Archive for the Category Monetarism


Allan Meltzer, RIP

I was sad to hear that Allan Meltzer passed away today, at the age of 89.  I always thought of him as one of the leaders of monetarism, along with Milton Friedman, Anna Schwartz and Karl Brunner (with whom he frequently collaborated on research.)  Unfortunately I didn’t meet Allan until he was in his 80s, but he was still quite energetic and passionate about both monetary economics and classical liberalism more broadly.  As recently as last year he participated in the Mercatus colloquium on the effect of low interest rates, and also spoke at one of our events.

My views on monetary policy were shaped by many different influences, but none more important that the monetarist revolution of the 1960s and 1970s, in which Meltzer played a key role. He also wrote a very interesting book on Keynes, whom he argues has been widely misunderstood.

Although market monetarism is somewhat different from traditional monetarism, in my view we are carrying the torch forward, with updates that are very much in the monetarist tradition (i.e., the view that markets are more efficient than bureaucrats.)  I would hope that future monetarists improve upon some of our ideas.

I met Meltzer at 3 or 4 conferences over the past 8 years, and he was always very nice to me.  I’ll miss him.


Japan hasn’t yet run out of ink and paper

Here’s Noah Smith at Bloomberg:

Japan’s great monetary policy experiment is drawing to a close, and the results may change the way the world thinks about central banking. The Bank of Japan’s recent quarterly report says, in effect, that the central bank has done all it can do to raise growth and inflation, and that fiscal policy needs to step in and help. The BOJ admitted that monetary policy alone won’t be enough to hit its 2 percent inflation target, now or ever.

This is very troubling for monetarists (as those who think that monetary policy is the key to macroeconomic stabilization are sometimes called). If central banks can’t control the rate of inflation, what hope do they have of affecting the economy?

I was surprised to read that the BOJ’s quarterly report had said that the BOJ had done all it could, particularly since the head of the BOJ frequently says exactly the opposite.  So I followed the link to the “quarterly report” and found . . . another Bloomberg article:

Many economists interpreted a BOJ policy shift in September as preparation for a sustained fight to generate inflation. Shirai said the central bank would maintain the status quo on policy unless the yen surges or economic data deteriorate.

And what will it do to policy if the yen “surges”?  Let me guess, it will ease policy. So why not ease policy today?

In fact, the BOJ denies that it is out of ammo.

Market monetarists have been more accurate in their Japan forecasts than any other group.  I believe that I was the first western blogger to comment on Abenomics, and I consistently predicted that the policy would raise inflation, but not all the way up to 2%.  That’s been my view all along, and that’s exactly what’s happened.  The actual inflation rate has averaged closer to 1.0%, but even that is a dramatic improvement over the deflation that preceded Abenomics (and this occurred during a period of rapidly falling oil prices, when even US inflation underperformed).  I also pointed out early in 2016 that the BOJ was moving to a more contractionary policy, and we now see the effects of that policy switch on Japanese inflation, which has fallen.  Even so, the impact of Abenomics on NGDP is clearly positive.  It began rising almost immediately after Abenomics was announced in late 2012:

screen-shot-2016-11-10-at-8-43-04-pmThe rest of the article makes the usual mistakes, confusing low interest rates and QE with easy money, whereas they are usually reflective of the fact that the central bank policy is too contractionary.  The market monetarist solution now is the same as it always was—NGDPLT—combined with a “whatever it takes approach” to monetary stimulus.  If you want a smaller central bank balance sheet, then aim for a higher NGDP growth target.  This is not rocket science; we know how to do it, we just need to get real world central banks to try.

But don’t let the perfect be the enemy of the good.  Abenomics really was much better than what came before, and we can do still better.  Instead of abandoning monetary policy, why not improve it?

There’s another thing I don’t understand about all these “monetarism has failed” articles—where are all the “Keynesianism has failed” articles? Didn’t Japan do massive fiscal stimulus, causing it’s debt to balloon to 250% of GDP?  Why isn’t fiscal stimulus viewed as a failure?  I suppose a Keynesian would say, “well they should have done even more”?  OK, but why doesn’t that also apply to monetary stimulus?  After all, fiscal stimulus is far more costly. In contrast, there’s no limit to how much money can be printed.  And why do we get this:

If Japan is out of the monetary easing game, other countries will doubtless follow. The era of bold monetary policy experimentation that began with the global financial crisis is now drawing to a close. More and more, economic policy makers will look to fiscal initiatives and to deeper structural reforms to boost growth and stop deflation.

