Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

It might be a surprise to most people but one of the fastest growing economies in the world over the last 10-15 years has been Angola. A combination of structural reforms and a commodity boom have boosted growth in the oil-rich African country. However, Angola is, however, at a crossroad and the future of the boom might very well now be questioned.

It is monetary tightening in China, which is now threatening the boom. The reason for this is that Angola has received significant direct investments from China over the past decade and the rising oil prices have fueled oil exports. However, as the People’s Bank of China continues to tighten monetary conditions in China it will likely have two effects. First, it is likely to reduce Chinese investments – also into Angola. Second, the slowdown in the Chinese economy undoubtedly is a key reason for the decline in oil prices. Both things are obviously having a direct negative impact on the Angolan economy.

Angola’s monetary policy is likely to exacerbate the ‘China shock’ 

This is how the IMF describes Angola’s monetary regime:

Angola’s de facto exchange arrangement has been classified as “other managed” since October 2009. The Banco Nacional de Angola (BNA) intervenes actively in the foreign exchange market in order to sterilize foreign currency inflows in the form of taxes paid by oil companies. Auctions were temporarily suspended from April 20 to October 1, 2009 leading to the establishment of a formal peg. Since the resumption of auctions, the kwanza has depreciated. However, the authorities maintain strong control over the exchange rate, which is the main anchor for the monetary policy. The BNA publishes a daily reference rate, which is computed as the transactionweighted average of the previous day’s rates negotiated with commercial banks. Banks and exchange bureaus may deal among themselves and with their customers at rates that can be freely negotiated provided they do not exceed the reference rate by more than 4 percent.

Hence Angola de facto operates a pegged exchange rate regime and it is pretty clear in my view that this regime is likely to exacerbate the negative impact from the ‘China shock’.

The China shock is likely to lead to depreciation pressures on the Angolan kwanza in two ways. First the drop in global oil prices is likely to push down Angolan export prices – more or less by a one-to-one ratio. Second, the expected drop in Chinese investment activity is likely to also reduce Chinese direct investments into Angola. The depreciation pressures could potentially become very significant. However, if the Angolan central bank tries to maintain a quasi-pegged exchange rate then these depreciation pressures will automatically translate into a significant monetary tightening. The right thing to do is therefore obvious to allow (if needed) the kwanza to depreciate to adjust to the shock.

There are two ways of ensuring such depreciation. The first one is to simply to allow the kwanza to float freely. That however, would necessitate serious reforms to deepen the Angolan capital markets and the introduction of an nominal target – such as either an inflation target or an NGDP target. Even though financial markets reforms undoubtedly are warranted I have a hard time seeing that happening fast. Therefore, an alternative option – the introduction of a Export Price Norm (EPN) is – is clearly something the Angolan authorities should consider. What I call EPN Jeff Frankel originally termed Peg-the-Export-Price (PEP).

I have long been a proponent of the Export Price Norm for commodity exporting economies such as Russia, Australia or Angola (or Malaysia for that matter). The idea with EPN is that the commodity exporting economy pegs the currency to the price of the commodity it exports such as oil in the case of Angola. Alternatively the currency should be pegged to a basket of a foreign currency (for example the dollar) and the oil price. The advantage of EPN is that it will combine the advantages of both a floating exchange (an “automatic” adjustment to external shocks) and of a pegged exchange rate (a rule based monetary policy). Furthermore, for a country like Angola where nearly everything that is being produced in the country is exported the EPN will effectively be an quasi-NGDP target as export growth and aggregate demand growth (NGDP growth) will be extremely highly correlated. So by stabilizing the export price in local currency the central bank will effectively be stabilizing aggregate demand and NGDP.

Operationally it would be extremely simple for the Angolan central bank to implement an EPN regime as al it would take would be to target a basket of for example oil and US dollars, which would not be very different operationally than what it is already doing. Without having done the ‘math’ I would imagine that a 20% oil and 80% US dollar basket would be fitting. That would provide a lot of projection against the China shock.

