What we can learn from the Trichet debacle
A few months ago I quoted Martin Wolf as follows:
In his latest press conference, Jean-Claude Trichet, outgoing president of the European Central Bank, pointed to the bank’s stellar counter-inflationary record, far better than the Bundesbank’s.
There are days when I think I must be living in some sort of alternative universe. In my universe the head of a brand new central bank would not be bragging about reducing inflation to levels “far better” than even the most hawkish country in the world, at the very moment his currency zone region was being wracked by the mother of all debt crises.
Thank God Trichet is finally gone. Now let’s see what we can learn from recent policy moves by the Bank of Japan and the ECB.
Start with the fact that both are ultra-conservative institutions. Then consider the following moves:
1. The BOJ tightens in 2000 by raising rates, despite no inflation. Soon after the economy turns down and the BOJ is forced into an embarrassing about face, rates are cut back to zero.
2. The BOJ tightens in 2006 by raising rates, despite no inflation. Soon after the economy turns down and the BOJ is forced into an embarrassing about face, rates are cut back to zero.
3. The ECB tightens policy by raising rates in mid-2008, just as a severe debt crisis is leading to a rush for liquidity, and threatening to plunge the world into recession. A few months later the economy turns down and the ECB is forced into an embarrassing about face, rates are cut sharply.
4. The ECB tightens policy by raising rates in mid-2011, just as a severe debt crisis is leading to a rush for liquidity, and threatening to plunge Europe into recession. Today the ECB was forced into another embarrassing about face, and cut rates by 1/4 point.
Remember, these are very conservative central banks. They are also institutions that hate admitting they were wrong. That means the actual about faces occurred long after it was obvious to everyone that they were needed.
You could argue that the Fed isn’t quite so pig-headed, and it’s true they haven’t raised rates once in the past 4 years. (Unless you count IOR.) But many of us complained loudly when they announced an intention to end QE2 when the economy was still very weak. Now there’s lots of speculation that QE3 is just around the corner.
The lesson here is that central banks need to use unconventional stimulus far more aggressively, until NGDP grows so fast that raising rates is the right thing to do.
There’s no one on the planet who wants higher interest rates than me. I am so thoroughly disgusted with living in Krugman’s “depression economics” world, where zero rates justify every cockamamie scheme from protectionism to building high speed trains to Orlando. But no matter how conservative the central bank, no matter if the FOMC was 12 Richard Fishers, or 12 Jean Claude Trichets, there’s only one way to get there: Easier money, indeed dramatically easier money. Any tight money shortcut will fail, just as they failed twice in Japan and now twice in Europe. Those are powerful lessons for inflation hawks–I hope they are paying attention.
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3. November 2011 at 06:56
Great post, Scott.
3. November 2011 at 07:15
The problem with NGDP targeting is that the Fed can boost NGDP only if it does fiscal policy, as MMT has been saying all along. It is just better, far more efficiently, done by the Treasury. The Fed will have a very limited success if it wants to limit itself to what is legal.
Assets swaps won’t boost NGDP, it is like believing that swapping savings accounts into checking accounts thoughout the country will boost NGDP.
3. November 2011 at 07:21
Thanks Joe2.
OhMy, I have many posts rebutting MMT.
3. November 2011 at 07:29
Scott, assume that on 11/11/11, you are appointed chairman/dictator of the Fed Board. Please tell me in detail how you’d implement your NGDP-targeting policy in the next 12 months. Please describe and justify in detail how you will set initially all policy instruments, and then explain how long you will wait to fine tune your policy instruments and on what bases you will do it. Please focus only on what you would do. Look forward to your reply.
3. November 2011 at 07:35
But Mario D did say, “”What makes you think that becoming the lender of last resort for governments is what you need to keep the euro region together?” Draghi told reporters in Frankfurt today. ” That is not really in the remit of the ECB. The remit of the ECB is maintaining price stability in the medium term.”
3. November 2011 at 07:35
“There’s no one on the planet who wants higher interest rates than me.”
