted in David Glasner
Tagged

Posted by Lars Christensen on February 3, 2012

https://marketmonetarist.com/2012/02/03/glasner-on-austrian-economics/

Robin Hanson’s brilliant idea for central bank decision-making

George Mason University professor Robin Hanson in my view is one of the most thought-provoking and innovative thinkers in the world. I often read Hanson’s blog Overcoming Bias and I always find my own views challenged and even though Hanson’s views often seem outrageous they surely make you think and personally I often conclude that Hanson is right.

One of Robin Hanson’s most provocative ideas is his suggestion to replace democracy with what he calls Futarchy. Hanson first presented this idea in his paper “Shall We Vote on Values, But Bet on Outcome?” originally from 2000 (and revised in 2007). Hanson’s view is that democracies often fail to aggregate information and different forms of bias – well known from the Public Choice literature – plague democracy, while the market mechanism is a much better aggregator of information that should be utilised in the decision making process.

Hanson thinks that democratically elected officials should vote on what objectives (“Values”) to pursue, but not on how to achieve these objectives.  Hanson instead suggest using Decision Markets to make decisions instead of voting on different proposals.

Most people will find Hanson’s suggestion outrageous and I am not advocating Futarchy as a general form of government, but I do think that Hanson’s idea have lot of merit in regard to the conduct of central banking (assuming that we want to have central banks in the first place…)

Today most “modern” central banks have some more or less clearly stated objective (“values” in Hanson’s terminology). For example the Swedish Riksbank, the New Zealand Reserve Bank or the Polish central bank all have relatively clearly defined inflation targets, while the ECB as objective has to ensure “price stability” (in praxis defined as an inflation target of 2%) and the Federal Reserve has the (in)famous “dual mandate” (price stability and a high level of employment). Market Monetarists of course are advocating NGDP level targeting.

Central banks around the world are relatively clear on what they want to achieve – at least on paper. However, when it comes to the question of how to achieve these objectives it is often a lot less clear. A reason for that is that economists often disagree on what model best describes the economy. Furthermore, often disagreement in what really should be the objective of the central bank blurs policy discussions. I have previously argued that central banks should utilise prediction markets to do macroeconomic forecasting, but why not take this one step further and listen to Robin Hanson and introduce Futarchy as the basis for decision-making in monetary policy? (Please note here that I am “just” thinking out loud here. I have no clue whether this is a good idea, but if we don’t play around with ideas we will never make progress…)

Today the decision-making process in most central banks follows a pretty well-defined “industry standard”, where policy decisions often are made on a monthly basis by what is often termed something like monetary policy committee (MPC). In the US this of course is the FOMC. Policy decisions are then made by a “democratic” method where the MPC members vote on different policy proposals – for example to cut or hike interest rates or to engage in asset buying and open market operations etc. The central bank’s research department will often play a key role in the decision making process as the research department will present scenario analysis based on different proposals. There are of course variations from country to country but I think this is pretty close to the “real-life” praxis in for example the Bank of England, the ECB and the Federal Reserve. The Bank of Israel is an interesting exemption. Here BoI governor Stanley Fischer is “monetary dictator” as he alone – at least on paper – makes decisions on monetary policy.

A monetary policy making process based on Futarchy would change that decision-making process in a significantly more transparent direction. Here is a simple illustrative “proposal” (I stress again that I am thinking out loud).

I imagine a four-step procedure. First, the MPC would vote on what objective to pursue – for example a NGDP level target and a target for the growth path of NGDP. Most likely that objective would be reaffirmed very month.

Second, each member of the MPC would be allowed to suggest a proposal for how to achieve the agreed policy objective. To make things simple the MPC would be asked to decide on from all the suggestions on three different suggestions based on the gross list of proposals. It would be conditioned that these proposals where clearly defined in terms of timing and execution – for example the central bank will buy X dollars (or whatever currency) of foreign currency every month in the coming 6 months or the central bank will increase the overnight rate by 25bp every quarter in the coming year. Compared to today’s policy-making process this would be much more transparent and clear to market participants.

Third, the central bank would set-up “policy markets” for each of the three policy proposals. These markets then will give an implicit estimate on the probability that each of the proposals will be successful in achieving the stated policy goal.  I imagine the markets are opened the day after the MPC decision and then be open initially for a week.

Forth, the one of the three policy proposals the market judges to have the highest probability of succeeding in achieving the policy objective is put into action. The two other policy markets would be closed down again and the investors in these markets would get their money back. This will happen one week after the three markets have been opened. Obviously the price of the chosen proposal would jump once it becomes clear that it will be put into action. This market will then automatically give a market based forecast on the likely outcome in terms of the overall policy objective of the chosen policy instrument.

Lets relate this to the present US monetary policy and lets assume the Fed has decided that it would target a return of NGDP to the pre-crisis trend by the end of 2014. The FOMC agrees on three alternative policy proposals to achieve this policy objective. 1) Ben’s solution: The Fed will keep interest rates at basically zero until late 2014. 2) Scott’s solution: The Fed will issue NGDP futures and target a level for the futures, which is compatible with the overall policy objective.  3) Irving’s solution: A modified version of the compensated dollar plan – the Fed will buy unlimited amounts of commodities until NGDP reaches the target level.

