I don’t care who becomes BoJ governor – I want better monetary policy rules

UPDATE: I have edited my post significantly – I misread what Scott really said. That is the result of writing blog posts very early in the morning after sleeping too little. Sorry Scott…

Scott Sumner has a blog post on who might become the next governor of Bank of Japan. Scott ends his post with the following comment:

Naturally I favor the least dovish of the three.

Note that Scott is saying “least dovish” (I missed “least” in my original post). But don’t we want a the most dovish BoJ governor? No, we want the most principled governor – or rather the governor most committed to a rule based monetary policy.

The debate over doves versus hawks is a debate among people who fundamentally think about monetary policy in a discretionary fashion. Market Monetarism is exactly the opposite. We are strongly against discretion in monetary policy (and fiscal policy for that matter).

The important thing is not who is BoJ governor – the important thing is that there are good institutions – good rules. As I have argued before – what we really want is a monetary constitution in spirit of Jim Buchanan. In that sense the BoJ governor should be replaced – as Milton Friedman suggested – by a ‘computer’ and not by the most ‘dovish’ candidate.

Market Monetarists would have been “hawks” in the 1970s in the sense that we would have argued that for example US monetary policy was far too easy and we are ‘doves’ now. But that is really a mistaken way to think about the issue. If we favour for example a 5% NGDP level target for the US today – then we would have been doves in 1974 or 1981. That would make us more or less dovish/hawkish at different times, but that debate is for people who favours discretionary monetary policies – not for Market Monetarists.

If we just want a ‘dovish’ BoJ governor then we should advocate that Prime Minister Shinzo Abe gives Zimbabwean central bank governor Gideon Gono a call. He knows all about monetary easing – and so do the central bank governors of Venezuela and Argentina. But we all know that these people are ludicrously bad central bankers.  In similar fashion Janet Yellen would not be the Market Monetarist candidate for the Federal Reserve chairman just because she tends to favour monetary easing – in fact it seems like Yellen always favours monetary easing. In fact you should be very suspicious of the views of policy makers who will always be hawks or doves.

Gideon_Gono10

The reason that Mark Carney is a good choice for new Bank of England governor is exactly that he is not ‘dovish’ or ‘hawkish’, but that he tend to stress the need for a rule based monetary policy. That said, the important thing is not Mark Carney, but rather whether the UK government is serious about introducing NGDP level targeting or not.

Monetary policy is not primarily about having the right people for the job, but rather about having the best institutions. Obviously you want to have the best people for the job, but ultimately even Scott Sumner would be a horrible Fed governor if his mandate was wrong.

If the BoJ had a rule based monetary policy and used for example NGDP futures to conduct monetary policy then it wouldn’t matter who becomes BoJ governor – because the policy would be the same no matter what. We cannot rely on central bankers to do the ‘right thing’. Central bankers only do the right thing by chance. We need to tie their hands with a monetary constitution – with strong rules.

Related posts:

Forget about “hawks” and “doves” – what we need is a “monetary constitution”
NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed
NGDP level targeting – the true Free Market alternative (we try again)

 

Argentina’s hidden inflation – another case of the horrors of price controls

In my previous post I discussed how price controls likely have created a wedge between inflation measured by CPI and by the GDP deflator in Malaysia. That made me think – can we find other examples of this in the world? And sure thing the story of Argentina’s inflation over the last decade seem to be more or less the same thing.

The graph below shows Argentine inflation measured by CPI and the GDP deflator since 2002. The difference is very easy to spot.

It is very clear that until 2005 the two measures of inflation tracks each other quite closely, but from 2005 a difference opens up. So what happened in 2005? Well, the story is exactly as in Malaysia – monetary policy is inflationary and the government tries to curb inflation not by printing less money, but by introducing price controls.

Here is a story from Bloomberg November 24 2005:

Argentine President Nestor Kirchner accused supermarkets of price fixing and said he would increase controls to slow a surge in inflation.

Kirchner, in a televised speech at the presidential palace, said agreements between supermarkets such as Coto CISA SA and Hipermercados Jumbo SA, a unit of Chilean retailer Cencosud SA, to increase prices would lead to 12 percent inflation next year. In the 12 months through October Argentina’s consumer prices rose 10.7 percent, the fastest rate of increase in 29 months.

