The Bulgarian government collapses – tight money and a negative supply shock in the end did it

This is from Reuters:

Bulgaria’s government resigned on Wednesday after violent nationwide protests against high electricity prices, joining a long list of European administrations felled by austerity after Europe’s debt crisis erupted in late 2009.

Many Bulgarians are deeply unhappy over high energy costs, power monopolies, low living standards and corruption in the European Union’s poorest country and protesters clashed again with police late on Tuesday.

Tens of thousands of Bulgarians have rallied in cities across the country since Sunday in protests which have turned violent, chanting “Mafia” and “Resign”.

Prime Minister Boiko Borisov had tried to calm protests by sacking hisfinance minister, pledging to cut power prices and punishing foreign-owned companies – risking a diplomatic row with EU partner the Czech Republic – but the measures failed to defuse discontent.

“I will not participate in a government under which police are beating people,” Borisov said as he announced his resignation on Wednesday. Parliament is expected to accept the resignation later in the day.

Borisov, a former bodyguard to communist dictator Todor Zhivkov, can now try to form a new government, using his rightist GERB party’s strong position in parliament. If he fails an election scheduled for July may be brought forward.

GERB’s popularity had held up well until late last year because austerity measures were relatively mild compared with many other European countries, with salaries and pensions frozen rather than cut. In the last opinion poll, taken before protests grew last weekend, the opposition Socialists were nearly tied with GERB.

Many Bulgarians are feeling frustrated with unemployment hitting a 10-month high of 11.9 percent and the average salary stuck at 800 levs ($550) a month. Frustrations boiled over when heating bills rose during the winter.

Bulgaria raised the costs of electricity – politically sensitive since bills eat a huge part of modest incomes – by 13 percent last July, but the real impact was not felt until households started using electrical power for heat in winter.

I am actually surprised that the Bulgarian government has lasted this long, but in the end the combination of tight monetary conditions (Bulgaria is “importing” tight monetary conditions through its currency board arrangement and the peg against the euro) and a negative (quasi) supply shock in the form of higher energy prices did it.

You can draw your own conclusions, but I can’t help wondering whether Simeon Djankov who was sacked as Bulgarian Finance Minister on Monday today thinks the combination of fiscal austerity and tight monetary conditions has worked well for Bulgaria.


Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

It is said that Europe is the biggest “victim” in what is said to be an international ‘currency war’ (it is really no war at all, but global monetary easing) as the euro has strengthened significantly on the back of the Federal Reserve and Bank of Japan having stepped up monetary easing.

However, the euro zone is no victim – to claim so is to reason from a price change as Scott Sumner would say. The price here of course is the euro exchange rate. The ‘currency war worriers’ claim that the strengthening is a disaster for European exports. What they of course forget is to ask is why the euro has strengthened.

The euro is stronger not because of monetary tightening in the euro zone, but because of monetary easing everywhere else. Easier monetary policies in the US and Japan obviously boost domestic demand in those countries and with it also imports. Higher American and Japanese import growth is certainly good news for European exports and that likely is much more important than the lose of “competitiveness” resulting from the stronger euro.

But have a look at European exporters think. The graph below is the Purchasing Managers Index (PMI) for euro zone new export orders. The graph is clear – optimism is spiking! The boost from improved Japanese and American growth prospects is clearly what is on the mind of European exporters rather than the strong euro.

PMIexport euro zone

Brad DeLong on the Sumner Critique and why the fiscal multiplier is zero

This is Brad DeLong:

An optimizing central bank that cares only about inflation and unemployment because it does not find itself at the zero nominal lower bound and does not fear engaging in nonstandard monetary policy will engage in full fiscal offset: it will take care to make sure that if fiscal policy becomes more stimulative then it will make monetary policy less stimulative by the same amount.

What Brad of course here is expressing is the so-called Sumner Critique – that is the fiscal multiplier will always be zero if the central bank directly or indirectly targets aggregate demand either as a result of an inflation target, an NGDP level target or for that matter a Bernanke-Evans style monetary rule.

Brad has a nice little model to illustrate his point. In some ways Brad’s model is similar to Nick Rowe’s game theoretical discussion of what Brad calls “full fiscal offset” (see my earlier post on the topic here). My simpler IS/LM+ model illustrates the same point (have a look at the model here).

