It is quite interesting to see how popular myths can live on in the public’s mind and continue to cause harm and irritation even when the facts speak to totally different language. How can education fail so badly?

The particular example I have in mind here is Germans’ supposed exceptionalism in matters of inflation hyper-sensitivity. Whether or not Germans really are special in this regard, even internationally many observers seem to feel that Germans would be truly justified to be that way. Hence Germans are readily excused for doing stupid things because they seem to be justified that way. There is a highly relevant context to this today: the ECB’s asymmetry in mindset and approach.

I recently argued in a Letter to the Editors, “Beware what you wish for when it comes to ECB measures,” published by The Financial Times on February 26 2014, that there was actually nothing really new about the ECB’s revealed asymmetry regarding inflation versus deflation risks. At issue is a genetic defect inherited from the Bundesbank. In fact, there can be absolutely no doubt anymore about the ECB being asymmetric in mindset and approach, and more and more observers have come to realize that in more recent times. But there is also a long track record of asymmetric “stability-oriented” monetary policy that includes and precedes the ECB’s own life.

My letter prompted a response from a Mr Han de Jong, the Chief Economist of ABN AMRO Bank in Amsterdam, arguing that there would be a solid basis in history for Americans to fear deflation over inflation while the opposite is true for Germans, pointing to the Great Depression as the biggest trauma in US economic history of the last 100 years and contrasting it with Germany’s hyperinflation of 1922-23 (“Economic trauma scarred both the US and Europe,” Letters, March 3 2014).

This is surely right about America. While some US economists speak of the “Great Inflation” of the 1970s, which was followed by the Volcker shock and a double-dip recession in the early 1980s, this episode truly pales in comparison to the calamitous Great Depression experience of the 1930s. The memory of the Great Depression lives on in modern America. US policymakers are haunted by the ghosts of that historical episode. And that is a good thing!

When it comes to Germany, however, the story is less straightforward than is popularly held. continue reading…

One thing Jan Kregel’s new policy note makes clear is that congressional debates about raising the debt ceiling were a great deal more enlightening in the 1940s and ’50s. Here is Rep. Wright Patman (D-TX) in 1943 defending his proposal to fund what were expected to be huge wartime expenditures by bypassing the private financial system and placing government debt directly with the Federal Reserve Banks at zero interest rates:

the Government of the United States, under the Constitution, has the power, and it is the duty of the Government, to create all money. The Treasury Department issues both money and bonds. Under the present system it sells the bonds to a bank that creates the money, and then if the bank needs the actual money, the actual printed greenbacks to pay the depositors, the Treasury will furnish that money to the banks to pay the depositors. In that way, the Government farms out the use of its own credit absolutely free.

To Patman, “farming” out the government’s credit in this way was just a direct — and unnecessary — subsidy to private banks: “I am opposed to the United States Government, which possesses the sovereign and exclusive privilege of creating money, paying private bankers for the use of its own money. These private bankers do not hire their own money to the Government; they hire only the Government’s money to the Government, and collect an interest charge annually.” “If money is to be created outright,” he argued, “it should be created by the Government and no interest paid on it.”

As Kregel points out, one of the challenges for Patman’s proposal is that a zero rate on government debt seems to require giving up control over interest rates as a tool of monetary policy. However, Kregel notes that a proposal appearing in a 1946 Federal Reserve annual report (and repeated a number of times until the 1951 Fed-Treasury Accord) offers a solution: with the aid of supplementary required reserves, it would be possible to maintain a zero rate on government bonds while allowing the policy rate to rise. (As Marriner Eccles realized, the use of such policies would also require that fiscal policy play a role in controlling inflation — very much in the vein of Abba Lerner’s functional finance, Kregel observes.)

One of the takeaways from this discussion — beyond the remarkable deterioration of the quality of congressional debate — is that the supposed problem of financing the debt should be getting a lot less attention than it does in today’s deficit and debt ceiling debates. The real question, Kregel stresses, is “whether the size of the deficit to be financed is compatible with the stable expansion of the economy.”

Read Kregel’s policy note: “Wright Patman’s Proposal to Fund Government Debt at Zero Interest Rates: Lessons for the Current Debate on the US Debt Limit“

I recently had the great fortune to listen to a speech delivered by Mr Yves Mersch, Member of the Executive Board of the European Central Bank. This was in Athens on November 8 at the first Minsky Conference in Greece organized by the Levy Economics Institute. The title of the conference was “The Eurozone crisis, Greece, and the Austerity Experience.” The conference was well attended by the interested public. As is typical of Minsky conferences, annually held in the United States, it brought together academic scholars, financial market practitioners, journalists, as well as policymakers, including Mr. Mersch, whose speech was titled “Intergenerational justice in times of sovereign debt crises” (see here). Mr Mersch played part in the negotiations of the Maastricht Treaty and has served as the Governor of the Central Bank of Luxembourg since its formation in 1998, before joining the ECB’s Executive Board last year.