“We will fight to defend consumers’ pockets,” Kirchner said, without specifying how he would slow price increases.

The accusation underscores the government’s concern over quickening inflation, which may increase poverty in a country where almost 50 percent of the population cannot afford to cover their food and other basic needs, said economist Rafael Ber of Argentine Research brokers in Buenos Aires.

Rising prices may also hurt the ability of Argentine producers to compete with foreign goods, Ber said.

Kirchner has already attacked private companies for increasing prices. In April, he called on consumers to boycott The Royal Dutch Shell Group after the energy company increased prices.

So there you go – price controls in response to inflation. That is never good news and the result has been the same in Argentina as in Malaysia (actually it is much worse) – shortages (See also my previous discussion of food shortages in Venezuela and Argentina here).

Price controls always have the same impact – shortages – and if you think Malaysia and Argentina are the only countries in the world to make this kind of policy mistakes think again. Here is from the US, where a Republican governor these days is experimenting with price controls and the result is the same as in Argentina and Malaysia – shortages!

PS it should be noted that the Argentine inflation data very likely is manipulated so there is more to it than just price controls – we also has a case of the books being cooked. See more on that here.

Regime Uncertainty, the Balkans and the weak US recovery

Today I have been in Oslo, Norway for client meetings. The topic on the agenda is Central and Eastern Europe and particularly the investment climate in South Eastern Europe. That gives me reason to discuss a favourite topic of mine – “regime uncertainty – as defined by Robert Higgs – and why the present lacklustre recovery in the US economy is unlikely in anyway to be related to such regime uncertainty.

As an economist who have been working professionally with Emerging Markets for more than I decade I know about regime uncertainty. In fact I think you to some extent can define an Emerging Markets economy as an economy where regime uncertainty is a dominant factor in the economy.

Robert Higgs basically defines regime uncertainty as a lack of protection of property right and a lack of respect for the rule of law. This is a serious problem in many Emerging Markets – including in the South Eastern European countries, which has been the focus of my meetings today.

My favourite source for a numerical measure of these uncertainties is the conservative Heritage Foundation’s Economic Freedom Index. We can use the sub-index for “Rule of Law” in the Economic Freedom Index as a proxy for “regime uncertainty”.

Let’s as an example look at two random South Eastern European countries – Albania and Bulgaria. Here is what Heritage Foundation has to say about the “Rule of Law” in Albania:

Albania still lacks a clear property rights system, particularly for land tenure. Security of land rights remains a problem in coastal areas where there is potential for tourism development. Although significant reforms of the legal system are underway, the courts are subject to political pressures and corruption. Protection of intellectual property rights is weak. Albania is a major transit country for human trafficking and illegal arms and narcotics.”

And similarly for Bulgaria:

“Respect for constitutional provisions securing property rights and providing for an independent judiciary is somewhat lax. The judicial system is unable to enforce property rights effectively, and inconsistent application of the rule of law discourages private investments. Despite legal restrictions, government corruption and organized crime present a threat to Bulgaria’s border security.”

In my view the Heritage Foundation’s description of the lack of respect for the rule of law and property rights in Albania and Bulgaria is pretty close to the reality in these two countries. So there is no doubt that there in both countries are a considerably degree of regime uncertainty.

This heightened level of regime uncertainty very likely is having a considerably negative impact on both foreign direct investments and domestic investments in both countries and therefore on the long-term growth prospects of these countries. Who would for example invest in a sea sight hotel in Albania it might be stolen from you tomorrow or in a year – maybe even with the tacit support of government officials?

Bulgaria and Albania are just two examples of serious regime uncertainty, but many (most!) developing economies and Emerging Markets around the world have serious problems with regime uncertainty. Therefore, as an Emerging Markets economist I find this issue highly relevant. However, I should also stress that I believe regime uncertainty is a supply side phenomenon. Regime uncertainty hampers investment, which reduces the productive capacity of the economy and hence reduces productivity growth, but as aggregate demand in the economy is determined by monetary factors regime uncertainty – in Higgs’ sense – cannot be a demand phenomenon. Yes, regime uncertainty can impact the composition of demand but not aggregate demand in the economy.

