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Monetary economics: a reading list

by Kurt Schuler June 30th, 2013 5:05 am

(Lars Christensen recently sent an e-mail asking for suggestions of five books that recipients would recommend to students of monetary economics. I assume that he will be posting the results on his blog, The Market Monetarist. His e-mail prompted me to retrieve the following more detailed survey that I wrote several years ago for my personal Web site, which is currently dark but will be posted again in a new location in a few months. Note that almost all books published in 1922 or before are now available for free someplace on the Internet, and that the Mises Institute has done good work in securing permission to post some newer works for free of the Austrian School and those who have influenced the Austrians. I have made a few updates for this post but have not updated all the links or inserted many new links. In the comments, I welcome suggestions for very important books in monetary economics, in the top 100 out of the many thousands that have been published on the subject.)

The readings here will provide a solid grounding for those interested in monetary theory and history. The list is written with economics graduate students in mind, since as far as I know there is no other recent list on the subject. The list reflects my beliefs in the importance of monetary history and alternatives to central banking. Books with asterisks (*) are those you should start with. The list does not include works on the monetary theory of business cycles. Dates are those of original editions; some books have been reprinted. Foreign readers will notice a predominance of material in English. Almost all the best foreign work in monetary economics has been translated into English.

Somebody asked me if I have really read all these books. I've read more than 90 percent of them all the way through and have read at least parts of all the rest (such as the reference volumes). I welcome suggestions for material to include or delete from the list, which I last updated slightly in January 2007. Some of the recent books may have newer editions than listed below.

Introductory books. (*)Dennis Robertson, Money (several editions beginning 1922) is a wonderfully lucid introduction. J. Huston McCulloch, Money and Inflation: A Monetarist Approach (2nd ed. 1982) is a suitable follow-up work. William Stanley Jevons, Money and the Mechanism of Exchange (1875) remains surprisingly useful. Alex N. McLeod, The Principles of Financial Intermediation (1984) is good but hard to find. No current textbook is outstanding, but okay texts include Meir G. Kohn, Money, Banking and Financial Markets (1993), Roger LeRoy Miller and David D. Van Hoose, Modern Money and Banking (3rd ed. 1993), and Frederic S. Mishkin, Economics of Money, Banking and Financial Markets (4th ed. 1995). If you read French, try Pascal Salin, La vérité sur la monnaie (1990).

Reading so-called high-level textbooks will in most cases reduce rather than increase your knowledge, because they focus on theoretical trivia rather than on the important issues. The graduate textbooks issued by MIT Press are a case in point. You are better off reading real books.

Monetary history. John Chown, A History of Money (1994) is as wide-ranging as its title implies. Abbott Payson Usher, The Early History of Deposit Banking in Mediterranean Europe (1943) covers the early history of modern banking. (*)Charles Conant, A History of Modern Banks of Issue (7 editions beginning 1896) surveys the history of banks the world over; read between the lines and you can learn a lot about the evolution of banking and about government involvement in the monetary system. Pierre Vilar, A History of Gold and Money, 1450-1920 (1969) is a useful although Marxian account. Charles Kindleberger, A Financial History of Western Europe (2nd ed. 1993) is an informative synthesis spanning 500 years, with a good bibliography. Kevin Dowd, editor, The Experience of Free Banking (1992) discusses historical episodes of free banking and also has a good bibliography. (*)Leland Yeager, International Monetary Relations: Theory, History, and Policy (2nd edition 1976) has an excellent historical account of the years 1914-1974. Harold James, International Monetary Cooperation Since Bretton Woods (1996) is a thorough discussion of its subject. Paul Einzig, History of Foreign Exchange (2nd ed. 1970) is wide-ranging in time and space.

In American monetary history, the standard works are Bray Hammond, Banks and Politics in the United States from the Revolution to the Civil War (1957) and Sovereignty and an Empty Purse (1970); (*)Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (1963); and Richard H. Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (1993). A good neglected work is A. Barton Hepburn, A History of Coinage and Currency in the United States, and the Perennial Contest for Sound Money (1903). For early statistics, see J. Van Fenstermaker (Fenstermaker is his last name), The Development of American Commercial Banking: 1782-1837 (1965), which however is hard to find.

International monetary economics. Roy Harrod, International Economics (4 editions 1933-1958) is an introductory account still worth reading. The current standard undergraduate textbook is Paul R. Krugman and Maurice Obstfeld, International Economics: Theory and Policy (6th edition 2003); it is not bad but not great. (*)Leland B. Yeager, International Monetary Relations: Theory, History, and Policy (2nd edition 1976) is a superb treatise masquerading as a textbook. Other advanced textbooks are Jürg Niehans, International Monetary Economics (1984) and Peter Isard, Exchange Rate Economics (1995). Rudiger Dornbusch, Exchange Rates and Inflation (1988) is a collection of essays on currently fashionable topics in international monetary economics. Ronald R. MacDonald, Floating Exchange Rates: Theories and Evidence (1988) is a good survey of its topic; see also Michael Rosenberg, Currency Forecasting (1996). On the history of thought, see M. June Flanders, International Monetary Economics 1870-1960: Between the Classical and the New Classical (1989).

Monetary theory before 1900. I list here nothing but the choicest of the choice. Classics include John Law, Money and Trade Considered, With a Proposal for Supplying the Nation with Money (2nd ed. 1720); Isaac Gervaise, The System or Theory of the Trade of the World (1720); Fernando Galiani, Della Moneta (1751); David Hume, "Of the Balance of Trade" (1752); Richard Cantillon, Essai sur la nature du commerce en général (1755; English translation 1931); Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776); (*)Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802)--the most brilliant performance ever in monetary theory; Edwin Cannan, The Paper Pound of 1797-1821; The Bullion Report, 8th June 1810 (2nd edtion 1925), which reprints the influential British Parliamentary Bullion Report; David Ricardo, "Proposal for an Economical and Secure Currency" (1816) and On the Principles of Political Economy and Taxation (3rd edition 1821); Thomas Tooke, An Inquiry into the Currency Principle (1844) and A History of Prices (6 v., 1837-57); C. J. G. Goschen, The Theory of the Foreign Exchanges (1861); John Stuart Mill, Principles of Political Economy with Some of Their Applications to Social Philosophy (7th ed. 1871); Walter Bagehot, Lombard Street: A Description of the Money Market (1873); and Henry Dunning McLeod, The Theory and Practice of Banking (2 volumes, 1881). You will find many of these and a few other works mentioned in other sections in the fine McMaster University Archive for the History of Economic Thought, the Online Library of Liberty,  the Internet Archive, HathiTrust, Mises Institute, or Google Book Search (use the Advanced Book Search feature if a simple search does not yield the desired results).

