The OECD understands the Sumner Critique – Europe’s problem is monetary

This is from OECD’s Economic Outlook report published earlier today:

In the euro area, the area-wide fiscal consolidation (measured as an improvement in the underlying primary budget balance) of just over 4% of GDP between 2009 and 2013 was similar to that in the United States over the same period. This casts doubts about the role of fiscal tightening in explaining the comparatively weak performance of the euro area.

The OECD is of course completely right. The fiscal tightening in the US and the in euro zone have been more or less of the same magnitude over the last four years. So don’t blame ‘austerity’ for the euro zone’s lackluster performance.

The real difference between the euro zone and the US is of course monetary. The central bank can always offset the impact of fiscal tightening on aggregate demand. The fed has shown that, while the ECB has failed to do so. Rather the ECB continues to keep monetary conditions insanely tight. Aggregate demand is weak in the euro zone because the ECB wants it to be weak.

The ECB has failed. It is as simple as that and the OECD understands that.

HT Jens Pedersen

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When US 30-year yields hit 5% the Great Recession will be over

US bond yields are spiking today. You might expect me to celebrate it and say this is great (while everybody else are freaking out…) Well, you are right – it doesn’t worry me the least bit.

That said, the US story is not necessarily the same story as the Japanese story. Hence, while Japanese real yields actually have declined sharply US real yields continue to rise as break-even inflation in the US has actually declined recently – most likely on the back of a positive supply shock due to lower commodity prices.

But obviously higher real yields should only be a worry if it is out sync with the development in the economy – as in 2008-9 when real yields and rates spiked, while at the same time the economy collapsed. However, if the economy is in recovery it is only naturally that real yields and rates start to rise as the recovery matures as it certainly seems to be the case in the US.

Anyway, this is not really what I wanted to discuss. Instead I was reminded about something Greenspan said in 1992:

“Let me put it to you this way. If you ask whether we are confirming our view to contain the success that we’ve had to date on inflation, the answer is “yes.” I think that policy is implicit among the members of this Committee, and the specific instruments that we may be using or not using are really a quite secondary question. As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies, we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that. And I don’t see any change in our view…and we will know they are convinced (about “price stability”) when we see the 30-year Treasury at 5-1/2 percent.

Yes, that is correct. Greenspan was thinking that the Federal Reserve should (or actually did) target NGDP growth of 4.5%. Furthermore, he (indirectly) said that that would correspond to 30-year US Treasury yields being around 5.5%.

This is more or less also what we had all through the Great Moderation – or rather both 5% 30-year yields and 5% NGDP growth. However, the story is different today. While, NGDP growth expectations for the next 1-2 years are around 4-5% (ish) 30-year bond yields are around 3.3%. This in my view is a pretty good illustration that while the US economy is in recovery market participants remain very doubtful that we are about to return to a New Great Moderation of stable 5% NGDP growth.

That said, with yields continuing to rise faster than the acceleration in NGDP growth we can say that we are seeing a gradual return to something more like the Great Moderation. That obviously is great news.

In fact I would argue that when US 30-year hopefully again soon hit 5% then I think that we at that time will have to conclude that the Great Recession finally has come to an end. Last time US 30-year yields were at 5% was in the last year of the Great Moderation – 2007.

We are still very far away from 5% yields, but we are getting closer than we have been for a very long time – thanks to the fed’s change of policy regime in September last year.

Finally, when US 30-year bond yields hit 5% I will stop calling for US monetary easing. I will, however, not stop calling for a proper transparent and rule-based NGDP level targeting regime before we get that.

A few words that would help Kuroda hit his target

The developments in the Japanese financial markets over the past week has caused a lot of debate about the sustainability of the “Kuroda shock”. It is particularly the rise in nominal bond yields, which seems to have shaken some Japanese policy makers.

Even though the rise in nominal bond yields is a completely expected (for Market Monetarists) and welcomed (!) result of monetary easing it has nonetheless caused some to suggest that Kuroda’s monetary regime change is self-defeating.

