This is why we love Scott Sumner

This is Scott Sumner:

And don’t say that “everyone is entitled to an opinion,” or that the bubble thing is a valid perspective. No, as Paul Krugman pointed out in Pop Internationalism, if you don’t understand the theory of comparative advantage you are not entitled to an opinion that protection makes sense today because comparative advantage doesn’t apply to the modern world for blah blah blah reasons. And I would say that people who don’t understand basic AS/AD are not entitled to an opinion that unconventional monetary policies that focus on “art and wine” markets are needed. First you have to show you understand conventional policies. And everywhere we look we see fewer and fewer people on both the left and the right that understand even economics 101. People who don’t are not entitled to an opinion. People who do, but still reject econ101, are entitled to an opinion.

This is exactly why Scott is one of the most popular Econ bloggers in the world. He just writes great stuff. Have a nice weekend all of you.

PS I know you all read the quote before at Scott’s blog – after all nobody would be reading my blog had it not been for Scott.



The end of Prohibition and two great monetary thinkers

Today it is 80 years ago that US alcohol prohibition was ended. Interestingly enough two of my favorite monetary thinkers of the time – Irving Fisher and Clark Warburton – had strong views on prohibition.

Hence, Irving Fisher was a strong advocate of prohibition, while Clark Warburton was strongly against prohibition.

I would especially encourage everybody to have a look at Clark Warburton’s empirical work on prohibition in his Ph.D. dissertation, which was published as The Economic Results of Prohibition in 1932 – one year ahead of the end of prohibition

Fisher and Warburton had very similar – monetarist – views on monetary policy and theory, but they certainly did not agree on prohibition.

Later an other monetarist – Milton Friedman – picked up on a similar theme and he was very outspoken against the US War on Drugs.

As I noted in my previous post I believe that an end to the War on Drugs would be a quite positive supply shock to the US economy and would improve US public finances. The end of prohibition in 1933 likely had a similar positive effect on the US economy, but unfortunately other regulations such are the National Industrial Recovery Act (NIRA) had much more negative supply effects. Said in another way Roosevelt was right on alcohol and money, but wrong on nearly everything else.

Prohibition Dec 5 1933I

I stole this picture from Cato Institute. Here is what Cato’s David Boaz has to say about the day to day.

HAWKISH Market Monetarists

Over the past five years Market Monetarists have gotten a reputation for always being dovish in terms of monetary policy. The Market Monetarists have day-in and day-out been pushing for monetary easing in the US, the UK and the euro zone. So our reputation is correct in the sense that we – the Market Monetarists – in general have favoured a more dovish monetary stance both in the US and in Europe than has been implemented by central banks.

However, one might notice that the Market Monetarist bloggers have been surprisingly calm in recent months despite the sharp decline in inflation we have see in particularly Europe. Overall, we have obviously maintained that monetary policy in the euro zone is far too tight and that we are heading for deflation as a result of this. But the primary cause of the sharp decline in headline inflation in the euro zone has been lower commodity prices and to some extent also a result of an “austerity pause” (no indirect tax hikes).

Hence, Market Monetarists do not think a decline in inflation due a positive supply shock in itself should trigger interest rate cuts (or other forms of monetary policy easing). Remember Market Monetarists favour nominal GDP targeting and a supply shock will not impact nominal GDP – only composition of nominal GDP growth between inflation and real GDP growth.

As a result Market Monetarists actually tend to be somewhat less alarmed by the recent inflation decline in the euro zone than for example the ECB and in that sense you can argue that the Market Monetarists actually are more “hawkish” than the ECB presently is when it comes to the need for monetary easing in response to the recent decline in euro zone inflation. When Market Monetarists are calling for monetary easing in the euro zone it is hence for a somewhat different reason than the ECB.

Monetary policy remains overly tight in the euro zone and we are likely heading for deflation – even disregarding the recent supply side driven drop in inflation – and that is why we – the Market Monetarists are advocating monetary easing in the euro zone. Just a look at the dismail growth of nominal GDP in the euro zone – there is no better indication than that of the ECB’s failure to ease monetary policy appropriately. So we shouldn’t be too sad if the ECB moves to ease monetary policy – even if Market Monetarists think it is for the wrong reasons.

In 3-5 years the Market Monetarists will be among the biggest hawks

If we are lucky we continue to see supply side conditions improve both in the US and the euro zone in the coming years. I am personally particular optimistic about the outlook for the US economy, where I do expect a number of factors to give a welcomed lift to US potential growth. The end of the so-called commodity super cycle and fracking might hopefully to reduce oil prices. This is a positive supply shock to the US economy.

