Archive for the 'monetary theory' Category

Zimbabwean Currencies: Condoms, Sweets and Paper Money

February 21, 2014

by Alexander Czombera*

If there is one single law in economics then it is that markets tend to equilibrium. Or, to align this with Grove’s law  (“Technology will always win. You can delay technology by legal interference, but technology will flow around legal barriers”), the free market will find its ways, whether in white, grey or black market. Despite of initially strong resistance of the Zimbabwean government it was market forces and not political consent that abolished central banking and legal tender laws in the South African country. Paper money of its original currency was replaced with notes from other countries, the shortage of coins was addressed by “efficient rounding”, condoms and sweets.

While inflation was mostly in double digits ever since its independence in 1980 it began to climb when the government faced high deficits and deep recessions in the early 2000s. In late 2008 it eventually reached a peak of  8.97 x 10 (to the 22nd power) percent. Prices doubled almost every day.

Because of the limited supply of foreign currencies and fixed exchange rates some people used this time to exploit arbitrage opportunities. The term burning money was coined when well-connected people in Harare exchanged their Zimbabwe Dollars into the limited supply of South African Rand at the fixed exchange rate and sold the Rand in the parallel market at a fair price.

The continuing devaluation of its own currency moved Zimbabwean citizens into other currencies, most notably Rand, Pula, US Dollar, Euro and Pound. In spite of legal tender laws these currencies became established in the regions which traded frequently with the countries issuing these currencies or having previously adopted them. Read the rest of this entry »

Clarifications of the Austro-Wicksellian Business Cycle Theory

December 31, 2012

by Mario Rizzo

There has been a lively debate on forecasts of high inflation made by those worried about the Fed’s recent policy of quantitative easing. For details I refer the reader to Daniel Kuehn’s excellent blog. The question to which I address myself is solely “What do these predictions have to do with core Austrian Business Cycle Theory?” This is my answer.

We must start with a few general points. First, I am talking about the Austro-Wicksellian business cycle theory as developed by Friedrich Hayek and Ludwig von Mises and as synthesized by Roger Garrison in his book Time and Money. I cannot take responsibility for versions constructed by others.  It is not that I think the others are necessarily wrong (and I mean no disrespect to them), but I do not know with sufficient precision what all these others are saying in the name of “Austrian theory.”

Secondly, the Austro-Wicksellian theory begins with either an endogenous increase in credit through the banking system or with an “exogenous” increase initiated by a central bank. In the latter case, however, the theory itself has little to say about the extent to which increases in base money will manifest themselves in increases in bank credit to producers.  (This may not be much of an issue during a boom but may be an issue during a recession or in a recovery.)

Third, the theory is fundamentally one about the “upper turning point” in the cycle – it is a theory about why a credit-induced boom must come to an end. It is not a theory, for better or worse, about the “secondary” factors that develop consequent on the break-up of the boom. These include possible recessionary-problems relating to bank runs (there is an Austrian inspired banking literature, but that is not the cycle theory) or what exactly will get investment expectations to turn around.  As to deflation, Lawrence White has argued that the logic of the theory requires the avoidance of deflation in accordance with Hayek’s very early recommendation to keep M V from falling.  (Hayek departed from this in the Depression, and later admitted he was incorrect to do so.)

Now to more specific points:   Read the rest of this entry »

Money and Government

November 25, 2012

by Jerry O’Driscoll  

The 30th annual Cato monetary conference was held in Washington, D.C. on November 15th. The theme was “Money, Markets, and Government: The Next 30 Years.” It was heavily attended in Cato’s new state-of-the-art Hayek auditorium. Jim Dorn has ably directed it over its entire history.

Because of the conference’s breadth and depth, I can only provide some highlights.

Vernon Smith gave a brilliant Keynote Address on the history of bubbles. It was rich in slides, which filled the giant screen in the auditorium. It was a tour de force, and I look forward to seeing it in the Proceedings. Read the rest of this entry »

“Modern Market” Monetarism?

October 17, 2012

by Mario Rizzo

Douglas Irwin, a very fine economist at Dartmouth College, has a very puzzling opinion piece in yesterday’s Financial Times. The root of the puzzle is that Irwin seems to accept what I consider the naïve monetarist view, yet calling it by a new name “market monetarism,” that the effectiveness of monetary policy largely revolves around portfolio adjustment effects that are induced by an increase in real balances. (Isn’t this warmed over Pigou, and 1970s monetarism?)

What seems to be new is the “Divisa monetary indexes” which weight the different components of the monetary aggregates by their monetary services. In principle, this is what Milton Friedman talked about in his course “Money: The Demand Side” in the early 1970s. He said then that he thought it would be a good idea to weight the various components of the money supply by their “degrees of moneyness.” He did wonder, as I recall, if these weights would be stable over time.

Now, by this new measure, monetary policy has been tight. In fact, the money supply is no higher today than in early 2008. Read the rest of this entry »

Who Said This and When? Do You Agree?

June 29, 2012

by Jerry O’Driscoll

“Why is easy monetary policy such a sin? Because in such an environment, loans are cheap and borrowers can finance every project that they dream up. This results in excesses, and also increases the severity of the recession that inevitably follows when the bubble bursts.”

