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Use googlenomics to track NGDP

Anybody who has been working on a trading floor will know the adrenalin rush one will experience when one of the major sets of macroeconomic data is published – for example US nonfarm payroll numbers. I think most dealers and analysts will recognise this and will acknowledge that it could become nearly addictive to get that feeling. However, I think that this might be a thing of the past due to the technological development.

Most macroeconomic data are published on a monthly or a quarterly basis. However, the economy does not develop in a discretionary fashion – rather the real economy develops continuously in time.

Now the technological development, however, gives us the possibility to follow the economic data real time. As more and more of the real economic happens on the internet or is reflected in some way on the internet the more easy it is to track economic developments in real time.

Just try to go to Google Trends and search words like “crisis”, “recession”, “Roubini” etc. and you will see that the trend in these searches tracks global macroeconomic developments in quite well. Another example is MIT’s so-called Billion Prices Project, which tracks consumer prices by monitoring prices on different retailers websites. The data is very strongly correlated with the official consumer price index for example in the US.

Market Monetarists are of course mostly interest in the development in nominal GDP – so he is a challenge to my reader – who can find the search word(s) on google trend that will track NGDP the best?

PS see also this paper by Google’s chief economist Hal Varian

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William Niskanen 1933-2011

William Niskanen passed away on October 26. I have always admired Niskanen a lot. He was a champion of liberty and a great economist.

Any student of Public Choice theory would know Niskanen’s classic Bureaucracy and Representative Government from 1971 and I still think of this as his greatest contribution to economic theory. However, as Bill Woolsey reminds us William Niskanen was also a long time proponent of nominal income targeting.

Niskanen first advocated nominal income targeting or rather targeting of nominal spending in his 1992 paper “Political Guidance on Monetary Policy”. Niskanen later elaborated on the subject in his 2001 paper “A test of the Demand Rule” and further in his 2002 paper “On the Death of the Phillips Curve”.

Marcus Nunes has an insight comment on “A test of the Demand Rule” here.

Milton Friedman on exchange rate policy #1

There is no doubt that Milton Friedman is my favourite economist (sorry Scott, you are only number two on the list). In the coming days I will share my interpretation of Friedman’s view of exchange rate policy.

Friedman’s contributions to both economic theory and the public debate have had considerable influence on the organisation of the global financial system and the choice of currency regimes around the world. This can best be illustrated by looking at the history of global financial and currency developments.

Prior to the First World War the international currency system was based on the gold standard. Individual national currencies had a particular gold value and could therefore be exchanged at a specified and fixed exchange rate. Thus the gold standard was a fixed exchange rate system. The First World War, however, led to this system breaking down – mainly as a result of the warring nations cancelling the gold convertibility of their bank notes: They financed their military expenses by printing money. This subsequently created a level of inflation that was incompatible with the gold standard.

Attempts were made to reintroduce the gold standard after the First World War, but the Great Depression of the 1930s, among other things, made this difficult. Nevertheless, the idea of fixed exchange rates still enjoyed significant political support, and there was broad agreement among economists that some form or other of fixed exchange rate policy was desirable. Hence a further attempt was made after the Second World War, and in 1944 the so-called Bretton Woods system was established, named after the US town where the agreement was made to set up a fixed exchange rate system.

The Bretton Woods agreement meant that the US dollar was pegged at a fixed rate to the price of gold, while the other participating currencies (the majority of global currencies) could be traded at a fixed rate to the dollar, thus once again establishing a global fixed exchange rate system. The system, which finally broke down in 1971 when the USA decided to abandon the dollar’s fixed peg to gold, was in many ways the main reason for Friedman’s huge involvement in the currency issue – both from an economic theory and from a political perspective. Friedman was an outspoken critic of the Bretton Woods system right from its creation to its final demise in 1971, and he supplied much of the theoretical ammunition that President Nixon used to justify his decision to “close the gold window”.

Friedman made his first major mark on the international currency system in 1948, when on 18 April he took part in a radio debate with the deputy governor of the Canadian central bank, Donald Gordon, discussing among other things Canada’s fixed exchange rate policy.

