Christmas musings on life, money and blogging

As year is coming to an end I am sure that a lot of you like myself are reflecting on life and the world you live in. Here is a bit of what I have been thinking about this year and about what I think will be my focus in my blogging in the coming year.

Three years of blogging is not important

2013 was my third year of blogging and I still enjoy it as much as when I started in October 2011. However, when I think of 2013 my blogging was certainly not the most importing thing. The most important thing to happen in 2013 was undoubtedly that our second child – Mathilde – was born on February 7. Being a parent puts everything else into perspective. Compared to that the daily ups and downs of the the global markets and the craziness of global central banking is really completely without importance.

Becoming a dad for a second time certainly has reduced the amount of time I have had for blogging and my blogging intensity has gone down. So I am blogging less these days than I used to. But the real reason isn’t really the family expansion, but rather that the world of monetary policy has been changing – for the better and as a result the global crisis has been easing dramatically.

Getting out of the crisis

The de facto introduction of the Evans rule in the US in September 2012 worked. There is no doubt about that in my mind. As a result the fear of a black swan event has clearly gone down. The markets no longer think that every small hiccup will blow up the global financial system and the global economy. Just think of the US government shutdown – nobody else than partisan political pundits ever thought of it as any particular risk to the US economy. And surely enough the US economy continues to expand despite of fiscal tightening in the US.

In that sense 2013 has been the year where it was so clearly demonstrated that Scott Sumner is right about the what has come to be known as the Sumner Critique – under inflation targeting, Price Level Tarting, NGDP targeting or the Evans rule the fiscal multiplier is zero – also if interest rates are at the Zero Lower Bound. The monetarists are right – the keynesians are wrong. It is that simple – Krugman forecasted that the fiscal cliff would cause a new recession. It didn’t. You can consolidate public finances without getting into a recession – just make sure that you get monetary policy right.

The New 90s – will we stop talking about monetary policy?

As the year is coming to an end I am sure that Ben Bernanke is also reflecting on life and money. He is leaving the Fed. His start at the Fed was catastrophic. However, in the end he got it right. Or at least he has done enough in terms of moving US monetary policy towards a rule based framework to ensure that the US recovery continues. And I would expect it to continue in 2014. In fact I am very optimistic on the outlook for the US economy. I have fantasies about “the New 90s” – a period of a positive supply shock and excess capacity in the US economy and a fairly rule based monetary policy where nominal GDP consistently growth by 4-6% and inflation is 1-2%, which will ensure real GDP growth of 3-5% in the coming 5 years.

This is obviously great and in many ways we can argue that we have returned to a world similar to the Great Moderation. US monetary policy is now fundamentally what Bob Hetzel has called a Lean-Against-the-Wind with credibility regime. That is certainly not a perfect world – far from it. But it is good enough to make monetary policy uninteresting for most economic commentators as this amount of nominal stability makes the world look like a Real Business Cycle world. If monetary policy provide a fairly large amount of nominal stability then ups and downs in the economy will be a result of supply side shocks.

My bet is therefore that there is will be significantly less discussion about monetary policy in the coming five years than over the past five years. For somebody who blogs about monetary policy that is bad news. Or rather we have to think about how we blog about monetary policy. The Market Monetarists should continue to push for the right policies, but the discussion should not be about what the Fed should do at the next FOMC meeting, but rather be about fundamental institutional change.

Furthermore, I can’t help thinking that when the Fed got it more or less right in 1990s Milton Friedman mostly stopped talked about monetary policy and instead started to talk about ending the war of drugs. I do not plan to start blogging a lot of this topic, but I think I will focus more on some of Friedman’s non-monetary policy ideas – school vouchers, the Negative Income Tax and drug liberalization.

Warning against the moral hazard problems

Monetarism was big in the 70s and 80s, but when the Fed – and other central banks around the world – finally got it right and monetary policy increasingly became rule based in 1990s interest in monetarism disappeared. I to some extent fear the same will happen to Market Monetarism. Market Monetarists identified the reasons for the crisis and gave a clear recipe for moving out of the crisis.

That has made Market Monetarism interesting. However, is there still a need for Market Monetarism as we are getting out of the crisis? There surely is – particularly as Market Monetarism in my view never was a about a one-off monetary stimulus to end this crisis, but rather about a way to think about money and macroeconomics and particularly about rule-based monetary policy.

As a consequence I think my blogging is likely to move in a slightly more abstract direction in 2014. The day-to-day monetary events in the US is likely to become increasingly boring. Yes, tapering is a challenge, but overall I am pretty convinced that the Fed will manage this without major problems. US monetary policy is certainly not my major concern for 2014.

Looking further ahead I would actually think that what would move to the centre stage for Market Monetarists in the coming years is to not only argue for a even more rule-based monetary policy – including the use of NGDP futures – but it is also the time to start to warn about the very significant increase in moral hazard problems we have seen around the world. These problems are significant – particularly in Europe. That said, in Europe we still have moved nowhere in terms of monetary policy. The euro zone today is the gold bloc in 1934-35 – the crisis has eased, but there has not been any fundamental change to the monetary policy regime. That is unsustainable. I will continue to argue that in my blogging in 2014.

