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Yellen should re-read Friedman’s “The Role of Monetary Policy” and lay the Phillips curve to rest

It is the same thing every month – anybody seriously interested in financial markets and the global economy are sitting and waiting for the US labour market report to come out even though the numbers are notoriously unstable and unreliable.

Why is that? The simple answer is that it is not because the numbers are important on their own, but because the Federal Reserve seems to think the labor market report is very important.

And that particularly goes for Fed-chair Janet Yellen who doesn’t seem to miss any opportunity to talk about labour market conditions.

The problematic re-emergence of the Phillips curve as a policy indicator

To Janet Yellen changes in inflation seems to be determined by the amount of slack in the US labour market and if labour market conditions tighten then inflation will rise. This of course is essentially an old-school Phillips curve relationship and a relationship where causality runs from labour market conditions to wage growth and on to inflation.

This means that for the Yellen-fed labour market indicators essentially are as important as they were for former Fed chairman Arthur Burns in the 1970s and that could turn into a real problem for US monetary policy going forward.

Yellen should re-read Friedman’s “The Role of Monetary Policy”

To understand this we need to go back to Milton Friedman’s now famous presidential address delivered at the Eightieth Annual Meeting of the American Economic Association – “The Role of Monetary Policy” – in 1967 in, which he explained what monetary policy can and cannot do.

Among other things Friedman said:

What if the monetary authority chose the “natural” rate – either of interest or unemployment – as its target? One problem is that it cannot know what the “natural” rate is. Unfortunately, we have as yet devised no method to estimate accurately and readily the natural rate of either interest or unemployment. And the natural rate will itself change from time to time. But the basic problem is that even if the monetary authority knew the natural rate, and attempted to peg the market rate at that level, it would not be led to determinate policy. The “market” rate will vary from the natural rate for all sorts of reasons other than monetary policy. If the monetary authority responds to these variations, it will set in train longer term effects that will make any monetary growth path it follows ultimately consistent with the policy rule. The actual course of monetary growth will be analogous to a random walk, buffeted this way and that by the forces that produce temporary departures of the market rate from the natural rate.

To state this conclusion differently, there is always a temporary trade-off between inflation and unemployment: there is no permanent trade-off. The temporary trade-off comes not from inflation per se, but from unanticipated inflation which generally means, from a rising rate of inflation. The widespread belief that there is a permanent trade-off is a sophisticated version of the confusion between “high” and “rising” that we all recognize in simpler forms. A rising rate of inflation may reduce unemployment, a high rate will not.

…To state the general conclusion still differently, the monetary authority controls nominal quantities – directly, the quantity of its own liabilities. In principle, it can use this control to peg a nominal quantity – an exchange rate, the price level, the nominal level of income, the quantity of money by one or another definition – or to peg the rate of change in a nominal quantity – the rate of inflation or deflation, the rate of growth or decline in nominal national income, the rate of growth of the quantity of money.

It cannot use its controls over nominal quantities to peg a real quantity – the real rate of interest, the rate of unemployment, the level of real national income, the real quantity of money, the rate of growth of real income, or the rate of growth of the real quantity of money.

For many years – at least going back to the early 1990s – this was the clear consensus among mainstream macroeconomists. It is of course a variation of Friedman’s dictum that “inflation is always and everywhere a monetary phenomena.”

Central banks temporary can impact real variables such as unemployment or real GDP, but it cannot permanently impact these variables. Similarly there might be a short-term correlation between real variables and nominal variables such as a correlation between nominal wage growth (or inflation) and unemployment (or the output gap).

However, inflation or the growth of nominal income is not determined by real factors in the longer-term (and maybe not even in the short-term), but rather than by monetary factors – the balance between demand and supply of money.

The Yellen-fed seems to be questioning Friedman’s fundamental insight. Instead the Yellen-Fed seems to think of inflation/deflation as a result of the amount of “slack” in the economy and the Yellen-fed is therefore preoccupied with measuring this “slack” and this is what now seems to be leading Yellen & Co. to conclude it is time to tighten US monetary conditions.

This is of course the Phillips curve interpretation of the US economy – there has been steady job growth and unemployment is low so inflation most be set to rise no matter what nominal variables are indicating and not matter what market expectations are. Therefore, Yellen (likely) has concluded that a rate hike soon is warranted in the US.

