WARNING: Gold bugs beware. Existential crisis ahead:
Showing posts with label monetarism. Show all posts
Showing posts with label monetarism. Show all posts
Thursday, May 19, 2016
Wednesday, May 18, 2016
Close But No Cigar
You’re nearly there Tan Sri, just a little bit further (excerpt; emphasis mine):
The alchemy of money
BY ANDREW SHENG…When money was fully backed by gold, money was tied to real goods. But when paper currency was invented, money became a promisory note, first of the state – fiat money, supported by the power to impose taxes to repay that debt, and today, bank-created money, which is backed only by the assets and equity of the bank. The power to create “paper” money is truly alchemy – since promises by either the state or the banks can go on almost forever, until the trust runs out.
Friday, April 5, 2013
Japan’s Monetary Experiment
The BoJ has embarked on a radical new adventure:
BOJ shocks with new base money target, boosts asset buying
TOKYO: The Bank of Japan shocked markets on Thursday with a radical overhaul of its policymaking, adopting a new balance sheet target and pledging to double its government bond holdings in two years as it seeks to end nearly two decades of deflation.
At new Governor Haruhiko Kuroda's first policy-setting meeting, the central bank shifted its monetary policy target to the monetary base from the overnight call rate, which is set at a range of zero to 0.1 percent.
The unexpected scope of the changes Kuroda pushed through drove the yen lower and knocked the 10-year bond yield to its lowest in a decade.
Tuesday, July 3, 2012
Modern Money Creation
A fascinating article on VoxEU yesterday about what I’d consider to be shadow banking, and its a fairly clear exposition (excerpt):
The (other) deleveraging: What economists need to know about the modern money creation process
Manmohan Singh & Peter StellaThe world of credit creation has shifted over recent years. This column argues this shift is more profound than is commonly understood. It describes the private credit creation process, explains how the ‘money multiplier’ depends upon inter-bank trust, and discusses the implications for monetary policy.
Friday, October 14, 2011
David Beckworth on Market Monetarism
The recently coined Market Monetarism movement is relatively new. It’s also an oddity because it didn’t come from the traditional way economic schools of thought have grown via research – though its major proponents are mainly academics – but rather from interaction across the economics blogosphere. You might be surprised at the list of prominent economics bloggers who are beginning to lean towards these views.
David Beckworth explains (excerpt):
My Journey Into Market Monetarism
…Now here we are in 2011 and the Fed has yet to, one, correct its passive tightening of the past three years and, two, properly shape aggregate demand expectations by adopting something like a nominal GDP level target. It has been incredibly frustrating to watch the incredible amount of human suffering caused by these monetary policy failures. Consequently, I have been blogging away at these issues along with like-minded folks such as Scott Sumner, Nick Rowe, Bill Woolsey, Josh Hendrickson, Marcus Nunes, Nicklas Blanchard, Kantoos, and David Glasner. We all have been making the case that the prolonged economic slump has been mostly due to passively tightened monetary policy that could easily be loosened, even at the interest rate zero bound.
Friday, March 4, 2011
Quantitative Easing Versus Printing Money
Ooooh, this one’s a doozy. I know quite a few people who will blow a gasket (make that: the whole engine block) reading this (excerpt):
Deflation, debt, and economic stimulus
Richard WoodThe US, Japan, and Ireland are suffering from deficient private demand, rising debt, and a tendency to deflation. This column is asks what can be done about it.
We begin by assuming that relevant authorities have decided that new money creation is necessary to work against deflationary tendencies and to stimulate the economy. The central issue explored here then is how should such new money creation best be deployed to create the required economic stimulus?
Monetary Policy Strategy
This past couple of years has been a fascinating laboratory for assessing the effectiveness of alternative strategies of monetary policy. In the wake of the collapse of the Bretton Woods arrangements in the early 1970s, we’ve seen the rise and fall of monetarism (money base targeting), and the spreading hegemony of interest rate targeting (IRT), which involves using an intermediate target – typically overnight interbank rates – to influence price stability and the level of economic activity.
