Market monetarism

Last updated

Market monetarism is a school of macroeconomic thought that advocates that central banks target the level of nominal income instead of inflation, unemployment, or other measures of economic activity, including in times of shocks such as the bursting of the real estate bubble in 2006, and in the financial crisis that followed. [1] In contrast to traditional monetarists, market monetarists do not believe monetary aggregates or commodity prices such as gold are the optimal guide to intervention. Market monetarists also reject the New Keynesian focus on interest rates as the primary instrument of monetary policy. [1] Market monetarists prefer a nominal income target due to their twin beliefs that rational expectations are crucial to policy, and that markets react instantly to changes in their expectations about future policy, without the "long and variable lags" postulated by Milton Friedman. [2] [3]

Contents

History

The term "market monetarism" was coined by Danish economist Lars Christensen in August 2011, and was quickly adopted by prominent economists who advocated a nominal income target for monetary policy. Scott Sumner, a Bentley University economist and one of the most vocal advocates of a nominal income target, adopted the label of market monetarist in September 2011. [4] Sumner has been described as the "eminence grise" of market monetarism. [5] In addition to Scott Sumner, Lars Christensen attributes economists Nick Rowe, David Beckworth, Joshua Hendrickson, Bill Woolsey and Robert Hetzel to be "instrumental in forming the views of Market Monetarism". [1] Yue Chim Richard Wong, professor of economics at the University of Hong Kong, describes market monetarist economists as "relatively junior in the economics profession and ... concentrated in the teaching universities." [6] The Economist states that Sumner's blog "drew together like-minded economists, many of them at small schools some distance from the centre of the economic universe"; consequently, Christensen considers market monetarism to be the first economic school of thought born in the blogosphere. [7]

Although rejecting Milton Friedman's notion of long and variable lags in the effects of monetary policy, market monetarism is typically associated with Friedman's thought, especially with respect to the history of the Great Depression. Ambrose Evans-Pritchard has noted that Christensen, who coined the name "market monetarism," authored a book on Friedman. Evans-Pritchard described the school as, "not Keynesian. They are inspired by interwar economists Ralph Hawtrey and Sweden's Gustav Cassel, as well as monetarist guru Milton Friedman." [5] Evans-Pritchard traces the idea of nominal income targeting to Irving Fisher's Depression-era proposal of a "compensated dollar plan." [5] The idea of targeting nominal GDP was first proposed in James Meade (1978), [8] and discussed in the economic literature during the 1980s and 1990s. [9]

Bruce Bartlett, former adviser to U.S. President Ronald Reagan, and Treasury official under President George H. W. Bush, first noticed in 2010 the emergence of Scott Sumner, and the movement of economic debates to the blogosphere. Bartlett credited Sumner with bringing the concept of market monetarism into the national debate about economics. [10] The Economist later noted that Tyler Cowen, professor of economics at George Mason University, and Nobel laureate Paul Krugman had linked to Sumner's blog within a month of its inception, Cowen approving of Sumner's proposals, but Krugman more skeptical. [7]

By 2011, market monetarism's recommendation of nominal income targeting was becoming accepted in mainstream institutions, such as Goldman Sachs [11] and Northern Trust. [12] Years of sluggish economic performance in the United States had compelled a review of the strategies of the Federal Reserve Board. Later in 2011, Krugman publicly endorsed market monetarist policy recommendations, suggesting "a Fed regime shift" to "expectations-based monetary policy," and commending market monetarism for its focus on nominal GDP. [13] Krugman used the term "market monetarism" in his widely read blog. Also, in the fourth quarter of 2011, The Milken Institute released a study by Clark Johnson, advocating market monetarist approaches. [14] In late October 2011, former Chairwoman of the Council of Economic Advisors, Christina D. Romer, wrote a widely read editorial or "public letter" in The New York Times in which she called on Federal Reserve chair Ben Bernanke to target nominal GDP, a market monetarist tenet. [6]

