Macroeconomics and microeconomics

by Kurt Schuler December 30th, 2012 9:57 pm

David Glasner’s latest post concerns the state of macroeconomics. He observes that

"An especially pretentious conceit of the modern macroeconomics of the last 40 years is that the extreme assumptions on which it rests are the essential microfoundations without which macroeconomics lacks any scientific standing. That’s preposterous. Perfect foresight and rational expectations are assumptions required for finding the solution to a system of equations describing a general equilibrium. They are not essential properties of a system consistent with the basic rationality propositions of microeconomics."

Since the post is worth reading in its entirety, I will add only a few words. A recent related paper that I found valuable was Anwar Shaikh’s “Rethinking Microeconomics: A Proposed Reconstruction” (last paper listed on the page, currently). Shaikh points out that multiple microeconomic approaches are compatible with a body of macroeconomic facts (or what we think are facts) that economists are trying to explain. I add that economic history, and our understanding of current events, give us a way of judging among multiple approaches: we can compare which ones fit the available evidence best, a difficult but worthwhile endeavor. An attempt to do so that particularly impressed me was Truman Bewly's survey of employers to find out Why Wages Don't Fall during a Recession (published 1999; excerpt here, Amazon link here).


I'm dreaming of..."Debts"

by Kurt Schuler December 21st, 2012 11:39 pm

Irving Berlin, most commonly remembered around this time of year as the songwriter of "White Christmas," also wrote a song called "Debts" (alternate title: "We'll All Be in Heaven When the Dollar Goes to Hell"). He apparently wrote it in 1933. I was not aware of it until earlier this month. Sample lyrics:

Here's some news that you ought to know
Off the gold standard we must go
Like England and Italy and Germany and France
We are going to inflate
And we're very glad to state:

Let the pound go up, the franc go up, the mark go up as well
Uncle Sam will be in Heaven when the dollar goes to Hell

Bonus points to anyone who posts a link to a performance in the comments. All I found were the lyrics.

And if you get tired of listening to "White Christmas" and other cheery songs of the season, sober right up with Intervention and Misery: 1929-2008, whose message is right on the front cover: "How governments and central banks ruined the world and why the worst is still to come." My own view is more optimistic. There's a lot of ruin in a nation, and still more in a world. Still, an occasional dose of pessimism is invigorating. Perpetual optimism is as dull as perpetual "Blue Skies."



Cantillon effects in Africa

by Kurt Schuler December 15th, 2012 10:58 pm

Here's my small contribution to what J.P. Koning calls "The great monetary injection debate of 2012." (See also George Selgin's post two below.) It's a third-hand anecdote told to me by Larry White, who heard it from an African economist when Larry was chairing a conference whose proceedings were published as the book African Finance: Research and Reform.

The African economist told Larry, "Here's how the money supply increases in my country. The president orders the central bank to send an armored truck full of cash to his house. The president's wife goes into town and pays for her shopping spree with cash from the truck."

I doubt that these increases in the money supply were announced in advance or easily anticipated.


Best books of 2012...by us

by Kurt Schuler December 9th, 2012 11:00 pm

It is the time of year when many publications and blogs list what they consider to have been the best books of the year. I am giving a new twist to this old practice by limiting consideration to books on money and banking that contributors to this blog wrote, edited, or had chapters in. Surely you have many friends and relatives who would be happy to receive them as gifts. My wife and children have just loved the similar books I have given to them in years past.

The envelope, please—sorry, wrong event. Anyway, here goes:

Vern P. McKinley, Financing Failure: A Century of Bailouts—The history of U.S. bailouts and proposals for avoiding the mistakes they have made.

Lawrence H. White, The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years—The tumultuous 20th century.

David Beckworth, editor, Boom and Bust Banking: The Causes and Cures of the Great Recession—Includes chapters by Larry White and George Selgin.

Alex Chafuen and Judy Shelton, editors, Roads to Sound Money—Contains chapters by Jerry O’Driscoll, George Selgin, and Larry White.

Kurt Schuler and Andrew Rosenberg, The Bretton Woods Transcripts—Previously unpublished verbatim records of meetings at the historic 1944 conference that established the International Monetary Fund and the World Bank.

I have linked to the publishers’ Web sites, but all these books except Roads to Sound Money are also available on Amazon.