In 1948 Canada was pursuing a fixed exchange rate policy within the framework of the Bretton Woods system. However, the policy had given rise to a number of problems – including increasing inflation – and the government and central bank were considering major intervention in the Canadian economy in an attempt to maintain the fixed exchange rate. Among the proposals was one to significantly curb imports to Canada. So it would seem that the desire to maintain a fixed exchange rate policy was leading directly to protectionism. Since the 1940s this political connection has formed one of Friedman’s key arguments against a fixed exchange rate policy.

While the Canadian government attempted to defend its fixed exchange rate policy with protectionism and wage and price controls, Friedman’s approach was completely different: abandon the fixed exchange rate policy and let the currency float freely. Gordon rejected Friedman’s prescription for Canada’s ills, but 18 months later, in September 1950, the country’s finance minister, Douglas Abbott, decided to take Friedman’s medicine, announcing:

“Today the Government … cancelled the official rates of exchange. . . . Instead, rates of exchange will be determined by conditions of supply and demand for foreign currencies in Canada.”
(Quoted from Schembri, Lawrence, “Revisiting the Case for Flexible Exchange Rates”, Bank of Canada, November 2000).

Friedman could chalk up his first major victory in the currency debate – while the next was to come in 1971 when Bretton Woods was abandoned. In the intervening years Friedman made a huge contribution to changing how currencies and exchange rates are viewed in economic theory.

Calomiris on “Contagious Events”

As we minute by minute are inching closer to the announcement of some form of restructuring/write-down of Greek Sovereign debt nervous investors focus on the risk of contagion from the Greek crisis to other European economies and contagion in the European banking sector.

In a paper from 2007 Charles Calomiris has a good and interesting discussion of what he calls “Contagious events”.

Here is the abstract:

“Bank failures during banking crises, in theory, can result either from unwarranted depositor withdrawals during events characterized by contagion or panic, or as the result of fundamental bank insolvency. Various views of contagion are described and compared to historical evidence from banking crises, with special emphasis on the U.S. experience during and prior to the Great Depression. Panics or “contagion” played a small role in bank failure, during or before the Great Depression-era distress. Ironically, the government safety net, which was designed to forestall the (overestimated) risks of contagion, seems to have become the primary source of systemic instability in banking in the current era.”

WARNING: If you are looking for a justification for bailouts you will probably not find it in this paper, but you will find some interesting “advise” on banking regulation.

“Graph man” Nunes is having a look at the Plucking Model

In a recent post I highlighted Milton Friedman’s so-called “Plucking Model”. Marcus Nunes – also known as the “Graph man” among friends have been taking a look at how US data fits Friedman’s model. Marcus “Graph man” Nunes’ post is very educational – please have a look.

When central banking becomes central planning

The great thing about the blogosphere is that everything is happening in “real-time”. In economic journals the exchange of ideas and arguments can go on forever without getting to any real conclusion and some debates is never undertaken in the economic journals because of the format of journals.

Such a debate is the discussion about whether central banking is central planning, which has been going on between the one hand Kurt Schuler and on the other hand David Glasner and Bill Woolsey. Frankly speaking, I shouldn’t really get involved in this debate as the three gentlemen all are extreme knowledgeable about exactly this topic and they have all written extensively about Free Banking – something that I frankly has not written much about.

In my day-job central banks are just something we accept as a fact that is not up for debate. Anyway, I want to let me readers know about this interesting debate and maybe add a bit of my humble opinion as we go along. There is, however, no reason to “reprint” every single argument in the debate so here are the key links:

From Glasner:

“Gold and Ideology, continued”

“Central Banking is not Central Planning”

“Hayek on the meaning of planning”

“Central Banking and Central Planning, again”

From Schuler:

“Central Banking is a form of Central Planning”

“Once more: central banking is a form of central planning”

From Woolsey:

“Central Banking is Not Central Planning”

Initially my thinking was, yes, of course central banking is central planning, but Bill Woolsey arguments won the day (Sorry David, the Hayek quotes didn’t convince me…).