Kuroda’s success will continue in 2014 – I hope

It is not only the US that moved in the direction of a more rule based monetary policy. Japan has done so as well. After 15 years of failure the Bank of Japan under the leadership of governor Kuroda finally seem to be getting it right. I have paid quite a bit of attention to Japan in 2013. It has been great to follow how Kuroda’s new policy already has taken Japan out of deflation and the seen the Japanese economy starting an impressive recovery. Everything is certainly not perfect in Japan, but those who have said that monetary policy was ineffective at the Zero Lower Bound certainly have a problem explaining what have happening in the Japanese economy over the past year.

Looking into 2014 I expect the BoJ to continue it’s successful policies – and no I don’t fear a Japanese fiscal cliff. I am no fan of tax increases but the planned sales tax hikes in Japan will not kill the recovery. Rather it will be a reason for Kuroda to demonstrate that he is serious about taking Japan out of the deflationary trap.

George Osborne’s biggest success

I never was too impressed with UK chancellor of the exchequer George Osborne, but his decision to appoint Mark Carney as new Bank of England governor surely – so far – has been a success. Even though I personally has been somewhat disappointed with Carney’s performance it is unquestionable that there has been a major change in expectations about monetary policy in the UK and the UK economy is now recovering from the crisis. In fact particularly the recovery in the UK labour market is rather remarkable.

I remain quite fearful that the Bank of England’s success is mostly luck and that it still could derail the recovery and I particularly fear that the BoE might move to tighten monetary policy prematurely. Unfortunately in many ways the BoE is not that different from the ECB and its commitment to a rule-based monetary policy is certainly not strong and even more importantly it seems quite clear that the BoE as an institution is fundamentally not really – at this stage – able to think about monetary policy as money base control rather than interest rate targeting. That is unfortunate and that could bring new troubles for the BoE in the future. Furthermore, I am deeply skeptical about what seems to be an obsession with macroprudential policies at the BoE. I hope 2014 will be the year where the BoE continues to demonstrate that it is not a bad copy of the ECB.

Those who did well in 2008-9 has disappointed in 2013 – will it continue in 2014?

In 2008-9 some central banks managed the shock much better than others. For example the Swedish Riksbank, the Polish central bank, Bank of Canada and the Reserve Bank of Australia all did quite well in 2008-9. However, the performances of these central banks over the past year indicate that they did well because they where lucky rather than because of the fundamental institutional set-up guiding policy for these central banks. Hence, in my view all of the four mentioned central banks have erred on the hawkish side over the past 1-2 years – mostly because they have been overly focused on risks that should be of no concern of central banks.

Just take the Swedish and Australian central banks’ preoccupation with property prices and household debt. I particularly continue to be puzzled how the RBA fail to realize that it’s continued obsession with property market is also a direct reason why the Aussie dollar remain very strong (something the RBA also don’t like). Governor Stevens did you ever hear about the Tinbergen rule?  You cannot target four targets – interest rates, property prices, the Aussie dollar and inflation with one instrument (the money base).

The Riksbank recently has cut its key policy rate to 0.75% and there is a very clear risk the we will test the Zero Lower Bound if there is another negative shock to the Swedish economy (for example a policy induced downturn in the Swedish property market). I am afraid the Riksbank is completely unprepared for conducting monetary policy at the ZLB. Therefore it will be very interesting watch economic and particularly monetary events in Sweden in 2014.

But if the Riksbank needs inspiration on how to conduct monetary policy at the ZLB it should look to another small-open economy in Europe with a currency called the crown – the Czech Republic. In 2013 – after years of failure to do the right thing – the Czech central bank (CNB) finally moved to ease monetary policy by putting a floor under EUR/CZK at 27 – effectively devaluing the koruna by 4%. CNB acknowledges that there might be an ZLB (its key policy rate is at 0.05%), but there is no liquidity trap. Monetary policy can easily be eased also with interest rates at zero.

Even though I don’t think that the implemented policy change in the Czech Republic is enough I have high hope that it will spur nominal GDP growth in 2014 (my best estimate is by 1%-point compared what would have happened without policy change). Given the continued moderate downtrend in oil prices I would expect that supply side factors would keep Czech inflation well-below the CNB’s 2% inflation target in 2014 so most of the pick-up in NGDP growth is likely to be reflected in higher real GDP growth rather than a pick-up in inflation. That should keep the door open for the CNB to ease monetary policy even furthermore (my bet is that the CNB moves the “target” on EUR/CZK up in February or March.)

So I am looking forward to seeing CNB governor Singer teaching other central bankers around the world a lesson in how to conduct monetary policy at the ZLB in 2014. Because one thing is clear – we might be moving out of the crisis, but most central bankers still have a very hard time letting go of their obsession with using “the” interest rate as a policy instrument.

Merry Christmas

This has not exactly been a very well-organized blog post, but it has been written over three days and I really rather go back to the Christmas celebrations with the family.

So Merry Christmas to all of my readers from Mathilde, Mathias and Hanne and myself. See you soon.

PS I didn’t write much about the ECB above. There is a reason for that – we want to keep things positive during Christmas.

