The strange politics of fixed exchange rate systems

Next to North Korea’s 5 year plans, fixed exchange rates must be the worst economic policy ever devised by man:

1.  The fixed exchange rate regime of the interwar period was a complete disaster, arguably causing WWII.

2.  The Chilean peg of the early 198os led to a massive recession, before they switched to inflation targeting.

3.  The 1994 Mexican crisis.

4.  The 1997-98 East Asian crisis.

Then people said the regimes had to be more impregnable, so that even a speculative attack wouldn’t undermine the peg.  This led to:

5.  The Argentine depression of 1998-2001

Then people said even the currency board wasn’t enough,  As long as you still had a currency, there was always the possibility of devaluation.  This led to the idea of the single currency, the ultimate doomsday device:

6.  The eurozone crisis of 2008–2018

When you talk to proponents of a single currency, they talk of the huge efficiency gains, as if the Swiss and Swedes and Norwegians and Danes are disadvantaged by holding on to their old currencies.  (Actually they are slightly disadvantaged, as the euro is such a monumental failure that desperate Europeans are buying Swiss and Danish bonds with negative nominal yields, even more negative than Germany.)

In the comment section people sometimes ask me what it is that conservatives like so much about fixed rates.  But what’s really weird is that this isn’t even true:

1.  In the early 1930s many US unions and the socialists were opposed to dollar devaluation.  Fisher was a more aggressive proponent than Keynes (who favored just a small devaluation and then a return to the gold standard.)

2.  Under Bretton Woods (the one semi-successful fixed rate regime) Milton Friedman was the most famous opponent of fixed rates.

3.  The radical left in Greece wants to stay in the euro, and Berlusconi suggests Italy should consider leaving.

4.  The socialist Mitterrand pressured the Germans into supporting the euro project.

5.  Here’s Margaret Thatcher’s view:

Next week it will be 20 years since Margaret Thatcher fell. Pressure had been building on a number of fronts, but the issue which finally destroyed her was the yet-to-be-born euro. In the last weekend of October 1990, she travelled to a European summit in Rome, where Jacques Delors’ dream of European Monetary Union was high on the agenda. But while Mrs Thatcher was fighting her lone battle against the prospective single currency abroad, she was being fatally undermined at home. Geoffrey Howe, her bitterest cabinet critic, went on television to tell the interviewer Brian Walden that in principle Britain did not oppose the euro.

In her Commons statement after returning home, she was forced to slap Howe down: “this government believes in the pound sterling.” Howe resigned, and days later delivered the famous speech from the back benches that set in motion a leadership contest.

Today, Margaret Thatcher’s autobiography, first published in 1993, reads like a prophecy. It shows how deeply and with what extraordinary wisdom she had examined Delors’ proposals for the single currency. Her overriding objection was not ill-considered or xenophobic, as subsequent critics have repeatedly claimed.

They were economic. Right back in 1990, Mrs Thatcher foresaw with painful clarity the devastation it was bound to cause. Her autobiography records how she warned John Major, her euro-friendly chancellor of the exchequer, that the single currency could not accommodate both industrial powerhouses such as Germany and smaller countries such as Greece. Germany, forecast Thatcher, would be phobic about inflation, while the euro would prove fatal to the poorer countries because it would “devastate their inefficient economies”.

It is as if, all those years ago, the British prime minister possessed a crystal ball that enabled her to foresee the catastrophic events of the past year or so in Ireland, Greece and Portugal. Indeed, it is one of the tragedies of European history that the world chose not to believe her. President Mitterrand of France and Chancellor Kohl of Germany dismissed her words of caution. And when Mrs Thatcher was driven from office in 1990, a crucial voice was lost, and a new consensus started to form in Britain in favour of the euro.

This consensus stretched across the entire spectrum of the British establishment. It took in Tony Blair’s New Labour and all of Paddy Ashdown’s Liberal Democrats. The CBI came out for the euro, and so did the trades unions. The Foreign Office was doctrinally pro-single currency. Leading businessmen, such as Peter Sutherland (chairman of BP and Goldman Sachs International) and the fashion-conscious Richard Branson were strongly in favour. The Financial Times, a newspaper whose judgment has been wrong on every great economic issue of the last 40 years, was another supporter.

Ah, the good old days when the right was right.

Yes, smart liberals like Paul Krugman were also opposed.  Many conservatives favored the euro.  But nonetheless it’s undoubtedly true that fixed exchange rates appeal to both sides of the political spectrum.  But why?

This is just a guess, but for the right it might represent “hard money” and a lack of discretion for monetary policymakers.  For the left it might represent a distrust of market prices, which fluctuate wildly in response to the whims of speculators.  Whatever the reason, this unholy alliance of the left and right has produced one policy fiasco after another.

In fairness to the other side, Bretton Woods worked pretty well in the 1950s and 1960s.  In my view that reflected rapid growth in European countries like Italy, which benefited from the Balassa-Samuelson effect.  Fixed rates may be OK for small open economies like Hong Kong or Dubai (but Singapore suggests they aren’t essential).  They might be the lesser of evils for countries prone to hyperinflation like Zimbabwe.  They might work in small homogeneous areas like Austria/Germany/Benelux.  But in the modern world the presumption should be flexible exchange rates with NGDP targeting.  The burden of proof should be on those advocating fixed rates.

HT:  Gregory Barr



80 Responses to “The strange politics of fixed exchange rate systems”

  1. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 05:49

    “So you think a fixed exchange-rate system is more conducive to global free trade and global economic recovery than floating rates?” I ask.

    Mr. Mundell registers surprise that I would even inquire. “The whole idea of having a free trade area when you have gyrating exchange rates doesn’t make sense at all. It just spoils the effect of any kind of free trade agreement.”

  2. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 05:50

    “So our problems today,” I posit, “are related to the fact that the Bretton Woods system of fixed exchange-rates linked to gold broke down?”

    “The system broke down,” he hastens to explain, “not because of fixed rates. Fixed exchange rates operate between California and New York . . . the system broke down because there was no mechanism to keep the world price level in line with the price of gold.”

  3. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 05:54


    So if in 10 years…. Greece is a cross between South Carolina and Florida.

    A growing tourist state with no serious labor protections and a public sector half its current size.

    That’s a win right?

  4. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. June 2012 at 06:24

    “They might work in small homogeneous areas like Austria/Germany/Benelux.”

    If by homogeneous you mean economically then you should note that the Netherlands just experienced its third quarter of negative growth in a row and RGDP is down 1.3% year on year:

    P.S. But then I suppose that one could argue that no eurozone country is performing well with perhaps the exception of Finland and Estonia (provided one ignores the fact that Estonia’s RGDP is still nearly 10% below previous peak in 2007 and is forecast by the IMF to not surpass that peak until 2015).

  5. Gravatar of dwb dwb
    4. June 2012 at 06:58

    So if in 10 years…. Greece is a cross between South Carolina and Florida.

    i sure hope they do a lot better than SC and FL. I would not hold those states up as models.

  6. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 07:23


    Why not? What exactly about those states wouldn’t Greece trade for?

  7. Gravatar of marcus nunes marcus nunes
    4. June 2012 at 07:25

    Margareth Tatcher had good economic advisers, Sir Alan Walters and Patrick Minford, the latter a good friend of mine. Above all, she had one of the best brains in the “prime ministership business”.
    And Bretton Woods began to unravel when the US, quite unlike Germany today for the Euro, started inflating in the mid 6os.

  8. Gravatar of Neal Neal
    4. June 2012 at 07:26

    I guess the fixed exchange rates 1880-1914 were horrible, too? We should say: fixed exchange rates, given wage and price inflexibility, are bad.

    I wonder how the US would do with two or three currencies and central banks with NGDP targeting — a currency for the middle, a currency for the south, and a currency for the coasts. Would that make the country more or less efficient? (Assume the central banks are completely independent and performing 5% NGDP targeting.)

  9. Gravatar of Neal Neal
    4. June 2012 at 07:26

    Didn’t Nixon end Bretton Woods when he was faced with the prospect of downward wage adjustment in an election year?

  10. Gravatar of JimP JimP
    4. June 2012 at 07:28

    The dead center:

    This is the lady we must convince – and what she knows about monetary policy is less than my pet bird knows.

  11. Gravatar of dwb dwb
    4. June 2012 at 07:32

    Why not? What exactly about those states wouldn’t Greece trade for?

    No doubt trading up for FL or SC would be positive for Greece, but i would hope they shoot for something significantly better.

  12. Gravatar of dwb dwb
    4. June 2012 at 07:36

    This is the lady we must convince – and what she knows about monetary policy is less than my pet bird knows.

    She is exhibit A for why we need ngdp futures contracts or Schiiler’s “Trills”

    Her model! I would not trust her model to do anything but give the economy the blue screen of death.

  13. Gravatar of Steve Steve
    4. June 2012 at 07:48

    ¡Acabad ya con esta crisis!

    The Krugman bus has arrived.

  14. Gravatar of dwb dwb
    4. June 2012 at 07:49

    BTW, contrast Pianalto’s views with this from 2007:

    Generally speaking, brief periods of elevated inflation do not pose immediate threats to economic growth. However, if inflation rates remain high for a prolonged period of time, people might reasonably believe that inflation has permanently shifted higher, and adjust their behavior accordingly. If that happens, the whole inflation environment could change for the worse – distorting investment decisions, reducing productivity, and affecting economic growth.

    Now, i have to ask, whose putting the “credibility” story into the FOMC punchbowl??

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. June 2012 at 07:52


    I found the following interview of Pianalto to be very interesting, not so much for what it said about her, but for what it said about the differences between Greenspan and Bernanke. Pianalto served under both in the FOMC and so may have a unique perspective:

    “Finally, I would note the change in chairmen since I joined the committee in 2003. Alan Greenspan was chairman then, and now Ben Bernanke is chair. And Ben has changed the way we conduct our meetings. You can read the transcripts””I’m not sharing anything that’s confidential””but when Alan Greenspan was chair, he would usually go first in our policy go-round, when we take turns explaining our views.

    If you look at the transcripts, you’ll see that oftentimes the conversation following his recommendation on policy would be, “I agree, Mr. Chairman,” “I agree, Mr. Chairman,” “I agree, Mr. Chairman.” By contrast, Ben goes last on the policy go-round. That requires each one of us to give our views on appropriate monetary policy, and Ben listens to our views and then presents his own perspective. He then puts forward a recommendation that he believes best reflects the appropriate course for policy, consistent with the views of the Committee. We then act on that recommendation.”