As I have explained earlier the increase in bond yields in itself is not a threat to the recovery, but I must also admit that some Japanese policy makers (and a lot of commentators) have a hard time understanding this. It might therefore be warranted that Bank of Japan chief Kuroda puts the record straight.

He can do this by again and again repeating the following statement:

“The increase in Japanese nominal government bond yields is welcomed news as it reflects investors’ expectations for higher nominal spending growth. Furthermore, I am very happy to see that real bond yields continue to decline as markets are pricing in that we are increasingly likely to hit our 2% inflation target.

However, I am not satisfied with the speed of adjustment of market expectations to our inflation target. When we say we have a 2% inflation target investors should listen.

So while inflation expectations have increased they are still far below our 2% inflation target on all relevant time horizons. We therefore stand ready if necessary to further step up the monthly increase in the money base. We will evaluate that need based on market expectations of future inflation.

We will particularly focus on market pricing of 2year/2year and 5year/5year break-even inflation expectations. We want investors to understand that we will ensure that market pricing fully reflects our inflation target. That means 2% inflation expectations on all relevant time horizons. No less, no more.”

Anybody who have been reading my blog (and Robert Hetzel!) should understand why the reference to break-even inflation expectations is extremely important…

Mr. Kuroda, the advise is for free. Please take it.

Japan badly needs structural reforms, but not more than the rest of the G7 countries

A key critique of monetary easing in Japan is that Japan’s real problem is not monetary, but rather a supply side problem. I strongly agree that the Japanese economy is facing serious structural challenges – particularly an old-age population and a declining labour force. However, I also think that there often is a tendency for commentators to overstate these problems compared to supply side problems in other developed economies.

In this post I will therefore try to compare Japan’s structural problems with the structural problems of the other G7 economies – the US, UK, Canada, Germany, France and Italy.

The conservative US think tank Heritage Foundation every year produces an Economic Freedom Index. Even though one certainly can discuss the methods used to calculate this index I overall believe that the Index gives a pretty good description of the level of economic liberalization in difference countries. And yes, I do equate the level of economic liberalization with less structural problems.

The graph below shows the ranking of the G7 countries in the 2013 Index of Economic Freedom.

Economic Freedom Index G7

The picture is pretty clear. The Anglo-Saxon countries Canada (6), USA (10) and the UK (14) are significantly more economically free than particularly the interventionist South European countries France (62) and Italy (83).

Japan (24) shares the “median” position with the other large exporter in the group – Germany (19).

So while there certainly is scope for reforms in Japan it is hard to argue that Japan in general is a lot more interventionist than the other large economies of the world.

In fact it is also hard to argue that Japan has performed worse than the other G7 countries over the past decade. As the graph below shows Japanese GDP/capita has grown more or less in line with the other G7 countries since 2001-3. The real underperformer is Italy rather than Japan, which should not be surprising given Italy’s interventionist policies and excessive regulation.

A closer look at Japan’s structural weaknesses

But lets have a closer look at the data and see what Japan’s structural problems really are.

The graph below shows Japan’s relative ranking among the G7 economies in each of the subcategories of Index of Economic Freedom. I have indexed the average G7 ranking for each category at 100. The higher a score the more “free”.

Economic Freedom Japan 2Again the story is the same – Japan falls smack in the middle among the G7 countries when it comes to economic freedom – with an average for all the categories score of 101.

The breakdown of the numbers reveals both Japan’s relative strengths and weaknesses.

For example the Japanese public sector is relative small compared to the average of the other G7 countries and the Japan’s labour market is relatively free.

However, it is also clear that there are some clear regulatory weaknesses. This is particularly the case in the areas of trade, business, investment and financial freedom.

The three first of them all really is about an overly protectionist Japanese economy – both when it comes to foreign and domestic investors and I think it is pretty obvious that this is where the reform effort in Japan should be focused.