And if it turns out that China is not slowing and oil prices again will rise an EPN will just lead to an ‘automatic’ appreciation of the kwanza and monetary tightening of Angolan monetary conditions and in that way be a very useful tool in avoiding that skyrocketing oil prices and booming inward investments do not lead to the formation of for example property bubbles (many would argue that there already is a huge property bubble in the Angola economy – take a look here).

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Let me say it again – it’s domestic demand (in Japan), stupid

The Nikkei had a 20% set-back, but is now surely making a major comeback. This morning Nikkei is up 3.5%. The rally continues supported by very strong macroeconomic numbers and you have to be very suborn to continue to claim that monetary easing is not working in Japan (I wonder what Richard Koo will be saying…)

I think the most notable thing about the Japanese economy right now is that it is domestic demand rather than exports, which is really the driver of growth. This is of course what I have argued all along (see my earlier comments here, here, here and here).

But let me instead quote my good colleague and Danske Bank’s Asia analyst Flemming Nielsen:

“Data released overnight shows that the Japanese economy continues to power ahead and now appears to be moving out of deflation. While Japan’s export so far is urprisingly resilient, it would be wrong to accuse Japan of just stealing growth from the rest of the world through a weaker yen. On the contrary the Japanese economy currently appears to be gaining much of its strength from strong domestic demand.

Despite all the focus on the negative impact from a weaker yen, Japan at the moment appears to be a stabilizing force for the global economy. The data released overnight indicates GDP growth above 3.5% q/q AR in Q2 on the back of 4.1% q/q growth in Q1.

…Japan’s industrial production continued to expand solidly in May, where industrial production seasonal adjusted increased 2.0% m/m. This was much stronger than expected and the fourth month in a row with an increase. The strength in manufacturing activity was also evident in the Markit/JMMA manufacturing PMI for June, where it improved to 52.3 from 51.5 in May …The export orders component did decrease slightly from 52.1 from 52.6 but overall was surprisingly resilient. Total new orders continued to improve to 54.7 in June from 53.7 in May underscoring the current importance of strong domestic demand for the recovery in Japan.

…Deflation continued to ease in May where CPI excl. fresh food (the inflation measure BoJ targets) increased 0.0% y/y after declining 0.4% y/y in April. Core CPI excl. food & energy declined 0.3% y/y after declining 0.6% y/y in April. Based on preliminary CPI date for June for the Tokyo area we estimate that nationwide CPI excl. fresh food will stay at 0.0% y/y in June but CPI should start to show a positive year-on-year increase during Q3.

I find it very hard to be pessimistic about the Japanese story – monetary policy is working exactly the way Market Monetarists have argued it would work. The Bank of Japan is ending 15 years of deflation and in the process the Japanese economy is taking off. Imagine that the ECB would dare do something similar?

PS Yes, Kuroda still needs to work on communication and yes Japan badly needs structural reforms, but that is not changing that monetary policy is working.

Kuroda still needs to work on communication

Bank of Japan governor Haruhiko Kuroda must feel relieved as attention has turned away from sharply rising bond yields and a sharp set-back in the Nikkei to bad Federal Reserve communication and market turmoil in China. And I am sure that he like me have noticed that Nikkei has outperformed most major global stock markets in recent weeks. That could seem like a vindication of BoJ’s policies and to extent it is. However, I would cautious against too much optimism. Kuroda still needs to work on this communication.

Two things have been notable about the recent global financial turmoil in regard to Japan. First, as mentioned the Nikkei as outperformed other major global stock markets. Second, the yen has not strengthened nearly as much as it “normally” would have done in a situation of a sharp increase in global risk aversion. This could indicate that investors expect the BoJ to offset any shock to Japanese aggregate demand from global factors. That is good news and an indication that the BoJ has gained some credibility.

However, all it not well. The BoJ is targeting 2% inflation so that is really the only true measure we can use to judge BoJ’s success. Judging from inflation expectations the BoJ is still far away from having been successful. In fact if anything we are only half way there and as global inflation expectations have dropped back recently so have Japanese inflation expectations.

