Mr. Carney, the Old Lady is not for tying

I found this caricature in The Times last Saturday (see below) and I could not resist the temptation to write a post on it. With a blog like this one, with its name, I had no other choice but to welcome and echo this caricature and its message. As I already explained in more detail here, I do believe that a  course on money and central banking could be taught by using these classical (and contemporary) caricatures as the main material of the course. They provide the political and historical context needed to properly analyse how different constraints/events have affected the policies conducted by the central banks along the modern history.

As J. Gillray masterly did it two centuries ago, here you will find again the (poor) Old Lady screaming and fighting with the authorities; represented this time not by the prime minister but by the next governor of the Bank of England, Mr. Carney. There are some other differences of course. In this new version of Gillray’s “Political-ravishment, or the old lady of Treadneedle-Street in danger!” (1797), the new governor is not taking some gold coins from her pocket but trying to keep the Lady well tied up and under his control. The Lady is obviously protesting and is struggling to free herself from the new ties imposed in the last years; ties which represent the new and extraordinary lending facilities the Bank has had to implement since the outbreak of the recent financial crisis to assist the banking system and the Government. True, many will say that the central banks, wisely acting as the lenders of last resort of the financial system, had no other alternative but to support the banking system and maintain the proper running of the payment system. Fine, I agree to some extent since, in the face of a major financial panic, the central bank must act firmly and timely to avoid the collapse of the financial system. But at some point these extraordinary policies will have to cease and the central banks will return gradually to normality in the coming years; which certainly will mean the adoption of a more orthodox monetary policy, one committed to maintaining the stability of the financial system but also the purchasing power of the currency. Let’s see if the new governor of the Bank of England succeeds and is able to extend the existing “ties” or even adopt new ones: an expansionary nominal income targeting strategy?, the adoption of a new, higher of course, inflation target?

Nothing new at all. Under the gold standard there were clear rules which prevented the central banks from printing too much money. In our days, under a fully fiat monetary system, one in which money is created out of thin air (or ex novo), those rules are even much more needed (though become blurred many times …); so, yes, somebody must tie the hands of the Government and those of its bank (i.e. the national central bank) not to overspend and overissue respectively, in order to maintain monetary stability and the purchasing power of the currency in the medium to the long term. Until relatively recently (in the interwar years), it was in the very nature of the central bank to limit the amount of money in circulation to preserve the value of its own currency in the markets. It was a profit maximising institution for quite a long time and that was the best policy to increase the demand of its money and thus its revenues (the seigniorage). However, as depicted in this caricature, this time it looks like the world is turning upside down, since it is the (next) governor of the Bank of England, the “manager” of the bank, the one who wants to impose his own (new) ties to the Old Lady to keep on running extraordinary policy measures in the UK.

Future will tell which vision prevails in the UK and elsewhere, the classical one which defines the central bank as a bank which provides essential financial services to the banking system (a sound money amongst them) or the modern view of the central bank as a major policy actor committed to a time changing basket of macroeconomic goals, either given by the government or not.

Paraphrasing Mrs. Thatcher’s very famous quote (1980), The Time‘s cartoonist has chosen a very clever title for this satirical caricature: “the Lady is not for tying“ (see below). Enjoy it.

Juan Castañeda

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Published in The Times, 4th May 2013. Business section p. 51. “The Lady’s not for tying”. By CD, after Gillray.

 

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A market solution for the Euro crisis

This month the Institute of Economic Affairs (London) has published a new book with a collection of essays of different authors on the crisis of the euro, edited by Philip Booth: “The Euro- the beginning, the middle … and the end?“. In these troubled times, dominated by those who only see more fiscal centralisation as the single way to overcome the euro crisis, this book is a true rarity; as, amongst others, it has several chapters with practical proposals to foster the introduction of more monetary competition to address and finally tackle some of the major problems affecting the European Monetary Union. And yes, I said “practical” proposals because, some of the chapters of the book do contain not only a description of the benefits of having more monetary competition in order to achieve more monetary stability in the medium to the long run, but also the institutional and market arrangements needed to be implemented in the current scenario in Europe.  A novelty indeed! In this regard, the proposal I support in the book (chapter 6), which consist of (1) at least the elimination of the legal tender clause and (2) the competition of the euro with the former national currencies, could be just a starting point in the right direction. Even more, we (profs. Schwartz, Cabrillo and myself) have calculated the costs of this alternative (more open) monetary regime and they are by far less than the costs we are all still paying just to maintain the current (flawed) system.

