All posts in category Economic and monetary history

Clark Johnson has written what will become a Market Monetarist Classic

As I have written about in an earlier post I am reading Clash Johnson’s book on the Great Depression “Gold, France and the Great Depression”. So far it has proved to be an interesting and insightful book on what (to me) is familiar story of how especially French and US gold hoarding was a major cause for the Great Depression.

Clark Johnson’s explanation of Great Depression is similar to that of two other great historians of the Great Depression Scott Sumner and Douglas Irwin. Both are of course as you know Market Monetarists.

Given Johnson’s “international monetary disorder view” of the Great Depression I have been wondering whether he also had a Market Monetarist explanation for the Great Recession. I now have the answer to that question and it is affirmative – Clark Johnson is indeed a Market Monetarist, which becomes very clear when reading a new paper from the Milken Institute written by Johnson.

One thing I find especially interesting about Johnson’s paper is that he notes the importance of the US dollar as the global reserve currency and this mean that US monetary policy tightening has what Johnson calls “secondary effects” on the global economy. I have long argued that Market Monetarists should have less US centric and more global perspective on the global crisis. Johnson seems to share that view, which is not really surprising given Johnson’s work on the international monetary perspective on the Great Depression.

Johnson presents six myths about monetary policy and the six realities, which debunk these myths. Here are the six myths.

Myth 1: The Federal Reserve has followed a highly expansionary monetary policy since August, 2008.

Johnson argues that US monetary policy has not been expansionary despite the increase in the money base and the key reason for this is a large share of the money base increase happened in the form of a similar increase in bank reserves. This is a result of the fact that the Federal Reserve is paying positive interest rates on excess reserves. This is of course similar to the explanation by other Market Monetarists such as David Beckworth and Scott Sumner. Furthermore, Johnsons notes that the increase that we have seen in broader measure of the money supply mostly reflects increased demand for dollars rather than expansionary monetary policies.

Johnson notes in line with Market Monetarist reasoning: “Monetary policy works best by guiding expectations of growth and prices, rather than by just reacting to events by adjusting short-term interests”.

Myth 2: Recoveries from recessions triggered by financial crises are necessarily low.

Ben Bernanke’s theory of the Great Depression is a “creditist” theory that explains (or rather does not…) the Great Depression as a consequence of the breakdown of financial intermediation. This is also at the core of the present Fed-thinking and as a result the policy reaction has been directed at banking bailouts and injection of capital into the US banking sector. Johnson strongly disagrees (as do other Market Monetarists) with this creditist interpretation of the Great Recession (and the Great Depression for that matter). Johnson correctly notes that the financial markets failed to react positively to the massive US banking bailout known as TARP, but on the other hand the market turned around decisively when the Federal Reserve announced the first round of quantitative easing (QE) in March 2009. This in my view is a very insightful comment and shows some real Market Monetarist inside: This crisis should not be solved through bailouts but via monetary policy tools.

Myth 3: Monetary policy becomes ineffective when short-term interest rates fall close to zero.

If there is an issue that frustrates Market Monetarists then it is the claim that monetary policy is ineffective when short-term rates are close to zero. This is the so-called liquidity trap. Johnson obviously shares this frustration and rightly claims that monetary policy primarily does not work via interest rate changes and that especially expectations are key to the understanding of the monetary transmission mechanism.

Myth 4: The greater the indebtedness incurred during growth years, the larger the subsequent need for debt reduction and the greater the downturn.

It is a widespread view that the world is now facing a “New Normal” where growth will have to be below previous trend growth due to widespread deleveraging. Johnson quotes David Beckworth on the deleveraging issue as well site Milton Friedman’s empirical research for the fact there is no empirical justification for the “New Normal” view. In fact, the recovery after the crisis dependent on the monetary response to the crisis than on the size of the expansion prior to the crisis.

Myth 5: When money policy breaks down there is a plausible case for a fiscal response.

Recently the Keynesian giants Paul Krugman and Brad DeLong have joined the Market Monetarists in calling for nominal GDP targeting in the US. However, Krugman and DeLong continue to insist on also loosening of US fiscal policy. Market Monetarists, however, remain highly skeptical that a loosening of fiscal policy on its own will have much impact on the outlook for US growth. Clark Johnson shares this view. Johnson’s view on fiscal policy reminds me of Clark Warburton’s position on fiscal policy: fiscal policy only works if it can alter the demand for money. Hence, fiscal policy can work, but basically only through a monetary channel. I hope to do a post on Warburton’s analysis of fiscal policy at a later stage.

