Quick! To the Money-copter!
Friday, 10/30/2015 18:47
Keynes, monetarism and now inflation targeting failed. So let's dial back and try all three...!
ONCE UPON a time, the world was split into 'free' and 'Communist'. It made spotting the bad guys real easy,
writes Adrian Ash at BullionVault.
A nice variant applied closer to home, dividing the UK between 'Labour' and 'Tory'. And for teenage schoolkids, this mapped onto economics as 'Keynesians' versus 'monetarists'.
The first group said governments could boost growth by spending more and taxing less...or vice versa. But there was never much versa, as the monetarists noted, and that lower tax thing never came off.
Keynesianism proved itself false – deadly in fact – with the long inflation crisis of the 1970s.
No, what counted now was the money supply. Hence the name. Monetarism said growth rose and fell with the amount of money and credit supplied to an economy. So central banking, not government spending, was in fact the answer. The authorities could boost GDP by cutting interest rates to encourage new debt. But first they needed to tame inflation by setting rates higher than any time outside pre-modern wars.
It worked, or seemed to, in the way that
all cargo cults take hold at first. So by the time I was subjected to a high school education, monetarism ruled, moving from academic theory to a radical policy to the way things simply were inside two decades. At least, that's what we were told.
But monetarism, as in the life-cycle of all such ideas, had already gone a step further. The final step, in fact.
Yes, its key insight – the so-called 'M' aggregates of money supply – still appeared nightly on the TV news. It's still reported by many central banks today each month as well. But long before economics disturbed my adolescence, monetarism had already started to fail, and was being replaced a new model of how the world should work.
Inflation targeting.
"We didn't abandon the money-supply aggregates," said one central banker quoted in a 1995 history,
The Confidence Game, commenting on the
intellectual shift of a decade before.
"They abandoned us."
See, in the early-to-mid 1980s, the money supply numbers stopped doing what they were supposed to. Central bankers still trimmed interest rates here, nudged them up there, and messed about with reserve ratio requirements. But the M2, M3 and M4 aggregates – counting notes and coin in circulation, plus various measures of cash on deposit, short-term bills and other 'near-money' assets – no longer responded, running wild as if with a mind of their own.
Inflation sort of went down and growth kinda went up, as hoped. But while the policy decisions seemed to be working, the money-supply numbers supposed to inform them just didn't fit. And if the model doesn't fit reality (or vice versa), it needed replacing. A new theory and practice was needed. Academics delivered it right on cue.
Inflation targeting was what counted. Because hey, low inflation allowed strong growth, just so long as inflation didn't slip too low into the dreaded "deflation". So a target of, say, 2.0% per year for rises in the Consumer Price Index meant central bankers could keep everything rosy for Goldilocks – not too hot, not too cold, but just right – again by trimming rates here, or nudging them there. Only now, central bankers really understood how their actions affected the world, and the mechanism was much easier for the public to understand too.
The 'long boom' of the 1990s and early 2000s proved this new idea of inflation targeting to be perfect. Right up until it wasn't.
"Keeping inflation stable at a moderately low level is important," said Fed chair Janet Yellen earlier this fall in a lecture at the University of Massachusetts, "because inflation that is high, excessively low, or unstable imposes significant costs on households and businesses.
"[But] the Federal Reserve has not always been successful in fulfilling the price stability element of its mandate."
No fooling. Inflation overshot going into the financial crisis. Zero rates and QE money creation has since failed to stem its slide towards the dread zero. Twiddling the dials and pulling the levers is no longer working...if indeed it ever did. Maybe, just maybe, the central bankers aren't in fact in control.
The US Fed today targets 2.0% annual inflation. So does the Bank of England, the European Central Bank, and pretty much every other 'monetary authority' you can name. They judge that level as the sweet spot for price rises – too low to hurt anyone with 1970s-style price hikes, but a safe distance from letting shop prices fall, destroying profit margins, delaying consumer spending, and making debt ever-more expensive in real terms.
Inflation since the financial crash however has gone AWOL, despite interest rates at the lowest levels in history. The Fed met this month with headline US inflation
running at zero from 12 months before. So-called 'volatile' fuel and food aside (not part of anyone's cost of living, right?) it may as well have raised rates, instead of staying put for the 83rd month in succession. Because holding rates at zero ain't working.
Some academics
spotted the problem soon as the Lehman's crash hit. Indeed, the Bank of England's philosopher chief Mervyn King – governor during financial crisis part 1 – had warned about the worsening wrinkle in monetary theory and policy as far back as 2002.
"Acceptance of the idea that inflation is a monetary phenomenon has been accompanied by the lack of references to money in the conduct of monetary policy during its most successful period. The disappearance of money [supply aggregates] from the models used by economists is...more apparent than real...[But] nevertheless, there are real dangers in relegating money to this behind-the-scenes role."
Ignore the self-praise. Monetary policy's "most successful period" in fact accompanied the most fertile credit bubble in history. And when it burst, the Bank of England – like the Fed, European Central Bank, Swiss National Bank and most notably the Bank of Japan – quickly ran straight back to monetarism, applying the biggest dose of money-supply medicine in history.
Slashing rates to try and boost credit, they also pumped new money straight into the banking system in the hope of avoiding deflation. Just like King's former academic colleague at Princeton Ben Bernanke had theorized, also in 2002, when he told Japanese policymakers that fixing their soft, slow deflation would
take but a moment's work through the magic of ink and paper.
"The US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost. The government can [thus] reduce the value of a Dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services...Under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
Yet reviving the old, discredited model of monetary policy by running a trillion volts of electronic cash through it failed to revive inflation in the US either when its turn came. Still price levels stay static today. Inflation targeting is broken, and frantic monetarism hasn't worked either.
Central bankers need a new idea. Academics are happy to oblige. Stumble into the senior common room today, in fact, and you'd think you ate the wrong mushrooms for lunch...
"Martin and I
are in agreement...the merits of money-financed cash transfers (helicopter drops) overwhelm the alternatives [of abolishing cash and setting negative interest rates]..."
"We [wrongly] rule out helicopter money because it's undemocratic, but we rule out a discussion of helicopter money because
ordinary people might like the idea..."
"Helicopter Money is (almost)
inevitable. The only questions are: who does it; and when do they do it..."
"We now think the move to central banks endorsing fiscal policy and
essentially monetizing the added spending will be relatively quick and direct, in the event of a sudden slump in the global activity."
Doesn't the food taste strange to you?
That last soundbite isn't so academic. It's actually Citigroup economist Steven Englander, a managing director at US bank Citigroup's research division. And the idea of Helicopter Money...showering cash onto private households as a gift they can spend at will...is breaking out of the lecture hall just as Keynesianism, monetarism, and inflation targeting did before it.
You might fear this ends badly, or simply find it insane to begin with. Because the world is not short of money today.
How much abuse can this tool – the
most vague yet vital of social contracts – bear before it cracks entirely?
"Of course," said Ben Bernanke back in his
famous 2002 speech about how easy it was to defeat deflation, "the US government is not going to print money and distribute it willy-nilly."
Not even Ben Bernanke could see the pretty pass through which monetary academia is about to push us.
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