Ben Southwood finds lots of evidence for (market) monetarism
Ben Southwood of the Adam Smith Institute has several recent blog posts that are well worth reading.
When the Bank moves its key policy rate, commentators talk about it hiking or cutting interest rates; on top of this, we’ve seen extremely low effective interest rates in the marketplace; together this makes it reasonable to believe that the central bank is the cause of these low effective rates.
There are lots of reasons to doubt this claim. In a previous post I pointed out that the spreads between Bank Rate and market rates seem to be narrow and fairly consistent””until they’re not. I made the case that markets set rates in an open economy. And I arguedthat lowering Bank Rate or buying up assets with quantitative easing (QE) may well boost market rates because they raise the expected path of demand, the expected amount of profit opportunities in the future, and thus investment.
Since then I came across an elegant and compelling explanation of exactly why this is. In a 1998 paper, Tore Ellingsen and Ulf Söderström show that this is because some monetary policy changes are purely expected and ‘endogenous’ responses to economic events, whereas some monetary policy changes are unexpected ‘exogenous’ changes to the central bank’s overall policy framework (like raising or lowering the inflation rate that markets believe they really want).
When changes are expected, market rates keep a tight spread around policy rates; when changes are a surprise, cutting Bank Rate actually results in higher interest rates in the marketplace.
The post has some nice graphs showing this distinction. He has another post citing no less that 4 papers with monetarist-friendly findings. Here’s one example:
In “QE and the bank lending channel in the United Kingdom”, BoE economists Nick Butt, Rohan Churm, Michael McMahon, Arpad Morotz and Jochen Schanz tackle the popular creditist view that movements in lending drive overall activity, and that quantitative easing works by stimulating lending, and find “no evidence to suggest that quantitative easing (QE) operated via a traditional bank lending channel”. Instead, their evidence is consistent with the monetarist view, that “QE boosted aggregate demand and inflation via portfolio rebalancing channels.”
They find this result by looking at the difference between banks that dealt directly with the Bank of England when it was buying gilts (UK government bonds) with new money in its QE programme. If the creditist view held, these banks would be more able to expand their lending with the extra deposits created when the BoE hands over new money for gilts.
And a post exposing the silliness of internet Austrian commenters, who seem to think that anyone who is not an Austrian is a Keynesian.
Ben’s colleague Sam Bowman (also at the ASI) has a good post explaining NGDP targeting.
Meanwhile, the only head of a major central bank ever to say good things about NGDP targeting now presides over an economy that is creating jobs at a rate no one could have imagined 18 months ago.