Monetary policy: The Achilles Heel of the right

I’ve argued that monetary policy is the fatal flaw of the right.  In 1929 the US had an outstandingly efficient model.  Banks were conservatively managed (although branching laws meant there were far too many of them.)  We ran budget surpluses, trade surpluses, zero inflation, low unemployment, low taxes, etc.  Tariffs were a bit too high, but nobodys perfect.  And this policy regime was destroyed by the same people who had built it; conservatives.   The left blamed the Depression on the economic model, not deflation.   Then they proceeded to dismantle the model, which delayed the recovery for six years more than necessary.

In the 1990s Argentina finally started to move away from their statist model.  There were signs they might follow in the footsteps of Chile.  They achieved fast growth from 1991-98, even while bring inflation down from 171% to less than 1%.  But the conservatives always seem to go too far.  If low inflation is better than high inflation, then what’s wrong with deflation?  What’s wrong is that deflation causes depressions, which opens the door to left wing governments.  Sure enough the new Argentine government started moving back toward statism.  Naturally they got a cyclical recovery after a sharp devaluation, but the statist policies will insure years more of economic under-performance in Argentina. 

And now the once-promising Baltic States.  This is from Ed Dolan’s blog:

In contrast, in the Czech Republic, the post-accession boom was accompanied by rapid appreciation of the Czech koruna, which strengthened from 33 per euro to 23 per euro in just 4 years. The strong currency kept import prices low and helped restrain inflation. Without the need to hold the exchange rate fixed, the Czech central bank was able to use monetary policy to avoid excessive wage increases or a housing bubble. When the crisis hit, the koruna depreciated as quickly as it had earlier strengthened, quickly restoring competitiveness. The recession in the Czech Republic was among the mildest in the EU.

The effects of the crisis on Latvia were entirely different. Without a devaluation, the only way Latvia could restore competitiveness was through deflation of prices and wages. This strategy, often called “internal devaluation,” has been extremely painful. The unemployment rate has soared to 22 percent as prices and wages fall. Meanwhile, unemployment in the Czech Republic has risen only slightly and has remained below the EU average throughout the crisis.

When will the right ever learn? 

HT: Tyler Cowen


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51 Responses to “Monetary policy: The Achilles Heel of the right”

  1. Gravatar of Mattias Mattias
    29. May 2010 at 08:53

    The baltic countries weren’t allowed to devalue their currency because that would have ruined our banks in Sweden. At least that is how it has been reported in Swedish papers. Probably not our finest moment if that is true!

    The strange thing about the czechs is that I thought their president, Vaclav Klaus, is a big believer in Austrian economics.

  2. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. May 2010 at 09:16

    Perhaps I’m biased but Poland is an even better counterexample than the Czech Republic. It devalued the most with respect to the euro of any EU member with a flexible exchange rate between July 2008 and March 2009. Probably as a result it is the only EU member to have completely avoided a recession and unemployment has risen the least of any EU member since 2007.

    Estonia was recently rewarded for its tenacity in holding the peg with admission to the eurozone in January, 2011. It seems the only way to gain admission to the eurozone these days to put your economy into a depression.

  3. Gravatar of Brendan Brendan
    29. May 2010 at 09:39

    So if Ron Paul wins the presidency in 2012, appoints an Austrian to chair the Fed and we get whacked with a recession in 2013, are we screwed?

  4. Gravatar of ssumner ssumner
    29. May 2010 at 09:49

    Mattias, I’m guessing that Klaus doesn’t make that decision. Hasn’t he usually been President, not prime minister? I haven’t kept up on things there, but my sense is that the Czechk Republic is more pragmatic than Klaus himself.

    Mark, Yes, I agree about Poland.

    Brendan, After 8 years of Ron Paul the socialist party would be the largest party in America. And I say that as someone who voted for Paul in two different political parties.

  5. Gravatar of Indy Indy
    29. May 2010 at 10:17

    @Mattias / @ssumner

    Wait, which is the “Austrian” currency policy – market-based floating and/or restoration-of-competitive-equilibrium managed, or arbitrarily pegged exchange rates – rates fixed in the (foolish?) hopes on one day entering an apparently less-than-optimal currency region?

    Isn’t what the Baltics are doing (supposedly for the sake of their external creditors and access to future foreign investment) non-Austrian? Or is it Austrian after all?

    Please help me – I’ll never be able to figure out if I’m pro or con the Austrians if I don’t know what they recommend and why it does or does not work.

  6. Gravatar of Nick Nick
    29. May 2010 at 11:16

    ssumner said:
    “In 1929 the US had an outstandingly efficient model. Banks were conservatively managed (although branching laws meant there were far too many of them.)”

    With regard to branching laws, how did these laws provide the incentive that led to the creation of far too many banks? In your opinion, why was the risk of too many banks not more visible to those investing in the creation of so many new banks?