Brad, however, thinks that the fiscal multiplier is positive at the Zero Lower Bound (ZLB):

… this argument breaks down at the zero nominal lower bound. At the zero lower bound the central bank does care only about inflation and unemployment. It cares as well about the magnitude of the non-standard monetary policy measures it must take in order to achieve its net monetary policy impetus value m.

This argument is somewhat harder for me to get. The Zero Lower Bound only exists as a mental construction in the heads of central bankers. Central banks can always ease monetary policy – even if interest rates are close to zero. That is exactly what the Fed and the Bank of Japan are doing at the moment.

Furthermore, it might of course be right that “real world” central banks prefer not to use other instruments rather than interest rates and therefore prefer the government to “push” aggregate demand (hence that is why Brad argues that the “instrument” should enter into the utility function of the central  bank). However, that would still be monetary policy (rather than fiscal policy) as government spending would only impact aggregate demand/NGDP because the central bank chose not to offset the increase in government spending. If the central bank on the other hand used for example a money base rule or McCallum’s MC rule where the policy instrument is a combination of the exchange rate and interest rates then the central bank would not pay any attention to the ZLB.

PS I find it “interesting” to read the comment section on Brad’s blog. It is clear that some of the more ideologically inclined Keynesians have a very hard time accepting the fact that the fiscal multiplier might be zero. (yes, I similarly have a very hard time accepting arguments that it might be positive so I am no saint…)


This one is pretty funny (HT Daniel Brackins)

krugman astroid

Market Monetarism has come to Croatia, but unfortunately not to the Croatian central bank

Good news – the Market Monetarist gospel is spreading across the world. The latest arrival is Petar Sisko’s blog Money Mischief in Croatia. Petar blogs both in English and in Croatian. Petar has been a frequent commentator on my blog so I am happy that he is now taking the Market Monetarist message to Croatia. I like the fact that Petar has named his blog Money Mischief – undoubtedly after Milton Friedman’s book. Money Mischief is one of my favourite books on monetary matters and I strongly considered naming my blog Money Mischief when I started it in 2011.

Croatia certainly needs a shot of Market Monetarism. Since 2008 Croatian monetary policy has been extremely tight. Just take a look at the graph below.


Prior to when the crisis hit in 2008 the Croatian central bank (CNB) kept nominal GDP growth around 8% – more or less evenly split between 4% real GDP growth and 4% inflation.

However, since 2008 nominal GDP has barely grown. Since the central bank is in full control of nominal GDP the stance of the CNB since 2008 can only be termed extremely tight.

This is certainly also visible on the price level. From 2000 to 2007 inflation – measured with the GDP deflator – averaged around 4%. However, since 2008 inflation has dropped well below 4% and has averaged 2%.

Price Level Croatia

Obviously one could argue that inflation of 2% is preferable to 4% inflation and that 6% NGDP growth is preferable 8%. However, the shift in NGDP growth and inflation does not reflect the announcement of a new target, but rather a negative shock to monetary policy and that I believe is at the core of the Croatian crisis.

The best way to pull the economy out of the crisis is for the CNB to announce a 6% NGDP level target – and allow the Croatian kuna to float much more freely than is presently the case.

Over the longer run that would keep inflation around 2% as I think it is fair to think that trend real GDP growth is 4%.

I am sure Petar’s blog will help further the discussion about monetary policy and that should be welcomed.

PS If somebody asks why the CNB has not implemented more aggressive monetary easing then the answer probably is that the CNB fears weakening the Croatian kuna (the CNB is de facto operating a managed float/quasi-pegged exchange rate regime). Croatian households and corporations are heavily indebted in foreign currency. Hence, the CNB undoubtedly fears setting off a financial sector crisis if the kuna were to weaken significantly on the back of more aggressive monetary easing. I think those fears are unfounded, but that is another story that I might return to at a later stage.

PPS here is my old friend Boris Vujcic who since 2012 has been CNB governor in an interview with CNBC from last year on Croatian monetary policy. I say ‘old friend’, but don’t blame Boris for my views.

Jeff Cox is puzzled – maybe because he never asked anybody about monetary policy

This is CNBC’s Jeff Cox:

Investors who fled in fear over potentially massive tax increases associated with the “fiscal cliff” have barely broken a sweat over corresponding spending cuts that are only two weeks away.

The so-called sequestration of $110 billion a year in discretionary spending will happen March 1 if Congress does not come to an agreement.

With little indication that Washington is anywhere near a compromise similar to the one that avoided the full brunt of the fiscal cliff, markets could be expected to be in full panic mode.

But the post-cliff rally has shown no signs of letting up and the topic has gained little traction around Wall Street.

