Three simple changes to the Fed’s policy framework

Frankly speaking I don’t feel like commenting much on the FOMC’s decision today to keep the Fed fund target unchanged – it was as expected, but sadly it is very clear that the Fed has not given up the 1970s style focus on the Phillips curve and on the US labour market rather than focusing on monetary and market indicators. That is just plain depressing.

Anyway, I would rather focus on the policy framework rather than on today’s decision because at the core of why the Fed consistently seems to fail on monetary policy is the weaknesses in the monetary policy framework.

I here will suggest three simple changes in the Fed’s policy framework, which I believe would dramatically improve the quality of US monetary policy.

  1. Introduce a 4% Nominal GDP level target. The focus should be on the expected NGDP level in 18-24 month. A 4% NGDP target would over the medium term also ensure price stability and  “maximum employment”. No other targets are needed.
  2. The Fed should give up doing forecasting on its own. Instead three sources for NGDP expectations should be used: 1) The Fed set-up a prediction market for NGDP in 12 and 24 months. 2) Survey of professional forecasters’ NGDP expectations. 3) The Fed should set-up financial market based models for NGDP expectations.
  3. Give up interest rate targeting (the horrible “dot” forceasts from the FOMC members) and instead use the money base as the monetary policy framework. At each FOMC meeting the FOMC should announce the permanent yearly growth rate of the money base. The money base growth rate should be set to hit the Fed’s 4% NGDP level target. Interest rates should be completely market determined. The Fed should commit itself to only referring to the expected level for NGDP in 18-24 months compared to the targeted level when announcing the money base growth rate. Nothing else should be important for monetary policy.

This would have a number of positive consequences.

First, the policy would be completely rule based contrary to today’s discretion policy.

Second, the policy would be completely transparent and in reality the market would be doing most of the lifting in terms of implementing the NGDP target.

Third, there would never be a Zero-Lower-Bound problem. With money base control monetary policy can always be eased also if interest rates are at the ZLB.

Forth, all the silly talk about bubbles, moral hazard and irrational investors in the stock markets would come to an end. Please stop all the macro prudential nonsense right now. The Fed will never ever be able to spot bubbles and should not try to do it.

Fifth,the Fed would stop reacting to supply shocks (positive and negative) and finally six the FOMC could essentially be replaced by a computer as long ago suggested by Milton Friedman.

Will this ever happen? No, there is of course no chance that this will ever happen because that would mean that the FOMC members would have to give up the believe in their own super human abilities and the FOMC would have to give up its discretionary powers. So I guess we might as well prepare ourself for a US recession later this year. It seems incredible, but right now it seems like Janet Yellen’s Fed has repeated the Mistakes of ’37.

PS What I here have suggested is essentially a forward-looking McCallum rule.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

 

Do economists know what will happen in 2016?

For the last couple of months I have been writing a weekly column for the Icelandic newspaper Fréttablaðið. I enjoy it a lot. First of all it keeps me in contact with Iceland – a country that since 2006 has been an important part of my professional and personal life. Second, it is a good alternative to my blog where I mostly focus on monetary policy.

I normally do not share the stuff I write for Fréttablaðið on this blog, but will do it from time to time in the future if I think that others than an Icelandic audience can benefit from reading it and it fits the “profile” of my blog.

An example of this is the largest op-ed, which has been published today. Have a look at the Icelandic version here.

Here is the English version…

Do economists know what will happen in 2016?

I am not going to lie – I am proud of my forecast in 2006 that Iceland would be facing a server economic and financial crisis. However, I am always very humble about the fact that to forecast something correctly you have to a large extent to be lucky and I generally don’t think that economists or political scientist for that matter are especially good at forecasting.

In fact – and that might be a surprise to most non-economists – when you study economics there is not a course in “forecasting”. It is simply not what economists are educated to do.

What economist on the other hand can do is analysis the impact of different shocks to the economy or analysis the impact of for example an increase in the minimum wage.

Said in another way economists are very good at in hindsight explaining what happened and why it happened. The reason for this is that what economist cannot forecast shocks – for example an earthquake, a terror attack or for that matter a major positive technological development – since a shock by definition is exactly that something you didn’t see coming.

