A framework for understanding Tunisia’s economic crisis

The Arab Spring started in 2010-11 in Tunisia and until now Tunisia has been highlighted as basically the only country, where the Arab Spring has not ended in disaster. Unfortunately over the last couple of days social unrest and violent confrontation between demonstrators and police have erupted across Tunisia.

I this blog post I will have a look at the Tunisian economy and try to give my take on what is wrong with the economy. There is of course a lot of ground to cover and I can naturally not cover it all in one blog post, but I will try provide an overall framework for how to understand the economic situation in Tunisia.

The economy has been in crisis since 2011

A look at real GDP growth in Tunisia shows that the economy essentially has been suffering since the outbreak of the Arab Spring in 2010-11.


Prior to 2011 real GDP growth was averaging 4-5% a year – not very impressive given the high growth rate of the labour force and compared to for example Turkey, but nonetheless fairly robust and stable growth.

However, during the 2011 revolution GDP drop in around 2% and after initially recovering in 2011-12 growth have once against slowed significantly and as a consequence the level of real GDP today is more or less unchanged compared to early 2011.

It is hard not to see the latest social unrest and demonstrations in the light of this lackluster economic performance.

AS/AD – a framework for analyzing the crisis

Whenever I want to analyse the economic situation in any country in the world I find it very useful to start out with a simple AS/AD framework. I particularly like the AS/AD framework described in Tyler Cowen and Alex Tabarrok‘s textbook Modern Principles.

This gives us the possibility to think of three kind of shocks to the economy – An Aggregate Demand (AD) shock (essentially a monetary demand shock), a short-run Aggregate Supply (SRAS) shock and a shock to the long-term growth rate of the economy (this is also supply shock). Cowen and Tabarrok terms the long-term growth rate the Solow growth rate after Robert Solow’s famous growth model.

ASAD framework

We can relatively easily apply this model to the Tunisian economy and by looking at the development in inflation and real GDP we can assess whether the development in the economy is driven by supply shocks or demand (monetary) shocks.

Don’t blame monetary policy for the crisis

If the economy is hit by a negative demand shock – either a contraction in the money supply/base or a drop in money-velocity – the AD curve shifts to the left causing both inflation and real GDP to drop and hence therefore also nominal GDP to drop.

The graph below shows the development in real GDP (y), nominal GDP (y+p) and the GDP deflator (p) in Tunisia.


The graph shows that over the past 15 years nominal GDP growth has been relatively stable about 8% and even though there was a slowdown in nominal GDP growth in the period 2008-11 we have since seen a rebound in NGDP growth back to the old trend about 8%, which indicates that there has not been a major negative demand shock to the Tunisian economy.

This is further confirmed by the fact that inflation – measured by the GDP deflator – has in fact shifted upwards since 2010-11. If there had been a negative shock to aggregate demand (AD) we would have expected inflation to drop rather than to increase.

This all indicate that the we cannot blame the the present crisis on monetary policy failure and in fact the Tunisian central bank deserves some credit for – knowingly or not – to have kept nominal GDP on a pretty “straight line”, which in my view certainly is the preferable monetary policy.

NGDP trend

This obviously does not mean that monetary policy is perfect – far from it – and I certainly think that monetary reform is badly needed to ensure that monetary policy failure is avoided in the future, but at least over the past 15 years the Tunisian central bank very broadly speaking has got it more or less right.

The biggest risk as I see it now is that the central bank will be tempted to focus on inflation rather than nominal GDP growth and that that might cause the Tunisian central bank to tighten monetary conditions unduly in response to rise inflation caused by non-monetary factors (a negative supply shock).

The best away of avoiding this is to communicate and explicitly target nominal GDP growth at 8% as de facto has been the policy for the past 15 years. Alternatively the central bank could target nominal wage growth as a proxy for NGDP growth.

The real problem is a real problem

As the discussion above slows the main problem in the Tunisian economy right now is not a lack of demand and monetary policy failure cannot be blamed for the marked slowdown in growth particularly since 2011 and the crisis can therefore not be resolved through an easing of monetary conditions.

As a consequence we have to conclude that the problem is one of real factors (the supply side of the economy) rather than nominal factors (monetary conditions).

The question is, however, whether the the slowdown in growth is permanent or temporary. Said in another way has the crisis been caused by a shift to the left of the Short-run Aggregate Supply (SRAS) or is it rather the Solow growth curve, which has shifted to leftwards?

Whether it is the SRAS curve or the Solow growth curve, which has shifted leftwards does matter in terms of the impact on the economy presently, but only a shift in the Solow growth curve should be expected to cause a permanent decline in the long-term growth rate of the Tunisian economy. Below I will argue that it is a bit of both, but that it likely is short-term shocks that has dominated in the last couple of years.

The horrors of terror 

Tunisia has been hard hit by a number of terror attacks in recent years and particularly in 2015 a number of horrible terror attacks hit Tunisia.

One can think of a terror attack both as a demand shock and a supply shock. Hence, it is obvious that a terror attack will tend to scare tourists away and this is certainly also what we have seen.

This obviously is a negative demand shock. However, as we have seen above the Tunisian central bank has more or less kept nominal GDP growth on a 8% growth path. This means that any drop in tourism revenues will be compensated by higher demand growth other places in the economy. This essentially is a version of the so-called Sumner Critique, which says that if a central banks targets nominal GDP or inflation then it will keep aggregate demand growth stable and this will offset other shocks to aggregate demand.

Obviously Tunisian nominal GDP growth has not been completely stable at 8% and we have indeed seen a drop in NGDP growth over the past year, which do indicate some contraction in aggregate demand growth, which could indicate that the Tunisian central bank has not fully offset the shock to aggregate demand from the drop in tourism revenues, however, if the Tunisian central bank – hopefully – continues de facto to target 8% NGDP the effect on aggregate demand from the tourist attacks should prove to be short-lived.

More worryingly is, however, the fact that the threat of new terror attacks and more generally speaking the rise of islamist extremism is causing a more permanent increase in the cost of doing business in Tunisia.

It is hard to quantify just how big these effects are, but it is notable that real GDP slowed from around 2% to 0% during 2015 so the effects have certainly not been small. Whether they are permanent is another question.

The untold story of the ‘Phosphate Crisis’

When I started to think about the slowdown in the Tunisian economy I initially thought that it mostly was about the terror attracts in 2015 and I was unaware of something, which in reality is at least as important – namely what we could term the ‘Phosphate Crisis’.