Uhm, then why do you have such a hard time looking at the data from 1999 (or even 2005) and explaining what 5% level would have required in higher interest rates.
To conservatives, you don’t really sell your plan.
Not even a little bit.
3. November 2011 at 08:00
The lesson of this entire debacle seems to be a complete failure of technocracy or an inability to create an isolated technocratic environment. The former suggests just a straight fundamental misdiagnosis by technocrats. The latter suggests smart people like Bernanke are constrained by politics whether its Republicans writing letters, Bank Presidents pushing for low inflation to appease their bank appointees, etc. I am inclined to view the latter suggesting that a world where politics does not infect monetary policy is not possible within our given framework.
The question for me is how do we develop a better institution? Democratizing the Fed sounds terrifying. Rule-based monetary policy sounds like it suffers from the same commitment problems of “spend now, cut later.” Free banking makes sense but frankly I am new to the idea. My question is how would or by what mechanism could (will?) politics interfere in a free banking/NGDP futures market and would this reduce its efficacy as a first best option?
My assumption is politics will not leave monetary policy alone ever so intrusion into this market will occur. So does a politically constrained technocracy provide more clarity, certainty and better policy outcomes or would a politically regulated free banking/NGDP futures market do better? Or is it a wash? My gut is its a wash. We have the outcome our political system wants. If we change the playing field, the outcome will still be the same.
3. November 2011 at 08:00
The lesson of this entire debacle seems to be a complete failure of technocracy or an inability to create an isolated technocratic environment. The former suggests just a straight fundamental misdiagnosis by technocrats. The latter suggests smart people like Bernanke are constrained by politics whether its Republicans writing letters, Bank Presidents pushing for low inflation to appease their bank appointees, etc. I am inclined to view the latter suggesting that a world where politics does not infect monetary policy is not possible within our given framework.
The question for me is how do we develop a better institution? Democratizing the Fed sounds terrifying. Rule-based monetary policy sounds like it suffers from the same commitment problems of “spend now, cut later.” Free banking makes sense but frankly I am new to the idea. My question is how would or by what mechanism could (will?) politics interfere in a free banking/NGDP futures market and would this reduce its efficacy as a first best option?
My assumption is politics will not leave monetary policy alone ever so intrusion into this market will occur. So does a politically constrained technocracy provide more clarity, certainty and better policy outcomes or would a politically regulated free banking/NGDP futures market do better? Or is it a wash? My gut is its a wash. We have the outcome our political system wants. If we change the playing field, the outcome will still be the same.
3. November 2011 at 08:22
SSummner,
I know you have posts “rebutting MMT”, in each of the exchanges I saw they showed you that you don’t know how the mechanics of the monetary system work.
Please direct me to an an exchange that you won.
3. November 2011 at 08:37
“That means the actual about faces occurred long after it was obvious to everyone that they were needed.”
…or they occurred after the individuals responsible left office.
Note, the situation is partly complicated by an ideological war between the central banks and the fiscal regimes, and the inability of CBs to decide what they actually want. CBs desperately want reduced fiscal expenditures in most cases (they despise the notion of monetizing government debt). It seems they ONLY want more fiscal debt in situations where low fiscal expenditures is forcing the central bank to buy bonds, which is of course moronic, since that puts them at greater risk of monetizing debt. Largely, CB schizophrenia is driving fiscal insanity – citizens (and stock markets) rationally conclude that if the CB is going to crush them when they fiscally contract, then why bother? Better to go so far into debt that the CB is forced to monetize (unless you don’t have a CB, in which case you just default).
England seems the only sane one, but they have a huge hole to dig out of, and their major trade partners are messing themselves.
Trichet was nothing so much as a spoiled child.
3. November 2011 at 08:45
BB’s Other Self,
Please tell me in detail how you’d implement your NGDP-targeting policy in the next 12 months. Please describe and justify in detail how you will set initially all policy instruments, and then explain how long you will wait to fine tune your policy instruments and on what bases you will do it.