O’Driscoll and Rizzo Got There First

February 15, 2012

by Gene Callahan

I had believed that Tony Carilli and Greg Dempster (“Expectations in Austrian Business Cycle Theory: An Application of the Prisoner’s Dilemma,” The Review of Austrian Economics, 2001) made a major advance in Austrian Business Cycle Theory by hitting upon the correct solution to the challenge presented by, for instance, Gordon Tullock, who once wrote:

“The second nit has to do with Rothbard’s apparent belief that business people never learn. One would think that business people might be misled in the first couple of runs of the [Austrian] cycle and not anticipate that the low interest rate will later be raised. That they would continue unable to figure this out, however, seems unlikely.” (“Why the Austrians Are Wrong about Depressions”)

By posing the situation as a prisoner’s dilemma, where businessmen are rational to exploit the short-term profit opportunities offered by the boom phase (since if they don’t their competitors will) Carilli and Dempster adequately answered Tullock’s complaint. (I especially liked their solution because I independently had hit upon the same idea, which I was working out while writing my book, Economics for Real People. Well, I wasn’t the first to print, but at least I was the first to reference their paper!)

But yesterday, while editing someone else’s work, I discovered that Gerald O’Driscoll and Mario beat us to the basic insight by several decades, although they did not give it a game-theoretical formulation:

“[T]here are profits to be made from exploiting temporary situations. . . . Though entrepreneurs understand [the macro-aspects of a cycle] they cannot predict the exact features of the next cyclical expansion and contraction. . . . They lack the ability to make micro-predictions, even though they can predict the general sequence of events that will occur. These entrepreneurs have no reason to foreswear the temporary profits to be garnered in an inflationary episode. . . . From an individual perspective, then, an entrepreneur fully informed of the Austrian theory of economic cycles will face essentially the same uncertain world he always faced. Not theoretical or abstract knowledge, but knowledge of the circumstances of time and place is the source of profits.” O’Driscoll and Rizzo, The Economics of Time and Ignorance

Note: I still think what Carilli and Dempster did, in giving this a game-theoretic formulation, is great work. I just see it is not quite as original as I had thought.

Yes, Paul: It is Hayek versus Keynes

December 7, 2011

by Mario Rizzo

Although by the standards of contemporary economics, I am a historian of economic thought, I am not a historian of economic thought, properly considered. Thus my major interest in F.A. Hayek’s business cycle theory is not from the point of view of a historian. My interest is only incidentally in how Hayek’s contributions were perceived in the 1930s and 1940s, especially in light of John Maynard Keynes’s Treatise on Money and General Theory.

I am interested in Hayek’s business cycle theory because I believe it has much to teach us today – both in the style of reasoning it embodies and for its substantive points. Of course this is not to say that Hayek’s approach cannot be improved upon and revised in light of more recent theoretical and empirical developments.

But now comes Paul Krugman with his sometimes-echo Brad Delong (or is it vice versa?). Krugman thinks that Hayek was not an important “macro” economist; certainly not the rival or alternative to Keynes, either in the 1930s or today.  Read the rest of this entry »

Thomas Mayer: “I am an Austrian in Economics”

September 16, 2011

by Andreas Hoffmann

In today’s publication Thomas Mayer writes that he is “an Austrian in economics.” Mayer is the chief economist of Deutsche Bank Group and head of Deutsche Bank Research. Mayer argues that Austrian theory fits recent events well.  He suggests that

“Failure of the liquidationists to overcome the Great Depression of the early 1930s prepared the ground for an era of interventionist economic policies. Modern macroeconomics and finance nourished the belief that we can successfully plan for the future. But the present crisis teaches us that we live in a world of Knightian uncertainty, where the ―unknown unknowns dominate and our plans for the future are regularly thwarted by unforeseen and unforeseeable events. Read the rest of this entry »

Monetary Nationalism

September 12, 2011

by Jerry O’Driscoll

I recently read Money, Markets and Sovereignty by Benn Steil and Manuel Hinds. I highly recommend it. The jacket blurb accurately summarizes the book’s importance: “Benn Steil and Manuel Hinds offer the most powerful defense of economic liberalism since F. A. Hayek published The Road to Serfdom more than sixty years ago.”

Steil and Hinds focus on the institutional underpinnings of liberalism: the rule of law, globalization (free trade and free movement of capital) and commodity money. Their arguments on all points are powerful. Their argument on money runs against the grain of modern monetary theory. They rely heavily on history to buttress their arguments.

Reading the book motivated me to reread Hayek’s Monetary Nationalism and International Stability, upon which a good part of their monetary analysis is based. Though written in 1937, the book makes a powerful argument against the international monetary arrangements of the last 40 years: the 182 national fiat currencies.

Hayek argues the benefits of national fiat currency are largely illusory, and fiat money introduces problems unknown under the gold standard. For instance, Hayek, and Steil and Hinds explain why short-run capital flows can be destabilizing in a fiat money system, while they are stabilizing in a commodity standard. The two works follow the Misesian strategy of criticizing policies (or institutions) by demonstrating that they produce results different from or even the opposite of those intended by their advocates.

This year’s Cato monetary conference (November 16, 2011) will focus on monetary reform. Instead of a keynote address by a senior Fed official (a hallmark of past conferences), the opening address will be by Ron Paul. Panel I will be “Rethinking the Global Fiat Money System.” Chaired by Mary O’Grady of the Wall Street Journal, the panel will consist of Benn Steil, George Melloan and myself.

Are market rates below the natural rate again?

April 9, 2011

by Andreas Hoffmann and Mario Rizzo

We know from Wicksell’s (1898) Interest and Prices, there is something important about the interest rate that balances saving and investment in an economy over time. This equilibrium interest rate is called the “natural rate of interest”. When market interest rates are below the natural rate, an unsustainable credit boom which distorts the production structure in the economy and inflation are the result.

In line with this idea, most economists agree – today – that the Fed held interest rates “too low for too long” following the burst of the dot-com bubble. As expected, this contributed to a credit boom in the US economy. With the emergence of the crisis, the Fed lowered interest rates to stabilize the price level, financial system and output. Yet, a year of recovery is over and interest rates are still low. What about the natural rate today? Read the rest of this entry »

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