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Morkets motter, Moneg Motters

Essogs on morkets, moneg ond NCDP torgeting
Lors Christensen
Morch zo1j
Morketmonetorist.com
Puge z oI 1zq
Contents
1iscol cliff, the Sumner Critigue ond the Bernonke-Eoons rule ................................. Poge j-1o
The euro crisis ond the role of ECB's reoction function.............................................Poge 11-zS
Currencg Wor ond deooluotion................................................................................ Poge zp-gp
The end of Jopon's Long Deflotion ...........................................................................Poge oo-oq
Bonk of Englond, Mork Corneg ond NCDP torgeting .............................................. Poge og-oo
The 'Export Price Norm' - monetorg policg in commoditg exporting countries.......Poge o;-p1
Morkets, moneg ond the tronsmission mechonism................................................. Poge pz-11g
Monetorg historg - lessons for todog ................................................................... Poge 11o-1zq
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1iscol cliff, the Sumner Critigue ond the
Bernonke-Eoons rule
The fiscol cliff hos neoer heen o morket theme
WIen over LIe IusL coupIe oI duys Iuve Iooked uL my LwILLer uccounL nIne oI Len LweeLs Iuve been
ubouL LIe IIscuI cIIII und LIe IInuncIuI medIu uII over LIe worId Iuve been uII ubouL LIuL IorrIbIe
cIIII. CommenLuLors Irom IeIL Lo rIgIL In LIe US Iuve Issued wurnIngs ubouL LIe Iorrors oI LIe
IIscuI cIIII. Yes, IL Ius IeIL very mucI IIke we Indeed Iuve been IeudIng Ior un economIc meILdown.
EconomIc sIowdown In CIInu or LIe euro crIsIs Is noL ImporLunL - LIe onIy LIIng ImporLunL Is LIe
IIscuI cIIII (bIuI, bIuI.)
JusL Luke u Iook uL wIuL GoogIe Trends Is LeIIIng us. TIe grupI beIow sIows seurcIes Ior IIscuI
cIIII over LIe IusL qo duys.
SInce mId-November LIe seurcIes Ior jisccl clijj Ius cIeurIy pIcked up und reuIIy spIked In LIe IusL
coupIe oI weeks.
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However, despILe LIe desperuLe eIIorLs oI pundILs und LIe IInuncIuI medIu LIe IIscuI cIIII Ius never
reuIIy become u serIous murkeL LIeme. TIe besL wuy Lo IIIusLruLe LIIs Is Lo Iook uL LIe US sLock
murkeL - und more specIIIcuIIy on Lwo seLs oI sLocks - deIense sLocks und consumer
dIscreLIonurIes. BoLI secLors sIouId be expecLed Lo be ImpucLed IeuvIIy In LIe evenL oI u IuII-bIown
IIscuI cIIII evenL us u resuIL oI Lux IIkes und cuLs In US deIend spendIng. Iuve Iooked LIe Lwo
secLors` perIormunce durIng zo1z reIuLIve Lo LIe overuII sLock murkeL perIormunce (S&Poo).
I LIe murkeL reuIIy Iud been worrIed ubouL LIe IIscuI cIIII we sIouId Iuve seen deIense sLocks und
consumer dIscreLIonurIes pIummeL. However, us LIe grupI beIow sIows LIuL Ius cerLuInIy noL been
LIe cuse.
n IucL boLI consumer dIscreLIonurIes und deIence sLocks Iuve ouLperIormed LIe overuII US sLock
murkeL sInce AugusL-SepLember. TIereIore II unyLIIng LIe perIormunce oI LIese Lwo sub-IndIces
Iuve been posititel correIuLed wILI LIe IIscuI cIIII worrIes.
n IucL wouId urgue LIuL LIe murkeLs Iuve puId IILLIe subsLunLIuI uLLenLIon Lo LIe ongoIng poIILIcuI
noIse Irom WusIIngLon. L Is Ior exumpIe noLubIe LIuL deIence sLocks Iuve conLInued Lo do weII
despILe Obumu`s reeIecLIon.
TIIs oI course do noL prove LIuL IIscuI poIIcy Is noL ImporLunL - Iur Irom IL, buL oLIer LIIngs ure
cerLuInIy mucI more ImporLunL und LIe murkeLs ure u IoL more Iorwurd-IookIng LIun IL seems Lo be
LIe normuI percepLIon In LIe IInuncIuI medIu. TIe dIscussIon oI LIe IIscuI cIIII Ius noL been (u
murkeL movIng) surprIse Lo LIe murkeLs und neILIer Ius been LIe poIILIcuI sIow LIuL we Iuve
Puge oI 1zq
seen In recenL weeks. Yes, LIe US poIILIcuI sysLem Is dysIuncLIonuI, buL LIuL Is reuIIy no surprIse Lo
LIe murkeLs. Nor Is IL IIkeIy Lo be u surprIse Lo US corporuLIons und consumers. As consequence IL
Iurd Lo beIIeve LIuL LIe IIscuI cIIII cun be cIussIIIed us un sIock Lo LIe economIc sysLem.
A the fiscol cliff os o texthook toke-it-or-leooe-it gome
As my good IrIend proIessor PeLer KurrIId-KIILguurd Ius noLed LIe negoLIuLIons ubouL LIe IIscuI cIIII
Ius been u compIeLe LexLbook exumpIe oI u tcle-it-or-lecte-it gume. Even LIougI pundILs on LIe
IeIL und LIe rIgIL oI US poIILIcs Iuve busIed boLI LIe GOP und LIe DemocruLs Ior IuIIIng In LIe
negoLIuLIons LIere Is reuIIy noLIIng surprIsIng ubouL Iow LIe negoLIuLIons Iuve pIuyed ouL. Any
sLudenL oI gume LIeory wouId LeII you LIuL und uppurenLIy LIe murkeLs undersLund gume LIeory
beLLer LIun pundILs und LIe IInuncIuI medIu reporLers.
TIere Is no reuson Lo pIuy LIe bIume gume Iere - boLI LIe GOP und LIe DemocruLs (IncIudIng LIe
PresIdenL) Iuve so Iur preLLy mucI beIuved ruLIonuIIy (In u gume LIeoreLIcuI sense) - LIuL oI course
do noL meun LIuL wIuL LIey ure doIng Is nIce Lo Iook uL or Ior LIuL muLLer In LIe InLeresL oI LIe
AmerIcun peopIe, buL gume LIeorIsLs wouId noL be surprIsed - neILIer Ius LIe murkeLs been.
or good dIscussIon oI LIe gume LIeoreLIcuI uspecLs oI LIe IIscuI cIIII negoLIuLIon see LIIs exceIIenL
posL by JoIn PuLLy on LIe The Mcth oj Politics bIog Irom December 1q zo1z.
The reol morket mooer is monetorg policg
InuIIy IeL me jusL repeuL LIe MurkeL MoneLurIsL posILIon (see more prevIous posLs on LIe Issue
Iere, Iere, Iere und Iere). MoneLury poIIcy domInuLes IIscuI poIIcy - LIe ed wIII be ubIe Lo
counLerucL uny neguLIve sIock Lo uggreguLe demund (or nomInuI GDP). TIe perIormunce oI
consumer discretioncr sLocks preLLy weII IIIusLruLes LIIs. As LIe murkeL sLurLed Lo prIce In QE In
AugusL und IuLer wus posILIveIy surprIsed by LIe ImpIIcIL unnouncemenL oI LIe Bernunke-Evuns
ruIe In SepLember consumer dIscreLIonurIes Iuve ruIIIed. Hence, uL IeusL judgIng Irom LIe sLock
murkeL perIormunce moneLury poIIcy Ius domInuLed IIscuI poIIcy worrIes. um noL urguIng LIuL II
LIe LIere Iud noL been u deuI on LIe IIscuI cIIII LIe murkeLs wouId Iuve noL seen u seL-buck, buL
um cerLuInIy urguIng LIuL LIIs Issue Ius goLLen Iur Lo mucI uLLenLIon compured Lo Iuve reIuLIveIy
unImporLunL LIe Issue Is.
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um normuIIy noL mukIng predIcLIons Iere, buL Loduy predIcL LIuL jisccl clijj seurcIes on GoogIe
Ius uIreudy peuked (buL no um noL u beLLIng mun). rom Loduy LIe IIscuI cIIII Is so mucI zo1z. L
Is LIme Lo Iocus on someLIIng eIse.uIso Ior LIe IInuncIuI medIu.
PS IIscuI poIIcy uIwuys Iuve un ImpucL oI Income dIsLrIbuLIon und us Iur und us cun see LIIs Is LIe
reuI Issue In LIe US, buL LIuL does noL reuIIy muke LIe dIscussIon ImporLunL Irom u mucroeconomIc
perspecLIve (unIess IL Ius suppIy sIde eIIecLs).
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Doniel Lin is teoching mocro! Lets introduce his students
to the 1S,LM+ model
TIIs semesLer proIessor DunIeI In Is LeucIIng u cIuss In Mucro uL LIe AmerIcun UnIversILy und
Iuve u LrudILIon Lo InLerIere wILI Iow DunIeI sIouId LeucI IIs sLudenLs - so wIII noL IeL down LIe
opporLunILy Lo do IL once uguIn.
Iuve uIreudy wrILLen u posL on Iow LIInk Econ 1o1 sIouId be LuugIL. So don`L wunL Lo go
LIrougI LIuL once uguIn und Iuve uIso wrILLen ubouL wIy DunIeI sIouId be Iuppy ubouL IIs eurIIer
cIuss on MIcro.
Iuve Ior someLIme been LIInkIng ubouL LIe ImpucL on Iow mucroeconomIcs Is LuugIL Lo
economIcs sLudenLs us IundumenLuIIy LIInk mosL prccticin economists Ior exumpIe cIvII
servunLs or IInuncIuI secLor economIsLs LIInk ubouL mucroeconomIc Issues bused on wIuL LIey
Ieurned by reudIng LIe IIrsL 1o puges oI LIeIr IIrsL (und onIy?) mucroeconomIc LexLbook. ew
prucLIcIng economIsLs ever LIInk ubouL InLerLemporuI opLImIzuLIon, ruLIonuI expecLuLIons,
moneLury poIIcy reucLIons IuncLIons eLc. Yes, everybody know ubouL New KeynesIun modeIs und
mosL cenLruI bunks wIII proudIy sIow oII LIeIr DSGE modeIs, buL LIe IucL Is LIuL mosL cenLruI
bunkers, cIvII servunLs und commercIuI bunkers uIIke reuIIy ure jusL usIng u rudImenLury puIeo
KeynesIun modeI Lo LIInk ubouL mucroeconomIc Issues.
My IIrsL mucroeconomIc LexLbook wus DornbuscI und IscIer`s LexLbook Mccroeconomics. L Is u
LypIcuI AmerIcun LexLbook - Iur Loo muny puges und Iur Loo muny boxes und grupIs. NoneLIeIess
sLIII Irom LIme Lo LIme Iuve u Iook In IL - even LIougI reud IL IIrsL LIme In 1qqo. TIe book consIsLs
oI LIree purLs, buL sInce we wIII onIy Iocus on LIe IIrsL 1o puges (remember LIuL Is wIuL LIe
prucLIcIng economIsLs remember) so we wIII onIy geL IuII LIrougI LIe IIrsL purL oI LIe book (yes, US
LexLbooks ure Iur Loo Iong).
On LIe IIrsL 1o puges we ure InLroduced IIrsL Lo LIe sImpIe (puIeo) KeynesIun modeI und we Ieurn
LIuL Y=C++G+X-M. TIere ure reuIIy no prIces, no IInuncIuI murkeLs und no money In LIe modeI. A
sIockIng number oI prucLIcIng economIsLs In reuIILy LIInk ubouL mucroeconomIcs bused on LIese
sImpIe (und IIgIIy probIemuLIc) modeIs. TIe more cIever sLeudenL geLs Lo LIe nexL o puges, wIere
Puge 8 oI 1zq
money und u very rudImenLury IInuncIuI secLor (LIe bond murkeL) Is InLroduced. TIIs Is LIe SJM
modeI.
Doniel - lets trg to introduce o monetorg policg reoction function eorlg on
um reuIIy noL Iuppy ubouL LIIs wuy oI InLroducIng IuLure economIsLs Lo mucroeconomIcs -
wouId mucI preIer sLurLIng Irom u more cIeur mIcro IounduLIon us Iuve descrIbed In un eurIIer
posL. Anywuy, IeLs ussume LIuL we ure sLuck wILI one oI LIe sLundurd mucroeconomIc LexLbooks so
we wIII Iuve Lo go uIong wILI LIe puIeo KeynesIun modeI und LIe SJM sLuII.
BuL IeLs uIso ussume LIuL we cun do LIuL In 1qo puges - so we now Iuve 1o puges Lo udd someLIIng
InLeresLIng. wouId use LIe IusL 1o puges Lo InLroduce u moneLury poIIcy reucLIon IuncLIon InLo LIe
SJM modeI - IeL cuII LIIs modeI LIe SJM+ modeI.
The 1S,LM+ model
MosL economIc sLudenLs ure LuugIL LIuL cenLruI bunks Iuve un InIIuLIon LurgeL, buL LIuL Is noL reuIIy
u proper LurgeL In LIe SJM modeI us LIere Is no InIIuLIon In LIe SJM modeI us prIces ure pegged
(ucLuuIIy mosL sLudenLs und LIere proIessors don`L even noLIce LIuL LIere ure prIces In LIe modeI).
So IeLs InsLeud ImugIne LIuL LIe MurkeL MoneLurIsLs` propugundu Ius been successIuI und LIuL
nomInuI GDP LurgeLIng Ius become commonIy uccepLed uL LIe LurgeL LIuL cenLruI bunks sIouId
Iuve.
eLs reLurn Lo LIe moneLury poIIcy LurgeL beIow, buL IeLs IIrsL sLurL ouL wILI LIe S und M curves.
We sLurL ouL wILI LIe Lwo sLundurd equuLIons In LIe SJM modeI. TIIs Is Irom my eurIIer posL on
LIe SJM modeI:
The mone demcnd junction:
(:) m=p+-ur
Where m is the mone suppl,demcnd, p is prices cnd is recl GDP. r is the interest rcte cnd u is
c coejjicient.
Puge q oI 1zq
Arecte demcnd is dejined cs jollous:
(z) =-r
Arecte demcnd equcls public spendin cnd pritcte sector demcnd (r), uhich is c
junction oj the interest rcte r. is c coejjicient. It is cssumed thct pritcte demcnd drops uhen the
interest rcte increcses.
This is bcsiccll cll ou need in the textbool IS,LM model. Houeter, ue clso need to dejine c
monetcr polic rule to be cble to sc somethin cbout the recl uorld.
So IeLs InLroduce LIe NGDP LurgeL. TIe cenLruI bunk LurgeLs u specIIIc growLI ruLe Ior NGDP: p+y
und LIe cenLruI bunk wIII cIunge LIe money suppIy Lo IIL IL`s LurgeL. TIuL gIves us LIe IoIIowIng
moneLury poIIcy reucLIon IuncLIon:
() m=-t((p+y)-(p+y))
eLs Ior sImpIIcILy ussume LIuL p+y Is normuIIzed uL zero:
()` m=-t(p+y)
PuL (1) und ()` LogeLIer und we Iuve u M curve:
M: r=((1+t)Jo)(p+y)
And we geL LIe S curve by reurrungIng (z):
S: r =(1J)g-(1J)y
Under normuI ussumpLIons ubouL LIe coeIIIcIenLs In LIe modeI LIe M curve Is upwurd sIopIng und
LIe S curve Is downwurd sIopIng. TIIs Is us In LIe LexLbook versIon.
NoLe, Iowever, LIuL LIe sIope oI LIe M does noL onIy depend on LIe money demund`s InLeresL ruLe
eIusLIcILy (o), buL uIso on Iow uggressIve (t) LIe cenLruI bunk wIII reucL Lo devIuLIons In NGDP
(p+y) Irom LIe LurgeL (seL uL zero). TIIs Is LIe key dIIIerence beLween LIe SJM+ modeI und LIe
LrudILIonuI SJM modeI.
Puge 1o oI 1zq
The Somner Critiqoe: =
TIe IucL LIuL LIe sIope oI LIe M curve depends on t Is crILIcuI. Hence, II LIe cenLruI bunk Is IuIIy
commILLed Lo IILLIng LIe NGDP LurgeL und wIII do everyLIIng Lo IuIIIII IL LIen t wIII equuI InIInILy
() .
ObvIousIy, II t= LIen LIe M curve Is verLIcuI - us In LIe moneLurIsL cuse In LIe LexLbook versIon
oI LIe SJM modeI. However, conLrury Lo LIe normuI M curve we don`L need o Lo be zero Lo
ensure u verLIcuI M curve.