This certainly is unfortunately. Instead of focusing on the labour market Janet Yellen should instead pay a lot more attention to the development in nominal variables and to the expectations about these variables.

What are nominal variable telling us?

Friedman mentions a number of variables that the monetary authorities directly or indirectly can control – among others the price level, the level of nominal income and the money supply. We could add to that nominal wages.

So what are these variables then telling us about the US economy and the state of monetary policy? Lets take them one-by-one.

We start with the price level – based on core PCE deflator.

PCE core

The graph shows that it looks as if the Federal Reserve has had a price level target since the (“official”) end of the 2008-9 recession in the summer of 2009. In fact at no time since 2009 has the actual price level (PCE core deflator) diverged more than 0.5% from the trend. Interestingly, however, the trend growth rate of the price level has been nearly exactly 1.5% – pretty much in line with medium-term market expectations for inflation, but below the Fed’s official 2% inflation target.

However, if we define the Fed’s actual target as the trend in the price level over the past 5-6 years then there is no indication that monetary policy should be tightened. In fact the actual price level has this year fallen slightly below the 1.5%-“target path” indicating if anything that monetary conditions is slightly too tight (but nearly perfect). Obviously if we want to hit a new 2% path then someeasing of monetary conditions is warranted.

So how about the favorite Market Monetarist-indicator – Nominal GDP?

NGDP gap

Again the picture is the same – the Fed has actually delivered a remarkable level of nominal stability since the summer of 2009. Hence, nominal GDP has grown nicely along at a trend since Q3 2009 and the actual NGDP level has remains remarkably close to the trend path for NGDP – as if the Fed was actually targeting the NGDP level along a (close to) 4% path.

And as with the price level – the present NGDP level is slightly below the trend over the past 5-6 years indicating a slightly too tight monetary stance. Furthermore, it should be noted that prediction markets such as Hypermind presently are predicting around 3.5% NGDP growth in 2015 – below the 4% de facto target. So again if anything US monetary policy is – judging from NGDP and NGDP expectations – just a tiny bit too tight.

And what about Milton Friedman’s favourite nominal indicator – the broad money supply? Here we look at M2.

M2 gap US

Once again we have seen a remarkable amount of nominal stability judging from the development in US M2 – particularly since 2011 with only tiny deviations in the level of M2 from the post-2009 trend. Milton Friedman undoubtedly would have praised the Fed for this. Hence, it looks as if the Fed actually have had a 7% growth path target for M2.

But again, recently – as is the case with the price level and NGDP – the actual money supply (M2) as dropped moderately below the the post-2009 trend indicating that monetary conditions are slightly too tight rather than too easy.

Then what about nominal wages? We here look at average hourly earnings for all all employees (total private).

wage gap

Surprise, surprise – again incredible nominal stability in the sense that average hourly earnings have grown very close to a near-perfect 2% trend in the past 5-6 years. However, unlike the other nominal measures recently the “wage gap” – the difference between actual nominal wages and the trend – has turned slightly positive indicating that monetary conditions is a bit too easy to achieve 2% trend growth in US nominal wages.

But again we are very, very close to the post-2009 trend. We could of course also notice that a 2% nominal wage growth target is unlikely to be comparable to a 2% inflation target if we have positive productivity growth in the US economy.

Conclusion: Preoccupation with the Phillips curve could course the Fed to hike too early

…Nominal variables tell the Fed to postpone a hike until 2016

The message from Milton Friedman is clear – we should not judge monetary conditions on real variables such as labour market conditions. Instead we should focus on nominal variables.

If we look at nominal variables – the price level, NGDP, the money supply and nominal wages – the conclusion is rather clear. The Fed has actually since 2009 delivered a remarkable level of nominal stability in terms of keeping nominal variables very close to the post-2009 trend.

If we want to think about the Bernanke-Fed the Fed had one of the following targets: 1.5% core PCE level targeting, 4% NGDP level targeting, 7% M2-level targeting or 2% wage level targeting at least after the summer of 2009.

However, the Yellen-Fed seems to be focusing on real variables – and particularly labour market variables – instead. This is apparently leading Janet Yellen to conclude that monetary conditions should be tightened.