    That one went first and the other last tells you a lot. Greenspan let everyone know he was “The Maestro.” Bernanke on the other hand apparently views his role as the bagel meister:


  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. June 2012 at 07:53


    “On the administrative side, I served seven years as the chair of the Princeton economics department, where I had responsibility for major policy decisions such as whether to serve bagels or doughnuts at the department coffee hour.”

  17. Gravatar of J.V. Dubois J.V. Dubois
    4. June 2012 at 08:00

    Nice post. Only I wish I would share your optimism for the Eurozone as 2008 – 2018 crisis. Judging from what we have so far I would say that this mess can take longer to resolve. You cannot imagine how hopeless the discussion here in the Eurozone is.

    I have so low opinion about EU policy makers that I wouldn’t put it past them to actively sabotage any recovery of particular peripheral countries just to put other countries still in the currency union in line in “see this is what you’ll get if you won’t behave” manner. I know it sounds crazy, but I think that crazy and insane is the only word left to describe what is happening right now.

  18. Gravatar of JimP JimP
    4. June 2012 at 08:16


    And that shows the disaster of Bernanke. Like Obama – both of them allow debate and then plant themselves in the middle. Obama does this because he doesn’t actually know anything, and he knows he doesn’t. Bernanke does it because, in my opinion at least, he is a flat coward. Bernanke knows what he should do – he just flat refuses to do it.

  19. Gravatar of JimP JimP
    4. June 2012 at 08:33


    There is this story about Lincoln – it is famous and maybe you know it. There was a cabinet debate about whether or not he should do the Emancipation Proclamation – no small matter obviously – as the outcome of the Civil War and the survival of our democracy depended on it. The cabinet vote was 12 no (or another number reflective of the fact that the entire cabinet voted against it) and one yes. Lincoln was the one yes.

    And his response to the vote? “And the ayes have it.”

    That is what we need now -and what we do not have.

  20. Gravatar of Josiah Josiah
    4. June 2012 at 08:48

    And yet, it was Labour’s Gordon Brown and Ed Balls who ultimately kept Britain out of the Euro.

  21. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 08:48

    The Washington Post
    November 12, 2000, Sunday, Final Edition
    A Republican Fed chairman and a Democratic president might have seemed strange bedfellows. But Alan Greenspan and Bill Clinton became the best of partners and the economy soared

    By Bob Woodward

    Federal Reserve Chairman Alan Greenspan jumped at the invitation to visit the man who would be the next president. Arkansas Gov. Bill Clinton had just won the election in November 1992, and he wanted to reach out to the powerful Fed chairman. So a month after the election Greenspan was asked to come to Little Rock.

    Greenspan, 66, had been chairman of the Fed for five years. A lifelong Republican, he had first been appointed by President Reagan in 1987. President Bush had reappointed him in 1991, even though Greenspan had had a very uneasy and contentious relationship with Bush’s economic advisers. The chairman was determined to establish a good relationship with the new president, though Clinton was a Democrat.

    With a somewhat severe face, bespectacled, a bit hunched, narrow-eyed and pensive, Greenspan radiated gloom. He spoke in a gravelly monotone, often cloaking his thoughts in indirect constructions reflecting the economist’s “on the one hand, on the other hand.” It was almost as if his words were scouting parties, sent out less to convey than to probe and explore.

    On December 3, Greenspan took a commercial flight to Little Rock to meet with Clinton. As they talked alone in the governor’s mansion, Greenspan found himself quite taken with the new young leader. Clinton was totally focused, as if he had no other care in the world and unlimited time. They ranged over topics from foreign policy to education, and Greenspan saw that Clinton’s reputation as a policy junkie was richly deserved. The president-elect seemed not only engaged but engrossed.

    Greenspan saw an opening to give an economics lesson. The short-term interest rates that the Fed controlled were at 3 percent, as low as they could practically go in these economic conditions, he said. But the Fed could keep them there.

    The 10-year and longer rates were an unusual 3 to 4 percentage points higher than the short-term rate, at about 7 percent. The gap between the short-term rate and the long-term rate, Greenspan lectured, was an inflation premium being paid for one simple reason: The lenders of long-term money expected the federal deficit to continue to grow and explode. They had good reason, given the double-digit inflation of the late 1970s and the expanding budget deficits under Reagan. They demanded the premium because of the expectation of new inflation. The dollars they had invested would, in the future, be worth less and less.

    Perhaps no single overall economic event could do more to help the economy, businesses and society as a whole than a drop in long-term interest rates, Greenspan said. The Fed didn’t control them — the market did. But credible action to reduce the federal deficit would force long-term interest rates to drop, as the markets slowly moved away from the expectation of inflation, and could trigger a series of payoffs for the economy.

    Clinton was so sincere and attentive that Greenspan continued. He outlined a blueprint for economic recovery. Lower long-term rates would galvanize demand for new mortgages, refinancing at more favorable rates and more consumer loans. This would in turn result in increased consumer spending, which would expand the economy.

    As long-term rates dropped, investors would get less return on bonds and move into the stock market instead. The market would climb — an additional payoff. The federal deficit was so high and cumulatively unstable, Greenspan said, that increased government spending to increase jobs — in accordance with the traditional Keynesian model — no longer worked. The economic growth from deficit reduction could actually increase employment — a critical third payoff.

    Greenspan noted that the economy was rebounding from the brief recession of 1990-91, but there was no telling if it would last. As had happened in the past, the recovering economy could fall on its face. Getting the long rates down and keeping them down with a strong deficit-reduction program could sustain and increase economic growth even more than the conservative estimates that were circulating in the government or privately.

    This conversation continued for 21/2 hours. Greenspan had not intended to stay for lunch, but he did. From the beginning he sensed that Clinton was different from the four Republican presidents Greenspan had seen up close — Nixon, Ford, Reagan and Bush. The chairman left the meeting thinking, Either this guy has a lot of the same views as I do, or he is the cleverest chameleon I have ever run into.

    On the five-hour trip back to Washington, Greenspan tried to assess what he had observed. Clinton was what Greenspan termed an “intellectual pragmatist.” The term also applied to Greenspan himself. Clinton’s campaign promises included tax increases on the wealthy, a violation of Republican orthodoxy. But increasing taxes reduced the federal deficit — and those deficits, Greenspan thought, were such a threat to the future of the economy that it might just be worth it to support Clinton’s proposal.

    One of the paradoxes, Greenspan realized, was that by running up the federal budget deficits, Reagan had effectively borrowed from the period that was now going to be the Clinton era. Clinton would have to pay it back by paying down the deficit in some way. The irony was that Clinton probably wouldn’t have been elected if Reagan hadn’t created the deficits.

    Reagan had given Bill Clinton the opportunity to win the presidency, but he had also bequeathed to the new president a major problem.

    Greenspan’s real connection to the new administration was Lloyd Bentsen, the former Texas senator who was now Clinton’s treasury secretary. They were close friends and regularly played tennis together. Though a partisan Democrat, Bentsen had been chairman of the powerful Senate Finance Committee and was conservative on fiscal and money matters.

    Bentsen arranged for Greenspan to see Clinton on Thursday, January 28, the eighth day of the new administration. Greenspan told the president that it would be dangerous not to confront the deficit very soon. The problem would not make itself immediately apparent during the next several years, because defense spending cuts would obscure the ballooning deficit. After 1996, though, the data projections showed that the deficit and interest on the federal debt would become explosive.

    “You cannot procrastinate indefinitely on this issue,” Greenspan warned. Without action, he forecast “financial catastrophe.”

    Clinton made clear that he had received the message.

    With Bentsen, Greenspan went further. He urged the new administration to set ambitious deficit-reduction targets for the federal budget. On February 5, the White House economic advisers sent Clinton a 15-page memo that summarized budget options and Greenspan’s analysis.

    It read, in part: “Greenspan believes that a major deficit reduction (above $ 130 billion) will lead to interest rate changes more than offsetting” the contraction to the economy caused by less government spending. This meant long-term rates would come down if the deficit reduction was sufficient to have credibility in the financial markets.

    On his copy, Bentsen had written with his lead pencil referring to Greenspan, “He urges 140 or above,” meaning Greenspan thought a $ 140 billion reduction in the economic plan four years out (1997) would be more credible than $ 130 billion. It revealed their most private, confidential talks.

    Bentsen urged the president to develop a personal relationship of trust with Greenspan. He also emphasized to Clinton the importance of deficit reduction as a catalyst for lower long-term interest rates.

    In a sense, Bentsen and Greenspan were using each other. For Bentsen, Greenspan’s view on a specific deficit target was a potent weapon in the Clinton administration deliberations. For Greenspan, a big reduction in the federal deficit would make his job immensely easier, because lower deficits would likely mean lower actual inflation.

    Clinton adopted the $ 140 billion target for 1997.

    When the president unveiled his economic plan at his first State of the Union address to a joint session of Congress on February 17, 1993, Greenspan was there in the gallery, in seat A6 — right between Hillary Clinton and Tipper Gore, the vice president’s wife, on full display as the national television cameras swung over to get reaction. The first lady had invited him to sit in her box for the speech, and Greenspan had accepted on the basis that protocol dictated he not refuse.

    As Clinton spoke, Greenspan applauded stiffly. He believed the White House had given him enormous power, because if he chose to criticize the Clinton economic plan, he could do substantial damage — even perhaps do it in. But the large deficit-reduction portion was in part his own design, and he was hardly going to shoot it down.

    On February 19, in testimony before the Senate Banking Committee, Greenspan said that the Clinton plan was “serious” and “credible,” making headlines with his support. Greenspan thought that Clinton had broken the gridlock on dealing with the deficit. He couldn’t say it publicly, but he believed the president had displayed an element of political courage. He was taking a stance that some in his own party would fight him on. In Greenspan’s view, Clinton deserved commendation if there was any justice in the crazy town of Washington.

    It had been a remarkable four months for Greenspan. His impact on the new Democratic president was real and positive — a degree of influence he had not begun to approach during the more than five years he had been chairman under Reagan and Bush.

    Within a week, long-term interest rates began to fall, and Clinton said in a speech, “Just yesterday, due to increased confidence in the plan in the bond market, long-term interest rates fell to a 16-year low.” The yield on the 30-year Treasury bond had dropped below 7 percent.

    Bentsen was delighted. He was all over Greenspan, peppering him with questions about the chairman’s forecast and projections for the bond market. The long bond rate was the new talisman in the Clinton administration.