Monetary theory since 1900: Swedes and Austrians. This tradition derives mainly from the Swedish economist Knut Wicksell. (*)Knut Wicksell, Lectures in Political Economy, volume 2 (1908; English translation 1934) expounds the theory of the "natural rate of interest" more clearly than Interest and Prices (1898). Gunnar Myrdal, Monetary Equilibrium (1931; English version 1939) develops the theory. One of the fountainheads of Austrian monetary thought is Ludwig von Mises, The Theory of Money and Credit (1912; English translation 1934)--ponderous but worthwhile. Tjardus Greidanus, The Value of Money (2nd edition 1950) is a neglected classic expounding a "yield theory" of money. Greidanus was Dutch.

The Swedes virtually disappeared as a distinctive school in monetary theory after the 1930s. The Austrians almost did, too, but revived in the 1970s. The "free banking" category below lists recent Austrian work.

Twentieth century monetary theory: monetarism. (*)C. A. Phillips, Bank Credit (1921) explains how the reserve multiplier works. Irving Fisher, The Theory of Interest (1930) and (*)The Purchasing Power of Money (revised edition 1931) describe the quantity theory approach. Milton Friedman, Essays in the Positive Economics (1953) and The Optimum Quantity of Money and Other Essays (1969) develop Fisher's ideas further; see also Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (1963), and Harry G. Johnson, Essays in Monetary Theory (1967) and Further Essays in Monetary Theory (1973).

Twentieth century monetary theory: Cambridge (U.K.) and the Keynesians. Alfred Marshall, Money, Credit, and Commerce (1923) and Official Papers of Alfred Marshall (edited by John Maynard Keynes, 1926) contain the beginnings of the Cambridge school approach. (*)John Maynard Keynes, A Tract on Monetary Reform (1923) is better than his other major works on money, A Treatise on Money (2 volumes, 1930) and The General Theory of Employment, Interest and Money (1936). (*)John Hicks, Critical Essays in Monetary Theory (1967) is a marvelously stimulating collection. Don Patinkin, Money, Interest, and Prices: An Integration of Monetary and Value Theory (2nd ed. 1965) is a massive elaboration (or overelaboration) of the Keynesian-neoclassical synthesis.

Two works of the 1960s that are not really Keynesian but merit mention are John G. Gurley and Edward S. Shaw, Money in a Theory of Finance (1960), and Boris P. Pesek and Thomas R. Saving, Money, Wealth, and Economic Theory (1967). Jürg Niehans, The Theory of Money (1978) was state of the art when written--in other words, it has not aged well.

The best later Keynesians are Robert Clower and Axel Leijonhufvud: see (*)Donald A. Walker, ed., Money and Markets: Essays by Robert W. Clower (1984), and (*)Axel Leijonhufvud, Information and Coordination: Essays in Macroeconomic Theory (1981).

Mention should also be made of the Post-Keynesians. Geoffrey Ingham, The Nature of Money (2004) is by my reading the first classic of the school. Worthwhile older books are Paul Davidson, Money and the Real World (2nd ed. 1978), Colin Rogers, Money, Interest and Capital: A Study in the Foundations of Monetary Theory (1989), and L. Randall Wray, Understanding Modern Money (1998). Heinz-Peter Spahn, From Gold to Euro: On Monetary Theory and the History of Monetary Systems (2001) is influenced by Post-Keynesianism, though I do not know if the author would call himself Post-Keynesian.

Twentieth century monetary theory: the new classicals. Kevin Hoover, The New Classical Macroeconomics (1988) is a very good discussion of the new classical school, who have not yet produced any classic books on monetary theory; Torsten Persson and Guido Tabellini, eds., Monetary and Fiscal Policy (2 v., 1994) has the most important papers by the new classicals. (*)Fischer Black, Business Cycles and Equilibrium (1987) is a provocative collection of essays by a writer who fits neatly into no school but is closest to the new classicals.

Monetary regimes. This topic is related to monetary theory, but more closely focused on institutions. On central banking, see Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802) and Walter Bagehot, Lombard Street: An Account of the Money Market (1873)--both classics; M. H. de Kock, Central Banking (several editions beginning 1939); (*)Charles Goodhart, The Evolution of Central Banks (1988); Alex Cukierman, Central Bank Strategy, Credibility, and Independence: Theory and Evidence (1992); and Anand Chandavarkar, Central Banking in Developing Countries (1996). Volume 2 of John Maynard Keynes's Treatise on Monetary Theory (1930) is something of a handbook on central banking. The best book on what guidelines to use for operating a central bank under floating exchange rates is Manuel H. Johnson and Robert F. Keleher, Monetary Policy, A Market Price Approach (1996). On free banking, see below. I am not impressed by the book that others consider the most important recent work in this field, Michael Woodford, Interest and Prices: Foundations of a Theory of Monetary Policy (2003), because it waxes long about details while neglecting to examine some truly foundational questions in any depth.

On the currency board system, see Steve H. Hanke, Lars Jonung, and Kurt Schuler, Russian Currency and Finance: A Currency Board Approach to Reform (1993). Maxwell Fry, Money, Interest, and Banking in Economic Development (2nd ed. 1995) is a good synthesis on its subject. No thorough account of socialist monetary systems exists, but Gavin Peebles, A Short History of Socialist Money (1991) is a sketch. On dollarization there is much material but as yet no really good book in English; in Spanish, see Jürgen Schuldt, Dolarización oficial de la economía (1999), the most successful use of the dialogue form I have ever seen in economics.

Free banking. For a detailed bibliography, see George A. Selgin and Lawrence H. White, "How Would the Invisible Hand Handle Money?," Journal of Economic Literature, December 1994. (If you belong to the American Economic Association you can obtain the article online.) Free banking thought goes all the way back to Adam Smith, and bloomed in the first half of the nineteenth century in Britain. (*)Lawrence H. White, Free Banking in Britain: Theory, Experience, and Debate 1800-1845 (2nd ed. 1995) summarizes the British free banking debates and discusses the history of the highly successful Scottish free banking system. Vera C. Smith (married name: Vera Lutz), The Rationale of Central Banking and the Free Banking Alternative (1990 [1936]) is an earlier survey of debates about free banking in Britain, America, and Western Europe.

Smith's book was a dissertation written under F. A. Hayek, who restarted the free banking movement with (*)Denationalisation of Money (1976; 3rd edition 1992). Hayek has influenced all other recent writers on free banking. (*)George Selgin, The Theory of Free Banking: Money Supply Under Competitive Note Issue (1988) is essential for an advanced understanding of free banking. It shows in detail why free banking works well and why central banking, like other forms of central planning, is unavoidably flawed. I consider this the second-best book ever written on money, after Henry Thornton's book, but it is not for beginners.