It is clear that Jeff never read any Market Monetarist blogs. If he had he would have known that monetary policy always overrules fiscal policy – there is monetary policy dominance and therefore financial markets should not be worried about a sizable fiscal tightening.

With the Bernanke-Evans rule the Fed has committed itself to continuing and escalating – if necessary – monetary easing until there is a substantial improvement of US labour market conditions – essentially this is a commitment to increasing aggregate demand. Hence, the Fed is also committed to counteract any negative impact on aggregate demand from a potential tightening of fiscal policy.

I have explained earlier that there is no reason to fear the fiscal cliff as long as there is a ‘monetary backstop’ in the form of the Bernanke-Evans rule:

Even if the fiscal cliff would be a negative shock to private consumption and public spending it is certainly not given that that would lead to a drop in overall aggregate demand. As I have discussed in earlier posts if the central bank targets NGDP or inflation for that matter then the central bank tries to counteract any negative demand shock (for example a fiscal tightening) by a similarly sized monetary expansion.

Even if we assume that we are in a textbook style IS/LM world with sticky prices and where the money demand is interest rate sensitive the budget multiplier will be zero if the central bank follows a rule to stabilize aggregate demand/NGDP.

As I have shown in an earlier post the LM curve becomes vertical if the monetary policy rule targets a certain level of unemployment or aggregate demand. This is exactly what the Bernanke-Evans rule implies. Effectively that means that if the fiscal cliff were to push up unemployment then the Fed would simply step up quantitative easing to force back down unemployment again.

Obviously the Fed’s actual conduct of monetary policy is much less “automatic” and rule-following than I here imply, but it is pretty certain that a 3, 4 or 5% of GDP tightening of fiscal policy in the US would trigger a very strong counter-reaction from the Federal Reserve and I strongly believe that the Fed would be able to counteract any negative shock to aggregate demand by easing monetary policy. This of course is the so-called Sumner Critique.

So Jeff the reason the markets are so relaxed about the so-called sequestration might very well be that the Fed has regained some credibility that it actually is controlling aggregate demand/NGDP. I know it is hard to understand that it is not important what is going on in the US Congress, but the markets really don’t care as long as the Fed is doing its job.

The Economics of Horsemeat

Well this is non-monetary, but I can’t help myself. One of the top media stories in Europe this week is the “Horsemeat scandal”.

This is the story according to CNN:

Horsemeat has been discovered in products labeled as 100% beef and sold in Sweden, the United Kingdom and France.
Food authorities in those countries have launched investigations but the supply chain being studied includes still more countries.

Any serious economist should of course be reminded what Nobel Prize winning Al Roth has to say about horsemeat:

“Why can’t you eat horse or dog meat in a restaurant in California, a state with a population that hails from all over the world, including some places where such meals are appreciated? The answer is that many Californians not only don’t wish to eat horses or dogs themselves, but find it repugnant that anyone else should do so, and they enacted this repugnance into California law by referendum in 1998. Section 598 of the California Penal Code states in part: “[H]orsemeat may not be offered for sale for human consumption. No restaurant, cafe, or other public eating place may offer horsemeat for human consumption.” The measure passed by a margin of 60 to 40 percent with over 4.6 million people voting for it.
Notice that this law does not seek to protect the safety of consumers by govern- ing the slaughter, sale, preparation, and labeling of animals used for food. It is different from laws prohibiting the inhumane treatment of animals, like rules on how farm animals can be raised or slaughtered, or laws prohibiting cockfights, or the recently established (and still contested) ban on selling foie gras in Chicago restaurants (Ruethling, 2006). It is not illegal in California to kill horses; the California law only outlaws such killing “if that person knows or should have known that any part of that horse will be used for human consumption.” The prohibited use is “human consumption,” so it apparently remains legal in California to buy and sell pet food that contains horse meat (although the use of horse meat in pet food has declined in the face of the demand in Europe for U.S. horse meat for human consumption).”

I don’t really have anything to add other than this might be a problem for my “Bacon Standard” – you might be able to debase the currency if you mix horsemeat into pork…


The New York Times joins the ‘currency war worriers’ – that is a mistake

It is very frustrating to follow the ongoing discussion of ‘currency war’. Unfortunately the prevailing view is that the world is heading for a ‘currency war’ in the form of ‘competitive devaluations’ that will only lead to misery for everybody. I have again, again and again stressed that when large parts of the world is caught in a low-growth quasi-deflationary trap then a competition to print more money is exactly what the world needs. ‘Currency war’ is a complete misnomer. What we are talking about is global monetary easing.