    On May 18, 1993, Greenspan and the Federal Reserve Open Market Committee, the key-interest-rate-setting body at the Fed, voted to “lean” toward higher interest rates and gave the chairman the authority to raise rates by himself before the next meeting. The vote — due to be made public six weeks after the meeting — indicated that interest rate hikes were likely coming because the economy was overheating and high growth was almost certain to trigger a new round of inflation.

    Six days later, the Wall Street Journal scooped everyone with a story reporting that “Federal Reserve officials voted to lean toward higher short-term interest rates.” The New York Times wrote that the Clinton White House “would view such action as a declaration of war. And it would probably direct its heavy artillery at Mr. Greenspan.”

    Greenspan wanted to avoid war between the Fed and the White House at almost any cost. He spoke with David Gergen, a longtime communications adviser to Republican presidents Nixon and Reagan who had just joined the Clinton White House staff in the same capacity. Greenspan had been friends with Gergen for years, part of his Washington network. Gergen urged the chairman to give Clinton a pep talk. Polls showed Clinton’s approval rating at 36 percent, the lowest of any new president in his first four months. Greenspan needed to encourage Clinton to continue to push his deficit-reduction plan.

    On Wednesday, June 9, Greenspan went to the White House to see the president. The chairman was upbeat. The new consumer price index due out the next day was expected to show an increase of only 0.1 percent, suggesting inflation was in check, he said. They could feel some relief. The long-term economic outlook was the best and most balanced in 40 years, he told the president. He confirmed the authority his committee had given him to raise rates.

    “If I have to do something, it will be very mild,” he assured Clinton. A small increase would signal to the markets that the Fed was on top of the situation, and it was likely that the long-term rates would come down.

    Several Democratic senators suggested publicly that Clinton drop his five-year deficit target. This was precisely the wrong message, Greenspan felt, and on July 20 he testified before the House Banking Committee with unusual directness, “If you appear to be backing off, I think the markets would react appropriately negatively.”

    Clinton’s hands were effectively tied. He stuck with his deficit-reduction plan, though Bentsen had to bat down an effort from populist advisers to trim it some more.

    In August, Clinton’s deficit-reduction plan passed Congress by the narrowest possible margins, 218 to 216 in the House, and 51 to 50 in the Senate, with Vice President Gore breaking the tie. Not a single Republican had voted for the plan, which cut $ 500 billion from the deficit over the next four years by increasing taxes and cutting some federal spending. The only real Republican support had come from Alan Greenspan.

    For years there had been discussions in the media and elsewhere of the possibility that the Fed could execute a so-called soft landing. That meant the Fed would take preemptive action to increase interest rates months before actual inflation showed up. This could take the top off any coming boom, moderate and stabilize the economy and prevent inflation — and a recession.

    Greenspan followed the discussion of this theory scrupulously. There was no doubt that raising or lowering interest rates worked with a lag, having an impact on the economy as much as a year or more later. Greenspan thought there was persuasive evidence that the Fed needed to be ahead of the game. Rates would have to be increased in anticipation of actual inflation. But when? And by how much?

    Earlier efforts at a soft landing had failed, including the Fed’s effort in 1988. Still, Greenspan was willing to give it a try. If the soft landing succeeded, he could see no downside for the economy. But if they failed, they might hamper or even strangle the economic recovery. Because it was untested and because it was not a concept rooted in economic theory, Greenspan recognized that it was very risky. To him, it was like saying, Let’s jump out of this 60-story building and land on our feet.

    Some signs of a major expansion in the economy became apparent to Greenspan by early 1994. Lower interest rates had helped the banks make money and save themselves from collapse. Credit was easing and businesses could get loans. The system had been “liquefied,” as he liked to say. High inflation could not be detected, but he suspected it was around the corner. He was almost sure.

    On January 21, 1994, Greenspan went to the White House to meet with President Clinton and his economic advisers to warn them that rate increases were likely. “We’ve got a dilemma, and you should understand,” the chairman said. “We haven’t made a decision, but the choices are, we sit and wait and then likely we’ll have to raise short-term interest rates more. Or we could take some small increases now.”

    “Obviously,” the president said, “I want to keep interest rates low, but I understand what you may have to do.”

    Bentsen saw that the president was reluctant. Clinton was swallowing about as hard as he could.

    “We’ve been flat so long,” Greenspan said, referring to some 15 months of a 3 percent short-term interest rate. “We almost have to show that we can do something, that we’re willing to move.”

    “Wait a minute!” Vice President Gore interjected. “What about the possibility that you introduce uncertainty?” Historically, the Fed moved in a series of stair-step increases. Gore noted that in 1988-89 the Fed’s short-term rate increases had gone from about 6.5 percent up to nearly 10 percent in a dozen small moves. With that expectation in the market, long-term rates could be driven back up.

    It was an interesting point, Greenspan said, but the long rates were high because of the inflation expectation, which the administration was addressing with its deficit-reduction plan. Even if long rates went up initially, he did not think they would stay up.

    Clinton and his advisers now had to face what potentially could be a profound change in their relations with Greenspan. Politics was often a matter of choosing sides. Which side was Greenspan on?

    For that matter, it was difficult to determine exactly which side Clinton was on. The president’s economic policies were difficult to label. He tended to talk liberal, especially as he pushed for his wife’s health care reform, which would extend universal health care insurance to more than 40 million Americans. But his actions so far had been a blend.

    The term Clinton liked was “New Democrat,” meaning someone who was pro-business but also concerned with the middle class and the poor. But his policies also included the more visible deficit-reduction, bond market, free-trade Eisenhower Republicanism that was more in tune with Greenspan than Clinton wanted to acknowledge.

    The blend was embodied in Robert E. Rubin, the former head of Goldman, Sachs & Co., the premier New York City investment banking firm, who was director of the White House National Economic Council, the administration’s coordinator of economic policy.

    Rubin had built a strong relationship with Clinton, and he reinforced Greenspan’s and Bentsen’s arguments that the first order of economic business had to be deficit reduction. Now, with interest rate hikes coming, Rubin urged Clinton to hold off on any public criticism of the Fed. Criticism simply would not be effective. The Fed considered itself almost religiously independent, and any effort to influence it would be counterproductive.

    Bentsen argued in turn to the president that it was better for the Fed to move now, in 1994. Given the one-year lag in the impact, any economic slowdown would occur in 1995, with a pickup in 1996. If the Fed waited and raised rates in 1995, the slowdown would be in . . . Before Bentsen could get “1996” out of his mouth, the president had grasped the point.

    Greenspan himself was certain that if they did not raise rates, history and experience dictated that at some point in 1995-96 there would be a recession. That Clinton would be running for reelection in 1996 obviously made it easier for Greenspan to sell an attempted soft landing. He would be taking economic growth from 1994 — lopping off the top of an expected boom of excessive growth — and saving it for 1995 and 1996. That is, if it worked.

    Making it work had a lot to do with timing, which in turn had to do with economic forecasting, an imprecise science that did not approach the mathematical certainty Greenspan loved. There was no alternative to forecasting. It wasn’t guessing or fortune-telling, but the forecasters, including himself, were going to be wrong some of the time.

    On February 4, 1994, the Fed’s key interest-rate-setting committee voted to raise rates by a quarter percent. It was the first rate increase in five years, and for the first time in history the Fed publicly announced the increase. That day, the Dow Jones industrial average dropped nearly 100 points, to 3871, the largest single-day loss in two years. Over the next four months, the Fed raised rates another full 1 percent.

    At the White House, the president was increasingly restless. Was this necessary? Was Greenspan going too far? Did he know what he was doing?

    Rubin and Bentsen insisted everything was okay.

    Clinton grew angrier and angrier. When he blew up about rising interest rates, as he frequently did, the members of his economic team let him blow off steam and then urged him to continue to confine his distress to the privacy of the Oval Office. Any reasonable Fed was going to have to pull the foot off the accelerator, they told him. The low short-term interest rate, the so-called fed funds rate, had been pumping up the economy, so interest rates were going to have to go up to cool things off. All the economic models built on years of history showed there was a limit to how high growth could go without triggering inflation. To complicate matters, the economists believed — and recent American economic history showed — that there was a level of so-called full employment. If unemployment dipped much below 6 percent, the pressure for wage increases would trigger inflation.

    The president was skeptical and even outraged. So the problems were too much economic growth and too many people working! It was ridiculous, he seethed.

    Once, when Greenspan had an appointment to see the president, Clinton and his economic team were assembled in the Oval Office. As they waited for Greenspan to arrive, the president had launched into a comedic imitation of the chairman. Speaking in a gloomy, deep voice, he mimicked Greenspan drumming on inflation. Inflation! Inflation was all-important. Inflation was the center of the universe. Inflation! Inflation! It was a pretty good caricature, and his advisers were in stitches. One checked nervously to make sure the soundproof Oval Office doors were shut tight so the chairman wouldn’t hear.

    Now there were no jokes coming out of the Oval Office about Greenspan.

    Worse, the bond market had gone to hell. The long-term rates were shooting up, nullifying the gains from the 1993 deficit-reduction plan. Where was the payoff? the president wanted to know.

    The Fed continued to raise rates into February 1995, taking the Fed’s key interest rate from 3 percent up to 6 percent in less than a year. By the summer of 1995, the economy showed clear signs of slowing. Growth was hovering at an anemic 2 percent.

    On Sunday, June 11, White House Chief of Staff Leon Panetta was on “Meet the Press” and was asked if the Fed should reduce interest rates. “Well,” Panetta said, “it would be nice to get whatever kind of cooperation we can get to get this economy going.”

    Asked if he was jawboning the Fed to get rates lower, Panetta replied with his overeager grin, “Is that what it’s called?”

    Bob Rubin, who had moved from the White House to become treasury secretary in early 1995, was furious. The administration had been so disciplined, avoiding any public or even private effort to pressure Greenspan. The soft landing would occur because the administration and Greenspan didn’t let the economy get out of control. It wasn’t science, Rubin knew, but he believed Greenspan was making a series of highly informed judgments — the best they had. White House pressure to cut rates could actually prevent a rate cut.

    Rubin immediately went public with a rebuke for Panetta and an assurance, almost an apology, to Greenspan. Of Panetta, Rubin said in a public statement, “I can assure you that his comments were not intended to signal any shift. Our policy with regard to the Federal Reserve has been consistent from the beginning of the administration — and that is not to comment.”

    President Clinton seemed to agree with Rubin. It appeared that Panetta was briefly put in the doghouse — an unusual place for the White House chief of staff, who was supposed to be managing the executive branch on behalf of the president. Rubin and others knew that a side of Clinton agreed with Panetta, but in terms of politics and public perception, Clinton’s relationship with Greenspan and the Fed were more important than his relationship with his chief of staff.