  7. Gravatar of Mattias Mattias
    29. May 2010 at 11:26

    Scott

    That’s probably right, but I still thought it a bit ironic. He complains about EU all the time and than his own country lets the currency fall.

    Indy

    I can’t speak for the Austrians. I know they do talk a lot about letting the free market decide all prices, but why did they then insist on higher interest rates in the fall of 2008 when the markets collapsed? When there’s a panic people rush for the safest place for their money making the risk free rate go to zero and beyond. That’s what happens in free markets.

  8. Gravatar of Tom_CZ Tom_CZ
    29. May 2010 at 12:00

    Scott, Mattias:

    Klaus is president since 2003, and since 2002 the prime minister has always been someone he doesn’t like. His only real influence on the Czech economy is that he appoints central bankers. As you can guess, he only appoints people who worked with/for him and therefore share his view of the world. They all express strongly Austrian views and they all oppose Euro.

  9. Gravatar of Indy Indy
    29. May 2010 at 12:00

    @Mattias

    I can’t speak for the Austrians either – that’s my problem. All I know is when people say “Austrian” what they usually mean (fairly or not) is some kind of ridiculous, unrealistic, dogmatic “let the chips fall where they may” absolutism which was proven 100% wrong ages ago.

    I’m just trying to figure out which absolutism describes them accurately – pegged rates or free-floating rates. I thought they would be against a peg, but it could be the opposite. It’s all very confusing.

  10. Gravatar of StatsGuy StatsGuy
    29. May 2010 at 12:18

    Are there any 1930s parallels to Czech/Poland?

    BTW, I think the modern day parallel to 1930s US is Germany today. The US accumulated a gold stockpile partly by running trade surpluses back then, and insisted on continuing to run surpluses (and stockpile gold). When everyone tries to run surpluses and stockpile gold, what happens? Price of gold goes up. If the price of gold goes up, and you want your currency to stay on par with gold, what do you need to do? Make sure the price of your currency goes up.

    Observe Germany – from the German perspective, the Euro surely seemed like a sweet deal (at least in the short term). It got to anchor its currency downward during the early Euro days while guaranteeing its export markets. Had the Mediterranean states devalued relative to Germany in 2002, they might be better off today. The sovereign debt crisis largely resulted from accounting gimmicks to permit Greece et. al. to maintain consumption of German exports…

    Perhaps that’s why under a gold standard – or a deflationary monetary regime – it’s not hard to see how people can start thinking of trade as a zero sum (mercantilist) game.

  11. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    29. May 2010 at 12:36

    1. Everything about Latvia is also applicable to Greece, Spain, Ireland and California.
    2. To a large extent the problems of Latvia are real. If they are solved by inflation, we get the case of Iceland. I don’t think right wing politics has a great future in the inflationary Iceland.
    3. Good example is Estonia – strong public finances will allow the continuation of laissez faire policies in fixed exchange rate Estonia.

  12. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    29. May 2010 at 12:42

    4. Pre-crisis NGDP growth of 20% was in any case unsustainable. What would Volcker say?

  13. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    29. May 2010 at 13:47

    Looking back is fun. I gave Ron Paul some money in 2008, and then immediately regretted doing so. I did vote for him for President in 1988, but not happily. I was a big supporter of Russell Means.

  14. Gravatar of Ed Dolan Ed Dolan
    29. May 2010 at 15:45

    Now I’m the one that is confused. Everyone is throwing around the left-right labels. Which is left and which is right, fixed or floating exchange rates? The Austrians (rightists?), who are sensible about a lot of things, include a lot of gold-standard advocates. Somehow, I think recent developments do not lend good support for a world-wide currency union of the gold standard type. Maybe some Austrians can explain why I’m wrong about that.

    BTW, with regard to parallels from the 1930s, wasn’t it true that countries that bailed out of the gold standard first had relatively mild downturns. I think Sweden was one–Mattias, is my memory right there?

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. May 2010 at 17:07

    Although I’m somewhat loathe to admit it, I too voted Ron Paul for President in 1988. I still have some souvenir bumper stickers to torture myself with. In those days I voted straight Libertarian so I would have voted for Russell Means if he had won the nomination.

  16. Gravatar of Bonnie Bonnie
    29. May 2010 at 19:23

    What does right/left have to do with whatever Bernanke and the rest of the Fed is doing, or should I say what they are not doing? You’ve spent quite a while now illustrating how Bernanke is not following his own advice, and I have to add that he was publicly supportive of the stimulus package that was opposed on the right instead of standing up and saying he knows of a better solution, which he does indeed. If we have resorted to statism instead, which I belive that stimulus package is the epitome, it is because the Fed did not do its job when required, not because we like it or want it.

