Reply to Peter Boettke

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.


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15 Responses to “Reply to Peter Boettke”

  1. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    30. July 2013 at 06:39

    Everyone at Boettke’s seems to have missed that you have an incentive scheme built in to give FOMC members something other than a benevolent planner mindset.

    One could argue that you need to refine that incentive structure–make it more like that sharpened steel spike protruding from the steering wheel, aimed at the driver’s heart?–but you clearly have dealt with the public choice issue.

  2. Gravatar of Becky Hargrove Becky Hargrove
    30. July 2013 at 07:05

    Lar’s recent post is also quite helpful:
    http://marketmonetarist.com/2013/07/29/beating-the-iron-law-of-public-choice-a-reply-to-peter-boettke/

  3. Gravatar of George Selgin George Selgin
    30. July 2013 at 08:16

    As you know Scott, I don’t think that there is really any conflict between a stable NGDP ideal and free banking, which (I’ve argued elsewhere) itself tends, when combined with a gold standard or fixed monetary base, to stabilize NGDP rather than P. (This does not mean, of course, that such regimes can achieve any particular positive NGDP growth rate.) I think it is misleading, on the other hand, to refer to the stable-NGDP outcome of a free banking system as an instance of NGDP “targeting,” because the outcome is not one deliberate sought by free bankers, as it must be if it is to be achieved by a central bank, but is rather the result of free bankers’ profit-maximizing behavior in the face of the constraint posed by random net reserve outflows and a limited nominal reserve stock. This difference, it seems to me, itself suggests a “robustness” point in favor of free banking, since it means that we need not rely on bureaucrats’ altruistic behavior to see the the achievement of the desired outcome.

    In any event the larger issue boils down to whether, among those reforms capable of achieving a stable level of NGDP, taking that ideal for granted, some (e.g., a move to free banking), are inherently more “robust” than others (e.g., central banking with NGDP futures targeting) to potential political interference.

    But despite what I said in favor of free banking a moment ago, the larger question remains a trickly one to answer. First of all, there are two senses of robustness to consider, one referring to the likelihood, given political reality, of a reform being implemented in the first place, and the other to the likelihood that a reform, once implemented, will be self-preserving rather than the object of subsequent political adulteration or interference. Of course the least radical reforms are always the most “robust” in the first of these senses, down to the trivial case consisting of simply settling for the status quo. This of course is, I take it, not what Pete wishes to encourage in championing “robust” reform; but the very fact that there is another sort of political “robustness” that seems to favor conservative over radical solutions, thus tugging us in a direction opposite the one Pete has in mind, needs to be recognized.

    Pete’s concern, then, seems to be that of having us embrace reforms which, if only they can be implemented, will prove relatively tamper-resistant. My own thoughts on what sort of reforms best fit this criterion remain far from settled. On the one hand, it seems to me that governments can undo any conceivable reform, though perhaps with more difficulty in some cases than in others. Evidently in our system a reform that is written into the Constitution, for example, is more robust than one that isn’t. But then why assume that a “free banking” Constitutional amendment (e.g. “Government shall make no laws regarding money and banks”) any more robust than an amendment calling for NGDP targeting? Putting the point this way resolves little, of course; but it may at least serve to suggest that the robustness of a reform may depend at least as much on its legislative basis as on the concrete nature of the reform itself. Some “scraps of paper” are simply easier to tear up than others, no matter what happens to be written on them.

  4. Gravatar of Adam Adam
    30. July 2013 at 08:34

    Careful, too much of this externalities talk and you might have to bash yourself.

  5. Gravatar of John Hall John Hall
    30. July 2013 at 08:38

    I didn’t care for Boettke’s argument, but I’m not sure how much I like yours and Lars’ response either. Saying it is a technical solution to a technical problem is a good start. Sometimes in economics it is important to begin by isolating the key features. In this case, you are focusing on what is an optimal approach to monetary policy. That’s important work. However, the argument you don’t make is that after proposing your technical solution, we can easily relax the assumptions and consider whether the public choice arguments have merit. I can certainly see why public choice considerations might prevent such a system from being created (which is not a good argument for advocating for it), but I don’t see why public choice considerations would be more damaging to its overall implementation than our current system or many other proposed systems (this is the part that Lars gets correct, but I felt like a lot of the rest of the post was strawmanning Pete’s position).

