All posts in category The Great Recession

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…

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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 Fed can save the euro

David Beckworth has a excellent comment on the correlation between NGDP in the US and the euro zone.

David shows that US NGDP growth leads NGDP growth in the euro zone. This means that if the Federal Reserve were to move to push NGDP back to the pre-crisis trend level then it would likely lead to a similar increase in the NGDP level in the euro zone.

Hence, if the Fed were to introduce a NGDP level target then because the US is a “global monetary superpower” then the ECB would effective be forced to do the same thing. Interestingly this would probably mean that the ECB would overshoot it’s 2% inflation in the short-run as NGDP shifts from on level to another. How would the ECB react to that? Well, first of all the EUR/USD would undoubtedly spike, which would curb short time inflationary pressures and the question is really whether the ECB would have time to do anything about the jump in NGDP. Paradoxically because the ECB is targeting future inflation then it could say “well, inflation is now at 5%, but that is really not something we can do anything about and inflation nonetheless be back to 2% once US NGDP settles down at the new (old) NGDP trend level so no tightening of monetary policy is needed”.

For now the ECB refuses any easing of monetary policy, but if the Fed were to act decisively then the ECB probably would import an easing of monetary policy – and that would probably save the euro. So please Ben can you help us?

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by Lars Christensen on November 15, 2011  •  Permalink
Posted in David Beckworth, euro crisis, Federal Reserve, MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Reading recommendations, The euro, The Great Recession
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Posted by Lars Christensen on November 15, 2011

https://marketmonetarist.com/2011/11/15/the-fed-can-save-the-euro/

Beckworth and Ponnuru: Tight budgets, Loose money

David Beckworth and Ramesh Ponnuru just came out with a new article on the economic policy debate in the US. Beckworth and Ponnuru lash out against both left and right in American politics. Let me just say that I agree with basically everything in the article, but you should read it yourself.

However, what I find most interesting in the article is not the discussion about the US political landscape, but rather the very clear description of both the Great Moderation and the causes for the Great Recession:

“The Fed did a pretty good job of stabilizing the economy. The result of its monetary policies was that the economy, measured in current-dollar or “nominal” terms, grew at about 5 percent a year, with inflation accounting for 2 percent of the increase and real economic growth 3 percent. Keeping nominal spending and nominal income on a predictable path is important for two reasons. First, most debts, such as mortgages, are contracted in nominal terms, so an unexpected slowdown in nominal income growth increases their burden. Also, the difficulty of adjusting nominal prices makes the business cycle more severe. If workers resist nominal wage cuts during a deflation, for example, mass unemployment results…During the great moderation, people began to expect spending and incomes to grow at a stable rate and made borrowing decisions based on it. But maintaining this stability requires the Fed to increase the money supply whenever the demand for money balances—people’s preference for cash over other assets—increases. This happened in 2008 when, as a result of the recession and the financial crisis, fearful Americans began to hold their cash. The Federal Reserve, first worried about increased commodity prices as a harbinger of inflation and then focused on saving the financial system, failed to increase the money supply enough to offset this shift in demand and allowed nominal spending to fall through mid-2009″

I wish a lot more people would understand this – Beckworth and Ponnuru are certainly not to blame if you don’t understand it yet.

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UPDATE: See this interesting comment on Niskanen and Beckworth/Ponnuru by Tim B. Lee.

1 Comment
by Lars Christensen on November 3, 2011  •  Permalink
Posted in David Beckworth, Monetary institutions, Monetary policy, NGDP Targeting, Nominal Income Targeting, Reading recommendations, The Great Moderation, The Great Recession
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Posted by Lars Christensen on November 3, 2011

https://marketmonetarist.com/2011/11/03/beckworth-and-ponnuru-tight-budgets-loose-money/

The Chuck Norris effect, Swiss lessons and a (not so) crazy idea

Here is from The Street Light:

“You may recall that in September the Swiss National Bank (SNB) announced that it was going to intervene as necessary in the currency markets to ensure that the Swiss Franc (CHF) stayed above a minimum exchange rate with the euro of 1.20 CHF/EUR. How has that been working out for them?

It turns out that it has been working extremely well. Today the SNB released data on its balance sheet for the end of September. During the month of August the SNB had to spend almost CHF 100 billion to buy foreign currency assets to keep the exchange rate at a reasonable level. But in September — most of which was after the announcement of the exchange rate minimum — the SNB’s foreign currency assets only grew by about CHF 25 billion. Furthermore, this increase in the CHF value of the SNB’s foreign currency assets likely includes substantial capital gains that the SNB reaped on its euro portfolio (which was valued at about €130 bn at the end of September), as the CHF was almost 10% weaker against the euro in September than in August. Given that, it seems likely that the SNB’s purchases of new euro assets in September after the announcement of the exchange rate floor almost completely stopped.”