With the latter, successful as it has been, you can immediately see one glaring problem: you’re using one instrument (the short term interest rate) to try and target two variables which often move at odds with each other. Aim for higher growth and you’re ipso facto accepting potentially higher price increases i.e. inflation, and reaching for price stability (and especially absolute price stability) will sacrifice economic growth. There’s also the fact that you’re depending on a stable transmission mechanism between short term nominal interest rates to longer term real interest rates, which are the ones that actually matter for credit creation, consumption and investment.
Thursday, October 15, 2009
Stronger Exchange Rate ≠ Strong Exchange Rate Policy
Jagdev Singh Sidhu over at The Star thinks we should pursue a strong currency policy because:
"A stronger ringgit will force Malaysians, both employees and employers, to be more efficient and that is something the economy needs to do as I feel it is somewhat in an economic mid-life crisis."
He also makes the statement that:
"The current preference of using interest rates to drive economic growth may be due for a re-think in favour of the currency as the lower-than-normal rates in Malaysia since the Asian financial crisis haven’t really worked."
And third:
"A stronger ringgit is no guarantee that the country will be able to make that transition to a high-income economy but there are a couple of examples nearby which we should look at.
Singapore and Taiwan endured short-term pains when they allowed their currencies to appreciate but they did make the adjustment to incorporate more skills and capital in manufacturing processes. The stronger currency was also a boost for the service sector in those countries."
As you can imagine, I’m going to pick a few holes in this argument.
The first statement assumes that the substitution effect dominates the income effect in the terms of trade (the purchasing power of money we receive from exports, relative to what we can buy of imports). In other words, a stronger exhange rate reduces our competitiveness and we have to become more efficient to continue to sell to external markets.
The general consensus and the empirical evidence in the research literature finds just the opposite. In other words, higher terms of trade (which is what you get with a stronger exchange rate) actually increases export revenues more than the loss coming from reduced demand. So there won’t be much impact in terms of forcing Malaysians to “be more efficient”. In fact, given the relative share of primary resources in exports, there’s probably going to be even less incentive to improve productivity.
A second point is that because of our low value-added industries and with multi-nationals involved in exports, strengthening the exchange rate should in fact have only marginal effects on incomes and trade volume because there’s little local currency pass-through. A higher exchange rate not only reduces the local currency value of exports, but at the same time reduces the local currency value of imported inputs. Assuming the exchange rate elasticities are equivalent, then there will be roughly no change in returns to local content.
Third, given the two effects above, it’s not obvious or automatic that a stronger exchange rate would raise labour incomes in the export sector. Because the income effect dominates, trade volumes will change very little in the manufactured sector, so demand for labour will not change much or at all – which means whatever excess returns are generated from a higher exchange rate will benefit owners of capital, not labour. This also true to a lesser degree for the primary resources sector, where the ratio of imported inputs (e.g. in CPO) is actually quite high. This is not a recipe for raising domestic income levels.
The second statement is really about the conduct of monetary policy in pursuing price stability and economic growth, with the priority on the former as it is also a precondition for the latter. The choices a central bank can make here are setting the monetary base (money supply targeting), setting the price of money (interest rate targeting), and setting the relative price of money (exchange rate targeting). More recently, some central banks have experimented with direct inflation targeting with some success, but our statistical capabilities have to be upgraded for that to happen here.
The first option is a proven failure after experimentation in the early 1980s in the US and UK, and gave rise to Goodhart’s Law. The second has had relative success in maintaining price stability over the past twenty years.
The third is only advisable for relatively small economies with high external exposure or for countries with no external credibility, because in essence it means abdication of any influence over domestic monetary conditions. That’s fairly obvious from the experience of both Singapore and Hong Kong, the two countries in East Asia that use exchange-rate targeting – interest rates and monetary aggregates are subject to far more volatility than countries that use interest rate targeting. It’s also interesting to note that Malaysia’s aggregate economic record in the last decade is marginally better than Singapore’s and much better than Hong Kong’s.
Given this weakness, I don’t see any advantages for Malaysia, with its much more diversified economy, to follow this route. Since the first option is also out, that leaves only interest rate, and potentially, inflation targeting as the basis for monetary policy.
