Denmark and Norway were the PIIGS of the Scandinavian Currency Union

As the euro crisis continues speculation of an eventual break-up of the euro also continues. There are numerous examples in monetary history of currency unions breaking up. One is the breakup of the Scandinavian Currency Union in 1924.

I have found an interesting paper on this important event in Scandinavian monetary history. In his 2004-paper “The Decline and Fall of the Scandinavian Currency Union 1914 – 1924: Events in the Aftermath of World War I” Krim Talia discusses the reason for the collapse of the Scandinavian Currency Union.

Here is the abstract:

In 1873, Denmark, Norway and Sweden formed the Scandinavian Currency Union (SCU) and adopted the gold standard. The Union worked fairly smoothly during the next thirty years and was partly extended until 1914. The outbreak of World War I triggered a series of events that eventually would lead to the formal cancellation of the union in 1924. The suspension of convertibility and the export prohibition on gold in 1914, opened exchange rate tensions within the union, and acted as a first nail in the SCU’s coffin. Although the countries de facto had their currencies valued at different rates externally, the treaty of 1873 made them tradable at par within the union. This conflict, between de facto situation and de jure regulation, opened arbitrage opportunities for the public; but also resulted in opportunistic behaviour in the relation between the Scandinavian Central Banks. This study of the break-up of the SCU finds that the gold standard functioned as a unifying straitjacket on monetary policy and was an important prerequisite for a monetary union without a common central bank. It also challenges earlier work on the break-up of the SCU, by suggesting that the most important factor behind the centrifugal tensions within the Currency Union was the improved Swedish balance of trade following the outbreak of Word War I. The fact that wartime trade performance differed between the three countries made the currency area face an asymmetric external shock that required an exchange-rate adjustment – causing the fall of the union.

What is the implication for the euro zone? Well, I am not sure, but it might be interesting to have a closer look at the internal trade imbalance in the Scandinavian currency union and compare that to the imbalances that we have seen build in the euro zone during the boom-year prior to 2008. Both Denmark and Norway saw booms (and bubbles) during the first World War years and the early 1920s. In that sense Denmark and Norway looked like today’s PIIGS, while Sweden with it’s increasing trade surplus was the Germany of the Scandinavian currency union. In my previous post I described how insane monetary tightening in Norway and Denmark after 1924 lead to depression, while Sweden avoided depression.

Danish and Norwegian monetary policy failure in 1920s – lessons for today

History is fully of examples of massive monetary policy failure and today’s policy makers can learn a lot from studying these events and no one is better to learn from than Swedish monetary guru Gustav Cassel. In the 1920s Cassel tried – unfortunately without luck – to advise Danish and Norwegian policy makers from making a massive monetary policy mistake.

After the First World War policy makers across Europe wanted to return to the gold standard and in many countries it became official policy to return to the pre-war gold parity despite massive inflation during the war. This was also the case in Denmark and Norway where policy makers decided to return the Norwegian and the Danish krone to the pre-war parity.

The decision to bring back the currencies to the pre-war gold-parity brought massive economic and social hardship to Denmark and Norway in the 1920s and probably also killed of the traditionally strong support for laissez faire capitalism in the two countries. Paradoxically one can say that government failure opened the door for a massive expansion of the role of government in both countries’ economies. No one understood the political dangers of monetary policy failure better than Gustav Cassel.

Here you see the impact of the Price Level (Index 1924=100) of the deflation policies in Denmark and Norway. Sweden did not go back to pre-war gold-parity.

While most of the world was enjoying relatively high growth in the second half of the 1920s the Danish and the Norwegian authorities brought hardship to their nations through a deliberate policy of deflation. As a result both nations saw a sharp rise in unemployment and a steep decline in economic activity. So when anybody tells you about how a country can go through “internal devaluation” please remind them of the Denmark and Norway in the 1920s. The polices were hardly successful, but despite the clear negative consequences policy makers and many economists in the Denmark and Norway insisted that it was the right policy to return to the pre-war gold-parity.

