Michael Darda is not only a nice guy – he is also clever. But frankly speaking it is a bit boring always being in agreement with him.
This is Mike speaking on Bloomberg radio. I fully share Mike’s positive view of the near-term outlook for the US economy.
Posted by Lars Christensen on February 28, 2013
https://marketmonetarist.com/2013/02/28/michael-darda-on-bloomberg-radio/
This week investors have been spooked by the election outcome in Italy, but frankly speaking is there anything new in that shady characters are doing well in an Italian election? Is there anything new in a hung parliament in Italy? Nope, judging from post-WWII Italian political history this is completely normal. Ok, Italian public finances is a mess, but again that not really news either.
So if all this is ‘business-as-usual’ why are investors suddenly so worried? My explanation would be that investors are not really worrying about what is going on in Rome, but rather about what is going on in Frankfurt.
Last year I argued that the ECB had introduced ‘political outcomes’ in its reaction function:
This particularly is the case in the euro zone where the ECB now openly is “sharing” the central bank’s view on all kind of policy matters – such as fiscal policy, bank regulation, “structural reforms” and even matters of closer European political integration. Furthermore, the ECB has quite openly said that it will make monetary policy decisions conditional on the “right” policies being implemented. It is for example clear that the ECB have indicated that it will not ease monetary policy (enough) unless the Greek government and the Spanish government will “deliver” on certain fiscal targets. So if Spanish fiscal policy is not “tight enough” for the liking of the ECB the ECB will not force down NGDP in the euro zone and as a result increase the funding problems of countries such as Spain. The ECB is open about this. The ECB call it to use “market forces” to convince governments to implement fiscal tightening. It of course has nothing to do with market forces. It is rather about manipulating market expectations to achieve a certain political outcome.
Said in another way the ECB has basically announced that it does not only have an inflation target, but also that certain political outcomes is part of its reaction function. This obviously mean that forward looking financial markets increasingly will act on political news as political news will have an impact of future monetary policy decisions from the ECB.
And this is really what concerns investors. The logic is that a ‘bad’ political outcome in Italy will lead the ECB to become more hawkish and effectively tighten monetary conditions by signaling that the ECB is not happy about the ‘outcome’ in Italy and therefore will not ease monetary policy going forward even if economic conditions would dictate that. This is exactly what happened in 2011-12 in the euro zone, where the political ‘outcomes’ in Greece, Italy and Spain clearly caused the ECB to become more hawkish.
The problems with introducing political outcomes into the monetary reaction function are obvious – or as I wrote last year:
Imaging a central bank say that it will triple the money supply if candidate A wins the presidential elections (due to his very sound fiscal policy ideas), but will cut in halve the money supply if candidate B wins (because he is a irresponsible bastard). This will automatically ensure that the opinion polls will determine monetary policy. If the opinion polls shows that candidate A will win then that will effectively be monetary easing as the market will start to price in future monetary policy easing. Hence, by announce that political outcomes is part of its reaction function will politics will make monetary policy endogenous. The ECB of course is operating a less extreme version of this set-up. Hence, it is for example very clear that the ECB’s monetary policy decisions in the coming months will dependent on the outcome of the Greek elections and on the Spanish government’s fiscal policy decisions.
The problem of course is that politics is highly unpredictable and as a result monetary policy becomes highly unpredictable and financial market volatility therefore is likely to increase dramatically. This of course is what has happened over the past year in Europe.
Furthermore, the political outcome also crucially dependents on the economic outcome. It is for example pretty clear that you would not have neo-nazis and Stalinists in the Greek parliament if the economy were doing well. Hence, there is a feedback from monetary policy to politics and back to monetary policy. This makes for a highly volatile financial environment. In fact it is hard to see how you can achieve any form of financial or economic stability if central banks instead of targeting only nominal variables start to target political outcomes.
Therefore investors are likely to watch comments from the ECB on the Italian elections as closely as the daily political show in Rome. However, there might be reasons to be less worried now than in 2011-12. The reason is not Europe, but rather what has been happening with US and Japanese monetary policy since August-September last year.
Hence, with the Fed effective operating the Bernanke-Evans rule and the Bank of Japan having introduced a 2% inflation target these two central banks effective have promised to offset any negative spill-over to aggregate demand from the euro zone to the US and the Japanese economy (this is basically the international financial version of the Sumner Critique – there is no global spill-over if the central banks have proper nominal targets).