The publication of the book (12th April) was accompanied by the following (joint) statement of the contributing authors (see their names and  affiliations here):

“The euro zone as we know it must end or be radically reformed. Current mechanisms being used to manage the euro crisis are inadequate at every level. And as Cyprus shows us, the euro-zone crisis is far from over.

In new research from the Institute of Economic Affairs, The Euro: The Beginning, the Middle … and the End?, leading economists in this field, analyse the problems with the current approach being taken to resolve the euro zone crisis and argue:

• Product and labour markets in euro-zone member states are far too rigid to respond adequately to economic shocks. The result has been high unemployment and prolonged recession in a number of euro-zone countries.

• The EU must therefore face up to the inadequacies of its policies both in terms of the long-term structural errors in policy and of the short-term management of the euro-zone crisis.

• There should not be a debt union of any form. Governments must be responsible for servicing their debts without bailouts.

• Euro-zone countries must deregulate their labour markets and reduce government spending. Decentralisation and the promotion of a market economy must be at the heart of EU policy.

The report outlines several options for radical reform of monetary arrangements within the euro zone, including:

• A complete and orderly break-up of the euro and a return to national currencies combined with the vigorous pursuit of free trade policies.

• The suspension of Greece, and possibly other failing euro members, from all the decision-making mechanisms of the euro. These countries could then re-establish their own national currency to run in parallel with the euro. Both would be legal tender currencies with free exchange rates. Such an approach should be part of a more general agenda for decentralisation in the EU. This proposal mirrors the “hard ecu” proposal of the UK government before the euro was adopted as a single currency.

• The enforcement of strict rules relating to government borrowing and debt that all member countries would have to meet. Member countries who did not obey the rules would not be able to take part in the decision-making mechanisms of the ECB. Furthermore, the ECB should play no part in underpinning the government debt of member countries.

• A system of liberalised free-banking within which businesses and individuals choose the currency they wish to use.”

You can find more details on the book (and the full book free online) here, at the IEA website. The book will be presented at the IEA on the 9th of May (18:30); see more details here if you wish to attend.

I hope you find it interesting to promote the discussion on these important issues. All comments on our proposal on parallel currencies for the Euro zone will be very welcome.

Juan Castañeda

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“Central banks should do less, not more” (“Los Bancos Centrales deben hacer menos, no más”)

 ”Los Bancos Centrales deben hacer menos, no más”

Este es el acertado titular con que el periodista especializado en economía, Diego Sánchez de la Cruz, resume nuestra entrevista, que acaba de publicarse en Libre Mercado (10/3/2013). En un tiempo en que parece que todos piden al banco central que haga más, como si fuera una especie de Deus ex Machina  omnipotente capaz de sacarnos de la crisis y parálisis económica actuales, merece la pena recordar que fue precisamente el activismo y excesivo crecimiento monetario desarrollado en la última expansión económica lo que está en la base de los problemas que aún padecemos. Por eso, una vez solventada la crisis financiera (cuando quiera que ésto sea), convendría reflexionar sobre cuál es la mejor política monetaria para la nueva etapa expansiva que, en mi opinión, pasará por una reforma en profundidad de las reglas monetarias vigentes hasta 2007. Una política monetaria que sea menos activa y se centre en la estabilidad monetaria y no en el manejo de la economía, el control del ciclo (del “output gap”) ni tampoco la estabilización de los precios, menos aún si se hace persiguiendo un crecimiento (aunque sea moderado) de la inflación medida mediante el IPC.

Hablamos también de los recientes rescates bancarios, la política de préstamo (más o menos expreso)  de los bancos centrales a sus Estados, así  como de algunas alternativas al sistema actual de monopolio de emisión de moneda de curso legal controlado en última instancia por el Estado. Como siempre, vuestros comentarios serán muy bienvenidos en el blog.

