The ECB Creates Jobs for Central Bankers Instead of Safeguarding Financial Stability

by Karl-Friedrich Israel and Gunther Schnabl

The ECB’s zero and negative interest rate policy continues despite the economic upswing. An interest rate hike is not expected before autumn 2019. The extensive purchases of government and corporate bonds will have reached €2,600 billion by the end of the year. The ECB’s financial market supervision as part of the Single Supervisory Mechanism (SSM), which was created in 2014 in response to the crisis, is proliferating. Most recently, ECB vice president Luis de Guindos has expressed the intention to monitor the investment fund sector.

Distributional Effects of Monetary Policy: An Opportunity for Austrian Economics

by Sebastian Müller

For a long time, Austrian macro had a unique selling point in what might be called the ‘money matters’ view: referring to the notion that changes in the money supply by their very nature can never be said to be neutral. Yeager (1997) and Horwitz (2000) describe the Austrian stance as a “fluttering veil”. On the one hand, it incorporates the belief that prosperity cannot be generated through an expansion of the money supply in the long-run (long-run neutrality of money). On the other hand, changes in the money supply have real effects (short-run non-neutrality).

This proposition can be traced back to the works of classical economists such as Hume (1970), Mill (1909), Cairnes (1873), and Cantillon (1755).[i] In his essay on economic theory, Cantillon (1755) points out that an expansion of the money supply necessarily entails distributional effects as first receivers of the newly created money benefit compared to those ones further down the line.

Ten Years After Lehman (4): Chinese Imports

by Edward Chancellor*

Interest rates in China may never have turned negative, as they did in neighbouring Japan. Yet China’s economy has also become distorted by the decade of easy money since the 2008 financial crisis. As in the West, low interest rates in China are responsible for inflating asset prices, misallocating capital, aggravating inequality and undermining financial stability.

Ten Years After Lehman: An Interest-Rate Perspective

by Edward Chancellor*

Back in November 2002, Ben Bernanke, then a governor of the Federal Reserve, attended Milton Friedman’s 90th birthday party. In his writings, the legendary monetarist had pinned the Great Depression on policy failures of the American central bank. Bernanke was a keen disciple and apologised to Friedman on behalf of his employer, vowing that the Fed wouldn’t make the same mistake again. Less than six years later, Bernanke found himself at the helm of the Fed on that fateful day, Sept. 15, 2008, when Lehman Brothers collapsed. Another Great Depression beckoned. But now the Fed chairman was ready to make good on his promise.

The Irrelevance of Deposit Creation for Prices and Allocation: Comments on Selgin

by Arash Molavi Vasséi

In a previous post, Andreas refers to George Selgin’s recent discussion of the place of fractional reserve banking in the Austrian Business Cycle Theory (ABCT). There, Selgin takes a swipe at the monetary pillar of the ABCT. According to the Austrian model, fractional reserve banking is inclined to create money out of “thin air” and, therewith, admits investment spending in excess of “voluntary saving”. This imbalance, allegedly induced by a decline in reserve ratios, is reflected in a Wicksellian interest rate gap, which is supposed to impact prices and the allocation in a systematic way (the real pillar of the ABCT). Selgin argues that fractional reserve banking does not account for the Austrian business cycle, and Andreas expresses sympathy for this view.

Turkey’s Nominal GDP: No Recession?

by Andreas Hoffmann

These days many commentators suggest that in Turkey a recession is on the way. But nominal GDP has continued to grow along trend.

Glasner on Merkel’s Legacy

by Andreas Hoffmann

I enjoy reading David Glasner’s commentaries. But his latest post, “What Hath Merkel Wrought?“, is absolutely misleading (with regard to Merkel and German elections).