    If people on the right are opposed to monetary stimulus it’s because they don’t understand macro, and they are very cynical about government control of anything with the perfect example being what’s not going on at the Fed and we can only speculate about why it isn’t doing its job. The view of this person from the right is that yes, the Fed should do its job and if it had we would have had a much better outcome than resorting to fiscal stimulus and the statism that comes with it which does nothing but rob wealth from the future and freedom from today.

  17. Gravatar of Mattias Mattias
    29. May 2010 at 23:14

    Sweden left the gold standard 1931, I think after UK had just left it too. The history would repeat itself 60 years later when Sweden gave up the peg after UK.

    I associate “right” with defending the currency and “left” with defending employment. Not because it has to be that way theoretically. It just seems to be what right and left leaning economists seem to prefer. I agree it’s not all that clear.

  18. Gravatar of scott sumner scott sumner
    30. May 2010 at 06:09

    Indy, Your guess is as good as mine. There are many kinds of Austrians.

    Nick, In states like Illinois and Texas, each bank was allowed only once branch. Thus each town would have its own independent banks. I believe that America had around 30,000 banks. Even banks in states that allowed more branches were not allowed to cross state lines.

    Thanks Tom CZ.

    Indy, Some Austrians favor the gold standard (a fixed rate regime) some do not.

    Statsguy, You asked:

    “Are there any 1930s parallels to Czech/Poland?”

    Yes, the countries that left the gold standard first tended to recover first.

    You need to be careful with analogies with the gold standard. There may be some, but gold could not be printed in the way dollars can. Thus a trade deficit doesn’t put deflationary pressure on the US the way it might have if another country was hoarding gold. We can just print more dollars. Of course DeLong and Krugman would say “Everything changes at the zero bound . . .

    123, I think you are probably right about Estonia, their strong fundamentals will allow them to do well in the long run. They may be more like HK (which survived a deflationary currency board) than Argentina.

    Your discussion of the real/nominal split raises two issues:

    1. How much damaged could have been avoided if they adopted NGDP targeting as the crisis began?
    2. How much damage could have been avoided if they had adopted NGDP targeting 10 years ago–and thus had a smaller boom and bubble?

    But even in the first case (i.e worst case) my hunch is that they would have done better. Didn’t Krugman have a post showing that even Iceland did better in this crisis than Latvia and Estonia? Still that’s is a good point, much more of the crisis was real than in the two previous examples I mentioned.

    Don, You really are a libertarian Dem!

    Ed Dolan, You are right about the Depression. I don’t know about the Austrians, but it was certainly conservatives who supported the tight money in the US and Argentina.

    Mark, I am surprised you were old enough to vote in 1988. You must be one of the older students in your class.

    Bonnie. You said;

    “If people on the right are opposed to monetary stimulus it’s because they don’t understand macro,”

    I just haven’t see much evidence that the more conservative “freshwater economists” have criticized the Fed for being too tight. On the other hand Krugman and DeLong have. Those at the fed who are most likely to favor tight money right now are the more conservative members.

    Mattias, As I recall it was almost 61 years to the day.

    I agree about the left/right distinction.

  19. Gravatar of david glasner david glasner
    30. May 2010 at 09:53

    Scott, I am in shock to read that someone who, like you, displays many outward signs of sanity would actually have voted twice for Ron Paul, but I hope that I will recover eventually.

    The other point that want to make is that Argentina did not choose deflation in the late 1990s. Deflation was the automatic result of the monetary regime that had been adopted in which the Argentine peso was pegged to the dollar at a fixed rate and pesos could be created only by selling dollars to the central bank (currency board). When the dollar appreciated rapidly in foreign exchange markets in the late 1990s, the result, for a small moderately open economy like Argentina, was deflation. The deflation mechanism in Argentina was exactly the same as that under the gold standard in 1929. Deflation was not an explicit choice, but it was inevitable under the fixed dollar peg/currency board regime combined with a rapidly appreciating dollar. Uou undoubtedly already knew that, but it wasn’t clear from your posting.

  20. Gravatar of david stinson david stinson
    30. May 2010 at 12:06

    Hi Scott.

    The mistake is to think of monetary policy in terms of “stimulus” or as “expansionary” or contractionary”, all of which sounds vaguely like interventionist/Keynesian fine-tuning and economic direction. The better way to think of monetary policy is the maintenance of some sort of desired relationship between money demand and money supply. In a free banking world, the adjustment of supply to demand would happen automatically through the market mechanism. If you don’t have free banking, then it falls to the central bank to manage the demand/supply relationship (which apparently they do rather badly).

    Another way of putting it is that the right generally tends to equate “sound money” with “tight money” rather than “neutral money”. To be fair, the clumsiness with which central banking necessarily manages money demand/supply relationship doesn’t inspire confidence and may create a bias on the part of the right toward a particular type of error, i.e., the non-inflationary kind.