How economists actually “forecast” – reversion to the mean

So what do for example bank economists do when they try to forecast what will happen to the Icelandic economy in 2016? Well, the first thing they do is basically to ask whether present growth is high or low compared to some measure of what is the long-term growth rate for the economy and this essentially is just assumed to be some measure of the historical average growth rate. Or said in another way if the present growth rate is above the historical average then the economist will “forecast” that growth will slow in the next 1-2 years back toward the historical average.

The “forecast” for inflation will typically be done in the same way maybe adjusting for whether the central bank has a target for inflation – for example 2%.

Obviously if a shock just hit – for example that Sedlabanki had hiked interest rates dramatically then the economist would try to take this into account, but the general rule is one of “mean-reversion”.

And this is in fact not a bad forecasting strategy or rather it is the only thing the economist can do and I personally have no problem with that. However, the problem is that economists are not too eager reminding people that this is in fact the way they do forecasting.

Set up prediction markets

So should we stop listening to economists? I certainly don’t think so, but we should also remember the joke that god invented economists to make meteorologists look good!

We are not better at forecasting Icelandic growth in 2016 than meteorologists are at forecasting the Icelandic weather in the Summer of 2016.

I, however, think that there is something else we could do. We could listen to the “wisdom of the crowds”. That is we could set-up so-called “prediction markets”. That is essentially betting markets, where you can bet on for example what real GDP growth will be in the third quarter of 2016. I have no clue what that number will be, but if there was a prediction market for Icelandic GDP in Q3 2016 I am sure it would be a better forecast that any forecast I could come up with.

Happy New Year!

 

 

Prediction market: Fed on track to hit 4% NGDP growth in 2015

Since December last year the prediction market site Hypermind has been running a prediction market for US nominal GDP growth for 2015 (plus markets for each quarter of the year).

I think the development of a prediction market for NGDP growth is extremely interesting and such market can help us much better to understand monetary and economic issues. Furthermore, the Federal Reserve should be very excited about such markets as they provide a minute-by-minute “tracker” of the Fed’s performance and credibility.

Of course the Federal Reserve does not official target nominal GDP growth, but I have earlier argued that the Fed effectively since Q2 2009 has kept US NGDP on a (very narrow) path close to a 4% trend. The graph below shows this.

What does the Hypermind’s prediction market then tell us? Well, guess what – right now the market is predicting NGDP growth to be exactly 4% in 2015! So at least judging from the prediction market US monetary policy is right now perfectly calibrated to keep actual NGDP on the 4% path through 2015.

NGDP prediction market Hypermind

This of course does not mean that US monetary policy is “perfect”. First, of all the Fed does not official have a 4% NGDP target. Second, communication about the Fed’s policy instrument(s) is far from perfect. But if we decide to say that the Fed effectively has a 4% NGDP target then at least the “market” now perceives this target as credible.

I have earlier argued that central bankers should endorse prediction markets such as Hypermind. This is what I wrote back in 2012:

My point is that the “average” forecast of the market often is a better forecast than the forecast of the individual forecaster. Furthermore, I know of no macroeconomic forecaster who has consistently over long periods been better than the “consensus” expectation. If my readers know of any such super forecaster I will be happy to know about them.

…Unlike the market where the profit motive rules central banks and governments are not guided by an objective profit motive but rather than by political motives – that might or might not be noble and objective.

It is well known among academic economists and market participants that the forecasts of government institutions are biased. For example Karl Brunner and Allan Meltzer have demonstrated that the IMF consistently are biased in a too optimistic direction in their forecasts.

…Instead of relying on in-house forecasts central banks could consult the market about the outlook for the economy and markets. Scott Sumner has for example argued that monetary policy should be conducted by targeting NGDP futures. I think that is an excellent idea. However, first of all it could be hard to set-up a genuine NGDP futures markets. Second, the experience with inflation linked bonds shows that the prices on these bonds often are distorted by for example lack of liquidity in the particular markets.

I believe that these problems can be solved and I think Scott’s suggestion ideally is the right one. However, there is a more simple solution, which in principle is the same thing, but which would be much less costly and complicated to operate. My suggestion is the central bank simply set-up a prediction market for key macroeconomic variables – including of the variables that the central bank targets (or could target) such as NGDP level and growth, inflation, the price level.

