Sunday, April 26, 2009

Protecting The League of Monetary Cranks

I think Bob Murphy is trying to stir up some trouble. There are obviously no radio shows he has to do this evening to promote his new book.

He sent a private email (well, it was private) to me with a link to a blog post by the economist Scott Sumner, who has formed The League of Monetary Cranks.

I think Bob believes that, based on Sumner's outlining of who would fall into the League, that I am smack dab in the middle of the League. And, Bob, knowing how I respond to affronts in a calm, bland manner, has probably microwaved some popcorn and is ready for my Sunday evening response to Professor Sumner. Well, I hate to disappointment Bob, but I proudly accept Bob's implied nomination of me into the League of Monetary Cranks.

Now, however, that I am almost inside the League, I am wondering who the hell is at the door letting all these other guys in?

To understand what is going on here, let's first take a look at why I belong.

Sumner, uses Frederic Mishkin, monetary policy textbook author, as an object lesson of someone who should be in the League. He points to 4 beliefs of Mishkin.

1. It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates

That's me:

The Fed lowering interest rates does not necessarily mean the Fed is increasing the money supply.It depends on the "real interest rate", where I define the "real interest rate" as what the market rate would be without Federal Reserve money manipulations...This is a very important technical point to understand, not only are interest rates and the money supply different things, but cutting rates does not mean necessarily mean the Fed is easing money growth. Likewise, increasing rates does not mean the Fed is tightening money supply, if the "real" rate remains above the point where the Fed has raised rates too
2. Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

I certainly agree with this. I can for instance see the possibility of a period, and I think this will actually occur, when the Fed raises rates and inflation spirals much higher. This I hasten to add is because the Fed rate at such period is below the "real" rate, resulting in money aggregates climbing.

I should point out that at this point, Sumner makes an odd point about Mishkin:

Note that he doesn’t say that monetary aggregates contain important information, only asset prices.
I don't think Mishkin is saying that "only" asset prices are indicative of monetary policy. It is simply that someone watching market prices for clues as to Fed policy may see more important signals from asset prices rather than short term debt.

I don't have Mishkin's text in front of me (I'm travelling), but, if Mishkin is indeed saying something closer to what Sumner suggests, then he should be thrown out of the league. And, for suggesting that Mishkin does not consider monetary aggregates preeminently important, but still allowing him into a league of monetary cranks, I think it is fair to suggest that Sumner should be tossed out of the very League he founded. You can't be a monetary crank, and not think money supply is the preeminent causal factor in the economy. At this point Sumner sounds more like mainstream, than a crank.

3. Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero. Sumner continues:

The sine qua non of a monetary crank is the bizarre belief that even depressions featuring zero interest rates can be magically cured by printing money.
I wouldn't use the term "cured", I think a depression can be reversed by money printing, but it is not a "cure", since the ultimate result is a problem greater than the depression itself, namely, runaway inflation, but I can let that slide (after commentary) and go along with the point.

4. Avoiding unanticipated fluctuations in the price level is an important objective of monetary policy, thus providing a rationale for price stability as the primary long -run goal for monetary policy.

This I disagree with, and apparently Sumner does also:

The only lesson that is slightly different from my own view is number 4
But, then, Sumner proclaims his own non-monetary guideposts as to how monetary policy should be conducted:

It is clear from his other writings that by “price stability” Mishkin means something more like 2% inflation. So I don’t really see any great difference from my own 5% NGDP growth target. That target shares 2% inflation “as the primary long-run goal for monetary policy.”
These are grounds again for throwing Sumner himself out of the League. How can you possibly watch a non-monetary target as a guide to monetary policy, rather than money aggregates themselves (Which, btw, should be constant) and consider yourself a member of the League of Monetary Cranks? I'm sorry, but Sumner has to go.

Outside of myself, the only other living economist, who comes to mind (There might be a couple of others, feel free to email me nominations), who can justifiably proudly wear the badge of the League of Monetary Cranks would be Stefan Karlsson. Posthumous indoctrinated members would include, Ludwig von Mises, Murray Rothbard, and Henry Hazlitt.


  1. If a 'monetary crank' is someone who (among other things) believes that inflation can cured / reverse a recession, why would Rothbard, Mises, and Hazlitt fit into the category? Surely Rothbard of all people would have nothing positive to say about monetary policy of any kind. And wouldn't the Austrian explanation of stagflation indicate that inflation actually can't do what you're suggesting?

  2. @Stewart

    Good questions.