Texto completo de la entrevista aquí:

http://www.libremercado.com/2013-03-10/juan-castaneda-los-bancos-centrales-deben-hacer-menos-no-mas-1276484372/

Juan Castañeda

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(A summary in English)

“Central banks should do less, not more”

This is the headline of my recent interwiew with the economic journalist, Diego Sánchez de la Cruz, just published in Libre Mercado (10/03/2013). In a time when all and sundry ask the central bank to do more, as if it were an omnipotent “Deus ex Machina”  able to overcome the current economic and financial crisis, it is worth remembering that it was central banks’ monetary activism and excessive money creation during the last economic expansion what ultimately caused a massive distortion in financial markets and led to the current crisis. As recessions and crises have its roots in the previous expansion, we should be discussing now which is the best monetary policy to be adopted in the next expansionary phase of the cycle (see here a summary of the debate in the UK). One less active and more focused on maintaining monetary stability and not the management of the economy, the stabilisation of the cycle (the “output gap”) or price stabilisation, let alone the stabilisation of a positive inflation target as measured by CPI.

We also discussed in the interview other “policies” of the central banks, such as the recent banks’ bailouts and the more or less explicit financial assistance to the(ir) States; finally, we also talk about some alternatives to the current monetary system ultimately controlled by the State. As always, your comments are very welcome.

Full access to the interview here:

http://www.libremercado.com/2013-03-10/juan-castaneda-los-bancos-centrales-deben-hacer-menos-no-mas-1276484372/

Juan Castañeda

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Monetary stability is what matters Mr. Carney

Quite a lot is being said and written recently on nominal income targeting. Mr. Carney, the new elected governor of the Bank of England, has had a primary role in it. Even though there has been a debate amongst academics and central banks’ analysts for quite a long time, his recent suggestion in a public speech (see here) of a nominal income rule for the conduction of monetary policy by the Bank of England has been the true milestone that have triggered the debate on monetary policy strategies across the world, and particularly in the UK. Almost everyday many commentators and columnists are analysing this question in prestigious and influential business papers such as Financial Times or The Economist. This is not surprising at all, as nominal income targeting is presented as an alternative to inflation targeting, the monetary strategy framework used de facto or officially by most central banks during the last business cycle expansion, the years of the so-called Great Moderation.

This debate is needed and essential for the conduction of a more stable monetary policy in the near future, but we should analyse in more detail what is being exactly proposed and for which purposes.

Just a transitory solution?

First of all, it is important to remember that Mr. Carney suggested the adoption of a nominal income rule as a new (and more flexible) policy framework to provide even further monetary stimulus to the economy. And, in particular, he has suggested a nominal GDP level target. However, following his own words, it can be interpreted as just a transitory policy proposal to allow the central banks the injection of more money in the economy. This is confirmed by the tone of the comments/articles published on his proposal, which evidenced a warm welcome by all and sundry. Just see below the reaction of The Economist  (“Shake´em up Mr Carney”) last week as an example, even suggesting a nominal GDP rate of growth target to be adopted by the Bank of England:

“That is where the nominal GDP target comes in. By promising to keep monetary conditions loose until nominal GDP has risen by 10%, the Bank would provide certainty that interest rates will stay low even as the economy recovers. That will encourage investment and spending. At the same time an explicit target of 10% would set a limit to the looseness, preventing people’s expectations for inflation becoming permanently unhinged. It is an approach similar in spirit to the Federal Reserve’s recent commitment not to raise interest rates until America’s unemployment rate falls below 6.5%”.

Following this article, there is no doubt that this strategy is taken as a mere temporary solution, just for the current (very much extraordinary) time:

“The last problem is Mr Osborne. A temporary nominal-GDP target needs his explicit support. He should give it, because against a background of tight fiscal policy, monetary policy is the best macroeconomic lever that Britain has”.

