The Hoover (Merkel/Sarkozy) Moratorium

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

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

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

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

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

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

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

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

Guest blog: Central banking – between planning and rules

I have asked Alex Salter to give his perspective on the ongoing debate about “Central banking is (not) central planning” in the blogosphere.

David Glasner also has a new comment on the subject.

But back to Alex…

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Guest blog:  Central banking – between planning and rules

Alex Salter
asalter2@gmu.edu

I’ve been reading about the central banking vs. central planning debate on the blogosphere; the more I think about it the more interesting it becomes. Whether central banking is a form of central planning depends on what exactly the central bank does.  There are two broad scenarios.  In the first, the central bank is following some sort of rule or trying to hit a target.  This can be a Taylor rule, inflation target, NGDP level target, or anything else.  In this case the central bank is trying to provide a stable economic setting so that individuals can effectively engage in the market process.  If this is what the central bank is doing, I don’t think it makes sense to call it central planning. All the central bank is trying to do is lay down the “ground rules” for economic behavior. If this is central planning, you could just as easily say any institution such as property rights or the rule of law is central planning too. This obviously isn’t a useful definition of central planning!

However, a central bank may be engaging in a type of central planning if it tries to bring about a specific allocation of resources.  For example, if the central bank thinks equities prices should be higher for some reason, and they start purchasing equities, you could make an argument that this is a type of central planning.  If the central bank explicitly tries to monetize the debt and acts as an enabler for the nation’s treasury department, you could also say this is a form of central planning.  It’s still not 100% clear, since presumably the central bank is not using coercion or the threat of coercion to get market participants to behave in the way it wants; there’s voluntary assent on the other side of the agreement, even if that voluntary assent is a response to warped incentives.

In closing: if a central bank is trying to create a specific framework in which agents can operate, it’s not central planning, it’s rule setting.  If on the other hand the central bank is trying to allocate specific resources, it may be a form of central planning.  In either scenario, the usual knowledge and incentive problems still apply.

Central banks cannot ”do nothing”

Central banks cannot ”do nothing” 

Some commentators have suggested that central banks should ”do nothing” in the present crisis, but even though that on the surface sounds appealing it is in fact nonsense to say a central bank should do nothing. Central banks in fact cannot “do nothing”. Let me explain why.

The first thing to ask is what “doing nothing” means. Often people talk about monetary policy as manipulating interest rates up and down and doing nothing is taken to mean that the central bank should keep interest rates “unchanged”. However, what we really are talking about is that the central bank is intervening in the money markets to keep the price of overnight credit fixed at a given level. So imagine the demand for overnight liquidity spikes for some reason then the central bank will have to increase liquidity to keep the market interest rate from rising. Hence, even a central bank that is “doing nothing” in the sense of keeping interest rates fixed might end up doing quite a bit. Central bank credibility might reduce the need for actual intervention to keep the interest rate fixed, but that does not change the principle that ultimately the central bank will have to actively manage things.

The story is the same for a central bank that has announce a fixed exchange rate policy. Here “doing nothing” is normally taken to mean that the central bank buys and sell the currency to ensure that the exchange rate indeed remains fixed. So again “doing nothing” might involve doing quite a bit – even though again credibility might indeed reduce the need to doing something on a daily basis, but even the most credibility fixed exchange rate regimes like the Denmark’s peg to the euro or Hong Kong’s peg to the dollar from time to time (quite often in fact) would require the central banks to buy and sell their currency.

In fact all central banking involve controlling the money base. The central bank can use different operational targets like interest rates or exchange rates, but the central bank is never doing nothing. George Selgin who (indirectly) inspired this blog post would of course say that if you want central banks to do nothing then you should abolish central banking all together, but that is not the purpose of this discussion.

An example of the fallacy that a central bank can do nothing is the debate about “quantitative easing” (QE). There is really nothing special about QE as it basically just means to increase the money base. This in someway is seen to be “dirty” or dangerous and it is getting a lot of attention, but some central banks are doing QE all the time, but it is getting no attention at all. Lets say a country has a fixed exchange rate policy and the demand for its currency for some reason increases – then the central bank will have to sell it own currency to curb the strengthening of the currency. But what does it mean to “sell the currency”? In fact that means to increase the money base. That is QE. So central banks with fixed exchanges could in fact be “doing nothing” and at the same time be engaged in QE on a massive scale – just ask the good people at People’s Bank of China about that.