PPS I did not provide any links above to my earlier posts on a number of topics above (I will rather play with Mathias and Mathilde…), but I would be very happy to hear, which posts of mine you have enjoyed over the year and what topics you think I should focus on in 2014.


Imagine that US non-farm payrolls were growing by 400k/month (that is how strong the UK labour market is)

My Danske Bank colleague Anders Vestergård Fischer had a fun idea today – he wanted to “translate” the latest UK labour market numbers into something an US audience could understand.

Here is the result of Anders’ back of an envelop calculations – if the US non-farm payrolls were growing as fast as the latest UK employment growth (Q3 2013) then the US economy would be adding 380-400k jobs per month! We haven’t seen job growth like that in the US since the late 1990s. Over the past three months US payrolls have growing around 190k per month.

So what are the explanations for the the UK labour market improvement? The negative spin: Horrible British productive growth. The positive spin: A very healthy combination of monetary easing and fiscal consolidation.

ECB: “We’re not sure we can get out of it”

When Milton Friedman turned 90 years back in 2002 Ben Bernanke famously apologized for the Federal Reserve’s role in the Great Depression:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

On Twiiter Ravi Varghese has paraphrased Bernanke to describe the role of the ECB in the present crisis:

“You’re right, we did it. We’re very sorry. But we’re not sure we can get out of it.”

Brilliant…follow Ravi on Twiiter here (and follow me here).

European horror graph of the day – the Greek price level collapse

It has been said that the recent decline in European inflation to a large extent is due to a positive supply shock. This is to some extent correct and it is something I have acknowledged on a number of occassions. However, the main deflationary problem comes from the demand side of the European economy and the fact that monetary policy remains extremely tight in the euro zone is the main cause of the deflationary pressures in the European economy. A simple (but incomplete) way to strip out supply side effects from the price level is to look at the GDP deflator. This is what I here have done for Greece. This is the horror graph of the day – it is the level of the Greek GDP deflator relative to the pre-crisis trend (2000-7).


I challenge my readers to find ANY example from history where such a collapse in the price level has ended in anything else than tears. PS note that there are no signs of inflationary pressures in the Greek economy escalating prior to the crisis. This is not about imbalances, but about a negative monetary policy shock.

Christopher Pissarides: Is Europe Working? (The answer obviously is no)

Nobel laureate Christopher Pissarides earlier this week gave a lecture at the London School of Economics on the theme “Is Europe Working?”. It is an extremely interesting lecture. I disagree with a lot of what professor Pissarides is saying. He focuses far too much on fiscal policy issues and far too little on monetary policy. But it is in general a very enlightened lecture and he raises a number of extremely important questions about the future of the euro zone.

Pissarides is clearly an old-fashioned Keynesian. I used to think that that was horrible, but frankly speaking old-fashioned Keynesian analysis of the euro crisis at least gets to the right conclusion in the sense that Keynesians agree with (market) monetarists that the core problem in the euro zone is weak aggregate demand (we – the monetarists – call it weak nominal spending/income growth). They are wrong on the solution (expansionary fiscal policy), but at least they make a lot more sense than the “calvinist” austerians who think that both fiscal and monetary policy need to be tightened.

Interestingly enough Pissarides used to be a “euro cheerleader” (Keynesians historically have been a lot more happy about fixed exchange rates than monetarists), but he now actually suggests to split-up the euro and it seems like he is realizing that different countries with different structures and fundamentals need their own sovereign monetary policy. He is not clear on that at all – after all he is a Keynesian so he doesn’t fully get that the “solution” is monetary rather than fiscal.

We don’t need fiscal union and fiscal transfers in the euro zone (this is Pissarides alternative to an euro split-up). What we need is for the ECB to provide nominal stability (See one of my suggestions on that topic here). At the moment the ECB is only providing continued deflationary pressures and therefore we are likely to continue to face debt-deflation problems. To avoid falling deeper into a deflationary trap we obviously need significant monetary easing within a forward-looking and rule-based framework. I wonder whether Pissarides would support that.

Listen to Professors Pissarides’ excellent lecture here (I say this despite the fact he says in the end of the lecture that he “was born a Keynesian and will die a Keynesian”)

PS I now know how uncomfortable Gustav Cassel must have felt agreeing more with Keynes than Hayek on the causes of and the solutions to the Great Depression.

PPS maybe the euro zone’s real problem is that European economists are all either Keynesians or Austrians (or should I say “Germans”?) Where are the European monetarists? And Market Monetarists?

Stanley Fischer – this guy can keep NGDP on a straight line

This is from Reuters:

Stanley Fischer, who led the Bank of Israel for eight years until he stepped down in June, has been asked to be the Federal Reserve’s next vice chair once Janet Yellen takes over as chief of the U.S. central bank, a source familiar with the issue said on Wednesday.

Fischer, 70, is widely respected as one of the world’s top monetary economists. At the Massachusetts Institute of Technology, he once taught current Fed Chairman Ben Bernanke and Mario Draghi, the European Central Bank president.

Yellen, the current Fed vice chair, is expected to win approval from the U.S. Senate next week to take the reins from Bernanke, whose term ends in January.

Fischer, as an American-Israeli, was widely credited with guiding Israel through the global economic crisis with minimal damage. For the Fed, he would offer the fresh perspective of a Fed outsider yet offer some continuity as well.

