MA growth rises to 9.27%

Our "Austrian" measure of the money supply showed growth of 9.27% in June, relative to last year. This is the highest rate since August 2014, and follows fairly stable growth of6%-8% since 2014.


Selgin on kaleidics 

"According to Shackle, the future is unknowable and 'kaleidic' (that is, dominated by patternless changes)"

George Selgin

I travelled to Madrid recently and caught up on some reading about Austrian school methodology. One article that particularly stood out was George Selgin's "Praxeology and understanding: An analysis of the controversy in Austrian Economics" (published in 1988 in the Review of Austrian Economics, and subsequently turned into a short book). I absolutely loved Selgin's defense of praxeology: (p.42)

Indeed. The challenging part though was Selgin's warning to "kaleidic" economists:

it is utterly contradictory for upholders of the doctrine that the future is kaleidic to involve themselves in theoretical doscussions, especially when such discussion refer to institutions such as banks of money or to classes of events such as the trade cycle or inflation (p.48)

Selgin's basic point is that praxeology beats kaleidics, and if you have to "temper" kaleidics to retain praxeology, it's no better than mere historicism. Those of us who adhere to Mises' distinction between theory and history; who favour explanation over prediction; and look for pattern changes rather than single point estimates; are thus not truly "kaleidic" economists. OK, fair enough. But there may still be an advantage to getting as close to radical subjectivism as one can get without falling down the black hole of nihilism. The world probably isn't kaleidic, but it may well be more kaleidic than the vast majority of economists are wont to admit. And at important moments it can appear kaleidic. Shackle may be presenting a view - something we can incorporate, without having to fully adopt. After all a kaleidiscope isn't "patternless". It's just highly complex, prone to unanticipated readjustment, and this impossible to forecast. According to Richard Wagner a "kaleidic" view of economists is simply one that takes time seriously, and sees turbulence as the "unavoidable incompleteness of intertemporarl coordinaiton". Yes!


Beckworth on the ECB and the crisis

The main purpose of this post is to promote David Beckworth's recent paper, The Monetary Policy Origins of the Eurozone Crisis. He presents a "standard view" of the crisis: a 2008 financial panic, which originated in the US, spread to the Eurozone causing a recession. In fact, he plausibly argues the monetary policy errors by the ECB caused an economic slowdown, which then caused the sovereign debt crisis. I recommend the whole article. He says,

This paper has argued that the ECB’s tightening of monetary policy in 2008 and again in 2010– 2011 caused the Eurozone economic crisis...

The ECB’s big mistake was in responding to these changes in inflation as if they were symptoms of a demand shock when, in fact, they were symptoms of a supply shock.

I totally agree that ECB policy decisions played an important causal role in the Eurozone crisis, and I endorse the conclusion that an NGDP level target target would work better. 

My only gripe is that I believe the lions share of the blame should be placed on the monetary regime that they were following (i.e. inflation targeting), rather than the decisions being made within that regime. In other words I don't think that the ECB are really to blame.

It's true that within an inflation targeting regime, policy makers have discretion to "see through" obvious supply shocks. The Bank of England "saw through" a very long period of above target inflation from 2010-2013. But there's two crucial point of difference between the ECB and other central banks, which constrains its actions.

One is that it doesn't have the ability to buy sovereign debt from the Eurozone as a whole. The reason for the ECB's slow uptake of QE is primarily due to the political implications of choosing what portfolio of sovereign debt to buy. It's signficantly easier for the US, UK, Japan etc. So to some extent the ECB had its hands tied in terms of the tools at its disposal.

But the second crucial point of difference, and more relevant to the 2008 and 2010/11 decisions to raise interest rates, is the fact that the ECB is a new institution with an explicit inflation-only mandate (i.e. its target). In particular, the ECB was tasked with keeping inflation below 2%. For most of its early years, this was reasonably successful. In May 2001 inflation hit 3.1% (and interestingly they decided to see through it, so maybe my point is totally facile), but aside from that single month inflation was under 3% from their creation right up until November 2007. By July 2008 it has reached 4.1%, which is double the upper threshold of its target. So this is the first real test of the strength of independance. A decade of suspicion that the ECB would cave in to political considerations for easy money was now under scrutiny. They cannot refer to unemployment as part of any dual mandate, because they only have a single mandate. Saying that they will see through inflation is akin to saying they don't see it as a problem. I can understand why they raised rates because in a "One Target One Tool" framework that's what you do when inflation is high. Especially when you're trying to create a reputation for being inflation hawks.

