August 2021

Sun Mon Tue Wed Thu Fri Sat
1 2 3 4 5 6 7
8 9 10 11 12 13 14
15 16 17 18 19 20 21
22 23 24 25 26 27 28
29 30 31        
Blog powered by Typepad

« The New Interventionist Economics | Main | My Latest FreemanOnline Column »

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

So Kevin Grier had a "sarcastic biting wit which was exceedingly charming."

Well, he'd better not venture it around here.

Grier's comment was unclear.

He asks whether the Fed can sucessfully target nominal interest rates at 0% and inflation at 5% or 10%. He says, I don't think so.

What does he mean?

I think he means that if the Fed successfully targets inflation at 10% or 5%, then nominal interest rates will be higher than zero.

Well, I know that Sumner would consider getting nominal interest rates above zero a good thing.
(And, as an aside, Sumner favors returning nominal expenditure to the growth path of the great moderation, and while that may result in higher expected inflation, the point is to raise real output.)

Getting nominal interest rates above zero is a good thing because of the liquidity trap. If higher expected inflation raises nominal interest rates above zero, then market forces can determine levels of real interest rates that clear markets.

If market forces create an excess supply of credit (or saving greater than investment) at a real rate equal to a zero nominal rate minus the expected inflation rate (usually deflation in this scenario), then the zero nominal bound creates a problem.

That problem is fixed if the expected inflation rate is high enough to get the nominal interest rate high enough that the market clearing real interest rate can be reached.

If you believe that prices and wages are perfectly flexible, then real expenditure is always equal to productive capacity, and reductions in real output always reflect decreases in productive capacity.

Either the lower price and wage levels impacts the natural interest rate (saving and investment, or the supply and demand for credit as you prefer) or else the price level overshoots (or perhaps one should say, undershoots) creating expected inflation and the market clearing real rate.

If prices and wages are not perfectly flexible, then real expenditures can be less than productive capacity and there is demand-contrained production. Production is below capacity until the price level is low enough to raise real expenditures back up to productive capacity.

Raising nominal expenditures fixes that problem. Lower market rates should raise nominal expenditures. But at the zero nominal bound, nominal interest rates can't fall. If it is possible to convince people that prices will rise more rapidly eventually, then even at the zero nominal rate, the implication is a lower real rate. There is presumably some expected inflation rate that is consistent with a market clearing real rate and a zero nominal rate, but if the expected inflation rate is higher than that, the nominal rates rise above zero and real rates still clear markets.

Does Grier believe that prices are always at the proper level so that real expenditures equals productive capacity so that current low levels of real output entirely reflect lower productive capacity? He doesn't say.

Does he believe that the current real interest rates clear markets? That is, the price level now must be at a level so that its expected future rate of of change when subtracted from current nominal rates clear markets? He doesn't say.

As far as I can see, he only seems to be arguing that the Fed cannot keep nominal rates at zero and inflation at 10% or 5%. So? Is there anyone who considers zero nominal interest rates an end in and of itself?

The point is to raise real output by raising real expenditures by raising nominal expenditures. This is only possible if the current price level is above its market clearing level. That given current levels of nominal expemditure, prices and wages need to fall by more. Raising nominal expenditures makes it so that prices and wages don't need to fall more.

While I favor a scenario where some price need to rise and others to fall (a stable price level,) I think Krugman and Sumner are pointing to a scenario where, for the most part, some prices need to rise more and others less. (Though I think neither of them have a problem with some prices falling.)

I believe that it is obvious that some reallocation of resources is needed and that productive capacity is depressed. Structural unemployment and so, the natural unemployment rate, are higher.

But I think real expenditure is low, the price level is too high, and current levels of output are lower than productive capacity. The current unemployment rate is above the natural unemployment rate.

Sumner agrees, though tends to downplay this effect. I think Krugman agrees too, but downplays it even more.

I read O'Driscoll, for example, as exagerating the effect of the change in productive capacity and the natural rate of unemployment, downplaying the impact of real expenditures and demand contrained production.

Personally, I don't why it is so hard to see that both things are happening at the same time.

