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Central Banks and Alternative Monetary Alternative Monetary Central Banks and Alternative Monetary Systems Christopher J. Neely AittViPAssistant Vice Presid idtent, Federal Reserve Bank of St. Louis Annual Educators Conference October 19, 2011 The opinions expressed are my own and not necessarily those of the Federal Reserve Bank of Saint Louis or the Federal Reserve System. 2 Today’sTopics s Topics Central Banks and Alternative Money Systems o What is Money? o Methods of Monetary Policy o ClBkCentral Banks o Central Banks vs. Commodity Standard 3 What is Money? Money • Money: That which can be exchanged for goods and services. – Functions: • Medium of exchange • Store of value • Unit of measure Why Do We Need Money? • Money solves the mutual coincidence of wants problem. • Greatly reduces transactions costs/shopping time. – My grocer does not want a lecture on economics in exchange for Cheerios. Historical Forms of Money • Commodities: cigarettes, furs, gold, Rai stones (Yap island) • Fiat money: Money whose vvuesoalue is not intrins sc.ic. – Introduced during wartime in the United States • Charac ter is tics of usef ul money – Durable, transportable, divisible, homogenous, easily produced (?) Historical Forms of Money Rai stone Historical Forms of Money • What are the advantages and disadvantages of having a currency that is easily produced? Money Supply • Monetary base: Currency and reserves with the central bank. • Narrow to broad definitions of money – Currency – Demand deposits – Time deposits, CDs, – Shor t-tbdterm bonds • Money and bonds are close to a continuum now – M0, M1, MZM, M2 Money Supply Monetary Base 3000 2500 ars ll 2000 1500 ns of US Dol 1000 Billio 500 Monetary Base (BASE) 0 2/1/1984 2/1/1989 2/1/1994 2/1/1999 2/1/2004 2/1/2009 Money Supply Money supply levels go up and up. M1 and M2 12000 10000 ss 8000 6000 f US Dollar oo 4000 Billions 2000 Money Stock (MZM) 0 M2 11/1/1980 11/1/1985 11/1/1990 11/1/1995 11/1/2000 11/1/2005 11/1/2010 Money Supply Money supply growth rates fluctuate. M1 and M2 25 years 20 15 ange over 3 ange over hh 10 ercentage c ercentage PP 5 MZM M2 0 Annualized Annualized How Do We Decide What I s M oney ? • At least two options – Use econ omi c theo ry. – Use a definition that works well in predictions • What to predict? Monetary Systems Monetary Systems • Commodity standards: Gold, silver – No current examples of major countries with commodity standards. • Central banks – The most common choice , by far . • Currency boards – Fixe d exc hange rate w it h 1: 1 reserves. – Outsourcing monetary policy. How Does the Money SlCh?Supply Change? • CommoditCommodity standard – People dig holes in the ground, haul out ore and turn iiit in to th e central lb bank kf for money. • Central bank – Central bank buys (sells) bonds, injecting ((g)yextracting) money from the econom y. – Central banks change the relative supplies of government debt. How Does the Money SlCh?Supply Change? • Question(s): Suppose that the supply of gold exogenously increases under a gold standard. ((pjPerhaps we just conq uered a gpgood portion of the New World.) – What happens to the domestic price level? – What happens to our imports and exports? – What happe ns to fo re ig n p rice leve ls? – What happens to production at existing gold mines? – What might be true of the price level in the very long run under a gold standard? Central Banks Functions of a Central Bank • Banking services for the government • Lender of last resort • Control of money supply and interest rates • Bankli?k regulation? • Payyyment systems? Why Do We Need a Lender ofLf Last R esort? • Bank runs can be self-fulfilling – “It’s a Wonderful Life” • Banking crises can severely reduce output and employment • A lender of last resort can reduce the frequency and severity of banking crises • The U.S. had repeated banking crises in the 19th century Why Do We Need a Lender ofLf Last R esort? 40% 5% 30% 3% 20% 1% 10% 0% -1% -10% -3% US Banking Crises -20% Output Growth (Left Axis) Inflation (Right Axis) -30% -5% 1880 1885 1890 1895 1900 1905 1910 Inflation and GDP data from www.measuringworth.com United States Crises dates, 1800-2010 Sources: Reinhart, Camen M. and Kenneth S. Rogoff, “From Financial Crash to Debt Crisis,” NBER Working Paper 15795, March 2010. Forthcoming in American Economic Review. Reinhart, Carmen M. ,“This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises,” NBER Working Paper 15815, March 2010. © 2010 by Carmen M. Reinhart and Kenneth S. Rogoff. All rights reserved. U.S. Central Banks • First Bank of the United States (1791 –1811) • Second Bank of the United States (1816–1836) – NlNo lend er of flt