Read it at Worthwhile Canadian Initiative
I had always thought "Oh yeah, dropping gold changed everything". But other than making the basket much more representative and sensible, which matters massively in practical terms, did it really change things theoretically?
From gold standard to CPI standard
by Nick Rowe
31 comments:
By the third bullet point, I realized this post was just screaming "I'm on a horse":
http://www.youtube.com/watch?v=owGykVbfgUE&
Horse's name is Paul, that is Krugman Paul.
I can't believe how far these guys are going trying to defend their false theories. How about just government net spending? Wouldn't that help?
@Trixie, a dead horse maybe ;)
The man runs through his list of points and doesn't actually talk about money or money formation and yet he "thinks" he's talking about money. It's mind boggling.
Hey, give Nick a break here. He is just asking us to think theoretically.
But I don't think that the example he gives is complete. The gold standard is a convertible fixed rate system where the standard happens to be gold. The point it that a non-financial anchor like gold is very different from CPI. Are they actually comparable theoretically in the example? I don't think so.
Under a convertible fixed rate system means domestic policy is subservient to external factors, chiefly the trade balance. The anchor price is fixed relative to different currencies and then countries compete with each other for gold stock, and everyone wants to be a net exporter, which impossible. (BTW they actually used to settle up daily in the vault deep beneath the FRBNY building by moving gold bars among cubicles marked with countries' names.) Under this arrangement the interest rate has be kept high enough to induce people to save more in the currency than they convert, regardless of the effect on domestic policy, e.g., by making capital more expensive for neet imports that have to impose higher rates. This inhibits investment and slows growth.
Under a non-convertible floating rate regime, the primary concern with the external position becomes secondary to domestic policy, opening up policy space for more liberal economic policy. Imports become an advantage in real terms of trade as long as the government's fiscal policy offset demand leakage. The floating exchange rate is presumed to adjust fx iaw all the factors that influence fx, which no one has yet been able to model.
@Tom, Why waste ones time thinking about something theoretically if it has limited or no use. What happens to Nick's model when you drop in an insolvent banking system and no credit worthy customers. How does he achieve his inflation targets. His theoretical model always assumes that credit can be extended or withdrawn on demand by the CB irregardless of the banking system or the borrowers.
It's important because it shows how many if not most economists think. It is what they are trained to do.
This is quite different from the case method of management problem-solving taught in most business schools.
Tom: Thanks!
OK, so let's compare two worlds (your commenters are going to hate this):
World 1: each country targets the price of a good called "gold".
World 2: each country targets the price of a basket of goods that happens to make up the CPI.
What is the economically relevant difference between the good we call "gold" and the basket of goods we call "the CPI basket" that makes the two worlds theoretically different?
1. Is it that there are non-traded goods, and different preferences, so that two countries' CPI baskets will not be the same (it's like comparing gold countries to silver countries)?
2. Is it that central banks may physically hold stocks of gold but don't hold stocks of haircuts? (My step 3).
3. Is it that the flow supply of newly-produced gold is very small and inelastic compared to the existing stock? (So the gold standard is like targeting land prices).
Or, let me pose the question another way.
Suppose you tell me that monetary theory is very different when central banks target the price of gold than when they target the price of the CPI basket, like modern central banks do.
Suppose I told you that central banks were targeting the price of good X. What would you need to know about good X before you could decide whether or not modern monetary theory is applicable?
The problem I have is not the desire to target the price of anything, but completely ignoring the mechanisms to get you there. The CB is performing monetary operations by increasing and decreasing reserves within the banking system. For that to have any effect on price it means those reserves have to get used. Somebody (a bank) has to be in the capital position to extend the loan; no amount of reserves will change a capital position of the bank unless the CB is performing a fiscal operation. Someone has to want the loan (borrow); and that borrower also has to be able to service the loan (future income). Your scenario completely assumes away/ignores what is going on at the transmission level.
When you ignore the transmission mechanisms you risk missing what Minsky wrote about.
Monetary policy is in essence money creation by increasing bank lending. What if your banking system is overly engaged in speculative lending. Speculative lending gone wrong and you wipe out a lot of bank capital and all of a sudden your transmission mechanism is no longer viable. Extend that onto Ponzi finance and not only do you risk the banking system but the borrowers, again shutting down your transmission mechanisms.
