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Brad, Ben (Beckworth?) and Bob

I have been a bit too busy to blog recently and at the moment I am enjoying a short Easter vacation with the family in the Christensen vacation home in Skåne (Southern Sweden), but just to remind you that I am still around I have a bit of stuff for you. Or rather there is quite a bit that I wanted to blog about, but which you will just get the links and some very short comments.

First, Brad DeLong is far to hard on us monetarists when he tells his story about “The Monetarist Mistake”. Brad story is essentially that the monetarists are wrong about the causes of the Great Depression and he is uses Barry Eichengreen (and his new book Hall of Mirrors to justify this view. I must admit I find Brad’s critique a bit odd. First of all because Eichengreen’s fantastic book “Golden Fetters” exactly shows how there clearly demonstrates the monetary causes of the Great Depression. Unfortunately Barry does not draw the same conclusion regarding the Great Recession in Hall of Mirrors (I have not finished reading it all yet – so it is not time for a review yet) even though I believe that (Market) Monetarists like Scott Sumner and Bob Hetzel forcefully have made the argument that the Great Recession – like the Great Depression – was caused by monetary policy failure. (David Glasner has a great blog on DeLong’s blog post – even though I still am puzzled why David remains so critical about Milton Friedman)

Second, Ben Bernanke is blogging! That is very good news for those of us interested in monetary matters. Bernanke was/is a great monetary scholar and even though I often have been critical about the Federal Reserve’s conduct of monetary policy under his leadership I certainly look forward to following his blogging.

The first blog posts are great. In the first post Bernanke is discussing why interest rates are so low as they presently are in the Western world. Bernanke is essentially echoing Milton Friedman and the (Market) Monetarist message – interest rates are low because the economy is weak and the Fed can essentially not control interest rates over the longer run. This is Bernanke:

If you asked the person in the street, “Why are interest rates so low?”, he or she would likely answer that the Fed is keeping them low. That’s true only in a very narrow sense. The Fed does, of course, set the benchmark nominal short-term interest rate. The Fed’s policies are also the primary determinant of inflation and inflation expectations over the longer term, and inflation trends affect interest rates, as the figure above shows. But what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate). The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.

To understand why this is so, it helps to introduce the concept of the equilibrium real interest rate (sometimes called the Wicksellian interest rate, after the late-nineteenth- and early twentieth-century Swedish economist Knut Wicksell). The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment. Many factors affect the equilibrium rate, which can and does change over time. In a rapidly growing, dynamic economy, we would expect the equilibrium interest rate to be high, all else equal, reflecting the high prospective return on capital investments. In a slowly growing or recessionary economy, the equilibrium real rate is likely to be low, since investment opportunities are limited and relatively unprofitable. Government spending and taxation policies also affect the equilibrium real rate: Large deficits will tend to increase the equilibrium real rate (again, all else equal), because government borrowing diverts savings away from private investment.

If the Fed wants to see full employment of capital and labor resources (which, of course, it does), then its task amounts to using its influence over market interest rates to push those rates toward levels consistent with the equilibrium rate, or—more realistically—its best estimate of the equilibrium rate, which is not directly observable. If the Fed were to try to keep market rates persistently too high, relative to the equilibrium rate, the economy would slow (perhaps falling into recession), because capital investments (and other long-lived purchases, like consumer durables) are unattractive when the cost of borrowing set by the Fed exceeds the potential return on those investments. Similarly, if the Fed were to push market rates too low, below the levels consistent with the equilibrium rate, the economy would eventually overheat, leading to inflation—also an unsustainable and undesirable situation. The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors. The Fed influences market rates but not in an unconstrained way; if it seeks a healthy economy, then it must try to push market rates toward levels consistent with the underlying equilibrium rate.

It will be hard to find any self-described Market Monetarist that would disagree with Bernanke’s comments. In fact as Benjamin Cole rightly notes Bernanke comes close to sounding exactly as David Beckworth. Just take a look at these blog posts by David (here, here and here).

So maybe Bernanke in future blog posts will come out even more directly advocating views that are similar to Market Monetarism and in this regard it would of course be extremely interesting to hear his views on Nominal GDP targeting.

Third and finally Richmond Fed’s Bob Hetzel has a very interesting new “Economic Brief”: Nominal GDP: Target or Benchmark? Here is the abstract:

Some observers have argued that the Federal Reserve would best fulfi ll its mandate by adopting a target for nominal gross domestic product (GDP). Insights from the monetarist tradition suggest that nominal GDP targeting could be destabilizing. However, adopting benchmarks for both nominal and real GDP could offer useful information about when monetary policy is too tight or too loose.

It might disappoint some that Bob fails to come out and explicitly advocate NGDP level targeting. However, I am not disappointed at all as I was well-aware of Bob’s reservations. However, the important point here is that Bob makes it clear that NGDP could be a useful “benchmark”. This is Bob:

At the same time, articulation of a benchmark path for the level of nominal GDP would be a useful start in formulating and communicating policy as a rule. An explicit rule would in turn highlight the importance of shaping the expectations of markets about the way in which the central bank will behave in the future. A benchmark path for the level of nominal GDP would encourage the FOMC to articulate a strategy (rule) that it believes will keep its forecasts of nominal GDP aligned with its benchmark path. In recessions, nominal GDP growth declines significantly. During periods of inflation, it increases significantly.