  21. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    30. May 2010 at 13:36

    Scott, you said:
    “But even in the first case (i.e worst case) my hunch is that they would have done better. Didn’t Krugman have a post showing that even Iceland did better in this crisis than Latvia and Estonia? Still that’s is a good point, much more of the crisis was real than in the two previous examples I mentioned.”
    I’m much more familiar with Latvian economy than Icelandic one, so I hope I don’t make any mistakes below. Certainly Icelandic labour market performance has been impressive, even after total collapse of their financial system they have lower unemployment than another floating rate country Hungary. Nevertheless I still think Latvians are happier with their economy than Icelandic people. There is still some slight risk that Latvia will follow the steps of Iceland, but at this point in time median Latvian has suffered smaller hit to real earnings (esp. non-PPP earnings) and what is even more important has much lower level of fear of financial distress.

    You said:
    “Your discussion of the real/nominal split raises two issues:
    1. How much damaged could have been avoided if they adopted NGDP targeting as the crisis began?
    2. How much damage could have been avoided if they had adopted NGDP targeting 10 years ago–and thus had a smaller boom and bubble”

    1 – not much damage could have been prevented by adopting 5% NGDP targeting as the crisis began. NGDP targeting in such a small open economy with institutions that everybody knows have mismanaged the macroeconomic parameters would have zero credibility. External adjustment would be faster but at a price of larger balance sheet issues.

    2 – here I remember the famous Mundell-Friedman debate. Baltic states have chosen the Mundellian path of currency boards that has an added benefit of automatic credibility – many people said there that unconstrained central banks would not achieve stable inflation. So the currency board was a natural solution for post-Soviet problem of lack of institutional credibility. Previously I have thought that even Poland would do better by implementing Mundellian solution, but during this crisis I have changed my mind. Now I think that Friedman’s recipe is optimal for states that have at least 5 million inhabitants. This means that Ireland should have it’s own currency, Baltic states should adopt euro, and Slovakia with 5 million inhabitants should toss a coin.

  22. Gravatar of GD GD
    30. May 2010 at 13:47

    Statsguy asked:

    “Are there any 1930s parallels to Czech/Poland?”

    Spain floated, depreciated, and essentially avoided the Great Depression. China, being on silver, also was less affected.

    http://www.jstor.org/pss/1991882

  23. Gravatar of davboz davboz
    30. May 2010 at 15:44

    You say:
    “And this policy regime was destroyed by the same people who had built it; conservatives. The left blamed the Depression on the economic model, not deflation. Then they proceeded to dismantle the model, which delayed the recovery for six years more than necessary.” ——————–
    So which is it? Or rather, which do YOU say it is?

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. May 2010 at 17:02

    Scott,
    You wrote:
    “Mark, I am surprised you were old enough to vote in 1988. You must be one of the older students in your class.”

    Ouch Scott! This is my second career (I was a HS math teacher before). Actually my dearest colleagues and I are all about the same age. We like to think we get better with age.

  25. Gravatar of Doc Merlin Doc Merlin
    30. May 2010 at 20:23

    In defense of Ron Paul and the Austrians:

    Paul would push for competitive banking (as he has been for years), not for a right winged fed, as the problem isn’t ultimately just too little or too much money… but it is not being able to tell exactly how much money is the right amount.
    Basically, what I am saying is that the socialist calculation problem applies to the price of money, and the real way to fix the problem is to allow competition into the system. Austrians also tend to agree with this, and Ron Paul has explicitly tried multiple times to introduce laws that would allow currency competition.
    In fact, the most famous Austrian, Hayek, endorsed both ideas. If we had to have monopoly banking, then we should target NGDP. However, he understood that regulators were inherently naive and competition is what was necessary to keep the proper quantity of money.

  26. Gravatar of Doc Merlin Doc Merlin
    30. May 2010 at 21:33

    @Scott:
    “123, I think you are probably right about Estonia, their strong fundamentals will allow them to do well in the long run. They may be more like HK (which survived a deflationary currency board) than Argentina.”

    HK did more than survive it prospered! This is partially because price deflation is only a problem in the short term or when we cycle unpredictably between inflation and deflation.

    Anyway: consistent price deflation isn’t a problem so long as expected real growth is positive and the same or larger than expected, /and/ NGDP level is as expected, over a very long forecast. The actual problem is when either NGDP changes unexpectedly /or/ real per capita growth crashes.

    Anyway in summary:
    NGDP falling expectedly is a problem, because then the debt side of the economy crashes horribly, but this isn’t caused by price deflation (or even monetary contraction). It is caused by inconsistent monetary policy, so very long term expectations are not met properly.

  27. Gravatar of Trei erori majore ale stângii și ale dreptei « standard.ro | Platforma de comentarii, bloguri si opinii MONEY.ro Trei erori majore ale stângii și ale dreptei « standard.ro | Platforma de comentarii, bloguri si opinii MONEY.ro
    31. May 2010 at 04:34

    [...] bune despre erorile principalelor două curente politice. Am selectat trei dintre aceste erori.Eroarea drepteiPolitica monetară este eroarea fatală a dreptei. În 1929 SUA au avut… surplus bugetar, excedent [...]

