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.


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.

Gold prices are telling us that monetary policy is too tight – or maybe not

Over the last week commodity prices has dropped quite a bit – and especially the much watched gold price has been quite a bit under pressure.

A lot of the alarmists who seem to be suffering from permanent inflation paranoia have pointed to gold prices as a good (the best?) indicator for further inflation. Now gold prices are dropping sharply (in fact much in the same manner as prior to the collapse of Lehman Brothers in 2008). So shouldn’t the inflation alarmists now come out as deflation alarmists? Of course they should – at least if they want to be consistent.

While I certainly agree that market prices – including that of commodity prices – give us a lot of information about the stance of monetary policy (remember money matters and markets matter) I would also argue never just to look at one market price. So if a numbers of market indicators of monetary policy is pointing in the same direction then we can safely conclude that monetary policy is becoming tighter or looser, but one or two more or less random prices will not tell us that.

All prices – including the price of gold – is determined by supply and demand. By (just) observing the drop in gold prices we can not say whether it is driven by a shift in demand for gold or a shift in the supply of gold. Furthermore, if it indeed is driven by a drop in demand we can not say that this is a result of a drop in only the demand for gold or a general drop in overall demand (monetary tightening).

So while there is no doubt that the move in gold prices is telling us something and surely indicating that monetary conditions might be tightening further I would like to warn against drawing to clear conclusions from this drop in gold prices.

I hope the inflation alarmists will think in the same way once and if gold prices again start to rise.





The thinking of a ”Great Moderation” economist

Imagine you are ”born” as a macroeconomists in the US or Europe around 1990. You are told that you are not allowed to study history and all you your thinking should be based on (apparent) correlations you observe from now on and going forward. What would you then think of the world?

First, you all you would see swings in economic activity and unemployment as basically being a result of swings in inventories and moderate supply shocks when oil prices drop or increase due to “geo-political” uncertainty in the Middle East. What is basically “white noise” in economic activity in a longer perspective (going back for example a 100 years) you will perceive as business cycles.

Second, inflation is anchored around 2% and you know that inflation normally tend to move back to this rate, but you really don’t care why that is the case. You will tell people that “globalisation” is the reason inflation remains low. But you also think that when inflation diverges from the 2% rate it is because geo-political uncertainty pushes oil prices up. Sometimes you will also refer to a rudimentary version of the Phillips curve where inflationary pressures increase when GDP growth is above what you define as trend-growth around 2-3%. But basically you don’t spend much time on the inflation process and even though you know that central banks target inflation you don’t really think of inflation as a monetary phenomenon.

Third, monetary policy is a focal point when you talk about economic policy. You will say things like “the Federal Reserve is increase interest rates because growth is strong”. For you think monetary policy is about controlling the level of interest rates. You never look at money supply numbers and have no real idea about how monetary policy is conduct (and you really don’t see why you should care). Central banks just cut or hike interest rates and central bankers have the same model as you so they move interest rates up or down according to a Taylor rule. And if somebody would to ask you about the “monetary transmission mechanism” you would have no clue about what they are talking about. But then you would explain that the central bank sets interest rates thereby control “the price of money” (this is here the Market Monetarist will be screaming!) and that this impact the investment and private consumption.

Forth, your world is basically “stationary” – GDP growth moves up and down 1-2%-point relative to trend growth of 2%. The same with inflation – inflation would more or less move around 2% +/- 1%-point. Given this and the Taylor rule it follows that interest rates will be moving up and down around what you will call the natural interest rate (you don’t know anything about Wicksell – and you don’t care what determine the natural interest rate). So sometimes interest rates moves up to 5-6% and sometime down to 2-3%.

What you off course does not realise is that what you are doing has nothing to do with macroeconomics. You are basically just observing “white noise” and trying to make sense of it and your economic analysis is basically empirical observations. You never heard of the Lucas critique so you don’t realise that observed empirical regularities is strictly dependent on what monetary policy regime you are in and you don’t realise that nominal GDP (NGDP) is growing closely around a 5% growth path and that mean that “macroeconomics” basically has disappeared. Everything is now really just about microeconomics.