This is a very strong demonstration of the power of monetary policy when the central bank is credible. This is the Chuck Norris effect of monetary policy: You don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target. (Nick Rowe and I like this sort of thing…)

And now to the (not so) crazy idea – if the SNB can ease monetary policy by announcing a devaluation why can’t the Federal Reserve and the ECB do it? Obviously some would say that not all central banks in the world can devalue at the same time – but they can. They can easily do it against commodity prices. So lets say that the ECB, the Federal Reserve, the Bank of Japan, the Bank of England and the SNB tomorrow announced a 15% devaluation against commodity prices (for example the CRB index) and that they will defend that one sided “peg” until the nominal GDP level returns to their pre-Great Recession trend levels. Why 15%? Because that is more or less the NGDP “gap” in the euro zone and the US.

The clever reader will notice that this is the coordinated and slightly more sexy version of Lars E. O. Svensson’s fool-proof way to escape deflation and the liquidity trap.

Is a coordinated 15% devaluation of the major currencies of the world (with the exception of RMB) a crazy idea? Yes, it is quite crazy and it could trigger all kind of political discussions, but I am pretty sure it would work and would very fast bring US and European NGDP back towards the pre-crisis trend. And for those who now scream at the screen “How the hell will higher commodity prices help us?” I will just remind you of the crucial difference between demand and supply driven increases in commodity prices. But okay, lets say we don’t want to do that – so lets instead do the following. The same central banks will “devalue” 15% against a composite index for stock prices in the US, the UK, the euro zone and Japan. Ok, I know you are very upset now. How can he suggest that? I am not really suggesting it, but I am arguing that monetary policy can easily work and all this “crazy idea” would actually do the trick and bring back NGDP back on track in both the US and Europe.  But you might have a better idea.

18 Comments
by Lars Christensen on November 3, 2011  •  Permalink
Posted in Chuck Norris, Chuck Norris Effect, MM Research agenda, Monetary policy, Monetary policy rules, NGDP Targeting, Nick Rowe, Nominal Income Targeting, The Great Recession, Uncategorized
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Posted by Lars Christensen on November 3, 2011

https://marketmonetarist.com/2011/11/03/the-chuck-norris-effect-swiss-lessons-and-a-not-so-crazy-idea/

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.

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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/

Milton Friedman on exchange rate policy #5

The euro – “a great mistake”

The European Monetary Union came into being in 1999, with the euro being introduced at the same time (as “account money”, and in 2002 as physical currency). Milton Friedman was an outspoken critic of this project, and his criticisms can be traced all the way back to “The Case for Flexible Exchange Rates” from 1953. The basic idea behind the euro is that to exploit the full potential of a single European market for goods, capital and labour – the inner market – a single common currency is essential. Friedman opposes this idea, as his view is namely that free trade is best promoted through floating exchange rates when wage and price formation are sluggish.

In Friedman’s eyes the euro area is not an optimal currency area, as the European goods and labour markets are still heavily regulated, and so prices and wages are relatively slow to adjust. At the same time, the mobility of labour between the euro countries is limited – due to both regulations and cultural differences. If this situation is not changed, it will, according to Friedman, inevitably lead to political tensions within the EU that may reach an intensity the European Central Bank (ECB) cannot ignore.

An asymmetric shock to one or more euro countries would require real national adjustment (price and wage adjustments), as nominal adjustments (exchange rate adjustments) are not possible within the framework of the monetary union. In Friedman’s view this would spark tension between the countries hit by the asymmetric shock and those not affected. Thus the euro might actually fan political conflict and the disintegration of Europe – which is in diametric opposition to the founding idea behind the single currency.

For Friedman the euro is not primarily an economic project. Rather, Friedman views the euro as basically a political concept designed to force further political integration onto Europe. Friedman believes that in the long run no country can maintain its sovereignty if it abandons its currency. The integration of the goods, capital and labour markets in the euro member countries is a prerequisite for the euro to function, and according to Friedman this can only happen through further political integration – something he fears will lead to the formation of a European superstate.

Recent developments unfortunately have proven Friedman’s analysis right…

5 Comments
by Lars Christensen on November 1, 2011  •  Permalink
Posted in euro crisis, Exchange rate policy, Exchange rates, Milton Friedman, MM Research agenda, Monetary institutions, The euro, The Great Recession
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Posted by Lars Christensen on November 1, 2011

https://marketmonetarist.com/2011/11/01/milton-friedman-on-exchange-rate-policy-5/

Christina Romer comes out in support of NGDP targeting

The momentum for NGDP targeting is clearly building. Anybody who is interested in monetary policy and in what will be driving the global market sentiment going forward should have a look this issue.

