Archive for the Category Heterodox macro


The myth at the heart of internet Austrianism

This post is not about Austrian economics, a field I know relatively little about.  Rather it is a response to dozens of comments I have received by people who claim to represent the Austrian viewpoint.  More specifically, it is a response to the claim that the 1929 crash was caused by a preceding inflationary bubble.  I will show that the 1920s were not inflationary, and hence that there was no bubble that could have caused an economic slump which began in late 1929.

1.  Inflation as price change:  Let’s start with the obvious, the 1920s was a decade of deflation; prices fell.  Indeed the 1927-29 expansion was the only deflationary expansion of the entire 20th century.  That’s right, believe it or not the price level actually declined during the boom at the end of the 1920s.

2.  Inflation as money creation:  At this point commenters start claiming that inflation doesn’t mean rising prices, it means a rising money supply.  I think that is absurd, as that would mean we lack a term for rising prices.  But let’s assume it’s true.  The next question is; which money?  If inflation means more money, then don’t you have to say “base inflation,” or “M2 inflation?”  After all, these quantities often go in dramatically different directions.  Since the internet Austrians seem to blame the Fed, let’s assume they are talking about the sort of money created by the Fed, the monetary base.  In January 1920 the base was $6.909 billion, and in December 1929 it was $6.978 billion.  Thus it was basically flat, and this was during a period where the US population and GDP rose dramatically.  The broader monetary aggregates rose significantly, but the government didn’t even keep data on M1 and M2 until fairly recently.  No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.

3.  Housing inflation:  There was no housing bubble in 1929, so there was nothing to burst and cause a depression.

4.  Asset inflation:  There was a stock price boom and crash, but we saw a crash of almost identical magnitude in 1987, and it had zero impact on the economy.  In any case, it would be odd to call rising stock prices “inflation,” because none of these internet Austrian commenters call falling stock prices “deflation.”  Stocks did very poorly during the 1966-82 period, yet I don’t see internet Austrians calling America’s Great Inflation a period of “deflation.”

5.  The price of gold:  Lots of modern internet Austrians focus on soaring gold prices as an indicator of inflation.  If we are going to use gold prices as a proxy, then here are the inflation rates for each year of the 1920s:  0%, 0%, 0%, 0%, 0%, 0%, 0%, 0%, 0%, and 0%.

6.  NGDP:  Ah, now we are talking.  I wish the term ‘inflation’ was used for rising NGDP, not rising prices.  And of course Hayek favored a stable NGDP.  If that’s what they mean by ‘inflation,’ then they can claim a meager victory for the 1920s, but very meager.  NGDP was (according to estimates of Gordon and Balke) $95.98 billion in the first quarter of 1920, and $100.92 billion in the 4th quarter of 1929.  That’s an increase of roughly 5% over 10 years, or about 0.5% a year.  This means NGDP per capita was falling sharply, as the US population rose by more than 15% during the 1920s.  I.e. NGDP per capita did much worse in the 1920s than it has in Japan during an 18 year period where total NGDP actually fell.  In fairness, there were sub-periods of faster NGDP growth, such as the 3% annual growth between the 1926:3 and 1929:3 cyclical peaks.  But that’s still far below average for the US, and thus I have trouble imagining how it could trigger the severe economic slump in late 1929.

And by the way, interest rates were not particularly low during the 1920s, particularly when you consider that it was a period of deflation.  So no one can seriously claim the Fed was following a low interest rate policy.

In my view monetary policy during the 1920s comes closer to the Austrian ideal than any other recent decade.  Then in the early 1930s we had deflation by almost any indicator (prices, NGDP, M1, M2, stock prices, etc) and the economy did poorly.  Too bad the Fed didn’t try to keep NGDP at $100 billion (as Hayek’s policy rule would have called for), instead of letting it fall to less than $50 billion in early 1933.

Austrian monetary economics has some great ideas–most notably NGDP targeting.  I wish internet Austrians would pay more attention to Hayek, and less attention to whomever is telling them that the Depression was triggered by the collapse of an inflationary bubble during the 1920s.  There was no inflationary bubble, by any reasonable definition of the word “inflation.”

PS.  I hope to do much less blogging in December, as I will be quite busy with various other tasks.  Of course if Europe collapses . . .

