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Archive for the ‘Monetary policy rules’ Category

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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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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Monetary economics is in shambles. More than eight years after the outbreak of the Global Financial Crisis  many things in our economies have changed indeed, particularly the range of operations in which central banks have embarked in the last few years; but the way mainstream academia and policy makers understand and approach monetary economics have not. The old policy rules which contributed so much to the building up of monetary instability and finally to a profound financial crisis have not really been questioned nor replaced yet by a consistent set of new policies (or better, a policy rule) committed to maintaining monetary stability over the medium and long term. Even worse, I have attended myself scientific meetings on this field in the last years and very rarely (if at all) ‘money’ or ‘monetary aggregates’ are even mentioned in (supposedly) specialised monetary talks and lectures. Instead we seem to be stuck in endless discussions on interest rates and how a 0.25 increase/decrease in the policy rate may affect consumption, investment and eventually output by the spending and credit channels; for the initiated in this subject this means we still use the late 1990s and early 2000s’ new Keynesian model (with no money) to analyse and prescribe monetary policies.

Well there are indeed notable exceptions to the mainstream, and I am very pleased to invite you all to the 2016 monetary Public Lecture of the Institute of International Monetary Research (IIMR), by professor Charles Goodhart. One of the main purposes of the Institute is to promote research into how developments in banking and finance affect the economy as a whole. The Institute’s wider aims are to enhance economic knowledge and understanding, and to seek price stability, steady economic growth and high employment. Particular attention is paid to the effect of changes in the quantity of money on inflation and deflation, and on boom and bust.

Banks and central banks play a central role in the sound functioning of modern monetary economies. The 2008-09 Global Financial Crisis has shown again how important it is to understand their functioning and operations, and the relationship between the quantity of money and the overall economy.

We have much pleasure in inviting you to join us at the Institute’s 2016 public lecture on Wednesday 2nd November (18:30 hrs.) by Professor Charles Goodhart (LSE): ‘What have we learned about money and banking during and since the Great Recession?’, at the Institute of Directors (116 Pall Mall, London).

You may want to visit our website to learn more about the Institute’s research agenda and our latest publications on our website (http://www.mv-pt.org/index). You may want to know the public lecture will be recorded and available on our site.

Thank you,

Juan C.

PS. Please confirm your attendance by e-mail to Gail Grimston at gail.grimston@buckingham.ac.uk

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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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In a series of posts on the assessment of the bias of the US Fed prior to the Global Financial Crisis published on Alt-M, the blog of the recently established Center for Money and Financial Alternatives at the Cato Institute, David Beckworth just published a post with a very clear analysis of the inflationary bias of the Fed before 2008, based on an excellent paper written along with George Selgin and Berrak Bahadir in the Journal of Policy Modelling (those interested in monetary policy rules cannot miss it!).

The publication of both these posts and the academic article couldn’t be more timely. Surprisingly enough, monetary economists still disagree on the stance of monetary policy (not just in the US but elsewhere) before the outbreak of the Global Financial Crisis; this proves that we, economists, are not even that good at what we were supposed to do well, that is, the ‘prediction’ of the past. Leaving the academic interest of the subject aside, this is a policy question of major concern for all, should we want to contribute to the running of more sound, and more monetary-stability-oriented, monetary policy rules in the years to come. Now there are very good academics suggesting the way to exit QE and to move forward towards a more ‘normal’ monetary environment, and it is thus the perfect time to make the case for a different type of policy rules, those compatible with the fall of prices in a growing economy.

As I wrote as a comment on a recent George Selgin’s entry to this blog, the productivity rule ‘certainly provides solid theoretical basis to support the running of a different type of monetary policy rules; indeed different to the (CPI) inflation stabilising rules applied by all and sundry before 2008, which contributed to the recent crisis as well as to the instability generated in markets in the last years. It is time to apply less active and less inflationary monetary rules, those that allow the price level to reflect changes in productivity during expansions. Rather than focusing on price stability (actually it is most often ‘inflation stability’) we should be focusing on rules that better preserve monetary and financial stability on longer term basis; and the productivity norm is a good example of the latter. They are not going to be the cure for all problems but at least they will not be adding monetary disturbances on top of other (real-side) disturbances and shocks affecting the economy. And this will help agents form their expectations and make their plans.

For those unfamiliar with this literature, David Beckworth’s post provides the explanation for why (market or Fed’s) interest rates should be increased whenever productivity raises, so that the market interest rate runs in parallel with the natural interest rate, as Wicksell put it a century ago. Since then, this has been taken as the condition to keep monetary equilibrium in the economy (or at least, to put it more modestly and accurately, to avoid at least major disequilibria in the markets) and thus to  prevent from the excess of money creation that so often has contributed to monetary and financial crises in the past as well as to the succession of the so-called boom and bust business cycles. Quoting Beckworth’s words from his recent post, ‘Was monetary policy loose during the last housing boom?’:

Note that the rise in the labor force and productivity growth rates both raised the expected return to capital. The faster productivity growth also implied higher expected household incomes. These developments, in turn, should have lead to less saving and more borrowing by firms and households and put upward pressure on the natural interest rate. Interest rates, in short, should have been rising given these large positive supply shocks during this time.

And guess what the Fed did during those years of increase in productivity? Focused much more on (a falling) CPI rate of inflation in a growing economy (which shouldn’t be surprising at all), its policy rule didn’t recommend a change in the Fed’s nominal interest rates (at the very best) and later on it kept on cutting them down for years to avoid deflation by all means. It is well time to put the debate on policy rules on the agenda so we dot repeat the same mistakes in the future.

Juan Castaneda

PS. To be fair and fully transparent, let me declare myself any possible conflict of interest (if at all): I am a lecturer at the University of Buckingham and yes, I am a visiting research scholar at Cato (during the spring 2015).

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