“Doing nothing” in monetary policy is not really as simple as it is often made up to be. There is, however, another way of looking at things and that is to differentiate between rules and discretion.

NGDP Targeting is as close to “doing nothing” as you get

After the outbreak of the Great Recession a lot of central banks have been conducting monetary policy on a discretionary basis – jumping from one crisis to another without defining the rules of engagement so to speak. An obvious example is the Federal Reserve which have implemented QE1 and QE2 and even the odd “operation twist” without bothering to state what the purpose of these policies are and under which circumstances to scale them up and down. Interestingly enough the Fed has been criticised for doing what central banks do – “playing around” with the money base – but there has been little criticism the discretionary fashion in which US monetary policy has been conducted. Even most of the Market Monetarist bloggers have failed in clearly stating this (sorry guys…).

Imagine instead that there had been a NGDP level target in place in the US when the Great Recession started. A NGDP target would have been a clear rule for the conduct of US monetary policy. It would have stated that if NGDP expectations (either market expectations or the Fed’s own forecast) drops below a certain target then the Fed should take actions to increase the money base (without any restrictions) until NGDP expectations had returned to the target level. That likely would have led to a significant increase in the money base, but within a very clearly defined framework and the increase in the money base would have been completely automatic (as would have been the “exit” from the boost in the money base). Very likely there would not have been any debate about whether this increase in the money base or not if the NGDP target framework had been in place. In fact the Fed could have said it was “doing nothing” – even though that would as demonstrated above, but it would not have done anything discretionary. The real problem with QE is not that the money base is increase, but that is done in a completely random fashion without any clear framework. So the best thing the Fed could do was to very soon implement some rules of engagement – preferably a market based NGDP level target.

PS Those of my reader who are in favour of a true gold standard should know that the central bank can easily end of doing quite a bit of manipulation of the money base within the framework of a gold standard.

PPS Just came to think of it – why did nobody debate the increase in the US money base prior to Y2K (that was actually quite insane a policy) or after 911?

80 years on – here we go again…

The year is 1931. US president Hoover on June 20 announces the so-called Hoover Moratorium. Hoover’s proposition was to put a one-year moratorium on payments of World War I and other war debt, postponing the initial payments, as well as interest. This obvious is especially a relief to Germany and Austria. The proposal outrages a lot of people and especially the France government is highly upset by the proposal.

July 23, 1931. After finally gaining French support, President Hoover announced that all of the important creditor governments had accepted the intergovernmental debt moratorium. While the U.S. government rejected the notion that inter-Allied war debts and reparations were connected, the European governments adopted the stand that Allied debts and reparations would stand or fall together. The delay in action on the debt moratorium contributed to the closing of all German banks by mid-July. (From youtube)

Here are the historical pictures from the Paris conference in 1931.

80 years on – now we are again talking about European debts. This time things a different now it is now Germany who are in need of a debt moratorium, but Greece. And guess who is upset this time around??

Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed

I always enjoy reading whatever George Selgin has to say about monetary theory and monetary policy and I mostly find myself in agreement with him.

George always is very positive towards the views of Milton Friedman, which is something I true enjoy as longtime Friedmanite. I particular like George’s 2008 paper “Milton Friedman and the Case against Currency Monopoly”, in which he describes Friedman’s transformation over the years from being in favour of activist monetary policy to becoming in favour of a constant growth rule for the money supply and then finally to a basically Free Banking view.

I believe that George’s arguments make a lot of sense I and I always thought of Milton Friedman as a much more radical libertarian than it is normally the perception. In my book (it’s in Danish – who will translate it into English?) on Friedman I make the argument that Friedman is a pragmatic revolutionary.

To radical libertarians like Murray Rothbard Milton Friedman seemed like a “pinko” who was compromising with the evil state. Friedman, however, did never compromise, but rather always presented his views in pragmatic fashion, but his ideas would ultimately have an revolutionary impact.

I there are two obvious examples of this. First Friedman’s proposal for a Negative Income Tax and second his proposal school vouchers. Both ideas have been bashed by Austrian school libertarians for compromising with the enemy and for accepting government involvement in education and “social welfare”. However, there is another way to see both proposals and is as privatization strategies. The first step towards the privatization of the production of educational and welfare services.