Myth 6: The rising prices of food and other commodities are evidence of expansionary policy and inflationary pressure.

It is often claimed that the rise in commodity prices in recent years is due to overly loose US monetary policy. Johnson refute that view and instead correctly notes that commodity price developments are related to growth on Emerging Markets in particular Asia rather than to US monetary policy.

Johnson’s answer: Rate HIKES!

Somewhat surprise after conducting an essentially Market Monetarist analysis of the causes of the Great Recession Clark Johnson comes up with a somewhat surprising policy recommendation – rate hikes! In fact he repeats Robert McKinnon’s suggestion that the four leading central banks of the world (the Federal Reserve, the ECB, the Bank of Japan and the Bank of England) jointly and coordinated increase their key policy rates to 2%.

Frankly, I have a very hard time seeing what an increase interest rates could do to ease monetary conditions in the US or anywhere else and I find it very odd that Clark Johnson is not even discussing changing the institutional set-up regarding monetary policy in the US after an essentially correct analysis of the state US monetary policy. It is especially odd, as Johnson clearly seem to acknowledge the US monetary policy is too tight. That however, does not take anything away from the fact that Clark Johnson has produced a very insightful and interesting paper on the causes for the Great Recession and monetary policy makers and students of monetary theory can learn a lot from reading Clark Johnson’s paper. In fact I think that Johnson’s paper might turnout to become an Market Monetarist classic similar to Robert Hetzel’s “Monetary Policy in the 2008-2009 Recession” and Scott Sumner’s “Real problem is nominal”.

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Update: Marcus Nunes and David Beckworth also comment on Clark Johnson’s paper. Thanks to both Benjamin “Mr. PR” Cole and Marcus Nunes for letting me know about Johnson’s great paper.

6 Comments
by Lars Christensen on October 22, 2011  •  Permalink
Posted in Economic and monetary history, MM Research agenda, Monetary policy, Reading recommendations, The Great Recession
Tagged , , , , ,

Posted by Lars Christensen on October 22, 2011

https://marketmonetarist.com/2011/10/22/clark-johnson-has-written-what-will-become-a-market-monetarist-classic/

“Our Monetary ills Laid to Puritanism”

Douglas Irwin has been so nice to send me an article from the New York Times from November 1 1931. It is a rather interesting article about the Swedish monetary guru Gustav Cassel’s view of monetary policy and especially how he saw puritanism among monetary policy makers as the great ill. I had not read the article when I wrote my comment on Calvinist economics, but I guess my thinking is rather Casselian.

The New York Times article is based on an article from the Swedish conservative Daily Svenska Dagbladet (the newspaper still exists).

Professor Cassel claims that overly tight US monetary policy in the early 1930s is due to two “main ills”: “deflation mania” and “liquidation fever”.

NYT quote Cassel: “The deeper psychological explanation of this whole movement..can without doubt be found in American Puritanism. This force assembled all its significant resources in what was considered a great moral attack on the diabolism of speculation. Each warning against deflation has stranded on fear on the part of Puritanism that a more liberal monetary policy might infuse new vigor in the spirit speculation.”

It isn’t it scary how much this reminds you about how today’s policy makers are scared of bubbles and inflation? I wonder what Gustav Cassel would tell the ECB to do today?

Maybe here would just say: “That the deflation has meant the ruin of one business after another and forced many banks to suspend payments is a matter that little concerns the stern Puritan”…”on the contrary, it is highly approves proper punishment of speculation and thorough cleaning out of questionable business projects. It totals disregards the fact that deflation in itself by degrees adversely affects the finances of any enterprise and forces even sound business to ruin”. 

Wouldn’t it be a blessing if Cassel was around today to advise central bankers? And that they actually would listen…but of course if you are a puritan or what I termed a believer on Calvinist economics then you don’t have to listen because all you want it just doom and pain to punish all the evil speculators.

