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The Bernanke rule looks like a Evans rule

We nearly got what Market Monetarists have been asking for – the Federal Reserve now have a relatively clear defined target and it will implement it through changes to the money base (by buying Mortgage backed securities). It is not a NGDP level target, but probably more a light version of the Mankiw rule or the so-called Evans rule.

Chicago Fed governor Charles Evans has suggested that the Fed should ease monetary policy – expand the money base – until unemployment drops below 7% or PCE core inflation increases above 3%.

The FOMC did not give any numbers yesterday, but I think it is pretty safe to assume that the Bernanke rule is in fact a Evans rule and it seems like most market participants also see it in this way.

This illustrate the clear advantage of a rule based approach to monetary policy rather than a discretionary monetary policy. The participants can pretty easy figure out when the Fed will step up monetary easing and when it will start tightening monetary policy.

This also means that the markets will help the fed do a lot of the lifting. Hence, if investors know that the fed will ease as long as the Bernanke-Evans rule says so investors will buy stocks, sell the dollar, expect long-yields to increase. This is of course also the market reaction we got after the FOMC’s announcement.

Similarly the Fed now have a pretty clear “exit strategy”. A big problem until now has been that the markets have been uncertain about when the fed would change direction in monetary policy. Now it seems safe to assume that the fed will continue ease until unemployment drops below 7% or PCE core inflation increases above 3%.

Update: My friend Daniel  has a comment on his blog on the fed’s policy action. Krugman has two posts on Bernanke – here and here.

PS Paradox: The GOP wants to sack Bernanke for proposing what essentially is a Mankiw rule. I wonder what Romney’s economic advisors think about that

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I think Ben just did it…

This is what I in a post earlier today asked the Federal Reserve to do:

Rather for example the Fed could just start at every regular FOMC meetings to state for example that “the expectations is now that without changes in our policy instrument we will undershoot our policy target and as a consequence we today have decided to use our policy instrument to increase the money base by X dollars to ensure that we will hit our policy target within the next 12 months. We will increase the money base further if contrary to our expectations policy target is not meet.”

I must admit Ben Bernanke nearly got it right! Here is from the FOMC’s statement:

“The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.  Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.  The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective….

…To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. 

…The Committee will closely monitor incoming information on economic and financial developments in coming months.  If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. “

So we nearly got what I asked for: 1) A clear target – not an NGDP level target, but a light Mankiw rule/Evans rule based on the Fed’s dual mandate. 2) A clear instrument to increase the money base: Mortgage backed securities. 3) A promise to do more if the target is not hit.

Now the markets should do a lot of the additional lifting.

I think it would be ungrateful to ask for more – yes, yes it is not NGDP level targeting and a lot of things can go wrong, but today I think we can take a little victory lap. This is excellent news for the US economy and for the global economy. Then we can hope that we in the coming months will get an even more clear defined “Bernanke rule” so we finally can back to a rule based rather than a discretionary monetary policy.

Related posts:

Scott Sumner has two comments (here and here) on the FOMC decision.

David Beckworth also has a comment and so has David Glanser.

While Scott and two times David share my general happiness about the Fed’s actions our friend Marcus Nunes is less euphoric. Marcus as always been the skeptic among the Market Monetarist bloggers, but he has also often been right so maybe we should be a little bit careful in not being carried away.

Update: Dajeeps and JPIrving are also happy.

Update 2: Our friend Mayor(!) Bill Woolsey also comments on the fed. Bill is as happy as the rest of us with the progress in the thinking of the FOMC, but he also correctly raises some points about the dangers of targeting real variables such as unemployment rather than focusing on nominal variables such as the NGDP level. Bill’s comment in many ways can be seen as the Market Monetarist reply to George Selgin’s friendly reminder to us (the Market Monetarists) that we should not become too friendly with the fed exactly because the fed is now so clearly targeting a real variable. Bill post was however (I think) written prior to George’s comment. Needless to say I agree with George and Bill. The FOMC’s actions is major step forward, BUT I am certainly also somewhat uncomfortable with the fact that the fed now so clearly targeting a real – rather than a nominal – variable.

Time to end discretionary monetary policy!