Furthermore, Friedman’s proposals also makes people think of the advantages if the freedom of choice and once people realize that school vouchers are preferable to a centrally planned school system then they might also realize that free choice as a general principle might be preferable.

In a similar sense one could argue that Scott Sumner and other Market Monetarists are pragmatic revolutionaries when they argue in favour of nominal GDP targeting.

Why is that? Well, it is a well-known result from the Free Banking literature that a privatization of the money supply will lead to money supply becoming perfectly elastic to changes in money demand. Said, in another way any drop in velocity will be accompanied by an “automatic” increase in the money, which effectively would mean that a Free Banking system would “target” nominal NGDP. Hence, as I have often stated NGDP targeting “emulates” a Free Banking outcome. In that sense Sumner’s proposal for NGDP targeting is similar to Friedman’s proposal for school vouchers. It is a step toward more freedom of choice. Scott therefore in many ways also is a pragmatic revolutionary as Friedman was.

There is, however, one crucial difference between Friedman and Sumner is that, while Friedman was in favour of a total privatization of the school system and just saw school vouchers as a step in that direction Scott does not (necessarily) favour Free Banking. Scott argues in favour of NGDP targeting based on its own merits and not as part of a privatization strategy. This is contrary to the Austrian NGDP targeting proponents like Steve Horwitz who clearly see NGDP targeting as a step towards Free Banking. Whether Scott favours Free Banking or not does, however, not change the fact that it might very well be seen as the first step towards the total privatization of the money supply.

Sumner’s proposal the implementation of NGDP futures could in a in similar fashion be seen as a integral part of the privatization of the money supply.

Friedman famously paraphrased the French Word War I Prime Minister George Clemenceau who said that “war is much too serious matter to be entrusted to the military” to “money is much too serious a mater to be entrusted to central banker”. Scott Sumner’s proposal for NGDP targeting within a NGDP futures framework in my view is the first step to taken away central bankers’ control of the money supply…but don’t tell that to the central bankers then they might never go along with NGDP Tageting in the first place.

For Scott own view of the Free Banking story see: “An idealistic defense of pragmatism” – he of course might as well have said “A revolutionary defense of pragmatism”.

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Update: I just found this fantastic quote from George Selgin (from comment section of Scott’s blog): ‘I only wish…that Scott would draw inspiration from Cato the Elder, andend each of his pleas for replacing current Fed practice with NGDP targeting with: “For the rest, I believe that the Federal Reserve System must ultimately be destroyed.”’

Chuck Norris on monetary policy #3

Yet another other great “fact” from www.chucknorrisfacts.com

“TARP didn’t have to be passed to kickstart the economy. All that the President needed to do was to ask Chuck Norris to roundhouse kick it”

Well, it is entirely correct – TARP really didn’t do anything to “kickstart” the US economy. Just look at the US stock markets – the ultimate forecasting tool for NGDP expectations. It kept dropping until the Federal Reserve called in Chuck Norris in March 2009 and initiated quantitative easing of monetary policy – the monetary version of a roundhouse kick.

“Nominal Income Targeting” on Wikipedia

First Market Monetarism hit Wikipedia and now it is “Nominal Income Targeting”. It is interesting stuff. So take a look. However, the writer(s) obviously has a Market Monetarist background of some kind (and no, it is not me…). This is obviously nice, but it should be noted that Nominal Income Targeting has quite long history in the economic literature pre-dating Market Monetarism and that in my view should be reflected on the “Nominal Income Targeting”-page on Wikipedia. I also miss the link to the Free Banking literature. Furthermore, there should be cross references to other monetary policy rules such as price level targeting and inflation targeting. But the great thing about Wikipedia is that these texts over time improves…

Anyway, it is nice to see NI targeting on Wikipedia. Keep up the good work those of you who are doing the hard work on Wikipedia texts.

Clark Johnson has written what will become a Market Monetarist Classic

As I have written about in an earlier post I am reading Clash Johnson’s book on the Great Depression “Gold, France and the Great Depression”. So far it has proved to be an interesting and insightful book on what (to me) is familiar story of how especially French and US gold hoarding was a major cause for the Great Depression.

Clark Johnson’s explanation of Great Depression is similar to that of two other great historians of the Great Depression Scott Sumner and Douglas Irwin. Both are of course as you know Market Monetarists.