And then disaster hits you right in the face! Nominal GDP collapses (you think it is a financial crisis). You are desperate because now the world is no longer “stationary”. All you models are not working anymore. What is happening? You are starting to make theories as you go alone (most of them without any foundation in logic analysis – crackpots have a field day). Now interest rates hit 0%. Your Taylor rule is telling you that central banks should cut interest rates to -7%. They can’t do that so that mean we are all doomed.

Then enters the Market Monetarists…they tell you that interest rates is not the price of money, that we are not doomed and central bank can ease monetary policy even with interest rates at zero if we just implement NGDP level targeting. You look at them and shake your head. They must be crazy. Haven’t they studied history?? They indeed have, but their history book started in 1929 and not in 1990.

David Eagle’s framework and the micro-foundation of Market Monetarism

Over the last couple of days I have done a couple of posts on the work of David Eagle (and Dale Domian). I guess that there still are a few posts that could be written on this topic. This is the next one.

Even though David Eagle’s work has been focusing on what he and Dale Domian have termed Quasi-Real Indexing I believe that his work is highly relevant for Market Monetarists. In this post I will try to draw up some lessons we can learn from David Eagle’s work and how it could be relevant to formulating a more consistent micro-foundation for Market Monetarism.

There are a no recessions in a world without money

The starting point in most of Eagle’s research is an Arrow-Debreu model of the world. Similarly the starting point for Market Monetarists like Nick Rowe and Bill Woolsey is Say’s Law – that supply creates its own demand. (See for example Nick on Say’s Law here).

This starting point is a world without money and both in the A-D model and under Say’s Law there can not be recessions in the sense of general glut in the product and labour markets.

However, once money and sticky prices and wages are introduced – both by Market Monetarists and by David Eagle – then we can have recessions. Hence, for Market Monetarists and David Eagle recessions are always and everywhere a monetary phenomenon.

N=PY – the simple way to illustrate some MM positions

In a number of his papers David Eagle introduces a simplified version of the equation of exchange where he re-writes MV=PY to N=PY. Hence, Eagle sees MV not some two variables, but rather as one variable – nominal spending (N), which is under the control the central bank. This is in fact quite similar to Market Monetarists thinking. While “old” monetarists traditional have assumed that V is constant (or is “stationary”) Market Monetarists acknowledges that this position no longer can be empirically supported. That is the reason why Market Monetarists have focused on the right hand side of the equation of exchange rather than on the left hand side like “old” monetarists like Milton Friedman used to do.

I, however, think that Eagle’s simplified equation of exchange has some merit in terms of clarifying some key Market Monetarist positions.

First of all N=PY gets us from micro to macro. Hence, PY is not one price and one output, but numerous prices and outputs. If N is kept constant that is basically the Arrow-Debreu world. That illustrates the point that we need changes in N to get recessions.

Second, N=PY can be a rearranged to P=N/Y. Hence, inflation is the “outcome” of the relationship between nominal spending (N) and real GDP (Y). In terms of causality this also illustrates (but it does not necessary prove) another key Market Monetarist point, which often has been put forward by especially Scott Sumner that nominal income (N) causes P and Y and not the other way around (See here and here). This is contrary to the New Keynesian formulation of the Phillips curve, where “excessive” growth in real GDP relative to “trend” GDP increases “price pressures”.

Third, P=N/Y also illustrates that there are two sources of price changes – nominal spending (N) and supply shocks. This lead us to another key Market Monetarist position – also stressed strongly by David Eagle – that there is good and bad inflation/deflation. This is a point stressed often by David Beckworth (See here and here). David Eagle of course uses this insight to argue that normal inflation indexing is sub-optimal to what he has termed Quasi-Real Indexing (QRI). This of course is similar to why Market Monetarists prefer NGDP targeting to Price Level Targeting (and inflation targeting).

The welfare economic arguments for NGDP targeting

In an Arrow-Debreu world the allocation is Pareto optimal and with fully flexible prices and wages changes in N will have no impact on allocation and an increase or a drop in N will have no impact on economic welfare. However, if we introduce sticky prices and wages in the model then unexpected changes in N will reduce welfare in the traditional neo-classical sense. Hence, to ensure Pareto optimality we have two options.