…The experience with prediction markets is quite good and prediction markets have been used to forecast everything from the outcome of elections to how much a movie will bring in at the box office. A clear advantage with prediction markets is that they are quite easy to set-up and run. Furthermore, it has been shown that even relatively small size bets give good and reliable predictions. This mean that if a central bank set up a prediction market then the average citizen in the country could easily participate in the “monetary policy market”.

I hence believe that prediction markets could be a very useful tool for central banks – both as a forecasting tool but also as a communication tool. A truly credible central bank would have no problem relying on market forecasts rather than on internal forecast.

I of course understand that central banks for all kind of reasons would be very reluctant to base monetary policy on market predictions, but imagine that the Federal Reserve had had a prediction market for NGDP (or inflation for that matter) in 2007-8. Then there is no doubt that it would have had a real-time indication of how much monetary conditions had tightened and that likely would caused the Fed into action much earlier than was actually the case. A problem with traditional macroeconomic forecasts is that they take time to do and hence are not available to policy makers before sometime has gone by.

With Hypermind’s NGDP prediction market we now have such a market I was calling for back in 2012 and in the future I will try to keep track of the Hypermind’s NGDP prediction market as I believe that such markets can teach us quite a bit about the workings of monetary policy.

Furthermore, it would be extremely interesting to see a similar market being set up for the euro zone so I hope Hypermind in the future will find a sponsor to set up such a market.

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Some of my earlier posts on prediction markets:

The Crowd: “Lars, you are fat!”
Prediction markets and UK monetary policy
Leave it to the market to decide on “tapering”
Guest post: Central bankers should watch the Eurovision (by Jens Pedersen)
Remembering the “Market” in Market Monetarism
Gabe Newell on prediction markets – NGDP level targeting and Lindsay Lohan
Yet another argument for prediction markets: “Reputation and Forecast Revisions: Evidence from the FOMC”
Benn & Ben – would prediction markets be of interest to you?
Prediction markets and government budget forecasts
Central banks should set up prediction markets
Markets are telling us where NGDP growth is heading
Scott’s prediction market
Bank of England should leave forecasting to Ladbrokes
Ben maybe you should try “policy futures”?
Robin Hanson’s brilliant idea for central bank decision-making

Tighter monetary conditions – not lower oil prices – are pushing down inflation expectations

Oil prices are tumbling and so are inflation expectations so it is only natural to conclude that the drop in inflation expectations is caused by a positive supply shock – lower oil prices. However, that is not necessarily the case. In fact I believe it is wrong.

Let me explain. If for example 2-year/2-year euro zone inflation expectations drop now because of lower oil prices then it cannot be because of lower oil prices now, but rather because of expectations for lower oil prices in the future.

2y2y BEI euro zone

But the market is not expecting lower oil prices (or lower commodity prices in general) in the future. In fact the oil futures market expects oil prices to rise going forward.

Just take a look at the so-called 1-year forward premium for brent oil. This is the expected increase in oil prices over the next year as priced by the forward market.

brent 1-year foreard

Oil prices have now dropped so much that market participants now actually expect rising oil prices over the going year.

Hence, we cannot justify lower inflation expectations by pointing to expectations for lower oil prices – because the market actual expects higher oil prices – more than 2.5% higher oil prices over the coming year.

So it is not primarily a positive supply shock we are seeing playing out right now. Rather it is primarily a negative demand shock – tighter monetary conditions.

Who is tightening? Well, everybody -The Fed has signalled rate hikes next year, the ECB is continuing to failing to deliver on QE, the BoJ is allowing the strengthening of the yen to continue and the PBoC is allowing nominal demand growth to continue to slow.

As a result the world is once again becoming increasingly deflationary and that might also be the real reason why we are seeing lower commodity prices right now.

Furthermore, if we were indeed primarily seeing a positive supply shock – rather than tighter global monetary conditions – then global stock prices would have been up and not down.

I can understand the confusion. It is hard to differentiate between supply and demand shocks, but we should never reason from a price change and Scott Sumner is therefore totally correct when he is saying that we need a NGDP futures market as such a market would give us a direct and very good indicator of whether monetary/demand conditions are tightening or not.

Unfortunately we do not have such a market and there is therefore the risk that central banks around the world will claim that the drop in inflation expectations is driven by supply factors and that they therefore don’t have to react to it, while in fact global monetary conditions once again are tightening.