Good news! Stanley Fischer certainly is qualified for the job. He knows about monetary theory and policy. And even better he used to have some sympathy for nominal income targeting. Just take a look at this quote from his 1995 American Economic Review article “Central Bank Independence Revisited” (I stole this from Evan Soltas):

“In the short run, monetary policy affects both output and inflation, and monetary policy is conducted in the short run–albeit with long-run targets and consequences in mind. Nominal- income-targeting provides an automatic answer to the question of how to combine real income and inflation targets, namely, they should be traded off one-for-one…Because a supply shock leads to higher prices and lower output, monetary policy would tend to tighten less in response to an adverse supply shock under nominal-income-targeting than it would under inflation-targeting. Thus nominal-income-targeting tends to implya better automatic response of monetary policy to supply shocks…I judge that inflation-targeting is preferable to nominal-income-targeting, provided the target is adjusted for supply shocks.”

While at the Bank of Israel Fischer certainly conducted monetary policy as if he was targeting the level of nominal GDP. Just take a look at the graph below and note the “missing” crisis in 2008.

NGDP Israel

Undoubtedly Fischer had some luck, while at the BoI, and I must also say that I think he from time to time had a problem with his “forward guidance”, but his track-record speaks for itself – while Bank of Israel  governor, Stanley Fischer provided unprecedented nominal stability, something very rare in Israeli economic history. Lets hope he will help do that at the Fed as well.

There is no bubble in the US stock market

Before you start reading this post note that I am not an equity market analyst and this is not investment advice. Rather it is an attempt to discuss the impact of monetary easing on the US stock market and to what extent the Fed’s actions have created a stock market bubble.

It is quite often said these days that the recovery we have seen in the US stock markets since early 2009 in some way is “phony” or “fake”, and that it has been driven by “easy money”. Even some policy makers, both in the US and other places, seem to think that there is a bubble in the global stock markets, which is a result of overly easy monetary policy.

To test these views in a simple way, I have estimated a model for the S&P500 going back to 1960.  It is a simple OLS regression. You can do something more fancy, but that is not the point here. It is all indicative. If you have a better model, I would love to see it.

Take a look at the graph below. The blue is the actual performance of S&P500, while the green line is the model “prediction”. Please note that I have estimated the model until 2007 to avoid the results being influenced by the monetary policy shift over the past five years (it doesn’t change the result in any substantial way, however, to estimate the model until today).

SP500 model

As you see, the model fits the actual performance of S&P500 over the decades quite well. The model is quite simple. I used only three explanatory variables – A corporate Aaa-rate long-term bond yield to capture funding costs and/or an alternative investment to stocks. I used the nominal Personal Consumption Expenditure to capture demand in the US economy. It is also a proxy for earnings growth and finally I used the ISM New Orders index as a proxy for growth expectations. All variables have the expected signs and are statistically significant.

Yes, it is a simple model, but it seems to work quite well in terms of fitting the actual level on the S&P500 over the years.

If anything stocks are still cheap (and monetary policy too tight)

As mentioned, I estimated the model with data until 2007, but I have used the model to “predict” how the stock market should have performed according to the model from 2008 until today.

The results are quite clear: Since 2008, stock prices have consistently been lower than what the model predicts. Only recently have stock prices approached the level predicted by the model. Based on this, it is quite hard to argue that stock prices in the US are overvalued. In fact if anything stocks remain “cheap” relative to the model predictions.

I don’t want to argue this too strongly and I am certainly not giving any advice on whether to buy or sell the US stock market at these levels – all kind of things tend to move the market up and down. What I am arguing is that the view that there is a bubble in the US stock market is pretty hard to justify based on my simple model. If you can come up with a better model, which can show that there is a bubble, I am all ears.

Therefore, it is very hard to argue in my view that overly easy monetary policy has distorted the pricing of US stocks. What has happened rather is that stocks became extremely cheap relative to “fundamentals” in early 2009, and what we have seen in the past five years is a closing of this “valuation gap”. Has monetary policy helped close the “gap”? Yes, that is likely, but that is not the same as saying that there is a bubble.

Concluding, there is no empirical reason in my view to claim that US monetary policy has unduly inflated US asset prices. And hence the performance of the US stock market over the past five years is not an argument for monetary tightening. It anything it is an argument that monetary policy has remained too tight.

PS if you are interested in the model output see below (it is not rocket science):

  • Model 1

    S&P500, rebase 01-01-1960 = 100.0

    • Observations 576
      Degrees of freedom 572
      R2 0,9597105111
      F 4541,7504443086
      Prob-value(F) 0
      Sum of squared errors 16279,404325032
      Standard error of regression 5,3348380549
      Durbin-Watson 0,0489587816
      AIC 6,1933143441
      HQ 6,2051117912
      Schwarz 6,2235650918
    • Coefficients Standard error t Prob-value
      Intercept -627,703293948 7,0591041987 -88,9210976745 0
      x1 -3,4836423233 0,096018312 -36,2810202582 0
      x2 28,8240799392 0,2485205896 115,9826635779 0
      x3 -0,0228854283 0,0303242775 -0,7546899778 0,4507456199
    • Legend
      x1 Corporate Benchmarks, Moody’s Aaa-Rated Long-Term, Yield, Average, USD
      x2 PCE
      x3 ISM PMI, Manufacturing Sector, New orders, SA
    • Covariance matrix
      Intercept x1 x2 x3
      Intercept 49,8309520883 0,0191128279 -1,6803093367 -0,067856727
      x1 0,0191128279 0,0092195162 -0,0048925278 0,0007896205
      x2 -1,6803093367 -0,0048925278 0,0617624835 0,0003876941
      x3 -0,067856727 0,0007896205 0,0003876941 0,0009195618