Don’t hold your breath, you will not hear back. Scott Sumner doesn’t understand how the banking system works, whenever he tries to talk specifics he is shown by the MMT crowd he doesn’t know what he is talking about, he can’t deliver. Look at Nick Rowe’s post about “how NGDP would be implemented”. No details, just some kid’s talk about “Chuck Norris with a bazooka”, so silly it is sad. QMs don’t have any idea about how Fed actions impact banks’ decisions, they have trouble telling fiscal operations from monetary operations and never bothered reading the laws governing the Fed’s actions, so they live happily without knowing what of their proposals are even legal.
3. November 2011 at 09:33
BB’s other self-
Scott will just say- no IOR, even though every economy with zero interest rates (recent Japan, USA in 1930s, USA today) has had significant excess reserves with or without IOR. IOR is not the point- it’s the liquidity trap, stupid.
The Fed has tripled the money base with little effect. Maybe quadrupling or quintupling will work? Anything is possible in with Tinkerbell Monetarists. Just believe.
3. November 2011 at 09:34
Oh My,
I agree with you that the biggest plus to MMT is that they actually bother to look at how the Fed and Treasury work. I wish they would emphasize that the government should not spend money in wasteful ways. I know that’s part of the MMT cannon but it seems like most of the believers are very liberal and don’t like to emphasize that point.
3. November 2011 at 09:37
Scott,
What could the ECB specifically due to boost NGDP? The long term low interest rate commitments don’t work and they are very institutionally constrained.
I think its funny that you say no one wants higher rates than you. Why don’t you just recommend that they raise rates and thereby temporarily tighten? That would flush all the bubble type activity leftover from 2006 out. What I wish you had said was that nobody wants market determined interest rates than you.
3. November 2011 at 10:16
John,
Theoretically, there’s nothing to stop an MMTist wanting fiscal stimulus via tax cuts rather than government spending. I do think it’s interesting that most of them don’t go down this root, however. A right-wing MMTist is rare, just like a left-wing Austrian Schooler is rare. In fact, both are arguably, in their strict senses, non-existence species.
3. November 2011 at 10:19
“Methodological individualism leads to political individualism.”
– FA Hayek. I suspect the converse is true as well: methodological collectivism leads to political collectivism. A view of an economy as a collection of roughly homogenous aggregates leads to a view of citizens as a roughly homogenous collective whose views would coincide under the guidance of a group of experts.
3. November 2011 at 10:23
Another side thought: If an institution can define success by a target it knows it can reach, then an institution will do that.
Making an economy grow is difficult, takes work, is subject to reverses, etc.
If a central bank can say it only has to bash inflation, it knows it can win. See Japan, see Volcker. Beating inflation is a one-dimensional easy win.
Then the central bank can shove responsibility for growth off somewhere else (even as its policies undermine growth).
3. November 2011 at 10:41
How to push NGDP with a really big “Bazooka” – and get some REAL growth? EASY: Just push up IOR to 50 % – conditionally:
The condition is: The banks have to lower interest on mortgages (existing and new) to MINUS 20 % (if you owe $ 1’000’000 now, you will only owe $ 800’000 in a year – or you get an additional depostit of $ 200’000.–). Consumer credit should be minus 5 % (or lower). 10 % of the IOR is reserved for top management bonuses, under the condition that they buy equity – so you can push up the DOW to 20’000, 50’000 or 100’000 point failry quick – house prices and sales go up, car and other consumer good sales go up, everyone is happy (or not). If this proposal seems a bit excessive, may be a rate somewhere in the middle of the present level and this proposal might be appropriate 😉 ?
3. November 2011 at 10:45
Good Habit,
Even assuming that’s a good idea: IIRC, the law allowing the Fed to pay IOR ties the rate to the FFR in some way or other. I’m also uncertain as to whether the Fed has discretionary powers as to whether it pays IOR to this institution or that.
3. November 2011 at 13:05
[…] der EZB-Politik findet sich in Scott Sumners Blog, der die dafür die Ãœberschrift gewählt hat: “žWhat can we learn from the Trichet debacle?” Die jetzige Änderung hängt wohl nur indirekt mit dem Wechsel von Trichet auf Draghi zusammen, […]
3. November 2011 at 17:42
W. Peden,
I can’t tell if your an Austrian or monetarist? Do you believe in formulas like mv=pq?