 

 

 

17 Comments
by Lars Christensen on October 21, 2011  •  Permalink
Posted in Economic and monetary history, euro crisis, Monetary policy, New Casselian economics, The Great Depression
Tagged , , , , ,

Posted by Lars Christensen on October 21, 2011

https://marketmonetarist.com/2011/10/21/our-monetary-ills-laid-to-puritanism/

Calvinist economics – the sin of our times

A couple a days ago I had a discussion with a colleague of mine about the situation in Greece. My view is that it is pretty clear to everybody in the market that Greece is insolvent and therefore sooner or later we would have to see Greece default in some way or another and that it therefore is insane to continue to demand even more austerity measures from the Greek government, while at the same time asking the already insolvent Greek government to take on even more debt. My colleague on the other hand insisted that the Greeks “should pay back what they owe” and said “we can’t let countries default on their debt then everybody will do it”. It was a moral and not an economic argument he was making.

I am certainly not a Keynesian and I do not think that fiscal tightening necessarily is a bad thing for Greece, but I do, however, object strongly to what I would call Calvinist economic thinking, which increasingly is taking hold of our profession.

At the core of Calvinist economics is that Greece and other countries have committed a sin and therefore now have to repent and pay for these sins. It is obvious that the Greek government failed to tighten fiscal policy in time and even lied about the numbers, but its highly problematic that economic thinking should be based on some kind of quasi-religious morals. If a country is insolvent then that means that it will never be able to pay back its debt. It is therefore in the interest for both the country and its creditors that a deal on debt restructuring is reached. That’s textbook economics. There is no “right” or “wrong” about it – it is simple math. If you can’t be pay back your debts then you can’t pay. It’s pretty simple.

In another area very Calvinist economic thinking is widespread is in the conduct of monetary policy. Around the world central bankers resist easing monetary policy despite clear disinflationary or even deflationary tendencies and the main reason for this is not economic analysis of the economic situation, but rather the view that a loosening of monetary policy would be immoral. The Calvinists are screaming out “We will have another bubble if you ease monetary policy! Don’t let the speculators of the hook!”

The problem is that the Calvinists are confusing an easing of monetary policy or the default of insolvent nations with moral hazard.

If a central bank for example has a inflation target of 2% and inflation is running at below 1% and the central bank then decides to loosen monetary policy – then that might well be positive for “speculators” – such as property owners, banks or equity investors. The Calvinists see this as evil. As immoral, but the fact is that that is exactly what a central bank that is undershooting its inflation target should. Monetary policy is not about making judgements of what is “fair” or not, but rather about securing a nominal anchor in which investors, labour, companies and consumers can conduct there business in the market place.

The Calvinists are saying “It will be Japan”, “the global economy will not grow for a decade” and blah, blah…it nearly seems as if they want this to happen. We have sinned and now we need to repent. The interesting thing is that these Calvinists where not Calvinists back in 2005-6 and when some of us warned about excesses in the global economy they where all cheerleaders of the boom. They are like born-again Christian ex-alcoholics.

And finally just to get it completely clear. I am not in favour of bailing out anybody, or against fiscal austerity and I despise inflation. But my economics is back on economic reasoning and not on quasi-religious dogma.

PS anybody that studies history will note that Calvinist economics dominated economic thinking in countries which held on to the gold standard for too long. This is what Peter Temin has called the “Gold Standard mentality”. The in countries like France and Austria the gold standard mentality were widespread in the 1930s. We today know the consequences of that – Austria had major banking crisis in 1931, the country defaulted in 1938 and the same it ceased to existed as an independent nation. Good luck with your Calvinist economics. It spells ruins for nations around the world.

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UPDATE: Douglas Irwin has kindly reminded me that my post remind him of Gustav Cassel. Cassel used the term “puritans” about what I call Calvinist economics. Maybe Market Monetarists are New Casselians?

36 Comments
by Lars Christensen on October 20, 2011  •  Permalink
Posted in Economic and monetary history, General economic theory, MM Research agenda, Monetary policy, The euro, The Great Depression
Tagged , , , , , ,

Posted by Lars Christensen on October 20, 2011

https://marketmonetarist.com/2011/10/20/calvinist-economics-the-sin-of-our-times/

“…political news kept slipping into the financial section”

As global stock markets once again takes another downturn on the back of renewed European worries I am reminded about a great blog post Scott Sumner wrote a couple a months ago about his studies of the Great Depression.
In its Scott says:

“And the worst part was the way political news kept slipping into the financial section. Nazis make ominous gains in the 1932 German elections, Spanish Civil War, etc, etc. In the 1930s the readers didn’t know what came next—but I did.”