The (Divisia) money trail – a very bullish UK story

Recently, the data for the UK economy has been very strong, and it is very clear that the UK economy is in recovery. So what is the reason? Well, you guessed it – monetary policy.

I think it is fairly easy to understand this recovery if we follow the money trail. It is a story about how UK households are reducing precautionary cash holdings (in long-term time deposits) because they no longer fear a deflationary scenario for the British economy and, that is due to the shift in UK monetary policy that basically started with the Bank of England’s second round of quantitative easing being initiated in October 2011.

The graphs below I think tells most of the story.

Lets start out with a series for growth of the Divisia Money Supply in the UK.

Divisia Money UK

Take a look at the pick-up in Divisia Money growth from around October 2011 and all through 2012 and 2013.

Historically, UK Divisia Money has been a quite strong leading indicator for UK nominal GDP growth so the sharp pick-up in Divisia Money growth is an indication of a future pick-up in NGDP growth. In fact recently, actual NGDP growth has picked up substantially, and other indicators show that the pick-up is continuing.

If you don’t believe me on the correlation between UK Divisia Money growth and NGDP growth, then take a look at this very informative blog post by Duncan Brown, who has done the econometrics to demonstrate the correlation between Divisia (and Broad) Money and NGDP growth in the UK.

Shifting money

So what caused Divisia Money growth to pick-up like this? Well, as I indicated, above the pick-up has coincided with a major movement of money in the UK economy – from less liquid time deposits to more liquid readably available short-term deposits. The graph below shows this.

Deposits UK

So here is the story as I see it.

In October 2011 (A:QE in the chart), the Bank of England restarts its quantitative easing program in response the escalating euro crisis. The BoE then steps up quantitative easing in both February 2012 (B: QE) and in July 2012 (C: QE). This I believe had two impacts.

First of all, it reduced deflationary fears in the UK economy, and as a result households moved to reduced their precautionary holdings of cash in higher-yielding time deposits. This is the drop in time deposits we are starting to see in the Autumn of 2011.

Second, there is a hot potato effect. As the Bank of England is buying assets, banks and financial institutions’ holdings of cash increase. As liquidity is now readily available to these institutions, they no longer to the same extent as earlier need to get liquidity from the household sector, and therefore they become less willing to accept time deposits than before.

Furthermore, it should be noted that in December 2012, the ECB started its so-called Long-Term Refinancing Operation (LTRO), which also made euro liquidity available to UK financial institutions. This further dramatically helped the liquidity situation for UK financial institutions.

Hence, we are seeing both a push and pull effect on the households’ time deposits. The net result has been a marked drop in time deposits and a similar increase in instant access deposits. I believe it has been equally important that there has been a marked shift in expectations about UK monetary policy with the appointment of Mark Carney in December 2012 (D: Carney).

Mark Carney’s hints – also in December 2012 – that he could favour NGDP targeting also helped send the signal that more monetary easing would be forthcoming if needed, as did the introduction of more clear forward guidance in August 2013 (E: ‘Carney Rule’). In addition to that, the general global easing of monetary conditions on the back of the Federal Reserve’s introduction of the Evans rule in September 2012 and the Bank of Japan’s aggressive measures to hit it new 2% inflation undoubtedly have also helped ease financial conditions in Britain.

Hence, I believe the shift in UK (and global) monetary policy that started in the Autumn of 2011 is the main reason for the shift in the UK households’ behaviour over the past two years.

Monetary policy is highly potent

But you might of course say – isn’t it just money being shifted around? How is that impacting the economy? Well, here the Divisia Money concept helps us. Divisia money uses a form of aggregation of money supply components that takes this into account and weights the components of money according to their usefulness in transactions.

Hence, as short-term deposits are more liquid and hence readably available for transactions (consumption or investments) than  time deposits a shift in cash holdings from time deposits to short-term deposits will cause an increase in the Divisia Money supply. This is exactly what we have seen in the UK over the past two years.

And since as we know that UK Divisia Money growth leads UK NGDP growth, there is good reason to expect this to continue to feed through to higher NGDP growth and higher economic activity in Britain.

Concluding, it seems rather clear that the quantitative easing implemented in 2011-12 in the UK and the change in forward guidance overall has not only increased UK money base growth, but also the much broader measures of money supply growth such as Divisia Money. This demonstrates that monetary policy is highly potent and also that expectations of future monetary policy, which helped caused this basic portfolio readjustment process, works quite well.