Kevin Dowd's The State and the Monetary System (1989) is the best introduction to free banking for readers totally unfamiliar with the idea. His Laissez Faire Banking (1993) is a collection of essays discussing theory and historical evidence on the stability of free banking systems and showing how free banking principles can guide present-day monetary reforms. (*)The Experience of Free Banking (1992) is a collection of essays by Dowd and others that analyzes nine historical episodes of free banking in detail and discusses the general experience of all the (almost sixty) currently known episodes of free banking. It refutes claims that free banking has not been widely tried or has not worked well.

Larry Sechrest, Free Banking: Theory, History and a Laissez-Faire Model (1993) reviews various approaches to free banking, including the author's own, and discusses their strengths and weaknesses. Lawrence H. White, editor, Free Banking (1993), is a three-volume collection of previously printed essays by various authors on the history of free banking. It contains almost everything printed so far on the subject except what is in The Experience of Free Banking. Mention must also be made of White's Competition and Currency: Essays on Free Banking and Money (1989), a collection of essays containing several gems. Steven Horwitz, Microfoundations and Macroeconomcs: An Austrian Perspective (2001) places free banking theory within a broader context of macroeconomics.

A few other books, not strictly on free banking, deserve notice. Roland Vaubel, Strategies for Currency Unification: The Economics of Currency Competition and the Case for a European Parallel Currency (1978) is a little-known but valuable book. M. L. Burstein's The New Art of Central Banking (1990) is written in a difficult style, but contains keen insights on the struggle between governments and markets and why markets will eventually win. Tyler Cowen and Randall Kroszner, Explorations in the New Monetary Economics (1993) examines the ideas of writers who as far back as the nineteenth century anticipated elements of the radically laissez faire approach of Burstein and others.

History of thought. The best recent summary is in French: Pierre-Bruno Ruffini, Les théories monétaires (1996), a brief work that manages to cover much ground. (*)Charles Rist, A History of Monetary and Credit Theory from John Law to the Present Day (1938) becomes less and less good the closer it comes to the time it was written. Lloyd W. Mints, A History of Banking Theory in Great Britain and the United States (1945) is interesting but idiosyncratic. (*)Joseph A. Schumpeter, History of Economic Analysis (1954) is a more general work that contains much history of monetary theory. M. June Flanders, International Monetary Economics 1870-1960: Between the Classical and the New Classical (1989) is engaging, but neglects most writers outside English-speaking countries.

Collections of journal articles. Three collections bear special mention: American Economic Association, Readings in Monetary Theory (1951), Thomas Mayer (editor), Monetary Theory (1990), and David Laidler (editor), The Foundations of Monetary Economics (3 volumes, 1999). The British publisher Edward Elgar prints collections of journal articles in various aspects of monetary economics in its "International Library of Macroeconomic and Financial History Series."

Practical works. Marcia Stigum, The Money Market (4th ed. 2007, revised by Anthony Crescenzi) is a superb description of all aspects of its subject. James C. Van Horne, Financial Market Rates and Flows (4th ed. 1994) is a useful summary of the financial theory underlying various financial instruments; see also Miles Livingston, Money and Capital Markets: Financial Instruments and Their Uses (1991). David E. W. Laidler, The Demand for Money: Theories, Evidence, and Problems (5th edition 1993) is a useful summary of the mainly useless studies on its subject.

Reference works; statistics. Perhaps because of the advent of the Internet, there does not seem to be any more recent book about information sources than James M. Rock, Money, Banking, and Macroeconomics: A Guide to Information Sources (1977). The standard encyclopedia of money and banking is (*)Peter Newman, Murray Milgate, and John Eatwell, editors, The New Palgrave Dictionary of Money and Finance (3 volumes, 1992; ). It's extremely good. For more detailed articles, see the Handbook series from North-Holland publishers (The Handbook of Monetary Economics, etc.).

For a chronology of currency devaluations to 1970, see Franz Pick and René Sédillot, All the Monies of the World: A Chronicle of Currency Values (1971). On interest rates, see Sidney Homer and Richard Sylla, A History of Interest Rates (3rd edition 1991). For historical tables of exchange rates, see Jürgen Schneider, Oskar Schwarzer, and Friedrich Zellfelder, Währungen der Welt (several volumes beginning 1991). For other historical statistics, see the volumes of international economic statistics edited by B[rian] R. Mitchell. For recent international statistics, see International Monetary Fund, International Monetary Statistics (since 1948; also online). For other information, see the defunct World Currency Yearbook (formerly Pick's Currency Yearbook). An online site that has some free information and some you have to pay for is Global Financial Data . From what I've seen, their data is not always completely accurate for historical cases, but that's simply because compiling the data is awfully hard sometimes.

Elsewhere on my site, you can find the beginnings of my attempt to collect information about the monetary authorities and exchange rate arrangements existing in all countries during modern times--basically, since paper money appeared. You may find my work useful to gain an overview of the monetary history of particular countries.

Journals. The two most important journals are the Journal of Money, Credit, and Banking and the Journal of Monetary Economics. Over the years they have come to embody more and more the academic vices of dullness and irrelevance. Other periodicals worth mentioning are IMF Staff Papers, Journal of International Money and Finance, Kredit und Kapital, and Central Banking .

For articles on monetary history, see Business History, Business History Review, Economic History Review, Explorations in Economic History, Journal of Economic History, and Journal of Financial History. For articles on the history of monetary thought, see History of Political Economy.

General economics journals that sometimes have useful articles on monetary theory or policy include the Cato Journal , Economic Development and Cultural Change, Kyklos, Journal of Development Economics, Journal of Institutional and Theoretical Economics, Journal of Political Economy, Weltwirtschafliches Archiv, World Bank Economic Review and World Bank Research Observer . The articles of other general economics journals are generally elaborations of the implausible and hence worthless, despite the prestige some of the journals have among economists.

Some journals are available through JSTOR (it's expensive, but if you are near a university library in the US and some other countries, the library should subscribe). The master source of listings of journal articles in monetary economics, as in every other field of economics, is the Journal of Economic Literature (accessible if you are a member of the American Economic Association), also available as the EconLit database on computer and as the Index to Economic Articles in annual volumes (the database and Index require extra fees). Its listings of articles in other languages are not as complete as listings of articles in English, but almost everything important in economics these days is either written in English or eventually translated into English. Many universities have the version of the EconLit database that has full-text access to many journal articles listed.

There are also many journals in finance and international economics, listed in the Journal of Economic Literature.