Also, from a currency perspective, it’s not the nominal interest rate that matters but the real interest rate differential. While both nominal and real interest rates have been low across the last decade, that’s consistent with the rest of the world (trade-weighted, real interest rate differential):
In fact, it looks remarkably stable to me since 1990. The implication of course is that with interest rate targeting, both the exchange rate and money supply growth would be inherently more volatile, which has indeed been the case:
Growth in Monetary Aggregates (log annual changes)
Nominal and Real Effective Exchange Rate Indexes (2000=100)
On that basis, since 2005 it’s hard to say that BNM has any currency policy at all, apart from occasional intervention to smoothen volatility as happened this past week.
Now, one might argue that the accumulation of foreign exchange reserves in the past 10 years is a sure sign that the currency is weak, and that the central bank is intervening to prevent currency appreciation. That’s only true if you think the standard open-economy model applies. But that makes it hard to reconcile Singapore’s reserve accumulation with their alleged strong currency policy:
Singapore's International Reserves
My critique is that many who take reserve accumulation as proof of a weak currency policy are ignoring the money supply implication of a trade surplus and capital flows, and the potential for financial fragility inherent with a large accumulation of foreign exchange deposits in the banking system (FX deposits are included in both M2 and M3).
On a more practical basis, it also makes sense for banks to sell their excess forex deposits to BNM since you can’t spend or lend those deposits within Malaysia. Hence inflows of foreign exchange raises demand for local currency, which causes interest rates to rise. Since we have an interest rate targeting regime, that requires the central bank to increase liquidity which damps pressure on interest rates, and incidentally involves selling Ringgit in return for foreign exchange.
Rather than a sign of currency intervention, accumulation of reserves then becomes a form of insurance, in short making sure enough foreign exchange is on hand in case of liquidity emergencies, such as occurred late last year when investor flight to quality caused a USD shortage the world over:
Net Official Reserves
Change in Net Official Reserves
The problem is that open market liquidity operations to manage money supply volatility, conducted in foreign exchange, is functional equivalent to foreign exchange rate intervention and vice-versa. You can’t tell the difference, and it is hardly proof that the central bank is taking any particular stance with respect to the currency, as opposed to domestic liquidity.
On the third statement, you can only accept that Singapore and Taiwan have “strong currency policies” if you believe that Purchasing Power Parity applies (PPP). Otherwise, the latest IMF Article IV consultation with Singapore indicates the SGD to be undervalued and other research (this for instance) indicates that both SGD and NTD are as undervalued as the MYR. The equivalent, opposite statement can actually be made about the USD - its highly overvalued and ought to depreciate relative to everybody else. The truth is probably somewhere in the middle.
And if you followed my writings at all, you’ll know that I believe that the causality between the services sector and the exchange rate runs the opposite from what is stated in the article – a stronger services sector creates an appreciation of the currency, not the other way around.
Bottom line? I don’t believe we have a currency policy at all – the preponderance of evidence suggests that BNM is only concerned with currency volatility, not its level or stability. On that basis, the MYR will continue to trade at or close to its short term, time-varying equilibrium (barring intervention) and gently move towards its medium term, fundamentally consistent equilibrium over the medium term (4-5 years) – which at the present time means an appreciation.
That doesn’t mean there won’t be large currency moves, against the USD for instance which has a lot of structural problems. But interference in the exchange rate won’t solve our structural problems – in fact a strong currency policy is more likely to paper over the problems we have than become a force for change. The MYR will get stronger, but as a consequence of a services-based economic growth strategy. As the fundamentals change, so will the equilibrium exchange rate level.
"A stronger ringgit will force Malaysians, both employees and employers, to be more efficient and that is something the economy needs to do as I feel it is somewhat in an economic mid-life crisis."
He also makes the statement that:
"The current preference of using interest rates to drive economic growth may be due for a re-think in favour of the currency as the lower-than-normal rates in Malaysia since the Asian financial crisis haven’t really worked."
And third:
"A stronger ringgit is no guarantee that the country will be able to make that transition to a high-income economy but there are a couple of examples nearby which we should look at.
Singapore and Taiwan endured short-term pains when they allowed their currencies to appreciate but they did make the adjustment to incorporate more skills and capital in manufacturing processes. The stronger currency was also a boost for the service sector in those countries."
As you can imagine, I’m going to pick a few holes in this argument.
The first statement assumes that the substitution effect dominates the income effect in the terms of trade (the purchasing power of money we receive from exports, relative to what we can buy of imports). In other words, a stronger exhange rate reduces our competitiveness and we have to become more efficient to continue to sell to external markets.
