All posts in category The Great Depression

The Compensated dollar and monetary policy in small open economies

It is Christmas time and I am spending time with the family so it is really not the time for blogging, but just a little note about something I have on my mind – Irving Fisher’s Compensated dollar plan and how it might be useful in today’s world – especially for small open economies.

I am really writing on a couple of other blog posts at the moment that I will return to in the coming days and weeks, but Irving Fisher is hard to let go of. First of all I need to finalise my small series on modern US monetary history through the lens of Quasi-Real Indexing and then I am working on a post on bubbles (that might in fact turn into a numbers of posts). So stay tuned for these posts.

Back to the Compensated dollar plan. I have always been rather skeptical about fixed exchange rate regimes even though I acknowledge that they have worked well in some countries and at certain times. My dislike of fixed exchange rates originally led me to think that then one should advocate floating exchange rates and I certainly still think that a free floating exchange rate regime is much preferable to a fixed exchange rate regime for a country like the US. However, the present crisis have made me think twice about floating exchange rates – not because I think floating exchange rates have done any harm in this crisis. Countries like Sweden, Australia, Canada, Poland and Turkey have all benefitted a great deal from having floating exchange rates in this crisis. However, exchange rates are really the true price of money (or rather the relative price of monies). Unlike the interest rate which is certainly NOT – contrary to popular believe – the price of money. Therefore, if we want to change the price of money then the most direct way to do that is through the exchange rate.

As a consequence I also come to think that variations of Fisher’s proposal could be an idea for small open economies – especially as these countries typically have less developed financial markets and due to financial innovation – in especially Emerging Markets – have a hard time controlling the domestic money supply. Furthermore, a key advantage of using the exchange rate to conduct monetary policy is that there is no “lower zero bound” on the exchange rate as is the case with interest rates and the central bank can effectively “circumvent” the financial sector in the conduct of monetary policy – something which is likely to be an advantage when there is a financial crisis.

The Compensated dollar plan 

But lets first start out by revisiting Fisher’s compensated dollar plan. Irving Fisher first suggested the compensated dollar plan in 1911 in his book The Purchasing Power of Money. The idea is that the dollar (Fisher had a US perspective) should be fixed to the price of gold, but the price should be adjustable to ensure a stable level of purchasing power for the dollar (zero inflation). Fisher starts out by defining a price index (equal to what we today we call a consumer price index) at 100. Then Fisher defines the target for the central bank as 100 for this index – so if the index increases above 100 then monetary policy should be tightened – and vis-a-vis if the index drops. This is achieved by a proportional adjustment of  the US rate vis-a-vis the the gold prices. So it the consumer price index increase from 100 to 101 the central bank intervenes to strengthen the dollar by 1% against gold. Ideally – and in my view also most likely – this system will ensure stable consumer prices and likely provide significant nominal stability.

Irving Fisher campaigned unsuccessfully for his proposals for years and despite the fact that is was widely discussed it was not really given a chance anywhere. However, Sweden in the 1930s implemented a quasi-compensated dollar plan and as a result was able to stabilize Swedish consumer prices in the 1930s. This undoubtedly was the key reason why Sweden came so well through the Great Depression. I am very certain that had the US had a variation of the compensated dollar plan in place in 2008-9 then the crisis in the global economy wold have been much smaller.

Three reservations about the Compensated dollar plan

There is no doubt that the Compensated dollar plan fits well into Market Monetarist thinking. It uses market prices (the exchange rate and gold prices) in the conduct of monetary policy rather than a monetary aggregate, it is strictly ruled based and it ensures a strong nominal anchor.

From a Market Monetarists perspective I, however, have three reservations about the idea.

First, the plan is basically a price level targeting plan (with zero inflation) rather than a plan to target nominal spending/income (NGDP targeting). This is clearly preferable to inflation targeting, but nonetheless fails to differentiate between supply and demand inflation and as such still risk leading to misallocation and potential bubbles. This is especially relevant for Emerging Markets, which undergoes significant structural changes and therefore continuously is “hit” by a number of minor and larger supply shocks.