    I would think without question that Rothbard, Mises and Hazlitt would think that an increase in money printing would reverse a recession. Note in my post, I was careful to say "reverse" and not "cure", since I note that the ultimate consequence of such money printing is hyper-inflation, but why wouldn't you be able to print enough money to restructure the economy to the old inflation fueled capital/consumption structure?

    Rothbard of all people would have nothing positive to say about monetary policy of any kind.

    Well, a gold standard could be said to be a monetary policy. And, certainly a constant money supply, would be a monetary policy Rothbard could support.

    The greatest mistake that most current day Austrians make is that stagflation is a necessary part of the business cycle. It isn't. Stagflation occurs when a central bank prints money, thus fueling inflation, but not enough to support the previous inflation fueled capital/consumption structure. Thus, you have a simultaneous recession and inflation.

  3. Maybe it's just a semantic distinction, but I don't think Rothbard's preference for gold-as-money was as a monetary policy. It was a lack of monetary policy which he advocated, and he assumed it would take the form of a gold standard as it had in the past.

    Re: stagflation, that's interesting. Wouldn't even larger amounts of new money merely postpone the eventual bust? It seems wrong to use even the word 'reverse' to describe what inflation can do for the economy. Even if it can push up demand, can it actually do anything positive for overall productivity?

  4. @ Stewart

    I think we are on semantic distinctions on both points. I get your point that a gold standard may semantically not be called a monetary policy. But, I think if we had a constant money supply, Rothbard would go for that and it would be considered a "fixed" monetary policy.

    As for using the term "reverse", I would argue that it is a less loaded term than "cure". But. something does occur if the Fed pumps enough money to reverse the increase in unemployments, declining GDP etc. It does need some name. I am open to suggestions for another term. However, as I try to stress I don't view it as a positive, but a clear economic event is occurring.

  5. The Treasury expects long term inflation, but doesn't see it short term.

    "Weak labor market conditions – employers are cutting not only headcount, but also hours and compensation of workers still on payrolls – are sustaining the specter of deflation.
    Yields on the 30-year bond have risen as of late and are probing their highest level since Autumn 2008. With inflationary pressures scant, the rise in long-dated rates largely is a by-product of the Treasury's outsized funding needs in the period ahead.
    While unlikely to materially affect real long-term interest rates today, such a fiscal path could force real rates notably higher at some point in the future."

    But, they have a plan. Increase long dated issues.

    "The average maturity of the debt peaked at over 70 months in 2000 and declined to approximately 55 months in 2002. It held relatively steady for several years but fell sharply to approximately 49 months, or only 4 years, recently.
    After some discussion, it was the Committee's conclusion that Treasury should incrementally increase the size of all coupon issues toward levels that the market could absorb and allow the Treasury to meet its financing needs over the short to intermediate term."

    TIPS = bad for the Treasury.

    "And, finally, the Committee discussed TIPs issuance and once again concluded that the Treasury would be ill-advised to increase the issuance of securities that historically and currently trade quite cheap to nominal issues. While many market participants and analysts enjoy the flexibility offered by TIPs, they have proven to be very costly to Treasury relative to nominal securities ex-post, as demonstrated in previous studies by TBAC."

    Demand for Treasuries will decrease.

    "The Treasury has recently benefited from the demand from flows into bond funds. In addition, over the past few years trade surpluses in foreign countries have created tangible demand for Treasury product as countries chose to recycle those dollars. Treasuries will probably not receive the same favorable demand treatment from either source over the coming quarters.
    Also, the Fed buying of Treasuries is creating at least temporarily, a real demand source for existing secondary issues."

    The entitlement nightmare is near.

    "In fact, it is these secular financing needs for entitlement spending which once seemed so distant, that has many market participants concerned. The fear is that there may be little reprieve from cyclical financing needs once the economy improves, given the secular forces in front of us.

    Faced with these issuance needs, the member suggested that the inevitable improvement in economic conditions would likely result in fewer inflows into Treasuries from the private sector, as well as from the Fed. This coupled with the potentially reduced demand for Treasuries from foreign sources could put medium to long-term pressure on interest rates."

    So, again, extend the time horizon.

    "With this in mind, the committee discussed the need for Treasury to extend the duration of the borrowing base to reap the benefits of an attractive rate environment today, coupled with the anticipation of a more expensive borrowing dynamic in the future. The committee reinforced some of the recommendations described earlier such as larger coupon note issuance, and a lesser reliance on the Bill sector in the near future."