WILI t= LIe budgeL muILIpIIer wIII be zero - suId In unoLIer wuy uny Increuse In pubIIc spendIng
(g) wIII jusL Ieud Lo un Increuse In LIe InLeresL ruLe (r) us LIe cenLruI bunk uuLomuLIcuIIy wIII
counLerucL LIe sLImuIuLIve eIIecLs oI LIe Increuse In pubIIc spendIng by decreusIng LIe money
suppIy Lo keep p+y uL LIe LurgeL IeveI (p+y). TIIs oI course Is LIe Sumner Critique - monetcr
polic dominctes jisccl polic II LIe cenLruI bunk LurgeLs NGDP even In u modeI wILI sLIcky prIces
und InLeresL ruLes sensILIve money demund.
Doniel lets chonge the thinking of future procticing economists
LIInk LIIs Is uII we need Lo IundumenLuIIy cIunge LIe LIInkIng oI IuLure prucLIcIng economIsLs -
one more equuLIon (LIe moneLury poIIcy reucLIon IuncLIon) In LIe SJM modeI. TIuL wouId muke
prucLIcIng economIsLs reuIIze LIuL we cunnoL Ignore LIe ucLIons oI LIe cenLruI bunk. TIe cenLruI
bunk - und noL governmenL spendIng - deLermInes uggreguLe demund (NGDP) even In u
IundumenLuIIy very keynesIun modeI.
Tuke II uwuy DunIeI!
Puge 11 oI 1zq
The euro crisis ond the role of ECB's reoction
function
The euro zone is heoding for deflotion
TIIs Is DuIIy TeIegrupI`s Ambrose Evuns-PrILcIurd quoLIng me on LIe rIsk oI deIIuLIon In LIe euro
zone:
Europe is hecdin into c dejlctioncr scencrio ij the don't do cnthin to boost the mone
suppl, scid Lcrs Christensen. This clrecd lools ter similcr to uhct hcppened in 1cpcn in
:pp cnd :pp;.
I you don`L uIreudy reuIIse wIy um LuIkIng ubouL LIe rIsk oI deIIuLIon LIen you jusL Iuve Lo
remember LIe equuLIon oI excIunge - MV=PY.
We cun rewrILe LIe equuLIon oI excIunge In growLI ruLes und reurrunge IL. TIuL gIves us LIe LIe
IoIIowIng modeI Ior medIum-Lerm InIIuLIon:
(1) m + v = p + y
<=>
(1)` p = m + v - y
I we ussume LIuL money-veIocILy (v) drops by z.% yJy (LIe IIsLorIcuI uveruge) und Lrend reuI GDP
growLI Is z% (uIso more or Iess LIe IIsLorIcuI uveruge) und use % us LIe presenL ruLe oI M growLI
LIen we geL LIe IoIIow 'IorecusL` Ior euro zone InIIuLIon:
(1)` p = % + -z.% - z% = -1.%
So LIe messuge Irom LIe equuLIon oI excIunge Is cIeur - we ure cIoser Lo z% dejlction LIun z%
InIIuLIon.
Yes, LIe worId Is mucI more compIIcuLed LIun LIIs, buL beIIeve LIIs Is u preLLy good IIIusLruLIon oI
LIe deIIuLIonury rIsks In LIe euro zone.
Puge 1z oI 1zq
We sLIII don`L Iuve ouLrIgIL deIIuLIon In LIe euro zone, buL we ure cerLuInIy geLLIng cIoser - und
InIIuLIon Is cerLuInIy weII beIow LIe ECB`s z% InIIuLIon LurgeL. TIe grupI beIow cIeurIy sIows LIuL.
So eIIecLIveIy LIe ECB Ius been undersIooLIng IL`s z% InIIuLIon LurgeL sInce zoo8 - uL IeusL II we
use LIe GDP deIIuLor ruLIer LIun ECB`s preIerred meusure oI InIIuLIon (HCP). See my eurIIer posL
on wIy LIe GDP deIIuLor Is u mucI beLLer IndIcuLor oI moneLury InIIuLIon LIun HCP Iere.
TIe reuson Ior LIese deIIuLIonury LendencIes Is obvIous - overIy LIgIL moneLury poIIcy.
JusL Iuve u Iook uL LIIs grupI - IL Is LIe IeveI M versus u IypoLIeLIcuI 6.% growLI puLI Ior M. (I
you reud LIIs bIog posL you wIII see wIy use 6.% us u bencImurk)
Puge 1 oI 1zq
TIIs Is wIy LuIk ubouL LIe need Lo boost money suppIy growLI. TIe ECB eILIer needs Lo Increuse
veIocILy growLI (LIe Ied und LIe BoJ Is IIkeIy IeIpIng u bIL on LIuL uL LIe momenL) or money suppIy
growLI oLIerwIse LIe euro zone Is IeudIng Ior deIIuLIon. L Is preLLy sImpIe.
Puge 1q oI 1zq
1riedmon's Joponese lessons for the ECB
oILen usk myseII wIuL MIILon rIedmun wouId Iuve suId ubouL LIe presenL crIsIs und wIuL Ie
wouId Iuve recommended. know wIuL LIe rIedmunILe modeI In my Ieud Is LeIIIng me, buL don`L
know wIuL MIILon rIedmun ucLuuIIy wouId Iuve suId Iud Ie been uIIve Loduy.
mIgIL conIess LIuL wIen Ieur (Iormer?) moneLurIsLs IIke AIIun MeILzer urgue LIuL rIedmun
wouId Iuve suId LIuL we were IucIng Iuge InIIuLIonury rIsks LIen geL some doubLs ubouL my
convIcLIons - noL ubouL wIeLIer MeILzer Is rIgIL or noL ubouL LIe perceIved InIIuLIonury rIsks (Ie Is
oI course very wrong), buL ubouL wIeLIer MIILon rIedmun wouId Iuve been on LIe sIde oI LIe
MurkeL MoneLurIsLs und cuIIed Ior moneLury eusIng In LIe euro zone und LIe US.
However, Loduy goL un Ideu ubouL Iow Lo LesL IndIrecLIy wIuL rIedmun wouId Iuve suId. My
Ideu Is LIuL LIere ure economIes LIuL In LIe pusL were sImIIur Lo LIe euro zone und LIe US
economIes oI Loduy und rIedmun oI course Iud u vIew on LIese economIes. Jupun nuLuruIIy comes
Lo mInd.
TIIs Is wIuL rIedmun suId ubouL Jupun In December 1qq;:
DeIenders oI LIe Bunk oI Jupun wIII suy, How? TIe bunk Ius uIreudy cuL ILs dIscounL ruLe Lo o.
percenL. WIuL more cun IL do Lo Increuse LIe quunLILy oI money?
TIe unswer Is sLruIgILIorwurd: TIe Bunk oI Jupun cun buy governmenL bonds on LIe open murkeL,
puyIng Ior LIem wILI eILIer currency or deposILs uL LIe Bunk oI Jupun, wIuL economIsLs cuII IIgI-
powered money. MosL oI LIe proceeds wIII end up In commercIuI bunks, uddIng Lo LIeIr reserves
und enubIIng LIem Lo expund LIeIr IIubIIILIes by Iouns und open murkeL purcIuses. BuL wIeLIer
LIey do so or noL, LIe money suppIy wIII Increuse.
TIere Is no IImIL Lo LIe exLenL Lo wIIcI LIe Bunk oI Jupun cun Increuse LIe money suppIy II IL
wIsIes Lo do so. HIgIer moneLury growLI wIII Iuve LIe sume eIIecL us uIwuys. AILer u yeur or so, LIe
economy wIII expund more rupIdIy; ouLpuL wIII grow, und uILer unoLIer deIuy, InIIuLIon wIII Increuse
moderuLeIy. A reLurn Lo LIe condILIons oI LIe IuLe 1q8os wouId rejuvenuLe Jupun und IeIp sIore up
LIe resL oI AsIu.
Puge 1 oI 1zq
So rIedmun wus busIcuIIy LeIIIng LIe Bunk oI Jupun Lo do quunLILuLIve eusIng - prInL money Lo buy
governmenL bonds (noL Lo buII ouL LIe governmenL, buL Lo Increuse LIe money buse).
WIuL were LIe economIc condILIons oI Jupun uL LIuL LIme? TIe grupI beIow IIIusLruLes LIIs. um
IookIng uL numbers Ior Q 1qq; (wIIcI wouId Iuve been LIe duLu uvuIIubIe wIen rIedmun
recommended QE Lo BoJ) und um IookIng uL LIIngs LIe cenLruI bunk cun InIIuence (or ruLIer cun
deLermIne) uccordIng Lo LrudILIonuI moneLurIsL LIInkIng: nomInuI GDP growLI, InIIuLIon und
money suppIy growLI. TIe bIue burs ure LIe Jupunese numbers.
Now compure LIe Jupunese numbers wILI LIe sImIIur duLu Ior LIe euro zone Loduy (Q1 zo1z). TIe
euro zone numbers ure LIe red burs.
sn`L sLrIkIng Iow sImIIur LIe numbers ure? nIIuLIon uround z-z.%, nomInuI GDP growLI oI 1-
1.% und broud money growLI uround %. TIuL wus LIe sLory In Jupun In 1qq; und LIuL Is LIe sLory
In LIe euro zone Loduy.
ObvIousIy LIere ure muny dIIIerences beLween Jupun In 1qq; und LIe euro zone Loduy
(unempIoymenL Is Ior exumpIe mucI IIgIer In LIe euro zone Loduy LIun IL wus In Jupun In 1qq;),
buL judgIng uIone Irom IucLors under LIe dIrecL conLroI oI LIe cenLruI bunk - NGDP, InIIuLIon und
LIe money suppIy - Jupun 1qq; und LIe euro zone zo1z ure very sImIIur.
TIereIore, LIInk IL Is preLLy obvIous. I rIedmun Iud been uIIve Loduy LIen IIs unuIysIs wouId
Iuve been sImIIur Lo IIs unuIysIs oI Jupun In 1qq; und IIs concIusIon wouId Iuve been LIe sume:
Puge 16 oI 1zq
MoneLury poIIcy In LIe euro zone Is Iur Loo LIgIL und LIe ECB needs Lo do QE Lo rejutencte LIe
Europeun economy. Any oLIer vIew wouId Iuve been LerrIbIy InconsIsLenL und wouId noL IIke Lo
LIInk LIuL rIedmun couId be so InconsIsLenL. AIIun MeILzer couId be, buL noL MIILon rIedmun.
---
Broud money Is Mz Ior Jupun und M Ior LIe euro zone.
Puge 1; oI 1zq
1ed NCDP torgeting uould greotlg increose glohol
finonciol stohilitg
JusL wIen we LIougIL LIuL LIe worsL wus over und LIuL LIe worId wus on LIe wuy suIeIy ouL oI LIe
crIsIs u new sIock IIL. NoL surprIsIngIy IL Is once uguIn u sIock Irom LIe euro zone. TIIs LIme LIe
budIy execuLed buIIouL (und buII-In) oI Cyprus. TIIs posL, Iowever, Is noL ubouL Cyprus, buL ruLIer
on ImporLunce oI LIe US moneLury poIIcy seLLIng on gIobuI IInuncIuI sLubIIILy, buL LIe cuse oI Cyprus
provIdes u remInder oI LIe presenL gIobuI IInuncIuI IrugIIILy und wIuL roIe moneLury poIIcy pIuys In
LIIs.
eLs Iook uL Lwo dIIIerenL IypoLIeLIcuI US moneLury poIIcy seLLIngs. IrsL wIuL we couId cuII un
'udupLIve` moneLury poIIcy ruIe und second on u sLrIcL NGDP LurgeLIng ruIe.
'Adoptioe' monetorg policg - o recipe for disoster
By un udupLIve moneLury poIIcy meun u poIIcy wIere LIe cenLruI bunk wIII uIIow 'ouLsIde` IucLors
Lo deLermIne or uL IeusL greuLIy InIIuence US moneLury condILIons und Ience LIe ed wouId noL
oIIseL sIocks Lo money veIocILy.
Hence, IeLs Ior exumpIe ImugIne LIuL u sovereIgn deIuuIL In un euro zone counLry sIocks InvesLors,
wIo run Ior cover und sLurLs buyIng 'suIe usseLs`. Among oLIer LIIngs LIuL wouId be LIe US doIIur.
TIIs wouId obvIousIy be sImIIurIy Lo wIuL Iuppened In LIe AuLumn oI zoo8 LIen US moneLury
poIIcy becume 'udupLIve` wIen InLeresL ruLes eIIecLIveIy IIL zero. As u consequence LIe US doIIur
ruIIIed sLrongIy. TIe III-LImed InLeresL ruLes IIkes Irom LIe ECB In zo11 Iud exucLIy LIe sume
ImpucL - u run Ior suIe usseLs cuused LIe doIIur Lo ruIIy.
n LIuL sense under un 'udupLIve` moneLury poIIcy LIe ed Is eIIecLIve uIIowIng externcl IInuncIuI
sIocks Lo become u LIgILenIng oI US moneLury condILIons. TIe consequence every LIme LIuL LIIs Is
IuppenIng Is noL onIy u neguLIve sIock Lo US economIc ucLIvILy, buL uIso Increused IInuncIuI
dIsLress - us In zoo8 und zo11.
As LIe ed Is u `lobcl monetcr superpouer' u LIgILenIng oI US moneLury condILIons by deIuuIL
Ieuds Lo u LIgILenIng oI gIobuI moneLury condILIons due Lo LIe doIIur`s roIe us un InLernuLIonuI
Puge 18 oI 1zq
reserve currency und due Lo LIe IucL LIuL muny cenLruI bunks uround LIe worId ure eILIer peggIng
LIeIr currencIes Lo LIe doIIur or uL IeusL ure 'sIudowIng` US moneLury poIIcy.
n LIuL sense u neguLIve IInuncIuI sIock Irom Europe wIII be 'escuIuLed` us LIe Ied conducLs
moneLury poIIcy In un udupLIve wuy und IuIIs Lo oIIseL neguLIve veIocILy sIocks.
TIIs uIso meuns LIuL under un 'udupLIve` poIIcy regIme LIe rIsk oI conLugIon Irom one counLry`s
crIsIs Lo unoLIer Is greuLIy Increused. TIIs obvIousIy Is wIuL we suw In zoo8-q.
NCDP torgeting greotlg increoses glohol finonciol stohilitg
I LIe ed on LIe oLIer Iund pursues u sLrIcL NGDP IeveI LurgeLIng regIme LIe sLory Is very dIIIerenL.
eLs uguIn Luke LIe cuse oI un Europeun sovereIgn deIuuIL. TIe sIock uguIn - InILIuIIy - mukes
InvesLors run Ior suIe usseLs. TIuL Is cuusIng LIe US doIIur Lo sLrengLIen, wIIcI Is pusIIng down US
money veIocILy (money demund Is IncreusIng reIuLIve Lo LIe money suppIy). However, us LIe ed Is
operuLIng u sLrIcL NGDP LurgeLIng regIme IL wouId 'uuLomuLIcuIIy` oIIseL LIe decreuse In veIocILy by
IncreusIng LIe money buse (und IndIrecLIy LIe money suppIy) Lo keep NGDP expecLuLIons 'on Lruck`.
Under u IuLures bused NGDP LurgeLIng regIme LIIs wouId be compIeLeIy uuLomuLIc und 'murkeL
deLermIned`.
Hence, u IInuncIuI sIock Irom un euro zone sovereIgn deIuuIL wouId Ieuve no mujor ImpucL on US
NGDP und LIereIore IIkeIy noL on US prIces und reuI economIc ucLIvILy us ed poIIcy uuLomuLIcuIIy
wouId counLerucL LIe sIock Lo US money-veIocILy. As u consequence LIere wouId be no reuson Lo
expecL uny mujor neguLIve ImpucL on Ior exumpIe LIe overuII perIormunce oI US sLock murkeLs.
urLIermore, us u 'gIobuI moneLury poIIcy` LIe uuLomuLIc Increuse In LIe US money buse wouId
curb LIe sLrengLIenIng oI LIe doIIur und Ience curb LIe LIgILenIng oI gIobuI moneLury condILIons,
wIIcI greuL wouId reduce LIe gIobuI IInuncIuI IuIIouL Irom LIe euro zone sovereIgn deIuuIL.
InuIIy und mosL ImporLunLIy LIe IInuncIuI murkeLs wouId under u sysLem oI u credIbIe ed NGDP
LurgeL IIgure uII LIIs ouL on LIeIr own. TIuL wouId meun LIuL InvesLors wouId noL necessurIIy run Ior
suIe usseLs In LIe evenL oI un euro zone counLry deIuuILIng - or some oLIer mujor IInuncIuI sIock
IuppenIng - us InvesLors wouId know LIuL LIe suppIy oI LIe doIIur eIIecLIveIy wouId be 'eIusLIc`. Any
Increuse In doIIur demund wouId be meeL by u one-Lo-one Increuse In LIe doIIur suppIy (un Increuse
Puge 1q oI 1zq
In LIe US money buse). Hence, LIe IIkeIIIood oI u `lobcl jincncicl pcnic' (Ior Iuck oI u beLLer Lerm)
Is mussIveIy reduced us InvesLors wIII noL be Ieud Lo Ieur LIuL we wIII 'run ouL oI doIIur` - us wus LIe
cuse In zoo8.