Mr. Abe please open up the Japanese economy

I really think it is straight forward. If Prime Minister Abe seriously wants to reform his country’s economy he needs to open it up to competition – both domestic and foreign.

In the domestic economy I would like other commentators highlight the lack of competition in the retail sector where for example the  “Large Scale Retail Location Law” tend to give artificial protection to small retail outlets (mom-and-pop shops) rather than bigger and more efficient retail shops such as hypermarkets.

Similarly zoning laws are hindering competition in the retail sector while at the same time is deepening the decade long Japanese property market crisis.

Finally I would note that interventionism in the agricultural sector in Japan is at least as bad as in the EU with price controls and very high levels of subsidies. Just see these scary facts from a recent WSJ article:

“In 2010, farmers added 4.6 trillion yen ($45 billion) in value and consumed 4.6 trillion yen in subsidies, meaning the industry netted out to zero. The average Japanese farmer is 66 years old and tills 1.9 hectares of land.”

This is hardly an efficient use of economic resources. The need for retail, housing and agricultural reforms therefor for seem to be very clear and this is where the focus should be for Mr. Abe when he fires off what he has called his “Third arrow” – structural reform.

Trade and investment liberalization will could enhance global support for Abenomics

Bank of Japan’s efforts to ease monetary policy has been criticized for being a beggar-they-neighbour policy. I think is a completely misplaced critique, however, it is indisputable that the outside world increasingly think of Japan as protectionist. I believe that a good way to calm these fears would be for the Japanese government to unilaterally remove all trade barriers and trade tariffs as well as opening up the Japanese economy to foreign investments. That would be in the best interest of the Japanese economy and would significantly boost Japanese productivity, while at the same making it very hard to the outside world to argue that Japan is protectionist.

The focus on monetary reform as been right and will support structural reforms

Even though there is an urgent need for economic reforms in Japan I fundamentally don’t think that the need for economic reforms is bigger than in France or Italy or even in Germany and I therefore think that the focus on monetary reform has been correct.

Furthermore, as the new monetary policy regime is likely to pull Japan out of deflation and boost economic growth (in the next 2-3 years) the Abe government is likely to get more support for implementing less popular reforms. Furthermore, as the new monetary policy regime is very likely to increase nominal GDP growth both public finance and banking problems are likely to be reduced, which in itself is likely to support real GDP growth over the longer run.

Concluding, the Abe government has gotten it more or less right on monetary regime (even though I would have preferred NGDP targeting to inflation targeting) and it is now time for Prime Minister Abe to prepare for his Third Arrow.

Two cheers for higher Japanese bond yields (in the spirit of Milton Friedman)

I have no doubt that Milton Friedman would have congratulated Bank of Japan governor Haruhiko Kuroda on the fact that Japanese bond yields continue to rise.

This is what Friedman said about the level of bond yields and interest rates in 1998:

“Initially, higher monetary growth would reduce short-term interest rates even further. As the economy revives, however, interest rates would start to rise. That is the standard pattern and explains why it is so misleading to judge monetary policy by interest rates. Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.”

Lets take it again – “As the economy revives, however, interest rates would start to rise”. Hence, the fact the Japanese bond yields are rising – and have done so since he presented his monetary policy regime change in early April – is a very clear sign that Mr. Kuroda’s efforts to get Japan out of deflation is working.

However, not all agree. This is  in the Telegraph quoting Richard Koo (Ambrose as we know do not agree with Koo):

“Richard Koo…an expert on Japan’s Lost Decade, said the sell-off in recent days has shown that the BoJ may not be able to hold down yields “no matter how many bonds it buys”. This could lead to a “loss of faith in the Japanese government” and the “beginning of the end” for its economy, if handled badly.”

Richard Koo obviously do not understand the monetary transmission mechanism. The purpose of what the Bank of Japan is doing is not to keep bond yields down. The purpose is to increase the money base and increase inflation expectations (to 2%). Both things are of course happening and the markets have not lost faith in the Japanese government or the Bank of Japan. Rather the opposite is the case.