Why not say the failure of fiscal stimulus in Japan means that governments are “out of the fiscal game”?  In fact, governments can never be out of the monetary policy game, unless they revert to barter.  As Nick Rowe likes to point out, there is no such thing as not doing monetary policy.  The only question is where are you going with that policy.  If you have a policy that delivers low NGDP growth rates and near zero interest rates, then you will end up with a big central bank balance sheet. There’s no way to avoid that except by aiming for a higher NGDP target.  Fiscal policy doesn’t create any short cut to success, as the Japanese case already showed. In January 2015, the Swiss tried to “get out of the monetary policy game” so they could shrink their balance sheet, and the balance sheet is now bigger than ever.  If you are going in the wrong direction, then switch policy.

If any central bank was going to fulfill the dreams of monetarists, it was Kuroda’s BOJ.

Actually, Australia’s much closer to what monetarists have in mind, unless you consider letting the yen appreciate from 125 to 100/dollar to be a monetarist “dream”.

Here’s another article on the BOJ, from last month:

“We are buying government bonds to achieve the 2% price target,” Kuroda said.

Kuroda said that he doesn’t expect the BOJ to run out of JGBs to purchase.

He said that the BOJ’s easy policy would not lead to hyper-inflation.

PS.  Stephen Kirchner sent me to this. Great idea, do massive fiscal stimulus when unemployment is 4.9% and the Fed is raising rates to prevent an overshoot of 2% inflation.  Why didn’t I think of that? I often say that talking about politics takes 30 points off a person’s IQ (including me).  I have a new one.  The zero bound takes 30 years of progress away from macroeconomics.  It took macro 30 years to recover from the Great Depression, and it’ll probably take 30 years to recover from the Great Recession. I won’t live that long.



Was the so-called “monetarist experiment” ever tried?

Jim Glass left this response to my (italicized) claim:

1. The Fed said it would start targeting the money supply, but it did not do so …. 1979-82 told us essentially nothing about the long run effect of money supply targeting. It wasn’t even tried.

I don’t understand you here. Certainly money supply targeting wasn’t tried over a long run, so one can’t see any long-run effect of it. But why do you say money supply targeting wasn’t adopted at all?

Volcker in his 1992 memoir “Changing Fortunes” explained why the Fed in 1981 had to change policy to money supply targeting from interest rate targeting, and went into considerable detail about the political resistance from the Reagan Administration that he had to overcome to do it, and the political ploys he used to do so. I don’t see why he’d make up such a detailed story about something that never happened.

Plus, looking at the M1 numbers for the period from Fred, one sees that after rising steadily pretty much from beginning of time, M1 peaked at $429 billion on 4/20/81, three months before the start of the recession, then went down a little bit, then bounced down a tiny tad and back up again repeatedly to hit pretty much exactly $429b again on 7/6, 8/10, and 10/12 thru 10/26 without ever going at all over $429b (or going below $423b). So on the dates three months before the recession started and then three months after it started, M1 was $429b, exactly unchanged. If the money supply wasn’t being targeted during that period, all those $429b numbers are a heck of a coincidence.

It’s certainly possible that the Fed was paying more attention to M1 than before.  I agree with that claim.  But there can be no dispute that they did not adopt Friedman’s proposal of a steady 4% growth rate in the money supply.  Indeed money growth actually became much less stable during 1979-82, which shows that Volcker moved policy even further away from Friedman’s ideal.  Now of course in a different sense you could say monetarism was adopted, as he used a tight money policy to control inflation.  That policy was a success.

But a money growth rule?  It’s never even been tried.  (And I hope it never will be tried, as it’s probably a lousy idea.)


Krugman suggests that New Keynesianism has disappeared (in the long run all theories are dead)

Here’s Paul Krugman:

Brad DeLong asks why monetarism — broadly defined as the view that monetary policy can and should be used to stabilize economies — has more or less disappeared from the scene, both intellectually and politically.

That’s not just a description of monetarism; it also describes New Keynesianism, as DeLong pointed out in 1999.  Is New Keynesian economics actually dead?  Here’s an example of New Keynesianism, from the same year that DeLong wrote the article:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

Yes, I’d say that NK view from 1999 (expressed by Paul Krugman, BTW) is essentially dead.  I’m not sure what we have now: new, new Keynesianism, old Keynesianism, or as many Keynesianism as there are Keynesians.  (I vote for the latter.) Just as old monetarism is mostly dead, having been replaced by market monetarism.