However, nominal variables are telling a different story – it seems like monetary conditions have become slightly too tight within the past 6-12 months and therefore the Fed needs to communicate that it will not hike interest rates in September if it wants to keep nominal variables on their post-2009 path.

Obviously the Fed cannot necessarily hit more than one nominal variable at the time so the fact that it has kept at least four nominal variables on track in the past 5-6 years is quite remarkable. However, the Fed needs to chose one nominal target and particularly needs to give up the foolish focus on labour market conditions and instead fully commit to a nominal target. My preferred target would certainly be a 4% (or 5%) Nominal GDP level target.

And Chair Yellen, please lay the Phillips curve to rest if you want to avoid sending the US economy into recession in 2016!

PS My thinking on these issues has strongly be influence by my good friend Mike Darda.

PPS think of the present time as one where Milton Friedman would be more dovish than Arthur Burns.

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: roz@specialistspeakers.com. For US readers note that I will be “touring” the US in the end of October.

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The market’s message to Yellen: You have become too hawkish

Recently the communication from the Federal Reserve seems to have become more hawkish. It all started on July 15 when Fed chair Janet Yellen testified in front of the House Financial Services Committee. Yellen among other things said:

“If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target”

This has been followed by comments from other Fed officials such as St. Louis Fed president James Bullard who in an interview with Fox TV on July 20 said that there was a “50% probability” a September rate hike. As my loyal readers know I like to watch the markets to assess monetary conditions. So lets see what the markets are saying about the US monetary policy stance right now – and how it has changed on the back of Yellen and Bullard’s comments. Lets start with the much talked about gold price. gold price It is hard to miss that it was Yellen’s hawkish comments that has sent gold prices down in recent weeks. So the drop in gold prices certainly is a indication that US monetary conditions are getting tighter. But it would of course be wrong to reason from the change in one price. We need more – so how about the dollar? DXY This is the so-called Dollar Index (DXY). Here the picture certainly is less clear than from the gold price. In fact the dollar index today is more or less a the same level as on July 15 when Yellen hinted at a rate hike this year.

However, we should remember that the exchange rate is telling us something about the relative monetary policy, so if US monetary conditions is in fact getting tighter and the dollar index is flat then it is an indication that monetary conditions are also getting tighter outside of the US. Given the Greek crisis and Chinese growth worries this is not an unreasonable assumption.

So how about inflation expectations? This is 2-year/2-year inflation expectations (so basically the expectation to the average inflation rate from August 2017 to August 2019) inflation expectations 2y2y Again the picture is clear – after Yellen and Bullard’s comments 2y/2y inflation expectations have dropped and equally important this happened at a time when inflation expectations already where below 2%. It should also be noted that prediction markets are telling the same story. Hence, from some time Hypermind’s market for nominal GDP growth in 2015 has been somewhat below 4% (which I believe has been Fed’s unannounced target for some time – see here.) The Fed is too hawkish and rate hikes should be postponed Concluding, the Fed’s more hawkish rhetoric has de facto led to a tightening of US monetary conditions already, which has pushed inflation expectations below the Fed’s own 2% inflation target. So effectively the markets are tellling the Fed that monetary conditions are becoming too tight and a September rate hike as suggested by advocated by Bullard would be premature. So if I was on the FOMC I would certainly vote against any rate hike in the present situation.

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: roz@specialistspeakers.com.

The Fed’s un-announced 4% NGDP target was introduced already in July 2009

Scott Sumner started his now famous blog TheMoneyIllusion in February 2009 it was among other things “to show that we have fundamentally misdiagnosed the nature of the recession, attributing to the banking crisis what is actually a failure of monetary policy”.

Said in another way the Federal Reserve was to blame for the Great Recession and there was only one way out and that was monetary easing within a regime of nominal GDP level targeting (NGDP targeting).

NGDP targeting is of course today synonymous Scott Sumner. He more or less single-handedly “re-invented” NGDP targeting and created an enormous interest in the topic among academics, bloggers, financial sector economists and even policy makers.

