Tuesday, November 25, 2014

Turning Back the Police State: Knowledge is Power

“The problem is at once to distinguish among events, to differentiate the networks and levels to which they belong, and to reconstitute for the lines along which they are connected and engender one another.  From this follows a refusal of domain analysis couched in terms of the symbolic field or the domain of signifying structures, and a recourse to analyses in terms of the genealogy of relations of force, strategic developments, and tactics. Here I believe one’s point of reference should not be to the great model of language (langue) and signs, but to that of war and battle. . . .

“It is hard to see where, either on the Right or the Left, this problem of power could then have been posed. . . . The way power was exercised – concretely and in detail – with its specificity, its techniques and tactics, was something that that no one attempted to ascertain; they contented themselves with denouncing it in a polemical and global fashion as it existed among the ‘other’ in the adversary camp. . . . but the mechanics of power in themselves were never analysed. This task could only begin after 1968, that is to say on the basis of daily struggles at the grassroots level, among those whose fight was located in the fine meshes of the web of power.”

-          Michel Foucault, “Truth and Power” in Power / Knowledge

Today I was pleasantly surprised to see that protests concerning the Michael Brown / Darren Wilson verdict have erupted across the nation. The moment I saw this, I knew that these must have been organized by people who are passionate about overcoming social injustices.

Power accumulates around particular nodes in any system. It is important that power does not accumulate in such a way as to neuter the citizenry of their civil liberties. In a fair legal system, individuals are treated as legal equals, not having any advantage over another in trial due to wealth, race, or gender of an individual. Neither should one be afforded a position of privilege by virtue of working for the state. Only under such a legal system can individuals work together to improve their own lives by cooperating with total strangers in social exchange of all kinds. When legal systems are hacked into by plunderers with political connections – in this case arms manufacturers that are part of the military industrial complex and corrupt police and police departments – individuals lose the ability to exercise their civil liberties. Property is seized indefinitely from those charged with drug possession, often never to return to its rightful owner.  The police departments reap the benefits. Individuals have their personal space violated upon any suspicion by an officer. And day after day, reports and videos of police shooting innocent civilians are published (I’ve linked to a Google news search for “police shoot unarmed”). Something must be done.

The first step is for community leaders to educate themselves concerning the politics that lead to their oppression. For this purpose, I have collected a number of articles that reveal, point by point, how the military industrial complex is destroying the public safety function of police, instead turning them into plunderers and oppressors of the weak and powerless. Also included are works that dig deeply into the philosophy, ethics, and, most basically, the heart state-sponsored aggression. I write this as a former public safety dispatcher for California Highway Patrol. When I worked there, I was surrounded by many good men and women, many of whom I still correspond with. It is time to renew the system that they work for and fight to defend. Incentives that encourage malicious activity, especially if of great pecuniary measure, can turn individuals and the groups they form into a machinery of grave evil and perpetual injustice. I hope that readers will use the information contained in the following literature to turn back this machinery.


1.       Radley Balko

Radley Balko is a journalist “who writes about criminal justice, the drug war, and civil liberties for The Washington Post.” He has made a video that is a great starting point for anyone trying to understand the growing police state and its display in Ferguson. See his Washington Post columns here. Also see his book Rise of the Warrior Cop.

2.       Christopher Coyne and Abigail Hall

There are a number of incisive works on the subject of the spreading militarization of police that any interested reader should read. I leave it to you to search Chris’s and Abby’s curriculums vitae. I find the following to be especially informative.

Coercive government actions that target another country often act like a boomerang, turning around and knocking down freedoms and liberties in the “throwing” nation. Two developments in the United States illustrate the boomerang effect: the rise of government surveillance and the growing militarization of the police.

This paper develops the political economy of the militarization of domestic policing. We analyze the mechanisms through which the “protective state” — where the government utilizes its monopoly on force to protect citizens’ rights — devolves into a “predatory state” which undermines the rights of the populace. We apply our theory to the U.S., where we trace the (failed) historical attempts to establish constraints to separate the military functions and policing functions of government. In doing so we emphasize the role of crises in the form of perpetual wars — the “War on Drugs” and the “War on Terror” — in the accelerated militarization of domestic policing.

General Smedley Butler had been on the inside. With a fervent cry, he digs into the military industrial complex before it was a distinct concept. He names those individuals and corporations that have much to gain from war. And shows how they can disguise their rent-seeking by wrapping their deeds in patriotism. Whether just or unjust, wars invite profiteering with the military-industrial complex demanding more war and in nuanced forms.

