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!

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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.

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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.

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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.

The Market Monetarist voice at Cato Institute

In a pervious post I have noted that Tim Lee a scholar at the libertarian Cato Institute has been endorsing basically Market Monetarist ideas. Now Tim has a comment on Market Monetarism. I am happy to see that Tim has nice things to say about Market Monetarism and my paper on Market Monetarism in his latest article at forbes.com.

Once again – I am happy to see that Tim Lee is continuing the work for nominal income targeting that William Niskanen started at the Cato Institute. NGDP should be the natural position of the good people at the Cato Institute.

Does China target NGDP?

Much of the debate about NGDP targeting in the blogosphere is about what the Federal Reserve should do. However, I think it is equally important to discuss and focus on what monetary regimes are preferable for other countries. I hope I will be able to increase the focus among Market Monetarists on monetary policy in other countries than the US.

Given that China is the second largest economy is the world it is somewhat surprising how little interest their is in Chinese monetary policy and especially in what are the key drivers of Chinese monetary policy. A working paper – “McCallum rule and Chinese monetary policy” – by Tuuli Koivu, Aaron Mehrotra and Riikka Nuutilainen from 2008 sheds more light on this important topic and Market Monetarists should be very interested in the results.

Here is the abstract:

“This paper evaluates the usefulness of a McCallum monetary policy rule based on money supply for maintaining price stability in mainland China. We examine whether excess money relative to rule-based values provides information that improves the forecasting of price developments. The results suggest that our monetary variable helps in predicting both consumer and corporate goods price inflation, but the results for consumer prices depend on the forecasting period. Nevertheless, growth of the Chinese monetary base has tracked the McCallum rule quite closely. Moreover, results using a structural vector autoregression suggest that our measure of excess money supply could be used to identify monetary policy shocks in the Chinese economy.”

Hence, according to the authors the People’s Bank of China (PBoC) follow a McCallum rule whereby they use the money base to hit a given target for growth in nominal GDP (NGDP).

This in my view is a highly interesting result and it is somewhat of a surprise that these empirical results have not gotten more attention – especially given China’s impressive economic performance in recent years. Furthermore, it would be extremely interesting to see how the results would look if they where updated to include the Great Recession period. I am sure there is lot of aspiring Market Monetarists out there who are getting ready to update these results…

The PBoC is certainly not conducting monetary policy in a transparent way and the Chinese financial markets remain overly regulated, but at least it seems like the PBoC got their money base control more or less right.

Tim Lee – Market Monetarist

Timothy B. Lee at the Cato Institute has a couple of interesting comments out on US monetary policy – they are at the core very much Market Monetarist.

Here is a few recommendations:

Fighting the Last Monetary War (Happy to see Tim is reading Friedman’s Money Mischief – one of my favourite books)
More on Nominal Sales and Monetary Policy (happy to see a tribute to William Niskanen’s monetary policy views)
Beckworth, Ponnuru and Niskanen on Monetary Policy (Tim, you make us proud…)

Most Market Monetarists talk about NGDP level targeting, but I guess people like Beckworth and Woolsey would prefer targeting “nominal final sales to domestic purchasers” as William Niskanen suggested. I have sympathy for that as well – especially if I think of none-US monetary policy then a target on what I would call final domestic spending would be appropriate. Furthermore, final sales was also Clark Warburton’s prefered measure for Py and given I think Warburton is the most underappreciated monetarist ever it is only natural for me to advocate to use final sales rather NGDP as a measure of Py.

Anyway, nice to see a Cato scholar on board. The Cato Institute has been at the forefront of “policy development” in the US for decades and it’s annual monetary conference continues to be hugely influential on US and global thinking about monetary policy and theory so it is truly great that Tim is spreading the message from William Niskanen.

Beckworth and Ponnuru: Tight budgets, Loose money

David Beckworth and Ramesh Ponnuru just came out with a new article on the economic policy debate in the US. Beckworth and Ponnuru lash out against both left and right in American politics. Let me just say that I agree with basically everything in the article, but you should read it yourself.

However, what I find most interesting in the article is not the discussion about the US political landscape, but rather the very clear description of both the Great Moderation and the causes for the Great Recession:

“The Fed did a pretty good job of stabilizing the economy. The result of its monetary policies was that the economy, measured in current-dollar or “nominal” terms, grew at about 5 percent a year, with inflation accounting for 2 percent of the increase and real economic growth 3 percent. Keeping nominal spending and nominal income on a predictable path is important for two reasons. First, most debts, such as mortgages, are contracted in nominal terms, so an unexpected slowdown in nominal income growth increases their burden. Also, the difficulty of adjusting nominal prices makes the business cycle more severe. If workers resist nominal wage cuts during a deflation, for example, mass unemployment results…During the great moderation, people began to expect spending and incomes to grow at a stable rate and made borrowing decisions based on it. But maintaining this stability requires the Fed to increase the money supply whenever the demand for money balances—people’s preference for cash over other assets—increases. This happened in 2008 when, as a result of the recession and the financial crisis, fearful Americans began to hold their cash. The Federal Reserve, first worried about increased commodity prices as a harbinger of inflation and then focused on saving the financial system, failed to increase the money supply enough to offset this shift in demand and allowed nominal spending to fall through mid-2009″

I wish a lot more people would understand this – Beckworth and Ponnuru are certainly not to blame if you don’t understand it yet.