Now the New York Times has joined the discussion with a pretty horrible editorial on ‘currency war’.

This is from the editorial:

If all countries were to competitively devalue their currencies, the result would be a downward spiral that would benefit no one, but could lead to high inflation. Certainly in Europe, altering exchange rates is not the answer; reviving economies will require giving up on austerity, which is choking demand and investment.

It is just frustrating to hear this argument again and again. Monetary easing is not a negative or a zero sum game. In a quasi-deflationary world monetary easing is a positive sum game. The New York Times claims that “competitive devaluations” will lead to increased inflation.

Well, lets start with stating the fact a that the New York Times seems to miss – both the Bretton Woods and the gold standard are dead. We – luckily – live in a world of (mostly) freely floating exchange rates. Hence, nobody is “devaluing” their currencies. What is happening is that some currencies like the Japanese yen are depreciating on the back of monetary easing. The New York Times – and French president Hollande and Bundesbank chief Weidmann for that matter – also fails to notice that the yen is depreciating because the Bank of Japan is implementing the exact same monetary target as the ECB has – a 2% inflation target. After 15 years of failure the BoJ is finally trying to get Japan out of a low-growth deflationary trap. How that can be a hostile act is impossible for me to comprehend.

Second, the New York Times obviously got it right that if we have an international “competition” to print more money then inflation will increase. But isn’t that exactly what we want in a quasi-deflationary world? Can we really blame the BoJ for printing more money after 15 years of deflation? Can we blame the Fed for doing the same thing when US unemployment is running at nearly 8% and there are no real inflationary pressures in the US economy? On the other hand we should blame the ECB for not doing the same thing with the euro zone economy moving closer and closer to deflation and with unemployment in Europe continuing to rise.

When the New York Times joins the “currency war worriers” then the newspaper effectively is arguing in favour of a return to internationally managed exchange rates – either in the form of a gold standard or a Bretton Woods style system. Both systems ended in disaster.

The best international monetary system remains a system where countries are free to pursue their own domestic monetary objectives. Where every country is free to succeed or fail. A system of internationally coordinated monetary policy is doomed to fail and end in disaster as was the case with both the gold standard and Bretton Woods – not to mentioned the ill-faited attempts to coordinate monetary policy through the Plaza and Louvre Accords.

The New York Times and other ‘currency war worriers’ seem to think that if countries are free to pursue their own domestic monetary policy objectives then it will not only lead to ‘currency war’, but also to ‘trade war’. Trade war obviously would be disastrous. However, the experiences from the 1930s clearly show that those countries that remained committed to international monetary policy coordination in the form of staying on the gold standard suffered the biggest output lose  and the biggest rise in unemployment. But more importantly these countries were also much more likely to implement protectionist measures – that is the clear conclusion from research conducted by for example Barry Eichengreen and Douglas Irwin.

‘Currency war’ is what we need to get the global economy out of the crisis and monetary easing is much preferable to the populist alternative – protectionism and ‘deflationism’.

HT William Bruce.

Update: It seems like Paul Krugman – who of course blogs at the New York Times – disagrees with the editors of the New York Times.

The root of most fallacies in economics: Forgetting to ask WHY prices change

Even though I am a Dane and work for a Danish bank I tend to not follow the Danish media too much – after all my field of work is international economics. But I can’t completely avoid reading Danish newspapers. My greatest frustration when I read the financial section of Danish newspapers undoubtedly is the tendency to reason from different price changes – for example changes in the price of oil or changes in bond yields – without discussing the courses of the price change.

The best example undoubtedly is changes in (mortgage) bond yields. Denmark has been a “safe haven” in the financial markets so when the euro crisis escalated in 2011 Danish bond yields dropped dramatically and short-term government bond yields even turned negative. That typically triggered the following type of headline in Danish newspapers: “Danish homeowners benefit from the euro crisis” or “The euro crisis is good news for the Danish economy”.

However, I doubt that any Danish homeowner felt especially happy about the euro crisis. Yes, bond yields did drop and that cut the interest rate payments for homeowners with floating rate mortgages. However, bond yields dropped for a reason – a sharp deterioration of the growth outlook in the euro zone due to the ECB’s two unwarranted interest rate hikes in 2011. As Denmark has a pegged exchange rate to the euro Denmark “imported” the ECB’s monetary tightening and with it also the prospects for lower growth. For the homeowner that means a higher probability of becoming unemployed and a prospect of seeing his or her property value go down as the Danish economy contracted. In that environment lower bond yields are of little consolation.