    Greenspan took Panetta’s comments as a cheap and ineffective hit. Rubin had it right, not because of their growing friendship but because Rubin saw it was in the president’s self-interest to avoid political meddling with the Fed. What was interesting, Greenspan realized, was that his relations with the administration were so good that the White House was more concerned about the perception of Panetta’s comments than Greenspan was himself.

    Now Greenspan had a chance to practice some of his fine-tuning. Having doubled short-term interest rates from 3 to 6 percent during 1994 and early 1995, he realized that he might have slightly overshot. To bring the economy in for the soft landing now required a slight easing. On Thursday, July 6, 1995, Greenspan proposed a rate cut of a quarter percent. It was the first decrease in nearly three years and the first rate cut during the Clinton administration.

    The chairman had been telling himself that he should not expect reappointment to another four-year term. After all, he had been appointed to the job twice by Republican presidents — Reagan in 1987 and Bush in 1991. A Democratic president would want to choose his own chairman. If Greenspan were president, he would want to choose his own person. It wasn’t plausible that Greenspan was going to get another chance.

    By November 1995, no one at the White House had brought up his reappointment in their frequent conversations with him. And, of course, Greenspan had not brought it up. His term was due to expire in five months.

    In the meantime, as he had from the start, the chairman worked the Washington network — parties, private lunches and dinners, tennis matches, a steady stream of private, off-the-record gossip, chat and court intrigue. When the subject of his future came up, Greenspan would adopt a stance of studied nonchalance. He would have had eight good years. If Clinton reappointed him, he would accept. If not, that, too, would be okay. He worked at showing neither anxiety nor pain. He wanted that to be clear. He shrugged. He smiled. But the message was clear: He was available.

    By the end of 1995, Greenspan had the economy right where he wanted it. Inflation was low, at less than 3 percent for the year. Unemployment was also low, steady in the 51/2-percent range, with the addition of 1.8 million jobs for the year. After 31/2-percent growth the previous year, the annual growth was down in the range of 11/2 percent. There had been no recession. Greenspan had delivered. The economic analysis he had given Clinton in December 1992 was turning out to be correct. The payoffs he had anticipated were evident. By keeping inflation low and cutting the federal deficit, the intermediate- and long-term interest rates — the key rates for businesses, home buyers and consumers — were 2 to 21/2 percent below their levels at the beginning of 1995. Bond prices, which move the opposite direction as interest rates, were up substantially, and the stock market was up about 35 percent with the Dow at 5117 — its best year in two decades.

    He was available.

    Rubin never considered it a real question. Reappointing Greenspan was a no-brainer. Rubin and Greenspan both attended a weekend meeting of the Group of Seven major economic powers in Paris in January 1996, and the two had a chance to speak privately. Taking advantage of a quiet moment, they walked together toward a series of large plate glass windows at one end of the room, with a view of Paris before them. The two men had established a feeling of trust. For Greenspan, such friendship, closeness and agreement gave him a sense that they were working for the same firm. Greenspan had once remarked privately, and only half-jokingly, that he considered Rubin the best Republican treasury secretary ever, though he was a Democrat.

    “When you get back,” Rubin said, “the president’s going to want to talk to you.”

    Greenspan could tell by the body language that it was all favorable.

    “The president’s quite pleased with what you’ve been doing,” Rubin said.

    The implausible had become plausible. Greenspan realized it was the soft landing that made his reappointment possible. He knew he had helped hand Clinton what the chairman called “a pro-incumbent type economy.” Most important, there had been no recession.

    Clinton understood the power of the economy in a presidential election. The 1990-91 recession — and the economic doldrums and pessimism of 1992 — had been the foundation of his first presidential campaign. The campaign’s memorable slogan, “It’s the Economy, Stupid,” devised by political strategist James Carville, contained a pledge that Clinton would be engaged and in touch with the forces that affected people’s daily lives. The last three presidents to lose — Ford, Carter and Bush — had failed in part because they had been perceived to have mismanaged the economy.

    On February 22, 1996, Clinton announced that he was reappointing Greenspan to a third term. “He brings his years of experience as a prominent economist,” Clinton said, “and, I might add, a leading Republican.”

    Clinton went on to win reelection, partly due to the sound economy. For the next two years, Greenspan resisted sustained pressure from within and outside the Fed to raise rates, increasing them only once, in March 1997, and only by a quarter percent.

    On Tuesday, May 5, 1998, Greenspan went to the Oval Office to see the president. It was the fourth month of Whitewater independent counsel Kenneth Starr’s investigation of Clinton’s relationship with former White House intern Monica Lewinsky. There was a sense that investigators were closing in.

    Greenspan had not visited the president formally for 16 months, and Clinton’s economic team wanted Clinton to bask a little in the positive domestic economic news. In any case, an hour with Greenspan was always educational and worthwhile, and on this occasion it would be a momentary diversion from the president’s mounting personal and legal troubles.

    “This is the best economy I’ve ever seen in 50 years of studying it every day,” Greenspan told Clinton. There had been a boom in productive capital. Money that businesses were spending was yielding an extraordinary return because of increased worker productivity. The computer and high technology investments were paying off. And those payoffs had to be real, because the higher profits and economic growth had continued for several years now.

    Greenspan said that the stock market was very high by historical standards, but it could stay high. Despite his statements about “irrational exuberance” 18 months earlier, the chairman said, it was basically an illusion to think that the Fed could tinker with the stock market.

    In June 1999 Greenspan passed word to Rubin that a rate increase would soon be necessary because the economy was overheating. Rubin had no real problem.

    The president was not as confident. Did this have to happen? Clinton asked his economic team. I don’t see any signs of inflation, he added, asking the same questions he had posed in 1994 when Greenspan was raising rates. Was this another preemptive stranglehold on the economy? he asked, echoing some liberal Democratic senators who had been his most vocal defenders during his impeachment trial, in which he had been acquitted.

    The president’s advisers defended Greenspan’s decision. Mr. President, said National Economic Council Director Gene Sperling, he is just putting his foot on the brake a little. This is good. It will keep the expansion going longer. The risk of inflation with unemployment at 4.2 percent was too great.

    Frankly, the president’s advisers explained, Greenspan was on the softer side of the Fed’s key interest rate committee, a little to the left even of the people that the president had appointed. Clinton’s private objections were muted, not as intense or as deep as they had been in 1994.

    “I bet he’ll stay there until they carry him out,” President Clinton joked to his economic advisers at the end of 1999, as they discussed a fourth term for Greenspan. Larry Summers, who had taken over as treasury secretary from Rubin that summer, recommended reappointing the Fed chairman. He and Sperling had already sounded Rubin out as a courtesy, to see if he wanted the Fed job. But Rubin had declined, saying, “Alan’s perfect for this.”

    White House Chief of Staff John Podesta got permission from Clinton to call Greenspan and offer the reappointment on behalf of the president. Greenspan accepted.

    At 73, the chairman found that his mind still functioned well. He figured he would know he was losing it when he started to have difficulty with mathematical relationships, and he was aware of no diminution of that mental capacity. He was fully engaged. His only problem was that occasionally he couldn’t remember people’s names.

    The White House set early January 2000 for the announcement, wanting to make the timing a surprise before Congress returned from recess. That way, Clinton could give his annual State of the Union address later in January and fully embrace the good economy and Greenspan, leaving no doubt about the chairman’s future role. In February, the American economy would officially have enjoyed the longest economic expansion in its history. The White House wanted the Clinton-Greenspan team to be part of the celebration.

    Greenspan arrived at the executive mansion on January 4. Clinton, Summers, Sperling and Council of Economic Advisers Chairman Martin N. Baily gathered around the dining room table next to the Oval Office with Greenspan. Podesta sat in a chair off to the side.

    Clinton and Greenspan were almost glowing at each other, odd partners sitting there around the polished wood table, linked surprisingly to each other’s greatest successes, wrapping themselves in each other’s legacy.

    “You know,” the president said, addressing Greenspan to his immediate left, “I have to congratulate you. You’ve done a great job in a period when there was no rule book to look to.”

    “Mr. President,” Greenspan replied, “I couldn’t have done it without what you did on deficit reduction. If you had not turned the fiscal situation around, we couldn’t have had the kind of monetary policy we’ve had.”

    “After doing so well,” Clinton said, “no one would blame you for wanting to go out now on top.”

    “Oh, no,” Greenspan said, “this is the greatest job in the world. It’s like eating peanuts. You keep doing it, keep doing it, and you never get tired.”

    Clinton folded his arms, tightened his body over his crossed legs and glanced over as if to say, I know what you mean. He seemed wistful.

    The irony was palpable. Greenspan, at 73, had already served 12 years and would get to be chairman for another four years. Clinton, 53, had served seven years as president, and had only another year. The Constitution barred him from seeking a third term. The younger man would have to leave office and re-create himself, while the man 20 years older would go on.

    Who would have thought, seven years before at their first meeting in Little Rock, that such economic conditions were even possible — steady growth, low inflation, unemployment hovering at an unheard-of 4 percent and the Dow above 11,000. More than 20 million new jobs had been created since Clinton took office. Some economists would have put the odds of that at 1 in a million. Greenspan, ever a stickler about probability, couldn’t even calculate it.

    Of all the important people in Clinton’s life, nearly all — including himself — had let him down, or not lived up to their full promise. Hillary had failed to deliver on health care, although she had stood by him during the Lewinsky scandal. Vice President Gore, though loyal, had not yet emerged as a vibrant successor. Dick Morris, the chief political strategist for the successful 1996 reelection campaign, had been forced out in a scandal and then turned on Clinton and written an informative-but-tattletale book. George Stephanopoulos, Clinton’s young and trusted adviser, had also written a book full of inside stories of anguished decision-making and private fury. Democratic leaders in the Senate and House had come and gone. Staff had come and gone. Rubin, the shinning light of the Cabinet, was gone. Clinton’s vaunted campaign fundraisers had brought scandal and doubt on the presidency. Clinton himself had not lived up to his own grand governing vision.

    Greenspan alone had stood and improved his ground.

    In the Oval Office, Clinton announced Greenspan’s reappointment to a fourth term. He would serve as Fed chairman until 2004. The two men showered each other with praise. Clinton said Greenspan’s willingness to stay in the job should be “a cause of celebration in this country and around the world.”

    Greenspan, in turn, gave Clinton the highest endorsement a Republican Fed chairman could offer a Democratic president. “And I must say you have been a good friend to America’s central bank. Thank you, sir.”