1)   The monetary institutional set-up should ensure a stable and predictable N. We can do that with a central bank that targets the NGDP level or with a Free Banking set-up (that ensures a stable N in a perfect competition Free Banking system). Hence, while Market Monetarists mostly argue in favour of NGDP from a macroeconomic perspective David Eagle’s framework also gives a strong welfare theoretical argument for NGDP targeting.

2)   (Full) Quasi-Real Indexing (QRI) will also ensure a Pareto optimal outcome – even with stick prices and wages and changes in N. David Eagle and Dale Domian have argued that QRI could be used to “immunise” the economy from recessions. Market Monetarists (other than myself) have so far as I know now directly addressed the usefulness of QRI.

Remaining with in the simplified version of the equation of exchange (N=PY) NGDP targeting focuses on left hand side of the equation, which can be determined by monetary policy, while QRI is focused on the right hand side of the equation. Obviously with one of the two in place the other would not be needed.

In my view the main problem with QRI is that the right hand side of the equation is not just one price and one output but millions of prices and outputs and the price system plays a extremely important role in the allocation of resources in the economy. It is therefore also impossible to expect some kind of “centralised” QRI (god forbid anybody would get such an idea…). I am pretty sure that my fellow Market Monetarist bloggers feel the same way. That said, I think that QRI can useful in understanding why the drop in nominal spending (N) has had such a negative impact on RGDP in the US and other places.

Furthermore, as I stressed in an earlier post QRI might be useful in housing funding reform in the US – as suggested by David Eagle. Furthermore, it is obviously QRI based government bonds could be used in the conduct of NGDP targeting – as in line with what Scott Sumner for example has suggested and as in fact also suggested by David Eagle.

David Eagle should inspire Market Monetarists

In conclusion I think that David Eagle’s and Dale Damion’s on work on both NGDP targeting and QRI will be a useful input to the further development of the Market Monetarist paradigm and I especially think it will be helpful in a more precise description of the micro-foundation of Market Monetarism.

PS David Eagle has also done work on interest rates targeting and is highly critical of Michael Woodford’s New Keynesian perspective on monetary policy. This research is relatively technical and not easily assessable, but should surely be of interest to Market Monetarists as well.


See my other posts on David Eagle and Dale Domian:
Quasi-Real indexing – indexing for Market Monetarists
A simple housing rescue package – QRI Mortgages and NGDP targeting
David Eagle on “Nominal Income Targeting for a Speedier Economic Recovery”

Market Monetarism comes to Hong Kong

Dr. Yue Chim Richard Wong Professor at the University of Hong Kong has an excellent comment on Market Monetarism on his great blog. Dr. Wong is a specialist among other things on the Hong Kong property market and a well-known economics commentator in Hong Kong.

In his comment “Easy Money, Tight Money, and Market Monetarism” he explains the background for Market Monetarism and explain the key theoretical insights and policy recommendations from Market Monetarism. It is an excellent introduction to Market Monetarism – to some extent a parallel description to my own working paper on the foundation for Market Monetarism.

Dr. Wong has some interesting observations about the main Market Monetarist thinkers/bloggers:

The Market Monetarist blogger are “(a)n assorted group of economists, mostly of the free market persuasion, (who) have joined Sumner in developing and elaborating the subtle logic behind NGDP targeting and they continue to debate the new Keynesians and old Monetarists…”

Dr. Wong continues: “The amazing fact about the group is that most of the members are relatively junior in the economics profession and are concentrated in the teaching universities. For me this was an absolutely delightful finding. I have always wondered if the pressure to publish research in ever more specialized and compartmentalized fields in the major research universities is an unqualified healthy outcome for academia.”

This I think is a very interesting observation. Scott Sumner spend more than 20 years teaching without anybody in the economics profession really noticing his important research (I did!). But once he started blogging he became the main force behind the creation of a new economic school. A school I am proud to belong to – Market Monetarism.