The Japanese Shinkin Banks Turn Away from the Regional Economy

by Taiki Murai and Gunther Schnabl

Similar to the credit unions in the US, the goal of the Japanese Shinkin banks is the promotion of the sound development of the regional economy. The members of these non-profit cooperatives are small- and medium-sized enterprises as well as natural persons from the respective regions of Japan. The Shinkin banks manage deposits, perform banking operations and make loans. Until the Japanese bubble economy burst in the early 1990s, they were the backbone of the regional economy in Japan. Since then, however, the business model has been gradually changing, driven by the Bank of Japan. The upshot is that the Shinkin banks’ business activities have been gradually turning away from the regions and, therefore, their original aim.

The Truth about Cash

by Jerry O’Driscoll*

For many years, pundits have been predicting the demise of cash for payments. Currency is bulky, dirty, subject to theft, etc. Making change at the point of payment is time consuming. The rise of e-commerce will surely bring about the demise of cash. Cash is passé.

Inflation Is Not Measured Correctly

by Gunther Schnabl*

The European Central Bank (ECB) continues buying securities. By the end of 2017, the balance sheet is expected to have further grown by about 800 billion euros. This corresponds to a growth rate of 20 percent per year, while real growth of the euro area is expected to be only 1.5 percent. Despite this tremendous monetary expansion, euro area inflation remains below the two percent target. This raises the question of whether the quantity equation, which Mark Blaug called “the oldest surviving theory in economics,” is still valid.

Unintended Monetary Policy Effects – Tale II: ECB Crisis Policies

by Andreas Hoffmann and Nicolás Cachanosky

The Federal Reserve’s (Fed) and European Central Bank’s (ECB) policy responses to the recent financial disasters offer two tales of unintended consequences. Our previous post outlined undesired effects of the Fed’s policies. In this post, we suggest that the ECB’s stabilization policy did not only fail to achieve its goals. Monetary policy has also hampered the structural adjustment of the European economy and prolonged the crisis.

The Bank of Japan Creates a State-Led Monopolistic Banking System

by Taiki Murai and Gunther Schnabl[*]

In the second half of the 1980s, 13 Japanese city banks climbed into the group of the world’s largest banks, boosted by a domestic speculation boom. With the bursting of the Japanese financial “bubble” in the early 1990s, a gradual decline followed. Since then, the Japanese city banks have been driven by Japanese monetary policy into a concentration process, which has produced new giants without increasing efficiency.

Two Tales of Unintended Consequences of Monetary Policy – Tale 1

by Nicolás Cachanosky and Andreas Hoffmann

Even when a policy is successful in achieving its desired ends, we have to consider its unintended and unforeseen consequences, resulting from cumulative market adjustments to policy changes that make it hard to judge the overall outcome of a policy in our complex economy. The Federal Reserve and European Central Bank’s monetary policy responses to the 2008 financial crisis offer two tales of major unintended consequences. This post discusses unintended outcomes of the U.S. Federal Reserve’s crisis policies. In our next post, we address ECB policies.

Globalization Alone Does Not Produce Losers!

by Gunther Schnabl*

The Brexit and the election of U.S. President Donald Trump were unexpected and were followed by a search for explanations. Subsequently, the common view spread that globalization is at the root of the frustrations of more and more people who are susceptible to strong nationalist statements from populists. This is surprising because for a long time, the reduction of trade barriers was acknowledged to be a basis for global prosperity. Why should the accepted view suddenly be so different?

Are we all Debt Liquidationists now? … No!

by Andreas Hoffmann

A growing number of economists suggest that governments in highly indebted countries should consider liquidating debt via financial repression. In other words, they want governments to intervene in financial markets and push government borrowing costs below the rate of inflation to erode the real value of debt. In a previous post, I argued that financial repression is dangerous and a drag on growth. This post explains why we can be hopeful that, despite a rise in popularity, the debt liquidationists will not succeed in putting their ideas to work. Debt liquidation via financial repression would necessitate far-reaching regulation or drastic measures, both of which seem unlikely in the US.