  6. Gravatar of ssumner ssumner
    30. July 2013 at 11:59

    Patrick, Good point. I may not have addressed THE public choice issue, but I addressed A public choice issue. I took control of interest rates and the money supply away from the government and turned it over to the market. Surely that counts for something?

    George, Good comment. I actually don’t want “robust reforms” because I’d like to see reforms that are easy to reverse . . . if they fail. The euro is an example of a monetary reform that is very difficult to reverse. So was the Argentine currency board. I’d argue that both reforms failed, and that a lot of damage was done to both economies precisely because the reforms were fairly robust, or difficult to reverse.

    John Hall, I’m confused. My post did not contain a single word characterizing Peter’s views. So how could I have “straw-manned” him. At worst I didn’t fully respond to his criticism, which is quite possible, because we all see these issues differently.

  7. Gravatar of Charlie Charlie
    30. July 2013 at 13:48

    “Because I envision a policy regime where government plays some role, the various proposals will be susceptible to the standard public choice critique. However, any reform proposal depends on at least some goodwill by policymakers.”

    Free Banking faces the same public choice problems as policy makers can just keep encroaching on Free Banking, until it is no longer free. The long history across governments and economies of regulating banking creates a large hurdle for Free Banking advocates to argue why their version of Free Banking is a stable political equilibrium.

    Also, you and Pete seem to be using “public choice” and “politically feasible” as synonyms. I think it is more useful to use politically feasible to describe policies that might actually be enacted, and to use public choice to describe the changes that may happen to enacted policies–regulatory capture, mission creep, rent seeking…

    NGDP targeting is not politically feasible right now, because most people don’t know or care about it. If the majority of economists started supporting it, it would be quite politically feasible. Public Choice is about the policy itself. Would the producers of NGDP estimates be captured? Would their be pressure to alter the policy from Congress?

    Neither the politically feasible or public choice aspects of the NGDP targets seems very significant to me. We already have CPI futures markets it TIPS, would NGDP futures markets be so much more difficult? Boettke offers no actual Public Choice critique of the policy. Convincing most economists is the difficult part.

  8. Gravatar of Bill Ellis Bill Ellis
    30. July 2013 at 16:20

    Scott, This just an observation, not a criticism.

    If a econ blogger cares to communicate with interested outsiders, it is helpful to define your common econ terms and acronyms.

    You could do it like this “…stable P, stable M, stable PY, stable growth path for PY, etc,… Where M is the quantity of money, P is the price level, and Y is aggregate output.

    Or maybe you would rather stick needles in your eyes. I get that.
    I got to say, what ever you think of Steve Randy Waldman, he does a great job reaching down to laypeople.

  9. Gravatar of Geoff Geoff
    30. July 2013 at 16:26

    “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.”

    Costs and benefits are individually subjective. They are unique to the individual. There is no coherent meaning to “costs” and “benefits” as you have implicitly defined them in the above passage.

    If 100 individuals work in the banks, and 10,000 individuals work outside of the banks, and we imagine either losses incurred by the 100 individuals in the banks, or losses incurred by the 10,000 individuals outside of the banks, there is no coherent meaning in the statement “The losses of the 100 bankers was outweighed by the losses of the 10,000 non-bankers”.

    The above theoretical approach of “socializing” the gains and losses, literally prevents one from considering any non-centralized power alternative for “controlling” the money commodity, without falling into contradiction.

    As soon as you start down the collectivist path of “social costs” and “social benefits”, a centralized alternative is the only logical outcome.