Last week we got the news that the Japanese government will resume the issuance of inflation-linked bonds. That is good news because I strongly believe that that is the most important communication and policy instrument available to the BoJ. Now the BoJ should start using market expectations for inflation a lot more actively in its communication. Mr. Kuroda should not waste any opportunity to say “while we have made progress in fighting deflation inflation expecations are still well-below our 2% inflation and we will do everything to push up inflation expectations until the markets price in 2% inflation on all relevant time horizons”. In fact this is more or less the only thing Mr. Kuroda needs to say.

Similarly regarding the recent “China turmoil” Mr. Kuroda should note  that “we have noticed the recent turmoil in global markets and that has put downward pressure on global inflation expectations. We will obviously do everything to offset any negative impact on Japanese inflation expectations.” 

Obviously I don’t think an inflation targeting regime is optimal and I would much have preferred that the BoJ had been targeting the NGDP level. However, given the inflation target the BoJ needs to make the best of it. Therefore, Mr. Kuroda should continue to repeat the message to markets: “We target 2% inflation so that is what markets should expect us to hit”.

PS it is obvious that communication is not everything and if the uptrend in inflation expectations is not resumed soon the BoJ should clearly signal a willingness to step up quantitative easing.

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Related post:
Mr. Kuroda’s credibility breakdown
Mr. Kuroda please ‘peg’ inflation expectations to 2% now
A few words that would help Kuroda hit his target

This is why we need an NGDP futures market

Until recently the global financial markets were on an one-way trip to recovery. Basically since the Federal Reserve in September implicitly announced the Bernanke-Evans rule investors have been betting on an US economic recovery – higher real and nominal GDP growth – and the Bank of Japan’s decisive actions to implement a 2% inflation target also have helped the sentiment. However, the picture has become a lot more confusing in recent weeks as turmoil has returned to the global financial markets.

The key problem is that we do not exactly know why there has been a sharp spike in market volatility. There is a number of competing theories. The most popular theory is that this is all Ben Bernanke’s fault as he has announced the “tapering” of quantitative easing – that according to the critiques has caused markets to price in tighter monetary conditions in the future and that is the reason why bond yields are rising while inflation expectations and stock markets are declining. A competing theory is that the real reason for this is not really Bernanke, but rather monetary tightening in China, which is forcing Chinese investors to liquidate investments – including in US Treasuries. I have a lot of sympathy for the later theory even though I think it is also right that Bernanke’s comments over the past months have been having an negative impact.

So why is it important what is the cause of these market moves? It’s it enough to note that all indications are that we globally are now seeing a contraction in aggregate demand and central banks should respond to that by easing monetary conditions? Yes and no. Yes because it is clear that monetary conditions are indeed getting tighter everywhere. However, no because that was not necessarily clear until last week.

Low inflation expectations is necessarily not a monetary easing

Interestingly enough it seems like everybody have become Market Monetarists recently in the sense that they think that it is the fed that is driving the markets via (bad) communication and the commentators are exactly looking at market indicators monetary conditions – for example market expectations for inflation.

And it is of course the sharp drop in inflation expectations, which is causing a lot of concern and I obviously agree that central banks should keep an very close eye on inflation expectations as an indicator for monetary conditions. HOWEVER, we should never forget that inflation expectations could drop either because of tighter monetary conditions or because of a positive supply shock.

Market Monetarists of course argue that central banks should not respond to supply shocks – positive or negative – and I would in fact argue that the drop in inflation expectations we have seen recently in the US (and other places) is to a large extent driven by a positive supply shock. That is good news for  real GDP growth. That is consistent with higher real bond yields and it not necessarily a problem (David Beckworth has been making that argument here). Hence, if the drop in inflation expectations had instead been primarily caused by tighter US monetary conditions then we should have expected to see the US stock markets plummet and the dollar should have strengthened.

That is of course what we have seen over the past week or so, but not in the month leading up to that. In that period the dollar was actually weakening moderately and the US stock market was holding up fairly well. That to me is an indication that the drop in inflation expectations have not only been about tighter US monetary condition.