  28. Gravatar of scott sumner scott sumner
    31. May 2010 at 05:14

    David Glasner, Yes, in none of the cases I mentioned was the deflation chosen intentionally. Rather it is a side effect of contractionary monetary policies chosen for other reasons.

    I hope you recover from your state of shock in time to enjoy the holiday weekend.

    David Stinson, I don’t agree that free banking would stabilize the price level, or any other aggregate like NGDP. I’ve seen people make that argument, but I am not convinced that there is any mechanism to make it happen. They generally assume that there is a fixed relationship between reserve demand and final goods transactions—which seems like a stretch to me.

    123, You also have to remember that the real shock in Iceland was much bigger. Their banking system basically collapsed. Isn’t it true that in Latvia many of the loans were from Swedish banks that have not collapsed–thus you are just looking at a real estate depression, not a financial system collapse as well? There was no way for Iceland to avoid taking a big hit. To some degree that is also true of Latvia, but I’d say to a lesser extent.

    Small countries find it easier to boost NGDP w/o credibility than big countries. Small countries can just devalue their currencies sharply–that boosts NGDP.

    2. You may be right (although Ireland has less than 5 million people) but I don’t see why a country that has enough discipline run a currency board, and avoid devaluation in a severe recession, would not have enough discipline to run a Chilean-style inflation targeting regime.

    GD, Those are good analogies.

    davboz, My argument is that real costs of deflation are falsely blamed on the free market, because it looks like the free market has failed. So the conservatives are to blame because they cause the deflation, but the left is also to blame because they falsely attribute the resulting problems to laissez-faire.

    Mark, I’m sure you’re still younger than me.

    Doc Merlin. I thought Ron Paul favored the gold standard? Even with free banking, the GS would cause deflation as newly-rich Asians snapped up more gold.

    Doc#2, The point is that they certainly did not prosper during the deflation. They had high unemployment during several different bouts of deflation. I think Singapore did better, but am not certain.

  29. Gravatar of Mark Washenberger Mark Washenberger
    31. May 2010 at 06:08

    Cheers Doc!

    I really don’t understand why we can get away with saying “deflation causes depressions.” Was the entire pre-fiat world one giant depression?

    More accurately, deflation in a debt-laden environment causes depressions. To me, the problem is the debt-laden environment and the state interventions that foster it.

  30. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    1. June 2010 at 05:40

    Scott, you said:
    “You also have to remember that the real shock in Iceland was much bigger. Their banking system basically collapsed. Isn’t it true that in Latvia many of the loans were from Swedish banks that have not collapsed–thus you are just looking at a real estate depression, not a financial system collapse as well? There was no way for Iceland to avoid taking a big hit. To some degree that is also true of Latvia, but I’d say to a lesser extent.”
    Foreign banks did not help Argentina in 2001, and Argentinian branches of international banks have collapsed there too.
    One reason Latvian crisis was deeper than Lithuanian was a big presence of local Latvian bank Parex. Problems at Parex were the trigger of the crisis in Latvia. At the peak of the crisis interbank markets and government debt markets were signaling almost 50% probability of Latvian default. The main difference that saved Latvia was strong balance sheet of central bank, while Icelandic currency collapsed.

    You said:
    “Small countries find it easier to boost NGDP w/o credibility than big countries. Small countries can just devalue their currencies sharply–that boosts NGDP”
    The problem is opposite. Let’s say Latvia wanted to switch to floating exchange rate with 5% nominal GDP targeting in 2008. The lack of credibility and associated excess exchange rate volatility would mean severe overshooting of NGDP target and Icelandic level of financial distress.

    You said:
    “but I don’t see why a country that has enough discipline run a currency board, and avoid devaluation in a severe recession, would not have enough discipline to run a Chilean-style inflation targeting regime.”
    Romania is a good example how inflation targeting works poorly in CEE. Hungary is a good example of fiscal mismanagement. Some people think that collapse of Yeltsin’s democratic achievements in Russia should be attributed to bad monetary/fiscal policy in 1992-1998. Keynesian stimulus was also popular in Lithuanian policy circles in 1992-1993 and Lithuanian macro performance was very poor in Lithuania in those two years (although not as bad as in Russia where fiscal madness was even more extreme), and currency board was simple and credible solution.

    You said:
    “(although Ireland has less than 5 million people) ”
    Oops, I was using IRA data…

  31. Gravatar of ssumner ssumner
    1. June 2010 at 05:53

    Mark, In this blog when I say “deflation” I mean “NGDP falling relative to trend,” it is much easier to say. Yes, there was some deflation in the late 1800s associated with growth.