Given Johnson’s “international monetary disorder view” of the Great Depression I have been wondering whether he also had a Market Monetarist explanation for the Great Recession. I now have the answer to that question and it is affirmative – Clark Johnson is indeed a Market Monetarist, which becomes very clear when reading a new paper from the Milken Institute written by Johnson.

One thing I find especially interesting about Johnson’s paper is that he notes the importance of the US dollar as the global reserve currency and this mean that US monetary policy tightening has what Johnson calls “secondary effects” on the global economy. I have long argued that Market Monetarists should have less US centric and more global perspective on the global crisis. Johnson seems to share that view, which is not really surprising given Johnson’s work on the international monetary perspective on the Great Depression.

Johnson presents six myths about monetary policy and the six realities, which debunk these myths. Here are the six myths.

Myth 1: The Federal Reserve has followed a highly expansionary monetary policy since August, 2008.

Johnson argues that US monetary policy has not been expansionary despite the increase in the money base and the key reason for this is a large share of the money base increase happened in the form of a similar increase in bank reserves. This is a result of the fact that the Federal Reserve is paying positive interest rates on excess reserves. This is of course similar to the explanation by other Market Monetarists such as David Beckworth and Scott Sumner. Furthermore, Johnsons notes that the increase that we have seen in broader measure of the money supply mostly reflects increased demand for dollars rather than expansionary monetary policies.

Johnson notes in line with Market Monetarist reasoning: “Monetary policy works best by guiding expectations of growth and prices, rather than by just reacting to events by adjusting short-term interests”.

Myth 2: Recoveries from recessions triggered by financial crises are necessarily low.

Ben Bernanke’s theory of the Great Depression is a “creditist” theory that explains (or rather does not…) the Great Depression as a consequence of the breakdown of financial intermediation. This is also at the core of the present Fed-thinking and as a result the policy reaction has been directed at banking bailouts and injection of capital into the US banking sector. Johnson strongly disagrees (as do other Market Monetarists) with this creditist interpretation of the Great Recession (and the Great Depression for that matter). Johnson correctly notes that the financial markets failed to react positively to the massive US banking bailout known as TARP, but on the other hand the market turned around decisively when the Federal Reserve announced the first round of quantitative easing (QE) in March 2009. This in my view is a very insightful comment and shows some real Market Monetarist inside: This crisis should not be solved through bailouts but via monetary policy tools.

Myth 3: Monetary policy becomes ineffective when short-term interest rates fall close to zero.

If there is an issue that frustrates Market Monetarists then it is the claim that monetary policy is ineffective when short-term rates are close to zero. This is the so-called liquidity trap. Johnson obviously shares this frustration and rightly claims that monetary policy primarily does not work via interest rate changes and that especially expectations are key to the understanding of the monetary transmission mechanism.

Myth 4: The greater the indebtedness incurred during growth years, the larger the subsequent need for debt reduction and the greater the downturn.

It is a widespread view that the world is now facing a “New Normal” where growth will have to be below previous trend growth due to widespread deleveraging. Johnson quotes David Beckworth on the deleveraging issue as well site Milton Friedman’s empirical research for the fact there is no empirical justification for the “New Normal” view. In fact, the recovery after the crisis dependent on the monetary response to the crisis than on the size of the expansion prior to the crisis.

Myth 5: When money policy breaks down there is a plausible case for a fiscal response.

Recently the Keynesian giants Paul Krugman and Brad DeLong have joined the Market Monetarists in calling for nominal GDP targeting in the US. However, Krugman and DeLong continue to insist on also loosening of US fiscal policy. Market Monetarists, however, remain highly skeptical that a loosening of fiscal policy on its own will have much impact on the outlook for US growth. Clark Johnson shares this view. Johnson’s view on fiscal policy reminds me of Clark Warburton’s position on fiscal policy: fiscal policy only works if it can alter the demand for money. Hence, fiscal policy can work, but basically only through a monetary channel. I hope to do a post on Warburton’s analysis of fiscal policy at a later stage.

Myth 6: The rising prices of food and other commodities are evidence of expansionary policy and inflationary pressure.

It is often claimed that the rise in commodity prices in recent years is due to overly loose US monetary policy. Johnson refute that view and instead correctly notes that commodity price developments are related to growth on Emerging Markets in particular Asia rather than to US monetary policy.