The general perception is that NGDP targeting and Market Monetarism got the real break-through in 2013 when the Federal Reserve introduced the so-called Evans rule in September 2012 (See for example Matt Yglesias’ tribute to Scott from September 2012).

This has also until a few days ago been my take on the story of the success of Scott’s (and other’s) advocacy of NGDP targeting. However, I have now come to realize that the story might be slightly different and that the Fed effectively has been “market monetarist” (in a very broad sense) since July 2009.

The Fed might not have followed the MM game plan, but the outcome has effectively been NGDP targeting

Originally Scott basically argued that the Fed needed to bring the level nominal GDP back to the pre-crisis 5% trend path in NGDP that we had known during the so-called Great Moderation from the mid-1980s and until 2007-8.

We all know that this never happened and as time has gone by the original arguments for returning to the “old” NGDP trend-level seem much less convincing as there has been considerable supply side adjustments in the US economy.

Therefore, as time has gone by it becomes less important what is the “starting point” for doing NGDP targeting. Therefore, if we forgive the Fed for not bringing NGDP back to the pre-crisis trend-level and instead focus on the Fed’s ability to keep NGDP on “a straight line” then what would we say about the Fed’s performance in recent years?

Take a look at graph below – I have used (Nominal) Private Consumption Expenditure (PCE) as a monthly proxy for NGDP.

PCE gap

If we use July 2009 – the month the 2008-9 recession officially ended according to NBER – as our starting point (rather than the pre-crisis trend) then it becomes clear that in past five years PCE (and NGDP) has closely tracked a 4% path. In fact at no month over the past five years have PCE diverged more than 1% from the 4% path. In that sense the degree of nominal stability in the US economy has been remarkable and one could easily argue that we have had higher nominal stability in this period than during the so-called Great Moderation.

In fact I am pretty sure that if somebody had told Scott in July 2009 that from now on the Fed will follow a 4% NGDP target starting at the then level of NGDP then Scott would have applauded it. He might have said that he would have preferred a 5% trend rather than a 4% trend, but overall I think Scott would have been very happy to see a 4% NGDP target as official Fed policy.

The paradox is that Scott has not sounded very happy about the Fed’s performance for most of this period and neither have I and other Market Monetarists. The reason for this is that while the actual outcome has looked like NGDP targeting the Fed’s implementation of monetary policy has certainly not followed the Market Monetarist game plan.

Hence, the Market Monetarist message has all along been that the Fed should clearly announce its target (a NGDP level target), do aggressive quantitative easing to bring NGDP growth “back on track”, stop focusing on interest rates as a policy instrument and target expected NGDP rather than present macroeconomic variables. Actual US monetary policy has gradually moved closer to this ideal on a number of these points – particularly with the so-called Evan rule introduced in September 2012, but we are still very far away from having a Market Monetarist Fed when it comes to policy implementation.

However, in the past five years the implementation of Fed policy has been one of trial-and-error – just think of QE1, QE2 and QE3, two times “Operation Twist” and all kinds of credit policies and a continued obsession with using interest rates rates as the primary policy “instrument”.

I believe we Market Monetarists rightly have been critical about the Fed’s muddling through and lack of commitment to transparent rules. However, I also think that we today have to acknowledge that this process of trail-and-error actually has served an important purpose and that is to have sent a very clear signal to the financial markets (and others for that matter) that the Fed is committed to re-establishing some kind of nominal stability and avoiding a deflationary depression. This of course is contrary to the much less clear commitment of the ECB.

The markets have understood it all along (and much better than the Fed)

Market Monetarists like to say that the markets are better at forecasting and the collective wisdom of the markets is bigger than that of individual market participants or policy makers and something could actually indicate that the markets from an early point understood that the Fed de facto would be keeping NGDP on a straight line.

An example is the US stock market bottomed out a few months before we started to establish the new 4% trend in US NGDP and the US stock markets have essentially been on an upward trend ever since, which is fully justified if you believe the Fed will keep this de facto NGDP target in place. Then we should basically be expecting US stock prices to increase more or less in line with NGDP (disregarding changes to interest rates).

Another and even more powerful example in my view is what the currency markets have been telling us. I  (and other Market Monetarists) have long argued that market expectations play a key role in the in the implementation of monetary policy and in the monetary policy transmission mechanism.