Here is a peak.
In the World War [I] a mere handful garnered the profits of the conflict. At least 21,000 new millionaires and billionaires were made in the United States during the World War. That many admitted their huge blood gains in their income tax returns. How many other war millionaires falsified their tax returns no one knows. 
How many of these war millionaires shouldered a rifle? How many of them dug a trench? How many of them knew what it meant to go hungry in a rat-infested dug-out? How many of them spent sleepless, frightened nights, ducking shells and shrapnel and machine gun bullets? How many of them parried a bayonet thrust of an enemy? How many of them were wounded or killed in battle? 
Out of war nations acquire additional territory, if they are victorious. They just take it. This newly acquired territory promptly is exploited by the few -- the selfsame few who wrung dollars out of blood in the war. The general public shoulders the bill. 
And what is this bill? 
This bill renders a horrible accounting. Newly placed gravestones. Mangled bodies. Shattered minds. Broken hearts and homes. Economic instability. Depression and all its attendant miseries. Back-breaking taxation for generations and generations.
For a great many years, as a soldier, I had a suspicion that war was a racket; not until I retired to civil life did I fully realize it. Now that I see the international war clouds gathering, as they are today, I must face it and speak out.

4.       Bastiat’s The Law

The Law is a primer on political plunder – i.e., the effects of special interests lobbying government. Within the context of Ferguson, these plunders include those mentioned above: organizations comprised of police officers and the military industrial complex. This is a nice starting point for anyone trying to understand and correct a system that generates unintended consequences that take the form of legal and physical aggression by agents of the state. See also What is Seen, and Unseen.
The law perverted! And the police powers of the state perverted along with it! The law, I say, not only turned from its proper purpose but made to follow an entirely contrary purpose! The law become the weapon of every kind of greed! Instead of checking crime, the law itself guilty of the evils it is supposed to punish.
If this is true, it is a serious fact, and moral duty requires me to call the attention of my fellow-citizens to it.

5.       Henry David Thoreau’s On Civil Disobedience

This goes without saying. See the opening below.
I HEARTILY ACCEPT the motto—"That government is best which governs least"; and I should like to see it acted up to more rapidly and systematically. Carried out, it finally amounts to this, which also I believe—"That government is best which governs not at all"; and when men are prepared for it, that will be the kind of government which they will have. Government is at best but an expedient; but most governments are usually, and all governments are sometimes, inexpedient. The objections which have been brought against a standing army, and they are many and weighty, and deserve to prevail, may also at last be brought against a standing government. The standing army is only an arm of the standing government. The government itself, which is only the mode which the people have chosen to execute their will, is equally liable to be abused and perverted before the people can act through it. Witness the present Mexican war, the work of comparatively a few individuals using the standing government as their tool; for, in the outset, the people would not have consented to this measure.

6.       Herbert Spencer’s “On Patriotism

This piece speaks for itself.
To me the cry – “Our country, right or wrong!” seems detestable. By association with love of country the sentiment it expresses gains a certain justification. Do but pull off the cloak, however, and the contained sentiment is seen to be of the lowest. Let us observe the alternative cases.
Suppose our country is in the right – suppose it is resisting invasion. Then the idea and feeling embodied in the cry are righteous. It may be effectively contended that self-defence is not only justified but is a duty. Now suppose, contrariwise, that our country is the aggressor – has taken possession of others’ territory, or is forcing by arms certain commodities on a nation which does not want them, or is backing up some of its agents in “punishing” those who have retaliated. Suppose it is doing something which, by the hypothesis, is admitted to be wrong. What is then the implication of the cry? The right is on the side of those who oppose us; the wrong is on our side. How in that case is to be expressed the so-called patriotic wish? Evidently the words must stand – “Down with the right, up with the wrong!” Now in other relations this combination of aims implies the acme of wickedness. In the minds of past men there existed, and there still exists in many minds, a belief in a personalized principle of evil – a Being going up and down in the world everywhere fighting against the good and helping the bad to triumph. Can there be more briefly expressed the aim of that Being than in the words “Up with the wrong and down with the right”? Do the so-called patriots like the endorsement? 