Here is what happened to unemployment (%).

Nobody listened to Cassel. As a result both the Danish and the Norwegian economies went into depression in the second half of the 1920s and unemployment skyrocketed. At the same time Finland and Sweden – which did not return to the pre-war gold-partiy – enjoyed strong post-war growth and low unemployment.

Gustav Cassel strongly warned against this policy as he today would have warned against the calls for “internal devaluation” in the euro zone. In 1924 Cassel at a speech in the Student Union in Copenhagen strongly advocated a devaluation of the Danish krone. The Danish central bank was not exactly pleased with Cassel’s message. However, the Danish central bank really had little to fear. Cassel’s message was overshadowed by the popular demand for what was called “Our old, honest krone”.

To force the policy of revaluation and return to the old gold-parity the Danish central bank tightened monetary policy dramatically and the bank’s discount rate was hiked to 7% (this is more or less today’s level for Spanish bond yields). From 1924 to 1924 to 1927 both the Norwegian and the Danish krone were basically doubled in value against gold by deliberate actions of the two Scandinavian nation’s central bank.

The gold-insanity was as widespread in Norway as in Denmark and also here Cassel was a lone voice of sanity. In a speech in Christiania (today’s Oslo) Cassel in November 1923 warned against the foolish idea of returning the Norwegian krone to the pre-war parity. The speech deeply upset Norwegian central bank governor Nicolai Rygg who was present at Cassel’s speech.

After Cassel’s speech Rygg rose and told the audience that the Norwegian krone had been brought back to parity a 100 years before and that it could and should be done again. He said: “We must and we will go back and we will not give up”. Next day the Norwegian Prime Minister Abraham Berge in an public interview gave his full support to Rygg’s statement. It was clear the Norwegian central bank and the Norwegian government were determined to return to the pre-war gold-parity.

This is the impact on the real GDP level of the gold-insanity in Denmark and Norway. Sweden did not suffer from gold-insanity and grew nicely in the 1920s.

The lack of reason among Danish and Norwegian central bankers in the 1920s is a reminder what happens once the “project” – whether the euro or the gold standard – becomes more important than economic reason and it shows that countries will suffer dire economic, social and political consequences when they are forced through “internal devaluation”. In both Denmark and Norway the deflation of the 1920s strengthened the Socialists parties and both the Norwegian and the Danish economies as a consequence moved away from the otherwise successful  laissez faire model. That should be a reminder to any free market oriented commentators, policy makers and economists that a deliberate attempt of forcing countries through internal devaluation is likely to bring more socialism and less free markets. Gustav Cassel knew that – as do the Market Monetarists today.

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My account of these events is based on Richard Lester’s paper “Gold-Parity Depression in Denmark and Norway, 1925-1928” (Journal of Political Economy, August 1937)

Update: Here is an example that not all German policy makers have studied economic and monetary history.

1931-33 – we should learn something from history

My previous post on Ferguson’s and Roubini’s FT piece about the lessons from 1932 reminded me that I actually have done quite a bit of blog posts on 1931-33 myself. Both about the actual events of those years and about what policy lessons these events should have for today’s policy makers.

Here is a list of some of those earlier blog posts:

1931:
The Tragic year: 1931
Germany 1931, Argentina 2001 – Greece 2011?
Brüning (1931) and Papandreou (2011)
Lorenzo on Tooze – and a bit on 1931
“Meantime people wrangle about fiscal remedies”
“Incredible Europeans” have learned nothing from history
The Hoover (Merkel/Sarkozy) Moratorium
80 years on – here we go again…
“Our Monetary ills Laid to Puritanism”
Monetary policy and banking crisis – lessons from the Great Depression

1932:
“The gold standard remains the best available monetary mechanism”
Hjalmar Schacht’s echo – it all feels a lot more like 1932 than 1923
Greek and French political news slipped into the financial section
Political news kept slipping into the financial section – European style
November 1932: Hitler, FDR and European central bankers
Please listen to Nicholas Craft!
Needed: Rooseveltian Resolve
Gold, France and book recommendations
“…political news kept slipping into the financial section”
Gideon Gono, a time machine and the liquidity trap
France caused the Great Depression – who caused the Great Recession?