There is no doubt that Dr. Wong is highly sympathetic to Market Monetarism and in that regard I don’t think it is a coincidence that Wong has his PhD from the University of Chicago as is the case for Scott Sumner. To me the link to the University of Chicago is key to the intellectual development of Market Monetarism.  It is, however, not today’s University of Chicago, but the 1960s and 1970s when Milton Friedman still was a professor at the University. Friedman retired in 1977. The economic and monetary theory that Friedman was teaching at the University of Chicago was policy oriented and “practical”. Contrary to the focus at most universities where students spending most of their time with advanced mathematically models with little or no relevance to the real world – and if the models are relevant the students and professors alike often don’t realise it themselves and the policy conclusions are often not spread to a wider audience.

Scott Sumner, David Beckworth and the other Market Monetarist bloggers have made monetary theory accessible to policy makers, market participants, commentators and journalists. This in my view is the real achievement of Market Monetarism and I am happy to say that Dr. Wong now is helping spreading the word.

PS Dr. Wong write comments in both English and Chinese. He writes a weekly political economy column for the Hong Kong Economic Journal.


Ambrose Evans-Pritchard comments on Market Monetarism

The excellent British commentator Ambrose Evans-Pritchard at the Daily Telegraph has a comment on the Euro crisis. I am happy to say that Ambrose comments positively on Market Monetarism. Here is a part of Ambrose’s comments:

“A pioneering school of “market monetarists” – perhaps the most creative in the current policy fog – says the Fed should reflate the world through a different mechanism, preferably with the Bank of Japan and a coalition of the willing.

Their strategy is to target nominal GDP (NGDP) growth in the United States and other aligned powers, restoring it to pre-crisis trend levels. The idea comes from Irving Fisher’s “compensated dollar plan” in the 1930s.

The school is not Keynesian. They are inspired by interwar economists Ralph Hawtrey and Sweden’s Gustav Cassel, as well as monetarist guru Milton Friedman. “Anybody who has studied the Great Depression should find recent European events surreal. Day-by-day history repeats itself. It is tragic,” said Lars Christensen from Danske Bank, author of a book on Friedman.

“It is possible that a dramatic shift toward monetary stimulus could rescue the euro,” said Scott Sumner, a professor at Bentley University and the group’s eminence grise. Instead, EU authorities are repeating the errors of the Slump by obsessing over inflation when (forward-looking) deflation is already the greater threat.

“I used to think people were stupid back in the 1930s. Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”? I used to wonder how people could have failed to see the real problem. I thought that progress in macroeconomic analysis made similar policy errors unlikely today. I couldn’t have been more wrong. We’re just as stupid,” he said.”

So Market Monetarism is now being noticed in the US and in the UK – I wonder when continental Europe will wake up.


Update: Scott Sumner also comments on Ambrose here – and in he has a related post to the euro crisis here.

Gustav Cassel foresaw the Great Depression

I might be a complete monetary nerd, but I truly happy when I receive a new working paper in the mail from Douglas Irwin on Gustav Cassel. That happened tonight. I have been waiting for the final version of the paper for a couple weeks. Doug was so nice to send me a “preview” a couple a weeks ago. However, now the paper has been published on Dartmouth College’s website.

Lets just say it at once – it is a great paper about the views and influences of the great Swedish economist and monetary expert Gustav Cassel.

Here is the abstract:

“The intellectual response to the Great Depression is often portrayed as a battle between the ideas of Friedrich Hayek and John Maynard Keynes. Yet both the Austrian and the Keynesian interpretations of the Depression were incomplete. Austrians could explain how a country might get into a depression (bust following an investment boom) but not how to get out of one (liquidation). Keynesians could explain how a country might get out of a depression (government spending on public works) but not how it got into one (animal spirits). By contrast, the monetary approach of economists such as Gustav Cassel has been ignored. As early as 1920, Cassel warned that mismanagement of the gold standard could lead to a severe depression. Cassel not only explained how this could occur, but his explanation anticipates the way that scholars today describe how the Great Depression actually occurred. Unlike Keynes or Hayek, Cassel explained both how a country could get into a depression (deflation due to tight monetary policies) and how it could get out of one (monetary expansion).”