I favor a substantial increase in nominal expenditure over the next year, returning it to a modified growth path consistent with price stability in the long run. I suspect that this would involve substantial price inflation. But the point is to get started on a regime of slow steady growth of nominal expenditure, and not starting with a situation where prices and wages remain above market clearing levels.

I actually worry about the zero nominal bound. I am skeptical about pull yourself up by your own bootstaps manipulations of expectations. Of course, only the safe and short nominal rates are near zero, and so quantitative easing can lower longer and riskier nominal rates. Or, a currency suspension would allow negative short and low risk nominal interest rates. The paradox is that a willingess to do either thing can get expected nominal expenditures back to its previous growth path, with the result that market clearing real and nominal interest rates should rise, without there actually being a currency suspension or massive quantitative easing.

So, while I see no value of targeting some high level of inflation, getting nominal interest rates up by shifing expectations is what I think needs to happen too.

Pete--
You have self-criticized yourself on the blog before for your attitudes towards others. Undoubtedly that's true--we all need to be better. But this is yet another example of your charitable credit towards others, and I've often seen similar credits (where appropriate) to those you disagree with. We notice, and I appreciate.

If nominal expenditure were stable, then changes in productivity would be the primary driver of changes in the price level. Ordinarily, one would expect a steadily declining price level as a consequence of economic growth. However, if a bursting bubble depresses productivity enough, then a temporary rise in the price level might follow.

If participants in the economy expected nominal expenditure to remain stable, then economic planning -- interest rates, repayment schedules, price changes, and wage increases -- would be predicated upon stable future nominal expenditure. Should actual nominal expenditure fall short of expectations, the flow of money that economic participants had planned on would not materialise. This may occur locally even when nominal expenditure is stable, because some economic plans are bad (i.e. malinvestment). However, if it occurs throughout the economy due to a shortfall in expected nominal expenditure, then many otherwise sound investments begin to founder. In other words, price signals are not distinguishing very well between good and bad investments, because the money shortage is introducing noise into the system. Thus, the perception of risk increases, nominal expenditure falls even more, and the downturn is exacerbated -- a secondary recession.

In the above story, it is assumed that nominal expenditure remained stable, but if participants in the economy expected a 5% growth path for nominal expenditure, then falling short of that expactation would have similar consequences. It is in this sense that monetary policy was too tight in early/mid 2008, and by the time the Fed did respond, the downturn had been so intensified that an unprecedented expansion of the monetary base wasn't all too crazy.

I don't understand why that is "wrong in so many ways."

Just to be clear: there was a bubble, it was aggravated by the Fed's loose monetary policy around 2002, and a recalculation is necessary. Resources have been wasted and productivity has been hit (so in a nominal expenditure targeting regime, I would expect a higher than normal rise in the price level). However, the best environment for the recalculation (redeployment of resources and relative price changes) to occur is one of stable expectations for nominal expenditure.

Apparently those good Keynesian socialists, Bill Woolsey and Lee Kelly, are as determined as ever to run my life for me.

Thanks, but no thanks!

Maybe I got up on the wrong side of the bed today, so I'm just in a "cranky" mood.

But I find myself in disagreement with Bill Woolsey. Why should the government "target" anything, including nominal income?

In a free market, including a free monetary system, nominal income would be whatever the cumulative interactions of the market participants generated in terms of their demand to hold various forms of money and the supply of commodity money and money substitutes.

End of story. I'm sick and tired of social enginering of any type or form. Who are these nominal income targeting "experts"? How do they know how much nominal income should be in the economy and what its "growth path" should be?

This is just another form of monetary central planning. Another form of Friedman's "rule" following. But even Milton Friedman in his presidential address before the Western Economic Association in 1985 declared that Public Choice theory had persuaded him that, in the long-run, it will never be in the interest of the monetary managers to follow some hypothetical monetary policy in the "public interest" -- whatever that is (and Hayek has taught us that that type of thing is all a "mirage").

