Sunday, May 15, 2011

Beckworth and Krugman on Quasi-monetarists

David Beckwoth recently linked to some criticisms of "hard money advocates" by Paul Krugman and some other blogs--such as Rortybomb. Beckworth agreed that some "hard money advocates" have made statements worthy of criticism from the quasi-monetarist point of view. Krugman responded, saying that he feels Beckworth's pain.

Beckworth and a few others are trying to keep the spirit of monetarism alive. What I mean by that is that, like Friedman, they’re trying to reconcile a conservative view of government’s proper role with a bit of macroeconomic realism. They accept that a recession represents a huge market failure demanding policy action. But they want to keep that policy action narrowly technocratic, limited to open-market operations by the central bank.

Market failure? Well, it depends. And technocratic? Them's fighting words!

Beckworth's response to Krugman was fine. Krugman had gone on to claim that the liquidity trap was real, and that open market operations in T-bills become ineffective with the short term nominal interest rates hit zero.

Beckworth explained, correctly, that while purchases of zero-nominal interest T-bills by the Fed might not do much good, that just means that the Fed should buy other sorts of financial assets. The point is to increase the quantity of money to meet the demand to hold money, or more exactly, what the demand to hold money would be if nominal expenditures on output were on target.

Beckworth also properly emphasized perhaps the most important change in emphasis for quasi-monetarists relative to the emphasis of orthodox monetarism. An explicit target for a growth path of money expenditures on output will do wonders in dampening actual fluctuations in money expenditures while avoiding any problems with the zero nominal bound on short and safe financial assets. It seems likely, in practice, that nothing more than a willingness to purchase long term or risky bonds would be necessary, and that liqudity traps can be avoided and only modest open market operations with ordinary T-bills would be necessary to keep money expenditures on an explicitly announced growth path.

Beckworth correctly points out that worries about the zero nominal bound are mostly about using the federal funds rate as an operating target. But there is more. Complicated rules about a somwhere between difficult and impossible to measure output gap along with keeping the expected price level rising two percent from wherever it happens to be now, are bad enough. Worse is the reality--generalities about high employment consistent with a commitment to stable prices that is obviously not taken literally. What the Fed is really trying to do is anyone's guess. Technocratic something or other.

Krugman's actual point was to criticize what he sees as the excessive conservatism of the Republican party. His oft-repeated, erroneous criticisms of quasi-monetarism were an aside. No, Beckworth and others (like me) supposedly have no political home, because the Republican party has given up on the tradition of Milton Friedman and has headed off into the the fever swamps of right wing extremism.

Of course, a few years ago, it would be difficult to imagine Krugman paying Friedman any kind of complement, if only a modest one. What I find most interesting is how this shows Krugman's extreme partisan focus. For him, it is all about the struggle between his heroic blue team and the wicked red team.

As someone who has always admired Milton Friedman, the notion that the Republican party of past years was devoted to implementing his libertarian policy preferences is a sad joke. I don't have a home in the Republican party? That is neither news nor is it a problem. I don't need to be on a political team, and I feel lucky when Republican politicians promote any halfway libertarian policy.

That the Tea Party has compelled the Republican party to at least rhetorically endorse a slightly more responsible fiscal policy, especially relative to the spend and borrow years of the Bush administration, is good news as far as I am concerned. How that all plays out will be seen as time passes. But what of monetary policy?

Beckworth linked to a post at Rortybomb, where Mike Konczal quoted a statement from the Club for Growth:

One of the pillars of economic growth is stable money – the most important responsibility of the Federal Reserve Board….

According to Konczal (and Krugman,) this is right wing quackery. But I heartily endorse that view, and would make it stronger-- the Federal Reserve's sole responsibility should be sound money.

The Club for Growth continued to criticize Fed-board nominee Peter Diamond:

While the Fed should be an independent institution to ensure sound money, Diamond is an activist-Keynesian who believes in a much larger role for government involvement in the economy. Most notably, he supported a larger stimulus than the failed one that passed into law in 2009. And he supports government-run healthcare administered through agencies similar to Fannie Mae and Freddie Mac….