Instead I think that we have seen a serious tightening of Chinese monetary condition and that has caused global commodity prices to drop. That is of course a negative demand shock in China, but it is a positive supply shock to the US economy. If that ONLY had been the case then it would be hard to the argument from a Market Monetarist perspective that the Federal Reserve should move to ease monetary conditions further. See my arguments from mid-May against monetary easing in responds to positive supply shocks here.

Avoid the confusion – set up an NGDP futures market

Sometimes it is pretty easy to “read” the markets to get an understanding of what is going on – it is for example pretty clear right now that Chinese monetary conditions are getting a lot tighter, but it is harder to say how much tighter US monetary conditions really have gotten over the past month or so and the bond market is certainly not a good indicator on its own (liquidity/flow effects vs expectational effects).

Hence, what should be the appropriate US monetary response? There is a significant difference between the appropriate respond to what is primarily a supply shock and what is primarily a demand shock. And it is of course not only me who is slightly confused about what is going on in the markets. Policy makers are likely to be at least as confused (likely a lot more…).

The best way to avoid any confusion is of course to set-up a market for exactly what the central bank is targeting. Hence, for an inflation targeting central bank there is of course inflation-linked bonds. However, that is not really a good guide for monetary policy if you want to avoid responding to supply shocks. Instead what we really need is NGDP-linked bonds. In the case of the US the US Treasury therefore should issue such bonds.

Had we had an US NGDP-linked bond now it would be very easy to see whether or not the markets where indeed pricing in tighter US monetary conditions and whether or not this should be a cause for concern. Furthermore, that would get us away from the constant discussion about whether higher bond yields is an indication of tighter or easier monetary conditions (it can in fact be both).

And finally if the there was an US NGDP-linked government bond then the fed could leave the time of “tapering” complete to the markets (See more on that here).

HT Cthorm

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PS Scott Sumner and Evan Soltas have similar discussions

China – my fear is a ”secondary deflation”

China has certainly moved to the very top of the agenda in the financial markets this week and a lot of what is playing out in the Chinese markets is eerily similar to what happened in the US and European markets in 2008.

As in 2008 there is a lot of focus on a bubble being deflated both among commentators and among central bankers. This in my view could lead to very unfortunate policy conclusions. I am particularly afraid that the People Bank of China’s fear of reflating the bubble will lead it to take too long to ease monetary policy – as clearly was the case in the US and Europe in 2008.

China – an “ideal” Hayekian boom-bust?

Market Monetarists are in general very sceptical about the Austrian story of the Great Recession and sceptical about a bubble explanation for the crisis. That, however, do not mean that Market Monetarists outright denies that there can be bubbles. In fact I certainly think that there was many examples of “bubbles” in 2008. However, the real reason for the bust was not overly easy monetary policy, but rather that monetary policy became insanely tight both in the US and the euro zone in 2008.

But how do that compare to the Chinese situation today? I have earlier argued that I don’t believe that easy monetary policy on its own it enough to create a major bubble. We need something more – and that is the existence of moral hazard or rather the implicit or explicit socialization of the cost of risk taking. One can certainty argue that Too-Big-To-Fail has been and still is a major problem in the Western world, but that is even more the case in China, where the banking sector remains under tight government control and where the banks are mostly government owned. Furthermore, the investment decisions in many industries remain under strict government control.

In that sense one can argue that China over the past 4-5 years have had the “ideal” environment – easing money and massive moral hazard problems – for creating a bubble. The result has most likely also been the creation of a bubble. I have no clue have big this bubble is, but I feel pretty certain that the Chinese government run banking system has created serious misallocation of capital and labour in the last 4-5 years. In that sense we have probably been through a Hayekian boom-bust in the Chinese economy.

Fear the secondary deflation rather than a new bubble

The Chinese authorities have been extremely focused on how to deflate what they consider to be a bubble and as a result Chinese monetary and credit policies have been tightened significantly since early 2010 when the PBoC the first time in the post-crisis recovery tightened reserve requirements.

