Calvinist economics – the sin of our times

A couple a days ago I had a discussion with a colleague of mine about the situation in Greece. My view is that it is pretty clear to everybody in the market that Greece is insolvent and therefore sooner or later we would have to see Greece default in some way or another and that it therefore is insane to continue to demand even more austerity measures from the Greek government, while at the same time asking the already insolvent Greek government to take on even more debt. My colleague on the other hand insisted that the Greeks “should pay back what they owe” and said “we can’t let countries default on their debt then everybody will do it”. It was a moral and not an economic argument he was making.

I am certainly not a Keynesian and I do not think that fiscal tightening necessarily is a bad thing for Greece, but I do, however, object strongly to what I would call Calvinist economic thinking, which increasingly is taking hold of our profession.

At the core of Calvinist economics is that Greece and other countries have committed a sin and therefore now have to repent and pay for these sins. It is obvious that the Greek government failed to tighten fiscal policy in time and even lied about the numbers, but its highly problematic that economic thinking should be based on some kind of quasi-religious morals. If a country is insolvent then that means that it will never be able to pay back its debt. It is therefore in the interest for both the country and its creditors that a deal on debt restructuring is reached. That’s textbook economics. There is no “right” or “wrong” about it – it is simple math. If you can’t be pay back your debts then you can’t pay. It’s pretty simple.

In another area very Calvinist economic thinking is widespread is in the conduct of monetary policy. Around the world central bankers resist easing monetary policy despite clear disinflationary or even deflationary tendencies and the main reason for this is not economic analysis of the economic situation, but rather the view that a loosening of monetary policy would be immoral. The Calvinists are screaming out “We will have another bubble if you ease monetary policy! Don’t let the speculators of the hook!”

The problem is that the Calvinists are confusing an easing of monetary policy or the default of insolvent nations with moral hazard.

If a central bank for example has a inflation target of 2% and inflation is running at below 1% and the central bank then decides to loosen monetary policy – then that might well be positive for “speculators” – such as property owners, banks or equity investors. The Calvinists see this as evil. As immoral, but the fact is that that is exactly what a central bank that is undershooting its inflation target should. Monetary policy is not about making judgements of what is “fair” or not, but rather about securing a nominal anchor in which investors, labour, companies and consumers can conduct there business in the market place.

The Calvinists are saying “It will be Japan”, “the global economy will not grow for a decade” and blah, blah…it nearly seems as if they want this to happen. We have sinned and now we need to repent. The interesting thing is that these Calvinists where not Calvinists back in 2005-6 and when some of us warned about excesses in the global economy they where all cheerleaders of the boom. They are like born-again Christian ex-alcoholics.

And finally just to get it completely clear. I am not in favour of bailing out anybody, or against fiscal austerity and I despise inflation. But my economics is back on economic reasoning and not on quasi-religious dogma.

PS anybody that studies history will note that Calvinist economics dominated economic thinking in countries which held on to the gold standard for too long. This is what Peter Temin has called the “Gold Standard mentality”. The in countries like France and Austria the gold standard mentality were widespread in the 1930s. We today know the consequences of that – Austria had major banking crisis in 1931, the country defaulted in 1938 and the same it ceased to existed as an independent nation. Good luck with your Calvinist economics. It spells ruins for nations around the world.

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UPDATE: Douglas Irwin has kindly reminded me that my post remind him of Gustav Cassel. Cassel used the term “puritans” about what I call Calvinist economics. Maybe Market Monetarists are New Casselians?

Beckworth’s NGDP Targeting links

Here is David Beckworth:

“Since nominal GDP level targeting seems to be really taking off now, I thought it would be useful to provide some links to past discussions here and elsewhere on the topic. Let me know in the comments section other pieces I should add to the lists.”

See David’s useful list of links on NGDP Level Targeting here.

And here is a link to one of my own stories on NGDP Targeting.

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

I have just printed three papers to (re)read when the rest of the family will be sleeping tonight. You might want to have a look at the same papers.

The two first are connected. It is Lastrapes’s and Selgin’s 1995 paper “Gold Price Targeting by the Fed” and McCallum’s 2006 paper “Policy-Rule Retrospective on the Greenspan Era”. Both papers are basically about how the Greenspan conducted monetary policy.