Furthermore, as I am optimistic that the US is in the process of ending two wars – the War on Drugs and the War on Terror. I will return to that issue in a later blog post, but I overall think that this is the direction we are moving in and that will be tremendously positive for the US labour supply (and public finances for that matter).

Finally, as the US economy continues to improve the present anti-immigration sentiment in the US will hopefully be reversed – after all Americans are more happy to welcome Mexicans to join the labour force when the economy is doing good rather than bad.

Add to that that US unemployment is still high so there is really no labour market constrains to growth at the moment in the US. So overall, I think we with a bit of luck could be in for a couple of years of fairly high real GDP growth driven by positive supply side factors. In such a scenario we could easily have 4% or even 5% real GDP growth for some years without any substantial pick-up in inflation. This would be very similar to mid-1990s.

Such a scenario would likely in 3-5 years time turn the Market Monetarist bloggers into proponents of Fed tightening – before most other economists would favour it. This would particularly be the case if the Fed overdo it on monetary easing in a scenario where positive supply side factors keep inflation low and hence we see a sharp pick-up in nominal GDP growth. This would of course be what Austrians call relative inflation.

So no, Market Monetarists are not always dovish. We advocate clear monetary policy rules and these rules sometimes leads us to advocate a dovish stance on monetary (as presently), but also to a hawkish stance if needed. For now I have no big fears that US monetary policy is becoming too easy, but if I am right about my “supply side optimism” then a Fed too focused on headline inflation might overdo it on the easy side down the road.

There is of course only one way to avoid such a monetary policy mistake – spell out a clear NGDP level targeting rule today.


PS The ECB today did NOTHING to avoid deflation in the euro zone. No comments on that other than the ECB missed yet another opportunity to do the right thing.

PPS My best guess is that Scott Sumner will be a ultra hawk on US monetary policy in 2018-9.

I just ordered “Fragile by Design”

I must admit that I am a bit of a “serial shopper” when it comes to buying books on Amazon. Today I (pre) ordered a book I have been waiting for some time –  “Fragile by Design: Banking Crises, Scarce Credit,and Political Bargains”  by Charles Calomiris and  Stephen Haber. I have written about the book before:

For natural reasons I have not read the book yet, but in a couple of recent papers and presentations by Calomiris and Haber have spelled out the main ideas of the book (See for example hereherehere andhere). I find their large survey of history of banking crisis tremendously interesting and I find it particularly interesting that Calomiris and Haber conclude that the root cause of banking crisis has to be found in what political institutions different countries have. Said in another way the main cause banking crisis is one of “political design”.

One of the main views of Calomiris and Haber is that some countries are a lot more prone to banking crisis than other. Calomiris and Haber list the following countries as particularly prone to banking crisis: Argentina, the Democratic Republic of the Congo, Chad, the Central African Republic, Cameroon, Guinea, Kenya, the Philippines, Nicaragua, Brazil, Bolivia, Costa Rica, Thailand, Mexico, Ecuador, Colombia, Uruguay, Chile, Turkey, Spain, Sweden and the United States.

Similarly Calomiris and Haber list a number of countries that in general have been crisis free (despite abundant credit):  Bahamas, Malta, Cyprus, Brunei, Singapore, Hong Kong, Macao, South Africa, Italy, Austria, New Zealand, Australia, and Canada.

The differences between USA and Canada seem to be particularly interesting (discussed in Chapter six of the book). Hence, since 1840 the US have had 14 banking crisis, while Canada have had none and this despite of the fact that credit have been as abundant in Canada as in the US. While the two countries have the a very similar cultural and colonial  history the political institutions in Canada and the USA are very different. These differences in political institutions according to Calomiris and the US have lead to the development of vastly different banking systems in the two countries – “branch banking” in Canada and “unit banking” in the US.

There are a lot more in the book than what I have discussed above and the papers that Haber and Calomiris already have put out are extremely interesting and insightful so I can’t wait to read the book!

Kuroda’s masterful forward guidance

This is from

Talk of further monetary stimulus from the Bank of Japan helped push the yen to a six-month low and lifted the Nikkei to a six-month high on Tuesday, and the move in Japanese assets may have further to run, analysts say.

Comments made by Bank of Japan (BOJ) governor Haruhiko Kuroda on Monday fueled speculation of further easing, after he told participants at a conference “we are ready to adjust monetary policy without hesitation if risks materialize.”