Hence, the Danish financial journalists failed to ask the crucial question why bond yields dropped. Or said in another way they failed to listen to the advice of Scott Sumner who always tells us not to reason from a price change.

This is what Scott has to say on the issue:

My suggestion is that people should never reason from a price change, but always start one step earlier—what caused the price to change.  If oil prices fall because Saudi Arabia increases production, then that is bullish news.  If oil prices fall because of falling AD in Europe, that might be expansionary for the US.  But if oil prices are falling because the euro crisis is increasing the demand for dollars and lowering AD worldwide; confirmed by falls in commodity prices, US equity prices, and TIPS spreads, then that is bearish news.

I totally agree. When we see a price change – for example oil prices or bond yields – we should ask ourselves why prices are changing if we want to know what macroeconomic impact the price change will have. It is really about figuring out whether the price change is caused by demand or supply shocks.

The euro strength is not necessarily bad news – more on the currency war that is not a war

A very good example of this general fallacy of forgetting to ask why prices are changing is the ongoing discussion of the “currency war”. From the perspective of some European policy makers – for example the French president Hollande – the Bank of Japan’s recent significant stepping up of monetary easing is bad news for the euro zone as it has led to a strengthening of the euro against most other major currencies in the world. The reasoning is that a stronger euro is hurting European “competitiveness” and hence will hurt European exports and therefore lower European growth.

This of course is a complete fallacy. Even ignoring the fact that the ECB can counteract any negative impact on European aggregate demand (the Sumner critique also applies for exports) we can see that this is a fallacy. What the “currency war worriers” fail to do is to ask why the euro is strengthening.

The euro is of course strengthening not because the ECB has tightened monetary policy but because the Bank of Japan and the Federal Reserve have stepped up monetary easing.

With the Fed and the BoJ significantly stepping up monetary easing the growth prospects for the largest and the third largest economies in the world have greatly improved. That surely is good news for European exporters. Yes, European exporters might have seen a slight erosion of their competitiveness, but I am pretty sure that they happily will accept that if they are told that Japanese and US aggregate demand – and hence imports – will accelerate strongly.

Instead of just looking at the euro rate European policy makers should consult more than one price (the euro rate) and look at other financial market prices – for example European stock prices. European stock prices have in fact increased significantly since August-September when the markets started to price in more aggressive monetary easing from the Fed and the BoJ. Or look at bond yields in the so-called PIIGS countries – they have dropped significantly. Both stock prices and bond yields in Europe hence are indicating that the outlook for the European economy is improving rather than deteriorating.

The oil price fallacy – growth is not bad news, but war in the Middle East is

A very common fallacy is to cry wolf when oil prices are rising – particularly in the US. The worst version of this fallacy is claiming that Federal Reserve monetary easing will be undermined by rising oil prices.

This of course is complete rubbish. If the Fed is easing monetary policy it will increase aggregate demand/NGDP and likely also NGDP in a lot of other countries in the world that directly or indirectly is shadowing Fed policy. Hence, with global NGDP rising the demand for commodities is rising – the global AD curve is shifting to the right. That is good news for growth – not bad news.

Said another way when the AD curve is shifting to the right – we are moving along the AS curve rather than moving the AS curve. That should never be a concern from a growth perspective. However, if oil prices are rising not because of the Fed or the actions of other central banks – for example because of fears of war in the Middle East then we have to be concerned from a growth perspective. This kind of thing of course is what happened in 2011 where the two major supply shocks – the Japanese tsunami and the revolutions in Northern Africa – pushed up oil prices.

At the time the ECB of course committed a fallacy by reasoning from one price change – the rise in European HICP inflation. The ECB unfortunately concluded that monetary policy was too easy as HICP inflation increased. Had the ECB instead asked why inflation was increasing then we would likely have avoided the rate hikes – and hence the escalation of the euro crisis. The AD curve (which the ECB effectively controls) had not shifted to the right in the euro area. Instead it was the AS curve that had shifted to the left. The ECB’s failure to ask why prices were rising nearly caused the collapse of the euro.