Second, the plan is based on a backward-looking target rather than on a forward-looking target – where is the price level today rather than where is the price level tomorrow? In stable times this is not a major problem, but in a time of shocks to the economy and the financial system this might become a problem. How big this problem is in reality is hard to say.

Finally third, the fact that the plan uses only one commodity price as an “anchor” might become a problem. As Robert Hall among other have argued it would be preferable to use a basket of commodities as an anchor instead and he has suggest the so-called ANCAP standard where the anchor is a basket of Ammonium Nitrate, Copper, Aluminum and Plywood.

Exchange rate based NGDP targeting for small-open economies

If we take this reservations into account we get to a proposal for an exchange rate based NGDP target regime which I believe would be particularly suiting for small open economies and Emerging Markets. I have in an earlier post spelled out the proposal – so I am repeating myself here, but I think the idea is worth it.

My suggestion is that it the the small open economy (SOE) announces that it will peg a growth path for NGDP (or maybe for nominal wages as data might be faster available than NGDP data) of for example 5% a year and it sets the index at 100 at the day of the introduction of the new monetary regime. Instead of targeting the gold price it could choose to either to “peg” the currency against a basket of other currencies – for example the 3-4 main trading partners of the country – or against a basket of commodities (I would prefer the CRB index which is pretty closely correlated with global NGDP growth).

Thereafter the central bank should every month announce a monthly rate of depreciation/appreciation of the currency against the anchor for the coming 24-36 month in the same way as most central banks today announces interest rate decisions. The target of course would be to “hit” the NGDP target path within a certain period. The rule could be fully automatic or there could be allowed for some discretion within the overall framework. Instead of using historical NGDP the central bank naturally should use some forecast for NGDP (for example market consensus or the central bank’s own forecast).

It could be done, but will anybody dare?

Central bankers are conservative people and they don’t go around and change their monetary policy set-up on a daily basis. Nonetheless it might be time for central banks around the world to reconsider their current set-up as monetary policy far from having been successfully in recent years. I believe Irving Fisher’s Compensated dollar plan is an excellent place to start and I have provided a (simple) proposal for how small-open economies might implement it.

7 Comments
by Lars Christensen on December 26, 2011  •  Permalink
Posted in Economic and monetary history, Emerging Markets, Exchange rate policy, Exchange rates, Federal Reserve, Financial markets, General economic theory, Gold prices, Gold Standard, Irving Fisher, The Great Depression, The Great Recession
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Posted by Lars Christensen on December 26, 2011

https://marketmonetarist.com/2011/12/26/the-compensated-dollar-and-monetary-policy-in-small-open-economies/

November 1932: Hitler, FDR and European central bankers

The headline of most stock markets reports yesterday said something like “Stocks: Worst Thanksgiving Drop Since ’32”. That made me think – what really happened in November 1932?

As is the case this time around European worries dominated the financial headlines back in November 1932. The first of two key events of November 1932 was the German federal elections on November 6 1932. We all know the outcome – Hitler’s National Socialist Germans Workers’ Party (NSDAP) won a landslide victory and got 33.1% of the vote. As the Communist Party won 16.9% the totalitarian parties commanded a firm majority – what at the time was called the “negative majority”. This eventually led to the formation of Hitler’s first cabinet in January 1933.

The second key event of November 1932 of course was the US presidential elections. Two days after the German in elections Franklin D. Roosevelt won the US presidential elections defeating incumbent president Herbert Hoover on November 8 1932. FDR of course in 1933 took the US of the gold standard, but also introduced the catastrophic National Industrial Recovery Act (NIRA).

Going through the New York Times articles of November 1932 I found a short article on the gold standard in which it said the following:

“Governors of Europe’s central banks who met today (November 13 1932) at the Bank of International Settlements expressed the unanimous opinion that the gold standard was the only basis on which the world economic situation could be bettered”

Obviously we today’s know that the failed gold standard was the key reason for the Great Depression and especially European central bankers’ desperate attempt to save the failed monetary regime created the environment in which Hitler and his nazi party was able to win the German elections in November 1932. What would have happened for example if Germany had been given proper debt relief, the European central banks had given up the gold standard and the French central bank had stopped the hoarding of gold?