The best way to illustrate that regime uncertainty is a supply side phenomenon is to look at three contemporary examples – Venezuela, Argentina and Iran. The regimes in all three countries obviously have very little respect for the rule of law and there is weak protection of property rights in all three countries. However, all three countries also are struggling with high – and to some extent even escalating – inflation. If regime uncertainty were a demand phenomenon then inflation would be low and falling in these countries. It is not.

When I listen to the present political-economic debate in the US many conservative and libertarians economists and commentators (who I would normally tend to agree with) point to regime uncertainty as a key reason for the weak US recovery. Frankly speaking while I acknowledge that there might have been a rise in regime uncertainty in the US – in frank I am certain there has been – I doubt that it in any meaningful way can be said to have had a notable and sizable negative impact on US investment activity. Furthermore, the US economy is showing all the signs of having a demand side problem rather than a supply side problem. If the US economy had undergone a serious negative supply shock then US inflation would has been increasing – as is the case in for example Iran. US inflation is not increasing – rather since 2008 US PCE core inflation has averaged a little more than 1% a year on average.

Furthermore, even though uncertainty about the outlook for US tax rules have increased and Obamacare likely have had a negative impact on the overall investor sentiment in the US it would be rather foolish to claim that property rights are not well-protected in the US.  This is what Heritage Foundation has to say about the rule of law in the US:

“Property rights are guaranteed, and the judiciary functions independently and predictably. Serious constitutional questions related to government-mandated health insurance have been under consideration in the courts. Corruption is a growing concern as the cronyism and economic rent-seeking associated with the growth of government have undermined institutional integrity.”

Even though Heritage Foundation highlights some negative factors the US can hardly be said to be Bulgaria and Albania. In fact the US is in the very top in the world when it comes to protection of property rights and the respect for the rule of law. I therefore doubt that US multinational companies like Apple of Coca Cola are seriously concerned about the rule of law in the US when you take into account that these companies have been seeing there strong sales and income growth in Emerging Markets like China, India, Russia and Brazil.

In fact I could understand if these US companies would be concerned about the present regime uncertainty in China in connection with the ongoing leadership change in the Chinese communist party, the crackdown on freedom of speech in Russia under president Putin’s leadership, the scaling back of economic reforms in India or the ad hoc nature of changes to taxation of inward investments into Brazil.

So while I certainly remain concerned about the regulatory developments in the US over the past decade (yes it started well before Obama became president) I doubt that the present lacklustre recovery can be blamed on these problems. The reason for the lacklustre recovery is rather monetary uncertainty rather than regime uncertainty. Since 2008 US monetary policy has moved away from a ruled based regime to a highly discretionary and to some extent highly unpredictable regime. That is the problem.

So yes, US companies are likely worried about regime uncertainty, but it likely worries about regime uncertainty in China or Brazil rather than regime uncertainty in the US.

A simple way to illustrate this is to look at the Heritage Foundation’s score for protection of property rights in some of the countries mentioned in this blog post. Heritage Foundation considers a score between 80 and 100 to be a “free country”. It is very clear from the graph that investors should worry (a lot) about the protection of property rights in Albania, Bulgaria or in the so-called BRIC economies, but I doubt that many international investors have sleepless nights over the whether or not property right will be well-protected in the US.

Finally I am as worried about the rise of interventionist economic policies in the US and in Europe as anybody else, but we should be right for the right reasons. Interventionist economic policies surely reduce the growth prospects in the US and Europe, but that is supply side concerns for the longer run and we can’t blame these failed policies for the weak recovery.

Is monetary easing (devaluation) a hostile act?

One of the great things about blogging is that people comment on your posts and thereby challenge your views and at the same time create new ideas for blog posts. Therefore I want to thank commentator Max for the following response to my previous post:

“I don’t think exchange rate intervention is a good idea for a large country. For one thing, it’s a hostile act given that other countries have exactly the same issue. And it can’t work without their cooperation, since they have the power to undo the intervention.” 

Let me start out by saying that Max is wrong on both accounts, but I would also acknowledge that both views are more or less the “consensus” view of devaluations and my view – which is based on the monetary approach to balance of payments and exchange rates – is the minority view. Let me address the two issues separately.