Apart from lauding Greece’s pension reforms as measures that were necessary in view of demographic trends, Mr Mersch hailed Greece’s achievements in closing its fiscal deficit as “remarkable,” describing the Greek austerity experience as a “fiscal adjustment of historic proportions.” That it truly was, and Mr Mersch was keen to emphasize that the “extraordinary efforts” undertaken by the Greek people refuted the naysayers and proved wrong prophetic claims heard in May 2010 that Greece would leave the euro area within months. Mr Mersch acknowledged that record-high unemployment was a “tragedy,” only to go on to assert that “this is the painful cost of reversing the misguided economic policies and lack of reforms in the past.”

And, of course, more of the same would be needed, according to Mr Mersch: more fiscal consolidation, more structural reforms, and lower wages and prices in order to increase external competitiveness and facilitate an export-led recovery, as Greece’s “external sector must go into surplus.” This may be painful, “but we are in a monetary union and this is how adjustment works.” In addition to more wage-price deflation, Mr Mersch singled out the need to restore the health of Greek banks and the need for attracting more foreign investment as the other key ingredients that would deliver adjustment and recovery in Greece.

During the Q&A session following his speech I asked Mr Mersch whether there might not be a conflict between, on the one hand, emphasizing the need of healthy banks that would fund the recovery and, on the other hand, prescribing more wage-price deflation. Since a deflationary environment was not exactly known as a factor that would tend to improve the health of banks. And I also asked him why the ECB was tolerating such a significant undershooting of its 2 percent stability norm while calling for even more wage-price deflation in crisis countries – instead of going for higher inflation in current account surplus countries such as Germany. At least to me it seemed obvious that a properly stability-oriented central bank should much prefer inflation in surplus countries to be sufficiently high so as to enable the bank to actually meet its mandate, that is, 2 percent HICP inflation on average across the currency union, over an outcome where even Germany has an inflation rate that is well below 2 percent, with the ECB ending up sharply missing its self-defined target in the downward direction.

Mindless austerity or stability-oriented austerity?
Mr Mersch’s answers were very interesting. continue reading…

Here’s a piece I published in HuffPost back on Oct 18, 2010. A flash from the past – three years ago – predicting that QE2 would prove to be as impotent as QE1 had been. And here we are, folks. No recovery in sight–at least once you get off Wall Street.

We’re now set–yet again – to go off the fiscal cliff. Some have begun to talk again of the Trillion Dollar Coin – an idea President Obama has again rejected. He fears it would get tied up in the courts. So what? That would take years to settle.

Or perhaps he doesn’t want to break the logjam. Politically, he’s winning while the Republicans self-destruct.

However, here’s a better idea. We’ve got museums and national parks shut down. Why not sell them to the Fed? We can find a few trillion dollars of Federal Government assets to sell – and the Treasury can pay down enough debt to postpone hitting the debt limit for years. Heck, if we run out of Parks and Recreation facilities to sell, why not have the Fed start buying up National Defense? How much are our nukes worth? That should provide enough spending room to keep the Deficit Hawk Republicans and Democrats happy for a decade or two.

Have you ever been inside one of the Fed’s buildings? Nice, huh? Good place to display art and artifacts. There’s little doubt that the Fed knows how to put on a good show. (Note I was recently in Colombia and found that the central bank does own and run museums – and does an excellent job. When you’ve got the magic porridge pot, you can afford good housekeeping.) Imagine the Fed running the National Parks. Without budget constraints! Fine wine served at every campfire. Flushing toilets – not those smelly old pits. And hot showers. Mints left on pillows before you turn in for the night. Hot espresso with your wake-up call. Bullet train to the top of Half Dome.

And the Fed has pretty safe safes – good places to store the nukes. Call me crazy, but I think I’d feel a bit more comfortable with either Uncle Ben or Aunt Janet with fingers on the triggers than most of our past, present or future presidents.

OK, enough of that. Here’s my 2010 piece:

Why QE2 Won’t Save Our Sinking Ship continue reading…

Stephanie Kelton recently sat down with L. Randall Wray to discuss, among other things, the news that the Federal Reserve will refrain for the time being  from tapering its asset purchases (QE).

Wray took the occasion to elaborate on his view that quantitative easing is ineffective as economic stimulus and that — given the tools at its disposal — the Fed can’t actually carry out its dual mandate (on employment and price stability).