Krugman also suggests that monetarism is dead because real world governments don’t implement our policies, exactly as we sketch them out.  (He forgets that market monetarists invented negative IOR).  Which of course means that Krugman’s Keynesianism is also dead, as governments are certainly not doing the sort of fiscal stimulus that he recommends.  Indeed the Japanese recently combined fiscal austerity with monetary stimulus, and he seemed to think the Japanese were doing a pretty good job when he met with them recently:

We are all very much wishing, I am a great admirer of the policy moves that have been made by Japan, but they are not good enough, partly because all of the rest of us are in trouble as well.

Yes, he would have preferred they not raise taxes, but the tax increase did not cause a setback to the labor market:

Screen Shot 2016-04-16 at 12.51.44 PMAnd monetary stimulus did get them out of deflation:

Screen Shot 2016-04-16 at 12.57.07 PM

However the BOJ needs to do much more if they don’t want to slip back into deflation.

PS.  Ramesh Ponnuru also has a reply to Paul Krugman.

HT:  James Elizondo

Francis Coppola on negative interest rates

Tyler Cowen linked to a post by Frances Coppola:

But one thing seems clear. How negative rates would work in practice is no clearer than how QE works in practice. They are experimental, and their effects are complex. Hydraulic monetarist arguments (“if you can get rates low enough the economy will rebound”) are simplistic.

Monetarist?  Don’t they focus on the money supply and/or NGDP expectations?  Most people would consider Milton Friedman a monetarist, and here’s what he had to say about low rates:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.   .   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

In a monetarist model, lower market interest rates are contractionary for any given monetary base, because they reduce velocity.  It’s the Keynesians who are likely to claim that lower rates are expansionary.  Now of course Friedman was talking about market interest rates, not IOR. Lower IOR is theoretically expansionary, and so far markets have reacted to negative IOR announcements as if they are expansionary.

Will that be true in the future?  Nothing is certain, as monetary policy is very complex, and concrete action A can always be interpreted as a signal of future concrete action B.  Anything is possible.  A $1 billion increase in the base can have a contractionary impact if a $2 billion increase was expected.  But any monetary analysis should start from the presumption that reducing the demand for an asset will reduce its value.  A reduction in the value of base money is expansionary.  That means lower IOR has a direct expansionary impact on NGDP.  (Secondary effects are complex, as Coppola suggests.)

Indeed, individual banks can avoid paying negative rates on excess reserves. They can discourage customers from making deposits; they can choose to hold reserves in the form of physical cash; or they can increase new lending (not refinancing), since the balance sheet result of new lending is replacement of reserves with loan assets.*

But of course the reserves do not disappear from the system. They simply move to another bank, which then incurs the tax. The banking system AS A WHOLE cannot avoid negative rates on reserves. The reserves are in the system, so someone has to pay the negative rate. If banks increase lending to avoid the negative rate, the velocity of reserves increases. It’s rather like a game of pass-the-parcel.

This is a common misconception, which I see all the time.  If individual banks don’t want to hold a lot of excess reserves, they can simply buy other assets with them.  If the banking system as a whole wants to reduce its holding of excess reserves, it can reduce the attractiveness of deposits until the excess reserves flow out into currency held by the public.  The central bank controls the monetary base, not bank reserves. The composition of the base is determined by banks and the public.

It seems reasonable to suppose that negative interest rates might increase loan demand. Negative interest rates on reserves put downwards pressure on benchmark rates and thus on bank lending rates, attracting those who would otherwise be priced out of borrowing. But typically those are riskier borrowers. We have just spent eight years forcing banks to reduce their balance sheet risk. Do we really want to force banks to lend to riskier borrowers? Of course, tight underwriting standards could be used to deny those people or businesses loans: but doesn’t that rather defeat the purpose of negative rates? It’s something of a double bind.

We need an easier money policy and, if banks are taking excessive risks, a tighter credit policy.  It’s best not to mix up monetary and credit issues.  Negative IOR is about reducing the demand for base money, which is inflationary; it’s not about increasing bank loans.  Central banks should not be trying to encourage more debt creation—unless you want to end up like China (where the policies are unfortunately linked together.)

In the end I agree with those who are skeptical of negative interest rates.  These ultra-low interest rates are a sign that monetary policy is too contractionary. The developed world needs much higher interest rates, but only if we get there with an expansionary monetary policy.  In December the Fed tried a short cut, raising rates without boosting NGDP growth. This is putting the cart before the horse.  You need to generate higher NGDP growth expectations first, and then you can achieve a permanently higher level of interest rates.