The general consensus and the empirical evidence in the research literature finds just the opposite. In other words, higher terms of trade (which is what you get with a stronger exchange rate) actually increases export revenues more than the loss coming from reduced demand. So there won’t be much impact in terms of forcing Malaysians to “be more efficient”. In fact, given the relative share of primary resources in exports, there’s probably going to be even less incentive to improve productivity.
A second point is that because of our low value-added industries and with multi-nationals involved in exports, strengthening the exchange rate should in fact have only marginal effects on incomes and trade volume because there’s little local currency pass-through. A higher exchange rate not only reduces the local currency value of exports, but at the same time reduces the local currency value of imported inputs. Assuming the exchange rate elasticities are equivalent, then there will be roughly no change in returns to local content.
Third, given the two effects above, it’s not obvious or automatic that a stronger exchange rate would raise labour incomes in the export sector. Because the income effect dominates, trade volumes will change very little in the manufactured sector, so demand for labour will not change much or at all – which means whatever excess returns are generated from a higher exchange rate will benefit owners of capital, not labour. This also true to a lesser degree for the primary resources sector, where the ratio of imported inputs (e.g. in CPO) is actually quite high. This is not a recipe for raising domestic income levels.
The second statement is really about the conduct of monetary policy in pursuing price stability and economic growth, with the priority on the former as it is also a precondition for the latter. The choices a central bank can make here are setting the monetary base (money supply targeting), setting the price of money (interest rate targeting), and setting the relative price of money (exchange rate targeting). More recently, some central banks have experimented with direct inflation targeting with some success, but our statistical capabilities have to be upgraded for that to happen here.
The first option is a proven failure after experimentation in the early 1980s in the US and UK, and gave rise to Goodhart’s Law. The second has had relative success in maintaining price stability over the past twenty years.
The third is only advisable for relatively small economies with high external exposure or for countries with no external credibility, because in essence it means abdication of any influence over domestic monetary conditions. That’s fairly obvious from the experience of both Singapore and Hong Kong, the two countries in East Asia that use exchange-rate targeting – interest rates and monetary aggregates are subject to far more volatility than countries that use interest rate targeting. It’s also interesting to note that Malaysia’s aggregate economic record in the last decade is marginally better than Singapore’s and much better than Hong Kong’s.
Given this weakness, I don’t see any advantages for Malaysia, with its much more diversified economy, to follow this route. Since the first option is also out, that leaves only interest rate, and potentially, inflation targeting as the basis for monetary policy.
Also, from a currency perspective, it’s not the nominal interest rate that matters but the real interest rate differential. While both nominal and real interest rates have been low across the last decade, that’s consistent with the rest of the world (trade-weighted, real interest rate differential):
In fact, it looks remarkably stable to me since 1990. The implication of course is that with interest rate targeting, both the exchange rate and money supply growth would be inherently more volatile, which has indeed been the case:
Growth in Monetary Aggregates (log annual changes)
Nominal and Real Effective Exchange Rate Indexes (2000=100)
On that basis, since 2005 it’s hard to say that BNM has any currency policy at all, apart from occasional intervention to smoothen volatility as happened this past week.
Now, one might argue that the accumulation of foreign exchange reserves in the past 10 years is a sure sign that the currency is weak, and that the central bank is intervening to prevent currency appreciation. That’s only true if you think the standard open-economy model applies. But that makes it hard to reconcile Singapore’s reserve accumulation with their alleged strong currency policy:
Singapore's International Reserves
My critique is that many who take reserve accumulation as proof of a weak currency policy are ignoring the money supply implication of a trade surplus and capital flows, and the potential for financial fragility inherent with a large accumulation of foreign exchange deposits in the banking system (FX deposits are included in both M2 and M3).
On a more practical basis, it also makes sense for banks to sell their excess forex deposits to BNM since you can’t spend or lend those deposits within Malaysia. Hence inflows of foreign exchange raises demand for local currency, which causes interest rates to rise. Since we have an interest rate targeting regime, that requires the central bank to increase liquidity which damps pressure on interest rates, and incidentally involves selling Ringgit in return for foreign exchange.