The hypothesis in the first paper is that the Greenspan Fed used gold prices as an indicator for inflationary pressures, while the other is a restatement and an empirical test of the so-called McCallum rule. The McCallum rule basically saying that the Fed is targeting nominal GDP growth at 5% by controlling the money base.

As both papers confirm their hypothesis why not combine the results from the two papers? The Fed reserve controls the money base to ensure 5% NGDP growth and use the the gold price to see whether it is on track or not. Okay, lets be a little more open-minded and lets include other asset prices and lets look at more commodity prices than just gold. Then we have rule, which I have earlier called a McCallum-Christensen (yes, yes I have a ego problem…).

The McCallum-Christensen rule can be estimated in the following form:

dB=a+b*dV+cNGDPMI

d is %-quarterly growth, B is the money base (or rather I use MZM), V is the 4-year moving average of MZM-velocity and NGDPMI is a composite index of asset prices that all are leading indicators of NGDPMI.

In my constructed NGDPMI I use the following variables: S&P500, the yield curve (10y-2y UST), the CRB index (Commodity prices) and an index for the nominal effective dollar rate. I have de-trended the variables with a four-year moving average (thats simple), but one could also use a HP-filter. I have then standardized each of the variable so they get an average of 0 and a standard deviation of 1 – and then taken the average of the four sub-indicators.

And guess what? It works really well. I can be shown that during the 1990ties the Fed moved MZM up and down to track market expectations of NGDP captured by my NGDPMI indicator. This is the time where Manley Johnson and Bob Keleher played an important role in the conduct and formulation of monetary policy in the US. As I have earlier blogged about I fundamentally think that the Johnson-Keleher view of monetary policy is closely connected to the Market Monetarist view.

The McCallum-Christensen rule also fit relatively well in the following period from 2000 to 2007/8, but it is clear that monetary policy is becoming more erratic during this period – probably due to Y2K, 911, Enron etc. Hence, there is indications that the influence of Johnson and Keleher has been faithing in that period, but overall the McCallum-Christensen rule still fits pretty well.

Then the Great Recession hits and it is here it becomes interesting. Initially the Fed reacts in accordance with the McCallum-Christensen rule, but then in 2009-2010 it becomes clear that MZM growth far too slow compared to what the MC rule is telling you. Hence, this confirms the Sumnerian hypothesis that monetary policy turned far to negative in 2009-10.

So why is it that I am not writing a Working Paper about these results? Well, I might, but I just think the result are so extremely interesting that I need to share them with you. And I need more people to get involved with the econometrics. So this is an invitation. Who out there want to write this paper with me? And we still need some more number crunching!

But for now the results are extremely promising.

Okay, on to the third paper “Reserve Accumulation and International Monetary Stability”. Its an IMF working paper. I have a theory that the sharp rise in the accumulation of FX Reserves after the outbreak of the Great Recession has prolonged the crisis…but more on that another day…

PS I promised something on Selgin and this was not really enough…but hey the guy is great and you are all cheating yourselves of great inside into monetary theory if you don’t read everything George ever wrote.

 

Killing the messenger won’t solve the debt crisis

I don’t even want to comment on this one: “EU reaches deal on naked CDS ban law”

Shoot the messenger and the problem will go away? I think not…

Share your views of the quality of policy makers in Europe please.

Chuck Norris on monetary policy #2

I am continuing my tribute to the great Chuck Norris.

Here this it truth from http://www.chucknorrisfacts.com

“If Chuck Norris goes to the bank to get money, all banks go on a world crisis. It happened on 2008”

Well, you are quite right it was not the collapse of Lehman Brothers, which triggered the kind of mess we are in now. Rather it was Chuck Norris who increased his demand for dollars. Or maybe it was not Chuck, but somebody else, but nonetheless the increase in demand for dollars both in the US and from Europe lead to an “passive” tightening of US monetary policy, which the Federal Reserve failed to respond forcefully enough to.