The US is a great counterexample. Whilst Bernanke cashed in the Fed's credibility by appearing at joint press conferences with Paulson (and doing so much that he could be accused of making matters worse), the ECB did too little. But they didn't have the option of a joint press conference with a Eurozone Minister of Finance, and if they'd ignored their inflation-fighting mandate they'd have jeapordised their raison d'etre.

When David promoted his paper on Twitter, he said

Imagine ECB eased in 2008 & 2011 instead of tightening and did QE earlier. If so, would Brexit be a thing?

I glibly replied,

if ECB totally disregarded its mandate and opted against building credibility would *it* be a thing?

I believe that if they had eased it would have cast serious doubt on the ECB's independence. The impact of their decision was terrible, but I understand why they made it. Indeed if the lesson is that they should have exercised more discretion the implication is that we need different people in charge. On the contrary, we need a different regime. The ECB failed because they were set up to fail.

P.S. I've been listening recently to David's podcast "Macro Musings" - it is really good. I enjoy Econ Talk but when they're over an hour long I struggle to get through them quickly enough. And because I can't be bothered to spend time identiying the ones I have an interest in I've actually stopped listening. By specialising on monetary economics I know that I will want to listen to each new episode of Macro Musings, and it's quickly become a favourite podcast. It's a brilliant substitute for a faculty lounge for those of us outside academic econ departments, but David ensures that key terms are defined and content is provided so non academics can get a lot out of it. I can't recommend it highly enough.

P.P.S. I can't believe my last two posts have been criticising Lars and David, and defending Carney and the ECB. It's been a long academic year and I clearly need some rest!


Brexit, regime uncertainty, and monetary policy

In light of Brexit, Lars Christensen has called on Mark Carney to adopt a 4% NGDP target. In doing so, he has argued that the result of the vote has increased regime uncertainty, which constitutes a negative supply shock. I disagree.

In a previous post Lars criticised the concept of regime uncertainty on the grounds that it was too Keynesian:

Higgs’ description is – believe it or not – fundamentally Keynesian in its character (no offence meant Bob): An increase in regime uncertainty reduces investments and that directly reduces real GDP. This is exactly similar to how the fiscal multiplier works in a traditional Keynesian model.

I don't see the problem. For me, an advantage of regime uncertainty is that it puts flesh on the bones of Keynes' "animal spirits". Rather than waving your hands and talking about the confidence fairy, regime uncertainty offers a clear mechanism to show how policy announcements can impact the economy. And that impact is not damaging the potential growth rate per se, but altering the immediate spending decisions of market participants. The two concepts are closely related - regime uncertainty will undoubtedly cause potential growth to fall. But in the first instance regime uncertainty affects aggregate demand.

Another way of putting this is that in the equation of exchange, MV=PY, there are two types of aggregate demand shock. Either the money supply can change (i.e. M), or "velocity". Technically, the definition of velocity is anything that affects PY holding M constant. Practically, this means shocks to spending that aren't brought about by changes in the money supply. In other words, they are changes in the demand to hold money.

My claim is that we don't need to alter what Higgs means by regime uncertainty to preserve a monetarist framework.

In a separate post, Lars says that,

First of all, it is clear that Brexit has caused an increase in particular demand for US dollar and other safe assets. This is essentially a precautionary increase in money demand and for a given money base this [is] a passive tightening of monetary conditions.

Secondly in my view, more importantly, the increase in regime uncertainty should basically be seen as a drop in the expected trend growth rate in both the UK and the euro zone. This means that we should expect the natural interest rate to drop both in the UK and in the euro zone and maybe even globally.

I don't believe there's a need to combine these two valid points.