In November 2011, Bernanke held a press conference stating that the Federal Reserve board of governors had discussed the idea of NGDP targeting, and were considering adding nominal GDP to their list of important economic indicators. [6] However, the board decided against adopting a strict NGDP targeting policy, because, The Economist reported, "switching to a new targeting regime could 'risk unmooring longer-term inflation expectations'. If inflation were allowed to rise to 5%, for example, people might regard that as permanent and set wages accordingly, even as output returned to normal. To show its mettle, the Fed would then have to restrict growth; the costs of proving its seriousness might swamp the benefits of the new regime." [7]

In December 2012, Mark Carney, governor of the Bank of Canada and later governor of the Bank of England, suggested adopting a nominal GDP level target (NGDP-LT). This would also have the advantage that during bad times people could trust on the interest rates staying low long enough, even though the inflation would exceed the old target. Therefore, the low interest rates would be more effective. [15]

According to Carney, the NGDP level is in many ways superior to the unemployment rate. It makes the central bank repair its old mistakes. This history-dependence is most advantageous during times of low interest rates by making monetary policy more credible and easier to understand. [16]

Rules-based policies

Market monetarists generally support a "rules-based" policy that they believe would increase economic stability. In particular, they criticize some tools of monetary policy, such as quantitative easing, for being too discretionary. [17] Market monetarists advocate that the central bank clearly express an NGDP target (such as 5–6 percent annual NGDP growth in ordinary times) and for the central bank to use its policy tools to adjust NGDP until NGDP futures markets predict that the target will be achieved.

Alternatively, the central bank could let markets do the work. The bank would offer to buy and sell NGDP futures contracts at a price that would change at the same rate as the NGDP target. Investors would initiate trades as long as they saw profit opportunities from NGDP growth above (or below) the target. The money supply and interest rates would adjust to the point where markets expected NGDP to reach the target. These "open market operation"s (OMOs) would automatically tighten or loosen the money supply and raise or lower interest rates. The bank's role is purely passive, buying or selling the contracts. This would partially or completely replace other bank's use of interest rates, quantitative easing, etc., to intervene in the economy. [18] Brad DeLong objects to this approach, writing, "The Federal Reserve would then become truly the lender of not just last but first resort." [19] Bill Woolsey offers several alternatives for the structure of such a futures market, suggesting an approach in which the Fed maintains a fixed price for the futures contract, hedging any resulting short or long position by conducting OMOs to match its net position and using other traditional techniques such as changing reserve requirements. He further recommends that private parties collateralize their positions using only securities such as treasury bills to prevent perverse effects from adjustments to margin accounts as the market moves. [20]

Nominal income target

Market monetarists maintain a nominal income target is the optimal monetary policy. [21] Market monetarists are skeptical that interest rates or monetary aggregates are good indicators for monetary policy and hence look to markets to indicate demand for money. Echoing Milton Friedman, [22] in the market monetarist view, low interest rates are indicators of past monetary tightness not current easing, and as such, are not an indicator of current monetary policy. Regarding monetary aggregates, they believe velocity is too volatile for a simple growth in base money to adequately accommodate market demand for money. In contrast, a nominal income target accommodates fluctuations in velocity by ensuring monetary policy is loose or tight enough in order to hit the target. This approach leaves interest rates to be decided by the market, while addressing inflation concerns as nominal GDP is also not allowed to grow faster than the level specified.

Market monetarists contend that by not paying attention to nominal income, the Federal Reserve has actually destabilized the US economy; nominal GDP fell 11% below trend during the 2008 recession, and has remained there since. Market monetarists believe that by explicitly following a nominal income target, monetary policy would be extremely effective in addressing aggregate demand shocks; summarizing this view, The Economist stated: "If people expect the central bank to return spending to a 5% growth path, their beliefs will help get it there. Firms will hire, confident that their revenues will expand; people will open their wallets, confident of keeping their jobs. Those hoarding cash will spend it or invest it, because they know that either output or prices will be higher in the future." [7]

Liquidity trap

Market monetarists reject the conventional wisdom that monetary policy is mostly irrelevant when an economy is in a liquidity trap (when short-term interest rates approach zero), arguing instead that liquidity traps are more associated with low nominal GDP growth than with low inflation. [23] Market monetarists claim that policies such as quantitative easing, charging instead of paying interest on excess bank reserves, and having the central bank publicly commit to nominal income targets can provide an exit from the trap. [18] Interest rates reached zero in Japan but not in China when they each experienced mild deflation. NGDP growth (Japan's has been near zero since 1993, while China's did not fall below the 5% to 10% range, even during the late 1990s East Asian financial crisis. [18] ) is seen as the more proximate determinant.