Because my work on The Bretton Woods Transcripts took so long, I failed to get beyond thinking of a title for my entry into the highly profitable erotica genre: Fifty Shades of Stimulus. The plot, such as it is, will have to come later.

If other contributors or frequent posters have had books published in 2012 on money and banking, please list them in the comments and I will insert an addendum to the post. I would also like to hear from anybody what books you read on money and banking published in 2012 that you found worthwhile. (Sorry, if it was published before this year but you only just got around to reading it, it doesn't count.)


Sumner v. Cantillon

by George Selgin December 9th, 2012 6:27 pm

(For Don.)

After trying a couple months back to defend the Austrian-School thesis that excessively rapid monetary expansion might give rise to what I termed "Intermediate Spending Booms," I promised myself that I'd keep out of the recent, related exchange between Scott Sumner and Sheldon Richman (among others) concerning so-called "Cantillon" effects. My inclination was, I daresay, only natural: after seeing commentators misrepresent my humble suggestion that a Fed policy involving a negative FFR target might perhaps have contributed just a wee bit to the subprime boom as (1) the simian proposition that that boom was entirely the Fed's fault and (2) the no-less absurd claim that the post-2008 collapse of nominal spending itself did no harm, I decided that this time I'd resist supplying raw material for more such libels by (for once) keeping my opinions to myself. (NB: Scott himself wasn't among the libelers.)

A couple nights ago, though, my good buddy Don Boudreaux wrote me asking, in effect, whether in denying Cantillon effects Scott had perhaps fallen off his rocker, and I promised to review the exchanges in question and to then give him my answer. And now, having done that, I just can't help sharing my conclusions. So much for resolutions.

The specific claim to which Scott objects is Sheldon's assertion that Fed open-market operations benefit those directly involved in them more than others because “early recipients—banks, securities dealers, government contractors—have the benefit of increased purchasing power before prices rise.” On its face that assertion appears, to me at least, as incontestable as the claim that, if I choose to do my Christmas shopping at Macy's rather than at Bloomingdale's, Macy's gains more from my display of Christmas spirit than Bloomingdale's does.

Nor can I see why it should matter whether the spending in question involves newly created money. Were I a counterfeiter whose products are perfectly indistinguishable from the real things, Macy's would still profit more from my spending than Bloomie's, provided it succeeds in fobbing the notes off just as easily as I do. The suppliers that Macy deals with are likely to profit as well, as may others who experience an increased nominal demand for their goods at stages of the "circular flow" not far removed from the fake notes' point-of-entry. Eventually, though, the notes will have worked their influence on prices generally, so that increased revenues, rather than going hand-in-hand with enhanced profits, merely compensate their recipients for a heightened cost either of living or of doing business.

How, then, does Scott attempt to refute Sheldon's argument? He does so mainly by resorting to two counterarguments, to wit: that Sheldon wrongly assumes that the Fed gives away new money instead of selling it, and that he confuses the effects of monetary policy strictly understood with those of what is properly regarded as fiscal policy.

"Richman seems to be assuming," Scott observes,"that OMOs are gifts of purchasing power from the Fed to the recipients.” Because the Fed actually sells new base money, Scott claims, initial buyers gain no more from it than anyone else, because they must part with other assets that are worth as much as the money they receive.

Much as I'm tempted to observe that the distinction between selling money and giving it away can get pretty darn blurry in practice (QE1, anyone?), it seems to me that Scott's position is unsound even putting that observation aside, for unless I'm missing something Scott here appears to neglect the basic truth that voluntary economic exchange is not a zero but a positive sum game. From that it follows that Primary Dealers, for instance, gain (or at least expect to gain) from their dealings with the New York Fed's Open Market desk no less than Macy's expects to gain from my doing my shopping there rather than somewhere else. They gain, moreover, even assuming that competitive bidding enforces a "zero-profit" condition, for that doesn't mean that such bidding rules out normal profits. And if anyone doubts that this is so, they would presumably have to insist that Primary Dealers, for starters, attach no particular importance to their status, and might indeed prefer to forgo it and let others go through the bother of selling stuff to the Fed since they would gain no less from its OMOs by waiting for new money to trickle its way toward them, and would do so notwithstanding the risk that the same money might in the meantime have raised the prices of their inputs.