It's possible to think about contemporary fiat money systems in same way that one thinks about gold-standard systems. This is usually referred to by MMTers as gold-standard thinking.
This kind of approach misses the point that fiat money makes it possible to approach things in a different way. Essentially the government/CB now has a magic goldmine which can produce an infinite amount of gold. Issuing bonds/borrowing is not really necessary - and bond issuance in itself isn't necessarily less inflationary than direct financing by CB 'money printing'. Interest rates can be determined by paying interest on reserves rather than by issuing bonds, though it would probably be better to control inflation through fiscal policy and to keep interest rates stable. Taxation becomes a way to regulate inflation rather than a way to raise revenue, and deficits are not in themselves 'unsustainable' (unless of course government spending is hugely wasteful). My two cents worth...
Nick: "Suppose I told you that central banks were targeting the price of good X. What would you need to know about good X before you could decide whether or not modern monetary theory is applicable?"
I would need to know how x affects the monetary system, i.e., whether the monetary system is fixed or floating rate. That tells us whether the price floats or quantity. If you say that the price is targeted then quantity floats. That is not the case with gold under a gold standard, where the cb alters the interest rate to target a constant reserve quantity ratio to gold supply to maintain the fixed conversion rate. But the cb doesn't just rely on the interest rate. It also buys and sells gold. The government also has to run a tight fiscal policy. Lots going on there.
Under a non-convertible system government can set the rate and let reserve quantity float. Under a non-convertible system, reserve quantity is set and price (interest rate) floats.
Under a convertible fixed rate system policy is limited by quantity of reserves and price (interest rate) has to be targeted to prevent excessive conversion in order to keep the value of the currency stable with respect to the fixed rate. This leaves little policy space to address adjusting effective demand to aggregate non-government saving desire since government has to tax and borrow wrt to quantity of reserves.
The thing about gold is that the price is fixed internationally. At the fixed rate if the price falls, then people will convert at the higher fixed price. If the price rises, then the country has to sell gold to keep the price in line with the fixed rate. It doesn't change the interest rate and wait for a correction, and interest rate setting is not precise enough to hit the sweet spot all the time. Countries had to defend their currencies all the time.
That seems to me to be different from a country managing it's domestic inflation rate in that more than the interest rate is involved in this, e.g., fiscal policy, use of buffer stocks for scarce resources. As you know MMT economists hold that monetary policy is a blunt tool that works slowly ing the transmission is chiefly through affects of mortgage rate changes on the housing market.
PKE doesn't buy into any more than a weak causal link running from interest rate to inflation rate. That is what the debate is all about. The interest rate is neither a necessary not a sufficient condition for changes in the inflation rate. That seems to me to be a gratuitous assumption.
This is where monetarism and PKE disagrees. Monetarism says interest rate and PKE says effective demand relative to capacity of the economy to expand. That's where we want to have the argument. A lot of us feel that instead of addressing the issues head on, monetarists want to have the debate on their own turf using their own assumptions, which is one of things that is at issue.
Right now, monetary policy feels like a set-up since it works primarily through lending channels. Experts claim we need to stimulate lending and credit channels to get the economy moving again, after spending the last 4 years wagging their fingers at households for being "irresponsible" and "living beyond their means". But thanks for the GDP growth while it lasted, mind doing that again suckas?
Meanwhile income inequality grows and wages decline despite massive productivity gains. Corporations are sitting on record level amounts of cash, and "job creators" have more wealth than they know what to do with. Other than speculate.
How about someone go all Henry Ford on the economy when he doubled the hourly wage, thereby doubling his PROFITS in a 2 year period? How about we stop trying to balance the budget on the backs of wage earners, the poor, and the elderly? How about we invest in PRODUCTIVE areas of the economy where the private sector never will: infrastructure, education, R&D, PEOPLE? How about we stop trying to entice "borrowing" from those who can least afford it? Because there's only so many times you can dip your hand in THAT till; they don't own the printing press, just FYI.