Rather than a sign of currency intervention, accumulation of reserves then becomes a form of insurance, in short making sure enough foreign exchange is on hand in case of liquidity emergencies, such as occurred late last year when investor flight to quality caused a USD shortage the world over:
Net Official Reserves
Change in Net Official Reserves
The problem is that open market liquidity operations to manage money supply volatility, conducted in foreign exchange, is functional equivalent to foreign exchange rate intervention and vice-versa. You can’t tell the difference, and it is hardly proof that the central bank is taking any particular stance with respect to the currency, as opposed to domestic liquidity.
On the third statement, you can only accept that Singapore and Taiwan have “strong currency policies” if you believe that Purchasing Power Parity applies (PPP). Otherwise, the latest IMF Article IV consultation with Singapore indicates the SGD to be undervalued and other research (this for instance) indicates that both SGD and NTD are as undervalued as the MYR. The equivalent, opposite statement can actually be made about the USD - its highly overvalued and ought to depreciate relative to everybody else. The truth is probably somewhere in the middle.
And if you followed my writings at all, you’ll know that I believe that the causality between the services sector and the exchange rate runs the opposite from what is stated in the article – a stronger services sector creates an appreciation of the currency, not the other way around.
Bottom line? I don’t believe we have a currency policy at all – the preponderance of evidence suggests that BNM is only concerned with currency volatility, not its level or stability. On that basis, the MYR will continue to trade at or close to its short term, time-varying equilibrium (barring intervention) and gently move towards its medium term, fundamentally consistent equilibrium over the medium term (4-5 years) – which at the present time means an appreciation.
That doesn’t mean there won’t be large currency moves, against the USD for instance which has a lot of structural problems. But interference in the exchange rate won’t solve our structural problems – in fact a strong currency policy is more likely to paper over the problems we have than become a force for change. The MYR will get stronger, but as a consequence of a services-based economic growth strategy. As the fundamentals change, so will the equilibrium exchange rate level.
Sunday, March 22, 2009
What Kind Of Economist Am I?
WY asks what school of economic thought I support. The answer in a nutshell is...whatever works.
Here's the story - strike that, here's my summary of the history of economic thought:
The classical school - Adam Smith, David Ricardo, Hume, Bentham, Marx, Marshall and many others - really set the foundations of economic thought. They gave rise to many competing ideologies which didn't necessarily agreed with each other. For instance libertarianism and the Austrian school take freedom as the sole guiding principle of economic organisation, while Marx suggests the diametric opposite. Both are considered on the lunatic fringe in modern economics.
The classical school eventually gave way to the neo-classical school, which attempted to describe economics within a mathematical framework. The Great Depression and the rise of the Keynesian revolution derailed this movement momentarily, but it revived and assimilated Keynesian thought under the neo-classical synthesis starting with John Hicks (the ever popular and still relevant IS-LM model).
The 1970s brought stagflation and the breakdown of heretofore established macro-relationships, bringing about a resurgence of classical ideas, with an emphasis on micro-foundations for macro analysis - the new classical school.
The 1960s-70s also coincided with the rise of monetarism, which combined some of the ideas of the Austrian school with the neo-classical synthesis. Also known as the Chicago School from its identification with Milton Friedman, monetarism reduced economic policy management to essentially one tool: "2% money supply growth" (see Goodhart's law to see why this failed).
The new keynesian school essentially takes a cue from the new classical school by applying micro-foundations to keynesian macro analysis. These two competing schools of thought comprise mainstream economics today.
Then there is the heterodox school. Well not really a school per se, but rather a loose term covering economists who don't fall under a convenient label. These include people like Joseph Schumpeter and JK Galbraith.
The reason why you see economists disagree in the current crisis on seemingly basic questions like the effectiveness of fiscal stimulus or its structure, or whether it will work at all, goes back to their basic ideologies:
1. New classicals believe in complete markets and rational agents, and that government is less efficient in allocating resources. As such fiscal stimulus is less likely to be effective, and if stimulus has to be done, tax cuts are preferred.
2. New keynesians believe that markets can fail and prices are sticky, in which case there is a strong case for government to step in. Inefficient allocation of resources is better than no use of resources at all.
3. Monetarists don't believe fiscal stimulus works. All we need is 2% money supply growth.
4. Austrians and libertarians don't believe in government. All we need to do is go back to the gold standard and abolish all the central banks.