PS both Nick Rowe and David Beckworth are now picking up the Chuck theme…

The open-minded Krugman

I didn’t expect this ever to happen, but I have to say something nice about Paul Krugman’s comments on his New York Times blog. Well, there is actually a lot of positive to say about Paul Krugman, but we just tend to forget it when he is giving us free market economists a hard time. However, the story today is not about what we think, but “where” we express our views and share our research.

As I have tried to argue in my paper “Market Monetarism – the second Monetarist counter-revolution” Market Monetarism is a school of economic thought basically born and shaped in the blogosphere.

Krugman has a positive view on what the blogosphere has done to open up the economic profession and haow the blogoshere is helping improve economic research.

Here is Krugman:

“What the blogs have done, in a way, is open up that process. Twenty years ago it was possible and even normal to get research into circulation and have everyone talking about it without having gone through the refereeing process – but you had to be part of a certain circle, and basically had to have graduated from a prestigious department, to be part of that game. Now you can break in from anywhere; although there’s still at any given time a sort of magic circle that’s hard to get into, it’s less formal and less defined by where you sit or where you went to school.

Since there’s some kind of conservation principle here, the fact that it’s easier for people with less formal credentials to get heard means that people who have those credentials are less guaranteed of respectful treatment. So yes, we’ve seen some famous names run into firestorms of criticism — *justified* criticism – even as some “nobodies” become players. That’s a good thing! Famous economists have been saying foolish things forever; now they get called on it.

And this process has showed what things are really like. If some famous economists seem to be showing themselves intellectually naked, it’s not really a change in their wardrobe, it’s the fact that it’s easier than it used to be for little boys to get a word in.”

So here we go again – I agree with Krugman. The blogosphere is opening up our profession and Krugman deserves credit for taking this debate serious. Have a look at Krugman’s comment here and share you views both here and on Krugman’s blog.

PS Krugman is still wrong about fiscal policy and his odd views of China – after all he is just a Keynesian, but nonetheless quite open-minded and probably more open-minded that I am…

HT Benjamin “Mr. PR” Cole

NGDP targeting is not about ”stimulus”

Market Monetarists are often misunderstood to think that monetary policy should “stimulate” growth and that monetary policy is like a joystick that can be used to fine-tune the economic development. Our view is in fact rather the opposite. Most Market Monetarists believe that the economy should be left to its own devises and that the more policy makers stay out of the “game” the better as we in general believe that the market rather than governments ensure the most efficient allocation of resources.

Exactly because we believe more in the market than in fine-tuning and government intervention we stress how important it is for monetary policy to provide a transparent, stable and predictable “nominal anchor”. A nominal GDP target could be such an anchor. A price level target could be another.

Traditional monetarists used to think that central banks should provide a stable nominal anchor through a fixed money supply growth rule. Market Monetarists do not disagree with the fundamental thinking behind this. We, however, are sceptical about money supply targeting because of technical and regulatory develops mean that velocity is not constant and because we from time to time see shocks to money demand – as for example during the Great Recession.

A way to illustrate this is the equation of exchange:

M*V=P*Y

If the traditional monetarist assumption hold and V (velocity) is constant then the traditional monetarist rule of a constant growth rate of M equals the Market Monetarist call for a constant growth rate of nominal GDP (PY). There is another crucial difference and that is that Market Monetarists are in favour of targeting the level of PY, while traditional monetarists favours a target of the growth of M. That means that a NGDP level rule has “memory” – if the target overshots one period then growth in NGDP need to be higher the following period.

In the light in the Great Recession what US based Market Monetarists like Bill Woolsey or Scott Sumner have been calling for is basically that M should be expanded to make up for the drop in V we have seen on the back of the Great Recession and bring PY back to its old level path. This is not “stimulus” in the traditional Keynesian sense. Rather it is about re-establishing the “old” monetary equilibrium.

In some way Market Monetarists are to blame for the misunderstandings themselves as they from time to time are calling for “monetary stimulus” and have supported QE1 and QE2. However, in the Market Monetarists sense “monetary stimulus” basically means to fill the whole created by the drop in velocity and while Market Monetarists have supported QE1 and QE2 they have surely been very critical about how quantitative easing has been conducted in the US by the Federal Reserve.