This is from an article from Al-Monitor from May 2013:

While phosphate is a pillar of the Tunisian economy, it also represents a social time bomb that nearly ousted the regime of former President Zine El Abidine Ben Ali in 2008, when the residents of the mining basin in southwestern Tunisia rose in rebellion, demanding their rights to employment, development and equitable distribution of wealth. Post-2011, protests paralyzing phosphate production became so rampant that the government announced in April the suspension of negotiations with the protesters. It also began a mass media campaign to explain the “phosphate crisis,” stressing these statistics:

The struggles faced by Tunisia’s economy following its 2011 popular uprising have been exacerbated by a decrease in phosphate production, one of the country’s most lucrative resources.
  • Production fell from 8 million metric tons a year to 2.7 million metric tons in 2012.
  • Financial losses reached 3 million dinars ($1.82 million) a day, amounting to a loss of nearly 2 billion dinars ($1.22 billion) in 2011 and 2012.
  • The phosphate company’s workforce tripled from 9,000 to 27,000 workers over the course of three years.

The government even went so far as to threaten to shut down the Gafsa Phosphate Co. The threat baffled [Tunisians], as the company serves as the only operator in mining basin cities and because phosphate is considered a significant source of hard currency in the country. Additionally, the government is currently experiencing several crises of its own, so this sort of escalation would not balance in its favor. Is the threat a political maneuver or an official admission of failure? If the latter is true, does the admission pave the way for the state to give up on “reforms” in the phosphate sector?

Even though the official rhetoric considers the Jan. 14, 2011, Revolution, which toppled Ben Ali, a societal revolution whose flame has been sparked inside the mining sector, all of the post-revolution governments have only shallowly looked into the problem, resulting in the adoption of ineffective administrative solutions.

The government regards the “phosphate crisis” as a mere blip in the flow of production caused by protests that are first and foremost demanding employment. Through the lens of the government, the crisis is temporary, isolated, and related to a lax security and social situation. Some officials even believe that the crisis has “separatist” aspects, and is even a political conspiracy fomented by “extremists who aim to sabotage the economy for political purposes.”

While this is from a 2013 article the crisis continues to this day. Just have a look at this graph of the output in the Tunisian mining sector.


Hence, mining output dropped sharply in 2011 and has remained more than 30% lower since then. This obviously is a major negative supply shock to the Tunisian economy and it seems of outmost importance to solve this crisis to get the Tunisian economy out of this crisis.

Corruption is just getting worse and worse

At the core of the protests in 2011 was anger over the widespread corruption in Tunisia and corruption remains a main problem for the Tunisian economy and it is certainly something, which is causing long-term growth to be lower than it could be been (permanently shifting the Solow curve to the left).

The graph below illustrates this.


The graph shows Transparency International’s so-called Corruption Perception Index. A lower score in the index indicates more corruption. The development is far from uplifting. In fact of nearly 15 years corruption has been constantly rising in Tunisia as seen by the consistent drop in the Corruption Perception Index.

And the business environment has become less friendly

Another factor that is contributing to shifting the Solow growth curve to the left – permanently lowering real GDP growth – is the fact that despite of the democratic revolution in Tunisia the general business environment has become less friendly.

A way to illustrate this is to look at the World Bank’s Ease of Doing Business survey.


A rise in the index indicates a worsening of the general ‘ease of doing business’ in Tunisia. The picture since 2010 is clear – the business environment has become less friendly in Tunisia. This surely is something, which is lowering Tunisia’s lower term growth potential.

A similarly negative trend is seen in for example Fraser Institute’s Economic Freedom of the World survey, where Tunisia’s overall ranking also have been declining in recent years.

Conclusion – reform is needed to unleash Tunisia’s economic potential

Tunisia is in the midst of a serious political, social and economic crisis. In this blog post I have tried to give an overview of what I believe are the main causes of the economic crisis.

Based on this analysis I would like to offer the following general recommendations for reform and crisis resolution in Tunisia:

  1. Despite the fact that the that Tunisia monetary policy overall has been successful in maintaining nominal stability in the past 15 years monetary reform is needed to ensure that nominal stability is also maintained in the future. A starting point for reform should be to the succes of monetary policy in the past 15 years – that means any new regime should continue to ensure nominal GDP growth around 8%. That would also ensure low and stable inflation in the future.
  2. The threat from terrorism and extremism should to be reduced. That is partly a question of law enforcement, but much more likely it is of outmost importance to empower low-income Tunisians so they to a larger extent are in control of their economic and social destiny and to create economic opportunties for all Tunisians. Other than general economic reform I also think that Tunisians should be given direct ownership of Tunisia’s many government owned companies for example through a Citizen’s account framework.
  3. Bold steps are needed to end the crisis in the Tunisian mining sector. Here privatization of the mining sector should be at the core of these efforts.
  4. Long-term economic growth needs to be increased through massive structural reforms with the purpose to reducing government intervention in the economy and empowering the Tunisian population.

Overall, I think Tunisia has an enormous economic potential – the country has a young and growing population, relatively low public debt, a historical and geographical closeness to (Southern) Europe and by Northern African standards a relatively open economy and access to (some) natural resources.

However, Tunisia cannot unleash this potential without reforms. We have had political revolution – now we need an economic revolution to free up the Tunisian economy.


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.

The Turkish demonstrations – and the usefulness of the AS/AD framework

Peter Dorman has a blog post that have gotten quite a bit of attention in the blogosphere on the AS-AD model and why he thinks it is not a useful framework. This is Peter:

“Introductory textbooks are supposed to give you simplified versions of the models that professionals use in their own work.  The blogosphere is a realm where people from a range of backgrounds discuss current issues often using simplified concepts so everyone can be on the same page.

But while the dominant framework used in introductory macro textbooks is aggregate supply—aggregate demand (AS-AD), it is almost never mentioned in the econ blogs.  My guess is that anyone who tried to make an argument about current macropolicy using an AS-AD diagram would just invite snickers.  This is not true on the micro side, where it’s perfectly normal to make an argument with a standard issue, partial equilibrium supply and demand diagram.  What’s going on here?”

I am somewhat surprised by Peter’s statement that the AS-AD framework is never mentioned on the econ blogs. That could indicate that Peter has never read my blog (no offense taken – I never read Peter’s blog before either). My regular readers would of course know that I am quite fund of using the AS-AD framework to illustrate my arguments. Other Market Monetarists – particularly Nick Rowe and Scott Sumner are doing the same thing quite regularly. See Nick’s discussion of Peter’s post here.