Where MMT went wrong

I must be a masochist.  I feel like Humphrey Bogart, about to slide back into that leech-infested water.  But here goes:

Suppose we pick a fairly “normal” year, when NGDP growth and nominal interest rates and unemployment are all around 5%.  It might be 2005, 1995, 1985, whatever.  The exact numbers aren’t important.  Now the Fed does an OMP and doubles the monetary base by purchasing T-securities.  They announce it’s permanent.  What happens?

One MMT answer is that the Fed can’t do this.  It would cause interest rates to change, and they peg interest rates.  But the more thoughtful MMTers seem to be willing to let me do this thought experiment, as long as I acknowledge that interest rates would change and that it’s not consistent with actual central bank practices.  I’m fine with that.

So let’s say they double the base and let rates go where ever they want.  I claim this action doubles NGDP and nearly doubles the price level.  MMTers seem to disagree, as I haven’t changed the amount of net financial assets (NFA) at all.

But here’s the Achilles heel of MMT.  Neither banks nor the public particularly wants to hold twice as much base money when interest rates are 5%, as that’s a high opportunity cost.  So they claim this action would drive nominal rates to zero, at which level people and/or banks would be willing to hold the extra base money.  Fair enough.  But then what?  You’ve got an economy far outside its Wicksellian equilibrium.

The MMTers like to talk about cases where large base injections did coincide with near zero rates—The US in 1932 or 2009, Japan in the late 1990s and early 2000s.  But those were all economies that were severely depressed and/or suffering deflation.  I find it hard to believe that you could cut rates from 5% to 0% in a healthy economy without triggering an explosion of AD, especially if the economy was already experiencing normal levels of NGDP, normal growth in NGDP, and normal unemployment levels.  The closest example might be the US after WWII, but remember that people (wrongly) expected deflation after the war, and by 1951 the Fed gave up on that policy due to rapidly rising inflation.

MMTers forgot that the nominal interest rate is the price of credit, not money.  The Fed can’t determine that rate, it reflects the forces of saving supply and investment demand.  Hence an attempt to set interest rates far below their correct level in savings/investment terms (the Wicksellian natural rate), would trigger an explosion in AD, and much higher inflation.  Central banks know this, which is why after the inflationary 1965-1981 period they adopted the Taylor Principle.

That’s the flaw with MMT; it’s not net financial assets that matters, it’s currency.   And the Fed doesn’t set interest rates, markets set interest rates.  The Fed can briefly push them out of equilibrium (due to sticky prices) but this triggers big changes in AD and the price level.

The whole point of my Quantity Theory of Money post (and especially the Canadian/Australian comparison) was to smoke out their views of currency and the price level.  It was hard sifting through all the comments, which were often on side issues, but it seems they regard base money as just another financial asset.  But it’s not, which is why their view of monetary policy is wrong.  Indeed in a sense they don’t even have a theory of monetary policy, they have a fiscal theory that implies open market operations don’t matter.   But the Canadian/Australian data tells us that currency does matter, and NFA is the wrong aggregate to look at.

This is my very last MMT post . . . until the next one.

PS.  Quiz question:

1.  Sumner claims that a 5% NGDP growth rule will lead to roughly 5% NGDP growth, 5% interest rates, and 5% unemployment.  What would a 3% NGDP target lead to?

Answer:  About 3% NGDP growth, about 3% interest rates, and about 5% unemployment.

PPS.  The previous MMT post has 292 comments, and counting.  I may not have time to answer all the comments here.  In that case I’ll answer the 1% or 2% that actually comment on what I say here.

The vacuum on the right

A year ago I did a post called “Two untimely deaths.”  Here’s an excerpt:

Milton Friedman died on November 16, 2006, one year before the sub-prime crisis.  I’d like to suggest that his death was the closest equivalent to the death of Strong in 1928.  In 1998 Friedman pointed out that the ultra low interest rates were a sign that Japanese monetary policy was very contractionary, at a time when most people characterized the policy as highly expansionary.