Johnson’s answer: Rate HIKES!

Somewhat surprise after conducting an essentially Market Monetarist analysis of the causes of the Great Recession Clark Johnson comes up with a somewhat surprising policy recommendation – rate hikes! In fact he repeats Robert McKinnon’s suggestion that the four leading central banks of the world (the Federal Reserve, the ECB, the Bank of Japan and the Bank of England) jointly and coordinated increase their key policy rates to 2%.

Frankly, I have a very hard time seeing what an increase interest rates could do to ease monetary conditions in the US or anywhere else and I find it very odd that Clark Johnson is not even discussing changing the institutional set-up regarding monetary policy in the US after an essentially correct analysis of the state US monetary policy. It is especially odd, as Johnson clearly seem to acknowledge the US monetary policy is too tight. That however, does not take anything away from the fact that Clark Johnson has produced a very insightful and interesting paper on the causes for the Great Recession and monetary policy makers and students of monetary theory can learn a lot from reading Clark Johnson’s paper. In fact I think that Johnson’s paper might turnout to become an Market Monetarist classic similar to Robert Hetzel’s “Monetary Policy in the 2008-2009 Recession” and Scott Sumner’s “Real problem is nominal”.

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Update: Marcus Nunes and David Beckworth also comment on Clark Johnson’s paper. Thanks to both Benjamin “Mr. PR” Cole and Marcus Nunes for letting me know about Johnson’s great paper.

Woolsey on DeLong on NGDP Targeting

Interestingly enough both Paul Krugman and Brad DeLong have now come out in favour of NGDP level targeting. Hence, the policy recommendation from these two Keynesian giants are the same as from the Market Monetarist bloggers, but even though the Keynesians now agree with our policy recommendation on monetary policy in the US the theoretical differences are still massive. Both Krugman and DeLong stress the need for fiscal easing in the US. Market Monetarists do not think fiscal policy will be efficient and we are in general skeptical about expanding the role of government in the economy.

Bill Woolsey has an excellent comment on Brad Delong’s support for NGDP targeting. Read it here.

Despite theoretical differences it is interesting how broad based the support for NGDP level targeting is becoming among US based economists (In Europe we don’t have that sort of debate…we are just Calvinist…)

Please help Mr. Simor

He is a challenge for you all.

András Simor is governor of the Hungarian central bank (MNB). Next week he will meet with his colleagues in the MNB’s Monetary Council. They will make announcement on the monetary policy action. Mr. Simor needs your help because he is in a tricky situation.

The MNB’s operates an inflation-targeting regime with a 3% inflation target. It is not a 100% credible and the MNB has a rather unfortunate history of overshooting the inflation target. At the moment inflation continues to be slightly above the inflation target and most forecasts shows that even though inflation is forecasted to come down a bit it will likely stay elevated for some time to come. At the same time Hungarian growth is basically zero and the outlook for the wider European economy is not giving much hope for optimism.

With inflation likely to inch down and growth still very weak some might argue that monetary policy should be eased.

However, there is a reason why Mr. Simor is not likely to do this and that is his worries about the state of the Hungarian financial system. More than half of all household loans are in foreign currency – mostly in Swiss franc. Lately the Hungarian forint has been significantly weakened against the Swiss franc (despite the efforts of the Swiss central bank to stop the strengthening of the franc against the euro) and that is significantly increasing the funding costs for both Hungarian households and companies. Hence, for many the weakening of the forint feels like monetary tightening rather monetary easing and if Mr. Simor was to announce next week that he would be cutting interests to spur growth the funding costs for many households and companies would likely go up rather than down.

Mr. Simor is caught between a rock and a hard. Either he cuts interest rates and allows the forint to weaken further in the hope that can spur growth or he does nothing or even hike interest rates to strengthen the forint and therefore ease the pains of Swiss franc funding households and companies.

Mr. Simor does not have an easy job and unfortunately there is little he can do to make things better. Or maybe you have an idea?

PS The Hungarian government is not intent on helping out Mr. Simor in any way.

PPS When I started this blog I promised be less US centric than the other mainly US based Market Monetarist bloggers – I hope that his post is a reminder that I take that promise serious.

PPPS if you care to know the key policy rate in Hungary is 6%, but as you know interest rates are not really a good indicator of monetary policy “tightness”.

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