The Bernonke-Eoons rule improoes glohol finonciol stohilitg, hut is for from enough
We uII know LIuL LIe ed Is noL operuLIng un NGDP LurgeLIng regIme Loduy. However, sInce
SepLember IusL yeur LIe ed cIeurIy Ius moved cIoser Lo u ruIe bused moneLury poIIcy In LIe Iorm oI
LIe Bernunke-Evuns ruIe. TIe E rule eIIecLIve meun LIuL LIe ed Ius commILLed ILseII Lo oIIseL uny
sIock LIuL wouId Increuse US unempIoymenL by sLeppIng up quunLILuLIve eusIng. TIuL uL IeusL
purLIuIIy Is u commILmenL Lo oIIseL neguLIve sIocks Lo money-veIocILy. However, LIe probIem Is LIuL
LIe Ied poIIcy Is sLIII uncIeur und LIere Is cerLuInIy sLIII u Iurge eIemenL oI 'udupLIve` poIIcy
(dIscreLIonury poIIcy) In LIe wuy LIe Ied Is conducLIng moneLury poIIcy. Hence, LIe murkeLs cunnoL
be sure LIuL LIe ed wIII ucLuuIIy IuIIy oIIseL neguLIve veIocILy-sIocks due Lo Ior exumpIe un euro
zone sovereIgn deIuuIL. BuL uL IeusL LIIs Is mucI beLLer LIun wIuL we Iud beIore - wIen ed poIIcy
wus IIgI dIscreLIonury.
urLIermore, LIInk LIere Is reuson Lo be Iuppy LIuL LIe Bunk oI Jupun now uIso Iuve moved
decIsIveIy Lowurds u more ruIe bused moneLury poIIcy In LIe Iorm oI u z% InIIuLIon LurgeLIng (un
NGDP LurgeLIng obvIousIy wouId Iuve been beLLer). or LIe pusL 1 yeur LIe BoJ Ius been LIe
'modeI` Ior udupLIve moneLury poIIcy, buL LIuL IopeIuIIy Is now cIungIng und us LIe yen uIso Is un
InLernuLIonuI reserve currency LIe yen Lends Lo sLrengLIen wIen InvesLors ure IookIng Ior suIe
usseLs. WILI u more sLrIcL InIIuLIon LurgeL LIe BoJ sIouId, Iowever, be expecLed Lo u Iurge exLenL Lo
oIIseL LIe sLrengLIenIng oI LIe yen us u sLronger yen Is pusI down Jupunese InIIuLIon.
TIereIore, LIe recenL cIunges oI moneLury poIIcy ruIes In LIe US und Jupun IIkeIy Is very good news
Ior gIobuI IInuncIuI sLubIIILy. However, LIe new regImes ure sLIII unLesLed und Is sLIII noL IuIIy
LrusLed by LIe murkeLs. TIuL meuns LIuL InvesLors cun sLIII noL be IuIIy convInced LIuL u sovereIgn
deIuuIL In u mInor euro zone counLry wIII noL cuuse gIobuI IInuncIuI dIsLress.
Puge zo oI 1zq
The ECB is turning into the BoJ
TIIs Is ECB CIIeI MurIo DrugII:
WeII, IeL me IIrsL jusL poInL ouL LIuL never menLIoned deIIuLIon. DeIIuLIon Is u generuIIsed IuII In
LIe prIce IeveI ucross secLors und IL Is seII-susLuInIng. And so Iur we Iuve noL seen sIgns oI deIIuLIon,
neILIer uL LIe euro ureu IeveI nor uL counLry IeveI. We sIouId uIso be very cureIuI ubouL noL mIxIng
up wIuL Is u normuI prIce reudjusLmenL due Lo LIe resLoruLIon oI compeLILIveness In some oI LIese
counLrIes. TIey wIII necessurIIy Iuve Lo go LIrougI u re-udjusLmenL oI prIces. We sIouId noL
conIuse LIIs reudjusLmenL oI prIces, wIIcI Is ucLuuIIy weIcome, wILI deIIuLIon. Busicully, we see
price behuvioor in line with oor mediom-term objectives. So, we see prIce sLubIIILy over
LIe medIum Lerm. AIso consIder LIuL monetury policy is ulreudy very uccommodutive,
consIder LIe very Iow IeveI oI InLeresL ruLes und LIuL reuI InLeresL ruLes ure neguLIve In u Iurge purL oI
LIe euro ureu.
WIen reud DrugII`s commenLs LIe IIrsL LIIng cume Lo LIInk oI wus Iow mucI LIIs sounds IIke
commenLs Irom Bunk oI Jupun oIIIcIuIs over LIe IusL 1 yeurs.
Muybe MurIo DrugII wouId be InLeresLed In LIIs grupI. L sIow LIe growLI oI broud money In LIe
euro zone und Jupun. Iuve consLrucLed LIe grupI so LIe growLI oI money peuks more or Iess uL
LIe sume LIme In LIe grupI Ior Jupun und LIe euro zone. Mz growLI peuked uround 1qqo In Jupun
und zoo8 In LIe euro zone. TIe grupI cIeurIy sIows boLI LIe boom und LIe busL und Ior Jupun u
very Iong perIod - more LIun u decude - oI very Iow money suppIy growLI.
Puge z1 oI 1zq
busIcuIIy IuLe LIIs kInd oI grupI buL LIe sImIIurILy Is Iurd Lo mIss. I MurIo DrugII LIInks euro
zone moneLury poIIcy Is uccommoduLIve Loduy LIen Ie wouId uIso Iuve Lo LIInk Jupunese
moneLury poIIcy wus uccommoduLIve In 1qqq-qq.
BUT worse II LIe ECB conLInues on IL`s presenL puLI IL wIII IIkeIy repeuL LIe mIsLukes oI LIe BoJ und
LIen we mIgIL be In Ior yeurs oI deIIuLIon. know LIuL LIIs Is noL wIuL DrugII wunLs, buL LIe ECB`s
presenL poIIcy Is unIorLunuLeIy noL gIvIng mucI Iope LIuL u Jupunese scenurIo cun be uvoIded.
By LIe wuy LIuL Is LIe reuI reuson Ior LIe sIump we ure seeIng In gIobuI sLock murkeLs LIese duys
und IL IIkeIy Ius very IILLIe Lo do wILI Obumu`s reeIecLIon und LIe Ieur oI LIe IIscuI cIIII. L Is mosLIy
ubouL LIe escuIuLIon oI bud news ouL oI Europe. Iope DrugII wIII soon reuIIze LIuL unIess Ie
sIows some Rooseoeltion Resoloe LIen LIe bud news wIII conLInue Ior unoLIer decude.
Puge zz oI 1zq
Pleose keep "politics" out of the monetorg
reoction function
DurIng LIe GreuL ModeruLIon IL wus normuI Lo suy LIuL LIe ederuI Reserve und LIe ECB (und muny
oLIer cenLruI bunks Ior LIuL muLLer) wus IoIIowIng u reIuLIveIy weII-deIIned moneLury poIIcy
reucLIon IuncLIon. L Is debuLubIe wIuL LIese cenLruI bunks wIere ucLuuIIy LurgeLIng, buL LIere
wIere Is no doubL LIuL boLI LIe ed und LIe ECB overuII cun be descrIpLed Lo Iuve conducLed
moneLury poIIcy Lo mInImIze some kInd oI Ioss IuncLIon wIIcI IncIuded boLI unempIoymenL und
InIIuLIon.
n u worId wIere LIe cenLruI bunk IoIIows u TuyIor ruIe sLyIe moneLury poIIcy reucLIon IuncLIon,
LurgeLs LIe NGDP IeveI, do InIIuLIon LurgeLIng or Iuve pegged LIe excIunge ruLe LIe murkeLs wIII
Lend Lo Ignore poIILIcuI news. TIe onIy ImporLunL LIIng wIII be Iow LIe ucLuuI economIc
deveIopmenL Is reIuLIve Lo LIe LurgeL und In u sILuuLIon wILI u credIbIe nomInuI LurgeL LIe CIuck
NorrIs eIIecL wIII ensure LIuL LIe murkeLs do mosL oI LIe IIILIng Lo ucIIeve LIe nomInuI LurgeL. TIe
onIy LIIngs LIuL couId cIunge LIuL wouId be II poIILIcIuns decIded Lo Luke uwuy LIe cenLruI bunk`s
Independence undJor cIunge LIe cenLruI bunk`s LurgeL.
WIen 1z yeurs ugo joIned LIe IInuncIuI secLor Irom u job In LIe pubIIc secLor wus IugeIy
surprIsed by Iow IILLIe uLLenLIon my coIIeugues In LIe bunk wus puyIng Lo poIILIcuI deveIopmenLs. ,
Iowever, soon Ieurned LIuL boLI IIscuI poIIcy und moneLury poIIcy In mosL deveIoped counLrIes Iud
become IIgIIy ruIe bused und LIereIore LIere wus reuIIy no reuson Lo puy Loo mucI uLLenLIon Lo LIe
nILLy-grILLy oI duy-Lo-duy poIILIcs. TIe onIy LIIng one sIouId puy uLLenLIon Lo wus wIeLIer or noL
gIven moneLury LurgeLs wIere on Lruck or noL. TIuL wus LIe good oId duys oI LIe GreuL ModeruLIon.
MoneLury poIIcy wus ruIe bused und LIereIore IIgIIy predIcLubIe und us u resuIL murkeL voIuLIIILy
wus very Iow.
TIIs Iuve uII cIunged In LIe bruve new worId oI GreuL RecessIon (IuIIed) moneLury poIIcy und LIese
duys IL seems IIke murkeL purLIcIpunLs ure doIng noLIIng eIse LIun LryIng Lo IorecusL wIuL wIII be
LIe poIILIcuI cIunges In counLry X, Y und Z. TIe reuson Ior LIuL Is LIe sIurp Increuse In LIe
poIILIcIun oI moneLury poIIcy.
Puge z oI 1zq
n LIe oId duys - prIor Lo LIe GreuL ModeruLIon - murkeL purLIcIpunLs were used Lo Iuve poIILIcIuns
messIng up moneLury poIIcIes. CenLruI bunks were rureIy IndependenL und dId noL LurgeL cIeur
nomInuI LurgeLs. However, Loduy LIe sILuuLIon Is dIIIerenL. Gone ure LIe duys oI ruIe bused
moneLury poIIcy, buL LIe Loduy IL Is noL LIe poIILIcIuns InLerIerIng In LIe conducL oI moneLury poIIcy,
buL ruLIer LIe cenLruI bunkers InLerIerIng In LIe conducL oI other poIIcIes.
TIIs purLIcuIurIy Is LIe cuse In LIe euro zone wIere LIe ECB now openIy Is sIurIng LIe cenLruI
bunk`s vIew on uII kInd oI poIIcy muLLers - sucI us IIscuI poIIcy, bunk reguIuLIon, sLrucLuruI
reIorms und even muLLers oI cIoser Europeun poIILIcuI InLegruLIon. urLIermore, LIe ECB Ius
quILe openIy suId LIuL IL wIII muke moneLury poIIcy decIsIons condILIonuI on LIe rIgIL poIIcIes
beIng ImpIemenLed. L Is Ior exumpIe cIeur LIuL LIe ECB Iuve IndIcuLed LIuL IL wIII noL euse
moneLury poIIcy (enougI) unIess LIe Greek governmenL und LIe SpunIsI governmenL wIII deIIver
on cerLuIn IIscuI LurgeLs. So II SpunIsI IIscuI poIIcy Is noL LIgIL enougI Ior LIe IIkIng oI LIe ECB LIe
ECB wIII noL Iorce down NGDP In LIe euro zone und us u resuIL Increuse LIe IundIng probIems oI
counLrIes sucI us SpuIn. TIe ECB Is open ubouL LIIs. TIe ECB cuII IL Lo use murkeL Iorces Lo
convInce governmenLs Lo ImpIemenL IIscuI LIgILenIng. L oI course Ius noLIIng Lo do wILI murkeL
Iorces. L Is ruLIer ubouL munIpuIuLIng murkeL expecLuLIons Lo ucIIeve u cerLuIn poIILIcuI ouLcome.
SuId In unoLIer wuy LIe ECB Ius busIcuIIy unnounced LIuL IL does noL onIy Iuve un InIIuLIon LurgeL,
buL uIso LIuL cerLuIn poIILIcuI ouLcomes Is purL oI ILs reucLIon IuncLIon. TIIs obvIousIy meun LIuL
Iorwurd IookIng IInuncIuI murkeLs IncreusIngIy wIII ucL on poIILIcuI news us poIILIcuI news wIII Iuve
un ImpucL oI IuLure moneLury poIIcy decIsIons Irom LIe ECB.
Any MurkeL MoneLurIsL wIII LeII you LIuL LIe expecLuLIonuI cIunneI Is exLremeIy ImporLunL Ior LIe
moneLury LrunsmIssIon mecIunIsm und LIIs Is purLIcuIurIy ImporLunL wIen u cenLruI bunk sLurL Lo
IncIude poIILIcuI ouLcomes In IL`s reucLIon IuncLIon.
mugIng u cenLruI bunk suy LIuL IL wIII LrIpIe LIe money suppIy II cundIduLe A wIns LIe presIdenLIuI
eIecLIons (due Lo IIs very sound IIscuI poIIcy Ideus), buL wIII cuL In IuIve LIe money suppIy II
cundIduLe B wIns (becuuse Ie Is u IrresponsIbIe busLurd). TIIs wIII uuLomuLIcuIIy ensure LIuL LIe
opInIon poIIs wIII deLermIne moneLury poIIcy. I LIe opInIon poIIs sIows LIuL cundIduLe A wIII wIn
LIen LIuL wIII eIIecLIveIy be moneLury eusIng us LIe murkeL wIII sLurL Lo prIce In IuLure moneLury
poIIcy eusIng. Hence, by unnounce LIuL poIILIcuI ouLcomes Is purL oI ILs reucLIon IuncLIon wIII
Puge zq oI 1zq
poIILIcs wIII muke moneLury poIIcy endogenous. TIe ECB oI course Is operuLIng u Iess exLreme
versIon oI LIIs seL-up. Hence, IL Is Ior exumpIe very cIeur LIuL LIe ECB`s moneLury poIIcy decIsIons
In LIe comIng monLIs wIII dependenL on LIe ouLcome oI LIe Greek eIecLIons und on LIe SpunIsI
governmenL`s IIscuI poIIcy decIsIons.
TIe probIem oI course Is LIuL poIILIcs Is IIgIIy unpredIcLubIe und us u resuIL moneLury poIIcy
becomes IIgIIy unpredIcLubIe und IInuncIuI murkeL voIuLIIILy LIereIore Is IIkeIy Lo Increuse
drumuLIcuIIy. TIIs oI course Is wIuL Ius Iuppened over LIe pusL yeur In Europe.
urLIermore, LIe poIILIcuI ouLcome uIso crucIuIIy dependenLs on LIe economIc ouLcome. L Is Ior
exumpIe preLLy cIeur LIuL you wouId noL Iuve neo-nuzIs und SLuIInIsLs In LIe Greek purIIumenL II
LIe economy were doIng weII. Hence, LIere Is u Ieedbuck Irom moneLury poIIcy Lo poIILIcs und buck
Lo moneLury poIIcy. TIIs mukes Ior u IIgIIy voIuLIIe IInuncIuI envIronmenL. n IucL IL Is Iurd Lo see
Iow you cun ucIIeve uny Iorm oI IInuncIuI or economIc sLubIIILy II cenLruI bunks InsLeud oI LurgeLIng
onIy nomInuI vurIubIes sLurL Lo LurgeL poIILIcuI ouLcomes.
So Iong Ior LIe duys wIen poIILIcs wus noL murkeL moves In LIe IInuncIuI murkeLs und Iope
cenLruI bunks uround LIe worId wouId soon Ieurn LIuL IL Is noL purL oI LIeIr munduLe Lo poIIce LIe
poIILIcuI process und punIsI governmenLs (und voLers!) Ior mukIng LIe wrong decIsIons. CenLruI
bunks sIouId onIy LurgeL nomInuI LurgeLs und noLIIng eIse. I LIey dIverge Irom LIuL LIen LIIngs
goes budIy wrong und murkeL voIuLIIILy Increuses sIurpIy.
