Here’s Simon Nixon writing in the WSJ:
Excessive praise for central bankers from politicians is rarely a healthy sign. The whole point of making these guardians of monetary policy independent was so that they could be a restraint on the inflationary tendencies of politicians.
So when the U.K. Treasury referred to Mark Carney last week as “the outstanding central banker of his generation” —before the Bank of Canada chief has even taken up his new post as Governor of the Bank of England—alarm bells rang in some quarters of the City of London.
After all, politicians used to say similar things about the Federal Reserve’s Alan Greenspan until his reputation collapsed along with the global economy. These days, it’s his predecessor, Paul Volcker, who stood up to politicians as he stamped out inflation in the 1980s, whose reputation now stands tall. Meanwhile Bank of Japan governor is expected to lose his job following Sunday’s election having resisted political demands to be more aggressive at inflating the economy.
Paul Volcker tried to reduce inflation in late 1979 and early 1980, and then gave up when a small recession hit the US in the first half of 1980. He then slashed short term interest rates sharply, and NGDP growth surged to a 19% rate in late 1980 and early 1981. Next time he tried he stuck with it, and inflation was running about 4% by 1982. But then Volcker got complacent—mission accomplished. Inflation stayed close to 4% all the way up to 1987 when Greenspan took over. But Greenspan wasn’t content with 4% inflation, and drove the rate down to 2%. And from this Nixon infers that Volcker is an anti-inflation hero, and Greenspan a villain?
Then there’s his comment on Japan. I thought the one thing all economists agreed on, both liberals and conservatives, was that the BOJ’s deflationary policy was utter madness. Even Japan’s NGDP has been falling in recent decades. And now Nixon criticizes those who favor a more expansionary monetary policy in Japan. Is Japan the new model for the WSJ editorial page?
Sure, a nominal GDP is superficially beguiling because it forces central banks to weigh their decisions explicitly through the prism of growth. It allows them to look through periods of high inflation when real economic growth is low.
But it is a dangerous path. Gross domestic product is hard to measure and prone to substantial revisions. Choosing an appropriate nominal-GDP target is problematic. It depends on assumptions about how fast output can grow without causing inflation.
Yes, NGDP is hard to measure, although NGDI is somewhat easier and is exactly the same concept. So the problem with revisions is not as severe as it first seems. But if NGDP is hard to measure, what are we to make of the CPI? Economists cannot even agree as to what the CPI is supposed to measure. Is it the size of a raise the average person would need to maintain constant utility? If not, what is it, and how could we possible measure it in the era of Facebook and smart phones?
And no, the NGDP target does NOT depend on estimates of how fast output can grow. We target NGDP because it is NGDP that matters for maximizing social welfare, and inflation does not matter. The problems that are assumed to represent the welfare costs of inflation; actually represent the welfare costs of high and volatile NGDP growth.
If the public sees prices rising, it may simply assume the central bank has lost control and react accordingly. The idea that central banks will act to dampen growth during a boom if inflation is low will strike many as particularly unrealistic.
No they won’t react accordingly, because wage demands depend on expected NGDP growth, not expected inflation. And the second sentence makes no sense at all. I thought the entire objection to Greenspan’s bubble era policy was that he targeted inflation during the housing bubble, and didn’t try to tighten enough to prevent overheating. That’s inflation targeting. But a few sentences back Nixon just bashed Greenspan’s policy. Does Nixon favor inflation targeting, or not? If he thinks Greenspan was too inflationary, then why not advocate NGDP targeting, as Friedrich Hayek did?
Besides, many suspect the BOE has already been covertly targeting nominal GDP, given it continued printing money even when inflation rose above 5% in 2011. The only reason for making the change is if one believes the central bank has somehow been excessively cautious in spending the mere equivalent of 30% of GDP to fund the purchase of 40% of the U.K. government bond market.
I don’t follow this at all. Central banks tend to run large balance sheets as a share of GDP when interest rates and inflation are low, not high. Look at the Bank of Japan, which has also monetized vast quantities of government debt. And the BOJ actually did so, using non-interest bearing base money (until 2008), unlike the BOE, which didn’t really monetize debt, it just exchanged one form of interest-bearing government debt for another. If Mr. Nixon wants smaller central bank balance sheets as a share of GDP, he should favor higher nominal interest rates and inflation, not lower.
Mr. Carney’s openness to further large-scale money printing will disappoint those who blame the lackluster U.K. economy on the inaction of politicians in facing up the U.K.’s deep structural problems. These supply-side challenges include an unproductive public sector that accounts for more than 50% of GDP; a welfare system that undermines labor mobility; a deficit reduction strategy that is barely reducing the deficit; and dysfunctional banking and planning systems.
Yes, Britain’s biggest problems are structural, but I favor more monetary stimulus because those structural problems are easier to address when the economy in not suffering from a lack of AD. As we saw in the US during the 1930s, Argentina in the 2000s, and much of the world today, bad demand-side policies lead to bad supply-side policies. Nothing discredits conservative economics so thoroughly as a demand shortfall, which looks like the “failure of capitalism” to the average person. Boost employment and the US will cut back on the excessive duration of unemployment benefits (which were boosted from 26 weeks to 99 weeks in the US during the current recession, before being reduced to 73 weeks.) It will be easier for Cameron to reduce the excessive taxes if Britain’s budget deficits are not bloated by the recession, and it will be easier to reduce excessive welfare spending if the public believes the economy can offer a job to any willing able-bodied worker. Was it a coincidence that America’s welfare reform was passed in 1996?
Matt O’Brien pointed me to another WSJ article on monetary policy. This one suggests that Poland avoided the Great Recession with a tight money policy (Mark Sadowski just had a heart attack, and is spinning in his grave.) Here’s how Matt responds:
What’s the secret of Poland’s mini-economic miracle? Matthew Kaminski of the Wall Street Journal interviewed former Polish central banker Leszek Balcerowicz to find out just how exactly the country managed to avoid a recession back in 2009. The answer is … well, it’s completely wrong. Kaminski says Poland’s “hard-money policies” from 2001 to 2007 deserve the credit, but doesn’t say a word about what happened afterward. That’s curious, because the global financial crisis was an equal opportunity destroyer of economies. Avoiding a bubble hardly guaranteed avoiding a recession. So, again, what did Poland do?
You probably know where this is going. It wasn’t hard money that saved Poland. It was really, really, really easy money that saved Poland. Just look at the chart below of the exchange rate between the Polish zloty and the euro the past five years. That’s a 33 percent drop starting in late 2008.
Throughout much of the WSJ article low interest rates are equated with easy money. Now Milton Friedman is spinning in his grave.
HT: David Gulley