The Monetarists are (Still) Winning
If you’d told me that we would go through a massive financial crisis where monetary policy was proven to be an extremely blunt instrument, I would have bet that the thinking about monetary and fiscal policy would change. But I don’t think that’s what’s happening at all. In fact, from what I gather on the policy front it seems like it is the monetarists (in this case, the market monetarists) who are winning. Not only are they gaining momentum in the research front (as the recent Woodford ruckus proves), but they are gaining momentum with Washington. After all, David Beckworth and Scott Sumner have been busy spending time in Washington briefing staffers.
I guess you could say, the more things change, the more they stay the same. And you know what? If the economy continues to expand following QE3 it will almost certainly be heralded as a huge success for the Federal Reserve….I like to think we learn from our mistakes. But that’s just wishful thinking.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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39 Comments
It’s amazing how the monetarists managed to rebrand themselves, recreate the same tired old ideas and very serious people buy it.
Hi Cullen,
I had to look up the phrase Market Monetarist http://en.wikipedia.org/wiki/Market_monetarism (it’s a recently coined descriptor circa 2011)
The Wikipedia entry left the impression that targeting GDP (income) is not likely to be any more successful than targeting interest rates (inflation)in terms of getting the private sector to spend. The last sentence of the Wiki entry reads:
“But eventually, instead of hoarding currency, they [the Private Sector] would spend and invest it, [the money flowing from the Fed] bidding up prices and, with luck, boosting production.” (notice the word “luck”)
The problem is that the private sector is in a balance sheet recession yes? (requires time to turn debt into equity) The Fed is just an asset swapping machine yes? (banks don’t lend from reserves). The Congress and their Fiscal policies is what needs to change yes? (Government should deficit spend on the productive potential of the private sector rather than become entwined with the biggest lobbyists)
Thanks, BR
Couple of things. Woodford is not a market monetarist, in fact I am not sure he is even a monetarist, and he is calling for more fiscal expenditure. Furthermore, market monetarists are still pretty small time, I do not know what they are getting up to in washington but I can tell you they are having a very low impact on the research front, if any.
Market Monetaristas are generational relics who lack any original ideas so they try to retool the inflationary theories of a failed economic theory (i.e Keynesian Economics).
Cognitive dissonance über alles on Keynes.
Keynes always said to pay back the excess spending during good times. Anyone who believes that this was practiced, please raise your hand.
If Keynes would have been 100% practiced in the area, we could not be in this mess.
Bart, Clinton ran a surplus during good times, which many believe was the root cause of the subsequent bad times.
Clinton ran a surplus only if you count on budget numbers alone. When off budget expenditures are added in (aka, a full & complete total), he was also a deficit spender.
This may be confirmed by just looking at how total Federal debt increased every year during his administration.
I’m unaware of any presidential administration since Keynes that did not deficit spend.
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
– Milton Friedman, A Monetary History of the United States 1867-1960 (1963)
I would disagree. But like Friedman says, by a more rapid increase in the quantity of money than in output we will have inflation. This is the case when too much money is chasing too few goods.
On the other hand if supply of goods increases rapidly (with rapid increasing demand) the money supply is ‘shrinking’ in relative terms against the supply of goods. This inflation though could also be regarded as monetary phenomenon.
But case is different if demand exceeds supply and prices of goods start to increase. This is by far not the same and it is clearly not a monetary phenomenon.
“But case is different if demand exceeds supply and prices of goods start to increase. This is by far not the same and it is clearly not a monetary phenomenon.”
Example please?
I suggest that it only occurs when the currency is inflating relative to other currencies, which is a monetary phenomenon. It may also occur due to monetary lags or velocity increases.
Example:
If oil rises due to a concatenation of circumstances in the 70′s (Oil embargo, Yom Kippur War, Iranian Revolution, Iraq/Iran War) from $3.- to $12.- you can hardly claim that this is a monetary phenomenon.
This is a very obvious example…
War is certainly one example, but you had a real demand shock and demand drop which is very much part of Friedman’s quote.
I also submit, to complete the picture, that the large inflation in the 60s and early 70s was not at all reflected in oil prices pre 1973-4. In other words, a monetary lag (**and encouraged via politics**).
The price move was very much also a catch up to prior excess money printing – aka, a monetary phenomenon and “a more rapid increase in the quantity of money than in output”. The Friedman quote makes no note of always immediate reactions from excess money printing, and factually he notes elsewhere that monetary lags are highly variable.
And oil prices continued up at a very rapid rate in the late 70s due to even more excess money creation.