“Monetary” analysis based on looking at interest rates would never had uncovered this. However, a traditional monetarist analysis of money and the monetary transmission mechanism, combined with Market Monetarist insights about the importance of expectations, can fully explain why we are now seeing a fairly sharp pick-up in UK growth. Now we just need policy makers to understand this.



I think some acknowledgements are in place here as this blog post has been inspired by the work of a number of other monetarist and monetarists oriented economists and commentators. First of all Britmouse needs thanking for pointing me to the excellent work on the “raid” on UK households’ saving by Sky TV’s economics editor Ed Conway, who himself was inspired by Henderson Economics’ chief economist Simon Ward, who has done excellent work on the dishoarding of money in the UK. My friend professor Anthony Evans also helped altert me to what is going on in UK Divisia Money growth. Anthony himself publishes a similar data series called MA.

Second of course, a thanks to Duncan Brown for his great econometric work on the causality of Divisia Money and NGDP growth in the UK.

And finally, thanks to the godfather of Divisia Money Bill Barnett who nearly single-handledly has pushed the agenda for Divisia Money as an alternative to simple-sum monetary aggregates for decades. In recent years, he has been helped by Josh Hendrickson and Mike Belongia who has done very interesting empirical work on Divisia Money.

For a very recent blog post on Divisia Money, see this excellent piece by JP Koning.

And while you are at it, you might as well buy Bill Barnett’s excellent book “Getting It Wrong” about “how faulty monetary statistics undermine the Fed, the financial system and the economy”.


There is a pragmatic (but not a libertarian) case for a “Basic Income Guarantee”

When I first read Milton Friedman’s Free to Choose when I was in my teens two things particularly impressed me. First of course Friedman’s monetarist ideas and second his strategies for moving from a Welfare State to a classical liberal society.

My blog is mostly committed to monetarist ideas. However, in this blog post I will write a bit about the strategies to move towards a classical liberal society. Two of such strategies that Milton Friedman suggested in Free to Choose (and in Capitalism and Freedom for that matter) are education vouchers and the so-called Negative Income Tax.

I have always had considerable sympathy for these ideas and still find both ideas much preferable to most of the welfare schemes we know from today’s Western societies. Not because I think of these ideas as ideal, but because I think there are good pragmatic reasons to advocate these ideas. After all I consider myself a pragmatic revolutionary.

Recently the idea of a Negative Income Tax has gotten some attention among libertarian bloggers. Or rather the more generalized form of a Basic Income Guarantee.

What is a Basic Income Guarantee?

In a recent blog post my friend Sam Bowman who is Research Director at the Adam Smith Institute in London makes the case for a Basic Income and explains the basic idea. This is Sam:

The British government spends more on welfare than it does on anything else apart from healthcare. The benefits system is arcane and unwieldy, a mish-mash of disparate attempts to address different social problems in a piecemeal fashion. It creates perverse incentives for those on it, such as people stuck in a ‘benefits trap’ where they lose almost as much money in benefits by working as they are earning, and distorts entire markets by inflating prices, as housing benefit does to the housing market.

…The ideal welfare system is a basic income, replacing the existing anti-poverty programmes the government carries out (tax credits and most of what the Department for Work and Pensions does besides pensions and child benefit). This would guarantee a certain income to people who have no earnings from work at all, and would gradually be tapered out according to earnings for people who do have an income until the tax-free allowance point, at which point they would begin to be taxed.

For example, we could set a basic income of £10,000/year by using a cut-off point of £20,000/year, and withdrawal rate of 50%. The basic income supplement would be equal to 50% of the difference between someone’s earnings from work and the £20,000 cut-off point. A person with no earnings would get a basic income of £10,000/year; a person who earned £10,000/year would get a supplementary income of £5,000; a person on £15,000/year would get a supplementary income of £2,500; and a person on £20,000 would get nothing (and begin paying tax on the next pound they earned).

These numbers are representative: no need to tell me that £10,000 is too low or too high. What matters is the mechanism.

What Sam here suggests is basically a system similar to the Negative Income Tax, which Friedman suggested in Capitalism and Freedom and Free to Choose.

Matt Zwolinski’s libertarian case for redistribution

Sam is not the only libertarian to recently having made the case a Basic Income Guarantee. Hence, in a recent post on Matt Zwolinski spells out The Libertarian Case for a Basic Income.

I must admit that when I read Matt’s blog post I was not totally convinced by his arguments – despite my general sympathy for the idea – and I felt like writing a blog post refuting some of Matt’s arguments for a Basic Income.

David Friedman, however, beat me to it and in a new blog post he discusses Matt’s arguments.

I find myself generally agreeing with David’s objections to Matt’s position on a Basic Income Guarantee. Or maybe I should say David’s objections to Matt’s libertarian case for income redistribution. That, however, does not mean that I agree with all of David’s objections as you will see below.

Matt makes three overall arguments for a Basic Income.

1) A Basic Income Guarantee would be much better than the current welfare state

This is Matt:

Current federal social welfare programs in the United States are an expensive, complicated mess. According to Michael Tanner, the federal government spent more than $668 billion on over one hundred and twenty-six anti-poverty programs in 2012. When you add in the $284 billion spent by state and local governments, that amounts to $20,610 for every poor person in America.

Wouldn’t it be better just to write the poor a check?