7.       Henry Highland Garnet’s “An Address to the Slaves of the United States

Garnet serves as a timely reminder that individual dignity and liberty lie in legal equity, not privilege which is anathema a legal system that commands common respect to all persons. Slavery was the utmost evil of his age. Now we face another.
Brethren, it is as wrong for your lordly oppressors to keep you in slavery, as it was for the man thief to steal our ancestors from the coast of Africa. You should therefore now use the same manner of resistance, as would have been just in our ancestors when the bloody foot prints of the first remorseless soul thief was placed upon the shores of our fatherland. The humblest peasant is as free in the sight of God as the proudest monarch that ever swayed a sceptre. Liberty is a spirit sent out from God, and like its great Author, is no respecter of persons.

8.       Percy Bysshe Shelley’s “The Mask of Anarchy

I’ve included the final blocks of this timely poem. Tyranny is self-consuming. Best to be rid of it.

‘The old laws of England—they
Whose reverend heads with age are gray,
Children of a wiser day ;
And whose solemn voice must be
Thine own echo—Liberty !

‘On those who first should violate
Such sacred heralds in their state
Rest the blood that must ensue,
And it will not rest on you.

‘And if then the tyrants dare
Let them ride among you there,
Slash, and stab, and maim, and hew, —
What they like, that let them do.

‘With folded arms and steady eyes,
And little fear, and less surprise,
Look upon them as they slay
Till their rage has died away.’

‘Then they will return with shame
To the place from which they came,
And the blood thus shed will speak
In hot blushes on their cheek.

‘Every woman in the land
Will point at them as they stand—
They will hardly dare to greet
Their acquaintance in the street.

‘And the bold, true warriors
Who have hugged Danger in wars
Will turn to those who would be free,
Ashamed of such base company.

‘And that slaughter to the Nation
Shall steam up like inspiration,
Eloquent, oracular ;
A volcano heard afar.

‘And these words shall then become
Like Oppression’s thundered doom
Ringing through each heart and brain.
Heard again—again—again—

‘Rise like Lions after slumber
In unvanquishable number—
Shake your chains to earth like dew
Which in sleep had fallen on you—
Ye are many—they are few.’


Last of all, the Ferguson National Response Network is organizing protests across the country, and even outside the United States. If any readers are participating, I encourage you to bring the material that you believe is most adequate for promoting insight into the problems faced by persons confronted with legally condoned brutality.

* Thank you to those of you who helped me form this list. Without you, what you just read would not exist.

**Edited link for Thoreau at 1106 PM EST.

Monday, November 10, 2014

Is a Commodity Reserve Standard with a Fixed Reserve Ratio More Tractable than a Nominal Income Target?

Formulating the blueprints of a commodity reserve standard with a fixed reserve ratio has proven to be more difficult to detail than I first imagined. In spite of that, I believed I have worked out the most important details. 
1) The central bank holds a bundle of commodities as a part of its reserves. The fraction of central bank notes and credits that these reserves represent must stay constant. 
2) The central bank also hold short-term securities for its remaining reserves. 
3) (Here’s the important part!) The central bank must hold constant its nominal value of reserves comprised by the commodity basket and its reserves comprised of credit. When interest rates fall, the central bank will sell securities, when they rise the central bank will buy securities. Likewise, when the price of the bundle falls, the government will buy shares of the bundle.
    a. The government does not buy the physical commodities, only promises to them.
That is the plan in a nutshell. Other details are, of course, important. For example, as I mentioned previously, the government should purchase from a variety of dealers so as to minimize Cantillon effects.

The core of good macroeconomics lies behind the proposal. Theoretically, it relies on Say’s principle, the equation of exchange, and expectations. Briefly, when prices fail to fully adjust there is a fall in output. If this was a one-time phenomenon, then it might be worth living with, but often the process is dragged out due to a high degree of deflationary expectations. It is not uncommon for bad policy to be the culprit in all of this. Given that monetary policy is not disappearing in the near future, the best policy makes the monetary base responsive to changes in demand for money.

So far you might be asking, why not just stick with nominal income targeting? Nominal income targeting does share the characteristics that I am describing, but I believe that providing good information may be a problem. How thick does the betting market need to be in order for information to be accurate and for the market not to be swallowed in volatility? Is NGDP the best indicator for monetary policy? Difficulty arises because in targeting macroeconomic variables, there will always be errors and transactions unaccounted for in the estimates. These problems are complicated which may be why the profession has not voiced widespread support for the proposal. (There are of course other reasons including bias, ignorance, gold-buggery, etc…) A commodity reserve currency with a fixed reserve ratio nominal value for the central bank's asset side of the ledger lacks these problems.