Douglas Irwin has written a great paper on Cassel and for those who do not already know Cassel’s important contributions not only to the monetary discussions in 1920s and 1930s, but to monetary theory should read Doug’s paper.

Cassel fully understood the monetary origins of the Great Depression contrary to the other main players in the discussion of the day – Hayek and Keynes. From the perspective of today it is striking how we are repeating all the discussions from the 1930s. To me there is no doubt Gustav Cassel would have been as outspoken a critique of both Keynesians and Austrians as he was in 1930s and I am pretty sure that he would have been a proud Market Monetarist. In fact – had it not been for the fantastic name of our school (ok, I got a ego problem…) then I might be tempted to say that we are really all New Casselian economists.

Cassel clearly explained how gold hoarding by especially the French and the US central banks was the key cause for the tightening of global monetary conditions that pushed the global economy into depression – exactly in the same way as “passive” monetary tightening due to a sharp rise in money demand generated deflationary pressures that push the global economy and particularly the US and the European economies into the Great Recession. I my mind Cassel would have been completely clear in his analysis of the causes of the Great Recession had he been alive today.

In fact even though I think Market Monetarists tell a convincing and correct story of the causes for the Great Recession and I also sure that Gustav Cassel would have helped Market Monetarists in seeing the international dimensions of the crisis – particular European demand for dollars – better.

Douglas Irwin has written an excellent paper and it should be read by anyone who is interested monetary theory and monetary history.

Thank you Doug – you did it again!


See a couple of previous comments on Doug’s work and on Cassel:

Hawtrey, Cassel and Glasner

“Our Monetary ills Laid to Puritanism”

“Calvinist economics – the sin of our times”

“Gustav Cassel on recessions”

“France caused the Great Depression – who caused the Great Recession?”

Selgin is right – Friedman wanted to abolish the Fed

I guess George Selgin is right  – Milton Friedman at the end of his life had come to the conclusion that the Federal Reserve should be abolished. See for yourself here. This is six months before his death in 2006.

See George’s excellent paper “Milton Friedman and the Case against Currency Monopoly”.

Friedman’s thermostat and why he obviously would support a NGDP target

In a recent comment Dan Alpert argues that Milton Friedman would be against NGDP targeting. I have the exact opposite view and I am increasingly convinced that Milton Friedman would be a strong supporter of NGDP targeting.

Ed Dolan as the same view as I have (I have stolen this from Scott Sumner):

“I see NGDP targeting as the natural heir to monetarist policy prescriptions of the 1960s and 70s…If we look at the textbook version of monetarism, the point is almost trivial. Textbook monetarism begins from the equation of exchange, MV=PQ, where M is money (M1, back in the day), V is velocity, P is the price level, Q is real GDP, and PQ is NGDP. Next it adds the simplifying assumption that velocity is constant. It follows that targeting a steady rate of money growth is identical to targeting a steady rate of NGDP growth.”

Dolan’s clear argument reminded me of Friedman’s paper from 2003 “The Fed’s Thermostat”.

Here is Friedman:

“To keep prices stable, the Fed must see to it that the quantity of money changes in such a way as to offset movements in velocity and output. Velocity is ordinarily very stable, fluctuating only mildly and rather randomly around a mild long-term trend from year to year. So long as that is the case, changes in prices (inflation or deflation) are dominated by what happens to the quantity of money per unit of output…since the mid ’80s, it (the Fed) has managed to control the money supply in such a way as to offset changes not only in output but also in velocity…The improvement in performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply — a veritable bubble in velocity. Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003.…The relatively low and stable inflation for this period …means that the Fed successfully offset both the decline in the demand for money (the rise in V) before 1973 and the subsequent increase in the demand for money. During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.”

Hence, Friedman clearly acknowledges that when velocity is unstable the central bank should “offset” the changes in velocity. This is exactly the Market Monetarist view – as so clearly stated by Ed Dolan above.

