Peter Boettke recently took issue with my paper on NGDP futures targeting:
Ignore the contradiction that Scott in this paper had already brushed aside the abolition of government’s monopoly status over currency as unrealistic, but now is asking us to unrealistically assume away public choice problems. The issue I want to raise is different.
Once one really gets the public choice logic, I always thought, you must endogenize politics into any analysis of public policy.
Here’s how I think about this issue. There are three dimensions to monetary policy:
1. How should the value of money be controlled? (I.e. stable P, stable M, stable PY, stable growth path for PY, etc.)
2. Who should control the value of money? (I.e. the Fed, free banks, etc.)
3. What technical mechanism can be constructed to make it easier to control the value of money in the desired way?
I tend to think of these problems separately, although I concede that it’s theoretically possible that the optimal target for free banks might be (let’s say) P*Y stability whereas the optimal target for central banks might be stable P. But I see no evidence of this being true. That’s because I also believe that the welfare effects of bad monetary policy (public or private) are overwhelmingly external. That is, the costs of unstable employment and NGDP vastly outweigh the fluctuations in gains or losses to the balance sheets of central banks or free banks. Thus I believe it makes sense to think about the optimal path for the value of money using macroeconomic theory, not micro-market efficiency models.
In an earlier Mercatus paper I tried to show that Hayek was correct in arguing that NGDP targeting is the best policy for the value of money. Or at least close to being best. In the more recent paper I took that goal as a given, and argued that NGDP futures targeting is the best way to implement NGDP targeting, if that’s what we’ve decided to do. On the other hand if society (or free banks) decide price level stability is best, then I think CPI futures targeting is the best way to go.
Now let me address Peter’s comment, to which I would normally be very sympathetic. For instance, public choice issues cannot be pushed aside when deciding on public policy in health care. But I see this issue somewhat differently. I favor NGDP futures targeting regardless of whether the monetary system is operated by a central bank or a collection of free banks—for the reason that the external costs to society from unstable NGDP are so high. The analogy I would prefer is electricity production.
Suppose I’m hired to design the optimal electricity system for a publicly-owned electricity company. I might advocate the stacking model, where you run low MC/high capital cost technologies 24/7 (hydro, nuclear), then medium cost (coal), and then low capital cost/high MC cost for peak demand (oil and gas.) Even though I’d designed this structure for a publicly-owned utility, I’d also argue it’s equally desirable for a privately-owned utility. It’s a technical solution to a technical problem.
Now of course one might argue that I shouldn’t even be picking something like NGDP targeting, the market should pick the target. That’s where my “externality” argument comes in. NGDP instability has huge external costs. If free banks happen to maximize profits at stable NGDP growth, then fine. If they don’t, then they need to be nudged in that direction. I certainly agree that society doesn’t need a government-run central bank. But I think it unlikely that free banks would just happen to produce the optimal policy for employment and nominal stability, and so I favor having the public sector set the target, at a minimum. Even if we decide to adopt free banking.
PS. Bill Woolsey made some related points in a comment.
HT: David Levey.
Update: Lars Christensen has an excellent post that addresses the “defeatist” aspect of some public choice arguments.