This week has been nearly 100% about monetary policy in the financial markets and in the international financial media. In fact since 2008 monetary policy has been the main driver of prices in basically all asset classes. In the markets the main job of investors is to guess what the ECB or the Federal Reserve will do next. However, the problem is that there is tremendous uncertainty about what the central banks will do and this uncertainty is multi-dimensional. Hence, the question is not only whether XYZ central bank will ease monetary policy or not, but also about how it will do it.

Just take Mario Draghi’s press conference last week – he had to read out numerous different communiqués and he had to introduce completely new monetary concepts – just take OMT. OMT means Outright Monetary Transactions – not exactly a term you will find in the monetary theory textbook. And he also had to come up with completely new quasi-monetary institutions – just take the ESM. The ESM is the European Stability Mechanism. This is not really necessary and it just introduce completely unnecessary uncertainty about European monetary policy.

In reality monetary policy is extremely simple. Central bankers can fundamentally do two things. First, the central bank can increase or decrease the money base and second it can guide expectations. It is really simple. There is no reason for ESM, OMT, QE3 etc. The problem, however, is that central banks used to control the money base and expectations with interest rates, but with interest rates close to zero central bankers around the world seem to have lost the ability to communicate about what they want to do. As a result monetary policy has become extremely discretionary in both Europe and the US.

That need to change as this discretion is at the core the uncertainty about monetary policy. Central bankers therefore have to do two things to get back on track and to create some kind of normality. First, central banks should define very clear targets of what the want to achieve – preferably the ECB and the Fed should announce nominal GDP targets, but other target might do as well. Second, the central banks should give up communicating about monetary policy in terms of interest rates and rather communicate in terms of how much they want to change the money base.

In terms of changes in the money base the central banks should clarify how the money base is changed. The central bank can increase the money base, by buying different assets such as government bonds, foreign currencies, commodities or stocks. The important thing is that the central banks do not try to affect relative prices in the financial markets. When the Fed is conducting it “twist operations” it is trying to distort relative prices, which essentially is a form of central planning and has little to do with monetary policy. Therefore, the best the central banks could do is to define a clear basket of assets it will be buying or selling to increase or decrease the money base. This could be a fixed basket of bonds, currencies, commodities and stocks – or it could just be short-term government bonds. The important thing is that the central bank define a clear instrument.

This would remove the “instrument uncertainty” and the ECB or the Fed would not have to come up with new weird instruments every single month. Rather for example the Fed could just start at every regular FOMC meetings to state for example that “the expectations is now that without changes in our policy instrument we will undershoot our policy target and as a consequence we today have decided to use our policy instrument to increase the money base by X dollars to ensure that we will hit our policy target within the next 12 months. We will increase the money base further if contrary to our expectations policy target is not meet.” 

In this world there would be no discretion at all – the central bank would be strictly rule following. It would use its well-defined policy instrument to always hit the policy target and there would be no problems with zero bound interest rates. But most important it would allow the financial markets to do most of the lifting as such set-up would be tremendously more transparent than what they are doing today.

Today we will see whether Ben Bernanke want to continue distorting relative prices and maintaining policy uncertainty by keeping the Fed’s highly discretionary habits or whether he want to ensure a target and rules based monetary policy.

PS a possibility would of course also be to use NGDP futures to conduct monetary policy as Scott Sumner has suggested, but that nearly seems like science fiction given the extreme conservatism of the world’s major central banks.

Steve, George and Bryan debate Austrian economics and empirics

I am a huge fan of Cato-Unbound.org. Here you find good insightful and intellectual debates amount classical liberal, libertarian and conservative scholars on a number of topics. The quality of the pieces on Cato Unbound is always very high. That is also the case for the latest “debate”. As always there is a “Lead Essay” and a number of “Response Essays”. This time the topic is “Theory and Practice in the Austrian School”.

The lead essay is written by Steve Hortwiz and the response essays are by George Selgin and Bryan Caplan.