I agree with the Club for Growth that if Diamond supports all of those things, then it does cast doubt upon his judgement. (On the other hand, from what I know of Diamond, there could be worse choices for the Board of Governors.)

And this leads to Krugman's claim that quasi-monetarists favor a "technocratic" approach to solving the "market failure" of recession. I think having the Fed implement some technocratic policy to do good is a mistake. Like many advocates of "sound money," I favor constitutional monetary reform to restrict the discretion of the technocrats at the Fed.

One reason I describe myself as a quasi-monetarist is because I believe the goal of such a reform is a stable growth path for money expenditures on output. I have given up on finding some good measure of the quantity of money and having some rule to control it, and have become very skeptical of an rule aimed at finding some appropriate measure of the price level and controlling its level or trajectory. I remain skeptical of a return to a gold standard.

Finally, while it would be nice if the market system was so good that it could overcome any interference created by wrongheaded government intervention, that is an unrealistic standard. As long as the Fed monopolizes the issue of base money, any recession due to a drop in money expenditures on output is a government failure--one that must be laid at the door of the Fed.

I admit, however, that it is likely that any fully private alternative monetary system would have similar problems to some degree--perhaps a larger degree. If we did have a privatized monetary system, then any recession due to a drop in money expenditures would be a market failure. But that isn't the world in which we live.


  1. I admit, however, that it is likely that any fully private alternative monetary system would have similar problems to some degree--perhaps a larger degree.

    Would you elaborate on that in light of modern free banking theory, which comes to the opposite conclusion?

  2. I am certain that free banking institutions will work imperfectly in this regard (and so the quantity of money will sometimes be below the demand to hold money and money expenditures will fall,) and I think it is possible that even the best of them will work much less well than I believe likely, (and so have an even worse disturbances to money expenditures than past and future Fed policy.) Finally, there are some privatized monetary arrangements that I believe likely to work much less well than past or likely future Fed policy.

  3. Have you argued for these points in more detail somewhere? If so, I'd appreciate the references.


  5. It's a bit unfair to compare ideal Fed policy to realistic free banking institutions. Surely, the question is not whether the Fed can provide better money than a free banking system, but rather which is more likely to provide better money? On that matter, I side with free banking.

    Interestingly, in his book on free banking, Selgin acknowledges some circumstances when free banking may create monetary disequilibrium.

  6. "What I find most interesting is how this shows Krugman's extreme partisan focus. For him, it is all about the struggle between his heroic blue team and the wicked red team."
    Obviously he is not alone
    "... I feel lucky when Republican politicians promote any halfway libertarian policy."

    Macroeconomics is ideological debate by fiat.

  7. Is it fair to say that one of the presumed advantages of NGDP targeting is that it should be more effective at avoiding close encounters with the zero bound?

    Is there anything additional to be said about the effectiveness of NGDP targeting in the event the zero bound actually is encountered?

  8. I find the fetish, or quasi-religious attachment to stable prices (if you can figure out what is stable, given iPads, Internet, cell phones, housing prices, new medical treatments etc) to be curious.

    I would prefer to live a nation with chronic five percent inflation and five percent real growth, to one with one percent inflation and one percent growth.

    What is the moral virtue in stable prices? Why is honor attached to such a situation as opposed to mild inflation, say in the four percent range?

    The US economy did very well, living standards rose nicely, all through the 1980s and 1990s, with mild inflation.

    Japan, on the other hand...the monetary noose has suffocated that nation for the last 20 years. No inflation, the yen rose. You can torture the stats to say it was not so bad...but in fact Korea and China have stolen the thunder.

    I am an atheist, maybe that explains my lack of resolve for zero inflation.

  9. A good chunk of this piece reads as bitter partisanship and I'd recommend you read Krugmans writings more frequently before attacking.