1933:
Who did most for the US stock market? FDR or Bernanke?
“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression
Remember the mistakes of 1937? A lesson for today’s policy makers
I am blaming Murray Rothbard for my writer’s block
Irving Fisher and the New Normal

No Nouriel, I am no longer optimistic – it feels like 1932

Niall Ferguson and Nouriel Roubini have a comment in the Financial Times. I have great respect for both gentlemen – even though I often disagree with both of them – and their latest comment raises some very key issues concerning the future of the euro zone and Europe in general. And it is very timely given that this weekend the Spanish government has asked the EU for a massive new bail out.

I will not address all of the topic’s in Ferguson’s and Roubini’s article, but let me just bring this telling quote:

We fear that the German government’s policy of doing “too little too late” risks a repeat of precisely the crisis of the mid-20th century that European integration was designed to avoid.

We find it extraordinary that it should be Germany, of all countries, that is failing to learn from history. Fixated on the non-threat of inflation, today’s Germans appear to attach more importance to 1923 (the year of hyperinflation) than to 1933 (the year democracy died). They would do well to remember how a European banking crisis two years before 1933 contributed directly to the breakdown of democracy not just in their own country but right across the European continent.

Hear! Hear! I have often been alarmed how European policy makers are bringing up the risk of higher inflation (1923) rather than the risk of deflation (1392-33) and I have earlier said that 2011 was shaping out to be like 1931. Unfortunately it more and more seems like 2012 is turning out to be like 1932 for Europe.

In the 1930s the crisis let to an attempt of a violent “unification” of Europe. This time around European policy makers are calling for more political integration to solve a monetary crisis despite the fact that European institutions like the ECB and the European Commission so far has failed utterly in solving the crisis. We all know that what is needed is not closer political integration in the EU, but monetary easing from the ECB. The ECB could end this crisis tomorrow, but the problem is that we apparently will only get monetary easing once further political integration is forced through. This is unfortunately what you get when political outcomes become part of the monetary policy reaction.

Last time I spoke face-to-face with Nouriel Roubini was in 2010 (I think just after Bernanke had announced QE2). Nouriel asked me “Lars, are you still so optimistic?” . I actually don’t remember my reply, but today my answer would certainly have been “NO! It all feels very much like 1932”

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UPDATE – some earlier posts in 1931-33:

1931:
The Tragic year: 1931
Germany 1931, Argentina 2001 – Greece 2011?
Brüning (1931) and Papandreou (2011)
Lorenzo on Tooze – and a bit on 1931
“Meantime people wrangle about fiscal remedies”
“Incredible Europeans” have learned nothing from history
The Hoover (Merkel/Sarkozy) Moratorium
80 years on – here we go again…
“Our Monetary ills Laid to Puritanism”
Monetary policy and banking crisis – lessons from the Great Depression

1932:
“The gold standard remains the best available monetary mechanism”
Hjalmar Schacht’s echo – it all feels a lot more like 1932 than 1923
Greek and French political news slipped into the financial section
Political news kept slipping into the financial section – European style
November 1932: Hitler, FDR and European central bankers
Please listen to Nicholas Craft!
Needed: Rooseveltian Resolve
Gold, France and book recommendations
“…political news kept slipping into the financial section”
Gideon Gono, a time machine and the liquidity trap
France caused the Great Depression – who caused the Great Recession?

1933:
Who did most for the US stock market? FDR or Bernanke?
“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression
Remember the mistakes of 1937? A lesson for today’s policy makers
I am blaming Murray Rothbard for my writer’s block
Irving Fisher and the New Normal

Gustav Cassel on Hoover’s Mistake and monetary policy failure

While I was going through old Australian newspaper articles (don’t ask me why…) I came across a wonderful little article by Gustav Cassel published on February 17 1930. In the article Cassel spells out why fiscal policy would not be able to pull out the US of the Depression and why the Great Depression was caused by  monetary policy failure. The whole thing sounds very Market Monetarist.