Beware of Financial Repression

by Andreas Hoffmann

Government debt levels in many advanced economies, especially in Southern Europe, in the US and in Japan, have reached peacetime records. People are worried and rightly so: C. Reinhart and K. Rogoff have provided evidence that elevated debt-to-GDP ratios may contribute to stagnation or even debt crises. As austerity policies are unpopular with voters and growth remains rather sluggish, Reinhart and Rogoff suggest that governments might have to consider other options to reduce debt-to-GDP ratios. Debt should be liquidated via financial repression. It’s how governments typically dealt with high levels of debt in history, they say. This time is not different.

The Blanchard Danger

by Roger Koppl

Oliver Blanchard tells us “Where Danger Lurks”  in the macro-finance world.

The big theme is nonlinearity, which is a profoundly conservative move: DSGE modeling is just fine and we don’t need to rethink it at all. We just need to add in some nonlinearities. Blanchard does not tell how to calibrate a model with extreme sensitivity to initial conditions. But if the system is chaotic, it is also unpredictable, so how can you pretend to merely add nonlinearities to DSGE models?  It seems like a pretty direct contradiction to me. I mean, you can have the model in a trivial sense, of course. But calibration is an empty exercise that will not let you look around corners.

Blanchard’s second main message is alarming: We do need theoretical innovation, however, in measuring systemic risk. In the modern network literature on financial markets and cascades, one key point is risk externality. My portfolio choice makes your portfolio riskier. We need two things to fix this market failure. First, we need Pigou taxes, which cannot be calculated unless everyone tells the regulator his portfolio so that it can measure systemic risk and calculate a separate Pigou tax for each financial institution. Second, we need to reduce systemic risk. (“[S]teps must be taken to reduce risk and increase distance” from the “dark corners” of the macro-finance system.) In the network literature I suspect Blanchard is alluding to, this is to be done (at least in some of the articles) by having the regulator directly control the portfolios of financial institutions. (Names include: Acharya 2009; Beale et al. 2011; Caccioli et al. 2011; Gai, Haldane,and Kapadia 2011; Haldane and May 2011; and Yellen 2009, 2011)

I take a rather different view of both economic theory and the crisis in my recent IEA Hobart paper From Crisis to Confidence: Macroeconomics after the Crash.

Overall, Blanchard’s message is meant to be reassuring: We the smart macro-finance experts have now got the message on nonlinearities. So no further need to worry, we’ve got the situation in hand. To keep the system out of the “dark corners,” however, we will need more discretionary authority. You don’t mind trading off a bit of financial freedom for greater financial safety do you?

The Macroeconomics of Food Stamps

by Mario Rizzo

The expansion of food stamp eligibility in response to the Great Recession was part of the so-called stimulus package. There were several aspects. First, there was a simple increase in the maximum amount allowed to beneficiaries of about 14%. There was also a tremendous drive to get people who are eligible, but did not get food stamps, to apply and get them. Then there was a loosening of eligibility requirements in some states. Finally, there was the increase in unemployment resulting from the recession and thus an increase in the number of eligible people.

In 2007 the number of people on food stamps was 26 million. Today it is about 48 million! But look more closely at the data (in thousands):

2008	28,223
2009	33,490
2010	40,302
2011	44,709
2012	46,609
2013	47,637

The reader should note that, even as unemployment has declined, the number of food-stamp recipients has increased. Based on decades long trends we should have observed a significant decrease in the number of recipients.

The Return of Inflationism?

by Mario Rizzo

The Fed has become desperate, not because the American economy is currently falling apart, but because the economy has stubbornly failed to respond well to the policies of the “best and the brightest.” And now, as if to welcome the impending chairmanship of Janet Yellen, stories are surfacing in various places about the growing consensus inside and outside of the Fed for inflation. There is not enough inflation to stimulate adequate economic growth. Just a little more, or maybe even a lot more (perhaps as high as 6 percent) is needed as Ken Rogoff of Harvard is suggesting.