Hence, since 2010 the PBoC has basically tried to “deflate the bubble” by tightening monetary conditions and as a result the Chinese economy has slowed dramatically.

The PBoC obviously has been right to tighten monetary policy, but I have for some time though that the PBoC was overdoing it (see for example my post on “dangerous bubble fears” from last year) and in that regard it is important to remind ourselves of Hayek’s advice on conduct of monetary policy in the “bust” phase of the business cycle.

When Hayek formulated his version of the Austrian business cycle theory in Prices and Production from 1931 he stressed that the monetary authority should let the bubble deflate with out any intervention. However, he later came to regret that he in the 1930s had not been more clear about the risk of what he called the “secondary deflation”. The secondary deflation is a “shock” that can follow the necessary correction of the “bubble” and send the economy into depression.

If we formulate this in Market Monetarist lingo we can say that the central bank should allow nominal GDP to fall back to the targeted level if there has been a “bubble” (NGDP has accelerated above the targeted level). This will ensure an orderly correction in the economy, but if the central bank allows NGDP to drop significantly below the “targeted” level then that will could trigger financial distress and banking crisis. This unfortunately seem to be exactly what we have seen some signs of in the Chinese markets lately.

The graph below shows two alternative hypothetical scenarios. The red line is what I call the “perfect landing” where the NGDP level is brought back on trend gradually and orderly, while the green line is the disorderly collapse in NGDP – the secondary deflation. The PBoC obviously should avoid the later scenario. This is what the ECB and fed failed to do in 2008.

boombust

Reasons why the PBoC might fail

I must admit that my fears of monetary policy failure in China have increased a lot this week, but luckily a secondary deflation can still be avoided if the PBoC moves swiftly to ease monetary conditions. However, I see a number of reasons why the PBoC might fail to do this.

First, there is no doubt that the PBoC is preoccupied with the risk of reflating the bubble rather than with avoiding secondary deflation. This I believe is the key reason why the PBoC has allowed things to get out of hand of the past weeks.

Second, significant monetary easing will necessitate that the PBoC should allow the renminbi to weaken. There might, however, be a number of reasons why the PBoC will be very reluctant to allow that. The primary reason would probably be that the Chinese do not want to be accused of engineering a “competitive deflation”. In that regard it should be noted that it would be catastrophic if the international community – particularly the Americans – opposed renminbi devaluation in a situation where the crisis escalates.

Third, the PBoC might feel uncomfortable with using certain instruments at its disposal for monetary easing. One thing is cut banks’ reserve requirements another thing is to conduct to do outright quantitative easing. We know from other central bank how there is a strong “mental” resentment to do QE.

I strongly hope that the PBoC will avoid remarking the ECB and fed’s mistakes of 2008, but the events of the past week certainly makes me nervous. Monetary policy failure can still be avoid it – how things develop from here on it up to the PBoC to decide.

Steve Horwitz has an good offer for you – learn about the Great Depression for free

My friend professor Steve Horwitz has a very good offer for students. He is offering an eight-week long program on the Great Depression at the Learn Liberty Academy. 

Here is what Steve has to say at the Bleeding Heart Libertarians blog about the program:

Starting next month, I will be teaching an eight-week long program on the Great Depression for my friends at the Learn Liberty Academy, which is part of the Institute for Humane Studies‘ Learn Liberty project.  If friends or students you refer to the program register and mention your name as having referred them, you’ll get an Amazon gift card, and you’ll get another if they complete the full program.  So, faculty and student readers of BHL, please feel free to pass this info on to your students and friends and have folks sign up. It’s going to be a really great program!

Steve and I do certainly not agree on everything about the Great Depression, but Steve has done a lot of work on the Great Depression and is an extremely clever economist and monetary theorists so I strongly recommend to any student to check out Steve’s offer.

See more on the “Making Sense of the Great Depression” program here.

PS Now Steve send me some books!

Chinese monetary policy failure

“Fed tapering” seems to be repeated in every single story in the financial media over the last couple of days. However, I am afraid that the financial media – as often is the case – is overly US centric. We might want to look at another central bank than the Fed. We should instead pay some (a lot!) of attention to the People’s Bank of China (PBoC).