Had I been a Marxist I would had been extremely depressed today because then I would had believed in historical determinism. Fortunately I think we can learn from history and avoid repeating past mistakes. I hope today’s European central bankers share this view and will learn a bit from the events of November 1932.

If European central bankers this time around decide not to learn from events of 1932 then they might be interested in learning about the dissolution of the Austro-Hungarian currency union in 1919. Then they just have to read this excellent paper by Peter Garber and Michael Spencer.

7 Comments
by Lars Christensen on November 26, 2011  •  Permalink
Posted in Economic and monetary history, euro crisis, Gold Standard, The euro, The Great Depression
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Posted by Lars Christensen on November 26, 2011

https://marketmonetarist.com/2011/11/26/november-1932-hitler-fdr-and-european-central-bankers/

“Fed greatly destabilized the U.S. economy”

As the European crisis just gets worse and worse I am reminded by what a clever man once said – he is that clever man Ben Bernanke in 2004:

“Some important lessons emerge from the story. One lesson is that ideas are critical. The gold standard orthodoxy, the adherence of some Federal Reserve policymakers to the liquidationist thesis, and the incorrect view that low nominal interest rates necessarily signaled monetary ease, all led policymakers astray, with disastrous consequences. We should not underestimate the need for careful research and analysis in guiding policy. Another lesson is that central banks and other governmental agencies have an important responsibility to maintain financial stability. The banking crises of the 1930s, both in the United States and abroad, were a significant source of output declines, both through their effects on money supplies and on credit supplies. Finally, perhaps the most important lesson of all is that price stability should be a key objective of monetary policy. By allowing persistent declines in the money supply and in the price level, the Federal Reserve of the late 1920s and 1930s greatly destabilized the U.S. economy and, through the workings of the gold standard, the economies of many other nations as well.”

I wonder what he is thinking of his colleagues in the ECB and about his own responsibilities today.

2 Comments
by Lars Christensen on November 16, 2011  •  Permalink
Posted in Banking crisis, Deflation, Economic and monetary history, Federal Reserve, Gold Standard, Monetary policy, The Great Depression
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Posted by Lars Christensen on November 16, 2011

https://marketmonetarist.com/2011/11/16/fed-greatly-destabilized-the-u-s-economy/

Please listen to Nicholas Craft!

Professor Nicholas Craft as written a report for the British think tank Centre Forum on “Delivering growth while reducing deficits: lessons from the 1930s”. The report is an excellent overview of the British experience during the 1930s, where monetary easing through exchange rate depreciation combined with fiscal tightening delivered results that certainly should be of interest to today’s policy makers.

If you are the lazy type then you can just read the conclusion:

“The 1930s offers important lessons for today’s policymakers. At that time, the UK was attempting fiscal consolidation with interest rates at the lower bound but devised a policy package that took the economy out of a double-dip recession and into a strong recovery. The way this was achieved was through monetary rather than fiscal stimulus.

The key to recovery both in the UK and the United States in the 1930s was the adoption of credible policies to raise the price level and in so doing to reduce real interest rates. This provided monetary stimulus even though, as today, nominal interest rates could not be cut further. In the UK, the ‘cheap money’ policy put in place in 1932 provided an important offset to the deflationary impact of fiscal consolidation that had pushed the economy into a double-dip recession in that year.

If economic recovery falters in 2012, it may be necessary to go beyond further quantitative easing as practised hitherto. It is important to recognize that at that point there would be an alternative to fiscal stimulus which might be preferable given the weak state of public finances. The key requirement would be to reduce real interest rates by raising inflationary expectations.

At that point, inflation targeting as currently practised in the UK would no longer be appropriate. A possible reform would be to adopt a price level target which commits the MPC to increase the price level by a significant amount, say 15 per cent, over four years. In the 1930s, the Treasury succeeded in developing a clear and credible policy to raise prices. It maybe necessary to adopt a similar strategy in the near future.

It would be attractive if this kind of monetary stimulus worked, as in the 1930s, through encouraging housebuilding. This suggests that an important complementary policy reform would be to liberalize the planning restrictions which make it most unlikely that we will ever see the private sector again build 293000 houses in a year as happened in 1934/5.”