One interesting wrinkle here is that Wray makes this case not just with regard to asset purchases — which even some QE supporters have admitted don’t accomplish much in and of themselves — but also the “expectations channel” (forward guidance).

Kelton and Wray also touch on the latest debt ceiling showdown and the future of retirement security programs.

Download or listen to the podcast here.

Regarding spurious policy arguments about “excessive growth of the money stock”: Ed Dolan posts helpfully to Economonitor on the more realistic approach suggested by the theory of endogenous money. In particular, I took note of the following passage, which brings up a point that I wrote about recently:

 “Formally, a model that includes a minimum reserve ratio or target plus unlimited access to borrowed reserves would not violate the multiplier model, in the sense that at any given time, the money stock would be equal to the multiplier times the sum of borrowed and non-borrowed reserves. However, the multiplier would have no functional effect, since the availability of reserves would no longer act as a constraint on the money supply. Economists describe such a situation as one of endogenous money, by which they mean that the quantity of money is determined from the inside by the behavior of banks and their customers, not from the outside by the central bank.”

In this simplified setting, the constant known as the “money multiplier” becomes the “credit divisor,” a concept defined in a short article I wrote recently for the forthcoming Elgar volume Encyclopedia of Central Banking.

Using the divisor D, instead of

bank reserves ×  M = money,

one can write

credit/D = bank reserves.

The equation reflects a theory in which causality runs from left to right, reflecting the endogeneity of reserves.

Indeed, the divisor is far more realistic as a model of the money-creation process than the money multiplier. The collapsing money multiplier in the figure in Dolan’s post corresponds to a rapidly rising credit divisor.

The post also points out that after loan demand, “the second constraint is bank capital.” The post notes that when this constraint is binding, the idea of a “reserve constraint” is still more irrelevant. Also, a profitable and solvent bank that wishes to expand its lending can usually increase its capital by retaining earnings or by other moves, as Marc Lavoie and others have pointed out in the academic literature. Moreover, Lavoie observes that a commercial bank having difficulty raising capital might be able get the central bank to purchase its shares in some countries.  Lavoie’s account can be found in his fairly comprehensive essay, “A Primer on Endogenous Money,” in Modern Theories of Money, edited by Louis-Philippe Rochon and Sergio Rossi, Edward Elgar, 2003.

From a policy perspective, a fast-growing stock of money is not generally a “cause” of inflation, though it can be an effect of rising prices or economic activity. (Of course, interest rates that were low enough long enough could cause inflation in a situation in which there was a lack of unused productive capacity.) Central banks cannot fix the growth rate of money to achieve a desired inflation rate, by setting the growth rate of bank reserves. For, as the concept of the credit divisor illustrates, the latter are also endogenous in a modern banking system.

Back in 2009, Janet Yellen delivered a speech at the Levy Institute’s Minsky conference that explained how the financial crisis had changed her views about the role of central banks in handling financial instability. At the time she was the head of the San Francisco Fed.

The focus of her 2009 remarks was the question of how (or whether) central banks should try to counteract bubbles in asset markets. (Yellen also recalled the unfortunate topic of her 1996 conference speech: supposedly promising new innovations in the financial industry for better measurement and management of risk.) Bursting suspected bubbles has become the topic du jour in US monetary policy discussions, as it currently stands as the fashionable justification for tightening despite low inflation and high unemployment.

With the announcement that Larry Summers’ name has been withdrawn from consideration for the next Fed chair, the spotlight has turned to Yellen. Here (from the 2009 conference proceedings) is the text of her speech and a transcript of the brief Q&A that followed:

A Minsky Meltdown: Lessons for Central Bankers? (1)

It’s a great pleasure to speak to this distinguished group at a conference that’s named for Hyman Minsky. My last talk at the Levy Institute was 13 years ago, when I served on the Fed’s Board of Governors, and my topic then was “The New Science of Credit Risk Management at Financial Institutions.” I described innovations that I expected to improve the measurement and management of risk. My talk today is titled “A Minsky Meltdown: Lessons for Central Bankers?” and I won’t dwell on the irony of that. Suffice it to say that with the financial world in turmoil, Minsky’s work has become required reading. It is getting the recognition it richly deserves. The dramatic events of the past year and a half are a classic case of the kind of systemic breakdown that he—and relatively few others—envisioned.