InuIIy sIouId sLress LIuL um noL urguIng In unywuy LIuL LIe ECB Is wrong Lo be concerned
ubouL IIscuI poIIcy beIng unsusLuInubIe In u number oI counLrIes. um deepIy concerned ubouL LIuL
sLuLe oI IIscuI poIIcy In u number oI counLrIes und LIInk IL Is preLLy cIeur Lo my reguIur reuders LIuL
do noL Iuvour eusIer IIscuI poIIcy Lo soIve LIe euro zone crIsIs. , Iowever, Is exLremeIy scepLIcuI
ubouL cerLuIn poIILIcuI resuILs beIng IncIuded In LIe ECB`s reucLIon IuncLIon. TIuL Is u recIpe Ior
Increused murkeL voIuLIIILy.
PS LIIs dIscussIon Is oI course very sImIIur Lo wIuL Iuppened durIng LIe GreuL DepressIon wIen
poIILIcs kepL sIIppIng InLo LIe newspupers` IInuncIuI secLor (See Iere und Iere)
Puge z oI 1zq
1t's 1ronkfurt thot should he gour uorrg - not Rome
TIIs week InvesLors Iuve been spooked by LIe eIecLIon ouLcome In LuIy, buL IrunkIy speukIng Is
LIere unyLIIng new In LIuL sIudy cIurucLers ure doIng weII In un LuIIun eIecLIon? s LIere unyLIIng
new In u Iung purIIumenL In LuIy? Nope, judgIng Irom posL-WW LuIIun poIILIcuI IIsLory LIIs Is
compIeLeIy normuI. Ok, LuIIun pubIIc IInunces Is u mess, buL uguIn LIuL noL reuIIy news eILIer.
So II uII LIIs Is `business-cs-usucl' wIy ure InvesLors suddenIy so worrIed? My expIunuLIon wouId be
LIuL InvesLors ure noL reuIIy worryIng ubouL wIuL Is goIng on In Rome, buL ruLIer ubouL wIuL Is
goIng on In Ircnljurt.
usL yeur urgued LIuL LIe ECB Iud InLroduced `politiccl outcomes' In ILs reucLIon IuncLIon:
This pcrticulcrl is the ccse in the euro zone uhere the EC nou openl is shcrin the centrcl
bcnl's tieu on cll lind oj polic mctters - such cs jisccl polic, bcnl reulction, structurcl
rejorms cnd eten mctters oj closer Europecn politiccl interction. Iurthermore, the EC hcs
quite openl scid thct it uill mcle monetcr polic decisions conditioncl on the riht policies
bein implemented. It is jor excmple clecr thct the EC hcte indiccted thct it uill not ecse
monetcr polic (enouh) unless the Greel oternment cnd the Spcnish oternment uill
deliter on certcin jisccl tcrets. So ij Spcnish jisccl polic is not tiht enouh jor the lilin oj
the EC the EC uill not jorce doun NGDP in the euro zone cnd cs c result increcse the jundin
problems oj countries such cs Spcin. The EC is open cbout this. The EC ccll it to use mcrlet
jorces to contince oternments to implement jisccl tihtenin. It oj course hcs nothin to do
uith mcrlet jorces. It is rcther cbout mcnipulctin mcrlet expectctions to cchiete c certcin
politiccl outcome.
Scid in cnother uc the EC hcs bcsiccll cnnounced thct it does not onl hcte cn injlction
tcret, but clso thct certcin politiccl outcomes is pcrt oj its recction junction. This obtiousl
mecn thct jorucrd loolin jincncicl mcrlets increcsinl uill cct on politiccl neus cs politiccl
neus uill hcte cn impcct oj juture monetcr polic decisions jrom the EC.
And LIIs Is reuIIy wIuL concerns InvesLors. TIe IogIc Is LIuL u 'bud` poIILIcuI ouLcome In LuIy wIII
Ieud LIe ECB Lo become more IuwkIsI und eIIecLIveIy LIgILen moneLury condILIons by sIgnuIIng
Puge z6 oI 1zq
LIuL LIe ECB Is noL Iuppy ubouL LIe 'ouLcome` In LuIy und LIereIore wIII noL euse moneLury poIIcy
goIng Iorwurd even II economIc condILIons wouId dIcLuLe LIuL. TIIs Is exucLIy wIuL Iuppened In
zo11-1z In LIe euro zone, wIere LIe poIILIcuI `outcomes' In Greece, LuIy und SpuIn cIeurIy cuused
LIe ECB Lo become more IuwkIsI.
TIe probIems wILI InLroducIng poIILIcuI ouLcomes InLo LIe moneLury reucLIon IuncLIon ure obvIous
- or us wroLe IusL yeur:
Imcin c centrcl bcnl sc thct it uill triple the mone suppl ij ccndidcte A uins the
presidenticl elections (due to his ter sound jisccl polic idecs), but uill cut in hclte the mone
suppl ij ccndidcte uins (beccuse he is c irresponsible bcstcrd). This uill cutomcticcll ensure
thct the opinion polls uill determine monetcr polic. Ij the opinion polls shous thct ccndidcte A
uill uin then thct uill ejjectitel be monetcr ecsin cs the mcrlet uill stcrt to price in juture
monetcr polic ecsin. Hence, b cnnounce thct politiccl outcomes is pcrt oj its recction
junction uill politics uill mcle monetcr polic endoenous. The EC oj course is operctin c
less extreme tersion oj this set-up. Hence, it is jor excmple ter clecr thct the EC's monetcr
polic decisions in the comin months uill dependent on the outcome oj the Greel elections cnd
on the Spcnish oternment's jisccl polic decisions.
The problem oj course is thct politics is hihl unpredictcble cnd cs c result monetcr polic
becomes hihl unpredictcble cnd jincncicl mcrlet tolctilit therejore is lilel to increcse
drcmcticcll. This oj course is uhct hcs hcppened oter the pcst ecr in Europe.
Iurthermore, the politiccl outcome clso crucicll dependents on the economic outcome. It is jor
excmple prett clecr thct ou uould not hcte neo-nczis cnd Stclinists in the Greel pcrlicment ij
the econom uere doin uell. Hence, there is c jeedbccl jrom monetcr polic to politics cnd
bccl to monetcr polic. This mcles jor c hihl tolctile jincncicl entironment. In jcct it is hcrd
to see hou ou ccn cchiete cn jorm oj jincncicl or economic stcbilit ij centrcl bcnls instecd oj
tcretin onl nomincl tcricbles stcrt to tcret politiccl outcomes.
TIereIore InvesLors ure IIkeIy Lo wuLcI commenLs Irom LIe ECB on LIe LuIIun eIecLIons us cIoseIy
us LIe duIIy poIILIcuI sIow In Rome. However, LIere mIgIL be reusons Lo be Iess worrIed now LIun
Puge z; oI 1zq
In zo11-1z. TIe reuson Is noL Europe, buL ruLIer wIuL Ius been IuppenIng wILI US und Jupunese
moneLury poIIcy sInce AugusL-SepLember IusL yeur.
Hence, wILI LIe ed eIIecLIve operuLIng LIe erncnle-Etcns rule und LIe Bunk oI Jupun IuvIng
InLroduced u z% InIIuLIon LurgeL LIese Lwo cenLruI bunks eIIecLIve Iuve promIsed Lo ojjset uny
neguLIve spIII-over Lo uggreguLe demund Irom LIe euro zone Lo LIe US und LIe Jupunese economy
(LIIs Is busIcuIIy LIe InLernuLIonuI IInuncIuI versIon oI the Sumner Critique - LIere Is no gIobuI
spIII-over II LIe cenLruI bunks Iuve proper nomInuI LurgeLs).
Hence, II LuIIun poIILIcuI jILLers spurk IInuncIuI jILLers LIuL LIreuLen Lo pusI up US unempIoymenL
LIen LIe ed wIII uuLomuLIcuIIy sLep up moneLury eusIng Lo oIIseL LIe sIock und InvesLors sIouId
IuII weII undersLund LIuL. Hence, LIe Bernunke-Evuns ruIe und LIe BoJ`s new InIIuLIon LurgeL ure
eIIecLIve bucksLops LIuL reduces LIe rIsk oI spill-oter Irom LuIy Lo LIe gIobuI murkeLs und LIe
gIobuI economy.
However, InvesLors obvIousIy sLIII worry ubouL LIe possIbIe reucLIon Irom LIe ECB. I LIe ECB -
und Europeun poIIcy mukers In generuI - uses poIILIcuI evenLs In LuIy Lo LIgILen moneLury
condILIons LIen we ure IIkeIy Lo see more unresL In LIe Europeun murkeLs. Hence, LIe ECB cun end
murkeL worrIes over LuIy Loduy by sImpIy sLuLIng LIuL LIe ECB nuLuruIIy wIII ucL Lo oIIseL uny spIII-
over Irom LuIy Lo LIe wIder Europeun murkeLs LIuL LIreuLens nomincl stcbilit In LIe euro zone.
Puge z8 oI 1zq
Creek ond 1rench politicol neus slipped into the
finonciol section
TIe poIILIcuI eIIecLs oI moneLury sLrunguIuLIon never IuIIs Lo sIow up. TIuL wus LIe cuse durIng LIe
1qos und LIuL Is LIe cuse Loduy.
TIe Europeun poIILIcuI news over LIe weekend: SocIuIIsL runcoIs HoIIunde won LIe second round
oI LIe rencI presIdenLIuI eIecLIons on un unLI-uusLerILy pIuLIorm und In Greece LIe muInsLreum
poIILIcuI purLIes Look u mujor beuLIng wILI exLremIsL purLIes doIng exLremeIy weII In yesLerduy`s
Greek purIIumenL voLe.
TIe rudIcuI-IeILIsL groupIng SyrIzu Is now LIe second IurgesL purLy In LIe Greek purIIumenL wILI
16.;% oI LIe voLe. TIe eIIecLIveIy neo-nuzI purLy GoIden Duwn PurLy won ;% und wIII now Ior LIe
IIrsL LIme be represenLed In LIe Greek purIIumenL. ( dure you Lo Iuve u Iook uL GoIden Duwn`s
Iogo.scury)
L does noL exucLIy Iook IIke LIe reIorm-LIrougI-LIgIL-money poIIcy Is workIng.jusL Iuve u Iook
uL LIe Europeun murkeLs Loduy.
PS TIe ouLcome oI LIe rencI presIdenLIuI eIecLIon remInded me oI wIuL Iuppened In runce
durIng LIe GreuL DepressIon. I you ure InLeresLed In LIuL LopIc you sIouId Iuve u Iook uL CIurk
JoInson`s cIussIc GoId, runce und LIe GreuL DepressIon.
Puge zq oI 1zq
Currencg Wor ond deooluotion
The 1ed's eosing is uorking.in Mexico
s LIe Bernunke-Evuns ruIe workIng? HeII yes! AL IeusL In MexIco!
TIe MexIcun economy recovered IusL Irom LIe sIock In zoo8-q und reuI GDP Ius been growIng
uround % In LIe IusL LIree yeurs und now growLI Is geLLIng u IurLIer boosL Irom LIe ed`s
moneLury eusIng. JusL Luke u Iook uL LIe grupIs beIow - especIuIIy keep un eye on wIuL Iuve
Iuppened sInce SepLember 1 wIen LIe so-cuIIed Bernunke-Evuns ruIe eIIecLIveIy wus unnounced.
The Bernonke-Eoons rule hoosts the Mexicon stock morket
Mexicon consumers get o hoost from Bernonke
Puge o oI 1zq
Mexicon industriolists ore folling in looe uith Bernonke
The US-Mex monetorg tronsmission mechonism
A LrudILIonuI KeynesIun InLerpreLuLIon oI wIuL Is goIng on wouId be LIuL Bernunke`s moneLury
eusIng Is boosLIng US IndusLrIuI producLIon, wIIcI Is IeudIng Lo un Increuse In MexIcun exporLs Lo
LIe US. TIe sLory Is obvIousIy rIgIL, buL wouId suggesL LIuL IL Is noL LIe mosL ImporLunL sLory.
RuLIer wIuL Is ImporLunL Is LIe moneLury LrunsmIssIon mecIunIsm Irom LIe US Lo MexIco.
Here Is LIuL sLory. WIen LIe ed sLeps up moneLury eusIng IL Ieuds Lo u weukenIng oI LIe doIIur
uguInsL uII oLIer currencIes - IncIudIng LIe MexIcun peso us Iunds IIow ouL oI LIe US und InLo LIe
MexIcun murkeLs. TIe MexIcun cenLruI bunk cnxico now Ius Lwo opLIons. EILIer LIe cenLruI bunk
Puge 1 oI 1zq
de IucLo uIIows LIe peso Lo sLrengLIen or IL decIdes Lo ImporL LIe ed`s moneLury eusIng by
dIrecLIy InLervenIng In LIe currency murkeL - buyIng doIIurs und seIIIng pesos - or by cuLLIng
InLeresL ruLes. No muLLer Iow LIIs Is done LIe resuIL wIII be un Increuse In LIe MexIcun money
suppIy (reIuLIve Lo wIuL oLIerwIse wouId Iuve Iuppened). TIIs In my vIew Is wIuL Is drIvIng LIe
ruIIy In LIe MexIcun sLock murkeL und LIe spIke In consumer und busIness conIIdence. L`s uII
moneLury my IrIend.
ObvIousIy BunxIco don`L Iuve Lo ImporL LIe moneLury eusIng Irom LIe US, buL so Iur Iuve cIosen Lo
do so. TIIs Ius probubIy been weII-udvIsed, buL LIe MexIcun economy Is cerLuInIy noL In need oI u
US scuIe moneLury eusIng. WIuL Is rIgIL Ior LIe US Is noL necessurIIy rIgIL Ior MexIco wIen IL
comes Lo moneLury eusIng. TIereIore, BunxIco sooner or IuLer Iuve sLop ImporLIng moneLury
eusIng Irom LIe US.
uckIIy LIe BunxIco cun cIoose Lo decoupIe Irom LIe US moneLury eusIng by uIIowIng LIe peso Lo
sLrengLIen und LIereby curb LIe Increuse In LIe money suppIy und reduce poLenLIuI InIIuLIonury
pressures. TIIs In IucL seems Lo be wIuL Ius been IuppenIng In recenL weeks wIere LIe peso Ius
ruIIIed uguInsL LIe doIIur.
TIIs Is noL LIe pIuce Lo dIscuss wIuL cnxico uill do, buL LIInk LIe dIscussIon oI LIe US-Mex
moneLury LrunsmIssIon mecIunIsm preLLy weII descrIbe wIuL muny EmergIng MurkeLs cenLruI
bunks ure now IucIng - moneLury eusIng Irom LIe US Is IorcIng LIem Lo cIoose beLween u sLronger
currency or u moneLury expunsIon. However, unIIke wIuL BruzIIIun Inunce MInIsLer MunLegu
seems Lo LIInk LIIs Is noL sucI u LerrIbIe LIIng. BunxIco und LIe BruzIIIun cenLruI bunk und oLIer
EM cenLruI bunks remuIn IuIIy In cIurge oI moneLury poIIcy LIemseIves und II LIe cenLruI bunks ure
cIeur ubouL LIeIr moneLury LurgeLs LIen LIe murkeLs wIII do mosL oI LIe IIILIng LIrougI LIe excIunge
ruLe cIunneI.
mugIne Ior exumpIe LIuL LIe MexIcun peso sLurLs Lo sLrengLIen drumuLIcuIIy. TIen LIuL IIkeIy wIII
pusI down MexIcun InIIuLIon beIow BunxIco`s InIIuLIon LurgeL preLLy IusL. WILI InIIuLIon droppIng
beIow LIe InIIuLIon LurgeL LIe murkeLs wIII sLurL Lo prIce u counLer-reucLIon und u sLeppIng up oI
moneLury eusIng Irom BunxIco und LIuL In ILseII wIII curb LIe sLrengLIenIng oI LIe peso. Hence, LIe
credIbIIILy oI LIe cenLruI bunk`s LurgeL Is key.
Puge z oI 1zq
And IL Is Iere LIuL LIe BruzIIIuns ure IucIng u probIem. As Iong us LIe cenLruI bunk Ius one LurgeL
LIIngs ure IIne. However, LIe BruzIIIun uuLIorILIes oILen Lry Lo do more LIun one LIIng wILI
moneLury poIIcy. mugIne LIe BruzIIIun economy Is growIng nIceIy und InIIuLIon Is uround LIe
cenLruI bunk`s InIIuLIon LurgeL. TIen u posILIve moneLury sIock Irom LIe US wIII Ieud LIe BruzIIIun
recl Lo sLrengLIen. TIuL Is no probIem In Lerms oI LIe InIIuLIon LurgeL. However, IL wIII IIkeIy uIso
Ieud LIe BruzIIIun exporL secLor IucIng u compeLILIveness probIem. TryIng Lo IIx LIIs probIem by
eusIng moneLury poIIcy wIII on LIe oLIer Iund Ieud Lo excessIveIy eusy moneLury poIIcy. TIe
BruzIIIun uuLIorILIes Iuve oILen LrIed Lo soIve LIIs probIem by LryIng Lo curb currency InIIows wILI
dIIIerenL Iorms oI currency resLrIcLIons und Luxes. TIuL Ius IurdIy been u success und IuckIIy LIe
MexIcun uuLIorILIes ure mucI Iess InLervenLIonIsL In LIeIr uLLILudes.