Here is Bill Woolsey:

“Comprehensive central planning of the economy is the central direction of the production and consumption of all goods services. How many cars do we want this year? How much steel is needed to produce those cars? How much iron ore is needed to produce the steel?…Trying to do this for every good and service all the time for millions of people producing and consuming is really, really hard. Perhaps impossible is not too strong of a word, though that really means impossible to do very well at all, much less do better than a competitive market system…Central banking is very different. It does involve having a monopoly over a very important good–base money. Early on, governments sold that monopoly to private firms, but later either explicitly nationalized the central banks, or regulated and “taxed” them to a point where any private elements are just window dressing…Schuler’s error is to identify this monopoly on the provision of an important good with comprehensive central planning. Yes, a monopolist must determine how much of its product to produce and what price to charge. The central bank must determine what quantity of base money to produce and what interest rate to pay (or charge) on reserve balances. But that is nothing like determining how much of each and every good is to be produced while making sure that the resources needed to produce them are properly delivered to the correct places at the correct times.”

Bill continues (here its gets really convincing…):

“Suppose electric power was produced as a government monopoly. That is certainly realistic. The inefficiency of multiple sets of transmission lines provides a plausible rationale. The government power monopoly would need to determine some pricing scheme and how much power to generate. And, of course, these decisions would have implications for the overall level of economic activity. Not enough capacity, and blackouts disrupt economic activity. Too much capacity, and the higher rates needed to pay for it deter economic activity…It is hard to conceive of an electric utility centrally directing the economy, but it isn’t impossible. Ration electricity to all firms based upon a comprehensive plan for what they should be doing. Any firm that produces the wrong amount and sends it to the wrong place is cut off.”

Central banking might not be central planning

Hence, there is a crucial difference between central planning and a government monopoly on the production of certain goods (as for example money). One can of course argue that if government produces anything it is socialism and therefore central planning. However, then central planning loses its meaning and will just become synonymous with socialism. Therefore, arguing that central banking is central planning as Schuler does is in my view wrong. It might be a integral part of an socialist economic system that money is monopolized, but that is still not the same thing as to say central banking is central planning.

But increasingly central banking is conducted as central planning

While central banking need not to be central banking it is also clear that during certain periods of history and in certain countries monetary policy has been conducted as if part (or actually being part of) a overall central planning scheme. In fact until the early 1980s most Western European economies and the US had massively regulated financial markets and credit and money were to a large extent allocated with central planning methods by the financial authorities and by the central banks. Furthermore, exchange controls meant that there was not a free flow of capital, which “necessitated” central planning of which companies and institutions should have access to foreign currency. Therefore, central banking during the 1970s for example clearly involved significant amounts of central planning.

However, the liberalization of the financial markets in most Western countries during the 1980s sharply reduced the elements of central planning in central banking around the world.

The Great Recession, however, has lead to a reversal of this trend away from “central bank planning” and central banks are increasingly involved in “micromanagement” and what clear feels and look like central planning.

In the US the Federal Reserve has been highly involved in buying “distressed assets” and hence strongly been influencing the relative prices in financial markets. In Europe the ECB has been actively interfering in the pricing of government bonds by actively buying for example Greek or Italian bonds to “support” the prices of these bonds. This obviously is not central banking, but central planning of financial markets. It is not and should not be the task of central banks to influence the allocation of credit and capital.

With central banks increasingly getting involved in micromanaging financial market prices and trying to decide what is the “right price” (contrary to the market price) the central banks obviously are facing the same challenges as any Soviet time central planning would face.

Mises and Hayek convincing won the Socialist calculation debate back in the 1920s and the collapse of communism once and for all proved the impossibility of a central planned economy. I am, however, afraid that central banks around the world have forgotten that lesson and increasing are acting as if it was not Mises and Hayek who prevailed in the Socialist-calculation debate but rather Lerner and Lange.