This is from CNBC:

“China’s central bank continued to test the resilience of local lenders to withstand a cash crunch on Thursday, as money market rates soared once again and short-term rates hit record highs.

The seven-day repo rate, which is seen as gauge of confidence to lend in the interbank market, rose to a record high above 10 percent. China’s overnight repo rate jumped to as high as 30 percent, analysts said.

Chinese money markets have suffered a severe liquidity strain in the past week, due to seasonal factors and a sharp slowdown in foreign exchange inflows, raising concerns about the financial risks facing the world’s second largest economy.

But to the surprise of many market participants, the central bank has held back from pumping cash into the market to ease the credit squeeze and analysts said a spike in the rates at which banks lend money to each other was also a concern. “

I can’t help thinking that we have seen this before. The fed and ECB actions in 2008 come to mind.

This is what I said in my post “Dangerous bubbles fears” in October last year:

“…the PBoC eased monetary policy aggressively in 2009 and that pulled the Chinese economy out of the crisis very fast, but since 2010 the PBoC obviously has become fearful that it had created a bubble – which is probably did. To me Chinese monetary policy probably became excessively easy in early 2010 so it was right to scale back on monetary easing, but money supply growth has slowed very dramatically in the last two years and monetary policy now seem to have become excessively tight.”

It seems to me that the PBoC is just continuing the excessive tightening and that seems to be the real culprit behind the stream of bad economic data we have got out of China recently. It looks like Chinese monetary policy failure.

So yes, Bernanke might have a communication problem, but at the moment it seems like the biggest monetary policy failure is Chinese rather than American.

PS it seems like the Bank of Japan is regaining some credibility – the Nikkei has been remarkably resilient in recent days.

George Selgin on Free Banking and NGDP targeting

I should really be sleeping but George Selign just put out a blog post on Free Banking and NGDP Targeting.

This is how George kicks off:

“Kurt’s recent post on NGDP targeting just happens to come right on time to introduce one I’d been contemplating concerning the connection between such targeting and free banking. While many readers may suppose the two things to represent entirely distinct, if not antagonistic, approaches to monetary reform, I have always regarded them as complementary. Yet I also agree with Kurt in regarding NGDP targeting as “a form of central economic planning.”

Am I contradicting myself? Much as I’d like to quote Walt Whitman, I don’t think I am. Instead, I think that it is those who would insist on the incompatibility of free banking and NGDP targeting whose reasoning is faulty. They fall victim, I believe, to a category error, namely, that of conflating banking regimes with base money regimes.”

Read the rest here.

Bedtime for me…

PS please read this as well.

Japan’s widening trade deficit

Remember my earlier comment on monetary easing in Japan and the possible impact on the Japanese trade balance:

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.

Today we got data that seems to support my view that monetary easing in Japan is likely to widen the trade deficit. This is from AP:

Japan’s trade deficit rose nearly 10 percent in May to 993.9 billion yen (nearly $10.5 billion) as rising costs for imports due to the cheaper yen matched a rebound in exports, the Ministry of Finance reported Wednesday.

Exports rose 10.1 percent in May over a year earlier to 5.77 trillion yen ($60.7 billion) while imports also surged 10 percent, to 6.76 trillion yen ($71.1 billion), the ministry said. Japan’s trade deficit in May 2012 was 907.93 billion yen.

Hence, just looking at the trend in the trade deficit – it is widening – it would be tempting to declare victory on my hypothesis that the “Kuroda boom” mostly will be about domestic demand. However, I must admit that a lot of the reason for the increase in imports is higher energy imports. So while I do think my view is correct I don’t think that trade data in itself provides a lot support for this view.

HT Yichuan Wang

Kurt Schuler endorses NGDP targeting

Long time free banking advocate Kurt Schuler has a new piece at freebanking.org in which he endorses NGDP targeting.