I have reproduced the entire article below. Enjoy the wisdom of Gustav Cassel.

President Hoover’s Mistake

– By Professor Gustav Cassel, the Distinguished Swedish Economist

It has been an open question for many years as to what Governments can do to counteract an economic depression… It has above all been suggested that public works should be regulated according to the fluctuations caused from time to time by economic conditions. In other words, the Government should start comprehensive undertakings at the moment when private enterprise begins to lag. The United States are at present in such a condition. Under the energetic leadership of President Hoover it seems that the Government is to intervene promptly and effectively in order to prevent the Stock Exchange crisis from developing into an economic depression.

This case can provide a most useful lesson for the general treatment of this problem and deserves special attention because Europe is more or less bound to be affected by an American depression and will then have to face the same difficulties against which America is fighting today. President Hoover’s programme, which has been given the name of ‘Prosperity Maintenance’ mainly comprises the starting of big undertakings in order to prevent the threatened reduction of industrial employment. To this purpose the official departments are to co-operate with the private employers.

The President called together at the White House several groups representing the economic activity of the country, and the representatives of the railways at once assured him of their cooperation in the form of a comprehensive programme of extensions.

Apart from a certain psychological influence, the President’s programme, is, however, in every way a mistake. It rests not only on an incorrect conception of the actual conditions, but also on an over-estimate the Government’s power.

In the endeavours to create employment by extraordinary new enterprises, it must be remembered very clearly that the burden will fill on the nation’s savings and reduce the amount of money available for the increase of true capital. An intervention by the State in order to increase the existing works and their machinery equipment might possibly be a sensible policy if a surplus of savings were available. The Hoover programme seems to assume that it is the case. In his message to Congress the President has proclaimed to the whole world that hitherto American capital was invested to an extraordinarily large proportion in stock speculation. The crisis is now said to have set this capital free, and made it available for general economic enterprises.

The ‘Government therefore considered it to be their duty to find employment for the capital supply. Every link in this chain or argument is a fallacy. Speculation in stocks has never involved any capital and cannot involve any. Therefore no capital can flow back from the Stock Exchange to economic enterprise. After all, America has no more available capital requiring a special effort for its employment.

The American Stock Exchange crisis signifies no more than that exaggerated quotations have been reduced to their normal value. There is no crisis in the economic life, but only a certain reduction of capital available, mostly for the building of dwelling houses. This reduction is caused immediately by the fact that the current new savings were not sufficient to maintain the production of real capital in the enormous proportions of last year.

The outstanding feature of the present position is therefore undoubtedly a great scarcity of capital. This being the case, is it not foolish to undertake large new enterprises in the belief that they can be paid for with available capital? Any effort in this direction, especially if made by the Government, is bound to waste the already scarce reserves, and thus to weaken the entire political economy.

That scarcity of capital is the principal feature of the present situation is also shown by the fact that the export of American capital has decreased very considerably indeed. If more surplus money were offered America would increase its export of capital and thereby improve the purchasing power of the other countries for the American export products. This would free the Government from many cares concerning inner political economy and at the same time render superfluous its efforts to exert its political power in creating outlets for American exports.

Such a development would be most welcome to all the countries needing capital. Conditions, the whole world over have shaped themselves in such a way that the export of American capital is an indispensable condition for a prosperous world economy. The whole world must therefore view with grave concern a Government intervention which, on account of its uneconomic investments, is bound to render impossible the accumulation of American savings.

Government intervention is in this case obviously to the detriment of the economic organisation. It would be far better to leave that organisation to look after itself. If this were done, any available new surplus money would very quickly be put, to use, provided that no new hindering circumstances should arise. An important American journal has recently collected a number of views on this subject by industrial leaders.

