Market Monetarism Roadmap to Economic Prosperity Marcus Nunes
Total Page：16
File Type：pdf, Size：1020Kb
Market Monetarism Roadmap to Economic Prosperity Marcus Nunes Benjamin Cole With a foreword by Scott Sumner Text Copyright © 2013 Marcus Nunes and Benjamin Cole All Rights Reserved Table of Contents Foreword Chapter 0: Introduction and Summary Chapter 1: It´s All in the Framing Chapter 2: Camelot and the origins of the Great Inflation Chapter 3: The Great Inflation Chapter 4: The Volcker Transition Chapter 5: The Great Moderation Chapter 6: The ‘Great Recession’ (or the ‘Bernanke Little Depression’) – Why Did It Happen? Chapter 7: The International Experience Concluding Thoughts - Thinking the Unthinkable: Quantitative Easing as Conventional Policy Tool Foreword During the 1930s most people thought the Great Depression represented a relapse after the exuberant boom of the 1920s, worsened by a severe international financial crisis. Then in the 1960s Milton Friedman and Anna Schwartz showed that the real problem was an excessively contractionary monetary policy. Yes, the Fed cut interest rates close to zero, and did what is now called “quantitative easing,” but it was too little too late. At Friedman’s 90th birthday party Ben Bernanke gave a speech that included this memorable promise: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.” In this path-breaking study of the Great Recession, Marcus Nunes and Benjamin Cole show that Ben Bernanke and the Fed made many of the same mistakes that were made during the 1930s. Yes, the Fed was more active this time. And yes, it could have been much worse. But our monetary policymakers still haven’t fully understood the importance of adopting a monetary policy that does whatever it takes to keep nominal GDP growing at a rate consistent with economic prosperity and low inflation. Nunes and Cole are part of a new movement called “market monetarism” which first arose on the internet and has recently revolutionized the way economists think about monetary policy in a deep slump. Prior to the recession, the standard formula called for adjusting interest rates up and down in order to target inflation. The hope was that a low and stable inflation rate would insure economic prosperity. We now know that this policy is not enough. Nunes and Cole trace the evolution of monetary policy from the 1960s to the present. They show how monetary policy failures led to the Great Inflation of the late 1960s, how Paul Volcker and the Fed brought inflation to much lower levels in the 1980s, and then how the Fed was able to produce a long period of stable growth and low inflation. The key was that the Fed never slavishly targeted inflation, but rather kept nominal GDP (i.e. total spending) growing at close to a 5.5% trend line. They also show how the ideology of “inflation targeting” became increasingly dominant at the Fed in recent years. The Fed lost its focus on nominal spending, and during 2008-09 didn’t realize the dangers of the sharp decline in nominal GDP until it was too late. By that point, interest rates had fallen to zero. But this didn’t represent “easy money” as people often assume, just as high interest rates during hyperinflation don’t represent “tight money.” Low interest rates reflected the weak condition of the economy. With rates near zero, the Fed had to move on to more “unconventional” stimulus techniques. This is where the inflation targeting ideology created problems for policymakers. They saw a need for stimulus, but were so afraid that inflation would rise above 2% that they were very slow and tentative in developing alternative policies. Their job was made much harder by their refusal to admit their mistake, and switch to a nominal GDP target, which would boost current demand by increasing expectations of future growth in spending. Meanwhile economists outside the Fed were increasingly drawn to nominal GDP targeting, with an all-star list including Christina Romer, Paul Krugman, Jan Hatzius, and Jeffrey Frankel endorsing the market monetarist proposal for NGDP “level targeting.” More recently, Mark Carney endorsed the idea. Carney’s endorsement represents an important breakthrough, as he will assume leadership at the Bank of England later in 2013. Over the past few years both Marcus Nunes and I have developed blogs focused on promoting market monetarist ideas. Benjamin Cole has also participated in the blogging debate, doing guest posts at various sites. Marcus brought to light some of Ben Bernanke’s earlier academic papers that warned Japan not to be timid in using monetary stimulus when interest rates fell to zero. And yet after 2008 the Fed refused to do some of the more aggressive monetary actions that Bernanke recommended to the Japanese. Marcus is also very skilled at using graphs to tell a story, and the graphs in this book are one of its strong points. I’d add that Benjamin Cole also