Is monetary easing a hostile act?

In his comment Max describes a devaluation as a hostile act towards other countries. This is a very common view and it is often said that it is a reflection of a beggar-thy-neighbour policy for a country to devalue its currency. I have two comments on that.

First, if a devaluation is a hostile act then all forms of monetary easing are hostile acts as any form of monetary easing is likely to lead to a weakening of the currency. Let’s for example assume that the Federal Reserve tomorrow announced that it would buy unlimited amounts of US equities and it would continue to do so until US nominal GDP had increased 15%. I am pretty sure that would lead to a massive weakening of the US dollar. In fact we can basically define monetary easing as a situation where the supply of the currency is increased relative to the demand for the currency. Said, in another way if the currency weakens it is a pretty good indication that monetary conditions are getting easier.

Second, I have often argued that the impact of a devaluation does not primarily work through an improvement in the country’s competitiveness. In fact the purpose of the devaluation should be to increase prices (and wages) and hence nominal GDP. An increase in prices and wages can hardly be said to be an improvement of competitiveness. It is correct that if prices and wages are sticky then you might get an initial real depreciation of the currency, however that impact is not really important compared to the monetary impact. Hence, a devaluation will lead to an increase in the money supply (that is how you engineer the devaluation) and likely also to an increase in money-velocity as inflation expectations increase. Empirically that is much more important than any possible competitiveness effect.

A good example of how the monetary effect dominates the competitiveness effect: the Argentine devaluation in 2002 actually led to a deterioration of the Argentine trade balance and what really was the driver of the recovery was the sharp pickup in domestic demand due to an increase in the money supply and money-velocity rather than an improvement in exports. See my previous comment on the episode here. When the US gave up the gold standard in 1933 the story was the same – the monetary effect strongly dominated the competitiveness effect.

Yet another example of the monetary effect of a devaluation dominating the competitiveness effect is Denmark and Sweden in 2008-9. It is a common misunderstanding that Sweden grew stronger than Denmark in 2008-9 because a sharp depreciation of the Swedish krona led to a massive improvement in competitiveness. It is correct that Swedish competitiveness was improved due to the weakening of the krona, but this was not the main reason for Sweden’s relatively fast recovery from the crisis. The real reason was that Sweden did not see any substantial decline in money-velocity and the Swedish money supply grew relatively steadily through the crisis.

Looking at Swedish exports in 2008-9 it is very hard to spot any advantage from the depreciation of the krona. In fact Swedish exports did more or less as badly as Danish exports in 2008-9 despite the fact that the Danish krone did not depreciate due to Denmark’s fixed exchange rate regime. However, looking at domestic demand there was a much sharper contraction in Danish private consumption and investment than was the case in Sweden. This difference can easily be explained by the sharp monetary contraction in Denmark in 2008-9 (both a drop in M and V).

Furthermore, let’s assume that the Federal Reserve announced massive intervention in the FX market to weaken the US dollar and the result was a sharp increase in US nominal GDP. Would the rest of the world be worse off? I doubt it. Yes, the likely impact would be that for example German exports would get under pressure as the euro would strengthen dramatically against the dollar. However, nothing would stop the ECB from also undertaking monetary easing to counteract the strengthening of the euro. This is what somebody calls “competitive devaluations” or even “currency war”. However, in a deflationary environment such “currency war” should be welcomed as it basically would be a competition to print money. Hence, the “net result” of currency war would not be any change in competitiveness, but an increase in the global money supply (and global money-velocity) and hence in global nominal GDP. Who would be against that and in a situation where the global economy continues to contract and as such a currency war like that would be very welcomed news. In fact we can not really talk about a “war” as it would be mutually beneficial. So I say please bring on the currency war!

Is global monetary cooperation needed? No, but…

This brings us to Max’s second argument: “And it can’t work without their cooperation, since they have the power to undo the intervention.