    ——————

    George Selgin:

    You argue that a free banking system would basically do the central bank’s job (according to market monetarist theory) of stabilizing NGDP, not in the sense of constant growth, but in the sense of no wild fluctuations.

    I agree. In a free banking system, the money supply would be roughly stable over time (with a mild growth rate on average). There is a logical connection between you owning more money, and my owning less money, and vice versa. To wit, if you exchange your money for my goods, then the money will simply change owner. The money supply would be unchanged for all acts of exchanges of (already existing) money.

    And the quantity theory of money teaches us that the amount of money spent, will be primarily a function of how much money exists. If the latter is stable over time, so will be the former. This isn’t in any sense “the goal” of money production and ownership, as you alluded to, it’s just a tendency; a natural, spontaneous outcome.

    I’m not sure how many market monetarists are aware of this, but during 2008 and into 2009, most measurements (public and private) of the widest money supply aggregate (M3, etc), turned negative in terms of growth. The money supply actually shrank, and as you likely know already, it was due to fractional reserve credit deleveraging and default. I believe this is one of the largest threats in our monetary system. With so much credit, i.e. claims to money, and, relatively speaking, so little actual money, one large-scale default on debt can, via counter-party monetary dependence, trigger a deflationary implosion as each default reduces the quantity and thus quantity of spending of money, which itself then causes further defaults and further reductions in the quantity of money, and so on.

    I think a far more “politically palatable” solution, given our existing system, would be for Congress to pass a 100% reserve requirement for all banks, which will eliminate the need for FDIC and large-scale bailouts. Milton Friedman was on board with this idea and supported a bill that would have introduced a 100% reserve requirement.

    The Bank of Amsterdam back in the 17th century for example practised virtually 100% reserve, and for almost 100 years was highly regarded around the world, and it played a large role in establishing Holland as a commercially dominant society. A safer banking system attracts more capital.

    Of course, the biggest barrier stopping this, is the intellectual bankruptcy prevalent in contemporary macro-economic thinking, which holds the false belief that credit expansion is needed to grow the economy. If we can eliminate that fallacy, it will be much easier for politicians to pass the 100% reserve requirement.

  10. Gravatar of Morgan Warstler Morgan Warstler
    30. July 2013 at 17:19

    There is a better response to libertarian purity args against NGDPLT and GI CYB….

    “shut up”

    Being a hard core anarcho-capitlist who hates every form of govt. that comes after step #1: the title office…

    well being that guy REQUIRES favoring the optimal free market policy agenda THAT CAN PASS.

    There is a choice only between optimal incremental strategic gains leading to the next most free market change in the system

    OR

    total policy nihilism of “let the whole thing crash” and then they will all learn!

    AND IF you want to pretend to play option #2, you still have to personally be doing EVERYTHING you can to deliver the crash.

    This would mean say preaching to Austrians that everyone is morally obligated to find every welfare loophole and suck up as many resources as possible to crash the system even faster.

    In short, there is NO passive “do nothing but bitch” response.

    Real technocrats ship, because when hard core anarcho capitalists WANT to change the world, they buckle down they get in the box of what is possible and they out think everyone else and become better technocrats than anyone else….

    they HACK the system.

    selah.

  11. Gravatar of Mike T Mike T
    30. July 2013 at 19:03

    Being a hard core anarcho-capitlist who hates every form of govt. that comes after step #1: the title office…
    >> Anarcho capitalism doesn’t necessitate any hate for government. Anarcho capitalism and the state are simply incompatible.

    well being that guy REQUIRES favoring the optimal free market policy agenda THAT CAN PASS.
    >> Defending a policy sourced from an entity granted a government monopoly on legal tender is incompatible with free markets. Would a government granted monopolist on farmable land targeting annual aggregate crop production be an “optimal free market policy agenda” as a response to periodic decreases in crop output? After all, there’s still plenty of free market competition in the wholesale, retail, and distribution of products and services that form the crop market. It’s not like we’re socialists! The irrational schizoprenia when it comes to money and how easily economists shy away from market forces and ignore economic law in certain circumstances (e.g. at the ZLB) is baffling.