The latest convert is Christina Romer the former chair of Council of Economic Advisers.

Have a look at Dr. Romer’s open letter to Ben Bernanke.

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Update: Scott Sumner has an excellent comment on Christina Romer, where he pays tribute to the great Bennett McCallum. Some thing I naturally appreciate very much given the attention that I have been giving to McCallum and the McCallum rule myself.

David Beckworth also has a comment on Romer (and some Baseball stuff an European like me can’t understand…)

See a few of my McCallum posts here:
Bennett McCallum – grandfather of Market Monetarism

More on the McCallum-Christensen rule (and something on Selgin and the IMF)

7 Comments
by Lars Christensen on October 29, 2011  •  Permalink
Posted in Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Reading recommendations, The Great Recession

Posted by Lars Christensen on October 29, 2011

https://marketmonetarist.com/2011/10/29/christina-romer-comes-out-in-support-of-ngdp-targeting/

The “China Bluff”

Nick Rowe has a short comment on the news that EU’s rescue fund the European Financial Stability Facility (EFSF) will try to tempt China to put money into the rescue fund by issuing bonds in Euros.

It is hard to disagree with Nicks’ comment: “The whole Eurozone problem is that each Eurozone country was issuing bonds in what was effectively a foreign currency, and so it lacked an effective lender of last resort. Now, if the Telegraph is correct, the Eurozone as a whole is planning to repeat the mistake, and become just like Greece.”

But that is not really what I want to comment on, but rather Nick’s comment reminded me about what we could call the “China bluff”. Since 2008 every time a bank or a country gets into serious trouble and is on the brink of collapse a CEO or Finance Minister or even a Prime Minister will say that some wealthy investor will soon throw money into the “project”. Most often these promises of “new money” coming in turn out to be far fetched fantasies.

The Icelandic collapse in 2008 maybe the most stunning example of the “China bluff”. At that time it was not China, but rather Russia that would come to the rescue of Iceland and the Icelandic banking sector. As the entire Icelandic financial system was collapsing suddenly Icelandic officials announced that Russia would step in with a loan to help Iceland and judging from the comments one was led to think that the Russian government already had agreed to a substantial loan to Iceland. However, the whole thing turned out to be a “China bluff” – an attempt by official to turn around market sentiment by promising that a wealthy investor would save the day. We all today know that Iceland had to call in the help of the Nordic countries and the IMF to avoid a default – Russian money was nowhere to be seen.

My recommendation to investors and the like is therefore that every time an embattled bank or nation “promises” money from China, Russia or the Middle East be skeptical…VERY SKEPTICAL. It might just be the China bluff.
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Update: Marcus Nunes also has a comment on the EFSF-China story.

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by Lars Christensen on October 29, 2011  •  Permalink
Posted in Banking crisis, China, euro crisis, MM Research agenda, The euro, The Great Recession
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Posted by Lars Christensen on October 29, 2011

https://marketmonetarist.com/2011/10/29/the-china-bluff/

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
Tagged , , , , ,

Posted by Lars Christensen on October 27, 2011

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

Google Trends: From Greek crisis to euro crisis

I have always found it fascinating how much information the internet is providing “real time” and  I believe that a lot of economic data can and should be “extracted” from data on internet activity. A good example is the development in google searches on the European debt crisis. Here Google Trends is an excellent tool.

We we input “Greek crisis” into Google Trends we get this timeline.

The graph is pretty clear – searches on the “Greek crisis” spikes in early 2010 and then start to ease off in May 2010. But then again from the early part of the Summer this year the “Greek crisis” start to take off again.

Then lets add one more search: “euro crisis”.

Here we compare the number of searches for “euro crisis” and “Greek crisis” respectively.

The picture is clear – there is a very high correlation between “Greek crisis” and “euro crisis”. However, there is more to tell. While “Greek crisis” searches is much higher the “euro crisis” searches in 2010 the picture has now changed.

Greek crisis becoming a euro crisis

Hence, since July the number of searches for “euro crisis” has outpaced the number of searches for “Greek crisis”. Zoom in on 2011 searches here.

Said in another way what Google Trends is telling us is that the Greek crisis has turned into a euro crisis. Is that a surprise? Maybe not, but it is an indication of the systemic risks involved in this terrible crisis.

2 Comments
by Lars Christensen on October 26, 2011  •  Permalink
Posted in Banking crisis, euro crisis, The euro, The Great Recession
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Posted by Lars Christensen on October 26, 2011

https://marketmonetarist.com/2011/10/26/google-trends-from-greek-crisis-to-euro-crisis/

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