Hence, if Italian political jitters spark financial jitters that threaten to push up US unemployment then the Fed will “automatically” step up monetary easing to offset the shock and investors should full well understand that. Hence, the Bernanke-Evans rule and the BoJ’s new inflation target are effective backstops that reduces the risk of spill-over from Italy to the global markets and the global economy.
However, investors obviously still worry about the possible reaction from the ECB. If the ECB – and European policy makers in general – uses political events in Italy to tighten monetary conditions then we are likely to see more unrest in the European markets. Hence, the ECB can end market worries over Italy today by simply stating that the ECB naturally will act to offset any spill-over from Italy to the wider European markets that threatens nominal stability in the euro zone.
Related posts:
News of Berlusconi once again slipped into the financial section
Spanish and Italian political news slipped into the financial section
Greek and French political news slipped into the financial section
Political news kept slipping into the financial section – European style
“…political news kept slipping into the financial section”
Posted by Lars Christensen on February 28, 2013
https://marketmonetarist.com/2013/02/28/its-frankfurt-that-should-be-your-worry-not-rome/
I stole this from Scott Sumner:
Sen. Tom Coburn (R., Okla.) asks whether all the major central banks easing might diminish the benefits and lead to trade protectionism.
“We don’t view monetary policy aimed at domestic goals a currency war,” [Bernanke] says. Easing policy can be “mutually beneficial” to other countries such as China, which depends on domestic demand in the U.S.
It’s a “positive-sum game, not a zero-sum game,” Bernanke says.
I don’t think Bernanke is reading this blog, but I feel like quoting myself:
Monetary easing is not a negative or a zero sum game. In a quasi-deflationary world monetary easing is a positive sum game.
I have not always been impressed with Bernanke and he has certainly made his fair share of mistakes, but he certainly is more knowledgable about monetary policy than Republican lawmakers.
Posted by Lars Christensen on February 27, 2013
https://marketmonetarist.com/2013/02/27/bernanke-knows-why-currency-war-is-good-news-us-lawmakers-dont/
This is what Bernanke could (or rather should) say about Italian events:
“Let me remind everybody that we have the instruments to shield the US economy from negative spill-over from political and financial events in Europe. We have said that we want to stabilize nominal spending in the US and if events in Europe jeopardize the fulfillment of our targets then we will increase money base growth to counteract these shocks. However, I do not expect that to be necessary as the markets should be well aware of our intentions to stabilize nominal spending and I therefore expect markets to adjust appropriately to do the job for us”
You can replace “stabilize nominal spending” with whatever nominal target you like.
End of story…
Posted by Lars Christensen on February 26, 2013
https://marketmonetarist.com/2013/02/26/what-bernanke-could-say-to-shield-the-us-from-spill-over-from-italy/
This is from CNBC:
European shares quickly cut their earlier gains to end mixed after a projection by Italian TV showed the center-right party, led by former leader Silvio Berlusconi, leading in elections for the Senate vote. Meanwhile, Italian state TV station RAI said none of the four main groups running in the Italian parliamentary election is likely to win a majority in the Senate. A coalition or party must win at least 158 of the 315 Senate seats to gain a majority in the upper house, which a government would need to pass legislation.
Investors have been closely watching the outcome of the Italian election as the government’s decision over the next few months could influence whether Europe can stem its financial crisis. Italy is the euro zone’s third largest economy.
Once again I am reminded of one of my favourite Scott Sumner quotes:
I once read all the New York Times from the 1930s (on microfilm.) You can’t even imagine how frustrating it was. They knew they had a big problem. Then knew that deflation had badly hurt the economy (including the capitalists.) They knew that monetary policy could reflate. And yet . . .
Weeks went by, then months, then years. Somehow they never connected the dots.
“Monetary policy is already highly stimulative.”
“There’s a danger we’d overshoot toward too much inflation.”
“Maybe the problems are structural.”
“There are green shoots, things are getting worse at a slower pace. The economy needs to heal itself.”
“Consumer demand is saturated. Even workingmen can now afford iceboxes and automobiles. We produced too much stuff in the 1920s.”
And the worst part was the way political news kept slipping into the financial section. Nazis make ominous gains in the 1932 German elections, Spanish Civil War, etc, etc. In the 1930s the readers didn’t know what came next—but I did.