Working papers. Academic journals often take up to two years to publish accepted papers, so reading working papers enables one to keep more current. Some working paper series that are particularly relevant to monetary economics are those of the Bank for International SettlementsInternational Monetary FundNational Bureau for Economic Research (free if you live outside the OECD countries: click here for details), U.S. Federal Reserve System, and World Bank. An Internet master database is WoPEc (which stands for Working Papers in Economics).

Internet. A wealth of information is now available on the Internet from governments, central banks, universities, think tanks, and individuals. A good source list is Bill Goffe's Resources for Economists on the Internet . For other sites, use a search engine such as Yahoo or Google .

People. To find out who is doing research in your area, two good places to look are directories of members published by the American Economic Association (online directory) and Royal Economic Society (no online directory yet, but here's a link to their home page ). The American Economic Association [AEA], based in the United States, publishes the American Economic Review; the Royal Economic Society, based in England, publishes the Economic Journal. The directories list members' areas of specialization.

Addendum, 2013. To the above sources I would add the following: (a) Books: Carmen M. Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly (2009); William Barnett, Getting It Wrong: How Faulty Monetary Statistics Undermine the Fed, the Financial System, and the Economy (2011). (b) Statistical sources: Historical Financial Statistics, which I edit, and Federal Reserve Economic Data (FRED; useful especially for the United States, but covers dozens of other countries to varying degrees also); Markus A. Denzel, Handbook of World Exchange Rates, 1590-1914 (2010). (c) Blogs: I wrote about this in an earlier post as it relates to free banking, and although few or none of the blog posts will be read 100 years from now, or even 100 days from now, blogs are a good resource for students because economists who write them try to explain themselves more clearly than they do when they write in academic journals.


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Academic dogs

by Kurt Schuler June 27th, 2013 10:35 pm

A link from Marginal Revolution took me to a paper called "An Empirical Guide to Hiring Assistant Professors in Economics." It is as interesting for what it doesn't say as for what it does. It concludes that "top 30" Ph.D. programs in economics, which accept a bunch of quite bright college graduates every year, do a terrible job in making those who graduate capable of publishing work that academic economists find sufficiently worthwhile to accept for publication in academic journals. From all the top 30 programs combined, the average number of economics Ph.D.s in the period the authors studied was 460. Only 143 (31 percent) had at least one publication in any academic journal ranked by the authors six years after graduating. Even at Harvard, Chicago, or Berkeley, the bottom half of the class essentially published nothing. The paper is talking about graduates, and is excluding students who didn't complete their degrees. Another finding: for graduates who were not at the top of their Ph.D. cohort, Princeton, Rochester, and the University of California-San Diego seem to have provided the best preparation for writing publishable academic papers.

An interesting thing that the paper leaves unsaid is that books count for little or nothing. Journal articles are all that count. I found that curious because if you want to leave an impact in the sphere of ideas that is lasting, which let us arbitrarily define as 50 years in the future, a book is better than a journal article for trying to do it.  Larry White and George Selgin's books on free banking from the 1980s will, I am convinced, still be read in the 2030s, by economists and by some interested noneconomists. Indeed, it is a strength of the idea of free banking that its audience is not purely academic. I cannot think of a single academic article from the 1980s that will be read by noneconomists (though I welcome your proposed counterexamples), and not very many that will be read even by economists.

Another interesting thing the paper leaves unsaid is what Ph.D.s who don't write academic journal articles do. The Dutch economist Arjo Klamer once wrote an essay called "Academic Dogs." (It is in  David Colander and Reuven Brenner, editors, Educating Economists, Ann Arbor: University of Michigan Press, 1992; I haven't found it online to give a link.) He compared academic publishing to a dog show. Owners spend a lot of time training their dogs to run through some paces to impress the judges at the dog show, but how useful is that outside the arena? Klamer decided that both he and his dog would be happier by staying out of dog shows. It is implausible to me that more than 300 Ph.D.s a year from the top 30 programs have nothing to say. Rather, I strongly suspect many of them have decided that the dog show of academic publishing does not interest them. Some prefer teaching students to publishing. Others go work in nonacademic settings--consulting firms, central banks, government agencies, banks, think tanks, international organizations, etc.--and write for audiences other than the dozen people in the world who care about some narrow academic topic and are unable to make anything come of it in the world.

For recent or future Ph.D.'s who like the academic dog show, fine: you will probably do well at it. A few of you will even do work that is truly important, that changes the world a little bit or at least changes what teachers of economics teach their students about the world. For those who don't like the dog show, take heart: you were wise to have studied for your Ph.D. in economics, not English, and you have many ways of using your knowledge in a worthwhile way outside of academia, at a good salary.


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A bit more on NGDP targeting

by Kurt Schuler June 25th, 2013 12:02 am

In my previous post I was perhaps not clear enough in explaining my main criticism of nominal GDP targeting. I would have no criticism of a private issuer trying nominal GDP targeting. If somebody wanted to issue "NGDP Bitcoin," for instance, that would be dandy. I would welcome a level playing field with issuers experimenting with various standards, say nominal GDP targeting versus inflation targeting versus a gold standard versus a frozen stock of the current monetary base versus whatever else people wanted to try.

As I explained, in principle I think that nominal GDP targeting is a better policy for a central bank than inflation targeting. Even so, it  has the flaw, common to all policies by central banks, that it is a centrally planned course of action rather than one that has to gain acceptance without privilege. Historical experience with monetary standards, as I interpret it, has been that a standard need only be good enough, not nearly perfect, to be durable, and nominal GDP targeting, once instituted, might beat all rival standards even if all barriers to competing against the central bank are removed. Nominal GDP targeting by a central bank might be 90 percent as good as a free banking system where the monetary standard exists only by mercantile custom and not by government promulgation. Without competition, though, we won't really know if the figure is 90 percent or only 40 percent.

Another point that is important to keep in mind about nominal GDP targeting is that, as George Selgin remarked to me, there is a difference between nominal GDP targeting as a monetary regime and as a mere policy. Establishing nominal GDP as a durable monetary regime requires establishing procedures to ensure that it remains in place even if central bank personnel change and that some penalty exist if the central bank repeatedly is far off target. If nominal GDP targeting is merely a policy, which the central bank is able to start and stop simply by a vote of its governing board, it may not have the same credibility and may not work the same as if it is a monetary regime. The public, though, and even most economists are not accustomed to drawing such distinctions. Instances where nominal GDP targeting worked poorly because central banks bungled it might have the same effect on the reputation of nominal GDP targeting that central bank bungling during the Great Depression had on the gold standard.

On another note, here is an amusing story of a reporter who tried to use only Bitcoin for a week.