Market monetarists dispute the claim of conventional theory that central banks that issue fiat money cannot boost nominal spending when the economy is in a liquidity trap: instead, they say that the central bank can indeed raise nominal spending, as evidenced by the assertion that the central bank can always “debase the currency” by raising the inflation rate, increasing nominal spending in the process. [24]

Market monetarists have argued that unconventional methods of making monetary policy can succeed. The Economist describes the market monetarist approach as potentially including "'heroic' purchases of assets, on a bigger scale than anything yet tried by the Fed or the Bank of England." However, it notes that "Even then, people might refuse to spend the newly minted money, or the banks might also refuse to lend it." Some market monetarists like Bill Woolsey have suggested that "The Fed could impose a fee on bank reserves, leaving banks to impose a negative interest rate on their customers’ deposits. That might simply serve to fill up sock-drawers as people took the money out of their accounts. But eventually, instead of hoarding currency, they would spend and invest it, bidding up prices and, with luck, boosting production." [7]

Related Research Articles

Macroeconomics Study of an economy as a whole

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and government spending to regulate an economy’s growth and stability. This includes regional, national, and global economies. According to a 2018 assessment by economists Emi Nakamura and Jón Steinsson, economic "evidence regarding the consequences of different macroeconomic policies is still highly imperfect and open to serious criticism."

Inflation Rise in price level in an economy over time

In economics, inflation is a general rise in the price level of an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualised percentage change in a general price index, usually the consumer price index, over time.

Monetarism School of thought in monetary economics

Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Monetarist theory asserts that variations in the money supply have major influences on national output in the short run and on price levels over longer periods. Monetarists assert that the objectives of monetary policy are best met by targeting the growth rate of the money supply rather than by engaging in discretionary monetary policy.

Monetary policy Policy adopted by the monetary authority to control the short-term interest rate or the money supply

Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing or the money supply, often as an attempt to reduce inflation or the interest rate, to ensure price stability and general trust of the value and stability of the nation's currency.

Zero interest-rate policy

Zero interest-rate policy (ZIRP) is a macroeconomic concept describing conditions with a very low nominal interest rate, such as those in contemporary Japan and December 2008 through December 2015 in the United States. ZIRP is considered to be an unconventional monetary policy instrument and can be associated with slow economic growth, deflation and deleverage.

Causes of the Great Depression

The causes of the Great Depression in the early 20th century in the USA have been extensively discussed by economists and remain a matter of active debate. They are part of the larger debate about economic crises and recessions. The specific economic events that took place during the Great Depression are well established. There was an initial stock market crash that triggered a "panic sell-off" of assets. This was followed by a deflation in asset and commodity prices, dramatic drops in demand and credit, and disruption of trade, ultimately resulting in widespread unemployment and impoverishment. However, economists and historians have not reached a consensus on the causal relationships between various events and government economic policies in causing or ameliorating the Depression.

The Taylor rule is one kind of targeting monetary policy used by central banks. The Taylor rule was proposed by the American economist John B. Taylor, economic adviser in the presidential administrations of Gerald Ford and George H. W. Bush, in 1992 as a central bank technique to stabilize economic activity by setting an interest rate.

Liquidity trap Situation described in Keynesian economics

A liquidity trap is a situation, described in Keynesian economics, in which, "after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rather than holding a debt which yields so low a rate of interest."

In monetary economics, the quantity theory of money is one of the directions of Western economic thought that emerged in the 16th-17th centuries. The QTM states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply. For example, if the amount of money in an economy doubles, QTM predicts that price levels will also double. The theory was originally formulated by Polish mathematician Nicolaus Copernicus in 1517, and was influentially restated by philosophers John Locke, David Hume, Jean Bodin. The theory experienced a large surge in popularity with economists Anna Schwartz and Milton Friedman's book A Monetary History of the United States, published in 1963.

Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption. Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy by creating money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models. Others like monetarism view money as being neutral only in the long-run.

Criticism of the Federal Reserve

The Federal Reserve System has faced various criticisms since it was authorized in 1913. Nobel laureate economist Milton Friedman and his fellow monetarist Anna Schwartz criticized the Fed's response to the Wall Street Crash of 1929 arguing that it greatly exacerbated the Great Depression. More recent prominent critics include former Congressman Ron Paul.

Inflation targeting is a monetary policy where a central bank follows an explicit target for the inflation rate for the medium-term and announces this inflation target to the public. The assumption is that the best that monetary policy can do to support long-term growth of the economy is to maintain price stability, and price stability is achieved by controlling inflation. The central bank uses interest rates, its main short-term monetary instrument.

In macroeconomics, discretionary policy is an economic policy based on the ad hoc judgment of policymakers as opposed to policy set by predetermined rules. For instance, a central banker could make decisions on interest rates on a case-by-case basis instead of allowing a set rule, such as Friedman's k-percent rule, an inflation target following the Taylor rule, or a nominal income target to determine interest rates or the money supply. In practice, most policy actions are discretionary in nature.

Friedman's k-percent rule is a monetary policy rule that the money supply should be increased by the central bank by a constant percentage rate every year, irrespective of business cycles. In A Monetary History of the United States, 1867–1960, monetarist economists Milton Friedman and Anna Schwartz attributed inflation to excess money supply generated by a central bank. It attributed deflationary spirals to the reverse effect of a failure of a central bank to support the money supply during a liquidity crunch. Friedman proposed a fixed monetary rule, called Friedman's k-percent rule, where the money supply would be calculated by known macroeconomic and financial factors, targeting a specific level or range of inflation.

Lost Decades Period of economic stagnation in Japan

The Lost Decades refers to a period of economic stagnation in Japan caused by the asset price bubble's collapse in late 1991. The term originally referred to the years from 1991 to 2001, but the decade from 2001 to 2011 and the decade from 2011 to 2021 have been included by commentators.

History of macroeconomic thought Aspect of history

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

Scott B. Sumner is an American economist and political activist for the Democratic Party. He is the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University, a Research Fellow at the Independent Institute, and professor who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Federal Reserve and other central banks should target nominal GDP, real GDP growth plus the rate of inflation, to better "induce the correct level of business investment".

A nominal income target is a monetary policy target. Such targets are adopted by central banks to manage national economic activity. Nominal aggregates are not adjusted for inflation. Nominal income aggregates that can serve as targets include nominal gross domestic product (NGDP) and nominal gross domestic income (GDI). Central banks use a variety of techniques to hit their targets, including conventional tools such as interest rate targeting or open market operations, unconventional tools such as quantitative easing or interest rates on excess reserves and expectations management to hit its target. The concept of NGDP targeting was formally proposed by Neo-Keynesian economists James Meade in 1977 and James Tobin in 1980, although Austrian economist Friedrich Hayek argued in favor of the stabilization of nominal income as a monetary policy norm as early as 1931 and as late as 1975.

The Zero Lower Bound (ZLB) or Zero Nominal Lower Bound (ZNLB) is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the central bank's capacity to stimulate economic growth.

David I. Meiselman American economist

David I. Meiselman was an American economist. Among his contributions to the field of economics are his work on the term structure of interest rates, the foundation today of the implementation of monetary policy by major central banks, and his work with Milton Friedman on the impact of monetary policy on the performance of the economy and inflation.