Gold standard = you need gold reserves that you can leverage so much
Fiat system = you need nothing, you create the reserves that banking system can leverage so much (credit).
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Gold standard = When you can't leverage reserves any longer, you're screwed (recession, eventually depression, until quantity of reserves rise appropriately), you can't create more money (eventually this reached its own logical end: the end of the gold standard). Gold is privately owned, though governments can also own it, they are competing with the private sector for limited reserves.
Fiat system = When you can't leverage any more, reserves are not a problem, you can create money, and if the demand of money increases because a mismatch between liabilities and asset prices, you can provide them ex-nihilo bidding the assets (ie. MBS). You can create price floors, independently if that's good or bad. Same for government securities.
Yes, inflation is a limitation itself, but how spending is done, on what can you bid and how much is much different on a gold standard that on a fiat currency.
Implications are not low: see difference between eurozone ('gold-standard') and other nations.
Trixie "monetary policy feels like a set-up since it works primarily through lending channels."
Some monetarist think it work chiefly through the expectations channel, that is, expectations is the causal transmission mechanism that begins operating immediately, increasing confidence, which gets the ball rolling in the desired direction.
Their argument now is that in a "liquidity trap" the Fed cannot lower the rate below zero, and this isn't enough. So the Fed would have to set a negative rate rate, charging interest to hold excess reserves. This would supposedly curb the propensity to save and raise prices ("increase inflation") by spurring more consumption and investment.
Right, Tom, I've heard about the so-called expectations channel. And I still don't see how you spur consumption with tapped out consumers. From Blackrock:
"Specifically, our debt-to-income ratio was close to 154% in Q4 2010, and deleveraging accomplished since the pre-recession peak was closer
to 7.5 percentage points. Judging from an historical perspective,
neither one of these outcomes looks particularly positive, nor are
they likely to correct very quickly. As a point of reference, the US consumer debt-to-income ratio (using the wages and salaries
metric) never exceeded the 80% level throughout the 1960s and
1970s, but then during the next two decades its debt structure fundamentally changed, resulting in a 105% increase over the same time period to ascend to current levels."
https://www2.blackrock.com/webcore/litService/search/getDocument.seam?venue=PUB_IND&source=GLOBAL&contentId=1111147677
I've heard "experts" applaud how much the household sector has deleveraged since the housing collapse. Anywhere from 7-10%. Great (!), but once it's put in perspective, it amounts to more of a golf clap than a standing ovation. We still have a long way to go.
And it's not as though we can pass the baton to a younger generation of potential higher-earning consumers who theoretically are starting off with a clean slate. Outstanding student loans have surpassed credit card debt for the first time ever:
http://www.chicagotribune.com/classified/realestate/foreclosure/sc-cons-0308-money-consumer-watch-20120308,0,516758.story
To add insult to injury, once these students graduate they are having a difficult time finding employment.
Private debt levels matter, and it's going to take a lot more than some hand-waving by the Fed to remedy the situation.
Monetarists tend to be supply siders and look for investment rather than consumption to lead. Business won't invest as long as it can get a modest safe return, even if low, rather than risk loss. The goal is to make it unattractive to firms to continue to save waiting for more a promising opportunity to invest.
"Monetarists tend to be supply siders..."
Ok, fine, but just wait until I tell this to heteconomist. They are gonna be in SO much trouble!
A basic disagreement in economics is whether demand (income) or supply (investment) is the driver. Keynesians in general say income-demand an orthodoxy in general says investment-supply. New Keynesians like Krugman agree with New Classicalism on this.
If Nick Rowe is saying that we're on a 'CPI standard' then essentially he's making an MMT claim. MMTers always tend to say that the only real constraint on government deficit spending (in a floating exchange rate fiat money system) is inflation..
"A basic disagreement in economics is whether demand (income) or supply (investment) is the driver. Keynesians in general say income-demand an orthodoxy in general says investment-supply"
Yeah and in my view the supply-side argument is very weak and never should have been taken seriously. Henry Ford knew that early on and we've managed to forget it.
I can't see any good arguments and certainly not much empirical evidence that supports the supply-side (voodoo economics - aptly named).