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The Rise and Fall of the Gold Standard

by George Selgin June 20th, 2013 10:30 am

When I began exploring the topic last year, I expected to find dozens of different, compact histories of the gold standard in the U.S. In fact, I didn't find but one, which left a number of what I considered to be important aspects of the topic unaddressed. I dare to hope, therefore, that no-one will say (as Moses Hades is reported to have said of some poor scholar's book) that my just-released Cato Policy Analysis "fills a much needed gap."


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Free Banking and NGDP Targeting

by George Selgin June 19th, 2013 6:20 pm

Kurt's recent post on NGDP targeting just happens to come right on time to introduce one I'd been contemplating concerning the connection between such targeting and free banking. While many readers may suppose the two things to represent alternative, if not antagonistic, approaches to monetary reform, I have always regarded them as complementary. Yet I also agree with Kurt in regarding NGDP targeting as "a form of central economic planning."

Am I contradicting myself? Much as I'd like to compare myself to Walt Whitman, I don't think so. Instead, I think that it is those who would insist on the incompatibility of free banking and NGDP targeting whose reasoning is faulty. They fall victim, I believe, to a category error, namely, that of conflating banking regimes with base money regimes.

A free banking system is, as the name suggests, a particular banking regime. A fiat money so managed, by a discretionary central authority or otherwise, as to achieve a specific NGDP target, is a particular monetary base regime. The former entails freeing banks from all manner of special regulations and guarantees, as distinct from their obligation to honor contracts voluntarily entered into with their customers or other banks. To set banks free is therefore not to commit them to any particular base regime. On the contrary, it leaves entirely to them and their clients decisions regarding which base money (or monies) to receive and to offer in exchange for deposit credits or notes; and those decisions will tend, overwhelmingly, to be dictated by custom. Is the prevailing base medium--the medium in which final payments are made--gold, or silver? Then the usual if not universal practice will be for banks, given the opportunity to do so, to receive and pay gold or silver. Is the prevailing medium some kind of fiat money? Then the banks will go on dealing in fiat money. Schemes such as Hayek's, in Denationalisation of Money, in which competing private "banks" introduce base monies of their own design, fiat or otherwise, though they provide for interesting thought experiments, are entirely at odds with the part that competitive banks play, or have ever played, in real world monetary systems. In the real world, such banks, unlike central banks, take the base regime as given. Their task is, not to encourage their clients to try some new base money of their own devising, but to get as much of an established base money directed their way as they are able to put to profitable use.

In short, free up the banks all you like; today, in the U.S., they will continue to receive and pay fiat Federal Reserve dollars, so long as no steps are taken to actually demonetize such dollars. Banks might, of course, also offer notes and deposits denominated in other less popular but still well-established currencies; and a few might even offer gold accounts and notes. But such non-dollar bank monies will be but tiny sideshows compared to the main act. And it will be a rare bank indeed that dares to enter the base-money-creation business, the rest remaining content to leave that business to central banks.

It follows that, because it leaves the base regime largely unaltered, a move from regulated to free banking today would not serve to eradicate inflation or otherwise guarantee monetary stability. Such a move would have led to improved stability a century or more ago, because it would have entailed depriving central banks of their role as currency suppliers: so long as gold and silver were economies' final settlement mediums, to deprive central banks of their paper currency monopolies was equivalent to reducing if not eliminating altogether any tendency for other banks to treat central bank paper (or other central bank liabilities) as a reserve medium, and hence as what might be termed "pseudo" base money. The strict dichotomy of bank- and base-regime that applies today did not, in other words, pertain to specie-based monetary systems. Today, however, the strict dichotomy is quite valid; and this means that freedom of banking alone will no longer suffice to make our (or any) monetary system sound.

Something else is needed, then. And that something must of course consist of a reform of the base regime itself. Broadly two alternatives exist for such reform. These are: (1) the restoration of a base medium consisting of some form of specie, or perhaps of some other commodity; and (2) reform of the existing fiat regime. Both options have advantages and disadvantages. A major advantage of the second is that it is likely to be less disruptive. This advantage isn't itself decisive. But it does supply one important reason for not simply dismissing out-of-hand proposals for imposing strict rules upon fiat-money issuing authorities, including rules that call for targeting NGDP. Where people have become long accustomed to using fiat money, the scarcity of which necessarily depends on some sort of "central planning," to suggest a better central plan, instead of merely insisting that people "ought" to use gold (or forcing them to use it when doing so may seriously disrupt their plans), doesn't make one a pinko--not, at least, so long as one also insists that there be no barriers in the way of people switching to gold voluntarily. It's easy enough to say, in hindsight at least, that Imperial Russian authorities screwed-up when they decided on a railroad gauge broader than that used elsewhere in Europe. But it doesn't follow that ripping up the old tracks post-haste, or just neglecting them, is a good idea. With base monies likewise, there is such a thing as sunk costs.

That banking reform and base-regime reform are two very different things does not mean that they cannot be complementary. On the contrary, they can be very complementary indeed; and I have long been convinced that this is particularly the case with regard to free banking and NGDP targeting. The complementarity here arises from the fact that free banking makes for an especially stable relationship between the stock of base money on the one hand and the level of spending (or NGDP) on the other.

How does free banking help? It does so, first, by allowing for a completely market-determined bank reserve ratio and, second, by allowing commercial banks to issue their own currency to take the place of publicly-held central bank notes. To the extent that commercial banks are able to "capture' the market for paper currency, the public's preferred "currency ratio" (that is, it's preferred mix of currency to bank deposit balances) ceases to influence the money multiplier, that is, the relationship between the stock of base money (B) and that of broad money (M). In the limit the multiplier, instead of having its usual, textbook formula of [(1 + c)/(r + c)], where r is the system reserve ratio and c is the currency ratio, becomes simply 1/r, making M = B(1/r); while the quantity of bank reserves, R, becomes equal to the stock of base money. The reserve ratio, in turn, will rise in proportion (though not necessarily in strict proportion) to the volume of gross bank clearings, that is, of payments, which will themselves depend on the velocity of money. As total payments increase, so does the demand for bank reserves. It follows that, for any given B (or, equivalently, any given nominal quantity of bank reserves) there will be a unique volume of payments consistent with equilibrium in the reserve market. Changes in V will tend, therefore, to give rise to such changes in r as will keep MV relatively stable.

This is, admittedly, a crude argument. (It is a little less crude as presented in The Theory of Free Banking and in this Economic Journal article, but not much.) For starters, it does not allow for changes in the ratio of income to total (income and non-income) payments; it does not allow for any influence on interest rates on the demand for bank reserves*; it does not allow for economies of reserve demand connected to changes in the composition of payments (e.g., from fewer large transfers to more numerous but smaller ones); and it does not allow for the potentially disruptive effects of changes in interbank clearing arrangements or technology. In short, it only describes a tendency.