contributed greatly to the market monetarist movement, and is a powerful writer. At first readers might be skeptical of some of the arguments made by Nunes and Cole. In 2008 and 2009 it didn’t seem like monetary policy was the cause of the crisis, or even that there was much the Fed could do to fix the problem. I’d ask readers to suspend their disbelief until they’ve looked at all of the evidence. Monetary economics is a very counterintuitive field. Most people think the Fed merely moves interest rates up and down, and that once rates fall to zero there’s nothing more the Fed can do to stimulate the economy. But cutting edge research in recent decades has suggested otherwise. We now know that low interest rates do not mean easy money, and that there are lots of things the Fed can do to boost spending once rates hit zero. If readers take an open-minded look at the evidence in this book, I believe they will be very surprised by what they see. The financial crisis and Great Recession that followed were not at all what they seemed to be at the time. The profession is beginning to come around to the market monetarist view of the importance of a stable growth path for nominal GDP, and this perspective casts a whole new light on the events of the past 5 years. Scott Sumner, Professor of Economics, Bentley University Chapter 0: Introduction and Summary In 2008, for the first time since the Great Depression and some dips at the end of World War II, the nominal Gross Domestic Product of the United States—that is the sum of all spending, before adjustment for inflation—actually shrank. In all other recessions after World War II, while real GDP fell, nominal GDP growth had remained positive. The 2008 recession was different, earning the moniker “the Great Recession.” Globally, economies were contracting—Japan was especially ill—while in the United States real GDP shrank at an 8.9 percent annually compounded rate in the fourth quarter of 2008. In the world of economic thought and punditry, there were two almost immediate ramifications. The first was that references (and comparisons) to the Great Depression became rife, the second was that the whole gamut of schools of economic thought—many of which had been dormant for ages—vied for explanatory supremacy (usually undergirded by political agendas). We will not delve into the relative merits of different schools in “explaining” the Great Recession, but just mention a list of some of the favorite causes. Such a list would include: The excess savings in emerging markets (savings glut), and subsequent lax or aggressive lending Lax Wall Street underwriting standards, in search of deals Expansionary monetary policies in the advanced economies in 2002-2005 (interest rates “too low for too long”) The securitization of finance, especially property mortgages The underestimation of aggregate risks The fall in loan underwriting standards The errors made by rating agencies Regulatory failure The aggressive tactics behind mortgage loans The public policies related to homeownership, especially in the form of federal agencies Fannie Mae and Freddie Mac. Most likely, all the above “suspects” share some degree of guilt in triggering loan defaults, and the unfortunate responses by monetary authorities leading up to the Great Recession. But the above list is actually misleading, by pulling economic forensic detectives off of the proper path—and the proper path leads to the role of monetary policy, as practiced by the Federal Reserve Board (in the United States) and other central banks around the world but especially the European Central Bank and the Bank of Japan. Above all, our view is that if central banks had not permitted nominal spending to seriously contract after mid-2008, there would have been no Great Recession. Our story will be told from the perspective of a “new” school of thought that has been aptly named “Market Monetarism.” We say “new” as there is little new in economics, rather there is the updated application of mixes of economic ideas to current situations. Market Monetarism bears homage to many traditions and thinkers, particularly including Swedish economist Gustav Cassel and British economist Ralph Hawtrey, but including more modern thinkers (particularly in elements of application) such as the iconic Milton Friedman and Stanford scholar John Taylor. In a 1978 well known academic paper—The Meaning of “Internal Balance” by the Nobel recipient British economist James Meade—proposed the Market Monetarist principle of targeting national nominal income: …If, however, it was total money incomes which were stabilized, a much more moderate decline in employment combined with a moderate rise in prices would serve to maintain the uninflated total of money incomes.” Sir Samuel Brittan, the doyen of British economic journalists, brought the idea into policy circles and has remained close to the theme ever since.