The money supply fallacy – the fallacy committed by traditional monetarists 

Traditional monetarists saw the money supply as the best and most reliable indicator of the development in prices (P) and nominal spending (PY). Market Monetarists do not disagree that there is a crucial link between money and prices/nominal spending. However, traditional monetarists tend(ed) to always see the quantity of money as being determined by the supply of money and often disregarded changes in the demand for money. That made perfectly good sense for example in the 1970s where the easy monetary policies were the main driver of the money supply in most industrialized countries, but that was not the case during the Great Moderation, where the money supply became “endogenous” due to a rule-based monetary policies or during the Great Recession where money demand spiked in particularly the US.

Hence, where traditional monetarists often fail – Allan Meltzer is probably the best example today – is that they forget to ask why the quantity of money is changing. Yes, the US money base exploded in 2008 – something that worried Meltzer a great deal – but so did the demand for base money. In fact the supply of base money failed to increase enough to counteract the explosion in demand for US money base, which effectively was a massive tightening of US monetary conditions.

So while Market Monetarists like myself certainly think money is extremely important we are skeptical about using the money supply as a singular indicator of the stance of monetary policy. Therefore, if we analyse money supply data we should constantly ask ourselves why the money supply is changing – is it really the supply of money increasing or is it the demand for money that is increasing? The best way to do that is to look at market data. If market expectations for inflation are going up, stock markets are rallying, the yield curve is steepening and global commodity prices are increasing then it is pretty reasonable to assume global monetary conditions are getting easier – whether or not the money supply is increasing or decreasing.

Finally I should say that my friends Bob Hetzel and David Laidler would object to this characterization of traditional monetarism. They would say that of course one should look at the balance between money demand and money supply to assess whether monetary conditions are easy or tight. And I would agree – traditional monetarists knew that very well, however, I would also argue that even Milton Friedman from time to time forgot it and became overly focused on money supply growth.

And finally I happily will admit committing that fallacy very often and I still remain committed to studying money supply data – after all being a Market Monetarist means that you still are 95% old-school traditional monetarist at least in my book.

PS maybe the root of all bad econometrics is the also forgetting to ask WHY prices change.

I am sick and tired of hearing about “currency war” – and so is Philipp Hildebrand

Milton Friedman used to talk about an interest rate fallacy – that people confuse low interest rates with easy monetary policy. However, I believe that we today are facing an even bigger fallacy – the exchange rate fallacy.

The problem is that many commentators, journalists, economists and policy makers think that exchange rate movements in some way are a zero sum game. If one country’s currency weakens then other countries lose competitiveness. In a world with sticky prices and wages that is of course correct in the short-term. However, what is not correct is that monetary easing that leads to currency depreciation hurts other countries.

Easing monetary conditions is about increasing domestic demand (or NGDP). In open economies a side effect can be a weakening of the country’s currency. However, any negative impact on other countries can always be counteracted by that country’s central bank. The Federal Reserve determines nominal GDP in the US. The Bank of Mexico determines Mexican NGDP. It is of course correct that strengthening of the Mexican peso against the US dollar can impact Mexican exports to the US, but the Fed can never “overrule” Banxico when it comes to determining NGDP in Mexico. This of course is a variation of the Sumner Critique – that the fiscal multiplier is zero if the central bank directly or indirectly targets aggregate demand (through for example inflation targeting or NGDP level targeting). Similarly the “export multiplier” is zero as the central bank always has the last word when it comes to aggregate demand. For a discussion of the US-Mexican monetary transmission mechanism see here.

At the core of the problem is that most people tend to think of economics in paleo-Keynesian terms – or what I earlier have termed national account economics. Luckily not everybody thinks like this. A good example of somebody who is able to understand something other than “national account economics” is former Swiss central banker Philipp Hildebrand.

Hildebrand has a great comment on on why there is “No such thing as a global currency war”.

Here is Hildebrand:

As finance ministers and central bankers make their way to this week’s Group of 20 leading nations meeting in Moscow, some of them may find it impossible to resist the temptation to grab headlines by lamenting a new round of “currency wars”. They should resist, for there is no such thing as a currency war.

This is because central banks are simply doing what they are meant to do and what they have always done. They set monetary policy consistent with their domestic mandates. All that has changed since the crisis is that central banks have had to resort to unconventional measures in an effort to revive wounded economies.

 So true, so true. Central banks are in the business of controlling nominal spending in their own economies to fulfill whatever domestic mandate they have.
Over the last couple of months the Federal Reserve and Bank of Japan have moved decisively in the direction of monetary easing and all indications are that the Bank of England is moving in the same direction. That is good news. Hildebrand agrees:

In the US, for example, the unemployment rate is 2 percentage points above its postwar average. In the UK, output remains 3 per cent below its level at the end of 2007.