"If Nick Rowe is saying that we're on a 'CPI standard' then essentially he's making an MMT claim."
MMT would never say that CPE is the measure of inflation though. Inflation is a continuous rise of price level, including wages, and CPI only measures an aspect of consumer prices. The so-called rate of inflation is an unobservable. Unemployment rate is much more evident. MMT looks to employment rate. As long as there is high unemployment and an output gap, the economy has room to expand so the economic definition of inflation does not apply.
"Henry Ford knew that early on and we've managed to forget it."
I was actually thinking of Ford when I wrote that up, but neglected to credit him. Thanks for doing so. This is so obvious it's mind-boggling that some folks can't seem to see this.
BTW, The PKE position is that the interest rate has to do with capital not price level. Warren Mosler recommends setting the interest rate at zero permanently, which which would result in a stable prime rate of about 3% after bank costs are added, which it used to be years ago. The fiscal policy would be used to achieve price stability. This would result in a more stable and predictable economic environment for business to make decisions and plan long term.
"As long as there is high unemployment and an output gap, the economy has room to expand so the economic definition of inflation does not apply."
It's quite possible to get high price inflation along with high unemployment. Isn't MMT at all concerned with this possibility? How would it solve it?
(Price) Inflation can pop up in unexpected ways and in unexpected places.. How would MMT deal with commodity-speculation driven inflation or house price inflation?
Government spending will presumably also be going into things other than automatic stabilisers such as the JG. I'm wondering therefore what MMT tax policy would look like in general compared to today's redistributive revenue-raising system.
"It's quite possible to get high price inflation along with high unemployment"
Under what conditions do you see this happening? What would be the cause of the inflation?
Once you've defined these things then we can look at them from an MMT perspective.
In order to be clear, let's stick with the economic definition of "inflation" of a continuous rise in price level, which includes wages and use price increases for other cases which don't quality for inflation. As rise in the CPI, for example, is not "inflation" but increase in consumer goods prices as measured by an index of a basket of goods.
MMT holds that there are two conditions that can result in inflation as defined technically — effective demand rising faster than the economy can expand to accomodate it and supply shortages of vital resources that spreads through the economy, like a shortage of energy. These are addressed differently.
Asset price appreciation is not inflation, but it can produced a "wealth effect" leads to increased propensity to spend, and the increased value of assets as collateral can increase spending power through borrowing against non-realized ("paper") gains, resulting in inflationary pressure.
"Asset price appreciation is not inflation"
The value of my savings in relation to house prices is now comical - the value of my cash has atrophied. That's inflation as far as I'm concerned.
People define inflation in different ways... Choosing a particular definition doesn't change the basic problem however - that of money losing value over time.
"let's stick with the economic definition of "inflation" - a continuous rise in price level, which includes wages"
Why should it include wages? Prices can go up continuously without wages keeping up.
"there are two conditions that can result in inflation as defined technically — effective demand rising faster than the economy can expand to accomodate it and supply shortages of vital resources that spreads through the economy, like a shortage of energy. These are addressed differently."
Ok, so my original question was how these are addressed within MMT..
"Ok, so my original question was how these are addressed within MMT"
Bill Mitchell, Modern monetary theory and inflation – Part 1
Modern monetary theory and inflation – Part 2
As far as asset price appreciation goes, that would involve curbing leverage to purchase assets at minimum. The whole financial system is structure for asset appreciation. Warren Mosler has put forward proposal for reforming the financial sector, but in the end this is a defect of capitalism, which cycles between boom and bust. Savers can attempt to protect themselves by portfolio shifting but the game is stacked atainst them.
"Why should it include wages? Prices can go up continuously without wages keeping up."
By definition price inflation includes wages. If wages don't go up with inflation that's a distribution prblem.
There's a reason there's a lot of discussion these days about inequality…a small percentage of the population is sucking all of the oxygen out of the room.
In that kind of environment inflation is the least of our problems. I'm 65 years old and I can't remember inflation having any effect on my life. In fact, it's probably helped me because my debt deflated while i was paying it off.
If a train is bearing down on your stalled car at a railroad crossing you have bigger problems than worrying if you have on clean underwear for the emergency room.
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