TIe Iesson Iere Is LIuL LIe ederuI Reserve Is u monetcr superpouer und LIe ed cun exporL
moneLury eusIng Lo oLIer counLrIes, buL LIuL do noL meun LIuL LIe ed Is In cIurge oI moneLury
poIIcy In BruzII or MexIco. TIe BruzIIIun und MexIcun cenLruI bunks cun uIso cIoose not Lo ImporL
LIe moneLury eusIng by sImpIy IeLLIng LIeIr currencIes sLrengLIen und InsLeud Iocus on IL`s own
moneLury poIIcy LurgeLs InsLeud oI LryIng Lo soIve oLIer probIems sucI us compeLILIveness
concerns. ExcessIve Iocus on compeLILIveness wIII Ieud cenLruI bunks Lo euse moneLury poIIcy Loo
mucI und LIe resuIL Is oILen rIsIng InIIuLIonury pressures und bubbIes.
PS don`L LIInk LIuL Is LIIs u zero sum - jusL becuuse LIe ed`s eusIng Is workIng In MexIco does noL
meun LIuL IL Is noL workIng In LIe US.
PPS NIck Rowe once LoId u sImIIur sLory ubouL Hong Kong.wILI unoLIer X regIme.
Puge oI 1zq
'The Mgth of Currencg Wor'
know LIuL mosL oI my reuders musL be sIck und LIred oI reudIng ubouL my vIew on 'currency wur`.
UnIorLunuLeIy Iuve more Ior you. My coIIeugue 1ens Pedersen und Iuve wrILLen un urLIcIe Ior LIe
DunIsI busIness duIIy Borsen. TIe pIece wus pubIIsIed In Loduy`s edILIon oI Borsen. L Is In DunIsI,
buL you cun IInd un EngIIsI LrunsIuLIon oI LIe urLIcIe Iere.
ReguIur reuders oI LIIs bIog wIII noL be surprIsed by LIe muIn messuge In LIe urLIcIe: TIe LuIk oI u
dungerous 'currency wur` Is jusL sIIIy. L Is noL reuIIy u 'currency wur`, buL ruLIer gIobuI moneLury
eusIng. GIobuI moneLury eusIng even IeIps LIe euro zone despILe LIe ECB`s exLreme reIucLunce Lo
euse moneLury poIIcy.
Jens Ius recenLIy uIso wrILLen un exLremeIy InLeresLIng puper on LIe consequence oI LIe 'currency
wur` Ior LIe DunIsI economy. Jens concIudes LIuL LIe currency wur - or ruLIer gIobuI moneLury
eusIng - Is good news Ior DunIsI exporLers despILe LIe IucL LIuL LIe DunIsI krone Ius been
sLrengLIenIng In IIne wILI LIe euro (remember LIe krone Is pegged Lo LIe euro). TIe reuson Is LIuL
gIobuI moneLury eusIng Is boosLIng gIobuI growLI und LIuL Is ouLweIgIIng uny neguLIve ImpucL on
exporLs Irom LIe sLrengLIenIng oI LIe krone.
Tuke u Iook uL Jens` puper Iere.
Puge q oI 1zq
Bring on the "Currencg uor"
Iuve been gIvIng LIe Issue oI devuIuuLIon u bIL oI uLLenLIon recenLIy. n my vIew mosL peopIe IuII Lo
undersLund LIe moneLury uspecLs oI currency moves - boLI wILIIn u IIouLIng excIunge ruLe regIme
und wILI munuged or pegged excIunge regImes.
Iuve uIreudy In my posL Exchcne rctes cnd monetcr polic - it's not cbout competititeness:
Some Arentine lessons urgued LIuL wIuL we sIouId Iocus on wIen we ure LuIkIng ubouL LIe
eIIecLs oI devuIuuLIon Is LIe ImpucL on LIe money suppIy und on money-veIocILy ruLIer LIun on
compeLILIveness. n my posL Mises ucs clueless cbout the ejjects oj detcluction urgued LIuL
udwIg von MIses busIcuIIy dId noL IuIIy compreIend LIe moneLury nuLure oI devuIuuLIons.
TIe IuIIure Lo undersLund LIe moneLury nuLure oI devuIuuLIon oILen Ieud Lo u wrongIuI unuIysIs oI
LIe ImpucL oI gIvIng up pegged excIunge ruLes or IeuvIng u currency unIon - or Ior LIuL muLLer
gIvIng up LIe goId sLundurd. L uIso Ieuds Lo u very wrong unuIysIs oI wIuL Ius been cuIIed
compeLILIve devuIuuLIons - u sILuuLIon wIere dIIIerenL counLrIes busIcuIIy ure movIng Lo weuken
LIeIr own currencIes uL LIe sume LIme. TIIs dIscussIon IIured up In LIe second IuII oI zo1o wIen
(LIe expecLuLIons oI) QEz Irom LIe ederuI Reserve LrIggered u sLrengLIenIng oI especIuIIy u
number oI EmergIng MurkeL currencIes. Muny EM cenLruI bunks moved Lo counLerucL LIe
sLrengLIenIng oI LIeIr currencIes by cuLLIng InLeresL ruLes und InLervenIng In LIe X murkeLs -
busIcuIIy underLukIng QE on LIeIr own. BruzIIIun Inunce MInIsLer GuIdo MunLegu even LuIked
ubouL currency wur (und Ie Ius uppurenLIy jusL redecIured currency wur.)
However, LIe Lerm currenc ucr Is IIgIIy mIsIeudIng. n u worId oI depressed gIobuI NGDP und
deIIuLIonury LendencIes LIere Is no probIem In compeLILIve devuIuuLIons. TIe crILIques wouId urgue
LIuL noL uII counLrIes cun devuIue und LIuL LIe neL ImpucL on gIobuI economIc ucLIvILy LIereIore
wouId be zero. TIIs, Iowever, Is Iur Irom rIgIL. As Iuve eurIIer urgued devuIuuLIon Is noL prImurIIy
ubouL compeLILIveness, buL ruLIer ubouL LIe ImpucL on moneLury condILIons. Hence, II counLrIes
compeLe Lo devuIue LIey busIcuIIy compeLe Lo Increuse LIe money suppIy und veIocILy. TIIs
obvIousIy Is very posILIve II LIere Is u generuI gIobuI probIem oI depressed nomInuI spendIng.
Hence by uII meuns brIng on LIe currency wur! urLIermore, IL sIouId be noLed LIuL In u sILuuLIon
wIere LIere Is IInuncIuI secLor probIems IL Is IIkeIy LIuL LIe LrunsmIssIon mecIunIsm wouId work
Puge oI 1zq
mucI sLronger LIrougI LIe X cIunneI LIun LIrougI LIe credIL cIunneI. See my reIuLed posL on LIIs
Iere.
mugIne LIIs IIgIIy unreuIIsLIc scenurIo. TIe ECB Lomorrow unnounces u LurgeL Ior EURJUSD oI
1.oo und unnounce IL wIII buy US usseLs Lo ucIIeve LIIs LurgeL. TIe purpose wouId be Lo Increuse LIe
euro zone`s nomInuI GDP by 1% und LIe ECB wouId onIy end ILs poIIcy once LIIs LurgeL Is
ucIIeved. As counLer-poIIcy LIe ederuI Reserve unnounces LIuL IL wIII do LIe opposILe und buy
Europeun usseLs unLII EURJUSD IILs 1.8o und LIuL IL wIII noL sLop LIIs poIIcy beIore US NGDP Ius
been Increused by 1%. euve usIde LIe poIILIcuI ImpIIcuLIons oI LIIs (LIe US congress wouId Ireuk
ouL.) wIuL wouId Iuppen? WeII busIcuIIy LIe ed wouId be doIng QE In Europe und ECB wouId be
doIng QE In LIe US. EURJUSD wouId probubIy noL move mucI, buL um preLLy sure InIIuLIon
expecLuLIons wouId spIke und gIobuI sLock murkeLs wouId Increuse sLrongIy. BuL mosL ImporLunL
NGDP wouId Increuse sIurpIy und IusL IIL LIe 1% LurgeL In boLI LIe euro zone und LIe US.
ObvIousIy LIIs poIIcy couId Ieud Lo uII kInd oI unwurrunLed sIde-eIIecLs und wouId cerLuInIy noL
recommend IL, buL IL Is u IIIusLruLIon LIuL we sIouId noL be Loo unIuppy II we Iuve IrIendIy
currency wur. By IrIendIy meun LIuL LIe currency wur does noL LrIgger cupILuI resLrIcLIons und
oLIer kInd oI InLervenLIonIsL poIIcy und LIuL Is cIeurIy u rIsk. However, IL Is preIerubIe Lo LIe presenL
sILuuLIon oI depressed gIobuI NGDP.
MuLLIew O`BrIen LIe ussocIuLe edILor uL The Atlcntic reucIes LIe sume concIusIon In u recenL
commenL. n Currency Wurs Are Good! MuLLIew uruges uIong LIe sume IInes us do:
A currenc ucr beins, simpl enouh, uhen c countr decides to push doun the tclue oj its
currenc. This mecns either printin mone or just threctenin to print mone. A checper
currenc mcles exports checper, cnd more competitite exports mecns more routh cnd hcppier
people. Well, eterbod except people in other countries uho uere just undersold cnd lost
exports. Thct's uh economists ccll this lind oj detcluction c becr-th-neihbor polic:
Countries boost exports ct the expense oj others.
This sounds bcd. Rcther thcn cooperctin, countries cre jihtin oter trcde. ut in this ccse,
some jihtin is ood, cnd more jihtin is better. Countries thct lose exports ucnt to et them
bccl. And the best uc to do thct is to detclue their oun currencies too. This, oj course, ccuses
Puge 6 oI 1zq
more countries to lose exports. The clso ucnt to et their exports bccl, so the clso push doun
their currencies. It's detcluction cll the uc doun. All thcnls to economic peer pressure.
The dounside oj detcluction is thct no countr cins c recl trcde cdtcntce, cnd uecler
currencies mecns the prices oj commodities lile oil shoot. ut - cnd here's the recll importcnt
pcrt - detcluin mecns printin mone. There isn't enouh mone in the uorld. Thct's the
simple cnd true recson uh the lobcl econom jell into crisis cnd hcs been so slou to recoter.
It's clso the simple cnd true recson uh the Grect Depression ucs so detcstctin. We lnou jrom
the :pos thct such competitite detcluction ccn turn thins cround.
Wcr is ood ij it crectes more oj somethin ou ucnt. A chcrit ucr betueen jriends is ood
beccuse it lecds to more donctions. A currenc ucr is ood beccuse it lecds to more mone. Ij
ucr is politics b other mecns, c currenc ucr is stimulus b other mecns.
So Lrue, so Lrue. So nexL LIme somebody sLurLs Lo worry ubouL currency wur pIeuse LeII LIem LIuL
Is exucLIy wIuL we wunL und Ior LIose counLrIes wIere moneLury poIIcy Is noL Loo LIgIL LeII LIem Lo
IeL LIeIr currencIes upprecIuLe. L wIII noL do LIem Iurm. s moneLury poIIcy Is uIreudy Loo Ioose
currency upprecIuLIon wIII be u weIcomed LIgILenIng oI moneLury condILIons.
PS you obvIousIy don`L wunL Lo see compeLILIve devuIuuLIons In u worId oI IIgI InIIuLIon. TIuL Is
wIuL Iuppened durIng LIe 1q;os, buL we cun IurdIy LuIk oI IIgI InIIuLIon Loduy - uL IeusL noL In LIe
US und LIe euro zone.
Puge ; oI 1zq
Don't tell me the 'currencg uor' is hod for Europeon
exports - the one groph oersion
L Is suId LIuL Europe Is LIe bIggesL vIcLIm In wIuL Is suId Lo be un InLernuLIonuI 'currency wur` (IL
Is reuIIy no wur uL uII, buL gIobuI moneLury eusIng) us LIe euro Ius sLrengLIened sIgnIIIcunLIy on LIe
buck oI LIe ederuI Reserve und Bunk oI Jupun IuvIng sLepped up moneLury eusIng.
However, LIe euro zone Is no vIcLIm - Lo cIuIm so Is Lo recson jrom c price chcne us ScoLL Sumner
wouId suy. TIe prIce Iere oI course Is LIe euro excIunge ruLe. TIe `currenc ucr uorriers' cIuIm
LIuL LIe sLrengLIenIng Is u dIsusLer Ior Europeun exporLs. WIuL LIey oI course IorgeL Is Lo usk Is
uh LIe euro Ius sLrengLIened.
TIe euro Is sLronger not becuuse oI moneLury LIgILenIng In LIe euro zone, buL becuuse oI moneLury
eusIng everywIere eIse. EusIer moneLury poIIcIes In LIe US und Jupun obvIousIy boosL domesLIc
demund In LIose counLrIes und wILI IL uIso ImporLs. HIgIer AmerIcun und Jupunese ImporL growLI
Is cerLuInIy good news Ior Europeun exporLs und LIuL IIkeIy Is mucI more ImporLunL LIun LIe Iose
oI compeLILIveness resuILIng Irom LIe sLronger euro.
BuL Iuve u Iook uL Europeun exporLers LIInk. TIe grupI beIow Is LIe PurcIusIng Munugers ndex
(PM) Ior euro zone new exporL orders. TIe grupI Is cIeur - opLImIsm Is spIkIng! TIe boosL Irom
Improved Jupunese und AmerIcun growLI prospecLs Is cIeurIy wIuL Is on LIe mInd oI Europeun
exporLers ruLIer LIun LIe sLrong euro.
Puge 8 oI 1zq
The exchonge rote follocg: Currencg uor or o roce to sooe
the glohol economg?
TIIs Is Irom CNB.com:
Icced uith c stubbornl slou cnd uneten lobcl economic recoter, more countries cre lilel to
resort to cuttin the tclue oj their currencies in order to cin c competitite ede.
1cpcn hcs set the stce jor c potenticl lobcl currenc ucr, cnnouncin plcns to crecte mone
cnd bu bonds cs the oternment oj Prime Minister Shinzo Abe lools to stimulcte the moribund
routh pcce.
Economists in turn cre expectin others to jollou thct lecd, settin ojj c bcttle thct uould benejit
those thct et out oj the cte quiclest but lilel hcmper the ncscent lobcl recoter cnd the
relctitel robust stocl mcrlet.
TIIs preLLy mucI Is wIuL wouId cuII LIe `exchcne rcte jcllcc' - Ience LIe beIIeI LIuL moneLury
eusIng In somewuy Is u zero sum gume wIere moneLury eusIng works LIrougI un unIuIr
compeLILIveness cIunneI und one counLry`s guIn Is unoLIer counLry`s Iose.
eLs Luke LIe urgumenLs one-by-one.
".countries ore likelg to resort to cutting the oolue of their currencies in order to
goin o competitioe edge."
TIe percepLIon Iere Is LIuL moneLury poIIcy prImurIIy works LIrougI u competititeness
chcnnel wIere u moneLury eusIng Ieuds Lo u weukenIng oI LIe currency und LIIs Improve LIe
compeLILIveness oI LIe nuLIon by weukenIng LIe recl vuIue oI LIe currency. TIe probIem wILI LIIs
urgumenL Is IIrsL oI uII LIuL LIIs onIy works II LIere Is no Increuse In prIces und wuges. L Is oI course
reusonubIe Lo ussume LIuL LIuL Is LIe cuse In LIe sIorL-run us prIces und wuges Lend Lo be sLIcky.
However, empIrIcuIIy sucI guIns ure mInor.
LIInk u good IIIusLruLIon oI LIIs Is reIuLIve perIormunce oI DunIsI und SwedIsI exporLs In zoo8-q.
WIen crIsIs IIL In zoo8 LIe SwedIsI kronu weukened sIurpIy us LIe RIksbunk moved Lo cuL InLeresL
Puge q oI 1zq
ruLes uggressIve und IoudIy weIcomed LIe weukenIng oI LIe kronu. On LIe oLIer Iund Denmurk
conLInued Lo operuLe IL`s pegged excIunge ruLe regIme vIs-u-vIs LIe euro. n oLIer words Sweden
InILIuIIy goL u mussIve boosL Lo IL`s compeLILIveness posILIon versus Denmurk.
However, Luke u Iook uL LIe exporL perIormunce oI LIe Lwo counLrIes In LIe grupI beIow.