But that tendency is, I think, important--and it is important in a way that should be taken to heart, not just by free banking fans, but by all proponents of NGDP targeting. Because the prospects for such targeting are only as good as those for holding central bankers accountable for their failure to abide by it. Doing so becomes much easier to the extent that achieving any prescribed NGDP target is simply a matter of maintaining a stable growth rate for the monetary base itself, that is, to the extent that changes in the base aren't needed to offset fluctuations in either the currency ratio or the velocity of money. The less need there is for central bank activity (meaning activity apart from that consistent with a predetermined schedule of open-market purchases), the stronger the case for a corresponding clipping of central bankers' wings such as will curb their capacity for mischief-making.

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*This elasticity will, however, differ from that noted for centralized currency systems, in that the demand for reserves under free banking does not include a substantial "vault cash" component that itself varies along with the public's preferred currency ratio. In a centralized arrangement lower interest rates, besides reducing the opportunity costs of reserve holding, are associated with an increase in the currency ratio and, hence, in bank's vault cash requirements. Under free banking the "vault cash" effect is reduced or eliminated. Consequently reserve demand is not likely to be as interest-elastic.


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The NGDP experiment

by Kurt Schuler June 18th, 2013 10:59 pm

Given that I do not expect to see free banking in the immediate future, I would like to see one, or preferably more, central banks that now target inflation try targeting nominal GDP targeting instead. Targeting nominal GDP has some prospective advantages over inflation targeting. One is that nominal GDP targeting allows what seems to be a more appropriate behavior for prices over the business cycle, allowing “good” (productivity- rather than money supply-driven) deflation during the boom and “good” inflation during the bust.

Another is that inflation targeting as it has been both most widely proposed and as it has always been adopted has been a “bygones are bygones” version, with no later compensation for past misses of the target. During the Great Recession, many central banks undershot their targets, even allowing deflation to occur. They never corrected their mistakes. Nominal GDP targeting in the form that Scott Sumner and others have advocated it requires the central bank to undo its past mistakes. If it undershot last year’s target, it has to increase the growth rate of the monetary base, other things being equal, to meet this year’s target, which is last year’s target plus several percentage points.

For all that, I am not an enthusiast of nominal GDP targeting. It is worth experimenting with, seeing as how that the widespread use of inflation targeting did not prevent the worst financial crisis since the Great Depression. (Indeed, inflation targeting aggravated the crisis with procyclical policies, according to accounts that I find convincing such as Robert Hetzel’s book The Great Recession.) Anyone with a long memory, though, will have some skepticism towards nominal GDP targeting. In the late 1980s and the 1990s a wave of enthusiasm for inflation targeting swept through economists and policy makers. Inflation targeting was supposed to be superior to what had come before it. As with nominal GDP targeting now, its advocates had the luxury of contrasting an idealized hypothetical system with an actual system that, like all actual systems, had faults. (George Selgin’s Less Than Zero was one of the few real criticisms of inflation targeting, comparing idealized inflation targeting to an idealized theoretical benchmark, the “productivity norm,” in a consistent way.) Now that we have experience with inflation targeting, we can compare actual inflation targeting to other actual monetary arrangements, and obviously it has lost the luster it had when it was only hypothetical. In particular, advocates of inflation targeting did not anticipate that central banks would be so willing to allow such rapid, though brief, deflation.

With nominal GDP targeting it may well also happen that there will be flaws that only become apparent through experience. My reason for thinking that flaws are likely is that, like inflation targeting, nominal GDP targeting is an imposed monetary arrangement. It is not a fully competitive one that that people are at liberty to cease using at will, individually, the way they can cease buying Coca-Coca and start buying Pepsi or apple juice instead. Nominal GDP targeting when carried out by a central bank, which has monopoly powers, is a form of central economic planning subject to the same criticisms that apply to all forms of central planning. In particular, it does not allow for the occurrence of the type of discovery of knowledge that comes from being able to replace one arrangement with another through competition.


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"Itchy Fingered Copy Editors"

by George Selgin June 12th, 2013 10:57 pm

That's the phrase Leland Yeager likes to use to describe those persons in the publishing industry who, given the task of correcting errors in an author's page proofs, or of making such changes as are dictated by a house style, can't resist otherwise "improving" the author's writing by changing his or her grammar, punctuation, and word choices so as to make them more consistent with the copy-editor's own notions as to what constitutes good prose, or what a writer really means.

Yeager himself, I recall, once became particularly irate at discovering that, whereas in a typescript he'd referred to James Buchanan as a "theorist," in print he'd instead called him a "terrorist." Presumably Yeager's copy editor had not heard of the prize-winning economist, but had heard of a bomb-throwing person of the same (or similar) name.

I've also had more than my share of run-ins with the itchy-fingered bunch--or so I imagine, perhaps because (like Yeager) I'm fussy (o.k., anally retentive) when it comes to my prose. In fact, although I dream about one day managing to get something published without a single typo--let alone some unwanted editor's "improvement"--it hasn't happened yet. That's one thing I like about blogging: there's no one to mess around with your prose, and you can always go back and fix the boo-boos you make yourself.

One sort of itchy-fingered editing that I find especially galling is the sort that happens when an editor assumes that he or she knows more about my subject than I do. It's not that that's impossible. But the odds are agin' it. Many years ago, for example, in writing about Chile's free banking episode, I referred in several places to Frank W. Fetter's writing's on Chilean monetary policy. But when the published version arrived in the mail, I discovered to my surprise and dismay that "Frank W." had become "Frank A." How come? It happens that the publication was an "Austrian" one, and that Austrian economists, or some at any rate, are rather fond of Frank Albert Fetter's writings on the theory of capital and interest. So am I, in fact. But whereas the person who copy-edited my article apparently had never heard of Frank Whitson Fetter, we monetary economists know that other Fetter pretty well, since he is a rather highly-regarded historian of monetary thought, who just happens to have been the capital-theorist's son.