  22. Gravatar of ssumner ssumner
    4. June 2012 at 08:51

    Morgan, The EU seems to work fine for countries like Britain and Sweden. So why are fixed rates needed?

    If Greece suddenly becomes a success, why would you attribute that to the euro? Even w/o the euro they would have hit a wall, and had to reform.

    Mark, What’s the unemployment rate in Holland–small country GDP numbers can be misleading.

    Marcus, I agree that US inflation was a big problem, but not the only one. Britain devalued in 1967. It was also the one size fits all problem.

    Neal, You said;

    “I guess the fixed exchange rates 1880-1914 were horrible, too?”

    A 2% inflation target with fiat money would have been much better–a way to avoid the depression of the 1890s. But I agree with your broader point, the evil of fixed rates is highly correlated with the degree of wage stickiness.

    You are right about Nixon.

    Steve, I’m suddenly optimistic about Spain.

    JimP, I’m blocked–any interesting quotes?

    dwb, So she’s fine with elevated inflation when we are booming, and 1% inflation forecasts when we are in a slump?

    Mark, Yup, he’s not a strong leader. In some ways that’s good–it’s more democratic. It just so happens that right now his views are probably better than the median voter.

    JimP, Great Lincoln story.

  23. Gravatar of ssumner ssumner
    4. June 2012 at 08:53

    Josiah, Thatcher’s a very persuasive woman. 🙂

    Morgan, A link would suffice.

  24. Gravatar of Mike Sax Mike Sax
    4. June 2012 at 08:56

    Morgan until I realized this was a piece I thought you were picking up the slack for Major Freedom who hasn’t been around a few days-cross our fingers.

  25. Gravatar of Steve Steve
    4. June 2012 at 08:57

    @ Mark, JimP

    That’s an incredibly interesting observation. Post-worthy. I’ve sat in large committees before; the people who speak first always anchor the discussion. There are well known social psychology experiments demonstrating this. Also, people are reluctant to express unconventional views in committees, due to professional reputation concerns. Contrarian or unconventional views need to be vetted *before* so that the speaker won’t be worried about appearing a fool.

    Bernanke’s meeting style alone exposes the Fed to a structural bias toward inflation fighting. That’s because inflation fighting is always superficially respectable for a central banker. Worrying about a crisis, worrying about deflation, worrying that old economic models are broken? That’s too unconventional to be spoken with conviction.

    As for Pianalto, she might not be the greatest monetary economist. But she sounds like someone open-minded, which is a rare virtue among regional Fed presidents.

  26. Gravatar of Steve Steve
    4. June 2012 at 09:01

    Scott, read my @Mark, JimP on behavioral dynamics of large committees. If you really want democratic, you need to take an anonymous straw poll, with good polling questions. Otherwise ordering and reputational caution take over.

  27. Gravatar of Saturos Saturos
    4. June 2012 at 09:01

    I’ve never really understood open-economy macro. Intuitively, I would like to reason about the world as a closed economy, and treat it the same way as other large diverse regions treated by economists as closed economies, like the United States. If it is economically efficient for the US to have a single currency, if it’s understood that it would be absurd for Illinois exporters to have to hedge against the foreign exchange risk of the Illinois dollar, then why can’t the same logic apply to Europe as well? (We reason about free trade in this way.) Why aren’t we petrified about an outflow of dollars and spending from California to New York causing a recession in the West and a boom in the East? Their economies are fairly different. Yes, I know, in America you all speak the same language and watch the same TV shows, but that can’t be the whole story. To me it’s just intuitively appealing for the efficiency gains from integrating international economies to go hand in hand with a common currency, and I suspect for many others too. But I’ll take the wisdom of people like Thatcher and Friedman, and you, and agree that the Euro was a bad idea (though I’m interested in how many of you actually took financial positions against it, if you’re all so prescient).

  28. Gravatar of Liberal Roman Liberal Roman
    4. June 2012 at 09:02

    More depressing press releases:

    Larry Summers thinks QE is pointless because rates are already low. If the Fedborg has convinced Bernanke of this as well, we can all retreat to our doomsday bunkers.

  29. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 09:06

    “On January 7, just under two weeks before inaugural day, Clinton had sat down with his new economic team in his Little Rock living room for a budget tutorial. The meeting lasted six hours””long enough for Clinton to confront the contradictions in his own program. For all the president’s reputation as a “policy wonk,” his knowledge on the most pressing domestic matter confronting him was rudimentary. Most of the dozen people before him were not people Clinton knew well. They included Lloyd Bentsen, the seventy-one-year-old Texas senator Clinton had selected as Treasury secretary; Robert Rubin, who had made a fortune on Wall Street and was joining the Clinton team to coordinate economic policy at the White House; and Leon Panetta, the California congressman whom Clinton had tapped to be federal budget director. Panetta had been startled in his job interview to discover the gaps in Clinton’s understanding.

    The mood in the room that day was subdued, even academic, during much of the discussion. But this was broken when Clinton suddenly flushed with a rude epiphany: “You mean to tell me that the success of my program and my re-election hinges on the Federal Reserve and a bunch of fucking bond traders?”

    The president-elect’s outburst captured an essential truth that he had not yet seized upon. The consuming task of his presidency would be to stanch a flow of budgetary red ink that had grown to some $290 billion a year. And these daunting numbers were growing larger still. Just the day before, the outgoing Bush administration, in a cruel welcoming gift to Clinton, announced that the projected deficit for 1997″”the year by which Clinton had pledged to cut the deficit in half””was going to be nearly a third larger than earlier forecasts. Deficit reduction, as part of an appeal to common sacrifice, had been one note in Clinton’s campaign message, but far from the major key. The candidate came to life talking about other things: his proposal to cut middle-class taxes, or his plan to jolt the economy with a burst of public works spending in the name of fiscal stimulus. Dearest to his heart was some $60 billion annually in education, child care subsidies, and other planned domestic programs that Clinton called his “investments”””so named because Clinton believed they were not mere spending, but catalysts for future prosperity. During the campaign it had been easy to be for it all. Now Clinton was learning that he had scarcely any choices. Lowering long-term interest rates was the key to priming the anemic economy for new growth, Clinton’s tutors told him. But a president had no direct control over interest rates. They were controlled by two factors. One was the Federal Reserve, led by its mumbling, enigmatic chairman, Alan Greenspan. The other was the capital markets, the actions of which determined the long-term interest rates on the bonds the government sold to finance its debt. Interest rates would come down only if Greenspan and the markets concluded the new president was serious enough about raising taxes and cutting spending to bring the budget deficit to heel. Clinton’s future indeed hinged on the Federal Reserve and a bunch of bond traders.”


    I think it is imperative for you all to GRASP, the political history of Clinton’s inaugural sacrifices.

    Obama HATED DESPISED what Clinton had done.

    The opportunity arose in his mind to take the “crisis” and instead of being Clinton, he’d go for Sea Change.

    This was a CHOICE.

    You people sound foolish acting as if Ben or the Fed would not come at the President the same way that Greenspan did.

    They may not be as activist, but their identity was very similar.


    It is impossible to look back on 2009 and not think about what the Fed would have done if Obama made like Clinton.

    I don’t think you LIKE the gamesmanship, I think you WANT to believe the Fed has no private sector favoritism.

    But it matters not.

    What matters is that you all admit that Ben has a 2% inflation target.

    We call it around here the Bernanke Put.

    And the Bernanke Put says that if Obama made like Clinton, the MM crowd would have gotten far more favorable monetary policy.

    You cannot play idealists here.

    Your own logic says BLAME OBAMA FOR DOING STIMULUS. Blame him for not banking on the Bernanke Put and actually making govt. become far more productive, cutting regulations, and generally favoring public policy that tries to drop prices.

  30. Gravatar of Saturos Saturos
    4. June 2012 at 09:06

    Surely at some sufficiently small scale, markets do clear and prices do adjust to spending levels. But is California small enough whilst Portugal is too big? Or do we always have to rely on factor mobility in the face of rigid price levels?

  31. Gravatar of Saturos Saturos
    4. June 2012 at 09:07

    “Larry Summers thinks QE is pointless because rates are already low.”

    Scott keeps wondering why Obama didn’t make better appointments. There’s your answer.

  32. Gravatar of Steve Steve
    4. June 2012 at 09:13

    Scott, I meant to respond to the original post.

    It’s one of my favorites; every paragraph I was ready to add a comment, but then the next paragraph *was* my comment.

    I especially agreed with your comment about conservatives liking hard money and socialists disliking market feedback.

    I’ve commented before that the political economy of the Euro is a disaster. Not only does it create deadweight losses (German savings wasted), but it creates a perception of culpability on the part of those who fit in least well.

  33. Gravatar of Saturos Saturos
    4. June 2012 at 09:17

    And Scott, don’t you at least agree with one aspect of Cochrane’s analysis: whatever the faults of the Euro, surely the case for it is not made worse by mismanagement of government budgets?

    But as I said, I don’t understand open-economy macro.

  34. Gravatar of Mike Sax Mike Sax
    4. June 2012 at 09:18

    FEH, dwb, and Negation; from Morgan’s post:

    “Rubin urged Clinton to hold off on any public criticism of the Fed. Criticism simply would not be effective. The Fed considered itself almost religiously independent, and any effort to influence it would be counterproductive.”

    See this is why Obama doesn’t criticize the Fed-long precedent.

    Morgan thing is I liked to Clinton but I really hated what he did with welfare reform. He didn’t reform it but gutted it.

    Most of these people didn’t make it but simply added to the child poverty statistics.

    Obama tried to do a Grand Bargain as well. Boehner agreed to it as did Mitch McConnell.

    So don’t blame the President that there was no deficit deal-not that I personallly give a hoot about deficits.

    Eric Cantor and John Kyle killed it. You complain about people changing the subject acknowledge this point-there would have been a deal but the number 2 GOP men in both Houses pulled the rug out from the GOP leaders.

    For more on this see David Corn’s “Showdown: The Inside Story of How Obama Fought Back Against Boehner, Cantor and the Tea Party.”

    See last Summer Obama had wanted to “Do a Clinton.” What happened is he realized the GOP simply won’t give him one no matter what.

    Clinton did deficit reduction with his bill in 1993 that included the tax hike on the rich that the GOP is hell bent on never returning to.

    There were no GOP votes for deficit reduction it passed solely on a party line.

    I love how Clinton has become the darling of the GOP-I even saw a poll in 2010 that the majority of Republicans now like Hillary Clinton.

    Meanwhile when they were in the White House the GOP sicked Ken Starr on them and impeached Clinton for an affair. This was the era of bipartisanship Republicans now look back on to reproach Obama with.