Yes, nominal bond yields are rising – as Friedman and every living Market Monetarist said they would. However, real bond yields have collapsed since the introduction of Japan’s new monetary regime as inflation expectations have picked up. Something Mr. Koo for years has denied the Bank of Japan would be able to do.

Furthermore – and much more important – the markets do not think that the Japanese government is about to go bankrupt. In fact completely in parallel with the increase in inflation expectations the markets’ perception of the Japanese government’s default risk have decreased. Hence, the 5-year Credit Default Swap on Japanese companies has dropped from around 225bp in October last year to around 70bp today and at the same time the CDS on the government of Japan has declined as well – albeit less so.

This is actually not surprising at all. As monetary policy has been eased the expectation for nominal GDP growth has accelerated and as a natural consequence the markets are also starting to price in that the debt-to-NGDP ratio will drop. This is simple arithmetics.

Hence, the markets today feels significantly more comfortable that Japan will not default than was the case prior to Shinzo Abe and his Liberal Democratic Party won the Japanese elections in September last year.

So it might be that Richard Koo is thinking that Abenomics is the “beginning of the end” for Japan, but I rather think that Abenomics might be the beginning of the end for Mr.Koo’s theory of the balance sheet recession in Japan.

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Nick Rowe has a blog post on the same topic.

Update: Scott Sumner basically put out the same post as me at the same time (at least the headlines are very similar). Scott, however, is slightly less optimistic about Abenomics than I am.

Update 2: And here is Marcus Nunes on a similar topic (why Richard Koo is wrong).

How to avoid a repeat of 1937 – lessons for both the fed and the BoJ

The Japanese stock market dropped more than 7% on Thursday and even though we are up 3% this morning there is no doubt that “something” had scared investors.

There are likely numerous reasons for the spike in risk aversion on Thursday, but one reason is probably that investors are getting concerned about the Federal Reserve and the Bank of Japan getting closer to scaling back monetary easing. That has reminded me on what happened in 1937 – when market participants panicked as they started to fear that the Federal Reserve would move prematurely towards monetary tightening – after the US economy had been in recovery since FDR took the US off the gold standard in 1933.

Going into 1937 both US government officials and the Fed officials started to voice concerns about inflationary pressures, which clearly sent a signal to market participants that monetary policy was about to be tightened. That caused the US stock market to slump and sent the US economy back into recession – the famous Recession in the Depression.

At the core of this policy mistake was the fact that the fed had never clearly defined and articulated a clear monetary policy target after going off the gold standard in 1933. The situation in many ways is similar today.

Market participants in general know that the fed is likely to scale back monetary easing when the US economy “improves”, but there is considerable uncertainties about what that means and the fed still has not clearly articulated its target(s). Furthermore, the fed continues to be very unclear about its monetary policy instruments. Hence, the fed still considers the fed fund target rate as its primary monetary policy instrument while at the same time doing quantitative easing.

These uncertainties in my view certainly make for a much less smooth ‘transition’ in monetary policy conditions in the US. Therefore, instead of focusing on when to scale back “QE” the fed should focus 100% on explaining its target so nobody is in doubt about what the fed really is targeting. Furthermore, the fed needs to stop thinking and communicating about monetary policy in terms of interest rates. The money base and not the interest rate is the key monetary policy instrument in the US and it is about time that the fed acknowledges this.

How about trying the “perfect world”

The best way of getting rid of these monetary policy uncertainties is for the fed to first of all give an explicit nominal target. Preferably the fed should simply state that it will conduct monetary policy in a way to increase nominal GDP by 15% in the coming two years and thereafter target 5% annual NGDP growth (level targeting).

Second, the fed then should become completely clear about its monetary policy. The best thing would be a futures based NGDP targeting. See here for a description about how that would work. Alternatively the fed should clearly spell out a ‘reaction function’ and clearly describe its monetary policy instrument – what assets will the fed buy to expand or contract the money base? It is really simple, but so far the fed has totally failed to do so.