In a situation where the central bank’s NGDP level target is credible rational investors will be able to forecast changes in the monetary policy stance based on the actual level of NGDP relative to the targeted level of NGDP. Hence, if actual NGDP is above the targeted level then it is rational to expect that the central bank will tighten the monetary policy stance to bring NGDP back on track with the target. This obviously has implications for the financial markets.

If the Fed is for example targeting a 4% NGDP path and the actual NGDP level is above this target then investors should rationally expect the dollar to strengthen until NGDP is back at the targeted level.

And guess what this is exactly how the dollar has traded since July 2009. Just take a look at the graph below.

NGDP gap dollar index 2

We are looking at the period where I argue that the Fed effectively has targeted a 4% NGDP path. Again I use PCE as a monthly proxy for NGDP and again the gap is the gap between the actual and the “targeted” NGDP (PCE) level. Look at the extremely close correlation with the dollar – here measured as a broad nominal dollar-index. Note the dollar-index is on an inverse axis.

The graph is very clear. When the NGDP gap has been negative/low (below target) as in the summer of 2010 then the dollar has weakened (as it was the case from from the summer of 2010under spring/summer of 2011. And similarly when the NGDP gap has been positive (NGDP above target) then the dollar has tended to strengthen as we essentially has seen since the second half of 2011 and until today.

I am not arguing that the dollar-level is determining the NGDP gap, but I rather argue that the dollar index has been a pretty good indicator for the future changes in monetary policy stance and therefore in NGDP.

Furthermore, I would argue that the FX markets essentially has figured out that the Fed de facto is targeting a 4% NGDP path and that currency investors have acted accordingly.

It is time for the Fed to fully recognize the 4% NGDP level target

Just because there has a very clear correlation between the dollar and the NGDP gap in the past five years it is not given that that correlation will remain in the future. A key reason for this is – and this is a key weakness in present Fed policy – that the Fed has not fully recognize that it is de facto targeting a 4%. Therefore, there is nothing that stops the Fed from diverging from the NGDP rule in the future.

Recognizing a 4% NGDP level target from the present level of NGDP in my view should be rather uncontroversial as this de facto has been the policy the Fed has been following over the past five years anyway. Furthermore, it could easily be argued as compatible  with the Fed’s (quasi) official 2% inflation target (assuming potential real GDP growth is around 2%).

In my previous post I argued that the ECB should introduce a 4% NGDP target. The Fed already done that. Now it is just up to Fed Chair Janet Yellen to announce it officially. Janet what are you waiting for?

Stock picker Janet Yellen

If you are looking for a new stock broker look no further! This is Fed chair Janet Yellen at her testimony in the US Senate yesterday:

“Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”

This is quite unusual to say the least that the head of most powerful central bank in the world basically is telling investors what stocks to buy and sell.

Unfortunately it seems to part of a growing tendency among central bankers globally to be obsessing about “financial stability” and “bubbles”, while at the same time increasingly pushing their primary nominal targets in the background. In Sweden an obsession about household debt and property prices has caused the Riksbank to consistently undershot its inflation target. Should we now start to think that the Fed will introduce the valuation of biotech and social media stocks in its reaction function? Will the Fed tighten monetary policy if Facebook stock rises “too much”? What is Fed’s “price target” in Linkedin?

I believe this is part of a very unfortunate trend among central bankers around the world to talk about monetary policy in terms of “trade-offs”. As I have argued in a recent post in the 1970s inflation expectations became un-anchored exactly because central bankers refused to take responsibility for providing a nominal anchor and the excuse was that there are trade-offs in monetary policy – “yes, we can reduce inflation, but that will cause unemployment to increase”.

Today the excuse for not providing a nominal anchor is not unemployment, but rather the perceived risk of “bubbles” (apparently in biotech and social media stocks!)  The result is that inflation expectations again are becoming un-anchored – this time the result, however, is not excessively high inflation, but rather deflation. The impact on the economy is, however, the same as the failure to provide a nominal anchor will make the working of the price system less efficient and therefore cause a general welfare lose.