In both of these countries, the remits given to the central banks make their responsibility clear: to take action to provide economic stimulus. The US Federal Reserve, for example, has responsibility to “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates”. In the UK, the Bank of England’s main objective is to maintain price stability. But subject to that, it is required to “support the economic policy of Her Majesty’s government, including its objectives for growth and employment”.

Japan’s problems are different in nature, and longer in the making. Japanese inflation has been negative, on average, for well over a decade. It is an environment that would not be tolerated in any other developed economy. The recently signalled desire for inflation of 2 per cent is hardly a leap towards monetary unorthodoxy, let alone an act of war.

Obviously the side effect of monetary easing from the major central banks of the world (with the horrible exception of the ECB) is that other countries’ currencies tend to strengthen. That is for example the case for the Mexican peso as I noted above. With currencies strengthening these countries are importing monetary tightening. However, that can easily be counteracted (if necessary!) by cutting interest rates or conducting quantitative easing. Hildebrand again nails it:

One can sympathise with emerging economies with floating exchange rates, which may feel they are bearing too much of the burden of adjustment. But surely the answer is not for developed economy central banks to turn away from their remits. Rather, it is for emerging economies to focus their own monetary policy on sensible domestic remits, with their exchange rates free to be determined in the market.

There is one small and particularly open economy where sustained currency movements were not merely the consequence of conventional or unconventional monetary policy measures but where the central bank opted to influence the exchange rate directly. In September 2011, when I was chairman of the Swiss National Bank, it announced that it would no longer tolerate an exchange rate below 1.20 Swiss francs to the euro – and to enforce that minimum rate it would be prepared to buy foreign currency in unlimited quantities.

If Mexico had a problem with US monetary easing then Banxico could simply copy the policies of SNB – and put a floor under USD/MXN. However, I doubt that that will be necessary as Mexican inflation is running slightly above Banxico’s inflation target and the prospects for Mexican growth are quite good.

Hildebrand concludes:

The monetary policy battles that have been fought and continue to be fought in so many economies are domestic ones. They are fights against weak demand, high unemployment and deflationary pressures. A greater danger to the world economy would in fact arise if central banks did not engage in these internal battles. These monetary battles are justified and fully embedded in legal mandates. They are not currency wars.

 Again Hildebrand is right. In fact I would go much further. What some calls currency war in my view is good news. We are not in a world of high inflation, but in a world of low growth and quasi-deflationary tendencies. The world needs easier monetary policy – so if central banks around the world compete to print more money then this time around it surely would be good news.
Unfortunately in Europe central bankers fail to understand this. Here is Bundesbank chief Jens Weidmann:
“Experience from previous, politically induced depreciations show that they don’t normally lead to a sustained increase in competitiveness,” Weidmann said. “Often, more and more depreciations are necessary. If more and more countries try to depress their currency, it will end in a depreciation competition, which will only produce losers.”
Dr. Weidmann – monetary easing is not about creating hyperinflation. Monetary depreciation is not about “competitiveness”. What we need is easier monetary policy and if the consequence is weaker currencies so be it. At least the Bank of Japan is now beginning to pull the Japanese economy out of 15 years of deflation. Unfortunately the ECB is doing the opposite.
Maybe Dr. Weidmann could benefit from studying monetary history. A good starting point is Ralph Hawtrey. This is from Hawtrey’s 1933 book “Trade Depression and the Way Out” (I stole this from David Glasner):

In consequence of the competitive advantage gained by a country’s manufacturers from a depreciation of its currency, any such depreciation is only too likely to meet with recriminations and even retaliation from its competitors. . . . Fears are even expressed that if one country starts depreciation, and others follow suit, there may result “a competitive depreciation” to which no end can be seen.

This competitive depreciation is an entirely imaginary danger. The benefit that a country derives from the depreciation of its currency is in the rise of its price level relative to its wage level, and does not depend on its competitive advantage. If other countries depreciate their currencies, its competitive advantage is destroyed, but the advantage of the price level remains both to it and to them. They in turn may carry the depreciation further, and gain a competitive advantage. But this race in depreciation reaches a natural limit when the fall in wages and in the prices of manufactured goods in terms of gold has gone so far in all the countries concerned as to regain the normal relation with the prices of primary products. When that occurs, the depression is over, and industry is everywhere remunerative and fully employed. Any countries that lag behind in the race will suffer from unemployment in their manufacturing industry. But the remedy lies in their own hands; all they have to do is to depreciate their currencies to the extent necessary to make the price level remunerative to their industry. Their tardiness does not benefit their competitors, once these latter are employed up to capacity. Indeed, if the countries that hang back are an important part of the world’s economic system, the result must be to leave the disparity of price levels partly uncorrected, with undesirable consequences to everybody. . .