The policy makes money responsive to prices. Market prices already exist and they are reliable indicators concerning the demands of consumers relative to the supply of available goods and services. One problem that I have been confronting with nominal income targeting is that the immediate change in the money supply may distort prices too much as all changes in demand for money will be fully and immediately compensated by changes in the base money stock. There may be good reasons that agents have increased demand their demand to hold money. A commodity reserve currency with a fixed reserve ratio would allow agents to exercise this preference and let it be reflected in prices. It simply prevents a deflationary spiral that may arise because of policy uncertainty or institutional collapse. Finally, a last advantage of the policy is that it not only constrains the central bank by a rule, but it makes the central bank act as a storehouse. By holding a stock of commodities during a bust and releasing them during a boom, the policy would alleviate, but not eliminate, price volatility. It would serve the same role for credit, preventing credit markets from seizing when liquidity dries up.

Perhaps the most attractive feature of the policy is that it does not need any more information than is already available. There is no need for policymakers to try to guess the future or to target a particular interest rate or price level. In fact, there is no need for policy makers once the rule is implemented. The rule is the only policy necessary. Prices and interests rates move and the base money stock responds. It is as simple as that.

**Thanks to Justin Merill, editor of the facebook groups freebanking and Emergent Society, for discussing this with me**

Late Thoughts: The purchase of commodities should also channel expansion into labor markets during the downturn. It therefore can be a replacement for discretionary fiscal stimulus.

**Edited 11/20/2014

Sunday, November 9, 2014

An Always Consistent David Glasner

After waiting a couple days and receiving no response, I was beginning to think I might not get a response from David Glasner. This would be, I believe, the first time. It wasn't. In fact, Glasner had 17 comments on his thread and took the time to go through each of them.  You can find his response to me if you want to read through.

  1. Jim, You are right, the Swiss central bank is not bound by a fixed exchange rate between its currency and gold, so there is a basic difference between its position, even if the referendum passes, and the Bank of France. The post was mainly intended as a sendup of gold-buggism as a social-psychological phenomenon and only partly as a warning about the policy consequences should the referendum actually pass. However, I suspect that requiring 20% gold cover will make it more costly for Swiss National Bank to maintain a peg against the euro, and will therefore increase the deflationary pressure on the Swiss franc.
    Tom, Thanks.
    Don, Thanks. There is a like button by the way, but you are free to keep ignoring it.
    Andrew, I am not worried about the Swiss balance of payments, and I don’t think anyone else needs to worry about it either, but I take your point about the consequences on the asset portfolio of the central bank.
    Elsa, Imply? I thought that I was being pretty unequivocal. People don’t have to hold euros. They can use their euros to buy all kinds of assets that are likely to appreciate or generate pecuniary returns that will provide their owners with a much higher return than gold. Same goes for holding sterling or any other currency. Gold, thank God, is not the only inflation hedge.
    Mike, I don’t say that a central bank should not hold any gold, but gold is certainly not the only asset with the property that its value is not highly correlated with the value of the currency issued by the central bank.
    Maynard, A gold bug is a gold bug regardless of nationality.
    elwailly, QE is about the total size of the central banks’s balance sheet. The referendum is not about the size of the balance sheet but about its composition.
    Shahid, I agree.
    Benjamin, Well they haven’t voted yet, so don’t assume that they have gone nuts.
    Mikael, Why do you assume it’s a helicopter drop? They will convert their foreign exchange to gold. They don’t have to increase their outstanding liabilities.
    Jim, Thanks for the link. Interesting.
    Scott, As I pointed out in my initial response to Jim, I was mostly responding to gold-buggery as social-psychology, not to the policy implications. However, although you may be right that the Swiss may be able to continue with a reasonable policy even if the referendum passes, I do think that the referendum would increase the risks of deflation in Switzerland, which would not be a good thing.

  2. I was pleased to see that he was mostly upset about "gold-buggery", but also has a legitmate concern about deflation. 
    As far as the monetary policy proposal goes, I've been working through some more bugs that I think I have finally ironed out including making the base money stock responsive to interest rates. I hope to have a full post later this week.

A Fixed Reserve Ratio Commodity Standard - More on Operating Procedures

Yesterday I laid out the basics of a fixed reserve ratio commodity reserve standard. The basic idea is that the central bank hold a broad basket of commodities. It does not attempt to stabilize the price of the basket. Instead, it buys or sells the basket as the reserve ratio deviates from its target, and only does so until the official reserve ratio has been reestablished.