That sort of editorial meddling is, of course, annoying because the author gets the blame for not getting his facts straight, when in fact they were perfectly straight until some smart-aleck bent them. But for those of us who are fussy about our prose, changes that don't alter any facts are hardly less mortifying. Not long ago, for instance, I was starting to go over the galleys for my and John Turner's JLE article "Strong Steam, Weak Patents" when, to my surprise, I read the word "indicated." Now, "indicated" is one of those words I go to great lengths to avoid, unless I'm referring to a dial of some sort. Yet here was I, about to go to press having (apparently) written that something other than a dial--I think it was James Watt--had "indicated" this or that. Naturally I turned to the typescript, and found, sure enough, that I'd written, not "indicated" but "meant." At that point, my surprise gave way to horror: the JLE, I realized, have got themselves an itchy-fingered copy editor! As I feared, my prose (I say "mine" because I was responsible for writing-up the article) had been altered throughout, without my consent and without the slightest indication of where changes had been made. And, believe me, the changes were all of them the sort one might expect from an editor who thinks that "indicate" is better than "meant."* So, after calling the managing editor and "indicating" my feelings to her, I spent the better part of two days seeking out the changes and restoring the original text. Alas, one change at least got away, resulting in an incoherent sentence. To this day I still can't bear to look at the published version. (That the JLE's typographic design is also one of the worst I've ever seen doesn't help.)

A preference for stilted words over their more natural counterparts is just one of the many foibles of bad copy-editors at academic journals and also, of course, of bad academic writers themselves. Another is a peculiar aversion to the word "I," even when its use is motivated, not by an author's lack of modesty, but by his or her desire to keep things honest. (The habit of assuming that "I" should never appear in an academic work seems especially ingrained among the natural scientists, who no doubt find the rule easy to insist upon at least in part because they seldom write anything except with the help of half a dozen coauthors.) I had a run in with an editor on this issue when, near the beginning of a long article, I wrote "I will assume... ." The editor replaced it with "It is assumed... ." I queried back, "Assumed by whom, if not by me? By God?" As I'm an atheist, and didn't wish in any event to pretend that I'd consulted any higher power concerning what was or wasn't to be assumed in the course of arguing my thesis, I refused to accept the passive-voice alternative. But the editor was no less unwilling to let that dreaded "I" in. Finally we settled on "Assume... ." And none too happily, so far as I was concerned, since I don't much like ordering my readers around. ("Let us assume" would have been a better compromise, in retrospect.)

Itchy-fingered copy-editors seem to imagine that someone's writing can always be improved by making it conform to strict rules like "never use the first person." But the truth is rather that most of the rules that such editors are especially likely to be sticklers for--"never split an infinitive," "every sentence must have a subject, object, and verb," "never end a sentence with a preposition," and so on--are just so many hollow superstitions that conscientious writers know better than to never break, and up with which self-respecting writers never put. Never.

Not surprisingly, given their preference for stiff language and strict (if phony) rules, itchy-fingered copy-editors are not people who can safely be assumed to have any sense of humor. I found that out the hard way when, in making corrections to the proofs for Good Money, I drew up the usual list of page numbers, desired changes, and my reasons for making the changes (e.g., typesetting error; error in manuscript). In one instance, I asked that a word be changed simply because I had thought of a better one. So under "reason" I wrote simply, "(le mot juste)". I leave it to you to imagine my reaction when I found those same words, parentheses and all, inserted in the published book!** (Did I mention that itchy-fingered copy-editors don't seem to know any French?)

Am I suggesting, then, that copy-editors ought never to try to improve an author's prose, or to correct what they believe to be errors of fact? Not at all. What they ought never to do is to make such "corrections" without letting an author know what they're up to, and hence without giving him or her a chance to reject the changes. Good copy-editors get this. The itchy-fingered sort ought to be doused with calamine lotion or Benadryl until they get it too.

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*If you think so too, then you probably prefer "disseminate" to "spread," "utilize" to "use," "feasible" to "possible," and "beverage" to "drink," in which case, I'm sorry to have to tell you, it is evident that you are not human at all but some sort of infernal machine, and as such not to be reasoned with.
**They didn't make it, thank goodness, into either the second printing or the paperback.


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Is Deflation Salvation?

by George Selgin June 11th, 2013 12:13 pm

That's the title that the Adam Smith Institute assigned to the talk I gave there a couple weeks ago. Not having realized that the talk was being taped, I was pleasantly surprised to discover it on YouTube today. It offers, I think, a pretty accessible half-hour overview (not counting question and answer) of my arguments concerning "good" deflation. I noted one gaffe, where I say that Keynes's theory assumes that prices are generally "below" equilibrium. Of course I ought to have said "above," or (alternatively) that equilibrium prices are generally below actual ones.

Do please pass the video on to anyone you know who believes that central banks should never allow prices generally to fall. Of course, we can't expect central bankers themselves to change their stripes. But we can and should try to encourage the public to question their arguments to the effect that having the general level of prices double every generation or so is a sine qua none of responsible monetary policy.

Addendum. O.K., I admit to having replied flippantly to the question concerning whether productivity-driven deflation would not cause a problem by encouraging everyone to put off buying things because they are likely to cost less in the future. But can you really blame me? I mean, consider: when the expected productivity growth rate goes up, so, ceteris paribus, must real interest rates and, hence, the return on saving. It follows that, in fact, people will be more inclined to put off consumption until later, that is, that they will be inclined to save more, but only to a limited extent. But what's wrong with that? Answer: nothing. Moreover, the extra saving will be inspired whether prices are allowed to decline or not, because it is a reaction, not to deflation per se, but to the increased return on capital, which is bound to manifest itself in higher equilibrium real interest rates no matter what the general price level does. If the price level is kept stable, both real and nominal rates will increase in response to improved productivity. If it is allowed to fall in accord with a productivity norm, nominal rates stay unchanged, but the deflation itself raises realized real returns. The only difference made by the productivity norm is that under it money balances also earn a return, making the overall inducement to save somewhat greater than it would be otherwise. And there's nothing wrong with that, either.


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An early critic of representative agent models

by Kurt Schuler June 7th, 2013 12:31 am

Economists' favorite number is one: one person/firm/country/good. Their second favorite number is two: one person/firm/country/good and a composite representing all the rest. Economists don't like numbers greater than two so much when making models because with three or more, complex interaction effects can occur.  That to me is the whole point, though. The world is complex, and reducing it to a single ("representative") agent or to one versus the rest of the world often produces misleading results by neglecting differences that are vitally important economically or politically. Money, for instance, requires the existence of at least three goods in principle, and many more in practice. Hence I was gratified to come across this passage:

I am speaking of the claim that it is best for the city to be entirely one to the greatest possible degree, for Socrates adopts that hypothesis [in Plato's Republic]. And yet it is evident that by advancing and becoming more of a one it will not be a city. For a city is by nature a certain kind of multiplicity; by becoming more of a one it would turn from a city into a household and from a household into a human being.