We have seen it over and over again in the past six years – monetary policy failure happens when central bankers fail to differentiate properly between supply and demand shocks. Hopefully this time they will realized the mistake before things get too bad.

PS I am not arguing that the drop in actual inflation right now is not caused by lower oil prices. I am claiming that lower inflation expectations are not caused by an expectation of lower oil prices in the future.

PPS This post was greatly inspired by clever young colleague Jens Pedersen.

The Crowd: “Lars, you are fat!”

On Friday I was doing a presentation on the global economy (yes, yes mainly on global monetary policy) for 40-50 colleagues who are working as investment advisors in the Danske Bank group.

As I was about to start my presentation somebody said “The audience have been kind of quiet today”. I thought that was a challenge so I immediately so I jumped on top of a table. That woke up the crowd.

I asked the audience to guess my weight. They all wrote their guesses on a piece of paper. All the guesses were collected and an average guess – the “consensus forecast” – was calculated, while I continued my presentation.

I started my presentation and I naturally started telling why all of my forecasts would be useless – or at least that they should not expect that I would be able to beat the market. I of course wanted to demonstrate exactly that with my little stunt. It was a matter of demonstrating the wisdom of the crowds – or a simple party-version of the Efficient Market Hypothesis.

I am certainly not weighing myself on a daily basis so I was “guestimating” my own weight then I told the audience that my weight is 81 kilograms (fully dressed). I usually think of my own weight as being just below 80 kg, but I was trying to correct it for the fact I was fully dressed – and I added a bit extra because my wife has been teasing me that I gained weight recently.

As always I was completely confident that the “survey” result would come in close to the “right” number. So I was bit surprised when the  “consensus forecast” for my weight came in at 84.6 kg

It was close enough for me to claim that the “market” – or the crowd – was good at “forecasting”, but I must say that I thought the “verdict” was wrong – nearly 85 kg. That is fat. I am not fat…or am I?

So once I came back home I immediately jumped on the scale – for once I hoped to show that the Efficient Market Hypothesis was wrong. But the verdict was even more cruel. 84 kg!

So the “consensus forecast” was only half a kilo wrong and way better than my own guestimate. So not only am I fat, but I was also beaten by the “market” in guessing my own weight.

I need a cake

PS My height is 183 cm – so my Body Mass Index is 25.08 – that is officially overweight (just a little – above 25 is overweight).

PPS I have done this kind of experiments before. See here.

Prediction markets and UK monetary policy

I have long argued that central banks should utilise prediction markets for macroeconomic forecasting and for the implementation of monetary policy.

In today’s edition of the UK business daily City AM I have an oped on this topic and about how the Bank of England should have a closer look at prediction markets. See here:

IN HIS first major speech since becoming governor of the Bank of England, Mark Carney is today likely to defend a policy that has come to be described as the “Carney rule”. Also known as forward guidance, the rule effectively promises that interest rates will stay at present levels until unemployment drops below 7 per cent, so long as the Bank’s inflation forecast does not top 2.5 per cent.
 
This kind of forward guidance is welcome news for the financial markets. We will now at least have some sort of map to navigate monetary policy, instead of relying on insinuations from the lips of the wise men on the Monetary Policy Committee (MPC).
 
But this still leaves markets at the mercy of the Bank of England’s internal forecasters, whose credibility can certainly be questioned. The Bank doesn’t need to be biased to consistently predict that it will hit its inflation target, for example (though what institution would forecast that it will fail?). Even with the best incentives, it cannot possibly bring together all the private knowledge spread across investors, firms and households.
 
It is this inability of elite central planners to gather such a wide source of information that led even committed Marxist GA Cohen to agree that markets may be necessary for a rational economic system. No individual, however intelligent, can know enough about the economy to make a really reliable prediction about it.
 
And it’s not just the dragging-together of information from thousands of different sources that makes market predictions more accurate than those made by small elite groups. Investors betting in markets have skin in the game; they have an extremely strong incentive to get their bets right, since they will lose money for bad (inaccurate) bets and win money for good (accurate) ones.
Read the rest of the piece here.
 