    His point that you don't have a home in the GOP anymore isn't so much a shot at the GOP as him making the point that true monetarists no longer have a venue to project their views/thoughts on the economy. Since the start of this recession the GOP line has been first that there is no recession, then that it was a "mental recession", then to claim it was completely structural and that 1920's Germany style inflation is on the way any moment. I imagine a monetarist would take great exception to this view and your voice isn't being heard at all, especially with the GOP's relentless attacks on the Fed.

  10. Benjamin,

    I believe that the long run phillips curve is vertical. However, focusing on inflation rates (or the price level) can be misleading. A steeper growth path of money expenditures on output simply results in a higher inflation rate in the long run and not a perpetual boom--either higher or more rapid growth in real output.

    A flatter growth path of money expenditures on output simply results in a lower inflation rate in the long run and not a perpetual recession. There is a exception--if the implied deflation rate is more negative that the real interest rate on assets whose riskiness is greater than or equal to currency. In that case, there is a "tale wagging the dog" problem with the nominal target interfering with the ability of real interest rates to coordinate. While I doubt it would result in permanent recession, it would be bad.

    As for historical examples, the more rapid growth of money expenditures in the seventies did not generate a perpetual boom. Similarly, the shift to a slower growth rate in the eighties and nineties heralded the great moderation rather than a perptual bust.

    In my judgement, if Japan kept money expenditures on growth path consistent with the trend growth path of potential output, it would do fine, even if the implied trend price level was constant. The problem isn't zero inflation (or even mild deflation) but rather using interest rate instruments to target the inflation rate. The experience of Japan, and the US recently, suggests that assuming that the price level always clears and that it solely problems with misperceptions of the inflation rate that disrupt output are mistaken. That is why I favor targeting a growth path of money expenditures and not a growth rate.

  11. I find it incredible that my anonymous posters find my post "partisan," much less bitterly so. It must be some kind of projection, because I am no partisan. I am a libertarian. Because of social policy and foreign policy issues I am not even tempted to be a blind supporter of the "red team." It is always candidate by candidate with lots of disappointment. I am supporting Gary Johnson for the Republican nomination for President these days.

  12. Lee:

    Which scheme is most likely to be least bad is my perspective. I agree that comparing the best possible Fed performance with the worst possible performance of some particular privatized regime is not a reasonable standard of comparison.

  13. Whatever a libertarian is they are always likely to find a home - if sometimes an unhappy one with the GOP. As profligate as Bush was he does not hold a candle to Obama.
    Having spent a fair amount of time commenting on liberal Blogs, there is no liberal concept of rights and liberty. Rights are what the government chooses them to be, and liberty is what the government chooses to allow. They do not grasp that they may well not be the ones doing the choosing. conservatives atleast recognize the existance of some rights, and do not presume the flow from government.
    The right seems to grasp that they spent the first decade of the 21st century on a bender. They are in spendaholics anonymous and trying to recover. Most certainly they will fall off the wagon again in time - even now they do nto seem to really grasp how bad their own policies are. But the left does not even see the problem.
    I am curious about your views on the causes of recessions. I have not yet seen an economic downturn that I think can credibly be blamed on the marketplace. In one way or another they all seem caused by government - whether in the form of the central banks or the legislature.
    I do not think it is necessary to have a monetary ideology to grasp that the Fed has been an abysmal failure.
    As to market based money - the market always has winners and losers. The winners should always outnumber the losers, it is not a zero sum game, and I fail to see how money is not a comodity just like everything else. The big monetary problem is not that mistakes will be made - mistakes are an inhernet part of human nature - regardless of the economic ideology. What is important is that everyone not blindly make exactly the same mistake on a large scale or over a large period of time. That just does nto happen in free markets. Eventually it always happens in regulated ones. The root problem with the central bank is that to avoid catastrophic failure they MUST always be right. That is not necescary in a marketplace.

  14. Out of curiosity, how does money expenditure targeting compare to current account targeting (to keep it in balance, not engineer a surplus)?

    Also how do you deal with cyclical hot money inflows? That topics comes up again and again in international economics circles, and no one seems to have solved it yet.

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