Is Matthew Yglesias now fully converted to Market Monetarism?

The always interesting Matthew Yglesias comments on my point that we should stop talking about national accounting standards. In the process Matt is having a bit of fun with two identities.

The national account standard:

(1) Y=C+I+G+NX

And the equation of exchange:

(2) MV=PY

As Matt rightly notes that we can combine the two:


Matt uses the notation X for net exports – I use NX. P is assumed to be 1.

This is of course completely correct – both are identities. They do not tell us anything about causality. However, the point I have been making is that when people think of (1) they also tend to think that causality runs from right to left in the equation. However, that is only the case if you ignore (2).

This is of course is also why the fiscal multiplier is zero. Hence, public spending (G) can only increase nominal GDP (PY) if the central bank plays along (and increases MV) or as Matt express it:

“If monetary stimulus increases MV then what you’ll get is more spending across a wide variety of categories. Since in today’s economy some things are scarce (gasoline, apartments in San Francisco) and other things are not (unskilled labor, mall space near Phoenix) that will mean some increase in real output and some increase in prices. Similarly on the fiscal policy side, there’s no such thing as an inflation-adjusted tax cut or appropriation. You’re pulling on nominal levers, so if crowding out doesn’t occur that has to be because the central bank is tolerating an increase in the price level.”

This is of course also why the idea that we could use fiscal stimulus to get us out of the European crisis makes no sense at all unless the ECB plays along. You can not increase PY without increasing MV.

Matt has been calling for fiscal stimulus in the US, but his fun with the identities could indicate that he is changing his mind or as David Wright comments on Matt’s article:

“The contrapositive of an assertion is logically equivilent to the original assertion, and the contrapositive of this statement is “if the central bank is enforcing an inflation target, fiscal policy will be ineffective because of crowding out”. This is precisely the claim that Scott Sumner has been shouting from the rooftops from the last couple of years, but in that same time you have been advocating fiscal stimulus and the fed has been consistently enforcing an inflation target. Have you changed your tune?” 

I will leave it to Matt to answer, but I agree with David that it surely looks like Matt is now fully converted from the New Keynesian view to Market Monetarism. Not that it really matters – Matt has long been advocating NGDP level targeting and that is what is really important…

UPDATE: Scott Sumner today comments on an other of Matt’s articles in which he also seems to endorse what he calls the Sumner Critique (the fiscal multiplier is zero).

– and unsurprisingly reaches the same conclusion as me (and a bit more).


Hjalmar Schacht’s echo – it all feels a lot more like 1932 than 1923

The weekend’s Greek elections brought a neo-nazi party (“Golden Dawn”) into the Greek parliament. The outcome of the Greek elections made me think about the German parliament elections in July 1932 which gave a stunning victory to Hitler’s nazi party. The Communist Party and other extreme leftist also did well in the Greek elections as they did in Germany in 1932. I am tempted to say that fascism is always and everywhere a monetary phenomenon. At least that was the case in Germany in 1932 as it is today in Greece. And as in 1932 central bankers does not seem to realise the connection between monetary strangulation and the rise of extremist political forces.

The rise of Hitler in 1932 was to a large extent a result of the deflationary policies of the German Reichbank under the leadership of the notorious Hjalmar Schacht who later served in Hitler’s government as Economics Ministers.

Schacht was both a hero and a villain. He successfully ended the 1923 German hyperinflation, but he also was a staunch supporter of the gold standard which lead to massive German deflation that laid the foundation for Hitler’s rise to power. After Hitler’s rise to power Schacht helped implement draconian policies, which effectively turned Germany into a planned economy that lead to the suffering of millions of Germans and he was instrumental in bringing in policies to support Hitler’s rearmament policies. However, he also played a (minor) role in the German resistance movement to Hitler.

The good and bad legacy of Hjalmar Schacht is a reminder that central bankers can do good and bad, but also that central bankers very seldom will admit when they make mistakes. This is what Matthew Yglesias in a blog post from last year called the Perverse Reputational Incentives In Central Banking.