And Mark Carney is lucky that he now in fact has a prediction market to look at. This is from a press release from the Adam Smith Institute:

Today we’ve launched two betting markets to try to use the ‘wisdom of crowds’ to beat government economic forecasters….The Bank of England’s economic forecasts have been wrong again and again. To counter this, the free market Adam Smith Institute is today (Wednesday 28th August) launching two betting markets where members of the public can bet on UK inflation and unemployment rates, taking the government’s experts on at their own game. The markets are designed to aggregate individual predictions about the economy’s prospects to use the ‘wisdom of crowds’ to beat the predictions of government experts.

The launch coincides with Mark Carney’s first major speech as governor of the Bank of England and follows his announcement earlier this month that the Bank will consider both inflation and unemployment when deciding monetary policy.
Read more here.
 
It will extremely interesting to follow how this prediction market will work and it will obviously be very interesting to see how it will impact the monetary policy debate in the UK. My hope certainly is that it will help the case for market-driven monetary policy implementation and also help “police” the Bank of England’s forecasts.
 
 
 
 
 

Leave it to the market to decide on “tapering”

The rally in the global stock markets has clearly run into trouble in the last couple of weeks. Particularly the Nikkei has taken a beating, but also the US stock market has been under some pressure.

If one follows the financial media on a daily basis it is very clear that there is basically only one reason being mentioned for the decline in global stock markets – the possible scaling back of the Federal Reserve’s quantitative easing.

This is three example from the past 24 hours. First CNBC:

“Stocks posted sharp declines across the board Wednesday, with the Dow ending below 15,000, following weakness in overseas markets and amid concerns over when the Fed will start tapering its bond-buying program on the heels of several mixed economic reports.”

And this is from Bloomberg:

“U.S. stocks fell, sending the Standard & Poor’s 500 Index to a one-month low, as jobs and factory data missed estimates and investors speculated whether the Federal Reserve will taper bond purchases.”

And finally Barron’s:

“Fear that the central bank may start scaling back its $85 billion in monthly bond purchases has helped trigger a sharp increase in market volatility over the last couple of weeks both here and overseas.”

I believe that what we are seeing in the financial markets right now is telling us a lot about how the monetary transmission mechanism works. Market Monetarists say that money matters and markets matter. The point is that the markets are telling us a lot about the expectations for future monetary policy. This is of course also why Scott Sumner likes to say that monetary policy works with long and variable LEADS.

Hence, what we are seeing now is that US monetary conditions are being tightened even before the fed has scaled back asset purchases. What is at work is the Chuck Norris effect. It is the threat of “tapering” that causes US stock markets to decline. Said in another way Ben Bernanke has over the past two weeks effectively tightened monetary conditions. I am not sure that that was Bernanke’s intension, but that has nonetheless been the consequence of his (badly timed) communication.

This is also telling us that Market Monetarists are right when we say that both interest rates and money supply data are unreliable indicators of monetary conditions – at least when they are used on their own. Market indicators are much better indicators of monetary conditions.

Hence, when the US stock market drops, the dollar strengthens and implied market expectations of inflation decline it is a very clear signal that US monetary conditions are becoming tighter. And this is of course exactly what have happened over the last couple of weeks – ever since Bernanke started to talk about “tapering”. The Bernanke triggered the tightening, but the markets are implementing the tigthening.

Leave it to the market to decide when the we should have “tapering”

I think it is pretty fair to say that Market Monetarists are not happy about what we are seeing playing out at the moment in the US markets or the global markets for that matter. The reason is that we are now effectively getting monetary tightening. This is certainly premature monetary tightening – unemployment is still significantly above the fed’s unofficial 6.5% “target”, inflation is well-below the fed’s other unofficial target – 2% inflation – and NGDP growth and the level NGDP is massively below where we would like to see it.

It is therefore hardly the market’s perception of where the economy is relative to the fed’s targets that now leads markets to price in monetary tightening, but rather it is Bernanke’s message of possible “tapering” of assets purchases, which has caused the market reaction.

This I believe this very well illustrates three problems with the way the fed conducts monetary policy.

First of all, there is considerable uncertainty about what the fed is actually trying to target. We have an general idea that the fed probably in some form is following an Evans rule – wanting to continue to expand the money base at a given speed as long as US unemployment is above 6.5% and PCE core inflation is below 3%. But we are certainly not sure about that as the fed has never directly formulated its target.