So are we just discussing about a temporary solution for an extraordinary scenario or are we proposing a permanent change of the monetary strategy followed by the Bank of England since 1998? The test to evaluate the true commitment of central banks to a more reliable and stable monetary policy rule will come when the economy enters into a new expansionary phase in the near future. At that time, a nominal income rule committed to monetary stability will prevent money and credit from growing as much as they both did in the past; so it will become much harder to follow it. We will see then how committed central bankers, academics and market analysts are to the conduct of this monetary rule.

Not a single but many nominal income rules

Secondly, there is no a single nominal income rule. Many considerations matter in its operational definition: it could be adopted either in terms of nominal GDP levels or in rates of growth; if just current indicators or alternatively expected variables enter into the decision-making process, it could be either a backward or a forward-looking rule; depending on the ability given to the central bank to react to (registered or expected) deviations from the target, it could be a passive (or non-reactive) or an active rule; the selection of the inflation and GDP growth targets obviously matter a lot, … . So, as some of their critics suggest, I agree that they could be used by central banks to inflate the markets in an attempt to manage again aggregate demand and real variables (see some on the critics here; made by a true expert in monetary economics, professor Goodhart). However, I do not agree with the critics on their entire dismissal of these rules, as they do not  have to be necessarily inflationary and destabilising monetary rules at all; quite the contrary!

You can find more detailed explanations on nominal income targeting and the reply to its most common critics in two excellent blogs on monetary economics: Scott Sumner´s The money illusion and Lars Christensen´s The market monetarist. I wrote a brief article on these rules in 2005 for the Journal of the Institute of Economic Affairs: “Towards a more neutral monetary policy: proposal of a nominal income rule”. As you will see there, I proposed a nominal income rule committed to maintaining monetary stability and not price stability; one by which (broad) money supply grows at the expected  rate of growth of the economy in the long term, and at the same time allowing prices to fall. As evidenced in a more recent paper written with professor G. Wood (see the full version here), its application would have led to much lower rates of growth of money during the last expansion of the economy and, on the other hand, it can be said that it would have avoided the sudden collapse in money growth since 2008. In sum, it would have provided both a (1) less inflationary and (2) more stable rate of growth of money.

Leaving the details (some very important indeed) aside, I do support a permanent change in the monetary policy strategy of central banks. It is time to abandon inflation stabilising rules that, as it is evident for almost all now, have not led to monetary nor financial stability.

A solid theoretical background: monetary stability rather than price stability

There has been a long debate and controversy amongst the supporters and critics of price stabilisation as a criterion for the running of monetary policy (2). F. A. Hayek masterly stated in the 20s and 30s how inflationary the application of that policy criterion could be in the presence of growing economies. As he explained, those central banks committed to maintaining price stability have to inject more money into the markets just to offset the (benign) deflationary pressures accompanying the expansion of the economy; which leads to a rapid (and unsustainable) growth of money and credit that finally distorts financial and real markets (the so-called “boom and bust” business cycle theory). However, since the end of WWII, and after three decades of fine tuning monetary policies and central banks subject to the financial needs of a growing State, the proposal and adoption of (low though positive) inflation targets since the late 70s was received as a blessing by mostly all; especially by the academia, who had been claiming long ago for a more consistent policy rule committed to price stability in the medium to the long run.

The american economist George Selgin followed Hayek´s lead and proposed in his excellent 1997´s “Less than zero. The case for a falling price level in a growing economy” (entirely available at the IEA´s site) what he called a “productivity norm”; which, in a nutshell, allowed for some (mild and benign) deflation when productivity and the supply of real goods and services are growing.

A discussion on monetary policy rules is essential to avoid some of the (monetary) mistakes made during the last expansion of the business cycle. We have already seen how the adoption of price stability as a policy target, or worse (CPI) inflation targeting rules, do not necessarily contribute to financial stability in the medium to the long run. J. A. Aguirre and I have proposed recently (see more details on our book here) another policy rule; one committed to monetary stability that prescribes money growth in line with the real growth of the economy in the long run, and allows for disinflation and even mild deflation when productivity growth increases the output of goods and services in the economy. Nominal income targeting may well be a (only one of them) way to implement it.

We have been waiting for a debate on this question for quite a long time and is indeed very much welcome.