Here is Matt:

I was reading recently in Hjalmar Schacht’s biography Confessions of the Old Wizard … and part of what’s so incredible about it are that Schacht’s two great achievements—the Weimar-era whipping of hyperinflation and the Nazi-era whipping of deflation—were both so easy. The both involved, in essence, simply deciding that the central bank actually wanted to solve the problem.

To step back to the hyperinflation. You might ask yourself how things could possibly have gotten that bad. And the answer really just comes down to refusal to admit that a mistake had been made. To halt the inflation, the Reichsbank would have to stop printing money. But once the inflation had gotten too high for Reichsbank President Rudolf Havenstein to stop printing money and stop the inflation would be an implicit admission that the whole thing had been his fault in the first place and he should have done it earlier…

…So things continued for several years until a new government brought Schacht on as a sort of currency czar. Schacht stopped the private issuance of money, launched a new land-backed currency and simply . . . refused to print too much of it. The problem was solved both very quickly and very easily…

…The institutional and psychological problem here turns out to be really severe. If the Federal Reserve Open Market Committee were to take strong action at its next meeting and put the United States on a path to rapid catch-up growth, all that would do is serve to vindicate the position of the Fed’s critics that it’s been screwing up for years now. Rather than looking like geniuses for solving the problem, they would look like idiots for having let it fester so long. By contrast, if you were to appoint an entirely new team then their reputational incentives would point in the direction of fixing the problem as soon as possible.

Matt is of course very right. Central banks and central banks alone determines inflation, deflation, the price level and nominal GDP. Therefore central banks are responsible if we get hyperinflation, debt-deflation or a massive drop in nominal GDP. However, central bankers seem to think that they are only in control of these factors when they are “on track”, but once the nominal variables move “off track” then it is the mistake of speculators, labour unions or irresponsible politicians. Just think of how Fed chief Arthur Burns kept demanding wage and price controls in the early 1970s to curb inflationary pressures he created himself by excessive money issuance.  The credo seems to be that central bankers are never to blame.

Here is today’s German central bank governor Jens Weidmann in comment in today’s edition of the Financial Times:

Contrary to widespread belief, monetary policy is not a panacea and central banks’ firepower is not unlimited, especially not in the monetary union. First, to protect their independence central banks in the eurozone face clear constraints to the risks they are allowed to take.

…Second, unconditional further easing would ignore the lessons learned from the financial crisis.

This crisis is exceptional in scale and scope and extraordinary times do call for extraordinary measures. But we have to make sure that by putting out the fire now, we are not unwittingly preparing the ground for the next one. The medicine of a near-zero interest rate policy combined with large-scale intervention in financial markets does not come without side effects – which are all the more severe, the longer the drug is administered.

I don’t feel like commenting more on Weidmann’s comments (you can pretty well guess what I think…), but I do note that German long-term bond yields today have inch down further and is now at record low levels. Normally long-term bond yields and NGDP growth tend to move more or less in sync – so with German government 10-year bond yields at 1.5% we can safely say that the markets are not exactly afraid of inflation. Or said in another way, if ECB deliver 2% inflation in line with its inflation target over the coming decade then you will be loosing 1/2% every year by holding German government bonds. This is not exactly an indication that we are about to repeat the mistakes of the Reichbank in 1923, but rather an indication that we are in the process of repeating the mistakes of 1932. The Greek election is sad testimony to that.

PS David Glasner comments also comments on Jens Weidmann. He is not holding back…

PPS Scott Sumner today compares the newly elected French president Francois Hollande with Léon Blum. I have been having been thinking the same thing. Léon Blum served as French Prime Minister from June 1936 to June 1937. Blum of course gave up the gold standard in 1936 and allowed a 25% devaluation of the French franc. While most of Blum’s economic policies were grossly misguided the devaluation of the franc nonetheless did the job – the French economy started a gradual recovery. Unfortunately at that time the gold standard had already destroyed Europe’s economy and the next thing that followed was World War II. I wonder if central bankers ever study history…They might want to start with Adam Tooze’s Wages of Destruction.

Update: See Matt O’Brien’s story on “Europe’s FDR? How France’s New President Could Save Europe”. Matt is making the same point as me – just a lot more forcefully.

%d bloggers like this: