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Broad money growth (M3, Shadow Government Statistics) in the US keeps on decelerating since the end of 2015. As reported in the latest Monthly Monetary Update (Institute of International Monetary Research, IIMR), ‘In the final quarter of 2016 US M3 grew at an annualised rate of 2.2%. This follows on from a mere 0.9% in the three months to November, the slowest annualised quarterly growth rate in over five years. 2016 ends with US broad money growing at an annual rate of 4.0%, which is respectable, but down on 2015’s figure of 4.3%. In mid- 2016, the figure was 4.5%. The subsequent slowdown in broad money growth has been primarily caused by “quantitative tightening” ‘.

money-growth-us

 

 

 

 

 

 

 

 

Source: January Money Update, IIMR

 

What is ‘Quantitative Tightening’? As stated in the IIMR’s January money update cited above ‘ (…) “quantitative tightening” (i.e., the reversal of quantitative easing) when it allows its stock of asset-backed securities to run off at maturity. The Fed can use proceeds from the maturing ABSs to reduce its cash reserve liabilities to the banks rather than to finance new, offsetting purchases of securities.’ (See the January Monetary Update, IIMR). What we do not know yet is whether the Fed has intentionally pursued such a monetary contractive policy, or rather it is just the (indeed surprisingly unnoticed) consequence of the fall securities in its balance sheet when they reach maturity. As far as I know the Fed has not made a public policy announcement in this regard nor committed to such policy.

Why does this matter? Well it does matter when the medium to the long term correlation between money growth and nominal income is acknowledged. Of course it is not a mechanical or a one-to-one correlation,  and indeed time lags should be taken into account; anyhow in an environment where the demand of money is fairly stable, changes in the rate of growth of money do translate into changes in nominal income. Table below shows such empirical relation in the US in the last five decades:

nominal-income-and-money-us

 

 

 

 

 

 

Source: January Money Update, IIMR

 

Thus should this weakening in money growth in the US continue in the next quarters it will most likely have an impact on economic growth forecasts. This is subject to several caveats though; the new US administration has already announced a profound change in bank regulation which may well ease the pressure put in the midst of the Global Financial Crisis on small and medium size banks particularly to expand their balance sheets. If this materialises in the near future, the creation of more bank deposits in the economy could offset the monetary contractive policy followed by the Fed in the last few months, intentionally or not.

 

Juan Castañeda

 

 

 

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As announced last month on this blog, you can find now the video of the IIMR 2016 Public Lecture given by Charles Goodhart (Financial Markets Group, LSE) available on the Institute of International Monetary Research website: http://www.mv-pt.org/2016-lecture-and-conference

Professor Goodhart, indeed a distinguished academic figure in monetary economics in the UK and a former member of the Bank of England’s Monetary Policy Committee, criticised many features of monetary policy-making both before and after the sharp global downturn of 2008 and early 2009. He also underlined some of the most important flaws in current macroeconomic models:

(1) The use of macroeconomic models with no money, nor a banking sector.
(2) No analysis of the monetary transmission mechanisms via the banking or the wider financial sectors.
(3) The assumption that there is a direct correlation between changes in the monetary base and changes in the amount of money.

In my view those flaws are yet to be properly addressed and if we could just agree on those very simple points we would make a major progress in current monetary economics! And we will very much reduce monetary instability and thus minimise the risk another financial collapse.

Just a final note on the Institute of International Monetary Research. Its main purpose is to demonstrate and to bring public attention to the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other. The Institute has been established in association with the university of Buckingham and is heavily involved in the analysis of banking systems, particularly their role in the creation of new money balances. You can subscribe to its newsletter and publications here: http://www.mv-pt.org/contactus

Juan Castañeda

PS. The text with the lecture will be available soon at the IIMR website.

 

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Did you know that central banks have not always been State-owned banks? The vast majority of them were in the hands of the public before the wave of nationalisations that took place right after the end of WWII. And the system did not work bad at all; the record of both price stability and financial stability before 1913 was certainly impressive. True, bank panics also occurred but the different response taken to such crises is the key to understand the pros of a monetary system fully in the hands of the public and market participants. And, a regards price stability, from approx. 1870 to 1913 most developed (and other less developed) economies ran the gold standard as the rule to determine the amount of money in the economy; a standard which very much tied the hands of central banks and governments as regards money creation. The outcome of the running of a system which preserved monetary stability for a 50 year-time period limited was (not surprisingly for any monetary economist!) was true price stability (by true, I mean that the price level in 1870 was roughly similar to that in 1913), and a growing and rather stable financial system on the whole.

Why was such a ‘miracle’ possible? There is no mystery nor secrecy about it at all! It was the establishment of the right institutions and policies to discipline both the Treasury and a highly independent (actually privately-owned!) central bank what explains such a favourable outcome. And, did you know something even more striking? Several central banks are traded in the market in our days in different ways: the Swiss National Bank, Belgium Central Bank, Reserve Bank of South Africa, Greece Central Bank and Bank of Japan. Historically speaking as I said above this is not an anomaly but the norm before the 1940s. Given the poor record of our monetary authorities since then and the miss-management of the recent financial crisis, why not extending private ownership even further and thus mitigate the threats of a politically-exposed (some will say ultimately ‘controlled’) central bank?

In an interview with Standard and Poor’s, ‘New way forward or outdated anomaly? The future of publicly traded central banks’ (S&P Global. Market Intelligence), I advocate for central banks to return to the public and the banking sector, in order to guarantee their independence from governments and thus be able to achieve a more sound and stable monetary system. You will find the arguments in favour of a more independent central banks, owned by market participants in many references. Here I will just mention two of them, one written by Tim Congdon (Chairman of the Institute of International Monetary Research), Central Banking in a Free Society (IEA), and the other by myself with Pedro Schwartz (Visiting Professor, University of Buckingham), Central banks; from politically dependent to market-independent institutions (Journal of Economic Affairs); both pieces written in the midst of the Global Financial Crisis (2008-09) and the observed mismanagement of the lender of last resort function of central banks.

Find below an extract from the interview with my arguments:

‘Those in favor of privately owned central banks say such institutions would be better equipped to preserve market stability and could help prevent future financial crises.

“If publicly traded or owned by the banking sector … the market incumbents will have a genuine interest in setting clear … rules for the central bank to maintain financial stability over the long term,” said Juan Castañeda, director of the Institute of International Monetary Research at the University of Buckingham in England.

In the event of another financial crisis, a central bank would be fully independent to intervene at a bank in need, and any injection of capital would come from the banking or private sector, Castañeda said. Situations like the nationalization of Northern Rock by the Bank of England at the outset of the global financial crisis could be averted were central banks not in public hands, he argued.

“Those are the things that you can avoid if your central bank is publicly traded,” he said, citing the late 19th century example of U.K.-based Barings Bank, which faced bankruptcy but was saved by a consortium of fellow lenders, helping to stave off a larger crisis.

Oversight of a central bank would belong to the bank’s shareholders, although national authorities would also have a say because of the bank’s management of monetary policy and financial stability.’

It is not surprising Tim Congdon and myself advocate for more independent central banks (privately-owned) as a way to protect them from political interference in the development of its functions. I do believe this would contribute to a more sound running of monetary policy and to less financial instability in the future. If publicly-traded or owned by the banking sector (following the US Fed model), market incumbents will have a genuine interest in setting clear mandates/rules for the central bank to maintain financial stability over the long term. Should another financial crisis occur in the future (that it will), the central bank will have free hands to intervene promptly and avoid the contagion of panic in the market (by the application of its lender of last resort function). And if any injections of capital were needed, it would be the banking sector (or the private sector as a whole) which would bail-in the bank in crisis and, most likely, taxpayers’ money will not be needed again.

Of course this alternative arrangement is fully compatible with the central bank be given statutory functions (such as an inflation target for example) and be subject to parliamentary oversee; so the Governor will have to answer not just to the Bank’s shareholders but to Parliament as well in relation to the running of monetary policy and financial stability (find further details on these arrangements in Congdon’s 2009 work mentioned above).

Juan Castañeda

PS. An excellent narrative of the flaws of the current system can be found in Milne and Wood (2008)’s  analysis of Northern Rock bank crisis in the UK.

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The Institute of International Monetary Research (IIMR, affiliated with the University of Buckingham) is holding an international conference on the assessment of Quantitative Easing (QE) in the US, UK, Eurozone and Japan on the 3rd of November (London). In the last few years a return to a more conventional set of monetary policies has been widely heralded, and in particular the return to a monetary policy rule focused on monetary stability and the stability of the overall economy over the long term (see the excellent conference organised by CATO and the Mercatus Centre  (George Mason University, US) on this very question just few weeks ago); but we believe the first priority at the moment is to analyse and clarify the impact of QE on financial markets and the broader economy. Amongst others, the following questions will be discussed: Has QE been instrumental in preventing another Great Depression? If QE is meant to boost asset prices, why has inflation generally been so low in recent years? Has QE increased inequality? Has QE been able to expand effectively broad money growth? Should QE programmes be extended at all? These are all vital questions we will address at the conference.

The conference is by invitation only and there are still (very few) places available, so please send an email to Gail Grimston at gail.grimston@buckingham.ac.uk should you wish to attend. It will be held on Thursday 3rd November 2016, in collaboration with Institute of Economic Affairs (IEA), at the IEA headquarters in London. You will be able to find a programme with all the topics and the speakers here  As you will see we are delighted to have an excellent panel of experts on this field from the US, continental Europe and the UK. There will be of course very well-known academics but also practitioners as well as central bank economists. In particular economists such as George Selgin (CATO), Kevin Dowd (Durham University), Christopher Neely (Federal Reserve Bank of St. Louis), Ryland Thomas (Bank of England) or Tim Congdon (IIMR, University of Buckingham) amongst many other very distinguished  economists will be giving a talk at the conference, which provides a unique opportunity to analyse in detail the effects and the effectiveness of QE in the most developed economies.

For your information you can also follow the conference live/streaming; please visit the IIMR website this week for further details on how to follow it remotely on the day. In addition the presentations (but not the discussion) will be filmed and published on our website later on. Drop us an email (enquiries@mv-pt.org) should you want to be updated on the Institute’s agenda and latest news.

Thank you,

Juan Castaneda

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The recent financial crisis has challenged quite many of the benchmarks and established monetary economic theory used in the 1990s and 2000s to analyse and prescribe monetary policy decisions. To be frank, we all have learned something in the recent crisis. Let me just list some of the lessons of the crisis I believe all and sundry very much agree on:

  • Changes in the monetary base are not good indicators of overall inflation. The three, four or even fivefold expansion of the central banks’ balance sheets has not been accompanied by inflation. It is broad money what explains inflation over the medium and long term.
  • In times of crisis, and even more if severe banking/financial crises occurred, central banks are not (cannot be) independent. In their current form central banks are indeed the bankers of governments and this becomes very evident when public revenues collapse and public spending soars, resulting in a much more expensive access to credit (if at all) and a greater and greater appetite to borrow money from the central bank. Perhaps the best we can do is to run healthy public finances in times of expansion so that the threat of ‘fiscal dominance’ is minimised and contained as much as possible.
  • CPI ‘inflation targeting’, at least as pursued in the years prior to 2007/08, is not enough to preserve monetary and financial stability over the medium and long term. Particularly in the four years running up to the crisis CPI inflation remained fairly stable (with some spikes though to oil price shocks mostly) and central banks achieved their inflation targets, consisting in a rate of Consumer Price Index inflation around 2% over the long term. However many other economy prices, in particular both financial and real assets’ of various types, did increase quite significantly, and now we know that in an unsustainable way.
  • At least in the current institutional setting, the lender of last resort (LOLR) function of central banks is an essential tool to preserve the functioning of monetary markets and thus of financial markets. As I will detail in a later post this does not mean bailing out too risky and insolvent banks (and even less bailing out their managers and shareholders), but preserving the sound operation of the financial and payments systems as a whole. The conditions to do this are very well-known to monetary historians and I am afraid they are many times forgotten.
  • Monetary aggregates (money) played virtually no role in the framing of monetary policy decisions before the crisis. However, it has been more than eight years now with historically low (policy) nominal interest rates, so central banks have had to resort to a different source of policy measures; that is, the expansion in the amount of money by the so-called Quantitative Easing (QE) operations. And what are they but purchases of bonds and even equity that ultimately aimed to increase the amount of money in the economy?
  • Central banks are not running out of weaponry. In our modern monetary systems, where central banks create the ultimate source of liquidity in the economy, there is virtually no limit for central banks to create more money. Central banks can (as they have done in these years) extend the maturity and the amount of the lending provided to the banking sector, increase their purchases of both private and public assets from financial and non-financial institutions, they can also purchase equity in the market, … .
  • Tightening bank regulation in the midst of one of the worst financial crisis in recent history can only aggravate the impact and length of the crisis. The raising of the capital ratios and the establishment of new liquidity ratios by the so-called ‘Basel III Accord’, initially  announced in the Autumn of 2008, forced banks to even contract more their balance sheets (to cut down their liabilities, deposits mainly). This resulted in sharp a fall in money growth and the worsening of the crisis, which had to be (partially) offset by central banks extraordinary policy measures (such as QE) to prevent money supply from falling even further.

There are many other much more disputable issues related to monetary economics and monetary policy indeed. But if we only agreed on the above we would be putting a remedy to some of the biggest gaps if not ‘holes’ in this field and thus creating the conditions to establish a much sounder and sustainable monetary policy framework.

I will devote a single entry to each of the them in the following weeks.

Juan C.

 

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A new monetary research centre has been established in collaboration with the University of Buckingham early this year, the Institute of International Monetary Research, to study something we should not have ever forgotten, the importance of the analysis of money growth in any modern economy. I know, it sounds simple and even obvious but it happens that we have disregarded monetary analysis for far too long, perhaps under the overall  dominant presumption at the time that just by focusing on stabilising CPI inflation (around a low but still positive rate of growth) the economy could maintain a stable rate of long term growth. As stated on the Institute’s website, its mission is quite clear:

“The purpose of the Institute of International Monetary Research is to demonstrate and bring to public attention the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other.”

Of course, central banks claim they have always paid attention to monetary aggregates; you may ask, ‘how could a central bank forget about money?!’ Well, let’s start saying that some have indeed forgotten more than others, and even those which did explicitly include a monetary analysis in its reports and in the communication with the public usually gave far more weight to other (macro) indicators in the making of monetary policy decisions, to say the least … . The facts well speak for themselves, and this is what clearly happened, at the very least in the 4-5 years prior to the outbreak of the Global Financial Crisis (GFC). We have seen again booming broad money growth during the last phase of the expansionary years prior to 2008 and then a sudden collapse in the midst of the GFC. The consequences and the impact on output growth have been enormous and this is another reminder on the key importance of keeping a stable rate of growth of money on long term basis as a policy goal. Those familiar with this blog will not find surprising my emphasis on monetary stability (see just a recent post on the topic here; let me say that I myself devoted my PhD dissertation to the distinction between monetary stability and price stability back in 2003! But of course nobody paid much attention to it then …).

Here you will find a video and the slides to the presentation of the Institute in London on the 11th of June (at the Royal Automobile Club), by its Director Tim Congdon. I have had the privilege to contribute to the Institute as one of its Deputy Directors and I do firmly believe there is ample room to both develop ourselves and cooperate with other colleagues and institutions to encourage much more monetary (and monetarist) research in the years to come so we can get a better understanding on the relation between broad money growth, overall inflation, asset price inflation and nominal income. More news and posts on the Institute’s events and agenda will follow.

Juan Castaneda

PS. The Institute’s website has not been chosen randomly of course, mv-pt.org, and requires no further explanation.

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 “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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