I did not fully lay out the nature of central bank non-commodity reserves. Expansion in this system would not only occur through the purchase of the commodity basket. The central bank would also purchase securities. The rate of purchase of these securities would be equal to the rate of purchase of the commodity basket. If the central bank need to increase it dollar value of commodity holdings by 10%, it would also increase by 10% it holding of treasuries. This should have two effects. First, the price of the bundle will not be determined by the central bank. Under this policy, the change in the price of the bundle cues action by the central bank. Central bank purchases of the commodity should make price movement  more shallow, but it will not eliminate price volatility altogether. This is a nice advantage as a change in prices is a force that pulls speculators into the market, and thus, information provided by speculators will not be lost or greatly distorted. Second, the central bank will also purchase or sell securities at the same rate that it alters holdings of the commodity basket. When it purchases these securities, it should do so from a large number of investment firms and from a variety of types of securities so as to minimize distortions in the market. When interest rates rise, the value of these holdings will increase, so the central bank will buy more commodities and securities. When interest rates fall, the opposite will occur. So we can see that holdings of commodities will make the base money stock responsive to changes in prices. Holdings of securities will make the base also help stabilize the interest rate. However, it would by no means determine the interest rate. That would be left up to the market process to decide. This proposal moderates prices and interest rates.

The final piece left to complete this sketch of policy is to determine the ratio of commodities that comprise central bank reserves. It may make sense to let commodities make up the same proportion of central bank reserves as they do for the proportion of total consumption they represent. The proportion of reserves that the commodities comprise should definitely be no greater than that proportion.

Saturday, November 8, 2014

A Workable Commodity Reserve Currency

I seem to have developed a reputation as being a "market monetarist" but not being an Austrian economist according to one corner of the web. I am far more interested in the principles behind policy rules than the rules themselves. In fact, I have been considering the nature of a proposal different than a nominal income target, but which is derived from the same principles. This proposal came to my attention when David Glasner decried the possibility of the Swiss National Bank adopting a fixed ratio of gold reserves as this issue will be decided in a vote at the end of the month.
There they go again. The gold bugs are rallying to prop up the gold-price bubble with mandated purchases of the useless yellow metal so that it can be locked up to lie idle and inert in the vaults of the Swiss National Bank. How insane is that?
Being intimately familiar with the gold standard in both its historical and theoretical forms, I noted in the comment that having a fixed reserve ratio without a fixed-exchange rate for gold itself may actually make for a good monetary policy rule. As the price of gold rises, the bank will sell its gold. When the price falls, the bank will purchase more gold. There is a problem though. Employing only gold as a reserve commodity adds noise as the price of a single commodity is unlikely to reflect underlying market conditions. I suggest this can be amended by broadening the basket of commodities.

The functioning of a commodity reserve currency is straight forward (Hayek 1943; Graham 1944). Hayek and Graham suggested that base money be fully backed by a basket of commodities and that authorities peg the price of the basket, selling the basket when the price rose above the target price and purchasing it when its price moved below that price. I suggest some slight deviations from this formulation. Under a regime with fractional reserves, the monetary authority agrees to back a particular fraction of its notes with a basket of a broad array of commodities. When the price of these commodities rise, the central bank must automatically sell its holdings of this basket until the ratio returns to its statutory level. If the value of the basket falls, the central bank will purchase shares of this basket to maintain the statutory reserve ratio. As prices are procyclical during the business cycle, this policy automatically acts as a stabilizing force in the economy, as it stabilizes prices and provides liquidity when money is dear. This rule is convenient because, once the basket of commodities and operating structure are chosen, it is simple to execute. That the base money stock is responsive to changes in prices means that this rule promotes a money stock that is adaptive to changing market conditions. That is, it tends to facilitate changes in demand for money. Furthermore, since not all base money must be backed by the basket, expansion and contraction will also target credit markets and, therefore, regulate them according to market conditions as reflected by the value of the basket of commodities.

* I'm still working out the details, so I would be more than happy to read your critiques in the comments.
** The above is taken from an amendment to "Wither Gold". The new draft is up online!

Late: The 20% reserve requirement for the Swiss National Bank is a minimum, not a fixed reserve ratio.