The general impression to be gathered from this inquiry is that the industrialists intend to carry on, notwithstanding the Stock Exchange crisis. In most branches of industry there is an acute necessity to enlarge the buildings and to improve the equipment. On reading the inquiry made by this journal we certainly do not feel that there is any lack of opportunities to use any available American capital. In the present situation there is indeed only one single factor which can seriously hinder development and this one factor has its origin in a Government Department. I am referring to the bank rate policy or in a wider sense to the limitation of money supplies to the economic life by the Federal Reserve System. This limitation has of late been far too strict. The reason is the attempt to regulate the bank rate in such a way that it, would have a supreme influence on the Stock Exchange, limiting the speculative inflation of share prices.

There is no doubt that this attempt constitutes an improper transgression of the natural limits of the tasks evolving upon a central banking institution – an attempt which ultimately can be traced back to the ardent desire of the Government to usurp an ever growing share of influence upon the country’s political economy. It is true that after the Stock Exchange crisis the bank rate has been slightly reduced. But this measure was taken far too slowly and hesitatingly.

The Federal Reserve system has not kept pace with the development, but since the last summer has adhered to rates which were far too high, with the result of a collapse in prices which seriously endangered the whole political economy, and which, so long as it continues will naturally prevent any sensible persons from making new investments. If the fall in prices were to continue, this would unavoidably prevent American economy from continuing its recent wonderful developments.

The collapse in prices is bound to drag with it the whole of the rest of the world and to create a universal condition which must react on the economy of the United States. And all this entirely unnecessary collapse of prices is exclusively the result of the mishandling of the American dollar value which in its turn is the consequence of an uncalled for excursion of Government influence into the province of economic problems.

The whole matter is a blatant example of what happens if we yield to the modern tendency of permitting the Government to meddle unnecessarily with economics. The Government assumes a task which is not in its province; in consequence of this it is driven to mismanage one of its most pertinent tasks, i.e., the supervision of money resources, this causes a depression, which the same government seeks to remedy by measures which are again outside the sphere of its true activity and which can only make the whole position worse.

The particular case under review is really only an illustration of a phenomenon which at present is very general; while neglecting their proper functions, governments greedily seize every opportunity to usurp provinces which are not their concern, and by doing so place themselves – with or against their will – on a plane inclined towards a form of socialism, the aim of which is, in this respect, to risk everything to obtain the utmost.

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Other posts on Gustav Cassel:

Gustav Cassel foresaw the Great Depression
Hawtrey, Cassel and Glasner
“Our Monetary ills Laid to Puritanism”
Calvinist economics – the sin of our times
Gustav Cassel on recessions

And Steve Horwitz on why Hoover was an interventionist.

Finally some proper research from a central bank

I spend a lot of time complaining about the work central banks do these days. However, we should not forget (and that goes for you my dear US readers as well) that the European football championship (Euro 2012) kicks off today (the opening match is between host nation Poland and serial defaulter Greece). What do these two things have in common? Well, have a look at this (relatively) new Working Paper from the Dutch central bank. Here is the abstract:

At the 2010 FIFA World Cup in South Africa, many soccer matches were played during stock market trading hours, providing us with a natural experiment to analyze fluctuations in investor attention. Using minute‐by‐minute trading data for fifteen international stock exchanges, we present three key findings. First, when the national team was playing, the number of trades dropped by 45%, while volumes were 55% lower. Second, market activity was influenced by match events. For instance, a goal caused an additional drop in trading activity by 5%. The magnitude of this reduction resembles what is observed during lunchtime, and as such might not be indicative for shifts in attention. However, our third finding is that the comovement between national and global stock market returns decreased by over 20% during World Cup matches, whereas no comparable decoupling can be found during lunchtime. We conclude that stock markets were following developments on the soccer pitch rather than in the trading pit, leading to a changed price formation process.

Meanwhile at Dublin Airport this greeting for the Calvinists.

PS I co-authored this paper about the World Cup in 2010. You should note my prediction was wrong.