But of course Primary Dealers do prefer dealing directly with the Fed to waiting along with everyone else for their share of enhanced Aggregate Demand. In suggesting that they shoudn't Scott appears (to invoke the terminology of Roman law) to overlook the crucial distinction between lucrum emergens and damnum cessans. Fed insiders alone experience the former, whereas the latter is the paltry reward typically granted by the Fed to hoi polloi.* (The reward is, of course, greater when the initial equilibrium involves a shortage of money--but Scott never claims that his arguments refer only to monetary expansions undertaken during a state of deflationary recession.)**

As for Scott's second counterargument, it seems to me to amount to nothing more than wordplay. Monetary expansion, Scott insists, is really "fiscal expansion" when it can be understood to involve an element of government largesse. Even a Friedman-style helicopter drop, according to this view, is really a form of fiscal rather than strictly monetary stimulus; monetary expansion in the strict sense of the term must take the form of conventional open-market purchases.

I've never had much use for a definition of "fiscal" policy that would have us believe that there's nothing "fiscal" about the Fed supporting the market for U.S. government securities. But in this case I fear the problem is more serious even than usual, for Scott comes perilously close to defining as "fiscal" any monetary operation that might have distribution effects of the kind Sheldon (and Cantillon) insist upon. Semantics aside, the real question isn't whether "pure" monetary expansions involve distribution effects, but whether most real-world monetary expansions have such effects, however pure or impure those monetary expansions may be.

As I conclude these remarks I already anticipate someone declaring in reply to them that I apparently believe that Cantillon effects are the only effects of monetary policy, or that Sheldon Richman is a better monetary economist than Scott Sumner, or that water flows uphill. For whoever does so, may the lamb of God stir his hoof through the roof of heaven, and kick you in the arse.

*Upon further reflection I concede that my emphasis on Primary Dealers is misleading, for when the assets that the Fed purchases are being actively traded in an organized market--as is the case with U.S. government securities, though it wasn't with MBSs back in 2008--all holders of such securities, and not merely those who deal directly with the Fed, gain from the Fed's purchases of them and their consequent appreciation. Here the analogy with shopping at Macy's also proves deficient, because an increase in demand for shirts at Macy's doesn't serve to immediately bid up the value of shirts everywhere. But the increase in the relative price of government securities, and corresponding reduction in their yield, ceteris paribus, is nonetheless a Cantillon effect, stemming from the initial injection of new money into a particular market; indeed, it is the most important sort of Cantillon effect in modern monetary arrangements, and one the existence of which is presupposed whenever the Fed employs an intermediate interest-rate target. (Note added on 12/9 at 8:45PM.)

**Upon still further reflection I conclude that most important determinant of whether or not Cantillon effects arise is not, as Scott maintains, whether or not the Fed gives money away, but precisely whether the economy is or isn't suffering from a deficiency of aggregate demand, with P > P,* when monetary expansion takes place. (Added 12/10 and 11:10AM.)



by George Selgin December 3rd, 2012 9:46 am

Although the movement to “End the Fed” has a considerable popular following, only a very tiny number of economists—our illustrious contributors amongst them—take the possibility seriously. For the rest, the Federal Reserve System is, not an ideal currency system to be sure (for who would dare to call it that?), but, implicitly at least, the best of all possible systems. And while there’s no shortage of proposals for reforming it almost all of them call only for mere tinkering. Tough though their love may be, the fact remains that most economists are stuck on the Fed.

This veneration of the Fed has long struck me as perverse. Its record can hardly be said, after all, to supply grounds for complacency, much less for the belief that no other system could possibly do better. (Indeed that record, as Bill Lastrapes, Larry White and I have shown, even makes it difficult to claim that the Fed has improved upon the evidently flawed National Currency system it replaced.) Further, as the Fed is both a monopoly and a central planning agency, one would expect economists’ general opposition to monopolies and to central planning, as informed by their welfare theorems and by the general collapse of socialism, to prejudice them against it. Yet instead of ganging up to look into market-based alternatives to the Fed, the profession for the most part has relegated such inquiries to its fringe.

Why? The question warrants an answer from those of us who insist that exploring alternatives to the Fed is worthwhile, if only to counter people’s natural but nevertheless mistaken inclination to assume that the rest of the profession isn’t interested in such alternatives because it has already carefully considered—and rejected—them.