Each one of those anti-poverty programs comes with its own bureaucracy and its own Byzantine set of rules. If you want to shrink the size and scope of government, eliminating those departments and replacing them with a program so simple it could virtually be administered by a computer seems like a good place to start. Eliminating bloated bureaucracies means more money in the hands of the poor and lower costs to the taxpayer. Win/Win.

A Basic Income Guarantee would also be considerably less paternalistic then the current welfare state, which is the bastard child of “conservative judgment and progressive condescension” toward the poor, in Andrea Castillo’s choice wordsConservatives want to help the poor, but only if they can demonstrate that they deserve it by jumping through a series of hoops meant to demonstrate their willingness to work, to stay off drugs, and preferably to settle down into a nice, stable, bourgeois family life. And while progressives generally reject this attempt to impose traditional values on the poor, they have almost always preferred in-kind grants to cash precisely as a way of making sure the poor get the help they “really” need. Shouldn’t we trust poor people to know what they need better than the federal government?

I think Matt has a point here – and it is very similar to the kind of argument Milton Friedman made for the Negative Income Taxif you are going to redistribute income anyway then why not do it in the least paternalistic way and at the lowest possible economic cost?

This is not a particularly strict libertarian argument, but from a purely pragmatic perspective it makes a lot of sense. And it is surely much less statist and interventionist than most of the present day welfare schemes in the Western world.

However, David Friedman explains why this might be less simple than his dad (and Matt and I) seemed to think. This is David:

That is probably true (that the Basic Income would be an improvement compared to the present welfare system), especially if you imagine it replacing not only welfare but all policies, such as the farm program, that are defended as helping poor people. The problem, as Matt appears to realize, is that if a guaranteed minimum income is introduced it will almost certainly be an addition to, not a substitute for, current programs.

David clearly also has a point, but I am afraid that this is an argument basically against any free market reforms that is not 100% denationalization and I can certainly easily see welfare reforms inspired by the Negative Income Tax/Basic Income Guarantee that will improve that present welfare system.

Hence, in the case of for example the Danish wide-ranging welfare system I could easily imagine a number different welfare schemes being “merged” into a Negative Income Tax style system – for example a NIT for all able-bodied persons between the age of 18 and 35 years. That surely would be an improvement over the present system. Would it be political realistic? Probably not, but realistic enough to being discussed and to generate ideas for genuine welfare reform.

2) A Basic Income Guarantee might be required on libertarian grounds as reparation for past injustice

Back to Matt’s second argument for a Basic Income:

One of libertarianism’s most distinctive commitments is its belief in the near-inviolability of private property rights. But it does not follow from this commitment that the existing distribution of property rights ought to be regarded as inviolable, because the existing distribution is in many ways the product of past acts of uncompensated theft and violence. However attractive libertarianism might be in theory, “Libertarianism…Starting Now!” has the ring of special pleading, especially when it comes from the mouths of people who have by and large emerged at the top of the bloody and murderous mess that is our collective history.

Radical libertarians have proposed several approaches to dealing with past injustice. But one suggestion that a lot of people seem to forget about comes from an unlikely source. Most people remember Robert Nozick’s Anarchy, State, and Utopia as a fairly uncompromising defense of natural-rights libertarianism. And most people remember that Nozick wrote that any state that goes beyond the minimal functions of protecting its citizens’ negative rights would be itself rights-violating and therefore unjust.

But Nozick’s entitlement theory of justice is a historical one, and an important component of that theory is a “principle of rectification” to deal with past injustice. Nozick himself provided almost no details at all regarding the nature or proper application of this principle (though others have speculated). But in one fascinating passage, Nozick suggests that we might regard patterned principles of justice (like Rawls’ Difference Principle) as “rough rules of thumb” for approximating the result of a detailed application of the principle of rectification. Here’s what Nozick has to say:

“Perhaps it is best to view some patterned principles of distributive justice as rough rules of thumb meant to approximate the general results of applying the principle of rectification of injustice. For example, lacking much historical information, and assuming (1) that victims of injustice generally do worse than they otherwise would and (2) that those from the least well-off group in the society have the highest probabilities of being the (descendants of) victims of the most serious injustice who are owed compensation by those who benefited from the injustices (assumed to be those better off, though sometimes the perpetrators will be others in the worst-off group), then a rough rule of thumb for rectifying injustices might seem to be the following: organize society so as to maximize the position of whatever group ends up least well-off in the society (p. 231).”

In a world in which all property was acquired by peaceful processes of labor-mixing and voluntary trade, a tax-funded Basic Income Guarantee might plausibly be held to violate libertarian rights. But our world is not that world. And since we do not have the information that would be necessary to engage in a precise rectification of past injustices, and since simplyignoring those injustices seems unfair, perhaps something like a Basic Income Guarantee can be justified as an approximate rectification?