Is forward guidance important? Yes, it is tremendously important – particularly is you have little credibility about your monetary policy target. The Bank of Japan for 15 years failed to meet any monetary policy target, but since Haruhiko Kuroda became BoJ governor things have changed. His masterful forward guidance has significantly increased monetary policy credibility in Japan.

Few in the market place today can doubt that governor Kuroda is committed to meeting his 2% inflation target and that he will do whatever it takes to hit that target. Furthermore, when Kuroda says that he is “ready to adjust monetary policy without hesitation if risks materialize” he is effectively making the the Sumner Critique official policy.

Said in another way – governor Kuroda will adjust his asset purchases – if necessary – to offset any other shocks to aggregate demand (or rather money-velocity) for example in response to the planned increase in Japanese sales taxes.

As a consequence of Kuroda’s forward guidance market participants know that the BoJ will offset any effect on aggregate demand of the higher sales tax and as a consequence the expected (net) impact of the sales tax increase is zero. This of course is the Sumner Critique – an inflation targeting (or NGDP targeting) central bank will offset fiscal shocks to ensure that the fiscal multiplier is zero.

So what is happening is that market participants expect monetary easing in reaction to fiscal tightening – this is now lifting Japanese equity prices and weakening the yen. This will boost private consumption, investment and exports and thereby offset the impact on aggregate demand from the increase in sales taxes.

The Bank of Japan likely have to step up its monthly asset purchases to offset the impact of the higher sales taxes as the BoJ’s inflation target is still not fully credible. However, given Mr. Kuroda’s skillful forward guidance the BoJ will have to do a lot less in terms of an actually increase in asset purchases than otherwise would have been the case. That in my view demonstrates the importance of forward guidance.

My expectation certainly is that the plan sales tax increase in Japan will once again demonstrate that the fiscal multiplier is zero under credible inflation targeting (also that the Zero Lower Bound!) and there is in my view good reason to think that the Japanese economy will continue to recover in 2014 – to a large extent thanks to governor Kuroda’s skillful forward guidance and his commitment to hitting the BoJ’s inflation target.


Related post: There is no ’fiscal cliff’ in Japan – a simple AS-AD analysis

Rwanda – The greatest reform story in the world?

This is from the World Bank:

“Between 2001 and 2012, real GDP growth averaged 8.1% per annum. The poverty rate dropped from 59% in 2001 to 45% in 2011. Starting in mid-2012, Rwanda experienced a sudden and sharp decline in aid. Through appropriate fiscal and monetary policies, high growth and stability prevailed throughout 2012. The economy grew by 8% and inflation was contained below 6%.”

You have to be optimistic about East Africa.

HT Ulrik Walther

PS see also this very uplifting story from The Atlantic about how Rwanda seems to be winning the fight against AIDS.

East African Monetary Union remains a very bad idea (I have a better idea)

This is from the Kenyan daily The Nation:

East African Community leaders on Saturday signed the Monetary Union Protocol which is intended to result in a single currency in 10 years’ time.

The signing ceremony held at Speke Resort Munyonyo in Uganda was witnessed by Members of the East Africa Legislative Assembly, diplomats and high ranking government officials of member states.

President Uhuru Kenyatta was earlier installed as chairman of the EAC, a major regional role that will see him become the focal point in discussing East Africa’s response to serious challenges ranging from hunger to terrorism.

President Kenyatta joined host President Yoweri Museveni, Rwandan President Paul Kagame, Tanzanian President Jakaya Kikwete and Burundi President Pierre Nkurunziza first at a resort on the shores of Lake Victoria for formal EAC talks.

…The protocol will provide for a wide scope of co-operation in monetary and financial sectors among EAC members.

Under the protocol, EAC states are expected to surrender monetary and exchange rates policies to one authority leading to a single currency regime within the region.

The protocol will be implemented over a ten year period, subsequently leading to creation of a regional central bank whose mandate is to stabilise financial prices as well as monitoring, surveillance and enforcing compliance of all other macro finance matters.

President Kenyatta told the launch the monetary union will accelerate trade growth within the region.

I strongly believe that there are great economic benefits from further economic integration in East Africa and I generally am quite (very!) optimistic about the prospects for the East African economies. However, I continue to be extremely skeptical about the benefits of an East African currency union. I have written about this issue before – so let me quote myself:

The euro crisis should give African policy makers a lot of reasons why not to rush into currency union – even taking into account the present problems with credibility in the present monetary regimes in many African countries. The experience from the euro zone is that if sufficient economic, financial and political (and dare I say cultural) convergence is not achieved between the members of the currency union then it could have disastrous consequences.