Fundamentally Steve’s claim is that Austrian method – praxeology – is not as strict anti-empirical as it is often said to be. In his essay “The Empirics of Austrian Economics” Steve makes an heroic attempt to argue that there is no real conflict between praxeology and empirical studies. Everybody who know me would know that I have greatest respect for Steve and I think he is a very open-minded Austrian. However, sometimes Steve’s attempt to defend Austrian economics goes too far. Fundamentally Steve is making up a version of Austrian economics, which never really existed – or rather the Austrian economics that Steve describes is not really Austrian economics, but rather it is how Steve would like to think Austrian economics should be. And I certainly admit I that I prefer Hortwizian economics to Misesian-Rothbardian economics and Steve certainly knows (much!) better than me what “Austrian economics” really is. However, his essay did not convince me that Austrians are as methodologically open-minded as he claims. Neither has he convinced Bryan Caplan and George Selgin.

Both Bryan and George are well-known friendly critics of Austrian Economics. My own feelings about Austrian economics are similar to those of Bryan and George. To me the world of economics would be very empty without Austrian economics. The contributions to economics by Mises, Hayek and Kirzner etc. can certainly not be overestimated. But I also share the view of particular Bryan who rightly notes that it is too bad that Austrians tend to marginalize themselves and the contributions of Austrian economics by their eagerness to not speak in language of mainstream economics. It is hard not from time to time to feel that Austrian economics is a cult. That is sad because it means that far to many economics students around the world are never introduced to Austrian economics (if you are one of them get a copy of Human Action and start reading NOW!).

Furthermore, I share George’s view that empirical research can be useful in understanding what is important and what is not important. Empirical research is also useful in figuring out the magnitude of a certain economic problem. We can deduct from praxeology that an increase in minimum wages will increase unemployment, but praxeology is not telling us anything about how large that the increase in unemployment will be if minimum wages are increased by X dollars. Both Mises and Rothbard were negative about this kind of empirical analysis – Steve tries to argue that that is not the case, but George shows that his arguments for this is rather weak.

Anyway, the three gentlemen have much better arguments than I have on these issues so read their pieces yourself:

Steve Horwitz: “The Empirics of Austrian Economics”

Bryan Caplan: “Horwitz, Economy and Empirics”

George Selgin: “How Austrian Is It?”

Update – follow-ups:

“Conditionality” is ECB’s term for the Sumner Critique

Some time ago Scott Sumner did a number of blog posts on fiscal policy and why he believes that the budget multiplier is zero. At the time I was somewhat frustrated that the amount of time Scott was using to focus on an issue that I found quite obvious. However, I now found myself doing exactly the same thing – I can’t let go of the game played by central banks against governments and impact this has on the economic policy mix. This is maybe because I find empirical evidence for the so-called Sumner Critique popping up everywhere.

The Sumner Critique basically says that the central bank can always overrule any impact of expansionary fiscal policy on aggregate demand by tightening monetary policy and if the central bank is targeting for example inflation or nominal GDP then it will do so. Therefore, under inflation targeting or NGDP targeting the budget multiplier will always be zero even if the world is Keynesian.

Last week’s policy announcement from the ECB gives further (quasi) empirical support for the Sumner Critique. Hence, the ECB announced that it would conduct what it calls “Outright Monetary Transactions” (OMT) – that is it would (or rather could) buy euro government bonds.

But see here what the ECB said about the conditions for OMT:

“A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.

The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.

Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.”

The important term here is “conditionality”. The ECB’s condition for buying government bonds is that the individual euro zone country has a EFSF/ESM macroeconomic adjustment programme. Such a programme is basically a pledge of a given government to tighten fiscal policy. In other words – the ECB could buy for example Spanish government bonds, but the condition would be that the Spanish government should tighten fiscal policy.

Therefore, what the ECB is doing is basically asking the Spanish government and other euro zone governments to be the “Stackelberg leader”: First you tighten fiscal policy and then we will ease monetary policy.

As a consequence the ECB has basically said that the fiscal multiplier should be zero – the ECB will “neutralize” any impact on aggregate demand of changes in fiscal policy. This is better news than it might sound. Obviously European monetary policy is much too tight in the euro zone and I would have liked to see a lot more action from the ECB. However, one could understand “conditionality” to mean that the ECB will fill the possible hole in aggregate demand from fiscal consolidation in euro zone – monetary policy will be eased in response to fiscal tightening. That is good news.