Japanese monetary policy has become a lot clearer after Haruhiko Kuroda has become Bank of Japan chief, but even the BoJ needs to work on its communication policy. Why is the BoJ not just announcing that since it now officially has a 2% inflation target it will ‘peg’ the market expectations for example for 2-year or 5 year (or both) inflation at 2% – and hence simply announce a commitment to sell or buy inflation-linked bonds so the implicit breakeven inflation is 2% on all time horizons at any period in time. This is of course a set-up Bob Hetzel long ago suggested for the fed. Maybe it is time the BoJ invited Bob back to for a visit in Japan?

If the fed and the BoJ in this fashion could greatly increased monetary policy transparency the markets would not be left guessing about what they central banks are targeting or about whether there will be a sudden redrawl of monetary policy accommodation.  Thereby it could be ensured that the scaling back of monetary easing will happen in a disorderly fashion. There is not reason why we need repeating the mistakes of 1937.

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Both David Glasner and Marcus Nunes have related posts.

See also here if you want to read what I wrote about the Japanese “jitters” yesterday in my day-job.

Japan: It’s domestic demand, stupid

I have been reading the reports on the Japanese trade data for April, which have been published this morning. The reporting is extremely telling about how most journalists (and economists!) fail to understand what is going on in Japan (the markets understand perfectly well – Nikkei is nicely up this morning).

In nearly all the reports on the data there is a 90% focus on the fact that exports grew slower than expected (3.8% y/y) and that the Japanese trade deficit remains in place. The slightly “disappointing” numbers is then in most news stories used to speculate that Bank of Japan’s monetary easing is not working – or rather the weaker yen has failed to boost exports as much as expected. On the other hand there is nearly no focus on the import data, which grew by nearly 10% y/y.

It is really the strong import growth, which is the interesting story here. As I earlier have argued the monetary easing in Japan is likely to boost domestic demand rather than net exports. This is from my latest post on BoJ:

While I strongly believe that the policies being undertaken by the Bank of Japan at the moment is likely to significantly boost Japanese nominal GDP growth – and likely also real GDP in the near-term – I doubt that the main contribution to growth will come from exports. Instead I believe that we are likely to see is a boost to domestic demand and that will be the main driver of growth. Yes, we are likely to see an improvement in Japanese export growth, but it is not really the most important channel for how monetary easing works….

…When the Bank of Japan is easing monetary policy it is likely to have a much bigger positive impact on domestic demand than on Japanese exports. In fact I would not be surprised if the Japanese trade balance will worsen as a consequence of Kuroda’s heroic efforts to get Japan out of the deflationary trap.

And this of course is exactly what we are now seeing in the data. Export growth continues to accelerate, but import growth accelerates even faster and the trade data is worsening. That is very good news – monetary policy is boosting domestic demand. Mr. Kuroda please keep up the good work.

BIS is fearful of bubbles, but is not always right (remember the gold standard?)

I think there is a bubble in bubble fears. This is particularly the the case for central bankers and institutional monetary institutions.

Here  in the Telegraph:

The two watchdogs launched broadsides against central bank largess last week. The BIS — the forum of central banks — was particularly blunt, seeming to imply that quantitative easing “does not work”.

Critics say this risks undermining the credibility of radical measures when more may yet be needed. They fear central banks could repeat the mistake made in 1937 when the Federal Reserve lost its nerve and tightened too soon, tipping America back into depression.