SLurLIng In Q zoo8 boLI DunIsI und SwedIsI exporLs pIummeLed. Yes, SwedIsI dropped sIIgILIy
Iess LIun DunIsI exporLs buL one cun IurdIy LuIk ubouL u Iurge dIIIerence wIen IL Is Luken InLo
uccounL Iow mucI LIe SwedIsI kronu weukened compured Lo LIe DunIsI krone.
And IL Is uIso obvIous LIuL sucI compeLILIveness udvunLuge Is IIkeIy Lo be IuIrIy sIorL-IIved us
InIIuLIon und wuge growLI sooner or IuLer wIII pIck up und erode uny sIorL-Lerm guIns Irom u
weukenIng oI LIe currency.
TIe ImporLunL dIIIerence beLween Denmurk und Sweden In zoo8-q wus Ience not LIe perIormunce
oI exporLs.
TIe ImporLunL dIIIerence on LIe oLIer Iund LIe perIormunce oI domesLIc demund. JusL Iuve u Iook
uL prIvuLe consumpLIon In Sweden und Denmurk In LIe sume perIod.
Puge qo oI 1zq
L Is very cIeur LIuL SwedIsI prIvuLe consumpLIon Look u mucI smuIIer IIL LIun DunIsI prIvuLe
consumpLIon In zoo8-q und consIsLenLIy Ius grown sLronger In LIe IoIIowIng yeurs.
TIe sume pIcLure emerges II we Iook uL InvesLmenL growLI - Iere LIe dIIIerence IL jusL mucI bIgger.
TIe dIIIerence beLween LIe perIormunce oI LIe DunIsI economy und LIe SwedIsI economy durIng
LIe GreuL RecessIon Ience Iuve very IILLIe Lo do wILI exporL perIormunce und everyLIIng Lo do wILI
domesLIc demund.
Puge q1 oI 1zq
Yes, InILIuIIy Sweden guIned u compeLILIve udvunLuge over Denmurk, buL LIe mujor dIIIerence wus
LIuL RIksbunken wus noL consLruIned In IL ubIIILy Lo euse moneLury poIIcy by u pegged excIunge ruLe
In LIe sume wuy us LIe DunIsI cenLruI bunk (NuLIonuIbunken) wus.
(or more on Denmurk und Sweden see my eurIIer posL The lucl oj the `Sccndies')
Hence, we sIouId noL see LIe excIunge ruLe us u meusure oI compeLILIveness, buL ruLIer us un
IndIcuLor oI moneLury poIIcy LIgILness.WIen LIe cenLruI bunk moves Lo euse moneLury poIIcy LIe
counLry`s currency wIII Lend Lo euse, buL LIe mujor ImpucL on uggreguLe demund wIII noL be
sLronger exporL perIormunce, buL ruLIer sLronger growLI In domesLIc demund. TIere ure oI course
numerous exumpIes oI LIIs In moneLury IIsLory. Iuve eurIIer dIscussed LIe cuse oI LIe ArgenLIne
devuIuuLIon In zoo1 LIuL boosLed domesLIc demund ruLIer exporLs. TIe sume Iuppened In LIe US
wIen DR guve up LIe goId sLundurd In 1q1. TIereIore, wIen journuIIsLs und commenLuLors Iocus
on LIe reIuLIonsIIp beLween moneLury eusIng, excIunge ruLes und compeLILIveness LIey ure LoLuIIy
mIssIng LIe poInL.
The 'foolproof' uog out of deflotion
TIuL does noL meun LIuL LIe excIunge ruLe Is noL ImporLunL, buL we sIouId noL LIInk oI LIe
excIunge ruLe In uny oLIer wuy LIun oLIer moneLury poIIcy InsLrumenLs IIke InLeresL ruLes. BoLI cun
Ieud Lo u cIunge In LIe money buse (LIe core moneLury poIIcy InsLrumenL) und gIve guIdunce ubouL
IuLure cIunges In LIe money buse.
WILI InLeresL ruLes eIIecLIveIy sLuck uL zero In muny deveIoped economIes cenLruI bunks needs Lo
use oLIer InsLrumenLs Lo escupe deIIuLIon. So Iur LIe mujor cenLruI bunks oI LIe worId Ius Iocused
on quunLILuLIve eusIng - IncreusIng In LIe money buse by buyIng (domesLIc) IInuncIuI usseLs sucI
us governmenL bonds. However, unoLIer wuy Lo Increuse LIe money buse Is obvIousIy Lo buy
jorein usseLs - sucI us IoreIgn currency or IoreIgn bonds. Hence, LIere Is IundumenLuIIy no
dIIIerence beLween LIe Bunk oI Jupun buyIng Jupunese governmenL bonds und buyIng IoreIgn
bonds (or currency). L Is boLI cIunneIs Ior IncreusIng LIe money buse Lo geL ouL oI deIIuLIon.
n IucL on couId urgue LIuL LIe excIunge ruLe cIunneI Is u IoL more eIIecLIve cIunneI oI moneLury
expunsIon LIun reguIur QE us excIunge ruLe InLervenLIon Is u more LrunspurenL und dIrecL wuy Ior
Puge qz oI 1zq
LIe cenLruI bunk Lo sIgnuI IL`s InLenLIons Lo euse moneLury poIIcy, buL IundumenLuIIy IL Is jusL
unoLIer wuy oI moneLury eusIng.
L LIereIore Is somewIuL odd LIuL muny commenLuLors und purLIcuIurIy IInuncIuI journuIIsLs don`L
seem Lo reuIIse LIuL X InLervenLIon Is jusL unoLIer Iorm oI moneLury eusIng und LIuL IL Is no Iess
IosLIIe LIun oLIer Iorms oI moneLury eusIng. I LIe ederuI Reserve buys US governmenL
LreusurIes IL wIII Ieud Lo u weukenIng oI doIIur In LIe sume wuy IL wouId do II LIe ed Iud been
buyIng SpunIsI governmenL bonds. TIere Is no dIIIerence beLween LIe Lwo. BoLI wIII Ieud Lo un
expunsIon oI LIe money buse und Lo u weuker doIIur.
"Economists in turn ore expecting others to follou thot leod, setting off o hottle thot
uould henefit those thot get out of the gote guickest hut likelg homper the noscent
glohol recooerg ond the relotioelg rohust stock morket"
TIIs quoLe Is LypIcuI oI LIe sLorIes ubouL currency wur. MoneLury eusIng Is seen us u zero sum
gume und onIy LIe IIrsL Lo move wIII guIn, buL IL wIII be on LIe expense oI oLIer counLrIes. TIIs
urgumenL compIeLeIy mIsses LIe poInL. MoneLury eusIng Is noL u zero sum gume - In IucL In un
quusI-deIIuLIonury worId wILI beIow Lrend-growLI u currency wur Is In IucL c rcce to scte the
uorld.
JusL Luke u Iook uL Europe. SInce SepLember boLI LIe ederuI Reserve und LIe Bunk oI Jupun Iuve
moved Lowurds u drumuLIcuIIy more eusy moneLury sLunce, wIIIe LIe ECB Ius conLInue Lo drug ILs
IeeL. n LIuL sense one cun suy LIuL LIuL LIe US und Jupun Iuve sLurLed u currency wur uguInsL
Europe und LIe resuIL Ius been LIuL boLI LIe yen und LIe doIIur Iuve been weukened uguInsL LIe
euro. However, LIe quesLIon Is wIeLIer Europe Is beLLer oII Loduy LIun prIor Lo LIe currency wur.
Anybody In LIe IInuncIuI murkeLs wouId LeII you LIuL Europe Is doIng beLLer Loduy LIun IuII u yeur
ugo und Europeun cun LIunk LIe Bunk oI Jupun und LIe ed Ior LIuL.
So Iow dId moneLury eusIng In LIe US und Jupun IeIp LIe euro zone? WeII, IL Is reuIIy preLLy
sImpIe. MoneLury eusIng (und LIe expecLuLIon oI IurLIer moneLury eusIng) In Jupun und LIe US us
pusI gIobuI InvesLors Lo Iook Ior IIgIer reLurns ouLsIde oI LIe US und Jupun. TIey Iuve Iound LIe
IIgIer reLurns In Ior exumpIe LIe SpunIsI und rIsI bond murkeLs. As u resuIL IundIng cosLs Ior LIe
SpunIsI und rIsI governmenLs Iuve dropped sIgnIIIcunLIy und us u resuIL greuLIy eused LIe
Puge q oI 1zq
LensIons In LIe Europeun IInuncIuI murkeLs. TIIs IIkeIy Is pusIIng up mone telocit In LIe euro
zone, wIIcI eIIecLIveIy Is moneLury eusIng (remember MV=PY) - LIIs oI course Is purudoxIcuIIy
wIuL Is now mukIng LIe ECB LIInk LIuL IL sIouId (premuLureIy!) redruw uccommoduLIon.
TIe ECB und Europeun poIIcy mukers sIouId LIereIore weIcome LIe moneLury eusIng Irom LIe ed
und LIe BoJ. L Is noL un IosLIIe ucL. n IucL IL Is very IeIpIuI In eusIng LIe Europeun crIsIs.
I LIe more eusy moneLury sLunce In Jupun und US wus un IosLIIe ucL LIen one sIouId Iuve
expecLed Lo see LIe Europeun murkeLs Luke u beuLIng. TIuL Iuve, Iowever, noL Iuppened. n IucL
boLI LIe Europeun IIxed Income und equILy murkeLs Iuve ruIIIed sLrongIy on purLIcuIurIy LIe new
Jupunese governmenL`s unnouncemenL LIuL IL wunL LIe Bunk oI Jupun Lo sLep up moneLury eusIng.
So IL mIgIL be LIuL some IInuncIuI journuIIsLs und poIIcy mukers ure scure ubouL LIe prospecLs Ior
currency wur, buL InvesLors on LIe oLIer Iund ure jubIIunL.
1f gou don't need monetorg eosing - don't import it
ConcIudIng, sLrongIy beIIeve LIuL u gIobuI currency wur Is very good news gIven LIe quusI-
deIIuLIonury sLuLe oI LIe Europeun economy und so Iur PrIme MInIsLer Abe und ed governor
Bernunke Iuve done u IoL more Lo geL LIe euro zone ouL oI LIe crIsIs LIun uny Europeun cenLruI
bunker Ius done und II Europeun poIIcy mukers don`L IIke LIe sLrengLIenIng oI LIe euro LIe ECB
cun jusL InLroduce quunLILuLIve eusIng. TIuL wouId curb LIe sLrengLIenIng oI LIe euro, buL more
ImporLunLIy IL wouId IInuIIy puII LIe euro zone ouL oI LIe crIsIs.
Hence, uL LIe momenL Europe Is ImporLIng moneLury eusIng Irom LIe US und Jupun despILe LIe
euro Ius been sLrengLIenIng. TIuL Is good news Ior LIe Europeun economy us moneLury eusIng Is
budIy needed. However, oLIer counLrIes mIgIL noL need moneLury eusIng.
As dIscussed In my recenL posL on MexIco u counLry cun decIde Lo ImporL or noL Lo ImporL
moneLury eusIng by uIIowIng LIe currency Lo sLrengLIen or noL. I LIe MexIcun cenLruI bunk don`L
wunL Lo ImporL moneLury eusIng Irom LIe US LIen IL cun sImpIy uIIow LIe peso sLrengLIen In
response Lo LIe ed`s moneLury eusIng.
Puge qq oI 1zq
Currency wur Is noL u LIreuL Lo LIe gIobuI economy, buL ruLIer IL Is wIuL couId IInuIIy puII LIe gIobuI
economy ouL oI LIIs crIsIs - now we jusL need LIe ECB Lo joIn LIe wur.
Puge q oI 1zq
1s monetorg eosing (deooluotionJ o hostile oct?
One oI LIe greuL LIIngs ubouL bIoggIng Is LIuL peopIe commenL on your posLs und LIereby cIuIIenge
your vIews und uL LIe sume LIme creuLe new Ideus Ior bIog posLs. TIereIore wunL Lo LIunk
commenLuLor Mux Ior LIe IoIIowIng response Lo my prevIous posL:
don`L LIInk excIunge ruLe InLervenLIon Is u good Ideu Ior u Iurge counLry. or one LIIng, IL`s u
IosLIIe ucL gIven LIuL oLIer counLrIes Iuve exucLIy LIe sume Issue. And IL cun`L work wILIouL LIeIr
cooperuLIon, sInce LIey Iuve LIe power Lo undo LIe InLervenLIon.
eL me sLurL ouL by suyIng LIuL Mux Is wrong on boLI uccounLs, buL wouId uIso ucknowIedge LIuL
boLI vIews ure more or Iess LIe consensus vIew oI devuIuuLIons und my vIew - wIIcI Is bused on
LIe moneLury upproucI Lo buIunce oI puymenLs und excIunge ruLes - Is LIe mInorILy vIew. eL me
uddress LIe Lwo Issues sepuruLeIy.
1s monetorg eosing o hostile oct?
n IIs commenL Mux descrIbes u devuIuuLIon us u IosLIIe ucL Lowurds oLIer counLrIes. TIIs Is u very
common vIew und IL Is oILen suId LIuL IL Is u reIIecLIon oI u beggur-LIy-neIgIbour poIIcy Ior u
counLry Lo devuIue ILs currency. Iuve Lwo commenLs on LIuL.
IrsL, II u devuIuuLIon Is u IosLIIe ucL LIen uII Iorms oI moneLury eusIng ure IosLIIe ucLs us uny Iorm
oI moneLury eusIng Is IIkeIy Lo Ieud Lo u weukenIng oI LIe currency. eL`s Ior exumpIe ussume LIuL
LIe ederuI Reserve Lomorrow unnounced LIuL IL wouId buy unIImILed umounLs oI US equILIes und
IL wouId conLInue Lo do so unLII US nomInuI GDP Iud Increused 1%. um preLLy sure LIuL wouId
Ieud Lo u mussIve weukenIng oI LIe US doIIur. n IucL we cun busIcuIIy deIIne moneLury eusIng us u
sILuuLIon wIere LIe suppIy oI LIe currency Is Increused reIuLIve Lo LIe demund Ior LIe currency.
SuId, In unoLIer wuy II LIe currency weukens IL Is u preLLy good IndIcuLIon LIuL moneLury condILIons
ure geLLIng eusIer.
Second, Iuve oILen urgued LIuL LIe ImpucL oI u devuIuuLIon does noL prImurIIy work LIrougI un
ImprovemenL In LIe counLry`s compeLILIveness. n IucL LIe purpose oI LIe devuIuuLIon sIouId be Lo
Increuse prIces (und wuges) und Ience nomInuI GDP. An Increuse In prIces und wuges cun IurdIy be
suId Lo be un ImprovemenL oI compeLILIveness. L Is correcL LIuL II prIces und wuges ure sLIcky LIen
Puge q6 oI 1zq
you mIgIL geL un InILIuI recl deprecIuLIon oI LIe currency, Iowever LIuL ImpucL Is noL reuIIy
ImporLunL compured Lo LIe moneLury ImpucL. Hence, u devuIuuLIon wIII Ieud Lo un Increuse In LIe
money suppIy (LIuL Is Iow you engIneer LIe devuIuuLIon) und IIkeIy uIso Lo un Increuse In money-
veIocILy us InIIuLIon expecLuLIons Increuse. EmpIrIcuIIy LIuL Is mucI more ImporLunL LIun uny
possIbIe compeLILIveness eIIecL.
A good exumpIe oI Iow LIe moneLury eIIecL domInuLes LIe compeLILIveness eIIecL: LIe ArgenLIne
devuIuuLIon In zooz ucLuuIIy Ied Lo u deLerIoruLIon oI LIe ArgenLIne Lrude buIunce und wIuL reuIIy
wus LIe drIver oI LIe recovery wus LIe sIurp pIckup In domesLIc demund due Lo un Increuse In LIe
money suppIy und money-veIocILy ruLIer LIun un ImprovemenL In exporLs. See my prevIous
commenL on LIe epIsode Iere. WIen LIe US guve up LIe goId sLundurd In 1q LIe sLory wus LIe
sume - LIe moneLury eIIecL sLrongIy domInuLed LIe compeLILIveness eIIecL.