Working and following the financial market on a daily basis, one gets the same feeling. Everything dependents on politics – who will bail out who and who will pay? I long for the day when the markets return to being markets and we will not have to worry about political news…However, I am afraid that that day is not around the corner anytime soon.

6 Comments
by Lars Christensen on October 17, 2011  •  Permalink
Posted in Economic and monetary history, Financial markets

Posted by Lars Christensen on October 17, 2011

https://marketmonetarist.com/2011/10/17/%e2%80%9c%e2%80%a6political-news-kept-slipping-into-the-financial-section%e2%80%9d/

Japan’s deflation story is not really a horror story

Many economists – including some Market Monetarists – tell the story about Japan’s economy as a true horror story and there is no doubt that Japan’s growth story for more than 15 years has not been too impressive – and it has certainly not been great to have been invested in Japanese stocks over last decade.

Some Market Monetarists are explaining Japan’s apparent weak economic performance with overly tight Japanese monetary policy, while others blame “zombie banks” and continued deleveraging after the bubble in to 1990s. I, however, increasingly think that these explanations are wrong for Japan.

Obviously, Japan has deflation because money demand growth consistently outpaces money supply growth. That’s pretty simple. That, however, does not necessarily have to be a problem in the long run if expectations have adjusted accordingly. The best indication that this has happened is that Japanese unemployment in fact is relatively low. So maybe what we are seeing in Japan is a version of George Selgin’s “productivity norm”. I am not saying Japanese monetary policy is fantastic, but it might not be worse than what we are seeing in the US and Europe.

The main reason Japan has low growth is demographics. If you adjust GDP growth for the growth (or rather the decline) in the labour force then one will see that the Japanese growth record really is not bad at all – especially taking into accord that Japan after all is a very high-income country.

Daniel Gros, whom I seldom agrees with (but do in this case), has done the math. He has looked Japanese growth over the last decade and compared to other industrialized countries. Here is Gros:

“Policymaking is often dominated by simple “lessons learned” from economic history. But the lesson learned from the case of Japan is largely a myth. The basis for the scare story about Japan is that its GDP has grown over the last decade at an average annual rate of only 0.6% compared to 1.7 % for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6 % qualifies as a lost decade…According to that standard, one could argue that a good part of Europe also “lost” the last decade, since Germany achieved about the same growth rates as Japan (0.6%) and Italy did even worse (0.2 %); only France and Spain performed somewhat better…But this picture of stagnation in many countries is misleading, because it leaves out an important factor, namely demography…How should one compare growth records among a group of similar, developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population represents an economy’s productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ…When one looks at GDP/WAP (defined as population aged 20-60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population…The difference between Japan and the US is instructive here: in terms of overall GDP growth, it was about one percentage point, but larger in terms of the annual WAP growth rates – more than 1.5 percentage points, given that the US working-age population grew by 0.8%, whereas Japan’s has been shrinking at about the same rate.”

So it is correct that Japanese monetary policy was overly tight after the Japanese bubble bursted in the mid-90ties, but that is primarily a story of the 90s, while the story over the last decade is primarily a story of bad demographics.

We can learn a lot from Japan, but I think Japan is often used as an example of all kind of illnesses, but few of those people who pull “the Japan-card” really have studied Japan. Similar for me – I am not expert on the Japanese economy – but both the monetary and the deleveraging explanations for Japan’s low growth during the past decade (not the 90ties) I believe to be wrong.

The Great Depression as well as the Great Recession are terrible examples of the disasters that the wrong monetary policy can bring and so is the Japan crisis in the mid-90s, but we need to make the right arguments for the right policies based on fact and not myth.

PS in Daniel Gros’ comment on Japan he makes some comments on the effectiveness of monetary policy. He seems to think that monetary policy is impotent in the present situation. I strongly disagree with that as I believe that monetary policy is in fact very effective in increasing nominal income growth as well as inflation. The liquidity trap is a myth in the same way the Japan growth story is a myth.