I will merely quote Ludwig von Mises from 1943:

"It is a thankless job indeed to express such radical and 'subversive' opinions and to incur the hatred of all supporters of the old system [of government intervention, regulation] which has amply proved its inexpediency.

"But it is not the duty of an economist to be fashionable and popular; he has to be right. Those timid souls who fear challenging spurious doctrines and superstitions because they have the support of influential circles will never improve conditions.

"Let them call us 'orthodox'; it is better to be an intransigent orthodox than an opportunist time-server."

Like I said, I guess I got up on the wrong side of the bed today.

Richard Ebeling

I was feeling slightly cranky, too. But Richard expressed so well what I might have said that I will just second his comments.

We recently discussed the knowledge problem of conducting optimal policy over at ThinkMarkets. Keynes understood that his policies required the rule of experts and was an elitist (also "an immoralist," his words). Rule by experts is inconsistent with a free society, and I would reject it even if it were more efficient. Which it isn't.

Trying for a little bit of inflation is like trying to be a little bit pregnant.

These discussions fortify the case for free banking. Issues of which aggregate monetary measures to use, which targets are optimal, which rules should be in place, how to shield rule-based targets from political manipulation and shortsightedness, and so on, are not the kind of questions required to have a sound free banking system.

Prof P,

One might interpret your statement this way:

Woolsey and Kelly are not really socialists, but realists, recognizing a fact of life, that we have a socialist money system, and, like it or not, must try to make it work as best we can.

But the fact remains that their conclusions of how best to do so are those of socialists, who think they know best, and not of free marketeers, who think the market knows best.

You refer to "the kind of questions required to have a sound free banking system."

One might interpret that statement this way:

How do we get from here to a free banking system, or simply to a free market, period?

What is your answer to that question?

Dave,

Too true, but making the case for free banking wouldn't lead to a very interesting discussion on this blog -- most people would just silently nod in agreement.

Except for socialists like Mr Lesvic, who seek to suppress the free market institution of fractional reserve banking, there wouldn't be much to discuss ;P

I agree. The free banking alternative is politically unrealistic. I've always been a pessimist when it comes to the possibility of establishing a truly free market system. My good friend Pete has always been the optimist. Ask him about his 50 year plan!

So it all comes back to gold.

We don't have a gold standard of any sort. But, if we did have a gold standard, and the demand for gold rose more than the supply, then the result would be deflation. And so, some feel the need to defend deflation.

I wonder why we don't see more defenses of inflation. If the supply of gold rises faster than the demand, the gold standard generates inflation.

I favor free banking, but I see no value having the government define the dollar in terms of some amount of gold or other, and then having free banking based upon that fixed nominal value.

Contrary to Ebeling, the determination of nominal expenditure in a gold standard depends on a price level that clears the market for gold, and a real income that depends on the productive capacity of the economy. Nominal expenditure adjusts to make nominal income equal to that value.

It is all driven by the fixed nominal value of gold.

In real free banking systems, there were contracts that allowed temporary breaks from gold. While the option clause was aimed to prevent bank runs, its effect was to dampen and perhaps prevent changes in nominal expenditure.

Preventing temporary fluctuations in nominal expenditures is great. And if a change is necessary, dampening it is probably a good idea. But why the return?

Anyway, there must be some fixed nominal value. A stable growth path for nominal expenditure is one approach, an approach that provides an excellent environment for microecnomic coordination. Changes in nominal prices and incomes provide good signals of changes in relative prices. Nominal interest rates provide excellent signals of real interest rates. Monetary disequilibirum is avoided--or at least, there is no need to adjust all the prices in the economy to adjust the quantity of money to the demand to hold it, or worse, the clear the market for gold.

Hayek's Denationalization of money was valuable. It is what led me to the position I have today. However, when multiple banks develop interbank clearing, it isn't like competing fiat currencies. Monetary conditions depend on their interactions. Hayek spoke about some kind of loose standards based upon price indices. Well, fine, but you get interbank clearing which has obvious benefits for the banks and those using money, then the money price of the bundle defining the index is not based upon each banks separate monetary policy.

And index futures convertibility on nominal expenditure looks better than index futures convertibility on some broad bundle of goods and services--price index targetting.