last resort tR. Repeat tdbkied banking cri ses i i19n 19th century. – 1907: JP Morgan organized a coalition of rich men to shore up the banking system. U.S. Central Banks • The Federal Reserve (1914 –2011) – Structure reflects fear of centralized power and moneyed interests. – 12 district banks. NY, Chicago, and SF are the 3 largest district banks in terms of assets. (50%) – FOMC voting structure • Permanent votes: 7 Governors and the President of the NY Fed • Rotating votes: 11 other FRB Presidents rotate annually through 4 voting slots. – FRBs are technically owned by member banks but subject to BOG supervision. FRBs exist to serve the public interest , not their shareholders . • 9 directors (6 elected by Banks, 3 by BOG); 3 A directors are professional bankers; 3 B directors are leaders from industry, labor agriculture; 3 C directors are appointed by BOG as public reps. • http://research.stlouisfed .org/publications/es/10/ES1010 .pdf CtlBkVCentral Banks Versus a Commodity Standard Goals of a Monetary Standard • Price stability – Inflation is a monetary phenomenon when measured over a sustained (years) period . – Congress mandates the Fed to pursue price stability. • Countercyclical policy – Subject to some debate. – Conggpress mandates the Fed to pursue maximum sustainable employment. Price Stability • Low and stable inflation. • Should inflation be zero on average? • Target prices or inflation? – What is the difference? Targeting prices implies that you make up for past errors. If inflation has been high, you attempt to reduce it below the long-run average. Price Stability Gold standard: Deflation from 1870 to 1895 and inflation after. 14 6% 12 4% =100) 44 10 2% 8 0% dex (1982-8 on (%) ii nn 6 -2% Inflat mer Price I mer 4 -4% uu Cons 2 -6% Price Level [Left Axis] Inflation [Right Axis] 0 -8% 1870 1875 1880 1885 1890 1895 1900 1905 1910 Data from www.measuringworth.com Price Stability Post-WWII: Rising inflation from 1960 to 1980, then the great Volcker disinflation. 120 16% 14% 100 100) == 12% 80 10% n (%) dex (1982-84 oo nn 60 8% 6% Inflati 40 mer Price I mer 4% uu 20 Cons Price Level [Left Axis] 2% Inflation [Right Axis] 0 0% 1/1/1960 1/1/1965 1/1/1970 1/1/1975 1/1/1980 1/1/1985 CPIAUCSL Price Stability Declining inflation. The Great Moderation … until 2008. 250 6% 5% 84=100) -- 200 4% 150 3% tion (%) Index (1982 Index aa ee Infl 2% 100 sumer Pric sumer nn Price Level [Left Axis] 1% Co 50 Inflation [Right Axis] 0% 0 -1% 1/1/1986 1/1/1991 1/1/1996 1/1/2001 1/1/2006 1/1/2011 CPIAUCSL The long-run value of the dollar? • The U.S. price level is about 20 times the price level in 1913. The do llar is on ly wort h 4-6% o f w hat it was worth. • http://www. measuringworth. com/uscompare/result. php?use%5B%5D= DOLLAR&use%5B%5D= GDPDEFLGDPDEFLATION&use%5B%5DATION&use%5B%5D= VCB&use%5B%5D= UNSK ILLED&use%5B%5D=MANCOMP&use%5B%5D=NOMGDPCP&use%5B%5D=NOMINALGDP&year_source=2010&amount=100&year_result=1913 The long-run value of the dollar? • Has the Fed debased the currency? Is this a monstrous filfailure? – No. The great majority of economists would argue that ldtblifltihllow and stable inflation has very low cost s. – Most economists would probably argue that low and stable inflation is better than inflation that averages zero . • This is disputed. Most would agree that the cost difference is very small. The long-run value of the dollar? • Price comparisons across long periods of time are not very useful as baskets of goods have changed. – Woodrow Wilson did not have an iPhone; neither did Wilson get an MRI after his stroke. – I do not buy many railroad tickets or much horse feed. The long -run value of the dollar? • Much of the inflation has been due to wars. The U.S. – and other countries – would regularly leave the gold standard during wars to raise revenue through inflation. The long -run value of the dollar? • What is the relative harm of low and stable inflation versus 0 inflation? • Two types of inflation: – Anticipated inflation can potentially distort price sildignals and causes peopl lte to economi ze on currency holdings. – UiidUnanticipated ifliinflation creates much greater distortions and arbitrary reallocations between creditors/debtors and workers/employers . The long -run value of the dollar? • Question: If you are happy working for $50,000 and you expect 2% inflation next year , h ow m uch sala ry do you wan t to ma ke you just as happy? • Suppose that you expect 2% inflation and you want to buy a bond to fund your retirement. If the bond pays a 5% yield , how much will your real return be? The long -run value of the dollar? • Low and stable inflation creates very small distortions.
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