Last time I used Scott’s quote I wrote the following, which I think is pretty telling of today’s markets:
Since August-September the Federal Reserve and the Bank of Japan the have moved in the direction of easing monetary policy and a significantly more ruled basked monetary policy and even the ECB has eased up with ECB chief Draghi’s promising to do “whatever it takes” to save the euro. And Mark Carney has given investors hope that the Bank of England will move towards some form of NGDP level targeting. As a result the “euro crisis” has more or less disappeared from the headlines in the newspapers’ “financial section” (just take a look at what Google trends has to say).
Hence, it seems pretty clear that the markets’ “responsiveness” to political worries is a function of the tightness of global monetary conditions with tighter monetary conditions leading to a bigger impact of political jitters.
The Fed – and every other central bank in the world – can effectively protect the US economy from negative spill-over from the European political jitters by introducing a proper monetary target – preferably an NGDP level target (the Bernanke-Evans rule already helps a lot).
Related posts:
Spanish and Italian political news slipped into the financial section
Greek and French political news slipped into the financial section
Political news kept slipping into the financial section – European style
“…political news kept slipping into the financial section”
Posted by Lars Christensen on February 25, 2013
https://marketmonetarist.com/2013/02/25/news-of-berlusconi-once-again-slipped-into-the-financial-section/
A couple of weeks ago I came across a great paper by Peter Rosenkranz, Tobias Straumann and Ulrich Woitek – “A Small Open Economy in the Great Depression: the Case of Switzerland”. It is great paper. Here is the abstract:
Estimating a New Keynesian small open economy model for the period 1926-1938, we investigate the causes of the slow recovery of the Swiss economy of the Great Depression in the 1930s. Our results show that the decision to participate in the gold bloc after 1933 at an overvalued currency can be identified as the main reason for the unusual long lasting recession. Even the recovery of the world econ- omy starting in 1931/1932, and thus a boost of foreign demand could not offset the negative effects of disadvantageous terms of trade. A counterfactual experiment demonstrates that in case of leaving gold earlier (e.g. together with the UK in 1931), the Swiss economy would have recovered much faster, almost immediately reaching the pre-crisis output level.
Posted by Lars Christensen on February 25, 2013
https://marketmonetarist.com/2013/02/25/working-paper-of-the-day-straumann-et-al-on-switzerland-the-great-depression-and-the-gold-standard/
UPDATE: I have edited my post significantly – I misread what Scott really said. That is the result of writing blog posts very early in the morning after sleeping too little. Sorry Scott…
Scott Sumner has a blog post on who might become the next governor of Bank of Japan. Scott ends his post with the following comment:
Naturally I favor the least dovish of the three.
Note that Scott is saying “least dovish” (I missed “least” in my original post). But don’t we want a the most dovish BoJ governor? No, we want the most principled governor – or rather the governor most committed to a rule based monetary policy.
The debate over doves versus hawks is a debate among people who fundamentally think about monetary policy in a discretionary fashion. Market Monetarism is exactly the opposite. We are strongly against discretion in monetary policy (and fiscal policy for that matter).
The important thing is not who is BoJ governor – the important thing is that there are good institutions – good rules. As I have argued before – what we really want is a monetary constitution in spirit of Jim Buchanan. In that sense the BoJ governor should be replaced – as Milton Friedman suggested – by a ‘computer’ and not by the most ‘dovish’ candidate.
Market Monetarists would have been “hawks” in the 1970s in the sense that we would have argued that for example US monetary policy was far too easy and we are ‘doves’ now. But that is really a mistaken way to think about the issue. If we favour for example a 5% NGDP level target for the US today – then we would have been doves in 1974 or 1981. That would make us more or less dovish/hawkish at different times, but that debate is for people who favours discretionary monetary policies – not for Market Monetarists.
If we just want a ‘dovish’ BoJ governor then we should advocate that Prime Minister Shinzo Abe gives Zimbabwean central bank governor Gideon Gono a call. He knows all about monetary easing – and so do the central bank governors of Venezuela and Argentina. But we all know that these people are ludicrously bad central bankers. In similar fashion Janet Yellen would not be the Market Monetarist candidate for the Federal Reserve chairman just because she tends to favour monetary easing – in fact it seems like Yellen always favours monetary easing. In fact you should be very suspicious of the views of policy makers who will always be hawks or doves.
The reason that Mark Carney is a good choice for new Bank of England governor is exactly that he is not ‘dovish’ or ‘hawkish’, but that he tend to stress the need for a rule based monetary policy. That said, the important thing is not Mark Carney, but rather whether the UK government is serious about introducing NGDP level targeting or not.