I must admit that I don’t find Matt’s arguments particularly convincing – as I didn’t find Nozick’s arguments convincing (when I long ago read Anarchy, State and Utopia). The problem in my view is that Matt is trying to make a libertarian argument in favour of redistribution (rather than just in favour of a Basic Income Guarantee). I generally don’t think you can make such an argument. David seems to agree:

As he (Matt) points out, the existing state of the world is in part a result of past rights violations. Land claims in libertarian theory may be based on a series of voluntary transfers beginning with the person who first mixed his labor with the land, but many land claims in the real world run back to an initial seizure by force. Similarly, claims to other forms of wealth must be justified, in libertarian moral theory, by a chain of voluntary transactions back to a first creator.

In at least some cases that chain is interrupted by involuntary transactions. Consider a house built by slave labor. Is the legitimate owner the person with the present title to it or the heir of the slaves forced to build it, or is it perhaps partly the legitimate property of one and partly of the other? What about property in other forms inherited through a chain that leads back to a slave holding or slave trading ancestor who owed, but never paid, compensation to his victims?

Most libertarians would recognize this as a legitimate problem, although many might point at the practical difficulty of establishing just ownership in such cases as justifying some sort of statute of limitations with regard to wrongs in the distant past. Matt’s alternative, suggested by a passage he quotes from Nozick, is to argue that the descendants of those who gained by past rights violations are on average better off than the descendants of those who lost, hence redistribution from richer to poorer in the form of a guaranteed minimum income represents an approximate rectification for past injustice.

While the argument suggests that transfers from richer to poorer might do a better job of rectification of past injustices than random transfers, it does not imply that such transfers do a better job than doing nothing, that they on net reduce injustice rather than increasing it. Some present wealth may be due to causes that are, from the standpoint of libertarian moral theory, unjust, but not all. If I justly owe you forty cents, taking a dollar from me and giving it to you makes the resulting distribution less just, not more. Unless most inequalities are inherited from past rights violations, a claim I think few libertarians would support, the logic of the argument breaks down.

3. A Basic Income Guarantee might be required to meet the basic needs of the poor

Again back to Matt and his third argument:

The previous two arguments both view a basic income as a kind of “second-best” policy, desirable not for its own sake but either as less-bad than what we’ve currently got or a necessary corrective to past injustice. But can libertarians go further than this? Could there be a libertarian case for the basic income not as a compromise but as an ideal?

There can and there has.

Both Milton Friedman and Friedrich Hayek advocated for something like a Basic Income Guarantee as a proper function of government, though on somewhat different grounds. Friedman’s argument comes in chapter 9 of his Capitalism and Freedomand is based on the idea that private attempts at relieving poverty involve what he called “neighborhood effects” or positive externalities. Such externalities, Friedman argues, mean that private charity will be undersupplied by voluntary action.

“[W]e might all of us be willing to contribute to the relief of poverty, provided everyone else did. We might not be willing to contribute the same amount without such assurance.”

And so, Friedman concludes, some “governmental action to alleviate poverty” is justified. Specifically, government is justified in setting “a floor under the standard of life of every person in the community,” a floor that takes the form of his famous “Negative Income Tax” proposal.

I must admit when I first read Friedman’s argument (or maybe later…) I found it a quite weak argument for redistribution and I don’t find it any stronger today. Here again I agree with David:

One version of that is to point out that private charity faces a public good problem, hence that we are on net better off if government taxes us to provide the charity that each of us wants provided but would prefer that other people pay for. This is not a particularly libertarian argument, but it is  essentially the same as one that many libertarians accept in the context of national defense.

One problem with the argument here is that we do not have any way of setting up mechanisms for income transfer that can only work in the way we would want them to. Once those mechanisms exist, individuals will try to game or alter them in order to be transferred to rather than from. That will impose real costs—resources spent gaming existing rules and lobbying to change them. And we may end up, as we often have in the past, with transfers that go up the income ladder rather than down or in all directions at once.

I totally agree – in fact I mostly tend to find collective goods arguments for government intervention to be quite weak as there are other mechanisms than government intervention to solve collective goods problems and furthermore Public Choice theory teaches us that there is no guarantee that government intervention will solve collective goods problems.

The Basic Income Guarantee should inspire welfare reform (but there is no libertarian case for redistribution)

Concluding, so while I have a lot of sympathy for Matt’s suggestion for a Basic Income Guarantee I have major problems with his arguments for income redistribution. Hence, I continue to think a Basic Income Guarantee or a Negative Income Tax is a good idea as a denationalization strategy that could bring us (a little) closer to the ideal of a non-paternalitic classical liberal society.

In that sense even though I agree with Matt’s policy suggestion (for a Basic Income Guarantee) I do not agree with his overall arguments for this suggestion. Overall, it seems to me that Matt’s Bleeding Heart Libertarian project in general is to find libertarian (sounding) arguments for income redistribution and even though I generally find this discussion interesting and an inspiring I seldom find myself convinced by the arguments. That is unfortunately also the case this time around.

PS Even though I do not consider myself to be a Bleeding Heart Libertarian (or a “left-libertarian”) I have quite a bit of sympathy for their general focus on “social justice” and their general arguments that classical liberal societies should not serve certain “class interests”. Capitalism is not an ideal to benefit the capitalists.

PPS don’t expect me to venture into a lot of political-philosophical posts in the future. I am an economist and I am obsessed with monetary matters. That will also be the case in the future and I do not for one second try to pretend to be more clever than people like Matt when it comes to political philosophy. I am not.

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