    123, I don’t follow your point about Argentina. The main problem there was nominal, not real. W/o the deflation their banks would have been in better shape. That is totally different from Iceland, where the problems were real.

    Did Parex have branches all over Europe?

    You said;

    “The problem is opposite. Let’s say Latvia wanted to switch to floating exchange rate with 5% nominal GDP targeting in 2008. The lack of credibility and associated excess exchange rate volatility would mean severe overshooting of NGDP target and Icelandic level of financial distress.”

    I don’t see why. Chile seems able to target inflation.

    On your last point, I agree that if you have a really inept government, then no policy will work. They also won’t stick to fixed rates. But the Latvian government showed enough discipline to avoid devaluation. So it’s not obvious to me that they couldn’t target NGDP. But I agree it is an open question.

  32. Gravatar of Mark Washenberger Mark Washenberger
    1. June 2010 at 06:16

    Scott,

    If you’ll entertain me for this, I’d really appreciate it.

    I’m trying to understand the picture you’re painting of deflation and recession. Is it

    1) Agents in the economy suddenly want more purchasing power, but there isn’t enough money in the system to provide it at the current real value of the money. However, prices are sticky, so instead of prices simply going down, people reduce their purchases.

    or

    2) Deflation (falling prices) puts borrowers underwater, and they default or otherwise discover they weren’t as rich as they thought they were. The borrowers reduce their purchases.

    or

    3) I am completely off base :-)

    Thanks.

  33. Gravatar of david glasner david glasner
    1. June 2010 at 10:48

    This is probably just a verbal quibble, but pegging your currency to another currency is not a contractionary policy per se. Whether it is or isn’t depends on what happens to the currency or asset to which you are pegging. Pegging a weak currency to a strong currency (strong in the sense that people have confidence in it and are willing to hold it, not in the sense that it is appreciating) is expansionary in the sense that the demand for your currency will go up as a result of the peg so that the number of currency units that are issued will increase. However, the peg involves a risk of deflation if the currency to which you are pegging appreciates. That was the great advantage of a bimetallism back in the nineteenth century when there were countries on a gold standard and countries on a silver standard. You could diversify and reduce the risk of deflation by adopting a bimetallic standard.

    I am not sticking up for the right, I just don’t see why you seem to regard the choice of a pegged exchange as somehow biased toward contraction.

    BTW I have recovered, thank you, but I am still feeling cognitive dissonance.

  34. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    2. June 2010 at 04:21

    Scott,
    you said:
    “123, I don’t follow your point about Argentina. The main problem there was nominal, not real. W/o the deflation their banks would have been in better shape. That is totally different from Iceland, where the problems were real.”
    The problem in Argentina was not only nominal, but also real. If there were only nominal problems, mild devaluation with 5% NGDP growth would be the answer. But the outcome was total collapse of the currency and 20+% NGDP growth. The real problem of Argentina is lack of fiscal credibility.

    “Did Parex have branches all over Europe?”
    Parex had virtual branches all over Russia – one of the main funding sources of Parex were Russian offshore deposits.

    “I don’t see why. Chile seems able to target inflation.”
    Chile is able, Argentina isn’t.

    “On your last point, I agree that if you have a really inept government, then no policy will work. They also won’t stick to fixed rates. But the Latvian government showed enough discipline to avoid devaluation. So it’s not obvious to me that they couldn’t target NGDP. But I agree it is an open question.”
    Even clever American scientists are unable to successfully target stable inflation expectations. In 1992-93 the advantage of currency board was that Soviet-educated policymakers could became currency board experts in 15 minutes. Since then the knowledge base of economists in Baltic states has significantly improved, but it has not reached the American levels yet.
    Latvian government has lost lots of credibility in 2006-2007 when they were unable to contain inflation and housing bubble.

  35. Gravatar of scott sumner scott sumner
    2. June 2010 at 05:11

    Mark, My vision is mostly sticky wages and prices (especially wages). Wages and prices were set on the assumption of 5% NGDP growth (the trend over several decades. When spending actually fell modestly, and far below the 5% increase expectation, then unemployment rose.

    Throughout history, this almost always occurs when NGDP growth is far below expectations (1921, 1930, 1938, 1982, 2009.

    David, I agree. But the decision to adopt that system, and stick with it under deflation, was a sort of contractionary policy. Thus Britain’s decision to devalue in 31, while France hung on until 1936, was essentially Britain indicating it wanted a more expansionary policy. But you are right, France didn’t really choose to have deflation, it was a side effect of another policy choice.

    123, I disagree. The Argentine currency had become vastly overvalued, probably 25% or more. The actual devaluation was much bigger than that, but that’s because the new left wing government ran an extremely inflationary monetary policy. If they had gone from deflation to mild inflation, as they should have, the devaluation would have been much milder. The fiscal problems were probably mostly caused by the depression. Look how our far milder recession has totally screwed up our fiscal situation.