9 Comments
by Lars Christensen on October 16, 2011  •  Permalink
Posted in Economic and monetary history, MM Research agenda, Monetary policy, Reading recommendations

Posted by Lars Christensen on October 16, 2011

https://marketmonetarist.com/2011/10/16/japan%e2%80%99s-deflation-story-is-not-really-a-horror-story/

”Recessions are always and everywhere a monetary phenomena”

At the core of Market Monetarist thinking, as in traditional monetarism, is the maxim that “money matters”. Hence, Market Monetarists share the view that inflation is always and everywhere a monetary phenomenon. However, it should also be noted that the focus of Market Monetarists has not been as much on inflation (risks) as on the cause of recession, as the starting point for the school has been the outbreak of the Great Recession.

Market Monetarists generally describe recessions within a Monetary Disequilibrium Theory framework in line with what has been outline by orthodox monetarists such as Leland Yeager and Clark Warburton. David Laidler has also been important in shaping the views of Market Monetarists (particularly Nick Rowe) on the causes of recessions and the general monetary transmission mechanism.

The starting point in monetary analysis is that money is a unique good. Here is how Nick Rowe describes that unique good.

“If there are n goods, including one called “money”, we do not have one big market where all n goods are traded with n excess demands whose values must sum to zero. We might call that good “money”, but it wouldn’t be money. It might be the medium of account, with a price set at one; but it is not the medium of exchange. All goods are means of payment in a world where all goods can be traded against all goods in one big centralised market. You can pay for anything with anything. In a monetary exchange economy, with n goods including money, there are n-1 markets. In each of those markets, there are two goods traded. Money is traded against one of the non-money goods.”

From this also comes the Market Monetarist theory of recessions. Rowe continues:

“Each market has two excess demands. The value of the excess demand (supply) for the non-money good must equal the excess supply (demand) for money in that market. That’s true for each individual (assuming no fat fingers) and must be true when we sum across individuals in a particular market. Summing across all n-1 markets, the sum of the values of the n-1 excess supplies of the non-money goods must equal the sum of the n-1 excess demands for money.”

Said in another way, recession is always and everywhere a monetary phenomenon in the same way as inflation is. Rowe again:

“Monetary Disequilibrium Theory says that a general glut of newly produced goods can only be matched by an excess demand for money.”

This also means that as long as the monetary authorities ensure that any increase in money demand is matched one to one by an increase in the money supply nominal GDP will remain stable (Market Monetarists obviously does not say that economic activity cannot drop as a result of a bad harvest or an earthquake, but such “events” does not create a general glut of goods and labour). This view is at the core of Market Monetarist’s recommendations on the conduct of monetary policy.

Obviously, if all prices and wages were fully flexible, then any imbalance between money supply and money demand would be corrected by immediate changes prices and wages. However, Market Monetarists acknowledge, as New Keynesians do, that prices and wages are sticky.

PS I inspired Nick Rowe to do a post on ”Recessions are always and everywhere a monetary phenomena”. Now I am stealing it back. Nick, I hope you can forgive me.

7 Comments
by Lars Christensen on October 16, 2011  •  Permalink
Posted in Economic and monetary history, General economic theory, Monetary policy, Nick Rowe, The Great Recession
Tagged , , , , ,

Posted by Lars Christensen on October 16, 2011

https://marketmonetarist.com/2011/10/16/recessions-are-always-and-everywhere-a-monetary-phenomenon/

Gustav Cassel on recessions

Swedish economist Gustav Cassel (1866-1945) had many views today is shared by Market Monetarism. I today was reminded by a Cassel quote that pretty much spells out the Market Monetarist view of the causes of recessions:

“(Recessions) are essentially a result of a supply of money that is too small, and to that extent are monetary phenomena…Complaints about excessive habits of saving are in such circumstances calculated to confuse the mind of the public and to distract attention from the shortcomings of monetary policy.”


- Gustav Cassel, Theory of Social Economy, 1918.

Cassel’s quote is an explanation for the Great Depression as well as for the Great Recession.

This is not the only area in which Market Monetarist can be inspired by and learn from Gustav Cassel. An obvious example is Gustav Cassel’s views on the Great Depression.