I am not arguing that there is not misallocation of credit and capital. I am just stating that it is not a task for central banks to deal with these problems. In think that moral hazard problems have grown significantly since 2008 – particularly in Europe. Therefore governments and international organisations like the EU and IMF need to reduce implicit and explicit guarantees and subsidies to (other) governments, banks and financial institutions to a minimum. And central banks should give up credit policies and focus 100% on monetary policy and on providing a nominal anchor for the economy and leave the price mechanism to allocate resources in the economy.

The Bird fight – Yellen vs Summers

I have co-authored a paper on Yellen versus Summers with my Danske Bank colleagues Signe Roed-Frederiksen, Kristoffer Kjær Lomholt and Mikael Olai Milhøj. This is the abstract:

Fed chairman Ben Bernanke’s second four-year term expires on 31 January 2014 and his successor needs to be vetted by Congress before then. Although a dark horse cannot be ruled out, there are two clear candidates: Lawrence Summers and Janet Yellen. The debate of who is the most suited successor to Big Ben has been surprisingly little about the candidate’s economic views and the level of innuendo has been a US presidential campaign worthy. The US economy is on the path to recovery and it is now as important as ever how the new chairman plans to run future US monetary policy. This paper discusses the differences in economic policy of Yellen and Summers and in particular if it is fair to call Yellen the most dovish of the two.

Our conclusions are as follows. We believe that the characterisation by the media of Lawrence Summers as being more hawkish than Janet Yellen is too simplistic. In fact we argue that Summers and Yellen are equally dovish when economic conditions improve, since they both have a very strong aversion to unemployment relative to inflation. It is first when the US is hit by a negative demand shock while interest rates are at the zero lower bound that Summers is likely to be more hawkish than Yellen. This is due to Summers’s open scepticism towards alternative monetary stimulus instruments such as QE – a scepticism not shared by Yellen.

We point out the importance of a transparent Fed and we believe that Yellen would support this transparency. On the other hand, Summers’s flamboyant personality together with his comments that he will be a fire-fighting Fed chairman indicate that the Fed would become less transparent if he was to be chosen by Obama.

Read the rest of the paper here.

Airport musings on India, Danish efficiency and Larry Summers

I am writing this while I am sitting in London’s Heathrow Airport (Terminal 5) after having spent a couple of days in London.

To be quite frank I think I have been suffering from a bit of writer’s block in the past couple of weeks – maybe because I have been too busy with other things, but also because I have been a bit uncertain what stories I really wanted to tell. I could of course blame Paul Krugman – after all his writings on Milton Friedman greatly upset me and I wanted to respond to Krugman’s posts on Friedman, but on the other hand I didn’t really want Krugman to dictate what I was going to blog about. So enough said about Krugman.

So now I am trying to get over the writer’s block with another round of musings.

The most interesting story – India. Unfortunately it is not positive

Since May the Indian rupee has more or less been in a free fall to the great concern of Indian policy makers who are trying hard to curb the sell-off. Anybody who has read and understood Milton Friedman’s classic article “The Case for Flexible Exchange Rates” will be able to realize that the Reserve Bank of India (RBI) is making a serious policy mistake when it is trying to curb the weakening of the rupee.

The sell-off in the rupee has likely been triggered by market fears of Fed tapering, general Emerging Markets gloom and spill-over from the Chinese growth slowdown. However, it is also clear that India is suffering from serious structural problems which have resulted in a double deficit – sizable current account and public finance deficits.

All this easily explains and justifies the weakening of the rupee. Hence, the sell-off is a natural reaction to external shocks and imbalances in the Indian economy. The Indian authorities should therefore fundamentally welcome the drop in the rupee as a natural adjustment. An adjustment that will be a lot smoother than if India had had a fixed exchange rate regime.

However, the RBI’s insistence on trying to curb the sell-off in the rupee is fundamentally an abrupt monetary policy tightening and the likely result is that Indian growth is going to take a beating.

One can of course argue that the RBI long ago should have moved to tighten monetary policy – NGDP growth clearly was excessive in 2008-10. However, the fundamental problem is the RBI’s lack of commitment to a clear and transparent monetary policy rule. The RBI’s continued extremely discretionary stop-go policies are a serious problem in terms of both macroeconomic and financial stability.