There is little doubt that Friedman would have recognized the low interest rates of late 2008 were a sign of economic weakness, not easy money.  But what about the big increase in the monetary base?  First of all, the base also rose by a lot in Japan, and in the US during the Great Contraction.  Second, Friedman would have clearly understood the importance of the interest on reserves policy, which was very similar in impact to the Fed’s decision to double reserve requirements in 1936-37.  And in his later years he became more open to non-traditional policy approaches, for instance he endorsed Hetzel’s 1989 proposal to target inflation expectations via the TIPS spreads.  Note that the TIPS markets showed inflation expectations actually turning negative in late 2008.

Why was Friedman so important?  I see him as having played the same role among right-wing economists that Ronald Reagan did among conservatives.  Reagan was really the only conservative that all sides respected; social conservatives, economic conservatives, and foreign policy (or neo-) conservatives.  After he left the scene, the conservative movement cracked-up.

Friedman was respected by libertarians, monetarists, new classicals, etc.  Last year I criticized Anna Schwartzfor adopting the sort of neo-Austrian view that she and Friedman had strongly criticized in their Monetary History.  If Friedman was still alive, and strongly insisting that money was actually far too tight, then I doubt very much that Schwartz would have gone off in another direction.  It would be like Brad DeLongdisagreeing with Paul Krugman on macroeconomic policy.  Once in a blue moon.

Today there is no real leadership among right wing economists.

[BTW, I kind of regret the shot at DeLong—I’m increasingly impressed by his brilliance, despite the fact that we often disagree.]

Now this issue is resurfacing.  Here’s Will Wilkinson:

TIM LEE asks an important question: why are conservatives and libertarians so uniformly hawkish about inflation? Mr Lee (a friend and former colleague) notes that this regularity is far from inevitable. Milton Friedman, a revered figure in right-of-centre circles, famously pinned the severity of the Great Depression on contractionary monetary policy. Scott Sumner, a professor of economics at Bentley University who identifies himself as a “neo-monetarist”, has argued that Friedman would have supported monetary stimulus. And he has argued, on neo-Friedmanite grounds, that tight monetary policy both precipitated and exacerbated our recent recession. I happen to think Mr Sumner is correct, but his expansionary prescription remains anathema on the right. Why?

.   .   .

Milton Friedman was one of the 20th century’s great economists as well as one its most formidable debaters. This made him a powerful check on the influence of anarcho-capitalist Austrians, obviously much to the chagrin of Rothbard. “As in many other spheres,” Rothbard wrote, “[Friedman] has functioned not as an opponent of statism and advocate of the free market, but as a technician advising the State on how to be more efficient in going about its evil work.” Rothbard’s fulminations notwithstanding, Mr Friedman died a beloved figure of the free-market right. Yet it does seem that his influence on the subject of his greatest technical competence, monetary theory, immediately and significantly waned after his death. This suggests to me that Friedman’s monetary views were more tolerated than embraced by the free-market rank and file, and that his departure from the scene gave the longstanding suspicion that central banking is an essentially illegitimate criminal enterprise freer rein.

I’d add a couple points here.  During his period of greatest influence he was known as somewhat of an inflation hawk, as high inflation was the big problem and the old Keynesian model didn’t have good answers.  The right was happy with that monetarist critique of Keynesianism.  And second, the most important section of Friedman and Schwartz’s Monetary History of the United States was the chapter on the Depression, where they were highly critical of the Fed’s deflationary policies.  Even inflation hawks don’t think rapid deflation is a good idea.  But the subtext of their monetary history was even more important.  The Great Depression had discredited capitalism in the eyes of most intellectuals.  By showing that the problem was tight money, not laissez-faire policy, Friedman and Schwartz opened the door to the neoliberalrevolution.  The New Keynesian technocrats who ran the world economy from 1983 to 2007 are much more comfortable with laissez-faire than their old Keynesian predecessors.

And here’s Tim Lee:

This has gotten me thinking about the broader connection between peoples’ views on monetary policy and their broader ideological worldviews. With the lonely exception of Scott Sumner, virtually every libertarian or conservative who has expressed a strong opinion about monetary policy has come down on the side of the inflation hawks. Over the last three years, a wide variety of fiscally conservative Republican politicians have attacked the Federal Reserve for its unduly expansionary monetary policy. I can’t think of a single Republican on the other side.

