Typography

I gave myself a quick whiff this week to determine if I pass the market monetarist smell test. This is by no means definitive, nor is this an officially administered MM® test. To be clear, my preferred policy end point is market choice in centralized banking. In other words, you, me, and my grandma should be able to start up a central bank. But that's a post for another day. First-best option aside, here's my reading of a few market monetarist ideas. Target the forecast **** 5 stars Big fan. Targeting the forecast would take away the ad hoccery and mystique that surrounds central banks. We want central bankers to be passive managers of yawn-inducing utilities, not all-stars who make front covers of magazines. First, have the central bank set a clear target x. This is the number that the central bank is mandated to hit in the course of manipulating its various levers, buttons, and pulleys. Modern central banks sorta set targets—they reserve the right to be flexible. Bu this isn...

The lever on which a central bank pushes or pulls in order to keep its target variable (say inflation) on track is commonly referred to as the central bank's policy instrument . The policy instrument is the variable that is under the direct control of a central banker. The classic story is that the pre-2008 Fed conducted monetary policy via its policy instrument of choice—the federal funds rate. By pushing the fed funds lever up or down, the Fed could change the entire spectrum of market interest rates. I think this is wrong. The fed funds rate was never the Fed's actual policy instrument. Now this isn't a novel claim. Market monetarists tend to say the same thing. According to folks like Nick Rowe, the quantity of money has always been the Fed's true policy instrument. The fed funds rate was little more than a useful shortcut (a communications device ) adopted by the Fed to convey to the public what it intended to do. I'm sympathetic to the market monetarist's ...

I'm running into a lot of central bank doubt lately. Mike Sax and Unlearning Economics , for instance, both question the ability of the Federal Reserve to create inflation and therefore set NGDP. The title of my post borrows from Archimedes. Give any central banker full reign and they'll be able to increase NGDP by whatever amount they desire. But if rules prevent a central banker from building a sufficiently long lever, or choosing the right spot to place the fulcrum, then their ability to go about the task of pushing up NGDP will be difficult. It is laws, not nature, that impinge on a central bankers ability to hit higher NGDP targets. Sax and Unlearning give market monetarists like Scott Sumner, king of NGDP targeting, a hard time for not explaining the "hot potato" transmission mechanism by which an increase in the money supply causes higher NGDP. I'm sympathetic to their criticisms. I've never entirely understood the precise market monetarist process for...

Market monetarists have a reductio ad absurdum that they like to throw in the face of anyone who doubts the ability of central banks to create inflation. It goes like this; "So, buddy, you deny that central bank purchases can have an affect on the price level? What if a central bank were to buy up every asset in the world? Wouldn't that create inflation?" Since it would be absurd to disagree with their point, the buying up everything gambit usually carries the day. In this post I'll bite. I'm going to show how a money issuer can buy up all of an economy's assets without having much of an effect on the price level. Let's return to my Google parable from last week. You don't have to read it, but you should. If you don't have the time, here's a brief summary. In an alternate world, Google stock has become the world's most popular exchange media and all prices are expressed in terms of Google shares. Google conducts monetary policy by changin...

Bill Woolsey , Scott Sumner ( here and here ), and Nick Rowe and a debate that was fun to follow. It seems to me that they more or less end up on the same page. Here's my rough synopsis. The argument seems to have started as a semantic battle over the definition of the word money. Scott holds that money is the medium of account (MOA), Nick and Bill say it's the medium of exchange (MOE). I say ignore this part of the conflict. Pretend the word money doesn't exist. Money . The semantics detract from the main points of the debate which, to me at least, is about how price rigidity, MOA, and MOE interact to cause recessions. Scott's point centres around the following example. The MOA in Zimbabwe is gold. This means that the sticker prices of goods and services are set in gold ounces. But Zimbabweans pay for these things using a central bank issued Zim$. Shopkeepers keep a sign at the till showing the current exchange rate between an ounce of gold and Zim$ so people who hav...

Having read Larry White's book on free banking ( pdf ) and a number of George Selgin's papers I consider myself to be an advocate of free banking. That being said, I can't help but wonder about a few of George's recent points in his post on Intermediate Spending Booms , the most recent in a series of posts that trains a critical eye on market monetarists. Here is George: But in seeking to free monetary theory and policy from the Keynesian overemphasis on interest rates, the Market Monetarists tend to downplay the extent to which central banks can cause or aggravate unsustainable asset price movements by means of policies that drive interest rates away from their "natural" values. Such distortions can be significant even when they don’t involve exceptionally rapid growth in nominal income, because measures of nominal income, including nominal GDP, do not measure financial activity or activity at early stages of production. George is saying that nominal GDP migh...