Monetary policy is not primarily about having the right people for the job, but rather about having the best institutions. Obviously you want to have the best people for the job, but ultimately even Scott Sumner would be a horrible Fed governor if his mandate was wrong.
If the BoJ had a rule based monetary policy and used for example NGDP futures to conduct monetary policy then it wouldn’t matter who becomes BoJ governor – because the policy would be the same no matter what. We cannot rely on central bankers to do the ‘right thing’. Central bankers only do the right thing by chance. We need to tie their hands with a monetary constitution – with strong rules.
Related posts:
Forget about “hawks” and “doves” – what we need is a “monetary constitution”
NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed
NGDP level targeting – the true Free Market alternative (we try again)
Posted by Lars Christensen on February 24, 2013
https://marketmonetarist.com/2013/02/24/i-dont-care-who-becomes-boj-governor-i-want-better-monetary-policy-rules/
One of the unfortunate consequences of this crisis is increased political backing for “reforms” that have negative impact on aggregate supply. In the US in the 1930s it was the horrible National Industrial Recovery Act (NIRA) and in today’s US it is higher minimum wages. I find it incredible that anybody seriously would question the negative supply side consequences of higher minimum wages. This is not a political issue, but a simple question of understanding the laws of supply and demand.
Anyway Bob Murphy explains it well in this Youtube video.
Of course you can also just look at a standard textbook graph. It should be pretty easy to understand.
W eq is the equilibrium wage that would emerge in an unregulated labour market with no minimum wage. In such a market employment would be N eq.
W min is the minimum wage, which is higher than the equilibrium wage (W eq). In such a world the demand for labour will be only N2, while the supply of labour will be N1. The difference between the N2 and N1 obviously is the level of unemployment caused by the minimum wage.
You really don’t need anything else than that to understand this issue…Or as Paul Krugman once said:
“So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment.”
PS Paul Krugman apparently no longer thinks that a higher minimum wage increases unemployment, but I will leave that to David Henderson to explain.
Posted by Lars Christensen on February 23, 2013
https://marketmonetarist.com/2013/02/23/bob-murphy-on-minimum-wages-and-a-textbook-graph-to-illustrate-it/
Is the Norwegian central bank – Norges Bank – targeting nominal GDP? Probably not, but this presentation by Norges Bank governor Øystein Olsen is nonetheless interesting.
Have a look at the graph on slide 17 of the presentation. The graph shows nominal GDP for what is called mainland Norway (“Fastlands-Norge”) which is the non-oil part of the Norwegian economy. The graph obviously is quite Market Monetarist in nature. I would certainly not argue that Norge Bank has started targeting Nominal GDP, but it is nonetheless interesting that governor Øystein have a Market Monetarist style graph in his presentation.
Related posts:
Denmark and Norway were the PIIGS of the Scandinavian Currency Union
Danish and Norwegian monetary policy failure in 1920s – lessons for today
Fear-of-floating, misallocation and the law of comparative advantages
Posted by Lars Christensen on February 21, 2013
https://marketmonetarist.com/2013/02/21/is-norges-bank-targeting-nominal-gdp/
I know that most of my readers must be sick and tired of reading about my view on ‘currency war’. Unfortunately I have more for you. My colleague Jens Pedersen and I have written an article for the Danish business daily Børsen. The piece was published in today’s edition of Børsen. It is in Danish, but you can find an English translation of the article here.
Regular readers of this blog will not be surprised by the main message in the article: The talk of a “dangerous” ‘currency war’ is just silly. It is not really a ‘currency war’, but rather global monetary easing. Global monetary easing even helps the euro zone despite the ECB’s extreme reluctance to ease monetary policy.
Jens has recently also written an extremely interesting paper on the consequence of the ‘currency war’ for the Danish economy. Jens concludes that the currency war – or rather global monetary easing – is good news for Danish exporters despite the fact that the Danish krone has been strengthening in line with the euro (remember the krone is pegged to the euro). The reason is that global monetary easing is boosting global growth and that is outweighing any negative impact on exports from the strengthening of the krone.
Take a look at Jens’ paper here.
Posted by Lars Christensen on February 20, 2013
https://marketmonetarist.com/2013/02/20/the-myth-of-currency-war/
The Market Monetarist
The Market Monetarist 