Tuesday, November 4, 2014

Two Roads?: Theoretical Case and Historical Precedent for a Nominal Anchor (Part IV)

We have left to consider the a defense of an endogenous fiat money base. Like the gold standard, but more responsive, a nominal income standard will alleviate excess demand for money. Sumner argues that nominal income targeting provides a nominal anchor, meaning that it prevents dramatic swings in prices that would otherwise result from an unstable demand for money (2012, 152). He notes that “the current price level and current NGDP are far more affected by the future expected money supply than they are by the current money supply (144).” If prices reflect expectations, then it is critical that growth rate of one of the major determinants of prices, the money stock, be predictable. Much in the way that “dynamic equilibrium requires consistency of plans which . . . depends on a flexible price system,” a rule that makes the expansion of the stock of base money stock both responsive to prices and predictable will help facilitate coordination of plans among economic actors (Lachmann 1978, 116). As convergent expectations are requisite for Say’s principle to hold, and therefore, for markets to clear, a clearly defined rule that predictably governs growth of the base money stock will reduce policy uncertainty and thereby increase the efficacy of the price system to convey tacit information (Hayek 1943).

The benefits of a nominal income level target are especially of significance for the loanable funds market as it should stabilize inflation expectations. By this effect, it will also better enable credit markets to clear as interest rates, the price of money in the future, will not suffer from distortions stemming from nominal factors such as volatile demand for base money. A nominal income target can also ensure that the rate of inflation remain positive. The significance of this becomes clear upon considering a scenario where the real rate, r, is less than the rate of deflation, -π. The Fisher equation denotes that in the long run the nominal – observed – interest rate as the sum of the real interest rate and the inflation rate. This is formally stated as:

i = r + π

We can imagine a scenario where the market clearing nominal rate of interest is negative. That is the abovementioned case where the real interest rate is less than the rate of deflation:

               r < -π

This special case was recognized in 1913 by Ralph Hawtrey:

What if the rate of depreciation of prices is actually greater than the natural rate of interest? If that is so nothing that the bankers can do will make borrowing sufficiently attractive. Business will be revolving in a vicious circle; the dealers unwilling to buy in a falling market, the manufacturers unable to maintain their output in face of ever-diminishing order, dealers and manufacturers alike cutting don their borrowings in proportion to the decline of business, demand falling in proportion to the shrinkage in credit money and with the falling demand, the dealers more unwilling to buy than ever. (186)

A reduction in the quantity of credit demanded leads to a surplus of savings. If, due to an abnormally high rate of deflation, the equilibrium nominal rate necessary to clear the loanable funds market is negative, then this surplus is inevitable. Since credit doubles as money, a fall in credit outstanding leads to an equivalent drop in total output. A nominal income target stops this problem in its tracks and will allow markets to more efficiently liquidate inventory. Instead of a fall in output, markets will respond by more quickly reallocating previously overvalued goods as a general expansion of the money stock is unlikely to save from bankruptcy those firms that made the most egregious mistakes during the boom. A base money stock that responds to changes in demand for money will help facilitate the reallocation of resource toward their highest valued use. Compare this to a general fall in prices whose end date is unknown.

The danger of tremendous deflation is not a new concern as bankers have long been concerned about financial destabilization due to deflation. Even before the establishment of the Federal Reserve, private banks innovated the means to mitigate the damaging effects of an elevated demand for money during recessions and depressions. Banks would issue temporary currency to stem a deflationary impulse (Timberlake 1984, 6). Money demand shocks were endogenously offset by temporary increases in the money stock. Those who issued the currency provided it to banks that appeared to be illiquid, but were unavailable to those banks that were clearly insolvent (7). Like endogenous gold and credit stocks, the increase in temporary currency arose due to the deflationary impulse set off by a sudden increase in demand for money. This temporary currency was elastic enough to prevent a crisis from turning systemic. Absent activist central bank policies, the gold standard, was able to serve as a nominal anchor. Only as a result of gold hoarding policies from the Bank of France and the Federal Reserve did the gold standard prevent a runaway deflation like occurred due to central bank intervention in 1929 (Eichengreen 1996; Irwin 2012). It does not take much imagination to see that a nominal income level target will serve a similar role to what temporary currency played in moderating crises.

Monday, November 3, 2014

Microfoundations?: Pascal Salin Needs Macroeconomic Tools to Conduct Macroeconomic Analysis

Pascal Salin’s “Money and Micro-Economics” is now online. I was hoping to find some insights into market process oriented macro, but instead found a blasé overview with a weak critique of market monetarism. Perhaps nothing stands out more than Salin’s distaste for monetary expansion. This attitude is reflected clearly in Salin’s suggestion that market monetarism should be called “market Kenesianism” as “it is simply a branch of new-Keynesianism." I’m not sure what book in intellectual history that Salin is reading from, but I do know that he lacks foundation for his interpretation of market monetarism. As I have noted before, market monetarists of the heirs of Ralph Hawtrey, not John Maynard Keynes. Macroeconomic outcomes are dependent upon microeconomic outcomes, but certain macroeconomic variables tell us a lot about economic conditions. This information can be employed in a manner that considers market process in analysis and policy implementation, rather than inhibits market robustness.