Furthermore, the central banks’ focus on micromanaging financial market prices is taking away attention from the actual conduct of monetary policy. This should also be a lesson for Market Monetarists who for example have supported quantitative easing in the US. The fact remains that what have been called QE in the US in fact does not have the purpose of increasing the money supply (to reduce monetary disequilibrium), but rather had the purpose of micromanaging financial market prices. Therefore, Market Monetarists should again and again stress that we support central bank actions to reduce monetary disequilibrium within a rule-based framework, but we object to any suggestion of the use  central planning “tools” in the conduct of monetary policy.

Woolsey on DeLong on NGDP Targeting

Interestingly enough both Paul Krugman and Brad DeLong have now come out in favour of NGDP level targeting. Hence, the policy recommendation from these two Keynesian giants are the same as from the Market Monetarist bloggers, but even though the Keynesians now agree with our policy recommendation on monetary policy in the US the theoretical differences are still massive. Both Krugman and DeLong stress the need for fiscal easing in the US. Market Monetarists do not think fiscal policy will be efficient and we are in general skeptical about expanding the role of government in the economy.

Bill Woolsey has an excellent comment on Brad Delong’s support for NGDP targeting. Read it here.

Despite theoretical differences it is interesting how broad based the support for NGDP level targeting is becoming among US based economists (In Europe we don’t have that sort of debate…we are just Calvinist…)

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?

Sexy new model could shed light on the Great Recession

Market Monetarists like myself claim that the Great Recession mostly was caused by the fact that the Federal Reserve and other central banks failed to meet a sharp increase in the demand for dollars. Hence, what we saw is what David Beckworth has termed a “passive” tightening of monetary policy.

I have come across a (rather) new paper that might be able to shed more light on what impact the increase in money demand had in the Great Recession.

Te paper by Irina A. Telyukova and Ludo Visschers presents a rather sexy model (that’s an economic model…), but has a rather unsexy title “Precautionary Demand for Money in a Monetary Business Cycle Model”. Here is the abstract:

“We investigate quantitative implications of precautionary demand for money for business cycle dynamics of velocity and other nominal aggregates. Accounting for such dynamics is a standing challenge in monetary macroeconomics: standard business cycle models that have incorporated money have failed to generate realistic predictions in this regard. In those models, the only uncertainty affecting money demand is aggregate. We investigate a model with uninsurable idiosyncratic uncertainty about liquidity need and find that the resulting precautionary motive for holding money produces substantial qualitative and quantitative improvements in accounting for business cycle behavior of nominal variables, at no cost to real variables.”

Hence, Telyukova and Visschers incorporate shocks to money velocity from increases in what they call “precautionary demand for money” into a dynamic business cycle model. The model is yielding rather interesting results, but it is also a rather technical paper so it might be hard to understand if you are a none-technical economist.
Anyway, the conclusion is relatively clear:

“By incorporating this idiosyncratic risk into a standard monetary model with aggregate risk, and by carefully calibrating the idiosyncratic shocks to data, we find that the model matches many dynamic moments of nominal variables well, and greatly improves on the performance of existing monetary models that do not incorporate such idiosyncratic shocks. We show that our results are robust to multiple possible ways of calibrating the model. We show also that omitting precautionary demand while targeting, in calibration, data properties of money demand – a standard calibration practice produces inferior performance in terms of matching the data, potentially misleading implications for parameters of the model, and may therefore adversely affect the model’s policy implications as well.”

The paper was first written back in June 2008 (talk about good timing) and then later updated in March 2011. Oddly enough the paper does not make any reference to the Great Recession! This is typical of this kind of technical papers – even though the results are highly relevant the authors fail to notice that (or ignore it). That does not, however, change the fact that Telyukova’s and Visschers’ paper could clearly shed new light on the Great Recession.

As I see it the Telyukova-Visschers model could be used in two ways which would be directly relevant for monetary policy making. 1) Use the model to simulate the Great Recession. Can the increase in precautionary demand for money account for the Great Recession? 2) The model can be used to test how different policy rules (NGDP targeting, price level, inflation targeting, a McCallum rule, Taylor rule etc.) will work and react to shocks to money demand. I hope that is the direction that Telyukova and Visschers will take their research in the future.

”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.

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