The EAC (the East African Community) is a much looser union than the EU and just the fact that an internal market in Eastern Africa has not even been fully implemented should make one very cautious about EA monetary union. Despite of that work with monetary integration in the region goes ahead – even though the pace is much slower than had been the official political ambition.

…monetary union should not be rushed through. Rather policy makers should look for other possible reforms that will enhance trade and financial integration in Eastern Africa.

And the issue of lack of trade integration is an issue brought up in article in The Nation:

President Kenyatta urged member states to eliminate all the remaining barriers to free movement of people, goods and services.

“Barriers to trade in particular assail the spirit of the Common Market, Customs Union and the Monetary Union,” said President Kenyatta, calling for the removal of all obstructions to the growth of the community, stressing the need to allow free movement of people, businesses and capital within the community to provide opportunities for generating prosperity.

He also called on investors and other businesspersons to enhance their participation and commitment to empowering economic growth in the community.

“Businesses and traders in the small and micro-enterprises sector need to be enabled to trade in the regional arena. I commend the work done in this regard, especially through regional exhibition,” President Kenyatta said.

The President also said the envisioned integration will work as intended when underpinned by a sound infrastructure system, stressing that development of infrastructure connecting member states was key to the integration process.

To me it is incredible that policy makers would push ahead with any kind of monetary union given the very obvious lack of political will to make a real push for a true East African free trade area.

Let me instead repeat an old idea of mine – privatized and endogenous monetary integration in East Africa:

It is certainly not obvious that the present “monetary borders” in Eastern Africa are optimal. Just the fact that borders across Africa are highly artificial and to a large extent due to colonial history could e an argument for currency unions across different countries in Africa – including in Eastern Africa. However, there is no reason why such monetary integration should happen through the introduction of common (monopoly) currency in the EAC. In fact there might be a better privatised option in the form of the so-called M-pesa and other electronic payment forms.

Over the last couple of years M-pesa which is a mobile telephone payment system (M-pesa means Mobile Money) has become hugely popular in Kenya and in many ways M-pesa has led to a quasi-privatisation of the monetary system in Kenya and M-pesa clearly has the potential to become a fully privatised parallel currency in Kenya.

M-pesa has also been introduced in other Eastern African countries but the success has been much more limited in countries like Tanzania than in Kenya. I believe that the primary reason for the success of M-pesa in Kenya is the fact that authorities wisely have not applied banking regulation to the M-pesa. On the other hand M-pesa is much more regulated in other Eastern African countries, which most likely has hampered the expansion of the M-pesa (and similar payment systems) in other East African countries.

I believe that many of the advantages of monetary union could easily be achieved by enhancing the use of M-pesa style payment systems across Eastern Africa. The main advantage of currency union is the reduction of transaction costs, but this is also the main advantage of M-pesa style systems. So if the EAC wants to help monetary integration in Eastern Africa then it would make much more sense to agree on common regulation of M-pesa style payment systems and allow these systems to be used across the EAC. In that regard it should of course be stressed that this regulation should be as “light” as possible and should not hamper the development of electronic and mobile based payment systems.

The clear advantage of such solutions for monetary integration in EAC would be that it would become “endogenous” meaning that households and corporations would only use a “common” currency (in the form of for example M-pesa) if they benefit from the use of that “currency”. Hence, one could easily imagine that most companies in for example Tanzania and Kenya would start using M-pesa style payment systems also for cross border payments, while for example households in Rwanda would prefer another payment system. Monetary Union limits monetary competition. This should never be the purpose of monetary reform. On the other hand deregulation (and common EAC regulation) of mobile payment systems will enhance monetary competition and likely lead to a more efficient form of monetary integration. Said, in another way why not let the market decided on the size of the optimal currency area?

If the EAC nonetheless wants to go ahead with creating a common currency it should opt for a “parallel currency” solution where the national currencies are maintained and the common currency is created as a common “accounting unit”. This accounting unit could take the form of what George Selgin has termed Quasi-commodity money (QCM), where the money base is expanded at a fixed yearly rate for example 5 or 10% based on an automatic electronic algorithm. It would be natural that private suppliers of M-pesa style payment systems would use this common accounting unit as the reference unit of accounting.

This is basically a suggestion for a privatised monetary integration in Eastern Africa. If successful this would lead to monetary integration in Eastern African and significantly reduce transaction costs of cross-border transactions, which exactly is the purpose of the EAC’s proposal for monetary union, but it would avoid the problems associated with lack of economic and political integration.

Concluding, forget about East African monetary, focus on removing barriers to the free movement of goods, capital and labour in East Africa and leave monetary integration to the free markets.

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