Salin's prime error appears to be the assumption that the macroeconomy can be defined solely in terms of microeconomic agents. A macroeconomics that does not give special attention to certain macrovariables is of little service. While it is understandable that economists interested in market process emphasize that information is lost in aggregation, a loss of information does not necessitate that useful information does not exist in these macrovariables. This really requires a detour into the pillars of macroeconomic analysis:
1.  Say’s Principle
2. The Equation of Exchange
3. Expectations
These concepts permeate any discussion of macroeconomics, although their employment is not always recognized explicitly. Consider Say’s principle. Say’s law expresses the principle in its most basic form. Goods must pay for goods. In other words, if you want to demand a good, you must have the means to facilitate exchange with payment. This means is tied at some point to either one’s labor, a good in one’s possession, or a promise, of a good or service outstanding. Say’s principle, as formulated by Leijonhufvud and Clower (1973), identify money as an nth commodity included in Say’s identity. It conveys that if there is an excess demand for money, there must be an excess supply of goods in some other market or markets. The only way for all markets of available goods and services to clear is for either more money to enter the hands of those agents demanding more money or for prices to fall. Prices, especially wages, tend to be sticky downward, so the extent to which prices are unable to adjust there is a shortfall in demand and a falloff in economic activity.

Cue the equation of exchange and the role of expectations. The equation of exchange, MV = Py, tells us that changes in velocity can affect prices and output levels. An increase in demand for money materializes as an increase cash balances. An agent will increase portfolio demand for money as a result of deflationary expectations (money is expected to be worth more in the future), in response to increased uncertainty, or as a result of planned future expenditures not induced by expected deflation. The reader can see that demand for money is dependent on what one expects to use it for in the future and on expectation of future conditions more generally. Modern finance blurs the line between an increase in portfolio demand and an increase in investment, the latter of which tends also to increase the broader money stock. The difficulty comes when secure investments are exhausted and cease to respond to the amount of savings in the economy. When this occurs, short term rates fall toward zero and the yield curve steepens (Moreira and Savov 2013; Sunderam 2012). In the short run, low rates might result from an expansion of the monetary base, but it is unlikely that the market could be fooled for nearly a decade. The cause of our recent low rates lies elsewhere. If nominal rates on short term securities are depressed for an extended period of time, the likely cause is increased uncertainty, deflationary expectations, or both. In any case, the reader can see that expectations are intimately tied to demand for money and quasi-moneys.

A nominal income target can help eliminate both uncertainty about the availability of credit to creditworthy borrowers during a downturn and self-feeding deflationary expectations. And as I will later explain, the mechanisms by which a nominal income rule can be implemented need not lead to insurmountable systemic distortions. The key to understanding this lies in tying together the core principles of classical macroeconomics which I have outlined.

As many of my readers know, the mechanisms governing the gold standard closely parallel those governing a nominal income level target. It should be no surprise that it also illustrates the principle that I am attempting to convey.  Under the gold standard, the monetary gold stock consistently grew at a rate of 2 to 3% per year. The years during which the growth rate of the gold stock deviated from this range tend to correlate tightly with changes in the price level (see figure from a recent post). When gold denominated prices fell sharply (the price of gold rose), the rate of growth might be as high as 7 to 10%. Barring a sudden reduction of the world’s gold stock – perhaps the plot of a devious Goldfinger or simply the result of insane banking policies – a rise in the price of gold was concomitant with an increase in demand for gold. As Say’s principle tells us, an increase in demand leading to an excess demand for gold implies a relative increase in present surplus stocks of goods. Luckily, an increase in the price of gold tends to increase the quantity supplied in a given period. Thus, gold flowed from mines and the market for non-monetary gold into the hands of those who valued it more as money. In other words, a shortage of gold identifies itself by a rise in the price of gold and, thus, simultaneously promotes its own remedy. Unfortunately, modern monetary systems lack this sort of mechanism for the monetary base.