Juan Castañeda

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(1) However, both in the oral and written evidence provided to the UK Parliament´s Treasury select committee this week Mr. Carney was much more conservative, and in fact supported the current “flexible inflation targeting” strategy of the Bank of England.

(2) As to the critique on price stabilisation rules, see some of my previous entries to the blog:

- “Central banks price stabilisation rules creates inflation”

- An a paper I wrote with Pedro Schwartz on this question: “Price stability does not always lead to monetary stability nor to financial stability” 

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Is nominal income targeting really on the table Mr Carney?

In a recent speech at Toronto, the next Governor of the Bank of England, Mr. Carney, has recently suggested (or better, implied) that nominal income targeting could be a better alternative monetary strategy to flexible inflation targeting. This is not trivial at all, and has not received enough attention in the media yet (amongst those who did, see Lars Christensen´s entry to his very interesting blog: “The Market Monetarist” from which I knew about it).

Mr Carney may have wisely identified one of the main flaws of  past monetary policy decisions and a major cause of the financial distress suffered in most developed economies since 2007/08: by targeting inflation and, even worse, CPI inflation, most central banks achieved price stability yes (thus defined), but at the same time credit and liquidity expanded too much and for too long worldwide. During the years of the expansion of world output prior to 2007 (during the so-called “Great Moderation” years), mainly due to significant technological progress and the huge development and growth of India and China´s exports of manufactured goods in international markets, a growing world supply of consumption goods and services led to quite stable and moderate (consumption) prices. However, at the same time (in particular, since early 2000s years), any measure of broad money growth showed an exceptional increase in liquidity, which distorted agents´s investment decisions and resources allocation. We now know how it badly ended in huge financial instability, massive output losses and employment cuts and even economic depression in some peripheral EMU countries. In a nutshell, as leading economists of the 20s clearly identified and stated (F.A. Hayek amongst them, or George Selgin in our days), in a growing economy, the conduct of a price stability rule does not guarantee monetary stability, nor financial stability. Contrary to what is commonly thought, it is not a necessary condition I am afraid (see more details here).

Unlike the standard “inflation targeting” strategy, the one adopted by the Bank of England (and many others) since 1998, a nominal income rule does not set an inflation target alone but a nominal income target. By doing so, the central bank would adopt the joint evolution of prices and real output as the policy target. Under this rule, if the economy is growing, an increasing supply of real output may be offset by decreasing inflation or even mild (benign) deflation, thus leading to a more modest nominal income measure, and thus less money growth. In my view, if adopted as a policy rule, this alternative monetary policy would have resulted in more modest and stable money growth (thus more money stability) and it may have reduced the likelihood of the massive dislocation of financial markets occurred in recent years. The theoretical basis of this rule can be seen in the work I published in 2005 for the Journal of the Institute of Economic Affairs, as well as its application in a more recent academic work I wrote with professor G. Wood. As stated in both works, a nominal income targeting rule is more compatible with monetary stability, a true necessary condition to achieve long run economic growth as well as financial stability.

There is a now a much clearer support for this type of rules. The reason is quite obvious: as real GDP is stagnated if not decreasing and CPI inflation is still moderate (roughly around 2%-3%), the conduction of a nominal income rule which targets the rate of growth of real GDP in the medium to the long run would produce higher rates of growth of money, being thus even more expansionary. This might be the reason why it is becoming a quite popular rule in our days. However, this is not all. In order to be a stabilising (sound and beneficial) rule in the medium to the long run, it should be fully symmetrical; so that in a context of a new phase of economic growth and disinflation (or mild deflation) liquidity growth becomes much more moderate than in the years prior to 2007. This will be the true test to this rule, if ever applied by central banks in the coming years.

Let´s see in the coming months if a very much needed debate on monetary policy rules is finally open in the UK or elsewhere. At least a major figure amongst central bankers has suggested it. Well done and good luck Mr Carney!

Juan Castañeda

PS. I want to acknowledge and thank Lars Christensen for his excellent blog on monetary economics (The Market Monetarist), from which I learned about Mr Carney´s speech.