The purpose of this post, however, is not really to discuss Peter’s critique of the AS-AD framework, but rather to show the usefulness of the framework with a example from today’s financial news flow. Furthermore, I will do a Market Monetarist ‘spin’ on the AS-AD framework. Hence, I will stress the importance of monetary policy rules and what financial markets tell us about AD and AS shocks.

The Istanbul demonstrations as an AS shock 

Over the weekend we have seen large street protests in Istanbul in Turkey. The demonstrations are the largest demonstrations ever against the ruling AKP party and Prime Minister Erdogan. Mr. Erdogan has been in power for a decade.

The demonstrations today triggered a 10% drop in the Istanbul stock exchange so there is no doubt that investors think that these demonstrations and the political ramifications of the demonstrations will have a profound negative economic impact.

I believe a core insight of Market Monetarist thinking is that financial markets are very useful indicators about monetary policy shocks. Hence, we for example argue that if the US dollar is depreciating, market inflation expectations are rising and the US stock market is rallying then it is a very clear indication that US monetary conditions are getting easier.

While the focus of Market Monetarists have not been as much on supply shocks as on monetary policy shocks (AD shocks) it is equal possible to ‘deduct’ AS shocks from financial markets. I believe that today’s market action in the Turkish markets are a pretty good indication of exactly that – the combination of lower stock prices, higher bond yields (higher risk premium and/or higher inflation expectations) and a weaker lira tells the story that investors see the demonstrations as a negative supply shock. It is less clear whether the shock is a long-term or a short-term shock.

A short-run AS shock – mostly about disruption of production

My preferred textbook version of the AS-AD model is a model similar to the one Tyler Cowen and Alex Tabarrok use in their great textbook Modern Principles of Economics where the model is expressed in growth rates (real GDP growth and inflation) rather than in levels.

It is obvious that the demonstrations and unrest in Istanbul are likely to lead to disruptions in production – roads are closed down, damages to infrastructure, some workers are not coming to work and even some lines of communication might be negatively impacted by the unrest. Compared to the entire Turkish economy the impact these effects is likely quite small, but it is nonetheless a negative supply shock. These shocks are, however, also likely to be temporary – short-term – rather than permanent. Hence, this is a short-run AS shock. I have illustrated that in the graph below.

AS AD SRAS shock

This is the well-known illustration of a negative short-run supply shock – inflation increases (from P to P’) and real GDP growth declines (from Y to Y’).

This might very well be what we will see in Turkey in the very short run – even though I believe these effects are likely to be quite small in size.

However, note that we here assume a “constant” AD curve.

Peter Dorman is rightly critical about this assumption in his blog post:

“…try the AD assumption that, even as the price level and real output in the economy go up or down, the money supply remains fixed.”

Peter is of course right that the implicit assumption is that the money supply (or money base) is constant. The standard IS/LM model suffers from the same problem. A fact that have led me to suggest an alternative ISLM model – the so-called IS/LM+ model in which the central bank’s monetary policy rule is taken into account.

Obviously no analysis of macroeconomic shocks should ignore the monetary policy reaction to different shocks. This is obviously something Market Monetarists have stressed again and again when it for example comes to fiscal shocks like the ‘fiscal cliff’ in the US. In the case of Turkey we should therefore take into account that the Turkish central bank (TCMB) officially is targeting 5% inflation.

Therefore if the TCMB was targeting headline inflation in a very rigid way (ECB style) it would have to react to the increase in inflation by tightening monetary policy (reducing the money base/supply) until inflation was back at the target. In the graph above that would mean that the AD curve would shift to the left until inflation would have been brought down back to 5%. The result obviously would be a further drop in real GDP growth.

In reality I believe that the TCMB would be very unlikely to react to such a short run supply. In fact the TCMB has recently cut interest rates despite the fact that inflation continue to run slightly above the inflation target of 5%. Numbers released today show Turkish headline inflation was at 6.6% in May.

In fact I believe that one with some justification can think of Turkish monetary policy as a “flexible NGDP growth targeting” (with horrible communication) where the TCMB effectively is targeting around 10% yearly NGDP growth. Interestingly enough in the Cowen-Tabarrok version of the AS-AD model that would mean that the TCMB would effectively keep the AD curve “unchanged” as the AD curve in reality is based in the equation of exchange (MV=PY).

The demonstrations could reduce long-term growth – its all about ‘regime uncertainty’

While the Istanbul demonstrations clearly can be seen as a short-run supply shock that is probably not what the markets are really reacting to. Instead it is much more likely the the markets are reacting to fears that the ultimate outcome of the demonstrations could lead to lower long-run real GDP growth.

Cowen and Tabarrok basically think of long-run growth within a Solow growth model. Hence, there are overall three drivers of growth in the long run – labour forces growth, an increase in the capital stock and higher total factor productivity (TFP – think of that as “knowledge”/technology).

I believe that the most relevant channel for affecting long-run growth in the case of the demonstrations is the impact on investments in Turkey which likely will influence both the size of the capital stock and TFP negatively.

Broadly speaking I think Robert Higgs concept of “Regime Uncertainty” comes in handy here.  This is Higgs:

“The hypothesis is a variant of an old idea: the willingness of businesspeople to invest requires a sufficiently healthy state of “business confidence,”  … To narrow the concept of business confidence, I adopt the interpretation that businesspeople may be more or less “uncertain about the regime,” by which I mean, distressed that investors’ private property rights in their capital and the income it yields will be attenuated further by government action. Such attenuations can arise from many sources, ranging from simple tax-rate increases to the imposition of new kinds of taxes to outright confiscation of private property. Many intermediate threats can arise from various sorts of regulation, for instance, of securities markets, labor markets, and product markets. In any event, the security of private property rights rests not so much on the letter of the law as on the character of the government that enforces, or threatens, presumptive rights.”

I think this is pretty telling about the fears that investors might have about the situation in Turkey. It might be that the Turkish government is not loved by investors, but investors are clearly uncertain about what would follow if the demonstrations led to “regime change” in Turkey and a new government. Furthermore, the main opposition party – the CHP – is hardly seen as reformist.

And even if the AKP does remain in power the increased public disconnect could lead to ‘disruptions of production’ (broadly speaking) again and again in the future.  Furthermore, the government hard-handed reaction to the demonstrations might also “complicate” Turkey’s relationship to both the EU and the US – something which likely also will weigh on foreign direct investments into Turkey.