However, the crucial problem of course is that the euro zone needs higher aggregate demand and therefore I would have been much happier if the ECB had announced a clear plan to increase aggregate demand (or rather nominal GDP) – it did not do that. However, if the ECB at least will try to counteract the possible negative impact on aggregate demand from fiscal consolidation then that is good news. One could of course say that this is a completely natural consequence of the ECB’s inflation targeting regime – if fiscal tightening reduces aggregate demand then the ECB should ease monetary policy to avoid inflation undershooting the inflation targeting.

Concluding, “conditionality” is another term for the Sumner Critique and it is in my view yet another illustration that expansionary fiscal policy is unlikely to bring us out of this crisis if central banks is not playing along.

Related posts:

In New Zealand the Sumner Critique is official policy
Policy coordination, game theory and the Sumner Critique
The fiscal cliff and why fiscal conservatives should endorse NGDP targeting
The Bundesbank demonstrated the Sumner critique in 1991-92
“Meantime people wrangle about fiscal remedies”
Please keep “politics” out of the monetary reaction function
Is Matthew Yglesias now fully converted to Market Monetarism?
Mr. Hollande the fiscal multiplier is zero if Mario says so
Maybe Jens Weidmann and Francios Hollande should switch jobs
There is no such thing as fiscal policy

David Laidler: “Two Crises, Two Ideas and One Question”

The main founding fathers of monetarism to me always was Milton Friedman, Anna Schwartz, Karl Brunner, Allan Meltzer and David Laidler. The three first have all now passed away and Allan Meltzer to some extent seems to have abandoned monetarism. However, David Laidler is still going strong and maintains his monetarist views. David has just published a new and very interesting paper – “Two Crises, Two Ideas and One Question” – in which he compares the Great Depression and the Great Recession through the lens of history of economic thought.

David’s paper is interesting in a number of respects and any student of economic history and history of economic thought will find it useful to read the paper. I particularly find David’s discussion of the views of Allan Meltzer and other (former!?) monetarists interesting. David makes it clear that he think that they have given up on monetarism or as he express it in footnote 18:

“In this group, with which I would usually expect to find myself in agreement (about the Great Recession), I include, among others, Thomas Humphrey, Allan Meltzer, the late Anna Schwartz, and John Taylor, though the latter does not have quite the same track record as a monetarist as do the others.”

Said in another way David basically thinks that these economists have given up on monetarism. However, according to David monetarism is not dead as another other group of economists today continues to carry the monetarist torch – footnote 18 continues:

“Note that I self-consciously exclude such commentators as Timothy Congdon (2011), Robert Hetzel (2012) and that group of bloggers known as the “market monetarists”, which includes Lars Christensen, Scott Sumner, Nicholas Rowe …. – See Christensen (2011) for a survey of their work – from this list. These have all consistently advocated measures designed to increase money growth in recent years, and have sounded many themes similar to those explored here in theory work.”

I personally think it is a tremendous boost to the intellectual standing of Market Monetarism that no other than David Laidler in this way recognize the work of the Market Monetarists. Furthermore and again from a personal perspective when David recognizes Market Monetarist thinking in this way and further goes on to advocate monetary easing as a respond to the present crisis I must say that it confirms that we (the Market Monetarists) are right in our analysis of the crisis and helps my convince myself that I have not gone completely crazy. But read David’s paper – there is much more to it than praise of Market Monetarism.

PS This year it is exactly 30 years ago David’s book “Monetarist Perspectives” was published. I still would recommend the book to anybody interested in monetary theory. It had a profound impact on me when I first read it in the early 1990s, but I must say that when I reread it a couple of months ago I found myself in even more agreement with it than was the case 20 years ago.

Update: David Glasner also comments on Laidler’s paper.

MRUniversity – join now!

Tyler Cowen and Alex Tabarrok have written one of the best economics textbooks out there and now they are introducing the Marginal Revolution University.

Is is how the gentlemen introduces MRUniversity:

We think education should be better, cheaper, and easier to access.  So we decided to take matters into our own hands and create a new online education platform toward those ends. We have decided to do more to communicate our personal vision of economics to you and to the broader world.

You can visit http://www.MRUniversity.com here.  There you can sign up for information about our first course, Development Economics, which is described by Alex below.