So why did Friedman man not come out and support NGDP targeting? To my knowledge he never spoke out against NGDP targeting. To be frank I think he never thought of the righthand side of the equation of exchange – he was focused on the the instruments rather than on outcome in policy formulation. I am sure had he been asked today he would clearly had supported NGDP targeting.

The only difference I possibly could see between what Friedman would advocate and what Market Monetarists are arguing today is whether to target NGDP growth or a path for the NGDP level.


PS I am not the first Market Monetarist to write about Friedman’s Thermostat – both Nick Rowe and David Beckworth have blogged about it before.

Argentine lessons for Greece

As Greek Prime Minister George Papandreou is fighting to putting together a new government after he yesterday survived a no-confidence vote in the Greek parliament I am once again reminded by the Argentine crisis of 2001-2002.

In my view the similarities with the Argentine crisis are striking – and most of the mistakes made by Argentine policy makers and by the international institutions are being repeated today in regard to the Greek crisis. Most important both in the Argentine case and in the Greek case policy makers refused to acknowledge that monetary policy is at the root of the problems rather than fiscal matters.

My favourite account of the Argentine crisis is the excellent book “And the Money Kept Rolling in (And Out)” by Paul Blustein.

You can’t help thinking of Greece and the efforts of the last year to “save“ the country when you see the title of Chapter 7: “Doubling a Losing Bet”.

I highly recommend Blustein’s book for those who want to understand how international institutions like the IMF works and why they fail and to understand how monetary regimes like Argentina’s currency board become “sacred” – in the same as the gold standard used to be – and this leads to crisis.

But back to Greece – or rather to the parallels to the Argentine crisis.

It has been rumours that former Greek central bank governor Lucas Papademos could take over as new Prime Minister in Greece. I have no clue whether this is going to happen, but the story made me think.

When you are in serious trouble you call in a well-respected former central banker to get some credibility. Argentina did that when Domingo Cavallo – the former successful central bank governor – became economics minister. Cavallo became economics minister on March 20 2001. He then tried to push through a number of austerity measures. He resigns on December 20 after massive protest and violence that kills 20 people. So far there has luckily been less killed in Greece.

So Cavallo lasted only 8 months – even respected central bankers cannot preform fiscal miracles in insolvent nations. But Cavollo’s 8 months as economics minister might be a benchmark for how long a central banker can stay on as economics minister – or Prime Minister.

Another measure of how long Papademos will be able to survive as Prime Minister if he indeed where to succeed Papandreou is to look at how many presidents Argentina had in 2001.

First president to step down was Fernando de la Rúa – on December 20 2001 – the same day Cavallo stepped.

Next one to step down was Adolfo Rodríguez Saá after 7 days in power on December 30 2001.

Eduardo Duhalde came into office January 2 2002 and stays on until May 25 2003. Duhalde a populist famously defaulted on Greece foreign debt – and is more popular with the Argentine public than with foreign creditors.

The question is whether Papademos would be Cavallo, Saá or Duhalde. He can’t really be Cavallo – as we are too long into the process and as Greece has already defaulted on some of the debt, but on the other hand the EU has not pulled the plug on Greece yet. It was really the IMF’s stop for funding of Argentina on December 5 2001 that “killed” Saá. Saá, however, while in government defaulted on foreign private debt on December 7 2001 (Greece effective defaulted on a large share of the private sector debt last week).

The Argentine currency board came to an end on January 6 2002 – around a month after the default on foreign debt and three weeks after Saá resigned…

If this is any guidance for the Greek situation we are surely in the end game…

PS I met Cavallo at a seminar back in 2008 – I was somewhat shocked to hear that he still thinks it was wrong that Argentina gave up the currency board despite more than 20 people died in civil unrest while he was economics minister. The Argentine economy rebound strongly after the currency board was given up and has growly strongly since then.I am certainly not claiming everything is fine in Argentina, but things are certainly better than in 2001.


Update: Cavallo indeed has a view on Greece in the light of his own expirience. See his comment here. Lets just say I think he is mostly wrong…

Update 2 (November 13): Scott Sumner is out with an excellent comment on the lessons from Argentina.

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