And here is my response in the same article:

“The BIS and the IMF are deeply misguided and risk doing the world a grave disservice. The biggest threat right now is irrational fear of bubbles among central banks,” said Lars Christensen 

Particularly the advise of BIS is taken to be very important as the general perception is that the BIS “got it right” prior to the crisis – the fact that it got it mostly wrong over the past five year apparently is less important. Paul Krugman has some not too kind words about BIS – or the Sadomonetarists of Basel as Krugman calls the institution headquartered in Switzerland:

I guess we can check the record here and see just how prescient the BIS was. What I do recall, however … is that the BIS has spent years warning about the dangers of low interest rates. Except that a couple of years back it was telling a completely different story about why we needed to raise rates; you see, the big danger was of imminent inflation…

…In fact, inflation is running below target just about everywhere. You might therefore think that the BIS would step back a bit and reconsider both its policy recommendations and the framework it uses to derive those recommendations.

I can, however, do better than Krugman. BIS’ Sadomonetarist tendencies date back more than five years. This is from BIS’ third annual report publish in May 1933:

“For the Bank for International Settlements, the year has been an eventful one, during which, while the volume of its ordinary banking business has necessarily been curtailed by the general falling off of international financial transactions and the continued departure from gold of more and more currencies, culminating in the defection of the American dollar, nevertheless the scope of its general activities has steadily broadened in sound directions. The widening of activities, aside from normal growth in developing new contacts, has been the consequence, primarily, of a year replete with international conferences, and, also, of the rapid extension of chaotic conditions in the international monetary system. In view of all the events which have occurred, the Bank’s Board of Directors determined to define the position of the Bank on the fundamental currency problems facing the world and it unanimously expressed the opinion, after due deliberation, that in the last analysis “the gold standard remains the best available monetary mechanism” and that it is consequently desirable to prepare all the necessary measures for its international reestablishment.”

And this is what I earlier had to say about that report:

Take a look at the report. The whole thing is outrageous – the world is falling apart and it is written very much as it is all business as usual. More and more countries are leaving the the gold standard and there had been massive bank runs across Europe and a number of countries in Europe had defaulted in 1932 (including Greece and Hungary!) Hitler had just become chancellor in Germany.

And then the report state: ”the gold standard remains the best available monetary mechanism”! It makes you wonder how anybody can reach such a conclusion and in hindsight obviously today’s economic historians will say that it was a collective psychosis – central bankers were suffering from some kind of irrational “gold standard mentality” that led them to insanely damaging conclusions, which brought deflation, depression and war to Europe.

Unfortunately BIS’ view haven’t changed much since 1933. Should we listen to the Sadomonetarists in Basel today?

Richard Fisher and the “working men and women of America”

This is Richard Fisher, President of Federal Reserve Bank of Dallas:

“We have made rich people richer,” Fisher told CNBC today. “The question is, what have we done for the working men and women of America?”

Fisher was one of the earliest and most outspoken advocates of winding down the bond-buying program…

I had to read the comment a couple of times to make sure that I understood correctly. Fisher actually claims that the fed should scale back monetary easing because it is not doing anything for the “working men and women of America”.

Fisher’s comments are truly bizarre. Most wealthy Americans are still very wealthy (I have no problem with that) – crisis or not – but it is pretty clear that the overly tight monetary policies in the US over the past fives years has been the main cause of the significant increase in US unemployment and in that sense been a massive assault on the “working men and women of America”.

If Richard Fisher seriously wants to do you something for the “working men and women” then he should come out and support to bring back the level of nominal GDP to the pre-crisis trend level. That undoubtedly would be the best “employment policy” anybody could come up with in the present situation. However, I suspect that Fisher is just coming up with random arguments for opposing monetary easing rather than truly caring about the “working men and women of America”. I am not impressed…

employment NGDP

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PS I am certainly not claiming to be speaking on behalf of the “working men and women of America” – I just find ludicrous when somebody actually in a position to do something for these people through his actions (opposing monetary easing) is doing exactly the opposite.

PPS I don’t think it should be the job of central banks to hit a certain “employment level” or any other real variable and I find the fed’s “dual mandate” seriously flawed, but it is certainly not the job of central banks to “destroy jobs” either. A proper NGDP level targeting regime will provide the best nominal framework for letting the labour market work in a proper and undistorted way and as such would indirectly ensure the highest level of employment given the structures of the economy.