8 Comments
by Lars Christensen on October 15, 2011  •  Permalink
Posted in Economic and monetary history, General economic theory, Monetary policy, Reading recommendations, The Great Depression, The Great Recession

Posted by Lars Christensen on October 15, 2011

https://marketmonetarist.com/2011/10/15/gustav-cassel-on-recessions/

Monetary policy and banking crisis – lessons from the Great Depression

As the Euro zone crisis continues to escalate and European policy makers are trying to avoid that the Greek sovereign debt crisis develops into a European wide banking crisis it might be an idea to study history. The Great Depression gives us many insides to what to do and what not to do to avoid crisis.

Maybe European policy makers should start having a look at Richard Grossman’s excellent paper “The Shoe That Didn’t Drop: Explaining Banking Stability During the Great Depression“ published in Journal of Economic History in 1994.

The key hypothesis in Grossman’s paper is that there is strong connection between banking crisis and the monetary policy regime in a country.

Here is the abstract for the paper:

“This article attempts to account for the exceptional stability exhibited by the banking systems of Britain, Canada, and ten other countries during the Great Depression. It considers three possible explanations of stability–the structure of the commercial banking system, macroeconomic policy and performance, and lender of last resort behavior–employing data from 25 countries across Europe and North America. The results suggest that macroeconomic policy–especially exchange-rate policy–and banking structure, but not lenders of last resort, were systematically responsible for banking stability.”

Peter Termin in “The Great Recession in Historical Context” summaries Grossman’s results nicely and puts it into a greater perspective:

“Many countries continued to maintain deflationary policies in the early 1930s as they tried to hold on to the gold standard or, in the case of Germany, follow their prescriptions even after abandoning the gold standard. Some countries followed England off gold and created room for expansive policies, which were neither large nor expansive enough to stimulate recovery in countries that remained in thrall to gold. It has become common to attribute the continued economic decline to banking crises, but banks failed only in countries that adhered to the gold standard (Grossman, 1994). As long as countries set policies to maintain the value of their currency, their banks were at risk; bank failures were a damaging outcome of the depression, not its cause. Governments and central bankers–not commercial banks–led the way into depression in country after country.

Policies were perverse because they were formulated to preserve the gold standard, not to stabilize output and employment. Central bankers thought that maintenance of the gold standard would in time restore employment, while attempts to increase employment directly would fail. The collapse of output and prices and the loss of savings as banks closed in the early 1930s were precisely what the gold standard promised to prevent. Reconciling outcomes with expectations consequently required interpreting these exceptional events in unexceptional terms. Where the crisis was most severe, blame was laid on the authorities’ failure to embrace the gold-standard mentality.”

Hence, if monetary policy fails so do banks. Its very simple. Let that be a lesson for central bankers around the world.

Luckily at the top of the ECB management we have somebody with great inside into the history and causes of Banking crisis. That is Aurel Schubert who wrote the excellent book “The Credit-Anstalt Crisis of 1931“. Aurel Schubert today is Director General Statistics at the ECB. Hopefully somebody will ask Mr. Schubert about the lessons from 1931.

Peter Coy the Economics editor of Bloomberg Businessweek provides an excellent overview of the Creditanstalt crisis of 1931 and draws parallels to the situation to in this article.

5 Comments
by Lars Christensen on October 12, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, Monetary policy, Reading recommendations, The euro

Posted by Lars Christensen on October 12, 2011

https://marketmonetarist.com/2011/10/12/monetary-policy-and-banking-crisis-lessons-from-the-great-depression/

Gideon Gono, a time machine and the liquidity trap

Here is a quote from a random article from the financial media in 2008:

“Central banks around the world are rapidly depleting their ammunition as interest rates head to unparalleled lows”

It is quite common that it is claimed that central banks around the world are out of ammunition because interest rates are close to zero and that there therefore are no more options for monetary stimulus. Market Monetarist obviously disagrees strongly with that assessment, but we are up against a long running tradition.

Lets jump into a time machine and fastback to 1935. This is US congressman T. Alan Goldsborough supporting Federal Reserve chairman Marriner Eccles in Congressional hearings on the Banking Act of 1935:

Governor Eccles: Under present circumstances, there is very little, if any, that can be done.

Congressman Goldsborough: You mean you cannot push on a string.