Hence, regime uncertainty therefore is likely to reduce the long-run growth in the Turkish economy. Obviously it is hard to estimate the scale such effects, but at least judging from the sharp drop in the Turkish stock market today the negative long-run supply shock is sizable.

I have illustrated such a negative long-run supply shock in the graph below.

LRAS shock

The result is the same as in the short-run model – a negative supply shock reduces real GDP growth and increases inflation.

However, I would stress that the TCMB would likely not in the long run accept a permanent higher rate of inflation and as a result the TCMB therefore sooner or later would have to tighten monetary policy to push down inflation (by shifting the AD curve to the left). This also illustrates that the demonstrations is likely to become a headache for the TCMB management.

Is the ‘tourism multiplier’ zero? 

Above I have primarily described the Istanbul demonstrations as a negative supply shock. However, some might argue that this is also going to lead to a negative demand shock.

Hence, Turkey very year has millions of tourists coming to the country and some them will likely stay away this year as a consequence of the unrest. In the Cowen- Tabarrok formulation of the AD curve a negative shock to tourism would effectively be a negative shock to money velocity. This obviously would shift the AD curve to the left – as illustrated in the graph below.

AD shock

Hence, we initially get a drop in both inflation and real GDP growth as the AD curve shifts left.

However, we should never forget to think about the central bank’s reaction to a negative AD shock. Hence, whether the TCMB is targeting inflation or some kind of NGDP growth target it would “automatically” react to the drop in aggregate demand by easing monetary policy.

In the case the TCMB is targeting inflation it would ease monetary policy until the AD curve has shifted back and the inflation rate is back at the inflation target.

This effectively means that a negative shock to Turkish tourism should not be expected to have an negative impact on aggregate demand in Turkey for long. This effectively is a variation of the Sumner Critique – this time, however, it is not the budget multiplier, which is zero, but rather the ‘tourism multiplier’.

Hence, from a macroeconomic perspective the demonstrations are unlikely to have any major negative impact on aggregate demand as we would expect the TCMB to offset any such negative shock by easing monetary policy.

That, however, does not mean that a negative shock to tourism will not impact the Turkish financial markets. Hence, there will be a change in the composition of aggregate demand – less tourism “exports” and more domestic demand. This likely is bad news for the Turkish lira.

Mission accomplished – we can use the AS-AD framework to analysis the ‘real world’

I hope that my discussion above have demonstrated that the AS-AD framework can be a very useful tool when analyzing real world problems – such as the present public unrest in Turkey. Obviously Peter Dorman is right – we should know the limitations of the AS-AD model and we should particularly be aware what kind of monetary policy reaction there will be to different shocks. But if we take that into account I believe the textbook (the Cowen-Tabarrok textbook) version of the AS-AD model is a quite useful tool. In fact it is a tool that I use every single day both when I produce research in my day-job or talk to clients about such ‘events’ as the Turkish demonstrations.

Furthermore, I would add that I could have done the same kind of analysis in a DSGE framework, but I doubt that my readers would have enjoyed looking at a lot of equations and a DSGE model would likely have reveal little more about the real world than the version of the AS-AD model I have presented above.

PS Please also take a look at this paper in which I discuss the politics and economics of the present Turkish crisis.

PPS Paul Krugman, Nick Rowe and Mark Thoma also comment on the usefulness of the AS-AD framework.

Answering Tyler’s question on Japan with old blog post

Here is Tyler Cowen on Twitter:

Still not seeing much discussion of 4.1% unemployment rate in Japan, would love to see “jump start” defined.

What Tyler is basically saying is that there really is not an argument for “jump starting” the Japanese economy with fiscal and monetary stimulus when unemployment is this low. I many ways I share Tyler’s skepticism about “stimulus” in the case of Japan.

I have long argued that Japanese story is a lot more complicated than it is normally said to be (my first post on the topic was: “Japan’s deflation story is not really a horror story” from October 2011). It is correct that Japan’s lost decade was not a story of two lost decades and in my view quantitative easing ended the “lost decade” in 2001. This is what I said in my post “Japan shows that QE works”

In early 2001 the Bank of Japan finally decided to listen to the advise of Milton Friedman and as the graph clearly shows this is when Japan started to emerge from the lost decade and when real GDP/capita started to grow in line with the other G7 (well, Italy was falling behind…).

The actions of the Bank of Japan after 2001 are certainly not perfect and one can clearly question how the BoJ implemented QE, but I think it is pretty clearly that even BoJ’s half-hearted monetary easing did the job and pull Japan out of the depression. In that regard it should be noted that headline inflation remained negative after 2001, but as I have shown in my previous post Bank of Japan managed to end demand deflation (while supply deflation persisted).

And yes, yes the Bank of Japan of course should have introduces much clearer nominal target (preferably a NGDP level target) and yes Japan has once again gone back to demand deflation after the Bank of Japan ended QE in 2007. But that does not change that the little the BoJ actually did was enough to get Japan growing again.

This graph of GDP/capita in the G7 countries illustrates my point:


As I said in my earlier post: “A clear picture emerges. Japan was a star performer in 1980s. The 1990s clearly was a lost decade, while Japan in the past decade has performed more or less in line with the other G7 countries. In fact there is only one G7 country with a “lost decade” over the paste 10 years and that is Italy.”

Hence, Japan came out of the crisis from 2001. However, it should also be noted that Japan has once again fallen into crisis and more importantly Japan’s monetary policy certainly is not based on a rule based framework so the risk that Japan will continue to fall back into crisis remains high. This in my view is a discussion about securing Japan a “Monetary constitution” rather than about stimulus. Unfortunately Prime Minister Abe’s new government do seem to be more focused on short-term stimulus rather than on real institutional reform.

There is no such thing as fiscal policy

– and that goes for Japan as well

The Abe government is not only pursuing expansionary monetary policies, but has also announced that it wants to ease fiscal policy dramatically. This obviously will scare any Market Monetarist – or anybody who are simply able to realise that there is a budget constrain that any government will have to fulfill in the long-run.

This is what I earlier have said on the fiscal issue in the case of Japan:

Furthermore, it is clear that Japan’s extremely weak fiscal position to a large extent can be explained by the fact that BoJ de facto has been targeting 0% NGDP growth rather than for example 3% or 5% NGDP growth. I basically don’t think that there is a problem with a 0% NGDP growth path target if you start out with a totally unleveraged economy – one can hardly say Japan did that. The problem is that BoJ changed its de facto NGDP target during the 1990s. As a result public debt ratios exploded. This is similar to what we see in Europe today.