Yet it’s not obvious why this should be. There’s a coherent ideological argument for abandoning central banking altogether in favor of a gold standard or free banking. In a nutshell, the argument is that no single institution will have the knowledge necessary to “steer” monetary policy, and so we should prefer a monetary system that decentralizes control over the supply of money.

But whether you like it or not, we do have a central bank and it’s important that it function effectively. Logically, it seems like libertarians should be equally worried about both the threat of too much inflation and the threat of too little. After all, one of Milton Friedman’s most famous books argued that the Depression was worsened by the Federal Reserve’s unduly contractionary monetary policy. Yet (again, aside from Sumner) no free-market thinkers or politicians made this argument even in the depths of the 2009 contraction.

So why is right-of-center opinion so lopsided? I can think of two possible explanations. One is that we’re still having the monetary policy debates of the 1970s, when right-of-center thinkers, following Milton Friedman, argued that the era’s persistently high inflation was the fault of unduly expansionary monetary policy. They were right about this, and a whole generation of free-market intellectuals has been on guard against the threat of inflation ever since. And this is obviously reinforced by the reciprocal trend on the left: because most of the inflation doves are on the left, people who are in the habit of disagreeing with left-wingers are discouraged from adopting their arguments on this issue.

Those are good points, but I’ll add a few more:

1. I t makes me uncomfortable to level this charge (as there is nothing I hate more than others questioning my motives) but it’s a bit awkward when you have conservative bastions like the Wall Street Journal bashing the Fed’s tight money policies in 1984, when inflation was 4% (and Reagan was in office) and making the opposite change when inflation is even lower, and Obama is in office.  I actually have a fairly positive view of the motives of most intellectuals on both the left and the right.  I assume they are well-intentioned.  But if a person strongly opposes a set of policies and hopes a new government will soon reverse them, it may at least subconsciously affect that person’s enthusiasm for monetary stimulus that would make the economy look much better, almost assuring the incumbents re-election.

2.  However I don’t believe even subconscious bias is the main issue.  The current policy stance looks much more expansionary than it really is (due to low rates and the hugely bloated monetary base.)  So there are certainly worrisome indicators that even the best macroeconomists could point to, especially given the (overrated) worry about “long and variable lags.”  It’s not all populism.  I was at a conference last year full of conservatives who knew just as much monetary economics as I do and they were almost all were opposed to QE2.  And conservatives weren’t criticizing the Fed in September 2008, when easier money might have helped McCain.

3.  I have very mixed feelings about seeing my name mentioned in both pieces.  Naturally I’m happy that people are paying attention to my ideas.  But I also worry about a world where I’m the name people mention when looking for someone who will carry on the tradition of Milton Friedman.  And this isn’t just false modesty.  No matter how highly I regard my own views, or those of similar bloggers like David Beckworth (who also could have been cited), the hard reality is that we don’t have the sort of credentials that carry a lot of weight among the elites.  (BTW, this doesn’t apply to Nick Rowe, who is probably has a much higher profile in Canada than we quasi-monetarists have in America.)

Cryptic prediction:  Before 12 moons have passed, a star will arise in the East to lead Milton’s scattered tribe into the promised land of respectability.

PS.  Thus far we’ve been called “quasi-monetarists.”  I would have preferred “new monetarists,” but Stephen Williamson’s already grabbed that name.  Will calls us neo-monetarists.  I’m growing increasing fond of ‘post-monetarist’—particularly for the futures targeting idea.  Weren’t post-modernists like Foucault skeptical of central authority?  And is it just me, or does “quasi” have a slightly negative connotation?

Is coin seignorage Obama’s magic bullet?

Here’s Felix Salmon on a crazy idea that’s been making the rounds:

Tools like the 14th Amendment or even crazier loopholes like coin seignorage would be signs of the utter failure of the US political system and civil society. And that alone could mean the loss of America’s status as a safe haven and a reserve currency. The present value of such a loss? Much bigger than $2 trillion. (Coin seignorage, if you’re wondering, is the right that Treasury has to mint a couple of one-ounce, $1 trillion coins and deposit those coins in its account at the New York Fed. It could then withdraw cash from that Fed account to make all the payments it wanted.)