Perhaps having a private clearinghouse develop the best nominal anchor and then let other alternative banking systems develop if they want would be the best approach.

But going back to gold would be a choice by the government, and it should be compared to other alternative nominal frameworks for free banking. Whatever deciision is made drives nominal expenditure, the quantity of money, the price level, the price of gold, or whatever.

But make no mistake, there must be a fixed nominal value.

(I know, ABG. Can't help it.)

Pete: thanks for your kind words. You and Dave and Steve were challenging but rewarding to teach. I am very impressed and happy with how well you guys have done.

Thanks for endorsing KPC too. Mike and I really enjoy doing it.


Lee Kelly referred to "socialists like Mr Lesvic, who seek to suppress the free market institution of fractional reserve banking."

I seem to recall your having said that before, and perhaps even more than once before.

Just go on setting up a straw man Lesvic, since you can't knock the real one down.

As for calling Kelly and Woolsey socialists, that may have gone too far. But, in this matter, at least, their position is the socialist position, that some Big Brother, and not the market itself, knows best.

Bill Woolsey raises the important issue of "going back to gold." I don't think one can turn back the historical clock. But I do think the discussion should be informed by the history of how we/the world got onto it. There was a moment when governments finally fixed a value of gold, just as it did for the foot (length). But that doesn't mean it was an arbitrary decision.

A government can decide that English will be the offical language of the country. The government does not "define" the language by doing that. The language pre-exists.

Money is part of a liberal order and the discussion cannot be divorced from it. There are technical issues, but the monetary order for a free society cannot be decided by technical issues alone.

On one technical issue, I don't think a free banking system can operate with fiat currencies. Hayek started with "Choice in Currencies" -- existing fiat currencies. It wasn't about free banking.

AIER ran a conference a few years ago on some of the technical issues of returning to the gold standard. (It was directed by Walker Todd.) I went away feeling that technical issues were not an obstacle. The chief obstacle is the failure to have a unified conception of a free society and a vison of a free monetary order within that.

The importance of a free monetary system for the long run preservation of a free society, as Jerry O'Driscoll suggests, cannot be too strongly emphasized.

In 1942, the German free market economist, Gustav Stopler (then in exile in America from war-torn Europe) observed in his book, "This Age of Fables":

"Hardly ever do the advocates of free capitalism realize how utterly their ideal was frustrated at the moment the state assumed control of the monetary system . . .

"A 'free' capitalism with government responsibility for money and credit has lost its innocence. From that point on it is no longer a matter of principle but one of expediency how far one wishes or permits government interference to go. Money control is the supreme and most comprehensive of all governmental controls short of expropriation. . ."

And writing at that time, Stolper also pointed out that, "There is today only one prominent [classical] liberal theorist consistent enough to advocate free, uncontrolled competition among banks in the creation of money, [Ludwig von] Mises."

Stopler despaired that Mises had seemingly failed to persuade any to follow him in supporting this position.

Luckily, over 65 years later there are far more advocates of the denationalization of money than when Mises stood alone.

Unless there are at least some who reason and attempt to persuade "outside the box" of the current debates over monetary and banking policy, such a change will and can never come about.

It was not enough in the 18th century, say, to call for more humane treatment of slaves; it was necessary to make the far more radical case for the actual abolition of slavery so in the 19th century that ages-long institution could be brought to an end.

We will never bring about the free society in general or the ending to monetary central planning in particular by advocating how monetary policy can be made more "humane" (i.e., less destabilizing). It is necessary to call for the end to the government's monetary monopoly, and the freeing of money and all forms of financial intermediation from state control and influence.

Richard Ebeling

Richard Ebeling's statement is eloquent and I support it. I wrote about a free monetary order for a conference on Natural Law and Economics at Princeton earlier this year. It has nothing to do with optimality, but with liberty.

It is fine to talk about improving monetary policy in the current context. I have been doing the same for banking regulation over at ThinkMarkets.

I would have thought the focus of this site would be on principles and idealism. I recommend everyone re-read Hayek's "Why I am Not a Conservative."