It’s tempting to blame Fedophilia, or what Larry White calls “status quo” bias in monetary research, on the Fed’s direct influence upon the economics profession. According to White, in 2005 the Fed employed about 27 percent more full-time macro- and monetary (including banking) economists than the top 50 US academic economics departments combined, while disseminating much of their research gratis through various in-house publications or as working papers. Perhaps not surprisingly, despite a thorough review of such publications White could not find “a single Fed-published article that calls for eliminating, privatizing, or even restructuring the Fed.” That professional monetary economics journals are not much better may in turn reflect the fact, also documented by White, that Fed-affiliated economists also dominate those journals' editorial boards.

But I doubt that a reluctance to bite the hand that feeds them is the only, or even the most important, reason why most economists seldom question the Fed’s desirability. Another reason, I suppose, is their desire to distance themselves from…kooks. Let’s face it: more than a few persons who’d like to “End the Fed” want to do so because they think the Rothschilds run it, that it had JFK killed because he planned to revive the silver dollar, and that the basic plan for it was hatched not by the Congressional Committee in charge of monetary reform but by a cabal of Wall Street bankers at a top-secret meeting on Jekyll Island.

Oh, wait: the last claim is actually true. But claims like the others give reasonable and well-informed Fed critics a bad name, while giving others reason for wishing to put as much space as possible between themselves and the anti-Fed fringe. (And please don’t bother to write telling me that the Fed really is a Zionist conspiracy or whatever, or I will personally arrange to have you tracked down and assassinated by someone named Rothschild, even if I have to have some hit man’s name legally changed for the purpose.)

I’m convinced that imagination, or the lack of it, also plays a part. To some extent the problem is too much rather than too little imagination. With fiat money, and a discretionary central bank, it’s always theoretically possible to have the money stock (or some other nominal variable) behave just like it ought to, according to whichever macroeconomic theory or model one prefers. In other words, a modern central bank is always technically capable of doing the right thing, just as a chimpanzee jumping on a keyboard is technically capable of typing-out War and Peace. Just as obviously, any conceivable alternative to a discretionary central bank, whether based on competition and a commodity standard or frozen fiat base or on some other “automatic” mechanisms, is bound to be imperfect, judged relative to some—indeed any—theoretical ideal. Consequently, an economist need only imagine that a central bank might somehow be managed according to his or her own particular monetary policy ideals to reckon it worthwhile to try and nudge it in that direction, but not to consider other conceivable arrangements.

That there’s a fallacy of composition of sorts at play here should be obvious, for a dozen economists might hold as many completely different monetary policy ideals; yet every one might be a Fedophile simply because the Fed could cater to his or her beliefs. In actual fact, of course, the Fed’s conduct can at most satisfy only one of them, and is indeed likely to satisfy none at all, and so might actually prove distinctly inferior to what some non-central bank alternative would achieve. So in letting their imaginations get the best of them, all twelve economists end up endorsing what’s really the inferior option. And if you don’t think economists are really capable of such naievete, I refer you to the literature on currency boards, in which one routinely encounters arguments to the effect that central banks are always better than currency boards because they might be better. Or how about those critics of the gold standard who, having first observed how, under such a standard, gold discoveries will cause inflation, go on to conclude, triumphantly, that a fiat-money issuing central-bank is better because it might keep prices stable?

But if economists let their imaginations run wild in having their ideal central banks stand in for the real McCoys, those same imaginations tend to run dry when it comes to contemplating radical alternatives to the monetary status quo. Regarding conventional beliefs concerning the need for government-run coin factories, which he (rightly) dismissed as so much poppycock, Herbert Spencer observed, “So much more does a realized fact influence us than an imagined one, that had the baking of bread been hitherto carried on by government agents, probably the supply of bread by private enterprise would scarcely be conceived possible, much less advantageous.” Economists who haven’t put any effort into imagining how non-central bank based monetary systems might work find it all too easy to simply suppose that they can’t work, or at least that they can’t work at all well. The workings of decentralized markets are often subtle; while such markets' ability to solve many difficult coordination problems is, not only mysterious to untrained observers, but often difficult if not impossible even for experts to fathom except by means of painstaking investigations. In comparison monetary central planning is duck soup—on paper, anyway.