Governor Eccles: That is a very good way to put it, one cannot push on a string. We are in the depths of a depression and… beyond creating an easy money situation through reduction of discount rates, there is very little, if anything, that the reserve organization can do to bring about recovery

There is now doubt that even in 1935 the situation was quite desperate, but not as desperate as it was before the US went off gold in 1933.

So further back to 1932.

In 1932 the US economy is deep in depression, unemployment is massively high and deflation has never been stronger.

The situation is desperate for president Hoover. No matter what ideas he comes up with nothing works and he stands no chance of winning the upcoming presidential elections.

The chairman of the Federal Reserve Eugene Meyer is telling Hoover that he should use fiscal policy to boost the economy, but that monetary policy loosening is no option.

But then it all becomes very sci-fi – Meyer is beamed up by Scotty  (Sumner) and replaced by Zimbabwean central bank governor Gideon Gono.

We need a little be more sci-fi: Everybody in 1932 knows the reputation of Gideon Gono as a money printing psycho central banker.

So what happened when Gono is beamed back to 1932? Well, everybody knows that he doesn’t care about any strings on money policy – he just print money like a mad man and everybody knows that he created hyperinflation in his previous job. So what would you expect? They would of course expect inflation! And they would expect the US to give up the gold standard very fast – after all Gideon Gono is not exactly Bob Murphy. And he probably would so with in minutes of arriving back in 1932.

What happens now? Everybody realise that the value of cash will not continue to increase so there will be no reason to hoard cash. Rather suddenly the dollars are burning holes in people pockets. And the same goes for banks and corporations: We don’t want dollar anymore. This is the hot potato effect in monetary theory. Money demand collapse relative to the money supply. That is monetary loosening!

So monetary policy works with long and variable LEADS – in fact with time warping leads.

Fast forward to 2011. The global economy is on the verge of a new depression – the talk of a debt-deflation continues nearly four years into the Great Recession. An economics professor Scotty starts blogging about monetary policy. His big hero is Gideon Gono – the Fed chairman who in 1933 pulled out the US from the Great Depression and with it the rest of the world. Nobody would remember Hitler and we would still be talking about the “Great War” rather than World War 1.

And no Gideon Gono was never a good central bank and he would probably have stolen the US gold reserve once he landed back in 1932. This is not an endorsement of inflationist policies or insane central bankers, but an illustration of the importance of what expectations mean for monetary policy effectiveness.

PS after Gideon Gono became Fed chairman Hoover won the presidential campaign and became the longest serving US president ever and became a much loved president in the Republican party. They call him: “The president who understood monetary policy”. And the Republican party is forever grateful to Hoover for never having introduced Social Security. And most important Paul Krugman would look pretty stupid when he went on and on about the liquidity trap.

PPS luckily Gideon Gono was not beamed back to 1979.

PPPS If you want to read a truly insane book on monetary policy have a look at Gideon Gono’s “masterpiece”: Zimbabwe’s Casino Economy: Extraordinary Measures for Extraordinary Challenges.

17 Comments
by Lars Christensen on October 11, 2011  •  Permalink
Posted in Economic and monetary history, Fantasy, MM Research agenda, Monetary policy, The Great Depression

Posted by Lars Christensen on October 11, 2011

https://marketmonetarist.com/2011/10/11/gideon-gono-a-time-machine-and-the-liquidity-trap/

Believe it or not, but Greenspan makes a lot of sense

I have often been critical about Alan Greenspan’s economic thinking, but listen to this Interview on CNBC. It is pretty good. Greenspan talks about the international financial linkages – particularly between the US and the euro zone. He makes a lot of sense (other than some odd cultural references, which the rather uneducated reporters just go along with…)

I think that US based Market Monetarists should pay attention here. The global financial markets are highly inter-linked. One can not ignore European issues if one want to understand US monetary policy issues as you can not understand the Great Depression without understand French goal hoarding and the collapse of the Austrian bank Creditanstalt.

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by Lars Christensen on October 10, 2011  •  Permalink
Posted in Economic and monetary history, Financial markets, Reading recommendations, The Great Depression, The Great Recession

Posted by Lars Christensen on October 10, 2011

https://marketmonetarist.com/2011/10/10/believe-it-or-not-but-greenspan-makes-a-lot-of-sense/

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