Why, Bill Woolsey asks, do we deplore an increase in the supply of paper money, relative to the demand for it, when we wouldn’t deplore an increase in the supply of gold, relative to the demand for it?

We wouldn’t care much about an increase in the supply of paper money, either, were it within the same limits as ordinary increases in the supply of gold.

But then it wouldn’t serve its purpose. It is precisely because the supply of paper money can be increased to so much greater an extent than that of gold that its increases are so much more damaging than those of gold.

Mr Woolsey says, “I favor free banking, but I see no value having the government define the dollar in terms of some amount of gold or other, and then having free banking based upon that fixed nominal value.”

I don't either. Let the market decide.

(Kelly, please note, once and for all!)

Woolsey wrote: “Contrary to Ebeling, the determination of nominal expenditure in a gold standard depends on a price level that clears the market for gold, and a real income that depends on the productive capacity of the economy. Nominal expenditure adjusts to make nominal income equal to that value.

It is all driven by the fixed nominal value of gold.”

I don’t know what he’s talking about, but I’d bet my fixed nominal value of gold on Ebeling.

He goes on: “In real free banking systems, there were contracts that allowed temporary breaks from gold. While the option clause was aimed to prevent bank runs, its effect was to dampen and perhaps prevent changes in nominal expenditure.
Preventing temporary fluctuations in nominal expenditures is great. And if a change is necessary, dampening it is probably a good idea. But why the return?”

What is “the return?” And what is he getting at? Is he trying to tell us that free market, free banking banks could inflate without consequence?

He continutues: “Anyway, there must be some fixed nominal value. A stable growth path for nominal expenditure is one approach, an approach that provides an excellent environment for microecnomic coordination. Changes in nominal prices and incomes provide good signals of changes in relative prices. Nominal interest rates provide excellent signals of real interest rates. Monetary disequilibirum is avoided--or at least, there is no need to adjust all the prices in the economy to adjust the quantity of money to the demand to hold it, or worse, the clear the market for gold.”

Again, what is he saying, that banks could inflate without consequence?

He goes on: “Hayek's Denationalization of money was valuable. It is what led me to the position I have today. However, when multiple banks develop interbank clearing, it isn't like competing fiat currencies. Monetary conditions depend on their interactions. Hayek spoke about some kind of loose standards based upon price indices. Well, fine, but you get interbank clearing which has obvious benefits for the banks and those using money, then the money price of the bundle defining the index is not based upon each banks separate monetary policy.

And index futures convertibility on nominal expenditure looks better than index futures convertibility on some broad bundle of goods and services--price index targetting.

Perhaps having a private clearinghouse develop the best nominal anchor and then let other alternative banking systems develop if they want would be the best approach.”

Again, what is he saying, that banks could inflate without consequence?

He goes on: “But going back to gold would be a choice by the government.”

I thought we were in the free market and a free banking system.

In conclusion, he says, “But make no mistake, there must be a fixed nominal value.”

And does that mean that the banks could inflate without consequence?

Mr. Woolsey spoke of a "fixed nominal value of gold."

What was that?

If a bank gives me a wharehouse receipt for the one ounce of gold I had deposited with it, that is not a nominal value of gold, but the actual quantity of it.

If I promise soneone an ounce of gold for a barrel of oil to be delivered in six months, that is not a fixed value of gold or oil. For the price could change during that time from one ounce for a barrel of oil to two ounces for it or a half ounce for it.

The terms of our contract are fixed. No matter what happens to the gold price of oil, we must still exchange them at the ratio of one ounce to one barrel. But that is the price only of one exchange, not of all exchanges of oil and gold. For all subsequent changes, the price has changed.

So what is this "fixed nominal value of gold?"

Typographical error.

I said, "For all subsequent changes, the price has changed."

I meant, For all subsequent exchanges....

I'll bet any fixed nominal value of gold that Mr Woolsey will never tell us what it is.

Mr Woolsey's presentation above reminds me of a story that a cousin of mine told me about her daughter, an economist. Upon giving her a monograph of hers to read, the economist warned her mother to read only the first part.