So yes, it is obvious that Japan can’t not afford “fiscal stimulus” – as it today is the case for the euro zone countries. But that discussion in my view is totally irrelevant! As I recently argued, there is no such thing as fiscal policy in the sense Keynesians claim. Only monetary policy can impact nominal spending and I strongly believe that fiscal policy has very little impact on the Japanese growth pattern over the last two decades.

Above I have basically added nothing new to the discussion about Japan’s lost decade (not decades!) and fiscal and monetary policy in Japan, but since Scott brought up the issue I thought it was an opportunity to remind my readers (including Scott) that I think that the Japanese story is pretty simple, but also that it is wrong that we keep on talking about Japan’s lost decades. The Japanese story tells us basically nothing new about fiscal policy (but reminds us that debt ratios explode when NGDP drops), but the experience shows that monetary policy is terribly important.

My advise: Target an 3% NGDP growth level path and balance the budget 

My advise to the Abe government would therefore be for the Bank of Japan to introduce proper monetary policy rules and I think that an NGDP level targeting rule targeting a growth path of 3% would be suiting for Japan given the negative demographic outlook for Japan. Furthermore, if the BoJ where to provide a proper framework for nominal stability then the Japanese government should begin a gradual process of fiscal consolidation by as soon as possible to bring the Japanese budget deficit back to balance. With an NGDP growth path of 3% Japanese public debt as a share of GDP would gradually decline in an orderly fashion on such fiscal-monetary framework.

So what Japan needs is not “stimulus” – neither fiscal nor monetary – but rather strict rules both for monetary policy and fiscal policy. The Abe government has the power to ensure that, but I am not optimistic that that will happen.

Earlier posts on Japan:

There is no such thing as fiscal policy – and that goes for Japan as well
The scary difference between the GDP deflator and CPI – the case of Japan
Friedman’s Japanese lessons for the ECB
There is no such thing as fiscal policy – and that goes for Japan as well
Japan shows that QE works
Did Japan have a “productivity norm”?
Japan’s deflation story is not really a horror story

PS even though I am skeptical about the way Shinzo Abe are going about things and I would have much preferred a rule based framework for Japan’s monetary and fiscal policy I nonetheless believe that the Abe government’s push for particularly monetary “stimulus” is likely to spur Japanese growth and is very likely to be good news for a global economy badly in need of higher growth.

Update: Scott Sumner also comments on Japan and it seems like we have more or less the same advise. Here is Scott:

“Just to be clear, my views are somewhere between those of Feldstein and the more extreme Keynesians.  I agree with Feldstein that Japan has big debt problems and big structural problems, and needs to address both.  And that fiscal stimulus is foolish (as even Adam Posen recently argued.)  Unlike Feldstein I also think they have an AD problem that calls for modestly higher inflation and NGDP growth.  At a minimum they should be shooting for 2% to 3% NGDP growth, instead of the negative NGDP growth of the past 20 years.”

The trillion dollar coin is an utterly idiotic idea

Following US political debate these days is like following a bad parody of a third world banana republic and even though I the deepest respect for Americans and US in general I must say it is hard not to agree with those Europeans that shake their heads these days and say “they are stupid those Americans”. Well, it is not the Americans – it is their politicians and you could say a similar thing about Europe.

The latest banana republic gimmick is the suggestion that the US Treasury should use a legal loophole to print a trillion dollar coin in the event that the US congressional majority – that’s the Republicans – would refuse to increase the so-called debt celling.

The idea in my view is completely ludicrous and it is incredible that anybody seriously would even contemplate such an idea. Anyway, is Nobel Prize winning economist Paul Krugman:

“It’s easy to make sententious remarks to the effect that we shouldn’t look for gimmicks, we should sit down like serious people and deal with our problems realistically. That may sound reasonable — if you’ve been living in a cave for the past four years.Given the realities of our political situation, and in particular the mixture of ruthlessness and craziness that now characterizes House Republicans, it’s just ridiculous — far more ridiculous than the notion of the coin.

So if the 14th amendment solution — simply declaring that the debt ceiling is unconstitutional — isn’t workable, go with the coin.”

Nobel Prize or not Krugman is wrong – as he so often is.

First, of all there is no reason to think that the US government would have to default on it’s public debt just because the debt ceiling is not increased. The monthly debt servicing costs in the US is significantly smaller than the US government’s total monthly tax revenues. It might be that the US Treasury would have to stop paying out salaries to US Congressmen and stop buying new military hardware for a while – neither would be a major lose – but the tax revenues would easily cover  the debt servicing costs. That of course do not mean that I suggest that the debt ceiling should not be increased – that is US party political shenanigans that I simply don’t even want to comment on. However, it is wrong to suggest that the US government would automatically default if the debt ceiling is not increased.

Lars, wouldn’t a 1 trillion dollar coin be monetary easing? So it most be good?

What I really want to discuss is the Market Monetarist perspective on this discussion. Yes, Market Monetarists have for the past four years argued that US monetary policy has been overly tight and the reason the US recovery has been so relatively weak is the that Federal Reserve has had too tight monetary policy. That has led Market Monetarists like myself and other to call for monetary easing from the Federal Reserve.

However, at the core of Market Monetarist thinking is not the call for monetary easing and no Market Monetarist has ever said that monetary easing is the cure of all evils. Rather at the centre of Market Monetarist thinking is the call for a rule based monetary policy. An easing of monetary policy based on a trillion dollar coin is probably the most discretionary and least rule based monetary (and fiscal) idea anybody have come up with over the past four years.

Yes, Market Monetarists are certainly skeptical about central bankers ability to conduct monetary policy in a proper fashion, but that certainly do not mean that we think US politicians and bureaucrats in the US Treasury would do a better job. Far from it!

I would even go further – I don’t necessarily think that the US economy needs more quantitative easing IF the Federal Reserve started conducting monetary policy based on a transparent monetary rule like NGDP level targeting. Furthermore, if I would have to chose between an NGDP level target or a massive ramping up of quantitative easing within a discretionary framework then there is no doubt that I would choose the rule based framework. Market Monetarists are not the monetary version of discretionary Krugmanian fiscal policy.

Concluding, the trillion dollar coin idea is stupid. It is stupid because it banana republic “economic” policy based on the worst political motives without any foundation in the rule of law and a general rules based framework.