I wonder how the markets would price these three proposals, but it doesn’t really matter because if you believe in the wisdom of the crowds then you will trust the markets will choose the policy that best ensures the overall objective. Furthermore, a complete commitment to the overall set-up would probably ensure that the markets would do a lot of the lifting on its own.

But yes, let me just say that I am still just thinking out loud, but I am looking forward to hear what my readers think of this “minor” institutional reform idea.

PS George Selgin would of course say that we should just get rid of central banks all together and Scott Sumner would say why not just implement NGDP futures? I would not argue with George and Scott, but for now we just want people to start thinking serious about monetary policy. And there is of course no conflict between a Hansonian monetary system and Scott’s ideas (which on it own could be seen as a privatisation strategy)

PPS In Hanson’s Futarchy paper he in fact briefly discusses monetary policy and decision markets.

9 Comments
by Lars Christensen on February 2, 2012  •  Permalink
Posted in Prediction markets, Robin Hanson
Tagged ,

Posted by Lars Christensen on February 2, 2012

https://marketmonetarist.com/2012/02/02/robin-hansons-brilliant-idea-for-central-bank-decision-making/

Market Monetarism vs Krugmanism

Here is an interesting comment from ‘JJA’ over at Scott Sumner’s blog:

“Scott, I have enjoyed reading your blog. As a practitioner (firm level decisions regarding export related efforts) I find you (and other market monetarists, especially Christensen and Nunes) very understandable and convincing. But… But I find Krugman and DeLong very understandable and convincing also… From my micro-level point of view it seems to be the case that both sides are right, but something is missing in-between.

Well, I am not an economist, but I think that I see NGDP as the ultimate aim in order to manage stable and prosperous economy. At the same time I see the importance of fiscal activity (from the state or whatever public body), and that is at the same time when I think that the monetary policy is the most important part of the situation. But I feel that monetary policy alone is not enough in order to achieve good results in a reasonable time. Therefore fiscal.

From my practical point of view, both market monetarists and old-style keynesians seem to be right at the same time. It may be that I am mad or something vital is missing from our understanding of economics.

But in any case, I just make decisions in practice. By the way, I am from the Eurozone (unfortunately).”

I think JJA raises a number of interesting questions about the similarities between Market Monetarism and “Krugmanism”. Yes, Krugman has endorsed NGDP level targeting as do Market Monetarists. However, just because we share the policy recommendation (and I am not sure we really do…) that does not mean that our theoretical thinking is close.

I do fundamentally think that Keynesians (including Krugman) and Market Monetarists (and old style Monetarists) are quite far away from each other theoretically.

I have three earlier posts that might clarify this:

On our macro/micro foundation: How I would like to teach Econ 101

On why we don’t think fiscal policy is effective. There is no such thing as fiscal policy

On why we favour a RULES based monetary policy: NGDP targeting is not a Keynesian business cycle policy

These three posts should make it clear what the key theoretical differences between Market Monetarists and Keynesians are.

That said, for the US and the euro zone Market Monetarists and New Keynesians (at least Krugman, DeLong and Romer) agree that monetary easing is warranted and that this could be done within the framework of NGDP level targeting. That said, Market Monetarists do not want to “fix” the economy and unlike keynesians we do not think that the problems are real, but rather nominal. The crisis is a result of a monetary policy mistakes rather than a “market failure”.

In regard to fiscal policy I might add that Market Monetarists probably are less concerned about the general fiscal troubles in the US and the euro zone than many “establishment” economists (and particularly European policy makers). David Beckworth have a number of good posts on this issue (See for example here). We agree that the present fiscal path is unsound in both the US and the euro zone, but if we get monetary policy right (target the NGDP level of the pre-crisis trend) then that would reduce the fiscal stress very significantly – not to speaking of reducing banking problems. Get monetary policy right and then the European and US banking problems and the fiscal policy problems will become manageable (on an overall level).

That said, Market Monetarists do in general not think that fiscal policy on its own can increase nominal spending in the economy so even though we think that fiscal policy should not be a major concern if monetary policy is “right” we also don’t think it is useful to spend a lot of time trying to “stimulate” the economy with fiscal measures. The only role we see for fiscal policy is to ensure long-term productivity growth and growth in the labour supply, but that is certainly not what Paul Krugman has in mind.

11 Comments
by Lars Christensen on February 1, 2012  •  Permalink
Posted in David Beckworth, Fiscal policy, MM Research agenda, Monetary policy, NGDP Targeting, Nominal Income Targeting, Paul Krugman, Scott Sumner
Tagged ,

Posted by Lars Christensen on February 1, 2012

https://marketmonetarist.com/2012/02/01/market-monetarism-vs-krugmanism/

Newer Posts »