    You obviously know more about Parax than me. Is Russia forcing Latvia to pay off those depositors? If so, it is a big percentage of Latvian GDP?

    I don’t get the Chile/Argentina argument, although I hear it all the time. People say country X needs a currency board, because they are too irresponsible to target inflation. But then they prove too irresponsible to stick with the currency board either. If you are really that irresponsible, you’re screwed either way.

    I agree that it is tough to target inflation perfectly, but Chile shows you can do it tolerably well. It’s not so much expertise you need, but credibility.

    Regarding the Latvian government, isn’t it difficult to contain housing bubbles if you have a currency board? You can’t raise rates.

  36. Gravatar of scott sumner scott sumner
    2. June 2010 at 05:41

    David, Obviously Ron Paul holds some wacky views. But check out this link form a respected liberal columnist:

    http://www.salon.com/news/opinion/glenn_greenwald/2010/05/28/crazy

  37. Gravatar of david glasner david glasner
    2. June 2010 at 06:44

    Scott, Thanks for the link. Actually to be truthful, I must admit that Glenn Greenwald, if he knew who I was, would not treat me as gently as he does Ron Paul. Nevertheless, despite the obvious (though understandable) provocation, I will decline the invitation to expound at length on the subject of Ron Paul. I will just leave at this. What is unnerving about Ron Paul is that he is obviously totally convinced that he knows what he’s talking about.

    And about deflation, I agree that to stick with a currency peg when it is causing ruinous deflation does become, at that point, contractionary.

  38. Gravatar of johnleemk johnleemk
    2. June 2010 at 08:01

    david,

    I am fairly tepid about Ron Paul compared to most libertarians, but I don’t think he’s particularly more self-assured than a lot of politicians currently in office. Sure, he’s probably unreasonably certain that a gold standard will solve America’s ills, but I wouldn’t rate that much worse than politicians who are certain about the worthiness of farm subsidies, or the cost-effectiveness of focusing on earmarks as a means to reducing government spending.

  39. Gravatar of Doc Merlin Doc Merlin
    2. June 2010 at 11:15

    @Scott
    “Doc Merlin. I thought Ron Paul favored the gold standard? Even with free banking, the GS would cause deflation as newly-rich Asians snapped up more gold”

    He said he likes a voluntary gold standard. What that means is that he has tried to pass bills allowing people to coin their own money, and removing capital gains taxes from precious metals.

    @Mark Washenberger

    “More accurately, deflation in a debt-laden environment causes depressions. To me, the problem is the debt-laden environment and the state interventions that foster it.”

    Exactly! High expected inflation or high expected money expansion causes high debt. Then when deflation (or disinflation) comes along without commensurate economic growth to compensate people have to default on debt obligations.

  40. Gravatar of david glasner david glasner
    2. June 2010 at 11:24

    John, My contribution to this thread actually started as just a friendly attempt to have a bit of fun at Scott’s expense by way of Ron Paul. I am actually not as obsessed with him as one might gather from the recent back and forth. And I probably should just leave it there, but I feel that my self-control is again deserting me, and I will make one more comment. The difference between Ron Paul and other politicians is that the other guys usually just repeat what they take to be the conventional wisdom, that is if they even bother to pretend that their votes reflect their own deeply held opinions, which is hardly the case when they vote for, say, farm subsidies, which are widely understood to be motivated by purely cynical considerations, whereas Ron Paul obviously believes that he is possessed of a much higher-order insight (Austro-libertarianism) than the mere conventional wisdom and that anyone who disagrees with him is either a fool or a knave. He sounds just like an idiot Marxist trying to explain why everything that happens in the world is the result of class struggle. I mean what kind of a father goes out and names his son “Rand” for heaven’s sake? Now there was a libertarian role model if there ever was one.

  41. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    3. June 2010 at 06:23

    “123, I disagree. The Argentine currency had become vastly overvalued, probably 25% or more. The actual devaluation was much bigger than that, but that’s because the new left wing government ran an extremely inflationary monetary policy. If they had gone from deflation to mild inflation, as they should have, the devaluation would have been much milder. The fiscal problems were probably mostly caused by the depression. Look how our far milder recession has totally screwed up our fiscal situation.”
    I had in mind long history of fiscal problems before the currency board. When currency board collapsed, the lack of credible precommitment not to have the inflation tax was the real problem.

    “You obviously know more about Parax than me. Is Russia forcing Latvia to pay off those depositors? If so, it is a big percentage of Latvian GDP?”
    So far Latvia has treated the domestic depositors and offshore depositors equally. The freeze in 2008 during the nationalisation of Parex was non-discriminatory. At this time only 200 accounts remain frozen, and they will all be transfered into the good bank during the planned good/bad bank split. I guess Russia was busy with it’s own run on rouble during the deposit freeze.