Second, it is clear that the fed has a clear instrument preference – the fed is uncomfortable with conducting monetary policy by changing the growth rate of the money base and would prefer to return to a world where the primary monetary policy instrument is the fed funds target rate. This means that the fed is tempted to start “tapering” even before we are certain that the fed will succeed in hitting its target(s). Said, in another way the monetary policy instrument is both on the left hand and the right hand side of the fed’s reaction function. By the way this is exactly what Brad DeLong has suggested is the case. Brad at the same time argues that that means that the fiscal multiplier is positive. See my discussion of that here.

Third the fed’s policy remains extremely discretionary rather than being rule based. Hence, Bernanke’s sudden talk of “tapering” was a major surprise to the financial markets. This would not have been the case had the fed formulated a clear nominal target and explained its “reaction function” to markets.

Market Montarists of course has the solution to these problems. First of all the fed should clearly formulate a clear nominal target. We obviously would prefer an NGDP level target, but nearly any nominal target – inflation targeting, price level targeting or NGDP growth targeting – would be preferable to the present “target uncertainty”.

Second, the fed should leave it to the market to decide on when monetary policy should be tightened (or eased) and leave it to the market to actually implement monetary policy. In the “perfect world” the fed would target a given price for an NGDP-linked bond so the implied market expectation for future NGDP was in line with the targeted level of NGDP.

Less can, however, do it – the fed could simply leave forecasting to either the markets (policy futures and other forms of prediction markets) or it could conduct surveys of professional forecasters and make it clear that it will target these forecasts. This is Lars E. O. Svensson’s suggestion for “targeting the forecast” (with a Market Monetarist twist).

Concluding, the heightened volatility we have seen in the US stocks markets over the last two weeks is mostly the result of monetary policy failure – a failure to formulate a clear target, a failure to be clear on the policy instrument and a failure of making it clear how to implement monetary policy.

Bernanke don’t have to order the printing of more money. We don’t need more or less QE. What is needed is that Bernanke finally tells us what he is really targeting and then he should leave it to the market to implement monetary policy to hit that target.

PS I could have addressed this post to Bank of Japan and governor Kuroda as well. Kuroda is struggling with similar troubles as Bernanke. But he could start out by reading these two posts: “Mr. Kuroda please ‘peg’ inflation expectations to 2% now” and “A few words that would help Kuroda hit his target”. Kuroda should also take a look at what Marcus Nunes has to say.

Guest post: Central bankers should watch the Eurovision (by Jens Pedersen)

Guest post: Central bankers should watch the Eurovision

By Jens Pedersen

Congratulations Emmelie de Forest with the 2013 Eurovision song contest first place. You have made all of Denmark very proud!! Denmark normally does not win anything, so this is really big for us! (note the irony…)

However, I regret to say that I did not watch the competition yesterday. Not that I do not like a good song contest or that I am not a patriot rooting for my country.  The reason that I did not watch the song contest was simply that the bookmakers had Denmark as a heavy favourite to win and history shows that the bookmakers are rarely wrong in their Eurovision predictions. Bookmakers have correctly predicted four out of last five Eurovision winners. Hence, the results were pretty much given before hand, which really takes away all of the excitement.

I do, however, hope that every central banker out there watched the Eurovision song contest yesterday. It serves a great example that looking at market expectations is the best way of predicting the outcome of an uncertain event.  If markets can predict the winner of the Eurovision they should also come pretty close at predicting the future rate of inflation, real and nominal GDP growth, the rate of unemployment etc. Hence, the first thing central banks should do on Monday is to set up prediction markets for key economic variables. This will be a great help in guiding future monetary policy decisions.

Remembering the “Market” in Market Monetarism

A couple of days ago the young and talented George Mason University economist Alex Salter wrote the following statement on his Facebook account:

I wish market monetarists would put relatively more emphasis on the “market” bit.

I agree with Alex as I believe that one of the main points of Market Monetarism is that not only do money matters, but it equally important that markets matter. Hence, it is no coincidence that the slogan of my blog ismarkets matter, money matters” and it was after all me who coined the phrase Market Monetarism.

Paul Krugman used to call Scott Sumner a quasi-monetarist, but I always thought that that missed an important point about Scott’s views (and my own views) and that of course is the “market” bit. In fact Alex’s statement reminded me of a blog post that I wrote back in January 2012 on exactly this topic.