In my view the RBI should implement an NGDP targeting regime targeting 7 or 8% NGDP growth going forward (see more on that suggestion here). That would be a “tighter” monetary policy than what we have seen in recent years, but it would likely be “expansionary” in the sense that it would provide a lot more stability for the Indian economy, which likely would help boost long-term real GDP growth. Furthermore, a clear and transparent monetary policy would provide the necessary nominal stability for the Indian government to start serious structural reforms to reduce India’s large public budget deficit and to boost long-term trend growth.

Ashok Rao has a couple of very good posts on India. Ashok provides some justification for the RBI’s attempts to curb the sell-off in the rupee and he also provides some arguments why we should not become too negative on the Indian economy. I disagree with some of what Ashok is saying, but he has good arguments. Take a look for yourself (here and here).

Denmark is the most efficient economy in the world (at least in terms of airport security)

Thursday morning when I was flying to London from Copenhagen I noticed a billboard saying that Copenhagen Airport has been voted the most efficient airport in the world when it comes to airport security by something called Skytrax. I have earlier argued that efficiency in airport security is a good indicator of the overall level of regulation/efficiency in an economy.

So I guess if Skytrax is right then there might be some reason to argue that Denmark indeed is the most efficient/competitive economy in the world or at least the least regulated economy in the world. If we look at different competitive and regulation indicators Denmark actually is on the very top in the world – whether you look at the Heritage Foundation’s Economic Freedom Index, the World’s Ease of Doing Business index or the World Economic Forum’s Global Competitiveness Report.

I haven’t had time to look more at the Skytrax data, but I am pretty convinced that the Skytrax rating of airport security efficiency will be highly correlated with other measures of economic efficiency/competitiveness. Maybe, maybe one of these days I will write more on this…

Summers is not more hawkish than Yellen, but he will be massively more partisan

I have been trying to write a blog post on Summers vs Yellen, but now I will instead just state some of the conclusions here.

It is normally assumed that Larry Summers will be a more hawkish Fed chairman than Janet Yellen because he dislikes quantitative easing (as many other paleo-Keynesians). However, I think it is important to note that Summers’ preferences in terms of unemployment versus inflation certainly are not hawkish. Rather the opposite. He just thinks that fiscal policy rather than monetary policy should be used to boost aggregate demand.

Therefore, in a world where the Fed is moving toward “tapering” and in a couple of years rate hikes there is likely not a big difference between Yellen and Summers. It is only if additional “stimulus” is needed – due to for example a new negative shock – that Summers will be more hawkish than Yellen.

Furthermore, Summers is a Democrat and part of the Clinton “family”. Therefore I am fairly convinced that he will do anything to help Hillary Clinton get elected US president in 2016. Yellen on the other hand is much less likely to act as a partisan Fed chairwoman.

Now some might say that Market Monetarists have been screaming about the need for monetary easing for years so we should be happy if Summers becomes Fed chairman and actually steps up monetary easing toward the 2016 presidential elections.

That, however, would completely miss the point Market Monetarists have been making. We want a clear monetary policy rule. We don’t care about discussing monetary policy in terms of hawks and doves. We need the Fed to follow a monetary policy rule. Both Yellen and Summers are likely to be tempted to continue the Fed’s unfortunate discretionary policies.

Summers famously was on the “committee to save the world” when he with Rubin and Greenspan “saved” the world from disaster during the Asian crisis in 1997. I am extremely critical about about Summers’ abilities as a firefighter. In fact I am extremely critical about the very concept that central bankers should act as firefighters.

Central bankers should instead stop starting fires. However, I am afraid that 2014 might very well be the year where Chairman Summers will be trying to save the world from the Second Asian Crisis. Yes, I have some very deep concerns about how things will play out in Asia – with both China and India likely to make new serious policy mistakes.

PS I most of this article was written in Heathrow airport on Friday. I am now happily back home in Denmark.

 

Forget about Yellen or Summers – it should be Chuck Norris or Bob Hetzel

I think Janet Yellen would be a pretty bad choice for new Fed chairman, but she is much preferable to Larry Summers. 

So among the bookmakers’ favourites I prefer Yellen to Summers. That is easy.   

However, I have another candidate. Chuck Norris! Or rather I strongly believe that monetary policy needs to be strictly rule based and if you have a rule based monetary policy who is fed chairman isn’t really important.