PPS it is no secret that other than my native Denmark I am cheering for Poland at euro 2012. I spend a lot of time in Poland over the past decade. It is a truly wonderful nation. I hope that they poles will have a lot of success at this championship.

“Meantime people wrangle about fiscal remedies”

The other day I wrote a piece about the risks of introducing politics (particularly fiscal policy) into the central bank’s reaction function. I used the example of the ECB, but now it seems like I should have given a bit more attention to the Federal Reserve as Fed chief Bernanke yesterday said the follow:

“Monetary policy is not a panacea, it would be much better to have a broad-based policy effort addressing a whole variety of issues…I’d be much more comfortable if, in fact, Congress would take some of this burden from us and address those issues.”

So what is Bernanke saying – well he sounds like a Keynesian who believes that we are in a liquidity trap and that monetary policy is inefficient. It is near-tragic that Bernanke uses the exact same wording as Bundesbank chief Jens Weidmann used recently (See here). While Bernanke is a keynesian Weidmann is a calvinist. Bernanke wants looser fiscal policy – Weidmann wants fiscal tightening. However, what they both have in common is that they are central bankers who apparently don’t think that nominal GDP is determined by monetary policy. Said, in another other way they say that nominal stability is not the responsibility of the central bank. You can then wonder what they then think central banks can do.

What both Weidmann and Bernanke effectively are saying is that they can not do anymore. They are out of ammunition. This is the good old  “pushing on a string” excuse for monetary in-action.  This is of course nonsense. The central bank can determine whatever level for nominal GDP it wants. Just ask Gedeon Gono. It is incredible that we four years into this mess still have central bankers from the biggest central banks in the world who are making the same mistakes as central bankers did during the Great Depression.

Yesterday Scott Sumner quoted Viscount d’Abernon who in 1931 said:

“This depression is the stupidest and most gratuitous in history!…The explanation of our anomalous situation…is that the machinery for handling and distributing the product of labor has proved inadequate. The means of payment provided by currency and credit have fallen so short of the amount required by increased production that a general fall in prices has ensued…This has not only caused a disturbance in the relations between buyer and seller, but has gravely aggravated the situation between debtor and creditor. The gold standard, which was adopted with a view to obtaining stability of price, has failed in its main function. In the meantime people wrangle about fiscal remedies and similar devices of secondary importance, neglecting the essential question of stability in standard of value…The situation could be remedied within a month by joint action of the principal gold-using countries through the taking of necessary steps by the central banks.”

It is tragic that the same day Scott quotes d’Abernon Ben Bernanke “wrangles about fiscal remedies”. Bernanke of course full well knows that the impact on nominal GDP and prices of fiscal policy depends 100% on actions of the Federal Reserve. Fiscal policy does not determine the level of NGDP – monetary policy determines NGDP (Remember MV=PY!).

The Great Depression was caused by monetary policy failure and so was the Great Recession (See here and here). In the 1930s the Lords of Finance Montagu, Norman, Meyer, Moret, Stringher, Hijikata and Schacht were all wrangling about fiscal remedies and defended their failed monetary policies. Today the New Lords of Finance Bernanke, Shirakawa, Draghi and Weidmann are doing the same thng. How little we – or rather central bankers – have learned in 80 years…

UPDATE: Maybe our New Lords of Finance should read this Easy Guide to Monetary Policy.

1930s style Greek politics

During the 1930s the political environment became increasing radicalized across Europe. You all the know the story – nazi and communist holligans fighting the streets, Spanish civil war and Hitler’s rise to power.

Unfortunately today’s Greek democracy is becoming increasingly radicalized as well. Just take a look at this TV “debate”. I have no clue what the communists and nazis are screaming at each other, but I think the pictures tell a story of deteriorating democracy.

Draghi “We never pre-commit” – well isn’t that exactly your problem?

I don’t particularly feel an obligation to comment on today’s ECB monetary policy announcement and I think my regular readers have a pretty good idea about how I feel about the ECB these days. However, ECB chief Mario Draghi pulled out a traditional ECB phrase on the outlook on monetary policy that I think pretty well describes the ECB’s problem and why we are in mess we are in.