In other words, yes I very much can claim that monetary phenomena were very much in evidence. Just because other factors like politics intervene for a while, it does not mean that large monetary phenomena aren’t or weren’t present.
ooops, make that “real supply shock and supply drop”
The oil price was one example… Certainly there might have been monetary factors playing a role too but it doesn’t still prove that monetary phenomenon is the only responsible factor causing an increase in prices… I’m sure you can’t explain all of the price increases due to “lagging inflation” or excess money printing…
The rise in commodity prices since 1999 is mostly due to excess demand (or decreasing supply and/or rising costs because open-pit mining is not possible anymore) and not lagging inflation (excess monetary expansion in the past) or money printing. Even though the monetary base was certainly expanding due to economic growth (which of course it had to grow otherwise we would have had deflation) but this is normal.
With great respect for Friedman but his view on inflation I can’t share…
BTW is you (Friedman) claim that inflation is only a monetary phenomenon then you must consequently believe that prices are fixed since if the monetary base doesn’t change the prices can’t change either…
Oh my… your understanding of both Friedman and monetary base has substantial shortcomings to say the least.
And monetary base doesn’t work like that, as Friedman himself noted. Sorry.
I find that I may have been less clear about base than I should have been.
Subtract “excess reserves” from base and you will get a picture that does not allow for a hyperinflationary outcome. Excess reserves should not be counted in base for prediction purposes.
“With great respect for Friedman but his view on inflation I can’t share…”
Fair enough, but to me the facts are quite clear.
Your apparent absolute certainty about inflation and its causes is clear.
I don’t want to confuse the issue with things like commodity inflation, but will state that the primary and not exclusive answer is contained in my original work and research on the paper vs. hard asset cycle.
And again, I note that Friedman’s original quote does not ignore supply or demand.
Dear bart, argumentum e contrario you (Friedman) must claim that deflation too is only a monetary phenomenon. If there is only a monetary cause for inflation/deflation then you must claim that technological progress can’t have any effects on prices since technological progress is not a monetary phenomenon. So if a TV, computer etc. is getting cheaper it must have a monetary reason.
The same qualifies as showed before with commodities and inflation. Today commodities are not found on the surface anymore and costs to excavate are higher and therefore prices rise.
But you and Friedman claim that this can’t be true since inflation (deflation) is always and everywhere a monetary phenomenon. Inflation can clearly be driven by cost factors and Friedman’s (and your) statement doesn’t apply.
But if there are exceptions, as you imply, you can’t claim:”Inflation is ALWAYS and EVERYWHERE a monetary phenomenon in the sense that it is and can be produced ONLY by a more rapid increase in the quantity of money than in output.”
I think the common doctrine about inflation – that there is no distinction between the several causes of inflation – is a major flaws in todays economic believe and therefore most economists can’t understand why money printing doesn’t necessarily causes inflation.
Montarism was a complete and total failure. So why both quoting Friedman when, in retrospect, he was wrong?
http://utip.gov.utexas.edu/papers/CollapseofMonetarismdelivered.pdf
Agree. But there are still many economists believing that inflation is nothing but a monetary phenomenon.
I believe that’s called “The Quantity Theory of Money” and it’s a belief shared by both neo-classcicists and Austrians… all except the “Real Bills” Austrians such as Antal Fekete.
However, that doesn’t mean that QTM believers think that the Fed’s QE actions are causing hyper-inflation (like some [i.e. Peter Schiff and Jim Rogers] keep harping on) or even inflation yet. Case in point: Market Monetarists and a few Austrians such as Mish Shedlock, David Stockman, and Chris Whalen. In fact Mish has written very critically of Schiff’s hyperinflation claims.
Monetarism is alive and well, has been developing & changing over the years, and doing quite fine thank you.
And if one paper somehow proves that monetarism is a failure, then every single school of economics (including MMT and its offshoots), has completely failed.
All one has to do to see the basic truths of monetarism is to contemplate the silly thought that total money supply changes are almost meaningless when looking at inflation or deflation.
Here’s my favorite Milton Friedman piece: an article he wrote for the Wall Street Journal about how wonderful the Great Moderation had been under Greenspan. He wrote it in 2006, the year of his death. Too bad he didn’t hang on a few more years to see how well Greenspan and Bernanke’s “Great Moderation” turned out:
http://online.wsj.com/article/SB113867954176960734.html
I believe that Friedman’s co-author for his book on the Great Depression, Anna Schwartz, did live to 2012. Does anybody know what her reaction was to the 2008 meltdown (if indeed she had one)?
Of course we all know Greenspan’s reaction: deer in the headlights admission before congress that there was a “flaw” in his understanding of the economy.
She was critical of Bernanke’s money printing. … I believe she felt that Bernanke treated the crisis as a liquidity issue instead of a solvency problem. Bernanke assumed that if you provided liquidity, then the crisis could be headed off. She said that Bernanke thought this was another Depression so he pumped money to the banks. That would have been the right strategy then, but the wrong strategy now.
…
We’re five years into the financial crisis and we still don’t know who is solvent and who is not.
I confirm that’s what Anna Schwartz’ comments were.
This is not very surprising. Economic policy within the US government emanates from the Fed, not the Treasury, and ‘Market Monetarists’ place the Fed at the center of the economy; a kind of quasi-dictatorial institution that can manipulate the economy via a combination of direct action and sheer force of will.
Monetary policy has a place but it is only one tooth in the cog and it ought to be used for short term small adjustments rather than long term economic life-support. Unfortunately political landscape being the way it is today means the government will continue to abdicate its responsibility for the rest of the economy.
The financial crisis in 2008 + 2009 have thouroughly discreidted the monetarists. When I hear about “targeting Nominal GDP” I stop reading.
It is amazing to me how the monetarists had been totally discredited and then managed to rebrand and rename their work under this “market monetarist” slogan. It’s one of the most amazing rebrandings ever. And now those of us who understand how the monetary system actually works have to sit around waiting for the professors and economists wade through this crap to find out how badly thought out it actually is. See you in 10 years when nothing’s been fixed and we’ve all debated whether this NGDP targeting “works” or not.
Friedman and most other economists of which I’m aware do not approve of NGDP.
Make that most other *sane* economists.
Yes. NGDP targeting is a phenomenally stupid idea, in my humble opinion. There are real issues of monetary policy, such as the overvaluation of the U.S. dollar which is a big factor in our chronic trade deficit, and the drainage of money and jobs from the U.S. economy. What do the market monetarists think about that, I wonder?
No kidding. NGDP doesn’t even capture shifts from production to service. It’s horrible. The only thing that makes any kind of sense is targeting some sane measure of inflation. And no I don’t necessarily think the current official measure is the best.
The main issues with CPI and why it is incorrect.
http://www.nowandfutures.com/cpi_issues.html
“If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand.”
– Milton Friedman
“Central bankers always try to avoid their last big mistake. So every time there’s the threat of a contraction in the economy, they’ll over stimulate the economy, by printing too much money. The result will be a rising roller coaster of inflation, with each high and low being higher than the preceding one.”
– Milton Friedman
“In my original support for a straight money target, I always emphasized that it was partly a case based on ignorance, based on the fact that we really did not understand sufficiently well the detailed relationship between money, income, interest rates, and the like to be able to fine-tune, that our goal should be to develop a detailed enough undderstanding so that we could do better than a simple constant monetary growth target.
However, I believe still, as I did then, that constant monetary growth would produce a highly satisfactory price path, and, if it enabled you to get rid of the Federal Reserve System, that gain would compensate for sacrificing the further improvement that a more sophisticatedrule could produce.”
– Milton Friedman, email to Edward Nelson (assistant vice president and economist at the Federal Reserve Bank of St. Louis), July 21, 2003
“… difference between me and people like Murray Rothbard is that, though I want to know what my ideal is, I think I also have to be willing to discuss changes that are less than ideal so long as they point me in that direction.”
– Milton Friedman, 1995 interview in Reason magazine
“[Milton Friedman] has always hated the fragmentation and bickering between schools of economics, which has occurred ever since Marx detached himself from the “classical” school of Smith and Ricardo. In 1974, when vacationing at his summer home in Vermont, Friedman spoke informally at a nearby conference about Austrian economics. He bluntly told the audience, ‘There is no Austrian economics–only good economics and bad economics’. (Dolan 1976: 4). His point was that any useful concepts coming out of Austrian economics (he specifically had reference to Hayek’s contributions) should be incorporated into the body of mainstream economic theory. In 1982, he made the same point at a conference on supply-side economics. ‘I am not a supply-side economist. I am not a monetarist economist. I am an economist.’ (Friedman 1982: 53).”
– Mark Skousen, The Making of Modern Economics, pg 432
And Friedman completely misses that a constant monetary base inflation won’t work either due to the changing landscape of the economy.
The rate that was good 30 years ago would be laughable now with offshore account USD holdings ramping up by 16% yearly, US corporates sitting on $5tn in liquid assets, and god knows how big the financial sector is now. And add general globalization effects on top of that (nonstop trade deficit with asia comes to mind).
I don’t fault him. The ground work for his theories was laid in simpler times.