  35. Gravatar of dwb dwb
    4. June 2012 at 09:26

    if you haven’t, read Joe Gangon’s Q&A (via MoneyBox), i think its informative.

    if you think that a change in administration will change fed policy, i think its good to remember that there are real-world constraints on the Fed, and the Fed guards its independence fiercely.

  36. Gravatar of Saturos Saturos
    4. June 2012 at 09:28

    Looks like the FOMC thinks exactly like Kimball.

  37. Gravatar of dwb dwb
    4. June 2012 at 09:30

    this part is particularly interesting:

    I think it reflects ill-defined concerns about the costs of taking more action to reduce unemployment faster. Some Wall Street economists fear that more aggressive Fed action now will give rise to more inflation in the future, but no Fed economist I know agrees with that. The Fed knows how to fight inflation and there is no reason that policy actions now need to cause excess inflation later.

    also, SW is starting to sound a bit like a market monetarist:

    Market participants are forward-looking, of course. You can get an effect on market prices from the QE announcement because it changes market participants views, either on the future course of the interest rate on reserves, or the future date at which the Fed reverts to channel-system monetary policy. The fact that market prices move on the announcement doesn’t tell you that the actual asset purchase is doing the work.

    shhhhh. keep that one to yourself.

  38. Gravatar of Saturos Saturos
    4. June 2012 at 09:37

    But here’s a prime example of the wrong view:

    “Among those actions, I would tend to favor those for which the Fed has direct tools, such as buying foreign exchange to push down the dollar, rather than trying to raise inflation expectations by verbal jawboning.”

    On the other hand he sounds like Scott here:
    “From the point of view of the United States, what matters is the consolidated government balance sheet (Fed + Treasury), and there is no way that QE can do anything but reduce our national debt burden. Any future losses by the Fed would be more than matched by gains to the Treasury.”

    and here:

    “The problem is that it has not achieved its objectives over the past three years and its own forecast shows it does not expect to achieve its objectives over the next three years. ”

    And here’s an interesting argument against level-targeting: “Some have argued for a price path target or a nominal GDP path target. In that case you do make up for past deviations in inflation. But I think it is difficult to explain to the public how the specific path is chosen. Why should the CPI be 105 in 2013, 107 in 2014, 109 in 2015, and so on indefinitely? People care about the inflation rate not, some arbitrary price level”

    But I think this is just confused: “And it means that after booms you must have deflation. Indeed, if one had started the path in the early 1990s, the late 1990s boom would have put us way above it. Then the Fed would have had to make the 2001 recession much more severe to get us back on the path. That would have been a tough sell politically.”

  39. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 09:49


    No Stimulus.
    No Obamacare.
    No trying to keep the state and local employees from being fired.
    Pipeline, sure!

    Laser focus on cutting spending, maybe SO MUCH SO, you even get a small tax bump, all the while the the fed stands by the printing press keeping you at 2% inflation.


    Look man, that is a Clinton / Bernanke Presidency

    You keep talking about what you LIKE, as if it matters.

    I’m describing to you what would have been Optimal Economic policy according to MM, the kind that lets Obama cruise to victory, and it generally entails NOT doing what Obama did.


    The questions FEH and SAX is: pretend I’m right, just pretend, is the economy in recovery and Obama winning again with ease WORTH DOING the above list???

    I’m trying to gauge where you come down without dancing.

  40. Gravatar of Saturos Saturos
    4. June 2012 at 09:52

    Scott, need some spare cash?

  41. Gravatar of Negation of Ideology Negation of Ideology
    4. June 2012 at 09:57

    Liberal Roman –

    More depressing press releases:

    The Fed is out of bullets? How is that possible?

    “Hembre said the Fed’s best course of action is to sit tight and wait for more data. ”

    “The best the market can hope for is that Bernanke and other Fed members will continue to talk about supporting the economy … but without pulling the trigger.” – Leslie Barbi

    Maybe we need an equivalent of the Whip Inflation Now (WIN) buttons! Can anyone think of a cool acronym?

  42. Gravatar of Major_Freedom Major_Freedom
    4. June 2012 at 10:02


    Fixed “aggregate spending” regimes, including all constant growth models, are also in the list of “worst economic policies.” The same philosophical, economic, and logic flaws that seem to support fixed exchange rate regimes, are the same flaws that underlie fixed aggregate spending regimes.

    It’s just that there isn’t much, if any, empirical data of NGDP targeting to show honest positivists that it doesn’t work. As always, Austrians have to be there to make a priori arguments about various proposals before they are put into effect by ignorant positivists. Austrians knew fixed exchange rate regimes would be a disaster, but positivist economists are superficial and had to convince governments to try it first, since a priori argumentation is allegedly invalid.

    So fast forward to 2012, and we have market monetarists who need to be educated by Austrians in why fixed aggregate spending won’t work. It should have been easy, since even market monetarists understand that it would be a bad idea if there was fixed aggregate spending money printing scheme at the individual firm level, and city level, and county level, and state level, but for obvious self-rescue reasons, they balk at the national level, or “optimal currency” level, and do a 180 and say a fixed aggregate spending money printing scheme is a good idea!

    They’re like Catholic priests who say child rape is bad, except at the whole Catholic Church level, where it becomes good.

    In fairness to the other side, Bretton Woods worked pretty well in the 1950s and 1960s.

    At what cost? Imbalances were building up on the basis of bank credit expansion, in addition to the unsustainability of printing money faster than the rate of gold discovery, which lead to the Fed defaulting on its international gold redemption commitments to other central banks. Austrians knew it would collapse.

    How can an inherently unsustainable monetary system be considered as something that worked out pretty well? By this logic, partying hard and drinking a lot for one night out “worked out pretty well”, that is until all the expected side-effects were experienced soon after.

    Bretton Woods worked better than post-1971 because central banks were more limited in their ability to inflate, which limited commercial banks from expanding credit. Pre-1913 classical gold standard worked out better than post-1913 (the top 4 worst slumps accompanying bank panics in US history occurred post 1913) because commercial banks were more limited in their ability to expand credit.

    The more discretion money printers have in printing money, the more these money printers try to sustain their control by attempting to eradicate corrections and brainwash people into believing that business cycles are their fault, rather than the fault of the money printers, the worse the outcomes will be.

  43. Gravatar of Mike Sproul Mike Sproul
    4. June 2012 at 10:06

    Scott: There must be something good about fixed exchange rates, or else private banks would not all fix the exchange rate of their checking account dollars into paper dollars. But they do leave themselves an escape in the form of suspension clauses that allow them, in case of insolvency, to suspend convertibility. The crises you mentioned happened because people didn’t use the escape valve.

  44. Gravatar of Joseph Ward Joseph Ward
    4. June 2012 at 10:15

    Big fan…

    Except for the recent Euro, central banks are not interested in Fixed Exchange Rates, except when they are attempting to solve local credibility issues. It is a way of re-establishing local (intrastate) trust in a currency after bad episodes.

    Chile is a perfect example of a country doing this after rampant problems with inflation. Chile is also a perfect example of how it can backfire. Chile chose an unusual time in the dollar when Fed Chair Volcker was attempting to shake off inflation by taking major contractionary movements. These movements by the Fed caused deflation and Chile just happened to peg right in the middle of that.

    The problem with fixed exchange rates is that you’re tying your economy to a currency whose Central Bank is not acting with your interests in mind and if they make policy decisions they may be very harmful to you.

  45. Gravatar of Major_Freedom Major_Freedom
    4. June 2012 at 10:19

    Propagation of Ideology:

    Suppose you were the creator of aggregate money supply, by being a lender of newly created money where I am your backstop in providing you with “base” money.

    Suppose you were convinced that prevailing and expected prices and profitability with the money currently in circulation has put a cap on your existing lending, and that only if profitability rises will you lend more, and thus increase the aggregate money supply and thus increase aggregate spending.

    Question: How can you as both lender AND creator of aggregate money supply, be convinced to lend more, if the only thing that changes is you getting more cash from me?

    Answer: It won’t convince you to lend more, not unless profitability rises on the basis of costs falling, not aggregate revenues rising. For aggregate revenues rise if you lend more, but that is the very thing you won’t do because of current profitability not justifying it.

    Therefore, the only way that credit expansion can be expected to rise, which is necessary for aggregate money supply to rise, which is necessary for aggregate spending to rise, is if costs fall in relation to aggregate revenues.

    The notion that the Fed can be out of bullets is true, if you understand that the Fed depends on the banks to expand credit to make the aggregate money supply rise and hence to make aggregate spending rise.

    Sumner stated that the Fed doesn’t have to send checks only to the banks. The Fed can send checks to non-banks who can simply spend without lending. While that is true in principle, it is not how things are actually done today. Today, the Fed sends checks to the primary dealer banks. Unless that changes, unless the Fed can get the aggregate money supply to rise by some means other than coaxing the banks to expand more credit, then it the case that the Fed can be out of bullets when nominal profitability is capped given the current supply of aggregate money created in the past.

    So when you see pundits on TV nodding and agreeing to the notion that the Fed can be in principle out of bullets, they aren’t completely wrong. You can’t blame them for not being able to read your minds, about the possibility of the Fed sending checks to institutions that don’t expand credit.

  46. Gravatar of Essayist-Lawyer Essayist-Lawyer
    4. June 2012 at 10:29

    Morgan, in case you haven’t read what you are quoting, the reason Clinton agreed to focus on deficit reduction was fear of high long-term rates ruining the economy.

    In case you haven’t been reading the paper, high long-term rates are (to put it mildly) not a problem right now.

    Also, in case you haven’t been following Ben Bernanke, he keeps urging Congress not to reduce the deficit.

    You remind me of the war hawks who keep saying that diplomacy failed in 1938 and let to WWII, so we must never use diplomacy again lest it cause WWIII.

  47. Gravatar of Essayist-Lawyer Essayist-Lawyer
    4. June 2012 at 10:42

    To our host:

    Since I assume this post was largely in response to me, I am honored. I am well aware that Milton Friedman was the biggest advocate of floating exchange rates, but let’s face facts. By today’s standards Friedman is only conservative on micro issues. On macro he’s a lefty, i.e., favors expansionary measures to fight economic downturns.

    I suppose as a liberal, I focused on conservatives because I understand pretty well why liberals might favor fixed exchange rates.
    Liberals don’t see government intervention in the economy as inherently wrong or immoral, only bad when it produces bad results.
    Floating exchange rates do jump around a lot, and cause a lot of inconvenience that most people would rather avoid.
    Trans-national currencies are a form of international cooperation. Liberals favor international cooperation, while conservatives are highly protective of national sovereignty. In the case of Europe, conservatives like Thatcher were clearly right.