-- Aristotle, Politics, Book II, chapter 4, Bekker page 1261B about lines 16-20, translated by Joe Sachs (Newburyport, Massachusetts: Focus Publishing, 2012)


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Monetary Policy: Is There a Prudent Second Best?

by George Selgin June 4th, 2013 4:06 pm

It's usually a good thing when representatives of the Von Mises Institute and George Mason ends of the Austrian-economics spectrum agree with each other. But I can't say I found it much to my liking when Joe Salerno and Pete Boettke agreed with each other concerning a CNBC interview I gave a week ago. For both held that, by declaring during that interview that "a case existed" for quantitative easing back in late 2008 and 2009, I seemed to forget my own case for free banking, joining ranks instead with apologists for monetary central planning.

Having defended myself against this particular accusation at the two sites where it came up (and in Joe's follow-up post), I don't intend to repeat my defense here, except to observe again that "a case existed" isn't the same as "a slam-dunk case existed," or something equivalent. I do, however, want to further engage the broader question concerning the pitfalls of the second best. For while I agree that the pitfalls are real, it hardly follows that what might be called the "intransigent first best" strategy, which is to say the strategy that treats second best prescriptions as slippery slopes to be rejected out of hand, is a more prudent alternative.

In considering whether it is, let's not conflate the question at hand with questions concerning the merits of the Fed's actual, recent undertakings. It seems to me relatively easy to find fault with those undertakings, including all three rounds of quantitative easing, even considered merely as second-best means for encouraging recovery, and I have for that reason not found it especially difficult to resist endorsing them. Instead, let's suppose that it is the autumn of 2008, that the wholesale credit market has shut down (thanks in large part, admittedly, to the combined shenanigans of the Fed and the FDIC), and that aggregate demand has consequently begun its downward spiral. Let us also assume (again, for the sake of argument, but also because there is, I believe, plenty of evidence for it) that the collapse of demand, if allowed to go on, is bound to lead to falling sales and unemployment and other sorts of hardship, beyond the hardship made inevitable by the end of any unsustainable boom, in part because prices, and wage rates especially, can only be expected to adjust downward in response to fallen demand very gradually, if at all.* Let's assume, further, that a free banking system would tend automatically to counter the tendency for demand to shrink, even despite a fixed monetary base, by allowing banks to operate on lower reserve ratios as the real demand for their deposits and notes increases. Finally, let's suppose that we are fully aware of the mischief that discretionary central banks can do, and that we are all anxious to avoid making any statement that might be construed as approving of, much less further empowering, such institutions.

The relevant question then is: given the existing, centralized arrangement, what should the Fed do? Suppose the question is asked of you on a popular, live TV broadcast. How to respond prudently?

Will merely insisting on the first-best solution suffice? I don't think so. In the present context that would mean saying something like, "The Fed should freeze the monetary base; but that isn't all: Congress should then wind it up, while allowing other banks complete freedom to meet the public's monetary needs, including the freedom to issue their own notes. This would also require doing away with deposit insurance and..." etc. Even supposing one could elaborate the argument in a few sound bites, or that one could go on for hours, the obvious problem remains that the steps required would take months to accomplish even if they could be instantly and universally agreed upon. The answer, therefore, begs the question, "What should the Fed do in the meantime?" We remain more or less where we began.

Nor, as some commentators (myself included) have noted elsewhere, is saying that the Fed should do "nothing" any better. So long as it exists the Fed is, of necessity, doing "something." So "nothing" here must actually refer to some particular Fed policy. Most often (I gather) it means that the Fed should refrain from any further lending or open-market activities, or from otherwise expanding its balance sheet. It amounts, in other words, to recommending that the Fed maintain a constant monetary base. But is asking the Fed to maintain a constant base really indicating any more principled opposition to monetary central planning than one indicates by calling upon it to alter the base by some particular amount, or by whatever it takes to achieve some particular target? I don't see why. Indeed, what some have wrongly taken to be the more principled of the two alternatives seems to me to be hardly more principled, though rather less prudent, for it calls, not for the avoidance of monetary central planning, but for the implementation of a monetary central plan that is likely, according to "our" theory, to be particularly lousy. Nor will it do to say that the "keep the base constant" alternative is superior in that it might be proposed, not just as a suggestion for the present, but as a hard-and-fast monetary rule, for the same might be said concerning the suggestion that the Fed expand the base only when doing so serves to keep spending stable.

The option of recommending that the central bank "do nothing" is, by the way, precisely the one Hayek chose to take back in the early 1930s when, despite having recognized in print the desirability of a constant "money stream," and despite the fact that the money stream had dried up dramatically, he campaigned against expansionary monetary policy. As he explained many years later, with regrets, Hayek's reason for departing from his own theoretical ideal had to do, not with any slippery-slope considerations, but with his belief that allowing the collapse of demand to go on could be just the thing needed to wrench the British labor market free from labor unions' stranglehold.** Still it is difficult to see why the results would have been any different if, instead of having opposed monetary expansion because he hoped by doing so to help thaw a rigid labor market, he did so on other political-economy grounds. To say that Hayek's strategy backfired is putting it mildly, for it was not labor unions but Hayek's own theoretical legacy that suffered.

Must one, then, simply endorse monetary expansion, setting aside the first-best alternative altogether, while also neglecting those political-economy considerations as point to the inherent dangers of such a compromise? I don't believe so. It seems to me that making a case for monetary expansion is not the same as making one for monetary central planning. It is a matter of choosing one's language carefully. The prudent answer to the interviewer's question may be something like this: "For better or for worse, we are forced to rely on the Fed to prevent such a collapse in demand, so the Fed should do what it is supposed to do. But the Fed is a deeply flawed system and continuing to rely on it is asking for trouble. There are better alternatives, and now is as good a time as any to start taking them seriously."

Perhaps putting it so would still make one an apologist for central banking. In that case, my plea to Pete and Joe is, "guilty as charged." But why settle for that, fellows, when you can throw the whole first-best book at me? After all, I also believe that, until better (free market) alternatives are in place, the USPS ought to deliver my first-class mail, and the FAA ought to keep the airplane I'm flying in from attempting to land on a busy runway.

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*I understand that the Salerno-Austrians will regard these assumptions as proof of my being a "Keynesian" and of my failing to understand Say's Law. In answer I can only observe (1) that if I'm a Keynesian so, too, are Milton Friedman and Leland Yeager, among others; and (2) that my "problem" is not that I don't understand Say's Law; it is, rather, that, like most neoclassical (and some classical) economists, I happen to think that Say erred in assuming that people (or banks) were never attempted to accumulate money balances. I know not how anyone can look at recent statistics regarding banks' (and other firms') accumulations of cash reserves and still treat Say's position as if it were irrefutable.
**See Lawrence H. White, The Clash of Economic Ideas (Cambridge, UK: Cambridge University Press, 2012, p. 95.


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