    “There is a choice only between optimal incremental strategic gains leading to the next most free market change in the system

    OR

    total policy nihilism of “let the whole thing crash” and then they will all learn!”
    >> False choice. I once thought this way as well. And perhaps I was right then and wrong now, but this reminds me of the news cycle today. To use a non-economics related analogy, I found it interesting to read much of the news stories and general reactions coming out in the wake of the Bradley Manning trial. Much of the reaction centered around the “aiding and abetting the enemy” charge where nearly everyone agreed was excessive and/or relieved when he was found not guilty. Largely lost in the discussion was how the guy could still face 150+ years after being found guilty of violating the Espionage Act, an old relic from WW1 invoked only 3 times prior to this current administration invoking it 7 times already and counting, for merely passing along low-level classified information for dissemination to the public. Should individuals rejoice in this “win” toward a bit more press freedom that journalists and their sources are spared by only risking spending a century in a cage if it means vindication from an even harsher charge? No, it’s a travesty the guy has to spend any more time in a cage than he already has and a larger travesty that nobody has even been charged with the crimes that he exposed.

    Incremental policy wins mean very little in the long run. It’s convincing and shaping hearts and minds that ultimately matter and which ultimately shapes future policy. Some of us have principles that won’t be compromised. In the mean time, advocating incremental policy steps toward some illusion of a free market system simply admits intellectual capitulation and concession further dampening and marginalizing the free flow exchange of ideas leading to real progress.

  12. Gravatar of Beating the Iron Law of Public Choice – a reply to Peter Boettke | The Market Monetarist Beating the Iron Law of Public Choice – a reply to Peter Boettke | The Market Monetarist
    31. July 2013 at 00:43

    […] 2: Scott Sumner also comments on Pete’s post. Read also the comment section – George Selgin has some very insightful comments on the relationship between Free […]

  13. Gravatar of Morgan Warstler Morgan Warstler
    31. July 2013 at 05:56

    Mike T,

    the logic of what you said is this:

    “False choice. I once thought this way as well. And perhaps I was right then and wrong now,”

    yes you were wrong before.

    The choice is binary, it is very much the Texan Hooker joke:

    She: What kind of woman do you think I am?

    He: We’ve already established that. Now we’re just haggling over the price.

    —–

    Once we establish that I am not the full on nihilist, and MORE SO, being the nihilist requires actively monkeywrenching the system to crash it faster…

    The ONLY discussion left is PRICE.

    Price in this case is “what CAN PASS that from today to tomorrow most actively shrinks govt. and promotes free markets/”

    And sadly, most libertarians don’t have the stones to actively engage in this kind of hardened hacker mindset.

    I’m far more impressed with a single entrepreneur flouting the TAXI regs in NYC, than I am the entire staff of Mercatus and CATO since their inception.

    And any other serious libertarian is too.

    Snowden has skin in the game.

    Manning does, but again, Snowden is PASSABLE, and Manning is not.

    Efforts towards freedom, are not created equal.

    —–

    note: I have come to think Scott and Taleb ought to start a media company (blog) together.

  14. Gravatar of John Hall John Hall
    31. July 2013 at 06:19

    Scott, I thought that Lars was strawmanning Pete in his response, not you. I just felt you didn’t go far enough in your response to Pete’s argument.

  15. Gravatar of ssumner ssumner
    31. July 2013 at 07:00

    Charlie, You said;

    “NGDP targeting is not politically feasible right now, because most people don’t know or care about it. If the majority of economists started supporting it, it would be quite politically feasible.”

    This is exactly right. And that’s the whole point of my blog. And my blog has been successful beyond my wildest dreams. And there’s still lots more work to be done.

    Bill, This blog isn’t really aimed at outsiders, it’s aimed at people who already know what P and Y and M are. If they don’t, then how could thy possibily understand the content of the blog?

    John, Sorry, I misread that.

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