A nominal income target is an nth best policy option which economists in favor of free markets ought to seriously consider. I don’t expect that anyone in the developed world will find himself or herself living in Mises’s evenly rotating economy any time soon. Absent from reality is a robust free-banking system that would develop absent financial regulation and central bank accommodation. Since I do not expect the state to give up its monopoly on  money any time soon. A rule that endogenizes the base money stock so as to 1) compensate for changes in portfolio demand for money and 2) stabilize expectations about the growth rate of the money stock, and therefore about inflation/deflation and monetary policy more generally, can help promote the coallescence of the plans of economic agents and avoid distortions that arise from expectation of targeted bail outs. This is especially important in a world where banks have come to expect central bank accommodation during periods of constrained liquidity and crisis. The recent crisis has shown that those managing private banks have come to integrate fiscal and monetary intervention into their expectations (Calomiris 2009). When accommodation becomes expected, the result is increased leverage and irresponsible lending.
By essentially turning the central bank into a computer program, a monetary rule will stabilize expectations about monetary policy. A monetary rule will essentially vanquish deflationary expectations and any expectations of a future bailout. This allows credit to play a coordinating rule whereby lending can, at a price, alleviate a shortage in money. If monetary expansion is 1) expected and 2) distributed broadly across financial markets, distortions from expansion will be minimized and money will tend to enter the hands of those who value it most (Selgin 2012). A policy of nominal income targeting alongside the reforms suggested by George Selgin would go a long way to minimizing distortions that result from interventions in financial markets. Thus, I am not convinced that Salin is considering a novel or uncorrectable problem in his description of Cantillon effects:

Those who are the first ones to borrow obtain a gain in purchasing power in comparison with others, since they can spend the money thus obtained before the increase in prices occurs when there is more money creation. Insofar as money creation implies a decrease in interest rates, some people also receive a benefit from money creation for this reason. Money creation therefore has distributional effects which cannot be justified since they are completely arbitrary. (11)

There is a cost to inaction just as there is a cost to monetary activism. At least a rule promotes stable expectations.

Unfortunately, Salin does not consider the three principles that lie at the heart of macroeconomics. By concentrating on microeconomic relationships and ignoring the macroeconomic principles that I have outlined, Salin has not really presented much that is new or useful to the debate regarding monetary policy. Strangely, he also finds that predictable expansion leads to uncertainty, but does not fully explain why:

In addition, an expansionary monetary policy creates uncertainty since no one can forecast accurately and precisely the rate of inflation and, above all, the distortions in price structures (which depend on the structure of credit and the structure of expenditures made by those who benefit from credits of monetary origin). (12)

To the extent that Salin is correct, this problem holds true for any expansion of the monetary base or of credit. This includes, to a lesser extent, expansion under a decentralized commodity standard, which is Salin’s (and my) standard par excellence.

Those of us interested in market process and macroeconomic problems need to consider the full extent of the problems which we study.  If I or anyone else promotes a free market monetary system, we cannot simply rely on the systems theoretical superiority to win the day. We need to consider improvements to the current system that can be made. As long as the government continues to promote a legal tender monopoly, bright minds should consider how to make that standard as little damaging as possible. In addition to those made in this post, I have suggested a number of other reforms including the elimination of capital gains taxes and of regulations that inhibit liquidity. If we are stuck with a legal tender monopoly, a monetary base constrained by a predictable rule is probably the best policy possible. Hayek appears to have come to grips with this once he stopped defending the international gold standard (both the classical gold and gold exchange standards were managed standards; see Hayek 1943 and 1960 about rules and predictability). It is time that market process theorists consider how an nth best policy might do the least harm or even promote development. In doing so, we must also make clear that we are suggesting an nth best solution, not a road to Utopia.

I’ll close by briefly addressing one critique by Salin that appears to have teeth. He argues that “monetary instruments should be used to solve monetary problems and real instruments to solve real problems (19).” Salin critiques nominal income level targeting on the grounds that expansion under a target will lead to inflation even when there is no growth in real income. On these grounds, I might also criticize the gold standard. The gold stock tended to grow even in years of contraction. In essence, the gold standard was a de facto income target, but one that was not only guided by changes in demand for money, but also changes in the supply of gold. In some years, surprise discoveries led to gold production that was far above average. In other years, constrained supply led to a relatively unresponsive money stock. As Barsky and DeLong have shown, inflationary expectations do not appear to have been accurate under such a scenario. Although his phrase may roll smoothly off my tongue – “monetary instruments should be used to solve monetary problems” – it is unclear that the type of system that Salin suggests is actually an historical artifact. No natural money that I know of is governed by this principle. 

Markets use imperfect moneys. What is important for a monetary system is that market actors can collectively form accurate expectations about future monetary conditions. This need a nominal income target can fulfill. If this condition is fulfilled, a failure of expectations to converge will not be the fault of monetary policy but will lie elsewhere.