The fact is that the US government faces serious fiscal challenges. The US public debt level needs to be reduced and even if the Federal Reserve pushed back NGDP to its pre-crisis trend level I believe there would be a significant need for fiscal consolidation. There is no getting around it – debt ceiling or not, trillion dollar coin or not – fiscal policy will have to be tightened sooner or later. And if you need idea about what to cut I have some ideas about that as well (see here).

It is simple mamanomics – you can’t continue spending more money than you have. It might be that certain US policy makers would be happy if their mom raised their weekly allowances, but would they also be happy if their mom prostituted herself to do that?

PS there is no party politics in what I am saying – I have the same lack of respect for both main political parties in the US as do most Americans.

PPS Scott Sumner and Tyler Cowen also comment on the trillion dollar coin – for some reason the two gentlemen are slightly more diplomatic than I am. Josh Hendrickson, however, is as clear on the issue as I am – Josh has two posts on the trillion dollar coin. See here and here.

PPPS If you think there is a lot of James Buchanan and Friedrich Hayek in this post then I have achieved what I want to achieve. After all Friedman and Schwartz’s “Monetary History” is not the only book I read.

Update: Both Steve Horwitz and George Selgin comment on the trillion dollar coin – not surprisingly I have no reason to disagree with the two gentlemen.

Paul Krugman warns against fiscal stimulus

This is Paul Krugman on the effectiveness on fiscal policy and why fiscal “stimulus” will in fact not be stimulative:

“The US is currently engaged in the largest peacetime fiscal stimulus in history, with a budget deficit of around 10 percent of GDP. And this stimulus is working in the narrow sense that it has headed off the imminent risk of a deflationary spiral, and generated some economic growth. On the other hand, deficits this size cannot be continued over the long haul; USA now has Italian (or Belgian) levels of internal debt, together with large implicit liabilities associated with its awkward demographics. So the current strategy can work in the larger sense only if it succeeds in jump-starting the economy, in eventually generating a self-sustaining recovery that persists even after the stimulus is phased out.

Is this likely? The phrase “self-sustaining recovery” trips lightly off the tongue of economic officials; but it is in fact a remarkably exotic idea. The purpose of this note is to expose this hidden exoticism – to show that anyone who believes that temporary fiscal stimulus will produce sustained recovery is implicitly endorsing a rather fancy economic model, the sort of model that finance ministries would under normal circumstances regard as implausible and disreputable…

…What continues to amaze me is this: USA’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.”

Wauw! What is this? What happened to the keynesian Krugman? Isn’t he calling for fiscal easing anymore? Well yes, but I am cheating here. This is Paul Krugman, but it is not today’s Paul Krugman. This is Paul Krugman in 1999 – and he is talking about Japan and not the US. I simply replaced “Japan” with “the US” in the Krugman quote above.

Read the entire article here.

HT Tyler Cowen and Vaidas Urba.

MRUniversity – join now!

Tyler Cowen and Alex Tabarrok have written one of the best economics textbooks out there and now they are introducing the Marginal Revolution University.

Is is how the gentlemen introduces MRUniversity:

We think education should be better, cheaper, and easier to access.  So we decided to take matters into our own hands and create a new online education platform toward those ends. We have decided to do more to communicate our personal vision of economics to you and to the broader world.

You can visit http://www.MRUniversity.com here.  There you can sign up for information about our first course, Development Economics, which is described by Alex below.

Here are a few of the principles behind MR University:

1. The product is free (like this blog), and we offer more material in less time.

2. Most of our videos are short, so you can view and listen between tasks, rather than needing to schedule time for them.  The average video is five minutes, twenty-eight seconds long.  When needed, more videos are used to explain complex topics.

3. No talking heads and no long, boring lectures.  We have tried to reconceptualize every aspect of the educational experience to be friendly to the on-line world.

4. It is low bandwidth and mobile-friendly.  No ads.

5. We offer tests and quizzes.

6. We have plans to subtitle the videos in major languages.  Our reach will be global, and in doing so we are building upon the global emphasis of our home institution, George Mason University.

7. We invite users to submit content.

8. It is a flexible learning module.  It is not a “MOOC” per se, although it can be used to create a MOOC, namely a massive, open on-line course.

9. It is designed to grow rapidly and flexibly, absorbing new content in modular fashion — note the beehive structure to our logo.  But we are starting with plenty of material.

10. We are pleased to announce that our first course will begin on October 1

I think this is a great idea and a very good opportunity for students of economics and amateur economists to get high quality economic education from some of the best and most clever guys out there. So I encourage everybody just remotely interested in economics to sign up NOW.

NGDP level targeting – the true Free Market alternative

Tyler Cown a couple of days ago put out a comment on “Why doesn’t the right-wing favor looser monetary policy?”

Tyler has three answers to his own question:

1. There is a widespread belief that inflation helped cause the initial mess (not to mention centuries of other macroeconomic problems, plus the problems from the 1970s, plus the collapse of Zimbabwe), and that therefore inflation cannot be part of a preferred solution.  It feels like a move in the wrong direction, and like an affiliation with ideas that are dangerous.  I recall being fourteen years of age, being lectured about Andrew Dickson White’s work on assignats in Revolutionary France, and being bored because I already had heard the story.

2. There is a widespread belief that we have beat a lot of problems by “getting tough” with them.  Reagan got tough with the Soviet Union, soon enough we need to get tough with government spending, and perhaps therefore we also need to be “tough on inflation.”  The “turning on the spigot” metaphor feels like a move in the wrong direction.  Tough guys turn off spigots.

3. There is a widespread belief that central bank discretion always will be abused (by no means is this view totally implausible).  “Expansionary” monetary policy feels “more discretionary” than does “tight” monetary policy.  Run those two words through your mind: “expansionary,” and “tight.”  Which one sounds and feels more like “discretion”?  To ask such a question is to answer it.

There is a lot of truth in what Tyler is saying. I especially like #2. There seem especially among US conservative and libertarian intellectuals a need to be “tough”. The dogma seems to be “no pain, no gain”. This obviously is an idiotic position. It seems like the tough guys have forgotten that sometimes there are indeed gains to be made with little or no pain. Just remember what the supply siders like Arthur Laffer taught us – sometimes you can cut tax rates and increase revenues. In fact most market reforms are exactly about that – economists call it a Pareto improvement. Unlike other monetary policy rules NGDP level targeting can actually be shown to ensure Pareto optimality (yes, yes I know it is based on questionable theoretical assumptions…)

Even though I like Tyler’s explanations to his question I think there is one big problem with his comment and that is his premise that Market Monetarists are advocating “expansionary” monetary policy. We are not – at least I am not and I don’t think Scott Sumner is. I have again and again argued that NGDP level targeting is not about “stimulus” and it is certainly not discretionary. Rather NGDP level targeting is about ensuring that monetary policy is “neutral” and does not distort the price system.