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And then we all became economists …

One of the few positive consequences of the recent financial crisis is that people do know now much more about how markets work, on the scope and limits of Government intervention and, even more important, on the unintended consequences of ill-designed policies and bad regulation. We might not be fully aware of it now, but better informed people will be an essential requisite to better monitor and control discretionary and inflationary policies in the future. Those who have a degree in Economics will be familiar with what economists usually call  ”rational behaviour” or “rational agents”, who are able to escape from another very important concept, “money illusion”. Let me explain then very briefly.

Being rational in economics means that we make decisions by exploiting all the information and resources at our disposal in order to get a particular outcome (whichever the final goal is: increasing the value of a portfolio or that of a charity). This rational assumption does not necessarily imply that people cannot err; of course they can, but then they will learn by their own experience and incorporate past failures in order to improve how to make their expectations in the future. So the key point is that they cannot be cheated systematically! One example of this is the ability of people to react to anticipated inflation; after suffering substantial losses in the past, as a consequence of recurrent inflationary policies, people have learned that (1) real variables is what really matters in making economic decisions and that (2) printing money is not tantamount to prosperity or economic growth (quite the contrary!). In consequence, in a nutshell, in the face of excessive fiscal spending and money growth, inflation will be expected; so people, instead of keeping on increasing their spending more and more, will be saving part of their income in deposits and other financial assets adjusted to inflation in order to maintain their purchasing power along the time. By doing so they will not have “money illusion” and will act rationally.

People may have finally seen that the expansionary monetary policies conducted before 2007 led to inflation and provoked market distortions and major financial instability. Let´s see if we have learned this important and painful lesson of the recent crisis, so we can counteract these policies should they persist in the near future.

Finally, find here a very brief and funny (fiction) movie that depicts a conversation amongst traditional Spanish housewives (in Andalusia), who wisely discuss on the current policies to overcome the crisis in a typical and beautiful southern spanish “patio”. I wish most economic ministers and Governments´economic advisers had their knowledge and vivid conversation! Enjoy it:

- Hablando en Plata (Directed by Mikel Gil, “Producciones Varadas”):

http://www.youtube.com/watch?v=09YSNOsVebM

Juan Castañeda

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Quantitative Easing or the reinvention of the wheel

Much has been said about the QE operations conducted in the US and elsewhere in the recent financial crisis. Some have claimed they constitute a true revolution in central banking; some have even gone further to suggest that it is the beginning of a new monetary policy. And, also quite many still claim that these extraordinary monetary policy measures should not be applied as they are supposed to be highly inflationary by their own nature.

Just a very quick look at the modern monetary history in Europe and in the US will reveal how wrong those views can be. On the one hand, as tested quite many times in our economic history, yes, too loose monetary policies (via QE operations or other else) will result in inflation, but only if (broad) money grows much faster than real income. So, how inflationary QE will be in the coming years cannot be assessed without making a proper monetarist analysis. Monetary expansion will have other effects, true (in part, already addressed here). On the other hand, even though under a different name, with the current QE operations we are just “inventing the wheel” or, following the Spanish saying, “discovering the Mediterranean sea”.

As quoted from Geoffrey Wood’s “The lender of last resort reconsidered” (A paper prepared for a conference in honour of Anna J Schwartz. Washington, 14-15 April 2000), in relation to the 1825 panic affecting the british banks:

“There had been a substantial external drain of gold, and there was a shortage of currency.  A panic developed, and there were runs on banks.  The type of bills the Bank would normally discount soon ran out and the panic continued.  If a wave of bank failures were to be prevented, the banks would have had to borrow on the security of other types of assets. Of that change of policy Jeremiah Harman, a Director of the Bank, spoke as follows when giving evidence before a Parliamentary Committee in 1832.  The Bank had lent money “… by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances in Exchequer bills, we not only discounted outright but we made advances on the deposit of bills of exchange to an immense amount, in short by every means consistent with the safety of the Bank, and we were not on some occasions over nice”. Published in the Journal of Financial Services Research, 2000, vol. 18, issue 2, pages 203-227. See:  http://link.springer.com/article/10.1023/A%3A1026542821454.