It seems that some of the MMT-types have been pushing this idea, for instance here’s Joe Firestone:

Throughout the next six months, a number of other posts appeared at various sites provided the authority, in legislation passed in 1996, for the US Mint to create platinum bullion or proof platinum coins with arbitrary fiat face value having no relationship to the value of the platinum used in these coins. These coins are legal tender. So, when the Mint deposits them in its Public Enterprise Fund account at the Fed, the Fed must credit that account with the face value of these coins. This difference between the Mint’s costs in producing the coins and the credit provided by the Fed is the US Mint’s profit. The US code also provides for the Treasury to periodically “sweep” the Mint’s account at the Federal Reserve Bank for profits earned from these coins. Coin seigniorage is just the profits from these coins, which are then booked as miscellaneous receipts (revenue) to the Treasury and go into the Treasury General Account (TGA), narrowing the revenue gap between spending and tax revenues. Platinum coins with huge face values e.g. $2 Trillion, could close the revenue gap entirely, and technically end deficit spending, while still retaining the gap between tax revenues and spending.

So is this a brilliant masterstroke that will solve all of Obama’s problems, or a loony idea that he should avoid touching with a ten foot pole.  Even though I only learned about this idea 30 minutes, ago, I can confidently answer “both.”

Let’s start with the easy part, the idea seems completely nuts.  The public would instinctively recoil from this idea, mainly because the public’s instincts are pretty good.  Roughly 99% of the time this sort of plan would produce hyperinflation.  It doesn’t really matter whether the idea is actually nutty, Presidents simply can’t be seen doing wild and crazy things with the currency.  FDR did something analogous (in a milder form) in 1933.  His policy led to the resignation in protest of a number of his top aides, including Secretary of the Treasury.  In the end FDR was forced to retreat.  And his political position was much stronger than Obama’s.  So if Obama’s political advisers are reading this, tell him to avoid the idea like the plague.

The harder part is whether it would work.  I don’t know if it’s legal, but Firestone seems to think so.  If it is legal it could not only solve Obama’s debt ceiling difficulties, it could also allow him to generate a fast economic recovery (in NGDP, or aggregate demand.)  In other words, he could do an end run around the Fed and run monetary policy right out of the White House, just as FDR did in 1933.  Or he could threaten the Fed to get his way, just as FDR did in 1933.  (FDR devalued the dollar, and basically told the Fed that if they tried to stop him he’d start printing fiat money, which was authorized by Congress in the devaluation bill.)  Of course either of these moves would delight Paul Krugman, and cause heart attacks amongst all the Very Serious People who run the country.  (You know, the ones who don’t understand the distinction between NGDP and RGDP.)  Just as FDR’s decision to torpedo the World Monetary Conference was called “magnificently right” by Keynes, but horrified all the Very Serious People of 1933.

I have to admit that as a contrarian, a quasi-monetarist, and a former coin collector, the idea of minting two $1,000,000,000,000 platinum coins as a way of solving our economic problems fills me with delight.  Remember, I’m the guy who once claimed the recession was caused by too few nickels.  Yes, I am slightly embarrassed to be in with the MMT people.  (Firestone seems to think we have 30% excess capacity, and that we could monetize the entire debt without creating hyperinflation.)  But not so embarrassed that I’m afraid to risk ridicule from the more respectable bloggers who dismiss this idea.

I hope the Fed has a safe place to store those coins—wouldn’t want to “misplace” two trillion dollars.

PS.  I’ve done about 900 posts.  The “nickels” post that I link to above might be my favorite.

An excellent new monetary blog

It’s getting harder and harder to keep up.  In addition to the new David Glasner blog, there is another noteworthy blog that I overlooked, called Free Banking.  This blog has about a dozen distinguished monetary economists, mostly working in the Austrian/free banking tradition.  I’ve been critical of some of the pop Austrianism on the internet, but these economists are very thoughtful.  George Selgin is the name most frequently mentioned over here, and of course he favors a productivity norm, which is not all that different from NGDP targeting.

I’m sure most of the people at Free Banking think I’m slightly unhinged in my relentless claim that money is actually far too tight.  But on many other issues we would tend to agree–such as distrust of having the Fed trying to fine tune the economy, and the need for monetary rules.  Kevin Dowd and I both published papers on CPI futures targeting.