5. Marxists believe capitalism is doomed to fail. All we need is...never mind.
Where do I stand in this milieu? I admit I began my career a monetarist, with some leanings toward libertarianism. Age and (hopefully) some wisdom now puts me somewhat left of centre - markets do fail, frequently in fact. I also have some sympathy for some of Galbraith's and Schumpeter's ideas, which while often in conflict, do a better job of describing the real world then either mainstream school. It's hard to accept the efficiency of price signals, when competitors are essentially oligopolistic.
Having said that, I think my approach to economics is purely pragmatic. Some ideas work at some times, but not at others. It is a mistake to take a one-size-fits-all approach, especially when contemplating a developing country with immature markets and institutions. Just as important, I lean on empirical evidence rather than relying purely on the dictates of theory.
Theory only provides a framework for thinking, and it pays to listen a little to all the schools of thoughts - even Marxists and Austrians occasionally have something worthwhile to say.
Here's the story - strike that, here's my summary of the history of economic thought:
The classical school - Adam Smith, David Ricardo, Hume, Bentham, Marx, Marshall and many others - really set the foundations of economic thought. They gave rise to many competing ideologies which didn't necessarily agreed with each other. For instance libertarianism and the Austrian school take freedom as the sole guiding principle of economic organisation, while Marx suggests the diametric opposite. Both are considered on the lunatic fringe in modern economics.
The classical school eventually gave way to the neo-classical school, which attempted to describe economics within a mathematical framework. The Great Depression and the rise of the Keynesian revolution derailed this movement momentarily, but it revived and assimilated Keynesian thought under the neo-classical synthesis starting with John Hicks (the ever popular and still relevant IS-LM model).
The 1970s brought stagflation and the breakdown of heretofore established macro-relationships, bringing about a resurgence of classical ideas, with an emphasis on micro-foundations for macro analysis - the new classical school.
The 1960s-70s also coincided with the rise of monetarism, which combined some of the ideas of the Austrian school with the neo-classical synthesis. Also known as the Chicago School from its identification with Milton Friedman, monetarism reduced economic policy management to essentially one tool: "2% money supply growth" (see Goodhart's law to see why this failed).
The new keynesian school essentially takes a cue from the new classical school by applying micro-foundations to keynesian macro analysis. These two competing schools of thought comprise mainstream economics today.
Then there is the heterodox school. Well not really a school per se, but rather a loose term covering economists who don't fall under a convenient label. These include people like Joseph Schumpeter and JK Galbraith.
The reason why you see economists disagree in the current crisis on seemingly basic questions like the effectiveness of fiscal stimulus or its structure, or whether it will work at all, goes back to their basic ideologies:
1. New classicals believe in complete markets and rational agents, and that government is less efficient in allocating resources. As such fiscal stimulus is less likely to be effective, and if stimulus has to be done, tax cuts are preferred.
2. New keynesians believe that markets can fail and prices are sticky, in which case there is a strong case for government to step in. Inefficient allocation of resources is better than no use of resources at all.
3. Monetarists don't believe fiscal stimulus works. All we need is 2% money supply growth.
4. Austrians and libertarians don't believe in government. All we need to do is go back to the gold standard and abolish all the central banks.
5. Marxists believe capitalism is doomed to fail. All we need is...never mind.
Where do I stand in this milieu? I admit I began my career a monetarist, with some leanings toward libertarianism. Age and (hopefully) some wisdom now puts me somewhat left of centre - markets do fail, frequently in fact. I also have some sympathy for some of Galbraith's and Schumpeter's ideas, which while often in conflict, do a better job of describing the real world then either mainstream school. It's hard to accept the efficiency of price signals, when competitors are essentially oligopolistic.
Having said that, I think my approach to economics is purely pragmatic. Some ideas work at some times, but not at others. It is a mistake to take a one-size-fits-all approach, especially when contemplating a developing country with immature markets and institutions. Just as important, I lean on empirical evidence rather than relying purely on the dictates of theory.
Theory only provides a framework for thinking, and it pays to listen a little to all the schools of thoughts - even Marxists and Austrians occasionally have something worthwhile to say.
Subscribe to:
Posts (Atom)
Posts