As I have earlier argued that if the central bank is pursuing a policy of NGDP level targeting then (ideally) relatively prices would be unaffected by monetary policy and hence be equal to what they would have been in a pure barter economy.

This is what I have called Selgin’s Monetary Credo:

The goal of monetary policy ought to be that of avoiding unnatural fluctuations in output…while refraining from interfering with fluctuations that are “natural.” That means having a single mandate only, where that mandate calls for the central bank to keep spending stable, and then tolerate as optimal, if it does not actually welcome, those changes in P and y that occur despite that stability

Hence, what we line with George Selgin are arguing is the true Free Market alternative to the present monetary policy in for example the euro zone and the US. Contrary to for example the Taylor rule which anybody who has studied David Eagle or George Selgin would tell you is leading to distortions of relative prices. How can any conservative or libertarian advocate a monetary policy rule which distorts market prices?

Furthermore, Scott Sumner, Bill Woolsey and myself have suggested that not only should the central banks target the only non-distortionary policy rule (NGDP level targeting), but the central bank should also leave the implementation of this rule to the market through the use of predictions markets (e.g. NGDP futures). I have not seen conservative economists like John Taylor or Allan Meltzer showing such trust in the free market. (The gold bugs and Rothbard style Austrians do not even want to let the market decide on was level of reserves banks should hold…)

Of course there is a position which is even more Free Market and that is of course the Free Banking alternative. However, as I argued the Market Monetarist position and the Free Banking position are fundamentally not in conflict. In fact NGDP targeting could be seen as a privatisation strategy. Free Banking theorists like George Selgin of course understand this, but will John Taylor or Allan Meltzer go along with that idea? I think not…

But why do people get confused and think we want monetary stimulus? Well, it is probably partly our own fault because we argue that the present crisis particularly in the US and Europe is due to overly tight monetary policy and as a natural consequence we seem to be favouring “expansionary” monetary policy or “monetary stimulus”.  However, the point is that we argue that the ECB and Fed failed in 2008 and to a large extent have continued to fail ever since and that they need to undo their mistakes. But we mostly want the central bank to stop distorting relative prices and we would really just like to have a big nice “computer” called The Market to take care of the implementation of monetary policy. That is also what Milton Friedman favoured and what right-winger would be against that?

PS I assume that Tyler uses the term “right-winger” to mean somebody who is in favour of free markets. That is at least how I here use the term.

Guest blog: Tyler Cowen is wrong about gold (By Blake Johnson)

In a recent post I commented on Tyler Cowen’s reservations about the gold standard on his excellent blog Marginal Revolution. In my comment I invited to dialogue between Market Monetarists and gold standard proponents and to a general discussion of commodity standards. I am happy that Blake Johnson has answered my call and written a today’s guest blog in which he discusses Tyler’s reservations about the gold standard.

Obviously I do not agree with everything that my guest bloggers write and that is also the case with Blake’s excellent guest blog. However, I think Blake is making some very valid points about the gold standard and commodity standards and I think that it is important that we continue to discuss the validity of different monetary institutions – including commodity based monetary systems – even though I would not “push the button” if I had the option to reintroduce the gold standard (I am indirectly quoting Tyler here).

Blake, thank you very much for contributing to my blog and I look forward to have you back another time.

Lars Christensen


Guest blog: Tyler Cowen is wrong about gold

By Blake Johnson

I have been reading Marginal Revolution for several years now, and genuinely find it to be one of the more interesting and insightful blogs out there. Tyler Cowen’s prolific blogging covers a massive range of topics, and he is so well read that he has something interesting to say about almost anything.

That is why I was surprised when I saw Tyler’s most recent post on the gold standard. I think Tyler makes some claims based on some puzzling assumptions. I’d like to respond here to Cowen’s criticism of the gold standard, as well as one or two of Lars’ points in his own response to Cowen.

“The most fundamental argument against a gold standard is that when the relative price of gold is go up, that creates deflationary pressures on the general price level, thereby harming output and employment.  There is also the potential for radically high inflation through gold, though today that seems like less a problem than it was in the seventeenth century.”

I am surprised that Cowen would call this the most fundamental argument against the gold standard. First, regular readers of the Market Monetarist are likely very familiar with Selgin’s excellent piece “Less than Zero” which Lars is very fond of. There is plenty of evidence that suggests that there is nothing necessarily harmful about deflation. Cowen’s blanket statement of the harmful effects of deflation neglects the fact that it matters very much why the price level is falling/the real price of gold is going up. The real price of gold could increase for many reasons.

If the deflation is the result of a monetary disequilibrium, i.e. an excess demand for money, then it will indeed have the kind of negative consequences Cowen suggests. However, the purchasing power of gold (PPG) will also increase as the rest of the economy becomes more productive. An ounce of gold will purchase more goods if per unit costs of other goods are falling from technological improvements. This kind of deflation, far from being harmful, is actually the most efficient way for the price system to convey information about the relative scarcity of goods.

Cowen’s claim likely refers to the deflation that turned what may have been a very mild recession in the late 1920’s into the Great Depression. The question then is whether or not this deflation was a necessary result of the gold standard. Douglas Irwin’s recent paper “Did France cause the Great Depression” suggests that the deflation from 1928-1932 was largely the result of the actions of the US and French central banks, namely that they sterilized gold inflows and allowed their cover ratios to balloon to ludicrous levels. Thus, central bankers were not “playing by the rules” of the gold standard.

Personally, I see this more as an indictment of central bank policy than of the gold standard. Peter Temin has claimed that the asymmetry in the ability of central banks to interfere with the price specie flow mechanism was the fundamental flaw in the inter-war gold standard. Central banks that wanted to inflate were eventually constrained by the process of adverse clearings when they attempted to cause the supply of their particular currency exceed the demand for that currency. However, because they were funded via taxpayer money, they were insulated from the profit motive that generally caused private banks to economize on gold reserves, and refrain from the kind of deflation that would result from allowing your cover ratio to increase as drastically as the US and French central banks did. Indeed, one does not generally hear the claim that private banks will issue too little currency, the fear of those in opposition to private banks issuing currency is often that they will issue currency ad infinitum and destroy the purchasing power of that currency.