    And, of course, most people, liberal or conservative, don’t understand monetary economics very well. But given the understanding that there is a tradeoff between fixing exchange rates and having a free hand to fight recessions, liberals will sacrifice fixed exchange rates every time. You certainly won’t find any liberals holding Latvia up as a model to be emulated.

    The other thing is that, whatever the history, the main voices I hear raised against letting exchange rates fall, and in favor of currency boards, currency pegs, and even the gold standard, all come from the right. Some of it I can put down to ignorance, like Ron Paul denouncing the Euro and then calling for a gold standard. But a lot of people who should know better, like, say, everyone at the Wallstreet Journal, seem to think keeping a high currency should be your top priority.

    PS: I should also add as a biographic note that (1) I consider myself a liberal; (2) my training in economics is limited to a few undergraduate courses in the early ’80’s and a lot of frantic self-education since the 2008 crisis; and (3) my self-education has convinced me an overvalued currency is every bit as bad a Milton Friedman says, and almost as bad as you say, taking account for hyperbole.

  48. Gravatar of Mike Sax Mike Sax
    4. June 2012 at 11:02

    Actually when you think of Mundell’s idea about the Unholy Trinity you realize why the euro is failing.

    According to his model you can’t have free capital movement, an independent monetary policy, and fixed exchange rate together.

  49. Gravatar of Negation of Ideology Negation of Ideology
    4. June 2012 at 12:01

    “While that is true in principle, it is not how things are actually done today.”

    Then change how things are done.

  50. Gravatar of Lars Christensen Lars Christensen
    4. June 2012 at 12:29

    Scott, excellent post.

    Milton Friedman of course has a excellent discussion about the importance of luck when it comes to fixed exchange rate regimes in “Monetary Mischief” where he discussion Israel successful fixed exchange rate regime (Israel of course later floated) and the disaster with the peg in Chile.

    In terms of luck it was mostly luck the Bretton Woods lasted so long, but eventually luck ran out. I am afraid the euro zone is now out of luck as well…

  51. Gravatar of Major_Freedom Major_Freedom
    4. June 2012 at 12:36


    Also, in case you haven’t been following Ben Bernanke, he keeps urging Congress not to reduce the deficit.

    Not quite. Bernanke has been urging caution in excessive deficit reduction. He isn’t again deficit reduction per se.

  52. Gravatar of Major_Freedom Major_Freedom
    4. June 2012 at 12:36


  53. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 12:41


    Dufus, I am not speaking about the excuse that Greenspan gave Clinton. The point was simply to get him to balance the budget and give up on spending. But remember, as soon as Clinton was gone, Greenspan told Congress to give a tax cut.

    I am also not suggesting that Ben will outright TELL Congress to spend less money (Greenspan would). But he will warn us off the “fiscal cliff.”

    This is fundamental to Scott’s position and the entire MM position.

    There is a Bernanke Put it is around 2%, and if YOU WANT QE, you can have it anytime we push towards deflation.

    Which leads to the very simple argument that had Obama not done $1T in stimulus, NO WORRIES Ben would have made sure we saw NO deflation from it.

    If Obama kept drilling in the Gulf like a madmen, cheered for racking, and approved as many pipelines as anyone asked for.

    Not only do commodity prices fall, but hey great! Ben will print more money to keep us on 2% inflation.

    Essayist, the point is ONCE YOU ADOPT the mindset of Market Monetarism, it isn’t just that fiscal is worthless, it is that

    The LEVER Obama has to get more monetary is to cause deflation on his spending side, since he can’t get tax increases he’s got only one thing left!

  54. Gravatar of Major_Freedom Major_Freedom
    4. June 2012 at 12:48

    Propagation of Ideology:

    “While that is true in principle, it is not how things are actually done today.”

    Then change how things are done.

    Market monetarists bite my head off every time I say that, and they tell me I should accept how things are done.

    Well, I will say to you:

    GIVEN how things ARE done, Sumner’s argument about the Fed allegedly not running out of ammo, is incorrect.

    Sure, if the way things are done can be changed, then I will say change it so that the Fed is abolished. If you can defend your claims by depending on things changing, then so can I.

  55. Gravatar of Jim Glass Jim Glass
    4. June 2012 at 12:52

    Next to North Korea’s 5 year plans, fixed exchange rates must be the worst economic policy ever devised by man

    Well, no. The North Korean five-year plans produce exactly what the Kim family and its tiny electorate of exploiters want. (See what North, Acemoglu, Bueno de Mesquita, have to say about that.)

    OTOH, a fixed exchange rate 9 times out of 10 results in abject failure in terms of the its creators say and believe they want.

    So in terms of failure, fixed exchange rates are much worse than North Korean five-year plans.

  56. Gravatar of Measure for Measure Measure for Measure
    4. June 2012 at 13:10

    Two arguments for a single currency, not mentioned in the blog post, but widely believed in the early 1990s:

    1. Tighter economic integration prevents another European war.

    2. Thirteen currencies (or whatever) in a small geographic area is unwieldy.

    I’m sympathetic to Sumner’s argument though. I’ve wondered about the viability of French/German/Benelux currency union, backed by a 1% VAT stabilization fund. Other countries would have a crawling peg against the main Euro. German/French integration would lower the odds of another big war. And arguably Benelux might have higher transnational job mobility, further addressing cyclic concerns.

    That said, the burden of proof should be on those advocating currency union. Any proposal should be subjected to rigorous analytic stress testing. It all looked so hopeful 20 years ago.

  57. Gravatar of Essayist-Lawyer Essayist-Lawyer
    4. June 2012 at 13:20

    Yes, Morgan, I get your point. The chairman of the Fed is our dictator who uses the threat of monetary contraction to impose his policy preferences. By an extraordinary coincidence, the Fed chairman’s policy preferences always match Morgan Warstler’s policy preferences, even if the chairman of the Fed expressly denies that his preferences are the same as Morgan Warstler’s preferences. Rebel against what Morgan Warstler wants, and the Fed will smack you down.

    You define this as Market Monetarism. Our host, by contrast, shares your views on the power of the Fed, but not on how that power is being used.

  58. Gravatar of Mike Sax Mike Sax
    4. June 2012 at 13:30

    Williamson is a fan of Miles.

  59. Gravatar of Mike Sax Mike Sax
    4. June 2012 at 13:31

    Basically what your saying Morgan is that Bernanke would just allow the house to burn down unless he gets GOP policies. That’s a pretty serious charge.

    If true then maybe he really is guilty of treason.

  60. Gravatar of Nick Rowe Nick Rowe
    4. June 2012 at 13:48

    Excellent post Scott.

  61. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. June 2012 at 14:15

    Scott wrote:
    “Mark, What’s the unemployment rate in Holland-small country GDP numbers can be misleading.”

    It’s 4.9%, up from 4.1% in June and 3.0% in November 2008, and it’s near the highest rate it’s attained since January 2006. Estimates of NAIRU usually put it at about 4%.

    So, I suppose things could be worse.

  62. Gravatar of ssumner ssumner
    4. June 2012 at 14:31

    Steve, Good observation.

    Saturos, I didn’t predict the euro would go down in flames. I thought it might actually work, and still think it might work for the northern tier (for reasons you indicated.) I did not know the PIGS were so messed up. I thought Britain was smart to stay out, but I thought it was a close call. Now I think it’s a no-brainer.

    Thanks Liberal Roman, I’ll use that in a new post.

    Saturos, Yes, I agree with Cochrane on fiscal issues.

    dwb, Thanks, I’ll take a look.

    And that SW quote is a good one.

    Saturos, I do need the money, but don’t have time for a long plan. My short plan is a one week bank holiday, with this:

    1. Every country must decide in or out during that week.
    2. No euro bonds.
    3. Germany gives in on monetary policy–agrees to a 4.5% eurozone NGDP target for 10 years, level targeting.
    4. ECB promises more LTRO.

    So it’s in or out. Normally a breakup where the PIIGS leave makes the euro too strong for France, and it then leaves, collapsing the entire euro. But the 4.5% NGDP target guarantees a weak enough euro so that France can make it, and even gives the PIIGS a fighting change if they are so inclined (although I think Greece needs to leave.) The plan is sprung on the world right after the Greek elections.

    One week to decide . . .

    Mike Sproul, You said;

    “Scott: There must be something good about fixed exchange rates, or else private banks would not all fix the exchange rate of their checking account dollars into paper dollars.”

    Fixed rates are great, as long as you aren’t tying down monetary policy. When banks fix rates they don’t do that, the Fed is still free to steer NGDP. But when a central bank fixes its currency to another, it has no way of preventing NGDP from falling in half, and causing mass unemployment. That actually happened in 1933. Central banks should never fix their medium of account to anything other than NGDP futures contracts.

    Joseph Ward, I agree.

    Easayist Lawyer, I don’t think you’ve really refuted my post. You told me about your impressions, but that’s coming for a very specific circumstance right now. Throughout history fixed exchange rates are not a right wing idea. And Friedman would certainly not be a lefty today, he’d be strongly opposed to fiscal stimulus. Nobody considers me a lefty.
    There were of course many other conservative economists who opposed fixed rates. The entire monetarist block was opposed, for instance. And the euro-left still supports the euro.

    Lars, Good points.

    Jim Glass, I suppose you are right.

    Measure, I agree.

    Thanks Nick.

  63. Gravatar of ssumner ssumner
    4. June 2012 at 14:32

    Mark, Interesting, but too small to be conclusive. Remember, data is more volatile in small countries.

  64. Gravatar of Negation of Ideology Negation of Ideology
    4. June 2012 at 14:59

    Major –

    “If you can defend your claims by depending on things changing, then so can I.”

    I have no problem with you advocating whatever changes you want. If someone criticized you for that, it wasn’t me. I may disagree with the changes you advocate, but that’s a different matter. Isn’t the whole point of this blog to change things? Are you under the impression that market monetarism means never change anything?

    In any case, I don’t speak for all market monetarists, only for myself. I’m for the following:

    1. A National Currency, issued by the government for public purposes including, but not limited to, paying taxes, gov’t spending, civil lawsuits, auctions of gov’t property, etc.

    2. No one should be required to accept that currency in trade except when they’ve contracted to do so. No one should be required to use it except when dealing with the gov’t.

    3. The Currency should be tied to as broad an index as possible within the country as possible, preferably GDP. Level targeting to make up for deviations from the path.