This is obviously related to the discussion above. Max seems to think a devaluation will not work if it is met by “competitive devaluations” from all other countries. As I have argued above this is completely wrong. It would work as the devaluation will increase the money supply and money-velocity even if the devaluation has no impact on competitiveness at all. As a result there is no need for international monetary cooperation. In fact healthy competition among currencies is exactly what we need. In fact every time the major nations of the world have gotten together to agree on realigning exchange rates it has had major negative consequences.

However, there is one argument for international coordination that I think is extremely important and that is the need for cooperation to avoid “competitive protectionism”. The problem is that most global policy makers perceive devaluations in the same way as Max. They see devaluations as hostile acts and therefore these policy makers might react to devaluations by introducing trade tariffs and other protectionist measures. This is what happened in the 1930s where especially the (foolish) countries which maintained the gold standard reacted by introducing trade tariffs against for example the UK and the Scandinavian countries, which early on gave up the gold standard.

Unfortunately Mitt Romney seems to think as Max

Republican presidential hopeful Mitt Romney has said that his first act as US president would be to slap tariffs on China for being a “currency manipulator”. Here is what Romney recently said:

“If I’m president, I will label China a currency manipulator and apply tariffs” wherever needed “to stop them from unfair trade practices”

The discussion above should show clearly that Romney’s comments on China’s currency policy is economically meaningless – or rather extremely dangerous. Imagine what would be the impact on the US economy if China tomorrow announced a 40% (just to pick a number) revaluation of the yuan. To engineer this the People’s Bank of China would have to cause a sharp contraction in the Chinese money supply and money-velocity. The result would undoubtedly throw China into a massive recession – or more likely a depression. You can only wonder what that would do to US exports to China and to US employment. Obviously this would be massively negative for the US economy.

Furthermore, a sharp appreciation of the yuan would effectively be a massive negative supply shock to the US economy as US import prices would skyrocket. Given the present (wrongful) thinking of the Federal Reserve, that might even trigger monetary tightening as US inflation would pick up. In other words the US might face stagflation and I am pretty sure that Romney would have no friends left on Wall Street if that where to happen and he would certainly not be reelected in four years.

I hope that Romney has some economic advisors that realize the insanity of forcing China to a massive appreciation of the yuan. Unfortunately I do not have high hope that there is an understanding of these issues in today’s Republican Party – as it was the case in 1930 when two Republican lawmakers Senator Reed Smoot and Representative Willis C. Hawley sponsored the draconian and very damaging Smoot-Hawley tariff act.

Finally, thanks to Max for your comments. I hope you appreciate that I do not think that you would like the same kind of protectionist policies as Mitt Romney, but I do think that when we get it wrong on the monetary impact of devaluations we might end up with the kind of policy response that Mitt Romney is suggesting. And no, this is no endorsement of President Obama – I think my readers fully understand that. Furthermore to Max, I do appreciate your comments even though I disagree on this exact topic.

PS if you want to learn more about the policy dynamics that led to Smoot-Hawley you should have a look at Doug Irwin’s great little book “Peddling Protectionism: Smoot-Hawley and the Great Depression”.

Update: Scott Sumner has a similar discussion of the effects of devaluation.

The worst central banker in the world

Zimbabwean central bank governor Gideon Gono has long held the title as the worst central banker in the world. However, I would suggest there might be a new candidate – Argentine central bank governor Mercedes Marcó del Pont.

Here is some quotes from a recent interview:

“it is totally false to say that printing more money generates inflation”

If that does not make you scream then listen to this:

We discard that financing the public sector is inflationary because according to that statement the increase in prices are caused by an excess of demand, something we do not see in Argentina. In our country the means of payment are adjusted to the growth of demand and tensions with prices must be looked on the supply side and the external sector”.

It gets worse…

“We’re recovering the sovereign capacity to formulate and implement economic policy”, said Marcó del Pont who anticipated some pictures will be coming down from the bank’s hall of fame “beginning with Milton Friedman.”

Ok, I kind of guessed that the governor doesn’t like Milton Friedman, but this is bad. It might be that US and euro zone monetary policy is too tight, but that is certainly not the case in Argentina. Instead all signs are that inflation is getting increasingly out of control in Argentina. However, that is not visible in the official Argentine statistics. You will see the reason here. Sad, sad story…

 

UPDATE: Marcus Nunes has exactly the same story, but as usual Marcus was faster.

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