"The rest was just meant to confound people."

Or, it could be that I'm just awfully dumb.

"Just go on setting up a straw man Lesvic, since you can't knock the real one down." - Mr Lesvic

I'm sorry, that was rude and thoughtless of me. Please accept my apologies.

Richard,

You said: "It is necessary to call for the end to the government's monetary monopoly, and the freeing of money and all forms of financial intermediation from state control and influence."

I agree wholeheartedly, but what does it achieve to call for an end to the government's monetary monopoly on a blog like this? When I discuss these matters with people away from this blog, I frequently argue for abolishing of the monetary monopoly, and just wrote a short essay arguing for just that last week.

On another matter, you said: "But even Milton Friedman in his presidential address before the Western Economic Association in 1985 declared that Public Choice theory had persuaded him that, in the long-run, it will never be in the interest of the monetary managers to follow some hypothetical monetary policy in the 'public interest'."

In the long-run, I don't think a free and open society can survive, but that doesn't mean that its establishment, however fleeting, is not worth pursuing given the alternatives.

I don't think any monetary rule can last forever, but it would be better than the prevailing regime, and if that means only for a short while, then it is still better than nothing at all.

The Fed has never been less popular among the geenral public than it is now. But the Fed's critics don't agree on an alternative. You can't replace something with nothing.

Cong. Ron Paul has pursued the governance issue to the point where he has the possibility of getting legislation passed. Transparency and accountability are the sine qua non for implementing any kind of rule. But what rule?

In my opinion, a free market in banking and money would have a propensity to stabilise nominal income/expenditure. Whether this would be achieved by increasing the supply of money depends on what is meant by "money." However, given the prevailing monetary order, the Federal Reserve will only stabilise nominal income/expenditure) by adjusting available reserves through open market operations. (I know they *could* do it in other ways, like by changing the reserve ratio, but they don't seem to like that.)

Please tell me if I am wrong? I am no expert on anything.

Therefore, it seems to me that the Fed should target a stable (or stable growth, at least) in nominal income/expenditure, because then it might roughly emulate what free banking would achieve in its absence. Of course, in the long-run, such a rule may be abolished in favour of expendiency, inflating out of a fiscal crisis, or whatever else, but even a few years of decent monetary policy would be better than none at all -- bureaucratic institutions tend to suffer from inertia, don't forget.

Perhaps a better solution would be to freeze the quantity of base money and currency in circulation, and then let banks determine their own reserve ratios and issue their own banknotes redeemable in U.S. Dollars (not unlike how 18th Century private coins in England were redeemable for the regal currency). And meanwhile abolish the various risk subsidies that breed imprudence.

In this world, the Fed could be replaced with some organisation that simply maintained the quantity of base money, and another which operated as an interbank clearing house. Thus, rather than having the Federal Reserve determine a single monetary policy for the entire United States, each bank would have its own monetary policy and customers could pick winners and losers.

Of course, it ain't gonna happen.

Kelly,

As I told you a long time ago, at Cafe Hayek, you were one of the best of the best, but I do seem to bring out the worst in people. Perhaps that's my gift. My wife hates me, my dog hates me, the finest economists in the world hate me, and I'm not too crazy about me myself.

But I really do think your keen instincts have deserted you on this inflation business. Wish you'd get back on track, because we need you.

Kelly,

Here's the root of your confusion.

You wrote,

"a free market in banking and money would have a propensity to stabilise nominal income/expenditure."

Ludwig von Mises wrote,

"With the real universe of action and unceasing change...neither neutrality of money nor stability of purchasing power are compatible. A world of the kind which the necessary requirements of neutral and stable money presuppose would be a world without action...in the frame of...a changing world money is neither neutral nor stable in purchasing power. All plans to render money neutral and stable are contradictory. Money is an element of action and consequently of change."

And, by the way, isn't it beginning to seem that Mr. Woolseye might have been trying to pull the wool over our eyes.

D.G.,

If I was ever one of the "best of the best," then the world is in deep trouble.

The comments to this entry are closed.

Our Books