So the Bank of England, already in the early 19th c., did conduct a truly active monetary policy to prevent the collapse of the banking system in Britain “by every possible means”; which included the purchase of stocks, public bonds, the discount of paper, … . And even most interesting,  Professor Wood (Cass Business School and University of Buckingham) provided in his work (written in 2000!) an excellent description of several successful application of the lender of last resort role of central banks that did prevent the collapse of the banking system without provoking (the supposed) hyperinflation. His work could have been taken as an excellent guide to make policy decisions from 2008 on.

The study of monetary history will do no harm to all of us at all, either academics or policy-makers. Quite the contrary!!!

Juan Castañeda

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Keynes and Hayek: A never ending controversy in funny videos (Econstories.tv)

Keynes and Hayek: A never ending controversy

A classic: what would have J. M. Keynes and F. A. Hayek said in the context of this major financial crisis were they alive? What would these “giants” of Economics suggest to tackle the problems arisen in the recent crisis?

Hayek

Well, we know quite well what Hayek would have probably suggested. Firstly, in relation to the diagnosis of the crisis, his theoretical works on the boom and bust crises fit very well with the current crisis. Moreover, his (Austrian) interpretation of the business cycles is very well-established in his works, mostly written in the 20s and 30s, and they have indeed received much more attention recently. So I do firmly think that he would claim some credit for the Austrian theory of the business cycle. As to his policy measures to overcome the crisis, I am afraid that he would probably suggest that the painful adjustment of the economy (including the liquidation of the so-called mal-investments, those associated with excessive money growth in the expansionary years) would have to take place, one way or another. And he would also possibly claim, as he did in his excellent works on money, central banks and the monetary system, that we should finally reform the nature of the monetary system with the introduction of more competence in the money market; which would imply the abolition of the legal tender clause of the national money(ies). This is exactly what he proposed in his Institute of Economic Affairs excellent “Denationalisation of money” in 1976.

Keynes

In relation to Keynes, we cannot be so positive about what he would have said. We know how pragmatic (and “case sensitive”) and even volatile Keynes could be, so we cannot really predict the policy solutions he would have proposed. This is exactly what Hayek claimed on the academic relation they maintained in the 30s. By the time Hayek was able to reply and contest a Keynes’ book or article, the latter had already launched another work with a different approach and even with a quite different perspective or theory. This was viewed by Hayek as a lack of consistency, something Hayek was not accustomed to and very much unusual for the very systematic Austrian theorist. Anyhow, if it were the Keynes of the General Theory, he would indeed ask the State to take firm steps in the running of the economy by the conduction of the aggregate (effective) demand. In essence, it would imply both (1) lowering nominal interest rates to the minimum and (2) then managing directly aggregate investment.

Another interpretation: some videos proposed

There is an excellent (and much funnier and entertaining) interpretation of their theories, and their application/adaptation to the current scenario, masterly made by John Papola and Russ Roberts in their very interesting and valuable “Econstories.tv” ‘s project. You will find below  several videos on the works and theories of these two economists, as well as interviews with excellent scholars on the works of this two excellent economists (see the interviews with Professor Lawrence White and Lord Robert Skidelsky).

- Video 1: “Fear the boom and bust”, at: http://econstories.tv/2010/06/22/fear-the-boom-and-bust/

- Video 2: “Fight of the century”, at: http://econstories.tv/2011/04/28/fight-of-the-century-music-video/

Enjoy them.

Juan Castañeda

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How money is created?

A conversation on money, central banks (and much more)

GoldMoney has just published a very interesting video on money and the current Eurozone crisis. In the video, James Turk interviews Professor Pedro Schwartz (San Pablo University, Madrid) on how central banks create money in our days and on the risks of the current expansionary monetary measures announced and developed by two major central banks, the ECB and the Federal Reserve of the US. As you will see, Professor Schwartz masterly explains how money is created “out of the blue” and why he thinks the ECB is actually disregarding its own Statutes, that clearly establish the prohibition of lending to any national government. How is the ECB doing so? Very easy; by purchasing public bonds of the States in crisis indirectly, in the secondary markets, and by accepting those bonds as valid and unlimited collateral in the conduction of the standard open market operations. Doing so the ECB is actually loosing its independence from political bodies and governments, and it is expanding its own remit; which was just to preserve price stability in the Eurozone, and not injecting money to foster GDP growth in the short run or to finance the State(s). Professor Schwartz also talks about the risks of inflation in the medium to the long term coming from the current (massive) injections of liquidity of central banks in the money markets.