If I have any reservations against Craft’s views then it is the focus on real interest rates in the monetary transmission mechanism. I think that is a far to narrow description of the transmission mechanism in which I think interest rates plays a rather minor role. See my previous comment on the transmission mechanism.

That minor issue aside Craft provides some very insightful comments on the 1930s and the present crisis and  I hope some European policy makers would read Craft’s report…

—

I got this reference from David Glasner who also has written a comment on Craft’s report.

6 Comments
by Lars Christensen on November 16, 2011  •  Permalink
Posted in David Glasner, Economic and monetary history, euro crisis, Exchange rate policy, Liquidity trap, Monetary policy, Price Level Targeting, The Great Depression, The Great Recession, Transmission mechanism
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Posted by Lars Christensen on November 16, 2011

https://marketmonetarist.com/2011/11/16/please-listen-to-nicholas-craft/

The Tragic year: 1931

Benjamin Anderson termed 1931 the “the tragic year” – these are some of the events in that tragic year: 

  1. One of Europe’s largest banks with large exposure to Central and Eastern Europe gets into serious trouble (It is of course Austria’s largest bank Österiechishe Kredit Anstalt – and it of course collapsed)
  2. Europe’s Sovereign debt crisis is threatening financial stability and currency collapse (It’s the Germans that are to blame – they can’t pay their war debts)
  3. Major international banks push for a big country to save the sinners (The US banks ask US president Hoover to help ease the pain on Germany)
  4. Debt restructuring (The Hoover moratorium gives Germany a bit of relief – the US banks are happy to begin with)
  5. Monetary policy keeps deflationary pressures on (The French central bank keeps hoarding gold)
  6. An insane commitment to a failed monetary system (the gold standard mentality keeps the commitment to the gold standard despite the fact that it is killing Europe)
  7. Some countries have had enough and give up the monetary standard (The UK leaves the gold standard – the Scandinavian countries follows suit – and recover fast from the Great Depression)
  8. Technocracy is popular and it suggested that indebted nations should be run by technocrats (The so-called Technocracy Movement became increasingly popular in German)

And here we are 80 years on…do you see any similarities? I wonder what 2012 will bring – in 1932 10 countries (or so…) defaulted…

8 Comments
by Lars Christensen on November 15, 2011  •  Permalink
Posted in Banking crisis, Central and Eastern Europe, Economic and monetary history, euro crisis, Gold Standard, Greece, MM Research agenda, Monetary institutions, The euro, The Great Depression
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Posted by Lars Christensen on November 15, 2011

https://marketmonetarist.com/2011/11/15/the-tragic-year-1931/

Germany 1931, Argentina 2001 – Greece 2011?

The events that we are seeing in Greece these days are undoubtedly events that economic historians will study for many years to come. But the similarities to historical crises are striking. I have already in previous posts reminded my readers of the stark similarities with the European – especially the German – debt crisis in 1931. However, one can undoubtedly also learn a lot from studying the Argentine crisis of 2001-2002 and the eventual Argentine default in 2002.

What this crises have in common is the combination of rigid monetary regimes (the gold standard, a currency board and the euro), serious fiscal austerity measures that ultimately leads to the downfall of the government and an international society that is desperately trying to solve the problem, but ultimately see domestic political events makes a rescue impossible – whether it was the Hoover administration and BIS in 1931, the IMF in 2001 or the EU (Germany/France) in 2011. The historical similarities are truly scary.

I have no clue how things will play out in Greece, but Germany 1931 and Argentina 2001 does not give much hope for optimism, but we can at least prepare ourselves for how things might play out by studying history.

I can recommend having a look at this timeline for how the Argentine crisis played out. You can start on page 3 – the Autumn of 2001. This is more or less where we are in Greece today.

6 Comments
by Lars Christensen on November 2, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, euro crisis, Exchange rate policy, Gold Standard, MM Research agenda, Monetary institutions, The euro, The Great Depression
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Posted by Lars Christensen on November 2, 2011

https://marketmonetarist.com/2011/11/02/germany-1931-argentina-2001-greece-2011/

80 years ago – history keeps repeating itself

Scott Sumner has a excellent post on events 80 years ago and the comparison with the situation today.