The FOMC would then need to address the source of these deviations. Did they arise as a consequence of powerful external shocks? Alternatively, did they arise as a consequence either of a poor strategy (rule) or from a departure from an optimal rule?

That I believe is the closest Bob ever on paper has been to give his full endorsement of NGDP “targeting” – Now we just need Bernanke (and Yellen!) to tell us that he agrees.

——

UPDATE: This blog post should really have had the headline “Brad, Ben, Bob AND George”…as George Selgin has a new blog post on the new(ish) blog Alt-M and that is ‘Definitely Not “Ben Bernanke’s Blog”’

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Book of the day – Nunes and Cole

Not much time for blogging, but this is ‘book of the day’ – it just arrived in the mail. Maybe you should buy it as well – do it here (ebook) or here (paperback).

nunescole

See also here.

New book on Market Monetarism from Nunes and Cole

I don’t have much time for blogging, but buy this new book written by my good friends Marcus Nunes and Benjamin Cole:  Market Monetarism Roadmap to Economic Prosperity

here is the book description:

Market Monetarism – Roadmap to Economic Prosperity takes readers though a succinct, entertaining and accessible history of United States monetary policy in the postwar era, and how the Federal Reserve Board propelled the nation into The Great Inflation (think 1960s-1970s), a brief Volcker Transition (early 1980s), then a pleasant sojourn to The Great Moderation (mid-1980s-2007), before a trip to The Great Recession (2008–). Abundant charts clearly and amply illustrate monetary and economic events. The concepts of Market Monetarism and nominal GDP targeting are also introduced, which provide a policy framework for the Federal Reserve Board and other central bankers to avoid future inflationary and recessionary traps.

And here is what I have to say about it on the cover of the book:

“Nunes and Cole have written the first fully Market Monetarist account of post-second world war US monetary history. They forcefully demonstrate the monetary nature of both the Great Inflation and the Great Recession. They show that the Federal Reserve is to blame both for the high inflation of the 1970s and the horrors of the Great Recession. I gladly recommend this book to the layperson and the economist alike who would like to understand why and how failed monetary policy caused the present crisis.”

 

Update: Scott Sumner also comments on the book.

Guest post: J’Accuse Mr. Ben Bernanke-San

Benjamin Cole is well-known commentator on the Market Monetarist blogs. Benjamin’s perspective is not that of an academic or a nerdy commercial bank economist, but rather the voice of the practically oriented advocate of Market Monetarist monetary policies.

I greatly admire Benjamin for his always frank advocacy for monetary easing to pull the US economy out of this crisis. I often also disagree with Benjamin, but my blog is open to free and frank discussion of monetary policy issues. I have therefore invited Benjamin to share his views on US monetary policy and to outline his monetary plan for revival of the US economy.

Benjamin’s advocacy brings memories of the 1980s where the US right had a pro-growth agenda that spurred optimism not only in the US, but around the world.  I am grateful to Benjamin for his contribution to my blog and hope my readers will enjoy it.

Benjamin, the floor is yours…

Lars Christensen

Guest post: J’Accuse Mr. Ben Bernanke-San

By Benjamin Cole

Regime Uncertainty? The business class of the United States needs a clear picture of where the Federal Reserve Board plans to go, and assurance that the Fed is will brook no obstacle or political interference in its journey.

Moreover, the Fed must define our future not only in terms of policies, but clear targets.  Lastly, the Fed must eschew any regime that places prosperity below other related goals.  The Fed’s obligations are catholic, enduring and immediate—and cannot be dodged by citing adherence and slavish rectitude towards “price stability,” however defined. Beating inflation is easy—the Bank of Japan has proved that, and redundantly.

Providing a regime for prosperity is another matter.

Recent events prove that the Fed, like the Bank of Japan, has failed in its true mission—sustained economic prosperity—perhaps aided by mediocre federal regulatory and tax policies.

The Cure—Market Monetarism

Ben Bernanke, Fed chieftain, must forthrightly embrace the targeting of growth in nominal gross domestic product, or NGDP, then publicly set targets, and then identify the appropriate, aggressive and sustained policies or mechanisms to reach the NGDP targets.  These are basic market monetarism principles.  Feeble dithering is not Market Monetarism.

Transparency, clarity and resolve in government are tonics upon markets, as they are upon democracies.  There is no better way to govern, whether from the White House or the Federal Reserve.   Ergo, Bernanke needs to directly, with resolve and without equivocation, dissembling or qualifiers, adopt of NGDP target of 7.5 percent annual growth for the next four years.  To get there, Bernanke needs to affirm to the market that the Fed will conduct quantitative easing to the tune of $100 billion a month until quarterly readings assure that we have reached the 7.5 percent level of NGDP growth—a policy very much in keeping with what the great economist Milton Friedman recommended to Japan, when he advised that nation in the 1990s.  Forgotten today is not only did Friedman advocate tight money for restraining inflation, but he also advocated aggressive central bank action to spur growth in low-inflation environments.