I would further point out that if you believe Scott Sumner’s claim that the Fed has failed to supply enough currency, and that there is a monetary disequilibrium at the root of the Great Recession, it seems even more clear that central bankers don’t need the gold standard to help them fail to reach a state of monetary equilibrium. While we obviously haven’t seen anything like the kind of deflation that occurred in the Great Depression, this is partially due to the drastically different inflation expectations between the 1920’s and the 2000’s. The Fed still allowed NGDP to fall well below trend, which I firmly believe has exacerbated the current crisis.

Finally, I would dispute the claim that the gold standard has the potential for “radically high inflation”. First, one has to ask the question, radically high compared to what? If one compares it to the era of fiat currency, the argument seems to fall flat on its face rather quickly. In a study by Rolnick and Weber, they found that the average inflation rate for countries during the gold standard to be somewhere between -0.5% and 1%, while the average inflation rate for fiat standards has been somewhere between 6.5% and 8%. That result is even more striking because Rolnick and Weber found this discrepancy even after throwing out all cases of hyperinflation under fiat standards. Perhaps the most fundamental benefit of a gold run is its property of keeping the long run price level relatively stable.

“Why put your economy at the mercy of these essentially random forces?  I believe the 19th century was a relatively good time to have had a gold standard, but the last twenty years, with their rising commodity prices, would have been an especially bad time.  When it comes to the next twenty years, who knows?”

I think Cowen makes two mistakes here. First, the forces behind a functioning gold standard are not random. They are the forces of supply and demand that seem to work pretty well in basically every other market. Lawrence H. White’s book “The Theory of Monetary Institutions” has an excellent discussion of the response in both the flow market for gold as well as the market for the stock of monetary gold to changes in the PPG. To go over it here in detail would take far too much space.

Second, commodity prices have not been increasing independent of monetary policy; the steady inflation over the last 30 years has had a significant effect on commodity prices. This is rather readily apparent if one looks at a graph of the real price of gold, which is extremely stable and even falling slightly until Nixon closes the Gold Window and ends the Bretton Woods system, at which point it begins fluctuating wildly. Market forces stabilize the purchasing power of the medium of redemption in a commodity standard; this would be true for any commodity standard, it is not something special about gold in particular.

As an aside, in response to Lars question, why gold and not some other commodity or basket of commodities, I would argue that without a low transaction cost medium of redemption the process of adverse clearings that ensures that money supply tends toward equilibrium becomes significantly less efficient. The reason the ANCAP standard, or a multi-commodity standard such as Yeager’s valun standard are not likely to have great success is mainly the problems of redemption (they also have not tracked inflation well since the 1980’s and 1990’s respectively.) I would gladly say that I believe there are many other commodities that a monetary standard could be based upon. C.O. Hardy argued that a clay brick standard would work fairly well if not for the problem of trying to get people to think of bricks as money (and Milton Friedman commented favorably on Hardy’s idea in a 1981 paper.)

“Whether or not there is “enough gold,” and there always will be at some price, the transition to a gold standard still involves the likelihood of major price level shocks, if only because the transition itself involves a repricing of gold.  A gold standard, by the way, is still compatible with plenty of state intervention.”

This is Cowen’s best point in my opinion. There would indeed be some sizable difficulties in returning from a fiat standard to a gold standard. In particular, it would not be fully effective if only one or two countries returned to a commodity standard, it would need to be part of a broader international movement to have the full positive effects of a commodity standard. Further, the parity at which countries return to the commodity standard would need to be better coordinated than the return to the gold standard in the 1920’s, when some countries returned with the currencies overvalued, and others returned with their currencies undervalued.

My main gripe is that Cowen’s claims seemed to be a broad indictment of the gold standard (or commodity standards) in general, rather than on the difficulties of returning to a gold standard today. They are two separate debates, and in my opinion, there is plenty of reason to believe that theoretically the gold standard is the better choice, particularly for lesser-developed countries. Even for countries such as the US with more advanced countries, the record does not seem so rosy. Central banks not only watched over, but we have reason to believe that their actions (or inaction) have been significant factors in the severity of both the Great Depression and the Great Recession.

© Copyright (2012) Blake Johnson

Tyler Cowen on the gold standard

Here is Tyler Cowen on the gold standard:

“The most fundamental argument against a gold standard is that when the relative price of gold is go up, that creates deflationary pressures on the general price level, thereby harming output and employment. There is also the potential for radically high inflation through gold, though today that seems like less a problem than it was in the seventeenth century.

Why put your economy at the mercy of these essentially random forces? I believe the 19th century was a relatively good time to have had a gold standard, but the last twenty years, with their rising commodity prices, would have been an especially bad time. When it comes to the next twenty years, who knows?

Whether or not there is “enough gold,” and there always will be at some price, the transition to a gold standard still involves the likelihood of major price level shocks, if only because the transition itself involves a repricing of gold. A gold standard, by the way, is still compatible with plenty of state intervention.”

I fully agree – I think it would be an extremely bad idea to introduce a gold standard today. That does not mean that the gold standard does not have some merits. It has – the gold standard will for example significantly reduce discretion in monetary policy and I surely prefer rules to discretion in monetary policy. Furthermore, I think that exchange rate based monetary policy also has some merits as it can “circumvent” the financial sector. Monetary policy is not conducted via a credit channel, but via a exchange rate channel – that makes a lot of sense in a situation will a financial crisis.

However, why gold? Why not silver? Or Uranium? Or rather a basket of commodities. Robert Hall has suggested a method that I fundamentally think has a lot of merit – the ANCAP standard, which is a basket of Ammonium Nitrate, Copper, Aluminum and Plywood. Why these commodities? Because as Robert Hall shows they have been relatively highly correlated with the general cost of living. I am not sure that these commodities are the best for a basket – I in fact think it would make more sense to use a even broader basket like the so-called CRB index, but that is not important – the important thing is that the best commodity standard is not one with one commodity (like gold), but rather a number of commodities so to reduce the volatility of the basket.

Furthermore, it makes very little sense to me to keep the exchange rate completely fixed against the the commodity basket. As I have advocated in a number of earlier posts I think a commodity-exchange rates based NGDP targeting regime could make sense for small open economies – and maybe even for large economies. Anyway, the important thing is that we can learn quite a bit from discussing exchange rate and commodity based monetary standards. Therefore, I think the Market Monetarists should engage gold standard proponents in in 2012. We might have more in common than we think.

Now I better stop blogging for this year – the guests will be here in a second and my wife don’t think it is polite to write about monetary theory while we have guests;-)

Happy new year everybody!

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