Mario Draghi said – as Trichet used to before him – that “we never pre-commit” to any particular future monetary policy action. My reply to Draghi would be isn’t that exactly your problem!?

Yesterday, I did a post on the importance of the expectational channel in monetary policy and how the Chuck Norris effect or what Matt O’Brien has called the Jedi mind trick can be a tremendous help in the conduct of monetary policy. If you have a credible target and credible reaction function the markets are likely to do most of the lifting in terms of monetary policy implementation. However, when Draghi is saying that the ECB is not pre-committed on monetary policy then he is effectively saying “We don’t want to tell you what your target is and we are not going to reveal our reaction function”. That of course means that the ECB will get no help from Chuck Norris (the markets) to implement policy.

On the other hand if Draghi had said “The ECB is pre-committed to use whatever instruments in our arsenal to achieve our nominal targets and will do unlimited amounts of buy or selling of assets to achieve these targets” then Draghi would not have to do much more. Chuck Norris would help him so he could spend more time golfing.

However, you get the feeling that the ECB on purpose wants to be ambiguous on what monetary policy action it will take and what it want to target. From a monetary policy perspective this makes no sense at all. Why would a central bank do something like that? What monetary theory is telling the ECB that it is a good idea not to pre-commit?  I think the answer is nothing to do with monetary theory and everything to do with public choice theory. The special ECB lingo like “we never pre-commit” seem to be designed to ensure the legitimacy of the ECB. The lingo is simply rituals that should convince us that the ECB is a legitimate institution and it’s powers should not be questioned. See more on this topic here.

Robert E. Keleher R.I.P.

I was saddened by the news that Robert E. Keleher has pasted away on May 27 at an age of 67. Keleher pioneered what he termed the Market Price Approach to Monetary Policy. I my view Keleher’s work on monetary policy clearly was similar to Market Monetarism.

Here is Kurt Schuler on Freebanking.org:

“Bob’s most significant work was Monetary Policy, a Market Price Approach, a book he wrote with Manuel H. Johnson. Bob developed the ideas that led to it while working as Johnson’s adviser when Johnson was vice governor of the Federal Reserve Board. It was published in 1996, after they had left the Board. It is, to my knowledge, the only book-length treatment of the question, What indicators should a central bank with a floating exchange rate use to conduct a forward-looking monetary policy? This is, obviously, the question facing most major central banks in the world today, and the answer is vital to the well-being of billions of people.

None of the work I have seen on inflation targeting addresses the question in a fully satisfactory way. Using last month’s inflation reading to guide this month’s monetary policy is like driving using the rear-view mirror. Proponents of inflation targeting understand this point, and they advocate an emphasis on expected inflation, but they do not say enough about the particular indicators that an inflation targeting central bank should use. In practice, central banks do look at particular indicators using particular frameworks, but their procedures are tacitly embodied in institutional practice rather than explicitly articulated in the way Bob’s book does.

The market price framework rests on ideas that come from the Swedish economist Knut Wicksell, and it is therefore of interest to any current of thought influenced by Wicksell’s monetary theory—not just inflation targeting, but nominal GDP targeting, more discretionary approaches to central banking, and even free banking. Advocates of nominal GDP targeting say, “Target the forecast!” The market price framework can help the private sector make the forecast. If free banking were to take the form envisioned by Friedrich Hayek, with competing floating-rate currencies, the market price framework can help issuers of currency decide how much currency to issue.

The particular forward-looking market price indicators the framework recommends examining are broad indices of commodity prices; foreign exchange rates; and bond yields. No mechanical rule suffices for judging whether the central bank is supplying an equilibrium amount of the monetary base, so the book explains how to examine indicators jointly and extract signals from them.”

I believe that Keleher’s work on monetary policy is highly relevant to today’s crisis and his work deserves a lot more attention than it has gotten. I have previously written on Keleher’s work. See here and here.

Robert. E. Keleher, R.I.P.

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