YeL unoLIer exumpIe oI LIe moneLury eIIecL oI u devuIuuLIon domInuLIng LIe compeLILIveness eIIecL
Is Denmurk und Sweden In zoo8-q. L Is u common mIsundersLundIng LIuL Sweden grew sLronger
LIun Denmurk In zoo8-q becuuse u sIurp deprecIuLIon oI LIe SwedIsI kronu Ied Lo u mussIve
ImprovemenL In compeLILIveness. L Is correcL LIuL SwedIsI compeLILIveness wus Improved due Lo
LIe weukenIng oI LIe kronu, buL LIIs wus noL LIe muIn reuson Ior Sweden`s reIuLIveIy IusL recovery
Irom LIe crIsIs. TIe reuI reuson wus LIuL Sweden dId noL see uny subsLunLIuI decIIne In money-
veIocILy und LIe SwedIsI money suppIy grew reIuLIveIy sLeudIIy LIrougI LIe crIsIs.
ookIng uL SwedIsI exporLs In zoo8-q IL Is very Iurd Lo spoL uny udvunLuge Irom LIe deprecIuLIon
oI LIe kronu. n IucL SwedIsI exporLs dId more or Iess us budIy us DunIsI exporLs In zoo8-q despILe
LIe IucL LIuL LIe DunIsI krone dId noL deprecIuLe due Lo Denmurk`s IIxed excIunge ruLe regIme.
However, IookIng uL domesLIc demund LIere wus u mucI sIurper conLrucLIon In DunIsI prIvuLe
consumpLIon und InvesLmenL LIun wus LIe cuse In Sweden. TIIs dIIIerence cun eusIIy be expIuIned
by LIe sIurp moneLury conLrucLIon In Denmurk In zoo8-q (boLI u drop In M und V).
urLIermore, IeL`s ussume LIuL LIe ederuI Reserve unnounced mussIve InLervenLIon In LIe X
murkeL Lo weuken LIe US doIIur und LIe resuIL wus u sIurp Increuse In US nomInuI GDP. WouId LIe
resL oI LIe worId be worse oII? doubL IL. Yes, LIe IIkeIy ImpucL wouId be LIuL Ior exumpIe Germun
exporLs wouId geL under pressure us LIe euro wouId sLrengLIen drumuLIcuIIy uguInsL LIe doIIur.
However, noLIIng wouId sLop LIe ECB Irom uIso underLukIng moneLury eusIng Lo counLerucL LIe
Puge q; oI 1zq
sLrengLIenIng oI LIe euro. TIIs Is wIuL somebody cuIIs compeLILIve devuIuuLIons or even
currency wur. However, In u deIIuLIonury envIronmenL sucI currency wur sIouId be weIcomed
us IL busIcuIIy wouId be u compeLILIon Lo prInL money. Hence, LIe neL resuIL oI currency wur wouId
noL be uny cIunge In compeLILIveness, buL un Increuse In LIe gIobuI money suppIy (und gIobuI
money-veIocILy) und Ience In gIobuI nomInuI GDP. WIo wouId be uguInsL LIuL und In u sILuuLIon
wIere LIe gIobuI economy conLInues Lo conLrucL und us sucI u currency wur IIke LIuL wouId be very
weIcomed news. n IucL we cun noL reuIIy LuIk ubouL u wur us IL wouId be muLuuIIy beneIIcIuI. So
suy pIeuse brIng on LIe currency wur!
1s glohol monetorg cooperotion needed? No, hut.
TIIs brIngs us Lo Mux`s second urgumenL: And it ccn't uorl uithout their cooperction, since the
hcte the pouer to undo the intertention.
TIIs Is obvIousIy reIuLed Lo LIe dIscussIon ubove. Mux seems Lo LIInk u devuIuuLIon wIII noL work II
IL Is meL by compeLILIve devuIuuLIons Irom uII oLIer counLrIes. As Iuve urgued ubove LIIs Is
compIeLeIy wrong. L wouId work us LIe devuIuuLIon wIII Increuse LIe money suppIy und money-
veIocILy even II LIe devuIuuLIon Ius no ImpucL on compeLILIveness uL uII. As u resuIL LIere Is no need
Ior InLernuLIonuI moneLury cooperuLIon. n IucL IeuILIy compeLILIon umong currencIes Is exucLIy
wIuL we need. n IucL every LIme LIe mujor nuLIons oI LIe worId Iuve goLLen LogeLIer Lo ugree on
reuIIgnIng excIunge ruLes IL Ius Iud mujor neguLIve consequences.
However, LIere Is one urgumenL Ior InLernuLIonuI coordInuLIon LIuL LIInk Is exLremeIy ImporLunL
und LIuL Is LIe need Ior cooperuLIon Lo uvoId compeLILIve proLecLIonIsm. TIe probIem Is LIuL mosL
gIobuI poIIcy mukers perceIve devuIuuLIons In LIe sume wuy us Mux. TIey see devuIuuLIons us
IosLIIe ucLs und LIereIore LIese poIIcy mukers mIgIL reucL Lo devuIuuLIons by InLroducIng Lrude
LurIIIs und oLIer proLecLIonIsL meusures. TIIs Is wIuL Iuppened In LIe 1qos wIere especIuIIy LIe
(IooIIsI) counLrIes wIIcI muInLuIned LIe goId sLundurd reucLed by InLroducIng Lrude LurIIIs uguInsL
Ior exumpIe LIe UK und LIe ScundInuvIun counLrIes, wIIcI eurIy on guve up LIe goId sLundurd.
Unfortunotelg Mitt Romneg seems to think os Mox
RepubIIcun presIdenLIuI IopeIuI MILL Romney Ius suId LIuL IIs IIrsL ucL us US presIdenL wouId be Lo
sIup LurIIIs on CIInu Ior beIng u currency munIpuIuLor. Here Is wIuL Romney recenLIy suId:
Puge q8 oI 1zq
I `m presIdenL, wIII IubeI CIInu u currency munIpuIuLor und uppIy LurIIIs wIerever needed Lo
sLop LIem Irom unIuIr Lrude prucLIces
TIe dIscussIon ubove sIouId sIow cIeurIy LIuL Romney`s commenLs on CIInu`s currency poIIcy Is
economIcuIIy meunIngIess - or ruLIer exLremeIy dungerous. mugIne wIuL wouId be LIe ImpucL on
LIe US economy II CIInu Lomorrow unnounced u qo% (jusL Lo pIck u number) revuIuuLIon oI LIe
yuun. To engIneer LIIs LIe PeopIe`s Bunk oI CIInu wouId Iuve Lo cuuse u sIurp conLrucLIon In LIe
CIInese money suppIy und money-veIocILy. TIe resuIL wouId undoubLedIy LIrow CIInu InLo u
mussIve recessIon - or more IIkeIy u depressIon. You cun onIy wonder wIuL LIuL wouId do Lo US
exporLs Lo CIInu und Lo US empIoymenL. ObvIousIy LIIs wouId be mussIveIy neguLIve Ior LIe US
economy.
urLIermore, u sIurp upprecIuLIon oI LIe yuun wouId eIIecLIveIy be u mussIve neguLIve suppIy sIock
Lo LIe US economy us US ImporL prIces wouId skyrockeL. GIven LIe presenL (wrongIuI) LIInkIng oI
LIe ederuI Reserve, LIuL mIgIL even LrIgger moneLury LIgILenIng us US InIIuLIon wouId pIck up. n
oLIer words LIe US mIgIL Iuce sLugIIuLIon und um preLLy sure LIuL Romney wouId Iuve no IrIends
IeIL on WuII SLreeL II LIuL wIere Lo Iuppen und Ie wouId cerLuInIy noL be reeIecLed In Iour yeurs.
Iope LIuL Romney Ius some economIc udvIsors LIuL reuIIze LIe InsunILy oI IorcIng CIInu Lo u
mussIve upprecIuLIon oI LIe yuun. UnIorLunuLeIy do noL Iuve IIgI Iope LIuL LIere Is un
undersLundIng oI LIese Issues In Loduy`s RepubIIcun PurLy - us IL wus LIe cuse In 1qo wIen Lwo
RepubIIcun Iuwmukers SenuLor Reed SmooL und RepresenLuLIve WIIIIs C. HuwIey sponsored LIe
druconIun und very dumugIng SmooL-HuwIey LurIII ucL.
InuIIy, LIunks Lo Mux Ior your commenLs. Iope you upprecIuLe LIuL do noL LIInk LIuL you wouId
IIke LIe sume kInd oI proLecLIonIsL poIIcIes us MILL Romney, buL do LIInk LIuL wIen we geL IL
wrong on LIe moneLury ImpucL oI devuIuuLIons we mIgIL end up wILI LIe kInd oI poIIcy response
LIuL MILL Romney Is suggesLIng. And no, LIIs Is no endorsemenL oI PresIdenL Obumu - LIInk my
reuders IuIIy undersLund LIuL. urLIermore Lo Mux, do upprecIuLe your commenLs even LIougI
dIsugree on LIIs exucL LopIc.
Puge qq oI 1zq
PS II you wunL Lo Ieurn more ubouL LIe poIIcy dynumIcs LIuL Ied Lo SmooL-HuwIey you sIouId Iuve
u Iook uL Doug rwIn`s greuL IILLIe book PeddIIng ProLecLIonIsm: SmooL-HuwIey und LIe GreuL
DepressIon.
UpduLe: ScoLL Sumner Ius u sImIIur dIscussIon oI LIe eIIecLs oI devuIuuLIon.
Puge o oI 1zq
The luck of the 'Scondies'
TIIs week we ure ceIebruLIng MIILon rIedmun`s cenLennIuI. MIILon rIedmun wus known Ior u IoL
oI LIIngs und one oI LIem wus IIs generuIIy skepLIcuI vIew oI pegged excIunge ruLes. n IIs Iumous
urLIcIe The Ccse jor Ilexible Exchcne Rctes Ie urgued sLrongIy uguInsL pegged excIunge ruLes
und Ior IIexIbIe excIunge ruLes.
Any reuder oI LIIs bIog wouId know LIuL sIure rIedmun`s scepLIcuI vIew oI IIxed excIunge ruLes.
However, wIII uIso Iuve Lo suy LIuL my vIew on excIunge ruLes poIIcy Ius become more prugmuLIc
over LIe yeurs. n IucL one cun suy LIuL uIso In LIIs ureu Iuve become more oI u rIedmunILe. TIIs
couId seem us u purudox gIven rIedmun`s pussIonuLe deIence oI IIouLIng excIunge ruLes. However,
rIedmun wus noL dogmuLIc on LIIs Issue. RuLIer rIedmun suw excIunge ruLe poIIcy us u wuy Lo
conLroI LIe money suppIy und Ie oILen urgued LIuL smuII counLrIes mIgIL noL Iuve LIe proper
InsLrumenLs und InIrusLrucLure Lo properIy conLroI LIe money suppIy. Hence IL wouId be un
udvunLuge Ior cerLuIn counLrIes Lo ouLsource moneLury poIIcy by peggIng LIe currency Lo Ior
exumpIe LIe US doIIur. Hong Kong`s currency bourd und ILs peg Lo LIe doIIur wus IIs IuvourILe
exumpIe. um Iess IncIIned Lo LIInk LIuL Hong Kong couId noL do beLLer LIun LIe currency bourd,
buL noneLIeIess LIInk rIedmun wus rIgIL In LIe sense LIuL LIere IundumenLuIIy Is no dIIIerence
beLween usIng Ior exumpIe InLeresL ruLes Lo conLroI LIe money suppIy und usIng LIe excIunge ruLe.
n IIs IIgIIy recommendubIe book Mone Mischiej MIILon rIedmun dIscusses LIe experIence wILI
IIxed excIunge ruLes In CIIIe und srueI. rIedmun documenLs CIIIe`s IorrIbIe experIence wILI
IIxed excIunge ruLes und srueI`s equuIIy successIuI experIence wILI IIxed excIunge ruLes. L Is In
reIuLIon Lo LIese exumpIes rIedmun sLuLes LIuL one never sIouId underesLImuLe LIe ImporLunce oI
Iuck oI nuLIons. TIuL credo Ius been u bIg InspIruLIon In my own LIInkIng und Ius cerLuInIy IeIped
me undersLund LIe dIIIerence In perIormunce oI dIIIerenL economIes durIng LIe presenL crIsIs. L Is
noL onIy ubouL poIIcy. WILI LIe rIgIL poIIcIes LIIs crIsIs couId Iuve been uvoId, buL on LIe oLIer
Iund despILe oI Iess LIun sLeIIur conducL oI moneLury poIIcy some counLrIes Iuve come LIrougI LIIs
crIsIs very weII. uck cerLuInIy Is ImporLunL.
TIe ScundInuvIun economIes provIde un exceIIenL exumpIe oI LIIs. Denmurk und Sweden ure In
muny wuys very sImIIur counLrIes - smuII open economIes wILI IIgI IeveIs oI GDPJcupILu, sLrong
pubIIc IInunces, un overbIown weIIure sLuLe, buL noneLIeIess quILe IIexIbIe producL und Iubour
Puge 1 oI 1zq
murkeLs und u quILe IIgI IeveI oI socIuI und economIc coIesIon. However, Denmurk und Sweden
dIIIer In one crucIuI IusIIon - LIe moneLury poIIcy regIme.
Denmurk Ius u IIxed excIunge ruLe (uguInsL LIe euro), wIIIe Sweden Ius u IIouLIng excIunge ruLe
und un InIIuLIon LurgeLIng regIme. TIe dIIIerenL moneLury poIIcy regImes Iuve Iud u sIgnIIIcunL
ImpucL on LIe perIormunce oI LIe DunIsI und LIe SwedIsI economIes durIng LIe presenL crIsIs.
ooS-q: Sweden's lock, enmurk's misery
WIen crIsIs IIL In zoo8 boLI Denmurk und Sweden goL IIL, buL Denmurk suIIered mucI more LIun
Sweden - noL onIy economIcuIIy buL uIso In Lerms oI IInuncIuI secLor dIsLress. TIe key reuson Ior
LIIs Is LIuL wIIIe moneLury condILIons conLrucLed sIgnIIIcunLIy Sweden dId noL see uny mujor
moneLury conLrucLIon. WIuL Iuppened wus LIuL us InvesLors scrumbIed Ior US doIIurs In LIe second
oI zoo8 LIey were seIIIng uII oLIer currencIes - uIso LIe SwedIsI kronu und LIe DunIsI krone.
TIe reucLIon Irom LIe DunIsI und LIe SwedIsI cenLruI bunks wus, Iowever, very dIIIerenL. As LIe
DunIsI krone cume under seIIIng pressures LIe DunIsI cenLruI bunk ucLed uccordIng Lo LIe IIxed
excIunge poIIcy by buyIng kroner. As u resuIL Denmurk suw u sIurp conLrucLIon In LIe money
suppIy - u conLrucLIon LIuL conLInued In zooq und zo1o, buL LIe peg survIved. TIe cenLruI bunk
Iud won und deIended LIe peg, buL uL u IIgI cosL. TIe moneLury conLrucLIon undoubLedIy dId u
IoL Lo worsen LIe DunIsI IInuncIuI secLor crIsIs und Iour yeurs IuLer DunIsI properLy prIces conLInue
Lo decIIne. On LIe oLIer Iund wIen LIe demund Ior SwedIsI kronu pIunged In zoo8-q LIe SwedIsI
cenLruI bunk uIIowed LIIs Lo Iuppen und LIe kronu weukened sIurpIy. SuId In unoLIer wuy LIe
SwedIsI money demund dropped reIuLIve Lo LIe money suppIy. SwedIsI moneLury condILIons
eused, wIIIe DunIsI moneLury condILIons LIgILened.
L Is oILen suId, LIuL Sweden`s sLronger economIc perIormunce reIuLIve Lo Denmurk In zoo8-q (und
zo1o-11 Ior LIuL muLLer) Is u resuIL oI LIe reIuLIve ImprovemenL In SwedIsI compeLILIveness us u
resuIL oI LIe sIurp deprecIuLIon oI LIe SwedIsI kronu. However, LIIs Is u wrong unuIysIs oI LIe
sILuuLIon. n IucL LIe mujor dIIIerence beLween LIe SwedIsI economy und LIe DunIsI economy Ius
very IILLIe Lo do wILI LIe reIuLIve exporL perIormunce. n IucL boLI counLrIes suw u more or Iess
equuI drop In exporLs In zoo8-q. TIe bIg dIIIerence wus LIe perIormunce In domesLIc demund.
WIIIe DunIsI domesLIc demund coIIupsed und properLy prIces were In u Iree IuII, domesLIc demund
Puge z oI 1zq
In Sweden perIormed sLrongIy und SwedIsI properLy prIces conLInued Lo rIse uILer LIe crIsIs IIL.
TIe dIIIerence obvIousIy Is u resuIL oI LIe dIIIerenL moneLury poIIcy reucLIons In LIe Lwo counLrIes.
