1. Tyler Cowen provides a strong argument for relying on monetary policy as a stabilization tool:
The greater the number of protected service sector jobs in an economy, the more likely those citizens will oppose inflation. Inflation brings the potential to lower real wages, possibly for good. How many insiders, if they had to renegotiate their current deals, would do just as well?
Get the picture?
This is a neglected cost of protected service sector jobs, namely that the economy’s central bank will face strong political pressures not to inflate even when a looser monetary policy would be welfare-improving.
I’ve already pointed out that this is an argument for switching from inflation to NGDP targeting. But it is also a strong argument for relying more on monetary stimulus than fiscal stimulus. After all, which institution is more susceptible to public pressure against inflation, and which is more shielded from that pressure? Would you rather have to face re-election every 2 years, or every 14 years?
[As an aside, we were all taught in grad school that central banks needed to be independent to resist public pressure to inflate. I'm inclined to discount most public choice explanations of monetary policy failure, and fall back on the "It's the stupidity, stupid." explanation.]
2. Nick Rowe had a string of great posts. Here’s the latest:
One of the things I was a little disappointed about in the recent money and banking controversy was that nobody (IIRC) picked up on my (it’s not original to me) point about asymmetric redeemability.
I’d like to put an end to his disappointment: “Great post Nick, I completely agree.” I hope Nick won’t be disappointed if I said I enjoyed this comment (from “Ritwik”) and his response even better:
Ritwik: “Point being that both the BoC/ BoM can create the medium of exchange, but only BoC defines the medium of account.”
That deserves one of my rare “Hmmmmm’s”. Even before reading that link.
Nick’s newer post actually contemplated the US dollar being pegged to the Canadian dollar. Under that regime a sudden massive increase in the supply of Canadian dollars would cause inflation in the US. Is that because the US medium of account (the Can$) lost value? Or because the dollar peg would force the Fed to inflate the US money supply, causing more inflation here? In other words, is the medium of account or the medium of exchange the “essence of money.” Nick and I can’t agree, and can’t seem to find a definitive natural experiment. (That which is without practical implications, is without philosophical implications?)
3. The commenter “dtoh” recently asked me what would happen “other things equal” if interest rates fell. I replied that other things equal, prices can never change. I vaguely recall Steve Landsburg once criticizing that argument. It is true that in graduate economics we separate out the various effects; the impact of a change in price on consumption, and the impact of the thing that caused the change in price on consumption. But my problem is that I don’t see people doing that, or even being aware of the problem.
Let’s take the recent discussion of whether the interest rate declines of late 2007 and early 2008 caused the oil price spike. To me, that’s a meaningless question unless we know why interest rates fell. If rates fell because of bearish expectations and reduced demand for credit, then you expect the combined impact of the expectations and the lower rates to be less demand for oil, and hence lower oil prices. BTW, that’s exactly what did happen in late 2008, in case anyone finds my argument far-fetched. On the other hand if rates fell because money was “easy” then you’d expect the impact to be higher oil prices. So which was it, and how do we know?
The worst thing to do would be to look at the rate actually targeted by the Fed (the fed funds rate) notice that the Fed dropped that target, and then announce it must be easy money. At a minimum we’d need to ask why the Fed lowered its target. For instance, suppose bearish expectations reduced market rates (longer term) and the Fed cut rates to keep up with the market. They might fear that the Wicksellian equilibrium rate was falling, and that a failure to cut the fed funds target would tighten monetary policy. How could we tell which it was?
In my view the best way to tell would be to look at AD, and NGDP growth. If it was easy money then the AD curve should have shifted right, and NGDP growth should have accelerated. In fact, NGDP growth slowed, indicating the fall in rates wasn’t easy money, but rather reduced demand for credit caused by the housing slump and lower sales of cars, trucks and RVs. So the thing that caused rates to fall lowered AD by more than the fall in interest rates raised AD.
Now I suppose one could argue that NGDP would have fallen even faster if the Fed hadn’t reduced the fed funds target. And in that sense the Fed was to blame for higher oil prices. But I’d consider that a very misleading argument. Rather the Fed prevented the slowdown in US credit demand from depressing oil prices by as much as they otherwise would have depressed those prices. But it’s crazy to argue the Fed reduced market interest rates in late 2007 and early 2008. Rather the Fed slowed the rate at which market rates were falling. With a neutral policy short term rates would have fallen even faster. In December 2007 the Fed cut its target by 1/4%, less than Wall Street had hoped for. Stocks crashed and the economy immediately fell into a (mild) recession. When the Fed saw what was going on they did an emergency meeting in January and cut rates by 125 basis points over two weeks. I suppose someone could call that “easy money” but it would be very misleading. It was tighter than optimal money pushing the economy into recession, at which point T-bond and T-bill yields fell, forcing the Fed to play catch-up if they didn’t want another Great Depression on their hands. Sorry, but I’m not willing to call that “easy money.” Nor will I attribute any oil price changes to that policy.
Why did oil prices rise, if not monetary policy? Check out where demand is increasing fastest:
4. Here’s a video from the recent Kansas City bloggers conference at the Kauffman Foundation. I can’t bear to watch myself, but I have watched Brink Lindsey’s 2 1/2 minute introduction (to panel 1) approximately 137 times, and still haven’t gotten tired of it.