Bob Murphy asks if central bank actions taken during the early 1930s might be considered "unprecedented". In the comments I pointed out that during that era an early form of QE was tried. I'm not referring here to the famous 1933 Roosevelt purchases of gold that market monetarists often point to. For instance, see David Glasner here , David Beckworth here , and Scott Sumner here . Scott also has a very interesting paper on the 1933 gold purchasing program ( pdf ). No, I was referring to the 1932 treasury purchasing program. I'm going to replicate the simple graphical analysis that market monetarists use in order to look at the 1932 episode. See this post by Lars Christensen, for example, who overlays important monetary events (QE1, QE2, LTRO) over the S&P500. Here is the context. Prior to 1932, the Federal Reserve system was significantly limited in its ability to embark on large purchases of government securities. This was because of strict backing laws in the ...

I once got accused by Scott Sumner of having the silliest comment he had ever read back on this post. Recent events show that I wasn't being so silly. Around that time, the Swiss National Bank (SNB) had announced a peg of 1.20 EUR/CHF. The argument going around the market monetarist blogs back then was that central banks were akin to Chuck Norris - they only needed to explicitly announce a target and that target would be effortlessly hit, just like how Chuck Norris can make a row of kung-fu masters fall like dominoes just by threatening to hit them. I made a few other comments to the effect that a central bank has to build up credibility before anyone will accept it as Chuck Norris-like. Here is one comment: On August 3, the SNB announced it would be purchasing CHF50b in assets to drive EUR/CHF up. Over the next five days it purchased this amount, but the CHF continued to strengthen. On the 10th the SNB announced it would be purchasing an additional CHF40b in assets, which it pro...

David Glasner recently posted on the economist William Hutt and his book A Rehabilitation of Say's Law : Hutt’s insight was to interpret Say’s Law differently from the way in which most previous writers, including Keynes, had interpreted it, by focusing on “supply failures” rather than “demand failures” as the cause of total output and income falling short of the full-employment level. Every failure of supply, in other words every failure to achieve market equilibrium, means that the total effective supply in that market is less than it would have been had the market cleared. So a failure of supply (a failure to reach the maximum output of a particular product or service, given the outputs of all other products and services) implies a restriction of demand, because all the factors engaged in producing the product whose effective supply is less than its market-clearing level are generating less demand for other products than if they were producing the market-clearing level of output...

Lars Christensen talks about the idea of setting a floor under inflation-linked bonds in order keep inflation expectations at some minimum level. It`s an interesting idea. Here is my comment: Interesting idea, Lars. One problem here is that the TIPS spread (I’ll use US lingo if you don’t mind) measures not only expected inflation but also the relative illiquidity of TIPS relative to Treasuries. It measures, in part, a liquidity premium. TIPS might fall to the central bank’s minimum buying price not because inflation expectations have fallen, but because the liquidity of TIPS relative to Treasuries has declined. This change in liquidity could be purely incidental. ie. it could be due to some unimportant technical change unique to Treasury markets. The result would be that the central bank buys up TIPS because it believes inflation expectations have fallen, when in actuality it is the liquidity premium that has changed. According to your rule, the money supply automatically increases, t...

Lars Christense n had some interesting comments and responses on market monetarism. I pushed him on how far market monetarists departed from traditional monetarists in admitting that money creation was endogenous, not exogenous. ie. determined by the central bank. If this is indeed the case, than the market monetarists stand nearer to the middle of the historic currency vs. banking school divide than Milton Friedman did. The latter would be considered a pure currency school theorist. Same with Mises and the traditional Austrians, although the Austrian free-bankers are surely not currency school theorists. The fact that market monetarists, according to Christensen, are willing to think about money endogenously, just as the banking school theorists did, is a healthy improvement.

Lars Christensen had an interesting post on moneyness and the Divisia indexes. He recommended an old paper of Steve Horowitz's which I read some time ago and have always respected. See A Subjectivist Approach to the Demand for Money . Essentially, you can't believe in the concept of moneyness and also believe in the effort to count money through indexes like M1, M2, or even the Divisia indexes. The two efforts contradict each other. The best way to get a market indication of moneyness, or liquidity, is through the introduction of liquidity options. My comment follows: If moneyness is a subjective concept, and I think it is, then trying to sum up various money assets into a Divisia index is problematic. That’s because an asset that appears to be high on one person’s subjective moneyness scale will be low on another’s, the result being that it is impossible to create objective categories for moneyness. Ultimately, the best way to determine moneyness is to back out the market’s a...