I share Scott’s view of the dismal situation 80 years ago and today.

See my posts on the issue from last week here and here.

Leave a comment
by Lars Christensen on November 2, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, euro crisis, Gold Standard, MM Research agenda, Reading recommendations, Scott Sumner, The Great Depression, The Great Recession
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Posted by Lars Christensen on November 2, 2011

https://marketmonetarist.com/2011/11/02/80-years-ago-history-keeps-repeating-itself/

The Hoover (Merkel/Sarkozy) Moratorium

The global stock markets are strongly up today on the latest news from the EU on the deal on Greek debt (and little bit less…). There is no reason to spend a lot of time describing the deal here, but I nonetheless feel it might be a good day to tell a bit about something else – the so-called Hoover Moratorium of 1931.

80 years ago it was not Greece, which was at the centre of attention, but rather Germany. Germany was struggling to pay back war debt and reparations for World War I and Germany was effectively on the brink of default and the Germany economy was in serious trouble – not much unlike today’s Greek situation.

On June 20 1931 US President Hoover issued a statement in which he suggested a moratorium on payments of World War I debts, postponing the initial payments, as well as interest. Hoover’s hope was the moratorium would ease the strains on especially the German economy and thereby in general help the global economy, which of course at that time was deep in depression.

Hoover’s idea was certainly not popular with many US citizens (like today’s German taxpayers who are not to happy to see their taxes being spending in “saving” Greece). However, the plan got most opposition from the French government, which insisted that the German government had to pay it’s debts on time as scheduled.

Despite the negative reception of Hoover’s proposal it went on to gain support from fifteen nations including France by July 6 1931.

An interesting side story on the Hoover Moratorium is why Hoover came up with the idea in the first place. Barry Eichengreen askes this question in his great book on the gold standard and the Great Depression, “Golden Fetters”: “It is unclear whether Hoover was motivated by the need for action to stabilize the international economy or by a desire to protect U.S. banks that had invested heavily in Germany”. Try replace “Hoover” with “Merkel/Sarkozy”, “U.S. banks” with “German/French banks” and “Germany” with “Greece”.

So how did the Hoover Moratorium play out? The initial market reaction July 1931 was very favourable. German stock jumped 25% on the Monday announce the initial announcement of the Hoover Moratorium. Here is how the New York Times described the global market reaction “the swiftest advance during any corresponding period in a generation” (quoted from Clark Johnson’s “Gold, France and the Great Depression”).

However, the party did not last and soon the international market turned down and the Depression continued. Many countries didn’t emerge from the Depression before the end of World War II. Lets hope we are more lucky this time around.

7 Comments
by Lars Christensen on October 27, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, euro crisis, The euro, The Great Depression, The Great Recession
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Posted by Lars Christensen on October 27, 2011

https://marketmonetarist.com/2011/10/27/the-hoover-merkelsarkozy-moratorium/

Hawtrey, Cassel and Glasner

Recently I have been giving quite a bit attention to the writings Gustav Cassel (and I plan more…), but I have failed to give any attention to the great British monetary economist Raplh G. Hawtrey. That is not really fair – Hawtrey and Cassel lived more or less at the same time and both played important roles in the debate and formulation of monetary policy and monetary thinking around the world in 1920s and 1930s.

Long ago David Glasner – one of my big heros and the blogger on uneasymoney.com – and Ronald W. Batchelder long ago wrote a paper on the monetary economics of both Cassel and Hawtrey – “Pre-Keynesian monetary theories of the Great Depression”. You should all read it.

6 Comments
by Lars Christensen on October 26, 2011  •  Permalink
Posted in Economic and monetary history, Monetary policy, New Casselian economics, The Great Depression
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Posted by Lars Christensen on October 26, 2011

https://marketmonetarist.com/2011/10/26/hawtrey-cassel-and-glasner/

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.

3 Comments
by Lars Christensen on October 25, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, General economic theory, The Great Depression
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Posted by Lars Christensen on October 25, 2011

https://marketmonetarist.com/2011/10/25/calomiris-on-contagious-events/

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