How much better the world would be had the central bankers of today read Cassel and Hawtrey and studied a bit of monetary history. Hildebrand did, Weidmann did not.

PS if the Fed and the BoJ’s recent actions are so terrible that they can be termed a currency war – imagine what would happen if the Fed and the BoJ had decided appreciate the dollar and the yen by lets say 20%. My guess is that we would be sitting on a major sovereign and banking crisis in the euro zone right now. Or maybe everybody has forgot the “reverse currency war” of 2008 when the dollar and the yen strengthened dramatically. Look how well that ended.


Related posts:

Is monetary easing (devaluation) a hostile act?
Bring on the “Currency war”
The Fed’s easing is working…in Mexico
Mises was clueless about the effects of devaluation
The luck of the ‘Scandies’
Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons
Fiscal devaluation – a terrible idea that will never work

“The Stock Exchange as Barometer”

At the core of Market Monetarist thinking is the view that financial markets are incredibly important indicators of monetary policy conditions. That idea is certainly not new. Just take a look at this article from April 28 1938 (reproduced from the Australian newspaper The Courier Mail):


Professor Gustav Cassel, of Sweden, states that the Stock Exchange has often been represented as an astonishingly sensitive barometer, which indicates beforehand what is going to happen in economic life.

Recent experience, however, forced the conclusion that the economic recession in 1937 was in a marked degree, the effect of the distrust shown by the Stock Exchange, and thus might have been avoided if the Stock Exchange had not been exposed to the serious disturbance of confidence which a vacillating monetary policy is always bound to entail.

The ability of the stock exchange to fulfil its functions and to make a firm resistance to a panicky pessimism was greatly impaired by a number of restrictive measures, which, even if they had a grain of justification; unfortunately were framed under the influence of dilettante ideas about the stock exchange as the root of all evil.

There we have it – Gustav Cassel was a Market Monetarist or rather Gustav Cassel is a great influence on Market Monetarist thinking even when we don’t realise it.

The following sentence is especially notable: “the effect of the distrust shown by the Stock Exchange, and thus might have been avoided if the Stock Exchange had not been exposed to the serious disturbance of confidence which a vacillating monetary policy is always bound to entail.”

It is not the drop in the stock market that is causing the crisis, but rather the failure of monetary policy that is at the root of the crisis. The stock market, however, is a strong indicator of monetary policy failure. The quote also clearly shows that Cassel understood well the forward-looking nature of markets and the importance of monetary policy guidance. The stock markets crash in 1937 because policy makers signaled that monetary policy would be tightened (and was indeed tightened) and not because investors panicked. For more on the 1937 see my previous post: Remember the mistakes of 1937? A lesson for today’s policy makers

Hence, the stock market remains a great “barometer” of monetary policy. That was the case in 1937 – as is it today. The graph below – which I have used in an earlier post – illustrates this point quite well I think.


At the moment the “barometer” is pretty clear in its verdict – stocks are going up and that is a pretty clear indication that monetary conditions are getting easier.

The upturn in the global markets since August-September last year of course has coincided with Mario Draghi’s “promise” to do “whatever it takes to save the euro”, the introduction of the Bernanke-Evans rule by the fed, Prime Minister Abe in Japan forcing Bank of Japan to seriously step up monetary easing and finally the hope the the Bank of England under the leadership of Mark Carney will introduce some form of NGDP targeting.

Gustav Cassel would have approved.


See also:

Imagine that a S&P500 future was the Fed’s key policy tool

And more on Gustav Cassel:

Gustav Cassel on Hoover’s Mistake and monetary policy failure
Gustav Cassel foresaw the Great Depression
Hawtrey, Cassel and Glasner
Gustav Cassel on recessions
Danish and Norwegian monetary policy failure in 1920s – lessons for today
“Our Monetary ills Laid to Puritanism”
Calvinist economics – the sin of our times
France caused the Great Depression – who caused the Great Recession?

Update: Felix Salmon has a some different blog post, but it is nonetheless related.

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