Under a strict monetary policy rule monetary policy will be fully “automatic” espcieally if you introduce “A Market-Driven Nominal GDP Targeting Regime”. This is of course what we call the Chuck Norris Effect – that the markets are implementing monetary policy. Or said in another way lets call the computer Milton Friedman wanted to run the fed Chuck Norris.

But there is of course no chance that we will get this kind of strict rule based monetary policy in the US. Therefore, if I was President Obama I would give Richmond fed economist Robert Hetzel a call. 

Why pick Hetzel? Well because he is the best qualified for the job. It is that easy. Anybody who reads my blog should understand why I think so.

Add to that nearly 40 years expirience within the fed system and Hetzel has probably participated in more FOMC meetings as an advisor to different Richmond fed persidents over the years than any other living economist in the world (I am guessing here, but if you know anybody else with this kind of expirience please let me.)

I am of course dreaming, but I won’t pick Yellen just because I think Summers would be a bad choice.

PS Happy 101st birthday Milton Friedman. See my personal tribute to ‘Uncle Milt’ from last here.

I don’t care who becomes BoJ governor – I want better monetary policy rules

UPDATE: I have edited my post significantly – I misread what Scott really said. That is the result of writing blog posts very early in the morning after sleeping too little. Sorry Scott…

Scott Sumner has a blog post on who might become the next governor of Bank of Japan. Scott ends his post with the following comment:

Naturally I favor the least dovish of the three.

Note that Scott is saying “least dovish” (I missed “least” in my original post). But don’t we want a the most dovish BoJ governor? No, we want the most principled governor – or rather the governor most committed to a rule based monetary policy.

The debate over doves versus hawks is a debate among people who fundamentally think about monetary policy in a discretionary fashion. Market Monetarism is exactly the opposite. We are strongly against discretion in monetary policy (and fiscal policy for that matter).

The important thing is not who is BoJ governor – the important thing is that there are good institutions – good rules. As I have argued before – what we really want is a monetary constitution in spirit of Jim Buchanan. In that sense the BoJ governor should be replaced – as Milton Friedman suggested – by a ‘computer’ and not by the most ‘dovish’ candidate.

Market Monetarists would have been “hawks” in the 1970s in the sense that we would have argued that for example US monetary policy was far too easy and we are ‘doves’ now. But that is really a mistaken way to think about the issue. If we favour for example a 5% NGDP level target for the US today – then we would have been doves in 1974 or 1981. That would make us more or less dovish/hawkish at different times, but that debate is for people who favours discretionary monetary policies – not for Market Monetarists.

If we just want a ‘dovish’ BoJ governor then we should advocate that Prime Minister Shinzo Abe gives Zimbabwean central bank governor Gideon Gono a call. He knows all about monetary easing – and so do the central bank governors of Venezuela and Argentina. But we all know that these people are ludicrously bad central bankers.  In similar fashion Janet Yellen would not be the Market Monetarist candidate for the Federal Reserve chairman just because she tends to favour monetary easing – in fact it seems like Yellen always favours monetary easing. In fact you should be very suspicious of the views of policy makers who will always be hawks or doves.

Gideon_Gono10

The reason that Mark Carney is a good choice for new Bank of England governor is exactly that he is not ‘dovish’ or ‘hawkish’, but that he tend to stress the need for a rule based monetary policy. That said, the important thing is not Mark Carney, but rather whether the UK government is serious about introducing NGDP level targeting or not.

Monetary policy is not primarily about having the right people for the job, but rather about having the best institutions. Obviously you want to have the best people for the job, but ultimately even Scott Sumner would be a horrible Fed governor if his mandate was wrong.

If the BoJ had a rule based monetary policy and used for example NGDP futures to conduct monetary policy then it wouldn’t matter who becomes BoJ governor – because the policy would be the same no matter what. We cannot rely on central bankers to do the ‘right thing’. Central bankers only do the right thing by chance. We need to tie their hands with a monetary constitution – with strong rules.

Related posts:

Forget about “hawks” and “doves” – what we need is a “monetary constitution”
NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed
NGDP level targeting – the true Free Market alternative (we try again)

 

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