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UPDATE: See this interesting comment on Niskanen and Beckworth/Ponnuru by Tim B. Lee.

The Chuck Norris effect, Swiss lessons and a (not so) crazy idea

Here is from The Street Light:

“You may recall that in September the Swiss National Bank (SNB) announced that it was going to intervene as necessary in the currency markets to ensure that the Swiss Franc (CHF) stayed above a minimum exchange rate with the euro of 1.20 CHF/EUR. How has that been working out for them?

It turns out that it has been working extremely well. Today the SNB released data on its balance sheet for the end of September. During the month of August the SNB had to spend almost CHF 100 billion to buy foreign currency assets to keep the exchange rate at a reasonable level. But in September — most of which was after the announcement of the exchange rate minimum — the SNB’s foreign currency assets only grew by about CHF 25 billion. Furthermore, this increase in the CHF value of the SNB’s foreign currency assets likely includes substantial capital gains that the SNB reaped on its euro portfolio (which was valued at about €130 bn at the end of September), as the CHF was almost 10% weaker against the euro in September than in August. Given that, it seems likely that the SNB’s purchases of new euro assets in September after the announcement of the exchange rate floor almost completely stopped.”

This is a very strong demonstration of the power of monetary policy when the central bank is credible. This is the Chuck Norris effect of monetary policy: You don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target. (Nick Rowe and I like this sort of thing…)

And now to the (not so) crazy idea – if the SNB can ease monetary policy by announcing a devaluation why can’t the Federal Reserve and the ECB do it? Obviously some would say that not all central banks in the world can devalue at the same time – but they can. They can easily do it against commodity prices. So lets say that the ECB, the Federal Reserve, the Bank of Japan, the Bank of England and the SNB tomorrow announced a 15% devaluation against commodity prices (for example the CRB index) and that they will defend that one sided “peg” until the nominal GDP level returns to their pre-Great Recession trend levels. Why 15%? Because that is more or less the NGDP “gap” in the euro zone and the US.

The clever reader will notice that this is the coordinated and slightly more sexy version of Lars E. O. Svensson’s fool-proof way to escape deflation and the liquidity trap.

Is a coordinated 15% devaluation of the major currencies of the world (with the exception of RMB) a crazy idea? Yes, it is quite crazy and it could trigger all kind of political discussions, but I am pretty sure it would work and would very fast bring US and European NGDP back towards the pre-crisis trend. And for those who now scream at the screen “How the hell will higher commodity prices help us?” I will just remind you of the crucial difference between demand and supply driven increases in commodity prices. But okay, lets say we don’t want to do that – so lets instead do the following. The same central banks will “devalue” 15% against a composite index for stock prices in the US, the UK, the euro zone and Japan. Ok, I know you are very upset now. How can he suggest that? I am not really suggesting it, but I am arguing that monetary policy can easily work and all this “crazy idea” would actually do the trick and bring back NGDP back on track in both the US and Europe.  But you might have a better idea.

George Selgin on Bernanke and NGDP targeting

Bill Woolsey has comment on Fed governor Ben Bernanke’s comment’s yesterday regarding NGDP targeting.

Here is what Bernanke said:

“So the fed’s mandate is, of course, a dual mandate. We have a mandate for both employment and for price stability. And we have a framework in place that allows us to communicate and to think about the two sides of that mandate. We talked yesterday about nominal GDP as an indicator, as an information variable, something to add to the list of variables that we think about. And it was a very interesting discussion. However, we think that within the existing framework that we have, which looks at both sides of the mandate, not just some combination of the two, we can communicate whatever we need to communicate about future monetary policy. So we are not contemplating at this time any radical change in framework. We are going to stay within the dual mandate approach that we’ve been using until this point.”

George Selgin who is one of the pioneers of NGDP targeting – even though we all know George prefers Free Banking – has a comment on Bill’s blog. I think George’s comment make a lot of sense:

“Right. BB doesn’t get it: nominal spending isn’t an indicator to be used in helping the Fed to regulate P and y. It is itself the very thing the Fed ought to regulate. The idea that Py is some sort of composite of two more “fundamental” variables, where the Fed is supposed to be concerned with the stability of each, is a crude fallacy. Neither stability of y nor that of P is desirable per se. Stability of Py, on the other hand–which is to say stability of nominal aggregate demand–is desirable in itself.”

Right on George! (for those not schooled in econ lingo P is prices and y is real GDP and Py obviously is nominal GDP).

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