References

  1. 1 2 3 Christensen, Lars (September 13, 2011). "Market Monetarism:The Second Monetarist Counterrevolution" (PDF). Retrieved October 19, 2011.
  2. Goodhart, Charles A.E. (July–August 2001). "Monetary Transmission Lags and the Formulation of the Policy Decision on Interest Rates" (PDF). St. Louis Federal Reserve Bank. Retrieved October 21, 2011.
  3. "Long and Variable LEADS".
  4. Sumner, Scott (September 13, 2011). "Market Monetarism?" . Retrieved October 18, 2011.
  5. 1 2 3 Evans-Pritchard, Ambrose (2011-11-27). "Should the Fed save Europe from disaster?". The Telegraph. Retrieved 2011-12-01.
  6. 1 2 3 Wong, Yue Chim Richard. "Easy Money, Tight Money, and Market Monetarism" . Retrieved 2011-12-02.
  7. 1 2 3 4 5 "Marginal revolutionaries". The Economist. 2011-12-31. Retrieved 2011-12-29.
  8. Meade, James (Sep 1978). "The Meaning of "Internal Balance"". The Economic Journal. 88 (351): 423–435. doi:10.2307/2232044. JSTOR   2232044.
  9. Frankel, Jeffrey (2012-06-19). "The death of inflation targeting". voxeu.org. CEPR. Retrieved 2019-04-22.
  10. "Bruce Bartlett Wants The Fed To Target Nominal GDP".
  11. Hatziusjan, Jan; Pandlzach, Zach; Phillips, Alec; Jari, Sven; Tilton, Andrew; Wu, Shuyan; Acosta-Cruz, Maria (October 14, 2011). "The Case for a Nominal GDP Level Target" (11). Goldman Sachs . Retrieved October 18, 2011.Cite journal requires |journal= (help)
  12. Weisenthal, Joe. "Goldman Advises The Fed To Go Nuclear, And Set A Target For Nominal GDP". Business Insider.
  13. Krugman, Paul (October 19, 2011). "Getting Nominal". The New York Times . Retrieved October 19, 2011.
  14. Johnson, Clark (Fourth Quarter 2011). "Monetary Policy and the Great Recession" (PDF). The Milken Institute Review. Archived from the original (PDF) on April 5, 2012. Retrieved October 22, 2011.
  15. Mark Carney suggests targeting economic output, BBC News, 12 December 2012.
  16. Mark Carney: Guidance, Remarks by Mr Mark Carney, Governor of the Bank of Canada and Chairman of the Financial Stability Board, to the CFA Society Toronto, Toronto, Ontario, 11 December 2012.
  17. Lee, Timothy (2011-11-05). "The Politics of Market Monetarism". Forbes. Retrieved 2011-11-10.
  18. 1 2 3 Sumner, Scott (Fall 2011). "Re-Targeting the Fed". National Affairs (9). Archived from the original on November 12, 2015. Retrieved October 17, 2011.
  19. Delong, Brad (December 14, 2010). "Scott Sumner Plumps for Nominal GDP Targeting--of a Sort". Grasping Reality with Both Hands. Retrieved October 30, 2011.[ permanent dead link ]
  20. Woolsey, Bill (December 16, 2010). "Sumner and DeLong on Index Futures Convertibility". Monetary Freedom. Retrieved October 30, 2011.
  21. Benchimol, Jonathan; Fourçans, André (2019). "Central bank losses and monetary policy rules: a DSGE investigation". International Review of Economics & Finance . 61 (1): 289–303. doi:10.1016/j.iref.2019.01.010. S2CID   159290669.
  22. Friedman, Milton (April 30, 1998). "Reviving Japan" . Retrieved January 8, 2017. After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.
  23. Sumner, Scott (2012), "5. How Nominal GDP Targeting Could Have Prevented the Crash of 2008", in Beckworth, David (ed.), Boom and Bust Banking: The Causes and Cures of the Great Recession, Independent Institute, p. 146–147, ISBN   978-1-59813-076-8, A liquidity trap is not so much associated with low inflation as it is with low NGDP growth. This is because the two components of interest rates – the real rate and the expected inflation rate – are closely linked to the two components of expected NGDP growth – expected real growth and expected inflation. The expected inflation components are identical, and the real interest rate is positively correlated with the expected real GDP growth rate.
  24. Sumner, Scott (March 3, 2011). "Yes, QE2 did happen, and it (sort of) worked". TheMoneyIllusion. Retrieved 2019-04-17.