The arguments being used today are not exactly the same as those of the 1970s, yet I have the feeling that I have been here before.  It is important to distinguish theory from what policy economics is about. Policy economics often comes down to rather simple ideas. The real world has a way of making a mockery of today’s sophisticated macroeconomic theory. For one thing, policy has to be relatively simple if it is to be transparent.

Lawrence Klein: Keynesian Economist Who Wanted to Sidestep the Constitution

By Richard M. Ebeling

Nobel Prizing-winning Keynesian economist, Lawrence Klein died on October 20, 2013, at the age of 93. A long-time professor of economics at the University of Pennsylvania, he was awarded the Nobel Prize in 1980 for his development of econometric (or statistical) models of the United States “macro” economy for purposes of prediction and “activist” government policy making.

 

He also was a senior economic advisor to Jimmy Carter during his successful run for the presidency in 1976, but Klein declined a position in the Carter Administration for fear of the negative publicity from his membership in the American Communist Party in the 1930s. 

 

What is less well known today is that immediately after World War II he was one of the great popularizers of the “new economics” of John Maynard Keynes, especially in his widely read book, The Keynesian Revolution, published in 1947.

 

Keynes’ Conception of Government as Savior

In The General Theory of Employment, Interest, and Money (1936) Keynes had argued that the market economy was inherently unstable and susceptible to wide and unpredictable swings in output, employment, and prices. Worse yet, he asserted, the market could get stuck in a prolonged period of high unemployment and idle resources. Only judicious government monetary and fiscal policy could assure a return to sustainable full employment.

Cyprus

By Jerry O’Driscoll

 

Cyprus is the latest country to succumb to the financial rot in the European Union. Once a banking center, its citizens now cannot pay for their own imports. Exporters are demanding cash only for goods sent to Cypriote businesses. Credit has dried up. Businesses are closing because they have no goods to sell.

The economic crises in the various countries have fallen into two types. In the first type, highly indebted governments experienced fiscal crises and could no longer service their debts. Banks had lent to these governments and their condition was impaired by the value of the government bonds falling.  The economies went into recession, which was aggravated by higher taxes and enhanced collection of taxes. Greece is the poster child for a financial and economic crisis begat by a fiscal crisis.

Easy Money, Slow Growth

by Jerry O’Driscoll

In today’s Wall Street Journal, John Taylor explains why the U.S. recovery has been tepid while money growth has been very rapid. The recovery has set records for its weak pace, while money growth has set records for its rapidity. Taylor supplies some of the numbers.

Taylor continues an argument he made at the November 2012 Cato Monetary conference. It is the Fed’s policy that is causing the anemic recovery. To quote, “while borrowers like near zero interest rates, there is little incentive for lenders to extend credit at that rate.” He analogizes the Fed’s fixing interest rates to a policy of price ceilings on housing rents. Lenders supply less credit at the lower interest rates, as landlords supply less housing services under rent controls.

Taylor also notes that the Fed’s policy interferes with the signaling of the price system. It distorts capital allocation. Any decently trained micro economist would understand this. Why cannot the backers of the Fed’s policy?

Clarifications of the Austro-Wicksellian Business Cycle Theory

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:  

Raise Middle Class Taxes Now!

by Mario Rizzo

I now favor expiration of the Bush era tax rates for everyone.  Why? Because the only way to curb spending in the long run is to make as large a number of Americans as possible truly feel the consequences of the expenditures they appear to desire.

If Americans saw the cost of the gigantic welfare state in their paychecks, they would, I am confident, radically re-evaluate the expenditure side of the situation we are in. Then when someone comes up with a genius idea for spending, the people would think: Is it worth higher taxes? Might I not spend it better on my family, my church – or even – on… champagne?

Money and Government

by Jerry O’Driscoll  

The 30^th annual Cato monetary conference was held in Washington, D.C. on November 15^th. 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.