Another way to address the issue is to say that the task of the central bank is to ensure “monetary neutrality”. Normally economists talk about monetary neutrality in a “positive” sense meaning that monetary policy cannot affect real GDP growth and employment in the long run. However, “monetary neutrality” can also be see in a “normative” sense to mean that monetary policy should not influence the allocation of economic resource. The central bank ensures monetary neutrality in a normative sense by always ensuring that the growth of money supply equals that growth of the money demand.

George Selgin and other Free Banking theorists have shown that in a Free Banking world where the money supply has been privatised the money supply is perfectly elastic to changes in money demand. In a Free Banking world an “automatic” increase in M will compensate for any drop V and visa versa. So in that sense a NGDP level target is basically committing the central bank to emulate the Free Banking (the Free Market) outcome in monetary matters.

The believe in the market rather than in “centralized control mechanisms” is also illustrated by the fact that Market Monetarists advocate using market indicators and preferably NGDP futures in the conduct of monetary policy rather than the central bank’s own subjective forecasts. In a world where monetary policy is linked to NGDP futures (or other market prices) the central bank basically do not need a research department to make forecasts. The market will take care of that. In fact monetary policy monetary policy will be completely automatic in the same way a gold standard or a fixed exchange rate policy is “automatic”.

Therefore Market Monetarists are certainly not Keynesian interventionist, but rather Free Banking Theorists that accept that central banks do exists – for now at least. If one wants to take the argument even further one could argue that NGDP level targeting is the first step toward the total privatisation of the money supply.

 

 

 

”Recessions are always and everywhere a monetary phenomena”

At the core of Market Monetarist thinking, as in traditional monetarism, is the maxim that “money matters”. Hence, Market Monetarists share the view that inflation is always and everywhere a monetary phenomenon. However, it should also be noted that the focus of Market Monetarists has not been as much on inflation (risks) as on the cause of recession, as the starting point for the school has been the outbreak of the Great Recession.

Market Monetarists generally describe recessions within a Monetary Disequilibrium Theory framework in line with what has been outline by orthodox monetarists such as Leland Yeager and Clark Warburton. David Laidler has also been important in shaping the views of Market Monetarists (particularly Nick Rowe) on the causes of recessions and the general monetary transmission mechanism.

The starting point in monetary analysis is that money is a unique good. Here is how Nick Rowe describes that unique good.

“If there are n goods, including one called “money”, we do not have one big market where all n goods are traded with n excess demands whose values must sum to zero. We might call that good “money”, but it wouldn’t be money. It might be the medium of account, with a price set at one; but it is not the medium of exchange. All goods are means of payment in a world where all goods can be traded against all goods in one big centralised market. You can pay for anything with anything. In a monetary exchange economy, with n goods including money, there are n-1 markets. In each of those markets, there are two goods traded. Money is traded against one of the non-money goods.”

From this also comes the Market Monetarist theory of recessions. Rowe continues:

“Each market has two excess demands. The value of the excess demand (supply) for the non-money good must equal the excess supply (demand) for money in that market. That’s true for each individual (assuming no fat fingers) and must be true when we sum across individuals in a particular market. Summing across all n-1 markets, the sum of the values of the n-1 excess supplies of the non-money goods must equal the sum of the n-1 excess demands for money.”

Said in another way, recession is always and everywhere a monetary phenomenon in the same way as inflation is. Rowe again:

“Monetary Disequilibrium Theory says that a general glut of newly produced goods can only be matched by an excess demand for money.”

This also means that as long as the monetary authorities ensure that any increase in money demand is matched one to one by an increase in the money supply nominal GDP will remain stable (Market Monetarists obviously does not say that economic activity cannot drop as a result of a bad harvest or an earthquake, but such “events” does not create a general glut of goods and labour). This view is at the core of Market Monetarist’s recommendations on the conduct of monetary policy.

Obviously, if all prices and wages were fully flexible, then any imbalance between money supply and money demand would be corrected by immediate changes prices and wages. However, Market Monetarists acknowledge, as New Keynesians do, that prices and wages are sticky.

PS I inspired Nick Rowe to do a post on ”Recessions are always and everywhere a monetary phenomena”. Now I am stealing it back. Nick, I hope you can forgive me.

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