Nor does the way monetary economics is taught help. In other subjects the welfare theorems are taken seriously. In classes on international trade, for example, time is always spent, early on, on the implications of free trade: never mind that the world has never witnessed perfectly free trade, and probably never will; it’s understood that the consequences of tariffs and other sorts of state interference can only be properly assessed by comparing them to the free trade alternative, and no one who hasn’t studied that alternative can expect to have his or her pronouncements about the virtues of protectionism taken seriously. In classes in monetary economics, on the other hand, the presence of a central bank—a monetary central planner, that is—is assumed from the get-go, and no serious attention is given to the implications of “free trade in money and banking." Consequently, when most monetary economists talk about the virtues of this or that central bank, they’re mostly talking through their hats, because they haven’t a clue concerning what other institutions might be present, and what they might be up to, if the central bank wasn’t there.

Since monetary systems not managed by central banks, including some very successful ones, have in fact existed, economists’ inability to envision such systems is also evidence of their ignorance of economic history. That ignorance in turn, among younger economists at least, is a predictable consequence of the now-orthodox view that history can be safely boiled down to a bunch of correlation coefficients, so that they need only gather enough numbers and run enough regressions to discover everything worth knowing about the past.

Those who’ve been spared such “training,” on the other hand, often have a purblind view of the history of money and banks—one that brings to mind Saul Steinberg’s famous New Yorker cover depicting a 9th-Avenuer’s view of the world, with its almost uninhabited desert between the Hudson and the Pacific, and China, Japan, and Russia barely visible on the horizon. If he or she knows any monetary history at all, the typical (which is to say American) economist knows something about that history in the U.S., and perhaps considerably less about events in Great Britain. Theirs is, in short, just the right amount of knowledge to be very dangerous indeed.

And dangerous it has been. In particular, because the U.S. before 1914, and England before the Bank of England began acting as a lender of last resort, happened to suffer frequent financial crises, economists' historical nearsightedness has given rise to the conventional wisdom that any fractional-reserve banking system lacking a lender of last resort must be crisis-prone, and to clever (if utterly fantastic) formal models serving to illustrate the same view (or, according to economists’ twisted rhetoric, to “prove” it “rigorously”). It has, correspondingly, led economists to ignore or at least to underestimate the extent to which legal restrictions, including unit banking laws in the U.S. and the six-partner rule in England, contributed to the deficiencies of those countries’ banking systems. Finally, and most regrettably, it has caused economists to overlook altogether the possibility that the monopolization of paper currency has itself been more a cause of than a cure for financial instability.

The good news is that Fedophilia is curable. Milton Friedman, for one, was a recovering Fedophile: later in his career he repudiated the mostly-conventional arguments he’d once put forward in defense of a currency monopoly. Friedman, of course, was a special case: a famous proponent of free markets, he had more reason than most economists do to view claims of market failure with skepticism, even if he’d once subscribed to them himself. Even so his was only a half-hearted change of heart, in part (I believe) because he still hadn't drawn the lessons he might have from the banking experiences of countries other than the U.S. and England.

Friedman’s case suggests that it will take some pretty intense therapy to deprogram other Fed inamoratos, including a regimen of required readings. Charles Conant’s History of Modern Banks of Issue will help them to overcome their historical parochialism. Vera Smith’s The Rationale of Central Banking will do more of the same, while also exposing them to the lively debates that took place between advocates and opponents of currency monopolies before the former (supported by their governments’ ravenous Treasuries) swept the field. The Experience of Free Banking, edited by Kevin Dowd (with contributions by several Freebanking.org contributors including yours truly) gathers studies of a number of past, decentralized currency systems, showing how they tended to be more stable than their more more centralized counterparts, while another collection, Rondo Cameron’s Banking in the Early Stages of Industrialization, shows that less centralized systems were also better at fostering economic development. Finally, instead of being allowed to merely pay lip service to Walter Bagehot’s Lombard Street, Fedophile’s should be forced, first to read it from cover to cover, and then to re-read out-loud those passages (there are several) in which Bagehot explains that there’d be no need for lenders of last resort had unwise legislation not created centralized (“one reserve”) currency systems in the first place. The last step works especially well in group therapy.

Of course even the most vigorous deprogramming regimen is unlikely to alter the habits of hard-core Fed enthusiasts. But it might at the very least make them more inclined to engage in serious debate with the Fed’s critics, instead of allowing the Fed's apologists to go on believing that they answer those critics convincingly simply by rolling their eyes.


Cato Institute Monetary Conference

by Kurt Schuler December 2nd, 2012 11:04 pm

Jerry O'Driscoll's summary here. Video here.