I agree that the surprise referendum result has generated uncertainty about the future institutional structure of the UK. And it is not just economic uncertainty, it is policy uncertainty. In fact, it's not just policy uncertainty, it's bona fide regime uncertainty. Lars' first point is that regime uncertainty, and the typical response to uncertainty - hoarding cash, buying gold - constitute an increase in the demand for money. This means that V has fallen, and this ceteris parabus so has (MV). I agree with this, but view it is a negative AD shock.

This regime uncertainty is likely to lead to lower growth prospects, but there are many things that affect future growth other than regime uncertainty. Indeed there's widespread certainty that regardless of the type of deal the UK get, and who the Prime Minister will be to negotiate it, Brexit will be economically damaging. Our future productive capacity has been dented by reduced economic cooperation with the EU. Thus Lars' second point that expected trend growth has collapsed is also true. But I don't see this as part and parcel of regime uncertainty. I see it as a separate shock.

The fact that sterling has weakened doesn't demonstrate that regime uncertainty is a negative supply shock, it just suggests that the negative supply shock has thus far dominated the negative demand shock. And I would give credit to Mark Carney for minimising the impact of regime uncertainty - he has calmly and credibly signalled that interest rates are more likely to be cut rather than increased. He hasn't said "a negative supply shock will put upward pressure on inflation and we will carefully monitor inflation expectations to ensure they remain anchored". Rather, he's said "we won't let AD contract". Perhaps he is a closet NGDP targeter after all!

Whilst I'd like to see the Bank of England adopt an NGDP target, unfortunately I don't see the present environment as being especially fertile. And crucially the reason is that inflation is currently well below target. If inflation was on target then whether Brexit constitutes a supply shock or a demand shock would matter because an NGDP target would imply a different policy response to an inflation target. For example, if inflation were currently 2% then a negative supply shock would cause an inflation targeting central banker to tighten policy.But an NGDP targeter would see no reason to change the policy stance. Thus a closet NGDP targeter might be tempted to jump ship. But inflation is 0.3%, and the Bank of England have plenty of room to permit supply shocks to manifest themselves without tightening. The regime doesn't really matter right now.

Finally, Lars says "In a Market Monetarist set-up this [a Keynesian view of regime uncertainty] will only have impact if the monetary authorities allowed it" which is true. Fortunately, however, Carney seems willing to offset regime uncertainty.


Brexit shows the value of scenarios

When the result of the UK referendum on exiting the EU (Brexit) was announced, the FTSE 100 immediately fell by 8.7% and sterling fell around 8% relative to the dollar, and down 5% against the Euro. Clearly, markets were surprised. But why? Even though opinion polls and betting markets indicated that "Remain" would win, it was hardly like Leicester winning the Premier League. I think the problem comes down to mindset.

The debate between opinion polls and prediction markets is essentially a debate about forecast techniques. Although useful, they drive attention to narrow outcomes. Billions of pounds were clearly hinging on a a few percentage points spread. This implies that in future we need better quality opinion polls and better functioning prediction markets, and lots of money can be made from better probability values.

However I'm pleased that the failure of forecasting has generated increased attention and utilisation of the scenario method. A scenario planner doesn't care what the probability of Brexit is. We simply didn't know. What we did know, was that one of two possible outcomes could happen - a Leave vote, or Remain. Therefore plans should be made around both. As an economist, I was routinely asked in the buld up to the vote "do you think we'll leave?" This is based on a forecasting mindset. I tried to say "I don't know", but it's hard not to weigh in with a (flawed) prediction. The better question would be "what should we do if we leave, and what should we do if we remain?"

Now that the result is in, the uncertainty is not over. The manner in which Brexit will occur, if at all, is the topic for discussion. And thus far no one has asked me "what do you think the most likely arrangement will be?" At heightened uncertainty, you only really have scenarios. Hence newspapers are discussing "The Norway option" or "Article 50 isn't triggered" or "Scotland has another referendum". Scenarios are the go to framework.

I don't meen to disaparage polls or markets. Both tell us different things, and are useful. But it's clear that too much money was riding on their predictive power, and we should be humbled by that. I am encouraged that people are thinking in terms of scenarios, and hope the economics professsion does the same.