    “I don’t get the Chile/Argentina argument, although I hear it all the time. People say country X needs a currency board, because they are too irresponsible to target inflation. But then they prove too irresponsible to stick with the currency board either. If you are really that irresponsible, you’re screwed either way.”
    The simplicity of currency board compared to inflation targeting means that borderline cases might be more successful in currency board.

    “Regarding the Latvian government, isn’t it difficult to contain housing bubbles if you have a currency board? You can’t raise rates.”
    You can raise general taxes and accumulate resources to soften the blow when the bubble bursts (as Estonia has done). It is also possible to tax the bubble directly, but I don’t know any case where it was done.

  42. Gravatar of Doc Merlin Doc Merlin
    3. June 2010 at 09:36

    @ david glasner
    1. Ron Paul isn’t an objectivist.
    2. Rand’s first name is Randall and he isn’t named after Ayn Rand.

    While I don’t agree with everything Ron Paul says, mischaracterizations annoy me. And this blog should be above that.

  43. Gravatar of scott sumner scott sumner
    3. June 2010 at 10:48

    David, I voted for him, but would have been terrified if he had won. You might then ask; why . . . .

    johnleemk, I agree. But I think what scares people about him is the sense that he wouldn’t moderate his views after taking office, and listen to experts. He’d just charge ahead. 80% of what he did might be good, but the other 20% might cause huge problems.

    Doc merlin, OK, that sounds more reasonable.

    David#2, Yeah, I also wondered about the name “Rand.” Maybe it was short for Kruegerrand. :)

    123, Thanks for that info. I’m guessing the losses at Parax were smaller than for the Icelandic banks.

    Regarding currency boards, also remember that the costs of a serious screwup under a currency board may well exceed the losses from discretionary policymakers missing their targets. Things can get far out of line, and then you have a traumatic adjustment. With a floating rate the adjustments after policy mistakes are often less traumatic.

    The last point about taxes is correct, there are non-monetary ways of trying to slow down bubbles. Of course as we saw in America the government may not want to slow the bubble, they get swept up in the same hysteria.

    Doc Merlin, Thanks for clearing that up, but don’t be so hard on David. I had the same impression, as I had never heard the name Rand used as a first name. But I’m glad to hear that as it would be weird to name your child after a controversial thinker. What if they hated the thinker?

    I hope I don’t sound too Anti-Rand Paul here. Now that he’s said he’d support the 1964 Civil Rights law, I would probably vote for him if I lived in Kentucky. I like his small government views.

  44. Gravatar of david glasner david glasner
    3. June 2010 at 11:18

    He named his son after Ayn Rand, I guess he thought that “Rand” was less weird than “Ayn.” Go figure.

  45. Gravatar of david glasner david glasner
    3. June 2010 at 11:28

    Doc Merlin, I just posted my understanding of who Rand Paul is named after, before having looked at your posting. The wikipedia article about Rand Paul supports your posting. I apologize for spreading an urban legend and for the unfair attack on Ron Paul for his choice of a name for his son. If I post anything else about the Pauls (which I will try to avoid doing) I will try to make sure that I am properly informed.

  46. Gravatar of ssumner ssumner
    4. June 2010 at 05:55

    David, I made the same mistake.

  47. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    4. June 2010 at 07:00

    “123, Thanks for that info. I’m guessing the losses at Parax were smaller than for the Icelandic banks. ”
    Latvians were lucky they had only one Parex instead of four Parexes in Iceland.

    “Regarding currency boards, also remember that the costs of a serious screwup under a currency board may well exceed the losses from discretionary policymakers missing their targets. Things can get far out of line, and then you have a traumatic adjustment. With a floating rate the adjustments after policy mistakes are often less traumatic.”
    Currency boards should be tried only by small countries and only in case there is a risk of hyperinflation.

  48. Gravatar of Doc Merlin Doc Merlin
    4. June 2010 at 17:28

    No, problem, y’all. It just annoys me when people confuse libertarians and Objectivists. I realize there is a lot of overlap, but plenty of us libertarians are not Objectivists.

  49. Gravatar of Doc Merlin Doc Merlin
    4. June 2010 at 17:34

    ROFL@Krugerrand joke.

    Yah, he was named Randal and used to go by Randy, but his wife shortened his nickname to Rand.

    In regards to the whole gold standard thing…
    Ron, like Hayek, is against a monopoly government currency. He has been trying, since he got into congress, to allow for legal competition to the USD. Anyway, the only purpose for the gold standard is that it made government borrowing difficult, competitive currency is a much better way to handle it imo.

  50. Gravatar of scott sumner scott sumner
    5. June 2010 at 09:50

    123, Fair enough.

    Doc, Yes, I’m also a libertarian but not an objectivist.

  51. Gravatar of jocuri barbie jocuri barbie
    9. September 2011 at 05:12

    Off topic: why you don’t you update the wp version? it seems like is loading kind of slowly.

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