In sum it is a very clear and interesting video that I do strongly recommend not only to any student of Economics, but also to anyone interested in how money is created in our days.

You will find below the summary of the conversation as extracted by GoldMoney.

Juan Castañeda

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“GoldMoney’s James Turk interviews Prof. Pedro Schwartz who is the president of the Economic and Social Council of Madrid. They talk about bank regulation, the creation of money out of thin air and the beauty of the free market system.

They discuss how banks have expanded despite of government regulation which Schwartz in large attributes to the granted privilege of fractional reserve lending. Using this procedure a bank can create loans above the actual amount of deposits at hand and therefore create new money. This also leads to fragility in the banking system and to boom and bust cycles. Schwartz argues for a leaner and more effective regulation of financial markets as the current regulation has not worked in regards to the financial crisis.

They talk about the “tennis” between the Federal Reserve and the European Central Bank when it comes to the creating money out of thin air. Schwartz states that the ECB is disregarding the rules that were aimed to guard it from being influenced by political pressure. Despite the opposition of the German Bundesbank they are buying government bonds. This is equal to digital money printing and Schwartz scents that it is not being done for monetary policy, but for the stimulation of the economy which goes beyond the original remit of the bank.

However despite the injections of new liquidity by the ECB Europe is still in recession, because interbank lending has dried up. That means that banks are parking much of the liquidity back at the ECB. The big question will be what will happen to inflation once the economy starts to pick up again and those funds find their way into the real economy. Schwartz also questions whether it is a productive business when banks can make a profit by borrowing money from the ECB at 1% interest and then turning around to buy government bond which yield 5% or 6%.

A serious inflationary disaster will only be prevented if governments will succeed in reducing their deficits and stop selling bonds. Schwartz states that cutting government spending is the only viable solution to the problem. To accomplish this there has to be a change in social mentality so that people recognise that nothing is free and that the government sector has to shrink. In the end the market is the most efficient mechanism of allocating resources according to the wants and needs of people.

This video was recorded on 14 September 2012 in Madrid.“

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(Summary from: http://www.goldmoney.com/video/pedro-schwartz-on-the-creation-of-money-out-of-thin-air.html)

 

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A chat on fractional reserve and monetary competition

This video was originally recorded in Spanish and released on the 15th of March 2012 at Vimeo (Spanish version). Then it was very kindly supported by the GoldMoney Foundation, so we could release an English version of the video on July this year, entitled: “The Spanish economic crisis”. I would like to thank GoldMoney very much for their support.

Link to the video:

http://www.goldmoney.com/video/the-spanish-economic-crisis.html

You can also find below a summary of the content of the video, as quoted from the GoldMoney website (research section).

Enjoy it! Comments very much welcome.

Juan Castañeda

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The Spanish economic crisis: ‘Yo Invito – ¿Dónde está mi dinero?’

What caused the Spanish economic crisis, and how safe is your money in banks? Maria Blanco, economist and member of the Instituto Juan de Mariana; Doctor in Economics Juan Castaneda; Marion Mueller, founder of OroyFinanzas.com; and Expansion.com journalist Miquel Roig discuss this and more over coffee at Madrid’s Café Gijón.

Fractional reserve banking, sound money, and the prospects for monetary reform in Spain and the wider world are the broader topics of conversation. Though the quartet are heartened that more and more people in Spain are taking an interest in economics since the country’s debt problems became apparent, they doubt that the kind of radical monetary reforms they favour would win support among many Spaniards. They are heartened though that elsewhere in the world – notably an increasing number of US states – the sound money cause is gaining support, albeit slowly, among citizens and politicians.

This video was recorded on 10 March 2012 in Madrid.

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