Here are a few of the principles behind MR University:

1. The product is free (like this blog), and we offer more material in less time.

2. Most of our videos are short, so you can view and listen between tasks, rather than needing to schedule time for them.  The average video is five minutes, twenty-eight seconds long.  When needed, more videos are used to explain complex topics.

3. No talking heads and no long, boring lectures.  We have tried to reconceptualize every aspect of the educational experience to be friendly to the on-line world.

4. It is low bandwidth and mobile-friendly.  No ads.

5. We offer tests and quizzes.

6. We have plans to subtitle the videos in major languages.  Our reach will be global, and in doing so we are building upon the global emphasis of our home institution, George Mason University.

7. We invite users to submit content.

8. It is a flexible learning module.  It is not a “MOOC” per se, although it can be used to create a MOOC, namely a massive, open on-line course.

9. It is designed to grow rapidly and flexibly, absorbing new content in modular fashion — note the beehive structure to our logo.  But we are starting with plenty of material.

10. We are pleased to announce that our first course will begin on October 1

I think this is a great idea and a very good opportunity for students of economics and amateur economists to get high quality economic education from some of the best and most clever guys out there. So I encourage everybody just remotely interested in economics to sign up NOW.

Help me locate the ECB’s “monetary pillar”

I am still in Russia and do not have much time to blog, but something have been on my mind in the last couple if days. Where did the ECB’s monetary pillar go? In the “old days” the ECB was hugely focused on what was happening to M3 growth. The ECB would talk about it reference value for M3 growth and it would analyse both the nominal and the real “money gap” to assess future inflationary (or deflationary) pressures. This of course to a large extent was the “darling” of then ECB chief economist Otmar Issing. However, Issing is no longer with the ECB and apparently monetary analysis has disappeared from the ECB with him – at least gradually.

Just have a look at the ECB’s Monthly Bulletin – the chapter on monetary analysis and become smaller and smaller in recent years. That is too bad as monetary analysis is more important than ever. However, the ECB now is more narrowly focused on interest rates than has ever been the case before. ECB officials these days very rarely make any comments on money supply growth or monetary factors in general. When did you last time hear an ECB official make a comment on the development in for example money-velocity?

Anyway, the ECB has never official buried the “monetary pillar” – it has just been allowed silently to disappear from the ECB’s policy toolbox. When did this exactly happen? I am not sure and that is why I turn to you dear readers? Who is able to locate the monetary pillar? Have you seen it anywhere? Furthermore, do any of my readers have a view about when the monetary pillar disappeared? Maybe somebody can tell me when the ECB the last time mentioned  the reference value for M3 and/or the “money gap”. I am not sarcastic – I genuinely would like to know what happened?

In my view the crisis would have played out much differently if the ECB had kept an eye on the “monetary pillar”. Furthermore, it would be interesting to hear if anybody have a clue about Otmar Issing’s view of this. As far as I know he thinks monetary policy is easy in the euro zone, however Issing style monetary analysis is in fact telling us the opposite – that monetary policy is very tight. See here to see why monetary analysis is telling us that euro zone monetary conditions are very tight.

PS I know I have not answered a number of comments on my previous posts – I hope to get back to that soon. Your comments are much appreciated.

“Synthesizing State and Spontaneous Order Theories of Money”

I have long been impressed with the young guard at George Mason University. Now two of them – Alex Salter and Will Luther – is out with a new Working Paper – “Synthesizing State and Spontaneous Order Theories of Money”. It is very interesting stuff and I highly recommend it to anyone who is interested in monetary theory. Here is the abstract:

“What role does government play in determining the medium of exchange? Economists weighing in on the issue typically espouse one of two views. State theorists credit government with the emergence and continued acceptance of commonly accepted media of exchange. In contrast, spontaneous order theorists find little need for government, maintaining that money emerges and continues to circulate as a result of a decentralized market process. History suggests a more subtle theory is required. We provide a generalized theory of the emergence and perpetuation of money, informed by both approaches and consistent with recent theoretical and empirical advances in the literature.”

PS Will is now an Assistant Professor at Kenyon College, while Alex is a PhD fellow at GMU.

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