3. November 2011 at 21:41
MV=PQ is an accounting identity, you can’t “disbelieve” it any more than 2+2=4.
4. November 2011 at 00:54
Scott, I’m very disappointed. I was sincerely expecting you to answer my request. A reasonable one. Last night, Obama asked the Europeans please tell me in detail how you are planning to help Greece. He’s still waiting –as much as BB and all America have been waiting for Obama to explain in detail how he would solve America’s huge fiscal crisis. I know how cheap is to talk about general ideas –as Tom Sowell used to say how easy is to write about milking a cow and how difficult is to come back with a bucket of milk.
Let me throw you a soft ball. Why do you think Goodhart law does not apply to NGDP?
4. November 2011 at 09:59
BB, I would create and subsidize trading in an NGDP futures market. I would buy and sell unlimited NGDP futures contracts at a price 7% above current levels. Each transaction would trigger a parallel OMO, which would adjust the monetary base.
More details can be found in my post “Spot the flaw in NGDP futures”
Morgan, Slower NGDP growth in 2005 would not necessarily have meant higher interest rates.
W. le B. I agree the ECB should not bail out governments, but I’d like to see it target NGDP.
Russ, I think that’s too pessimistic. Inflation targeting has done a reasonable job of delivering roughly 2% core inflation. So the Fed can and does hit an inflation target, or at least almost hits it. The main problem is that they shouldn’t target inflation, they should target NGDP. But inflation targeting is a huge improvement over the 1930s.
OhMy, All of them.
Statsguy, Good point.
Justanothereconomist. You should be thrilled with my answer (and you didn’t predict it accurately, BTW.) If I am wrong, and you are right, it would allow you to become wealthy.
Even Krugman’s pretty much given up on the liquidity trap argument–he’s joined me in demanding NGDP targeting. The LT says Switzerland can’t peg the SF at 1.2–except they just did. Time to move on.
John, If you think that you have anything in common with MMT, then you don’t understand MMT.
The ECB should cut rates.
Good habit, There are much easier ways.
Alex, Good point.
BB, Goodhart’s law has nothing to do with NGDP, it is about intermediate targets.
And you should stop demanding I answer your requests immediately. I have a life. I had a big gas leak to deal with yesterday. I have a job. I answer more comments then probably any economics blogger on earth. You comments reveal a very immature personality.
4. November 2011 at 10:49
[…] Sumner offers some context as he distills the macro lessons by reviewing the “Trichet debacle”… Thank God Trichet is finally gone. Now let’s see what we can learn from recent policy […]
4. November 2011 at 11:56
Alex,
I’d argue that MV=PQ doesn’t offer any useful information. Any story you plug into that equation, like the quantity theory of money, already comes from another theory and not the equation itself. Second, it’s not even clear that it’s true; Q refers to something like real GDP which only measures final and not intermediate goods. If you’re talking about Q, you’d have to make V into something like velocity of money used on final purchases. Third, it’s methodologically flawed. You wouldn’t explain the market for potatoes by saying the stock of potatoes times the velocity of potatoes= the price level of potatoes times the quantity of potatoes produced. It would be much better to explain things by ultimately deriving them from individual choices and subjective marginal utility.
4. November 2011 at 12:20
John,
MV = PQ is an equation used to provide a (somewhat flawed) definition of the inverse of the demand to hold money, which is inappropriately called “velocity”. Using that inverse statistic, we can estimate the demand to hold money at any particular point in time. Since, as a stipulative definition, it has no propositional content, I can neither believe it nor disbelieve it.
As to the question about whether I’m an Austrian or a monetarist, I’d say I’m somewhere in between. “Monetarist”, strictly applied, covers only a very small area of economics.
However, to give an example of a position I take on a specific issue- central banking- my stance is: “Austrian if we can, monetarist if we must.”