This is from my post “Don’t forget the “Market” in Market Monetarism”:

As traditional monetarists Market Monetarists see money as being at the centre of macroeconomic discussion. To us both inflation and recessions are monetary phenomena. If central banks print too much money we get inflation and if they print to little money we get recession or even depression.

This is often at the centre of the arguments made by Market Monetarists. However, we are exactly Market Monetarists because we have a broader view of monetary policy than traditional monetarists. We deeply believe in markets as the best “information system” – also about the stance of monetary policy. Even though we certainly do not disregard the value of studying monetary supply numbers we believe that the best indicator(s) of monetary policy stance is market pricing in currency markets, commodity markets, fixed income markets and equity markets. Hence, we believe in a Market Approach to monetary policy in the tradition of for example of “Manley” Johnson and Robert Keheler.

Interestingly enough Alex himself has just recently put out a new working paper – “There a Self-Enforcing Monetary Constitution?” –
that makes the exact same point. This is the abstract from Alex’s paper:

This paper uses insights from monetary theory and constitutional political economy to discover what a self-enforcing monetary constitution — one whose rules did not require external enforcement — would look like. I argue that a desirable monetary constitution (a) institutionalizes an environment conducive to economic calculation via an unhampered price mechanism and (b) enables agents acting within the system to uphold the rule even in the presence of deviations from ideal knowledge and incentive assumptions. I show two radical alternatives to current monetary institutions — a version of NGDP targeting that relies on market implementation of monetary policy and free banking — meet these requirements, and thus represent self-enforcing monetary constitutions. I ultimately conclude that the maintenance of a stable monetary framework necessitates branching out from monetary theory narrowly conceived and considering insights from political economy, and constitutional political economy in particular.

I very much like Alex’s constitutional spin on the monetary policy issue. I strongly agree that the biggest problem in the conduct of monetary policy – basically everywhere in the world – is the lack of a clear rule based framework for the monetary system and equally agree that NGDP targeting with “market implication” and Free Banking fulfill the requirement for a monetary constitution. Or as I put it in my 2012 post:

In fact we want to take out both the “central” and “banking” out of central banking and ideally replace monetary policy makers with the power of the market. Scott Sumner has suggested that the central banks should use NGDP futures in the conduct of monetary policy. In Scott’s set-up monetary policy ideally becomes “endogenous”. I on my part have suggested the use of prediction markets in the conduct of monetary policy.

…Even though Market Monetarists do not necessarily advocate Free Banking there is no doubt that Market Monetarist theory is closely related to the thinking of Free Banking theorist such as George Selgin and I have early argued that NGDP level targeting could be see as an “privatisation strategy”. A less ambitious interpretation of Market Monetarism is certainly also possible, but no matter what Market Monetarists stress the importance of markets – both in analysing monetary policy and in the conduct monetary policy.

Hence, Alex and I are in fundamental agreement, but I also want to acknowledge that we – the Market Monetarists – from time to time are more (too?) focused on the need to ease monetary policy – in the present situation in the US or the euro zone – than to talk about “market implementation” of monetary policy.

There are numerous reasons for this, but the key reason is probably one of political realism, but there is also a serious risk in letting “political realism” dictate the agenda. Therefore, I think we should listen to Alex’s advice and try to stress the “market” bit in Market Monetarism a bit more. Afterall, we have made serious inroads in the global monetary policy debate in regard to NGDP level targeting – why should we not be able to make the same kind of progress when it comes to “market implementation” of monetary policy?

Gabe Newell on prediction markets – NGDP level targeting and Lindsay Lohan

This is interesting – Gabe Newell on Youtube on the value of prediction markets. I love it…Gabe is co-founder and managing director of Video game developer video game development and online distribution company Valve Corporation (I stole that from Wikipedia). This guy is brilliant and he certainly understands markets.

Some of my earlier posts on prediction markets:

Yet another argument for prediction markets: “Reputation and Forecast Revisions: Evidence from the FOMC”
Benn & Ben – would prediction markets be of interest to you?
Prediction markets and government budget forecasts
Central banks should set up prediction markets
Markets are telling us where NGDP growth is heading
Scott’s prediction market
Bank of England should leave forecasting to Ladbrokes
Ben maybe you should try “policy futures”?
Robin Hanson’s brilliant idea for central bank decision-making

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