Central to Minsky’s view of how financial meltdowns occur, of course, are “asset price bubbles.” This evening I will revisit the ongoing debate over whether central banks should act to counter such bubbles, and discuss “lessons learned.” This issue seems especially compelling now that it’s evident that episodes of exuberance, like the ones that led to our bond and house price bubbles, can be time bombs that cause catastrophic damage to the economy when they explode. Indeed, in view of the financial mess we’re living through, I found it fascinating to read Minsky again and reexamine my own views about central bank responses to speculative financial booms. My thoughts on this have changed somewhat, as I will explain.(2) continue reading…

Robert Barbera, a regular contributor to the Levy Institute’s Minsky conferences, has a great post at Johns Hopkins’ Center for Financial Economics on the cycle of amnesia and remembrance that seems to plague mainstream economic theorists. Here’s a key passage:

Perhaps the most indictable offense that mainstream economists committed, from 1988 through 2008, was to retrace, step by step, Keynes’s path of discovery from 1924 through 1936. Wholesale deregulation of finance and categorical confidence in a reductionist role for central banks came into being as the conventional wisdom embraced the 1924 view that free markets and stable prices alone gave us the best chance for economic stability. To add insult to injury, the conventional wisdom before the crisis was embedded in models called “new Keynesian” which were gutted of the insights of Keynes. This conventional wisdom gave license to a succession of asset market boom/bust cycles that defied the inflation/deflation model but were, nonetheless, ignored by central bankers and regulators alike. Quite predictably, in the aftermath of the grand asset market boom/bust cycle of 2008-2009, we are jettisoning Keynes, circa 1924, for the Keynes of 1936.

It’s worth reading the whole thing: “Exit Keynes, the Friedmanite, Enter Minsky’s Keynes.”

The Modern Money Network at Columbia University — heir to the “Modern Money and Public Purpose” seminar series — is starting up in September, with a pair of events that might be interesting to some of our readers:

1. Money as a Hierarchical System

Date: Thursday, September 12th, 6.15pm
Location: Room 104, Jerome Greene Hall, Columbia Law School

Moderator: Raúl Carrillo, J.D. Candidate (’15), Columbia Law School
Speaker 1: Christine Desan, Leo Gottlieb Professor of Law, Harvard Law School
Speaker 2: L. Randall Wray, Professor of Economics, University of Missouri-Kansas City
Speaker 3: Katharina Pistor, Michael I. Sovern Professor of Law, Columbia Law School & Director, Center on Global Legal Transformation
Speaker 4: Perry Mehrling, Professor of Economics, Barnard College & Director of Education Programs, Institute for New Economic Thinking

2. Central Banking in Theory and Practice

Date: Monday, September 23th, 6.15pm
Location: Room 103, Jerome Greene Hall, Columbia Law School

Moderator: Richard Clarida, C. Lowell Harriss Professor of Economics and International Affairs, Columbia University
Speaker 1: Lord Adair Turner, Senior Fellow, Institute for New Economic Thinking and former Director, U.K. Financial Services Authority
Speaker 2: James K. Galbraith, Lloyd M. Bentsen Jr. Chair in Government/Business Relations and Professor of Government, University of Texas at Austin
Speaker 3: Matias Vernengo, Associate Professor, Bucknell University & Senior Research Manager, Central Bank of Argentina

Livestreaming of these events will be hosted at the MMN website (seminar 1; seminar 2) — the site also links to background reading for each seminar.

I was recently asked by an interviewer who’s going to replace Chairman Bernanke. I declined to predict because I don’t do horseraces. You’d have to be inside the beltway to understand which way President Obama is leaning. There’s not much doubt that Wall Street is pulling for one of its own, Larry Summers, and Wall Street usually gets what it wants.

Let me turn to what we should want in a central banker, rather than trying to pick the winner of the contest. To understand the qualities desired, we need to know what central bankers should be able to do. There is a lot of misconception over the role played by the Fed in our economy.

The power of the central bank is substantially less than usually imagined, or at least what influence it has is not in the areas usually identified. It has little direct impact on inflation, unemployment, economic growth, or exchange rates. It does set the overnight interest rate, but there is no plausible theory nor evidence that this matters very much. The “interest rate channel” is weak — normally the Fed is raising rates in a boom, when everyone is enthusiastically borrowing and spending, so higher rates do not diminish optimism. In a slump, when the Fed normally lowers rates, it is too late — pessimism has already taken hold.

The way that raising rates actually can work is by causing insolvency of those already heavily indebted — by pushing payments on floating rate debt above what can be afforded. There is no smooth relation between borrowing and interest rates that can be exploited by policymakers. Rather, they can cause a financial crisis if they are willing to do a “Volcker”: push rates so high that defaults snowball through the economy.

Over the past three decades, where the Chairman’s influence has been significant has been in the area of regulation and supervision of the financial sector. Unfortunately, three successive Chairmen have failed to pursue the public interest preferring instead to promote Wall Street’s interest. This has been disastrous. continue reading…