    4. All profits from issuing that currency should either go toward paying down the national debt, or if the debt is gone, then either a dividend to the states based on population, or a dividend to each citizen.

    5. No private corporation should have any say in whatever board issues the currency, it should only answer to the public.

    I think it is obvious to any thinking non-ideologue – right, left or center – that this is the fairest way for a nation to handle the money question. No one is favored over anyone else. Commodity producers are treated exactly the same as factory workers or service workers. Creditors are treated exactly the same as debtors. Bankers are treated exactly the same as doctors. And the rich are treated exactly the same as the poor.

  65. Gravatar of Essayist-Lawyer Essayist-Lawyer
    4. June 2012 at 15:09


    What do you mean no one considers you a lefty? You clearly belong to team supply rather than team demand. That disqualifies you from team Chicago. You favor countering the downturn with expansionary policy. That disqualifies you from team liquidationism. You think our inflation has been too low. That definitely disqualifies you from team price stability. You are unwilling to wreck the economy for partisan gain. That disqualifies you from team Republican.

    There is no room left for you on the right. (Or Friedman either). Welcome to your new home by default.

  66. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 15:27


    1. it isn’t MM. Soctt’s thing is even WORSE for you.

    2. it isn’t nefarious (as I keep saying), I just say it the nefarious way so you understand it. The Fed = bankers = concerned with the people who have money.

    My point is that is DUMB to not come to terms with reality before you form policy.

    If you assume the Fed PREFERS the private sector, you have a better shot at trying to move them.

    Look, conservatives can instantly bring pressure to the Fed on either side of the debate, depending on who is in office, this occurs because the Fed instinctively is biased at lizard brain level to think like conservatives.

    It is funny, progressives are so very good at understanding the deep cultural biases that that right has about subject A, B, C.

    But when I say, “yeah the fed is like that too,” you get super bitchy.

    Don’t be super bitchy Essay, think about what these facts mean and form your strategy accordingly.

  67. Gravatar of Mike Sax Mike Sax
    4. June 2012 at 15:39

    EL don’t you mean Scott’s for team demand rather than team supply? But the Right wing side comes in fiscal issues I think-Scott as he will tell you is a supply sider.

    What’s different is he doesn’t think supply side issues are the main drivers of the recession. He thinks structural reforms are a good thing-but then he always thinks they’re a good thing.

    What’s different is that he admits that rather than the conservatives who try to pretend that this is being driven by the need for structural reforms and they’ve never been so urgent as they are now. In reality they always want strcutural reforms-like Scott, but he admits that and doesn’t claim they’re super important right now.

    So how did I do Scott in cataloging your views?

  68. Gravatar of Mike Sproul Mike Sproul
    4. June 2012 at 18:07


    As usual, we’re seeing things from very different angles. I think the main problem with fixed exchange rates is that if banks somehow become insolvent, then they are unable to buy back all the money they have issued at par. If banks could suspend convertibility this wouldn’t be a huge problem. The money would just lose 10% or so of its value, banks would issue 10% more money to ease the resulting tight money condition, and things return to normal, except for the 10% haircut suffered by the bank or its customers.

    But if fixed exchange rates mean that banks cannot suspend, then we have a run, the money supply collapses, and the resulting (extremely) tight money condition leads to recession, since people deprived of a medium of exchange are forced to resort to barter.

    You seem to think a fixed exchange rate can cause a disaster even if banks remain solvent. I don’t see how. It looks to me like the money/banking system would be self-correcting in that case.

  69. Gravatar of Greg Ransom Greg Ransom
    4. June 2012 at 18:16

    Doesn’t China have the Renminbi pegged to the dollar?

    And therefore disaster must have happened already — or next week — right?

  70. Gravatar of Rien Huizer Rien Huizer
    5. June 2012 at 01:55


    You seem to believe that what is happening in Greece is worse with the EUR than with an independent currency. But with the potential for both seignorage (no doubt Greece gvts would like to fleece the few people holding wealth in the local currency first) and devaluing your way out, would the median Greek voter be able to consume a more valuable basket of goods and services, given the abysmal supply side of its economy.

    Of course Greece would not have had this completely improductive import of debt capital mediated through the state (istead of equity capital through the private sector that might have boosted productivity). But that stock of debt is basically worthless and unlikely to be services (even the remains after the first round of restructuring is unlikely to be serviced). If we look at a Greece with a public sector shrunken enough so that there is no longer a primary deficit and nominal wage levels comparable to the early 1990s, Greece may actually be able to survive within the EUR zone further assuming an outflow of all illegal immigrants plus an outflow of the mobile segment of the population. If we add to that a banking system outside the control of local politicians and taxes collection by an international contractor (like happened in Taiwan in the 1980s for a while), within one or two generations, Greece will be a poor, but self respecting member of the EU and as a good destination for specialist private sector FDI. All within the tarriff and exchange control walls of the EUR zone..

    What could the UK be doing that would lead to different outcomes under its pathetic little currency?independent exchange rates?

  71. Gravatar of "Next to North Korea’s 5 year plans, fixed exchange rates must be the worst economic policy ever devised by man. But nonetheless it’s undoubtedly true that fixed exchange rates appeal to both sides of the political spectrum. Why?" &l "Next to North Korea’s 5 year plans, fixed exchange rates must be the worst economic policy ever devised by man. But nonetheless it’s undoubtedly true that fixed exchange rates appeal to both sides of the political spectrum. Why?" &l
    5. June 2012 at 05:01

    […] Source […]

  72. Gravatar of ssumner ssumner
    5. June 2012 at 12:25

    Essayist, You may consider me a lefty, but no one else does. Krugman refers to me as conservative.

    Mike Sproul, You said;

    “But if fixed exchange rates mean that banks cannot suspend, then we have a run, the money supply collapses, and the resulting (extremely) tight money condition leads to recession, since people deprived of a medium of exchange are forced to resort to barter.”

    I strongly disagree. A bank crisis doesn’t reduce AD, only tight money does. It might cause some trouble for individual people, but as long as the Fed keeps NGDP growth on target, banking crises aren’t very important. That’s why monetary policy is much more important than banking policy.

    You said;

    “You seem to think a fixed exchange rate can cause a disaster even if banks remain solvent. I don’t see how. It looks to me like the money/banking system would be self-correcting in that case.”

    Very simple–it can causes deflation. Look at Canada in the early 1930s for a perfect example of a fixed exchange rate driving an economy into depression with no bank failures.

    Greg, You said;

    “Doesn’t China have the Renminbi pegged to the dollar?”

    Nope, it’s been appreciating, otherwise China would have the “disaster” of high inflation.

    Rien, The UK should target NGDP. When Greece had its own currency it could depreciate when necessary to prevent Great Depressions. They still had the occasion recession, and higher rates of inflation, but nothing like this massive depression. They are much worse off with fixed rates. Remember, it’s not a zero sum game, Greek output would be much higher under flexible rates, you can’t just look at who is helped and hurt by price level movements.

  73. Gravatar of Mike Sproul Mike Sproul
    5. June 2012 at 13:24

    “as long as the Fed keeps NGDP growth on target, banking crises aren’t very important. That’s why monetary policy is much more important than banking policy. ”

    You mean that if a run on private banks shrinks the supply of private money, the Fed can offset the resulting tight money condition by issuing more of its own money? We agree on that much. But I don’t see why you think fixed exchange rates are a problem even when the central bank is solvent and there is no bank run. Let’s say the real value of gold doubled, and the dollar remained pegged to it. There will of course be some wealth transfers, but people will have twice as much cash in real terms. Money won’t be tight, so no recession.

  74. Gravatar of anon anon
    5. June 2012 at 13:41

    “There will of course be some wealth transfers, but people will have twice as much cash in real terms.”

    Not in the short run, they won’t, because nominal prices do not adjust immediately. They will find themselves short of cash at prevailing prices, so they will hold onto it and expenditure will fall. This is really the hot-potato effect running in reverse, and you will find an account of it in any introductory to macro text.

  75. Gravatar of Mike Sproul Mike Sproul
    5. June 2012 at 15:20


    If gold is more valuable, and dollars are pegged to gold, then people have more cash in real terms, not less.

  76. Gravatar of ssumner ssumner
    6. June 2012 at 06:59

    Mike, Wages are sticky in nominal terms. That’s it. That’s my entire blog. That’s all I’ve been saying for 3 years.

    You may not agree, but it all boils down to “nominal shocks have real effects” in my view.

  77. Gravatar of MMJ MMJ
    6. June 2012 at 07:40

    Or perhaps the euro was a political rather than an economic project.

  78. Gravatar of Major_Freedom Major_Freedom
    7. June 2012 at 11:26

    You may not agree, but it all boils down to “nominal shocks have real effects” in my view.

    As always, you have it backwards. It is “real shocks” that have nominal effects. People don’t just capriciously reduce their spending for no reason. They do so when there is a change in the real economy.

    You’re treating money spending as a primary, when it is individual human action that is the primary. Individual human action in the division of labor requires economic coordination, and the unhampered, unadulterated price system is the best we have.

    Introducing inflation into this, introducing credit expansion into this, DISTORTS the ability of individual actors to coordinate their behaviors, as it pertains to the scarcity of resources, and the sustainability of investments. The reason why you see nominal “shocks” is because of “shocks” on the real side of the economy. And if those real “shocks” are caused by past nominal inflation and credit expansion, then more inflation and credit expansion cannot possibly be the solution.

    Wages are sticky? Relative to what? Instantaneous, non-information flow based, omniscient God-like entities who have the intellectual and physical wherewithal to adjust prices to every single change in millions of people’s ideas and preferences?

    Or are prices called sticky just so that you can find some justification in inflation, which by the way is also “sticky” because prices do not instantly adjust everywhere when a bank receives check from the Fed, or when a borrower receives credit from a bank?

    Inflation is therefore “sticky.”

  79. Gravatar of Skepticlawyer » Easy Guide to Monetary Policy Skepticlawyer » Easy Guide to Monetary Policy
    8. June 2012 at 22:06

    […] the central bank increases the money supply to compensate. (The history of fixed exchange rates has not been a notably happy one.) All members of the Eurozone have a fixed exchange rate relative to each other […]

  80. Gravatar of Skepticlawyer » Going for gold: perils of entering the goldzone Skepticlawyer » Going for gold: perils of entering the goldzone
    16. July 2012 at 17:59

    […] (Hayek also has an enthusiasm for fixed exchange rates I do not share; not only has a floating exchange rate been an excellent “shock absorber” for Australia, but the wider evidence is rather against them.) […]

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