The recommended concrete sum of $100 billion a month in QE is not an amount rendered after consultation with esoteric, complex and often fragile econometric models.  Quite the opposite—it is sum admittedly only roughly right, but more importantly a sum that sends a clear signal to the market.  It is a sum that can be tracked every month by all market players.  It has the supreme attributes of resolve, clarity and conviction. The sum states the Fed will beat the recession, that is the Fed’s goal, and that the Fed is bringing the big guns to bear until it does, no ifs, ands, or buts.

At such time that the NGDP growth targets are hit, the Fed should transparently usher in a new rules-based regime for targeting NGDP going forward, drawing upon the full range of tools, from interest rates to QE to limiting interest on excess reserves at commercial banks.

At the present, the Fed needs to stop rewarding banks to sit on their hands, as it does when it pays banks 0.25 percent annual interest on excess reserves.  This is not a time for “do nothing” policies, or to promote caution and inaction on the part of our nation’s banks.  Bankers always want to lend, especially on real estate, in good times—oddly enough, when risks to capital are highest. In bad times (after property values have cratered) banks don’t want to lend.  No need to the Fed to exacerbate this market curiosity.

Consider the current economic environment: Our countrymen are too much unemployed; indeed they are quitting the labor force, and labor participation rates are falling.  Our real estate industry is in a shambles, and the Dow Jones Industrial Average is languishing at levels breeched 13 years ago.  Ever more we resemble Japan.  In the United States, real GDP is 13 percent below trend, with attendant losses in income for businesses and families.  Investors have been kicked in the head—it is precisely the wrong time for do-nothing leaders, timid caretakers or kowtowing to the Chicken Inflation Littles.

That said, certain policies seem to reward unemployment, most notably the extended unemployment insurance.  The record shows people tend to find jobs when insurance runs out.  Ergo, unemployment insurance should not be extended—harsh medicine, but necessary for harsh times.

The American Character

The worst course of action today is to allow a peevish fixation—really an unhealthy obsession—with inflation to undercut a confident and expansionary monetary policy.

The United States economy flourished from 1982 to 2007—industrial production, for example, doubled, while per capita rose by more than one-third—while inflation (as measured by the CPI) almost invariably ranged between 2 percent and 6 percent. That is not an ideology speaking, that is not a theoretical construct.  It is irrefutably the historical record.  If that is the historical record, why the current hysterical insistence that inflation of more than 2 percent is dangerous or even catastrophic?

Why would Bernanke genuflect to 2 percent inflation—even in the depths of the worst recession since the days of Franklin Delano Roosevelt?  It is an inexplicably poor time to pompously pettifog about minute rates of inflation.

Add on: Americans like boom times; investors take the plunge not when they sense a pending 2 percent increase in asset values, but that home runs will be swatted. Few invest in real estate or stocks assuming values will rise by 2 percent a year.  Americans need the prospect of Fat City.  We have the gambling streak in us.  The Fed and tax and regulatory code must reward  risk-taking, a trait deep in the American character, but suffocated lately by the Fed’s overly cramped, even perversely obstinate monetary policy.  Is there anything more deeply annoying than prim announcements from the Fed that it could do more for the economy, but is not?

While the American business class needs assurance of a pro-growth monetary policy, instead the Fed issues sermonettes that caution, to the point of inaction, is prudent.  Every commodities boom—and commodities prices are determined in global markets and speculative exchanges—chills the American business class, who then fear the monetary noose of the Fed will draw tight.  That sort of regime uncertainty destroys investment incentives.

Some say the Fed cannot stimulate, as the economy cannot expand under he current regulatory regime, and thus only inflation will result. To be sure, the U.S. federal government needs to radically reconsider its posture towards business, and abandon any hint of an adversarial stance.  It is the private sector, for of all its flaws, that generates innovations and a higher standard of living.  The private sector, every year, does more with less, while the opposite is true of the federal government, civilian and military. Shrinking the federal government share of GDP to 18 percent or less should also be a goal.

However, in no way should monetary policy be held captive to the fiscal policy objectives or outcomes.  Whatever the share of federal spending of total outlays, or whatever the size of the federal deficit, or whatever regulatory regime is in place, the Fed must always target NGDP, to give at least that level of regime certainty to our business class.  By and large, today’s tax and regulatory regime is better than that of the 1970s, and on par with that of the 1980s and 1990s.  And most concede the United States has a better regulatory posture than the governments of Europe, or even that of mainland China.  The productivity of US workers is still rising, and unit labor costs are actually falling.  The regulatory environment could be improved, but that is no grounds to add to woes by an unpredictable and restrictive monetary policy.

Conclusion

There are times in history when caution is not rewarded, and for the crafters of monetary policy, this is one of those times.  What appears prudent by old shibboleths is in fact precarious by today’s realities.   Feeble inaction, and stilted moralizing about inflation are not substitutes for transparent resolve to reinvigorate the United States economy.

Market Monetarism is an idea whose time has come.  It offers a way to prosperity without crushing federal deficits, and offers regime stability to the American business class.

The only question is why Bernanke instead chooses the pathway cleared by the Bank of Japan.

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