PPPS I wrote this on a flight to Stockholm. I had been thinking about writing something about Swedish monetary policy or Africa (the topic I will be speaking about in Stockholm today), but you can all blame Richard Fisher for distracting me.

Toilet paper shortage is always and everywhere a monetary phenomenon

This is from Sky News:

Venezuelans have been hit by a chronic toilet paper shortage, leading to empty supermarket shelves and long queues to snap up the remaining rolls…When new stocks arrive at supermarkets customers have been rushing in to fill their trollies.

It started with a food shortage and now it is the lack of toilet paper that is the latest economic problem in Venezuela. It is pretty clear that Venezuela’s chronic shortages of essential goods are a result of the combination of excessively easy monetary policy and price controls.

If monetary policy is excessive easy you obviously get high and rising inflation. There is only on way of stopping excessive inflation and that is by slowing the money printing press. Instead the Venezuelan government continues to fight inflation with draconian price controls.

The toilet paper shortage is just the latest round of news that confirms the absolutely failed policies of the socialist Venezuelan government, but as usual the government is unwilling to accept any responsibility for the social ills it is causing. Instead the Venezuelan government blames the media:

Commerce minister Alejandro Fleming said “excessive demand” for the tissue had built up due to a “media campaign that has been generated to disrupt the country.”

He said monthly consumption of toilet paper was normally 125 million rolls, but current demand “leads us to think that 40 million more are required”.

“We will bring in 50 million to show those groups that they won’t make us bow down,” he said.

Anybody who have studied economics for 3 minutes of course knows that Fleming’s explanation of the toilet paper shortage is outrageously wrong, but I guess that the Minister himself is unlikely to have problems getting toilet paper supplies himself as the Venezuelan government is massively corrupted and Ministers certainly do not seem to suffer from the social ills that average Venezuelan have to struggle with.

Radical fiscal and monetary reforms are needed 

I have earlier argued that at the core of Venezuela’s economic policies is the fact that the central bank basically has been ordered to finance excessive public spending by letting the printing presses run overtime. There is only one way of stopping the inflation pressures and that is by stopping this monetary funding of public expenditures and then to implement radical monetary reform.

This is reform that I earlier have suggested:

Market Monetarists generally speaking favour nominal GDP targeting or what we also could call nominal demand targeting. For large economies like the US that generally implies targeting the level of NGDP. However, for a commodity exporting economy like Venezuela we can achieve nominal stability by stabilizing the price of the main export good – in the case of Venezuela that is the price of oil measured in Venezuelan bolivar. The reason for this is that aggregate demand in the economy is highly correlated with export revenues and hence with the price of oil.

I have therefore at numerous occasions suggested that commodity exporting countries implement what I have called an Export Price Norm (EPN) and what Jeff Frankel has called a Peg-the Export-Price (PEP) policy.

The idea with EPN is basically that the central bank should peg the country’s currency to the price of the main export good. In the case of Venezuela that obviously would be the price of oil. However, it is not given that an one-to-one relationship between the bolivar and the oil price will ensure nominal stability.

My suggestion is therefore that the bolivar should be pegged to basket of 75% US dollars and 25% oil price. That in my view would view would ensure a considerable degree of nominal stability in Venezuela. So in periods of stable oil prices the Venezuelan bolivar would be more or less “fixed” against the US dollar and that likely would lead to nominal GDP growth in Venezuela that would be slightly higher than in the US (due to catching up effects in Venezuelan productivity), but in periods of rising oil prices the bolivar would strengthen against the dollar, but keep nominal GDP growth fairly stable.

Maybe the toilet paper shortage could convince the new Venezuelan president Maduro to end the Hugo Chavez’s fail policies and implement radical fiscal and monetary reforms – otherwise Venezuela might turn into the smelliest country in the world.

HT Rasmus Ole Hansen

PS This is my blog post #600.

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