This is Kurt:

Given that I do not expect to see free banking in the immediate future, I would like to see one, or preferably more, central banks that now target inflation try targeting nominal GDP targeting instead. Targeting nominal GDP has some prospective advantages over inflation targeting. One is that nominal GDP targeting allows what seems to be a more appropriate behavior for prices over the business cycle, allowing “good” (productivity- rather than money supply-driven) deflation during the boom and “good” inflation during the bust.

I agree very much with Kurt on this and it is in fact one of the key reasons why I support NGDP targeting. Central banks should indeed allow ‘good deflation’ as well as ‘good inflation’. Hence, to the extent the present drop in inflation in for example the US reflects a positive supply shock the Federal Reserve should not react to that by easing monetary policy. I have discussed that topic in among others this recent post.

Back to Kurt:

Another is that inflation targeting as it has been both most widely proposed and as it has always been adopted has been a “bygones are bygones” version, with no later compensation for past misses of the target. During the Great Recession, many central banks undershot their targets, even allowing deflation to occur. They never corrected their mistakes. Nominal GDP targeting in the form that Scott Sumner and others have advocated it requires the central bank to undo its past mistakes.

Note here that Kurt comes out in favour of the Market Monetarist explanation of the Great Recession. It was the Federal Reserve and other central  banks’ failure to keep NGDP ‘on track’ – and even their failure to just hit their inflation targets – that caused the crisis.

And I think it is notable that Kurt notes that “(i)f it (the central bank) undershot last year’s target, it has to increase the growth rate of the monetary base, other things being equal, to meet this year’s target, which is last year’s target plus several percentage points.” 

That of course indirectly support for monetary easing to get the NGDP level back on track. I am sure that will enrage some Austrian School readers of freebanking.org in the same way as they recently got very upset by George Selgin apparent defense of quantitative easing in 2008/9. See for example Joe Salerno’s angry response to George Selgin here. See George’s reply to Joe (and Pete Boettke) here.

I am, however, not at all surprised by Kurt’s views on this issues – I knew them already – but I am happy to once again be reminded that Free Banking thinkers like Kurt and George and Market Monetarists think very alike. In fact I personally have a hard time disagreeing with anything Kurt and George has to say about monetary theory. And I would also note that Kurt has been an advocate of the market based approach to monetary policy analysis advocated particularly by Manley Johnson and Bob Keleher in their book “Monetary Policy, A Market Price Approach”. The Johnson-Keleher view of markets and money of course comes very close to being Market Monetarism. For more on this topic see Kurt on Keleher here.

However, I would also use this occasion to stress that Market Monetarists should learn from people like George and Kurt and we should particularly listen to their more cautious approach to central banks as hugely imperfect institutions. This is Kurt:

With nominal GDP targeting it may well also happen that there will be flaws that only become apparent through experience. My reason for thinking that flaws are likely is that, like inflation targeting, nominal GDP targeting is an imposed monetary arrangement. It is not a fully competitive one that that people are at liberty to cease using at will, individually, the way they can cease buying Coca-Coca and start buying Pepsi or apple juice instead. Nominal GDP targeting when carried out by a central bank, which has monopoly powers, is a form of central economic planning subject to the same criticisms that apply to all forms of central planning. In particular, it does not allow for the occurrence of the type of discovery of knowledge that comes from being able to replace one arrangement with another through competition.

I agree with Kurt here. Even if NGDP targeting is preferable to other “targets” central banks are still to a large extent very flared institutions. Therefore, it is in my opinion not enough just to advocate NGDP targeting – or even worse just advocating monetary easing in the present situation – we also need to fundamentally reform of monetary institutions.

Finally, advocating NGDP targeting is not just a plain argument for more monetary easing – not even in the present situation. Hence, it is for example notable that the recent drop in inflation in for example the US to a very large extent seems to have been caused by a positive supply shock. This has caused some to call for the fed to step up monetary easing. However, to the extent that what we are seeing is a positive supply this of course is “good deflation”. So yes, there are numerous reasons to argue for a continued expansion of the US money base, but lower inflation is not necessarily such reason.

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