TIIs Is busIcuIIy Iuck - LIe DunIsI moneLury regIme Ied Lo LIgILenIng oI moneLury condILIons In
reucLIon Lo LIe exLernuI sIock, wIIIe LIe SwedIsI cenLruI bunk Lo u Iurge exLenL counLerucLed LIe
sIock wILI un eusIng oI moneLury condILIons.
o1: The oseIol unish peg und the Iuilores oI Riksbunken
Toduy LIe DunIsI economy conLInues Lo do worse LIun LIe SwedIsI economy, buL LIe Iuck Is
cIungIng. And uguIn LIIs Ius Lo do wILI money demund. WIIIe LIe demund Ior SwedIsI kronu und
DunIsI kroner coIIupsed In zoo8-q LIe opposILe Is LIe cuse Loduy. Toduy InvesLors us u reucLIon Lo
LIe euro crIsIs ure runnIng scured uwuy Irom LIe euro und buyIng everyLIIng eIse (more or Iess). As
u resuIL money Is IIouLIng InLo boLI Denmurk und Sweden und LIe demund Ior boLI currencIes (und
SwedIsI und DunIsI usseLs In generuI) Ius escuIuLed sIurpIy. So conLrury Lo zoo8-q LIe demund Ior
(IocuI) money Is now rIsIng sIurpIy. TIIs Ior obvIous reusons Is IeudIng Lo upprecIuLIon pressures
on LIe ScundInuvIun currencIes.
Toduy, Iowever, LIe Dunes ure Iucky Lo Iuve LIe peg. Hence, us LIe DunIsI krone Ius Lended Lo
upprecIuLe LIe DunIsI cenLruI bunk Ius sLepped In und deIended LIe peg by expundIng LIe money
buse und Ior LIe IIrsL LIme In Iour yeurs LIe DunIsI money suppIy (Mz) Is now sIowIng reuI sIgns oI
recoverIng. TIIs oI course Is uIso wIy DunIsI sIorL-Lerm bond yIeIds und money murkeL ruLes Iuve
Lurned neguLIve. TIe money murkeLs ure beIng IIooded wILI IIquIdILy Lo keep LIe krone Irom
sLrengLIenIng. Hence, LIe DunIsI euro peg Is doIng u greuL job In uvoIdIng u neguLIve veIocILy
sIock. or LIe IIrsL LIme In Iour yeurs Dunes couId be Lrue Iuppy ubouL LIe peg.
On LIe oLIer Iund Ior LIe IIrsL LIme In Iour yeurs LIe SwedIsI moneLury poIIcy regIme Is noL work
us weII us one couId Iuve Ioped. As LIe demund Ior SwedIsI kronu Ius escuIuLed SwedIsI moneLury
condILIons ure geLLIng LIgILer und LIgILer duy by duy und LIe sIgns ure preLLy cIeur LIuL SwedIsI
money-veIocILy Is conLrucLIng. TIIs Is IurdIy good news Ior LIe SwedIsI economy.
ObvIousIy LIere Is noLIIng sLoppIng LIe SwedIsI cenLruI bunk Irom counLerucLIng LIe drop In
veIocILy (LIe Increused money demund) by expundIng LIe money buse und Iegendury SwedIsI
depuLy cenLruI bunk governor urs E. O. Svensson Ius been cuIIIng Ior moneLury eusIng Ior u wIIIe,
Puge oI 1zq
buL LIe mujorILy oI bourd members In LIe SwedIsI cenLruI bunk seem reIucLunL Lo sLep up und euse
moneLury poIIcy even LIougI IL duy by duy Is becomIng evIdenL LIuL moneLury eusIng Is needed.
Good policies ure the best sobstitote Ior good lock
ObvIousIy neILIer LIe DunIsI nor LIe SwedIsI moneLury poIIcy regIme Is opLImuI under uII
cIrcumsLunces und LIIs Is exucLIy wIuL Iuve LrIed Lo demonsLruLe ubove. TIe dIIIerence beLween
zoo8-q und zo11-1z Is LIe ImpucL on demund Ior LIe DunIsI und SwedIsI currency und LIese
dIIIerences Iuve been drIven mosLIy by exLernuI IucLors.
ObvIousIy one couId (und sIouId!) urgue LIuL Sweden`s probIem Loduy Is noL LIe IIouLIng excIunge
ruLe, buL ruLIer LIe InIIuLIon LurgeLIng regIme. I Sweden InsLeud Iud been LurgeLIng LIe (IuLure)
nomInuI GDP IeveI LIen RIksbunken wouId uIreudy Iud eused moneLury poIIcy mucI more
uggressIveIy LIun Ius been LIe cuse Lo counLerucL LIe conLrucLIon In money-veIocILy.
InuIIy, IL Is cIeur LIuL Iuck pIuyed u mujor roIe In Iow LIe crIsIs Ius pIuyed ouL In LIe ScundInuvIun
crIsIs. However, wILI LIe rIgIL moneLury poIIcIes - Ior exumpIe NGDP LurgeLIng - you ure mucI
more IIkeIy Lo Iuve Iuck on your sIde wIen crIsIs IIL.
Puge q oI 1zq
Exchonge rotes ond monetorg policg - it's not ohout
competitioeness: Some Argentine lessons
LIInk Rob wIo Is one my reuders IIL LIe nuII on LIe Ieud wIen Ie In u recenL commenL
commenLed LIuL one oI LIe LIIngs LIuL Is cIeurIy dIIIerenLIuLIng MurkeL MoneLurIsm Irom oLIer
scIooIs Is our vIew oI LIe moneLury LrunsmIssIon mecIunIsm. n my repIy Lo IIs commenL
promIsed Rob Lo wrILe more on LIe MM vIew oI LIe moneLury LrunsmIssIon mecIunIsm. Iope LIIs
posL wIII do exucLIy LIuL.
L Is weII known LIuL MurkeL MoneLurIsLs see u sIgnIIIcunLIy Iess cenLruI roIe Ior InLeresL ruLes In LIe
moneLury LrunsmIssIon mecIunIsm LIun New KeynesIuns (und LrudILIonuI KeynesIuns) und
AusLrIuns. As LrudILIonuI moneLurIsLs we beIIeve LIuL moneLury poIIcy works LIrougI numerous
cIunneIs und LIuL LIe InLeresL ruLe cIunneI Is jusL one sucI cIunneI (See Iere Ior u overvIew oI
some oI LIese cIunneIs Iere).
A cIunneI by wIIcI moneLury poIIcy uIso works Is LIe excIunge ruLe cIunneI. L Is weII recognIsed
by mosL economIsLs LIuL u weukenIng oI u counLry`s currency cun boosL LIe counLry`s nomInuI GDP
(NGDP) - even LIougI mosL economIsLs wouId Iocus on reuI GDP und InIIuLIon ruLIer LIun uL
NGDP. However, In my vIew LIe generuI percepLIon ubouL hou u weukenIng LIe currency ImpucLs
LIe economy Is oILen exLremeIy sImpIIIIed.
TIe normuI sLory ubouL LIe excIunge ruLe-LrunsmIssIon mecIunIsm Is LIuL u weukenIng oI LIe
currency wIII Ieud Lo un ImprovemenL oI LIe counLry`s compeLILIveness (us IL - rIgILIy - Is ussumed
LIuL prIces und wuges ure sLIcky) und LIuL wIII Ieud Lo un Increuse In exporLs und u decreuse In
ImporLs und Ience Increuse neL exporLs und In LrudILIonuI keynesIun IusIIon LIIs wIII In reuI GDP
(und NGDP). do noL dIsugree LIuL LIIs Is one wuy LIuL un excIunge ruLe deprecIuLIon (or
devuIuuLIon) cun ImpucL RGDP und NGDP. However, In my vIew LIe compeLILIveness cIunneI Is Iur
Irom LIe mosL ImporLunL cIunneI.
wouId poInL Lo Lwo key eIIecLs oI u devuIuuLIon oI u currency. One cIunneI ImpucLs LIe money
suppIy (M) und LIe oLIer LIe veIocILy oI money (V). As we know MV=PY=NGDP LIIs sIouId uIso
muke IL cIeur LIuL excIunge ruLes cIunges cun ImpucL NGDP vIu M or V.
Puge oI 1zq
eLs sLurL ouL In u economy wIere NGDP Is depressed und expecLuLIons ubouL LIe IuLure growLI oI
NGDP Is subdued. TIIs couId be Jupun In LIe IuLe 1qqos or ArgenLInu In zoo1 - or Greece Loduy Ior
LIuL muLLer.
I LIe cenLruI bunk Loduy unnounces LIuL IL Ius devuIued LIe counLry`s currency by o% LIen LIuL
wouId Iuve numerous ImpucLs on expecLuLIons. IrsL oI uII, InIIuLIon expecLuLIons wouId Increuse
drumuLIcuIIy (II LIe unnouncemenL Is unexpecLed) us IIgIer ImporL prIces IIkeIy wIII be pusI up
InIIuLIon, buL uIso becuuse - und more ImporLunL - LIe expecLuLIon Lo LIe IuLure puLI oI NGDP
wouId cIunge und LIe expecLuLIons Ior money suppIy growLI wouId cIunge. Tuke ArgenLInu In
zoo1. n zoo1 LIe ArgenLInIun cenLruI bunk wus drumuLIcuIIy LIgILenIng moneLury condILIons Lo
muInLuIn LIe pegged peso ruLe uguInsL LIe US doIIur. TIIs send u cIeur sIgnuI LIuL LIe uuLIorILIes
wus wIIIIng Lo uccepL u coIIupse In NGDP Lo muInLuIn LIe currency bourd. NuLuruIIy LIuL Ieud
consumers und InvesLors Lo expecL u IurLIer coIIupse In NGDP - expecLuLIons busIcuIIy becume
deIIuLIonury. However, once LIe LIe peg wus gIven up InIIuLIon und NGDP expecLuLIons spIked.
WILI LIe peso coIIupsIng LIe demund Ior (peso) cusI dropped drumuLIcuIIy - Ience money demund
dropped, wIIcI oI course In LIe equuLIon oI excIunge Is LIe sume us un Increuse In money-veIocILy.
WILI V spIkIng und ussumIng (Lo begIn wILI) LIuL LIe money suppIy Is uncIunged NGDP sIouId by
deIInILIon Increuse us mucI us LIe Increuse In V. TIIs Is LIe veIocILy-eIIecL oI u devuIuuLIon. n LIe
cuse oI ArgenLInu IL sIouId oI course be noLed LIuL LIe devuIuuLIon wus noL unexpecLed so veIocILy
sLurLed Lo Increuse prIor Lo LIe devuIuuLIon und LIe expecLuLIons oI u devuIuuLIon grew.
Second, In LIe cuse oI ArgenLInu wIere LIe uuLIorILIes busIcuIIy ouLsourced LIe money poIIcy Lo
LIe ederuI Reserve by peggIng LIe peso LIe doIIur. Hence, LIe ArgenLIne cenLruI bunk couId noL
IndependenLIy Increuse LIe money suppIy wILIouL gIvIng up LIe peg. n IucL In zoo1 LIere wus u
mussIve currency ouLIIow, wIIcI nuLuruIIy Ieud Lo u sIurp drop In LIe ArgenLIne X reserve. n u
IIxed excIunge ruLe regIme IL IoIIows LIuL uny drop In LIe IoreIgn currency reserve musL Ieud Lo un
equuI drop In LIe money buse. TIIs Is exucLIy wIuL Iuppened In ArgenLInu. However, once LIe peg
wus gIven up LIe cenLruI bunk wus Iree Lo Increuse LIe money buse. WILI M IncreusIng (und V
IncreusIng us urgued ubove) NGDP wouId Increuse IurLIer. TIIs Is LIe money suppIy-eIIecL oI u
devuIuuLIon.
TIe very sLrong correIuLIon beLween ArgenLIne Mz und NGDP cun be seen In LIe grupI beIow (Iog-
scuIe ndex).
beIIeve LIuL LIe combIned ImpucL oI veIocILy und money suppIy eIIecLs empIrIcuII
sLronger LIun LIe compeLILIveness eIIecL devuIuuLIon
quusI-deIIuLIonury sILuuLIon IIke ArgenLInu wus In In zoo1. TIIs Is uIso sLrongIy conIIrmed by wIuL
Iuppened In ArgenLInu Irom zooz und unLII zo
TIIs Is Irom Murk WeIsbroL`s und uIs SundovuI`s zoo;
Houeter, relctitel little oj Arentinc's routh oter the lcst j
exports or oj the jctorcble prices oj Arentinc's exports on uorld mcrlets. This must be
emphcsized beccuse the contrcr is uidel belieted, cnd this mistclen cssumption hcs ojten been
used to dismiss the success or imp
commodit export boom.
Durin this period (The jirst six months jollouin the detcluction in zooz) exports reu ct c .;
percent cnnucl rcte cnd cccounted jor ;:. percent oj GDP routh. Imports d
thcn z8 percent cnd therejore cccounted jor :;.8 percent oj GDP routh durin this period.
Thus net exports (exports minus imports) cccounted jor zp.: percent oj GDP routh durin the
jirst six months oj the recoter. This ucs countered mc
pritcte consumption jcllin ct c .o percent cnnucl rcte.
But exports did not plog o mojor role in the rest of the recooerg ofter the first six
months. The next phcse oj the recoter, jrom the third qucrter oj zooz to th
beIIeve LIuL LIe combIned ImpucL oI veIocILy und money suppIy eIIecLs empIrIcuII
sLronger LIun LIe compeLILIveness eIIecL devuIuuLIon - especIuIIy Ior counLrIes In u deIIuLIonury or
deIIuLIonury sILuuLIon IIke ArgenLInu wus In In zoo1. TIIs Is uIso sLrongIy conIIrmed by wIuL
Iuppened In ArgenLInu Irom zooz und unLII zoo-;.
Murk WeIsbroL`s und uIs SundovuI`s zoo;-puper on ArgenLInu`s economIc recovery
Houeter, relctitel little oj Arentinc's routh oter the lcst jite ecrs (zooz
exports or oj the jctorcble prices oj Arentinc's exports on uorld mcrlets. This must be
emphcsized beccuse the contrcr is uidel belieted, cnd this mistclen cssumption hcs ojten been
used to dismiss the success or importcnce oj the recoter, or to ccst it cs cn unsustcincble
Durin this period (The jirst six months jollouin the detcluction in zooz) exports reu ct c .;
percent cnnucl rcte cnd cccounted jor ;:. percent oj GDP routh. Imports d
thcn z8 percent cnd therejore cccounted jor :;.8 percent oj GDP routh durin this period.
Thus net exports (exports minus imports) cccounted jor zp.: percent oj GDP routh durin the
jirst six months oj the recoter. This ucs countered mcinl b declinin consumption, uith
pritcte consumption jcllin ct c .o percent cnnucl rcte.
But exports did not plog o mojor role in the rest of the recooerg ofter the first six
. The next phcse oj the recoter, jrom the third qucrter oj zooz to th
Puge 6 oI 1zq
beIIeve LIuL LIe combIned ImpucL oI veIocILy und money suppIy eIIecLs empIrIcuIIy ure mucI
especIuIIy Ior counLrIes In u deIIuLIonury or
deIIuLIonury sILuuLIon IIke ArgenLInu wus In In zoo1. TIIs Is uIso sLrongIy conIIrmed by wIuL
ArgenLInu`s economIc recovery:
ite ecrs (zooz-zoo;) is c result oj
exports or oj the jctorcble prices oj Arentinc's exports on uorld mcrlets. This must be
emphcsized beccuse the contrcr is uidel belieted, cnd this mistclen cssumption hcs ojten been
ortcnce oj the recoter, or to ccst it cs cn unsustcincble
Durin this period (The jirst six months jollouin the detcluction in zooz) exports reu ct c .;
percent cnnucl rcte cnd cccounted jor ;:. percent oj GDP routh. Imports dropped b more
thcn z8 percent cnd therejore cccounted jor :;.8 percent oj GDP routh durin this period.
Thus net exports (exports minus imports) cccounted jor zp.: percent oj GDP routh durin the
inl b declinin consumption, uith
But exports did not plog o mojor role in the rest of the recooerg ofter the first six
. The next phcse oj the recoter, jrom the third qucrter oj zooz to the second qucrter oj
Puge ; oI 1zq
zoo(, ucs driten b pritcte consumption cnd intestment, uith intestment rouin ct c (:.:
percent cnnucl rcte durin this period. Grouth durin the third phcse oj the recoter - the three
ecrs endin uith the second hclj oj this ecr - ucs clso driten mcinl b pritcte consumption
cnd intestment. Houeter, in this phcse exports did contribute more thcn in the pretious period,
cccountin jor cbout :.z percent oj routh, clthouh imports reu jcster, resultin in c
nectite contribution jor net exports. Dter the entire recoter throuh the jirst hclj oj this ecr,
exports cccounted jor cbout :. percent oj economic routh, cnd net exports (exports minus
imports) contributed c nectite :o.p percent.
The econom recched its pre-recession letel oj recl GDP in the jirst qucrter oj zoo. As oj the
second qucrter this ecr, GDP ucs zo.8 percent hiher thcn this pretious pecl. Since the
beinnin oj the recoter, recl (injlction-cdjusted) GDP hcs roun b o.p percent, ctercin
8.z percent cnnucll. All this is uorth notin pcrtl beccuse Arentinc's rcpid expcnsion is still
sometimes dismissed cs little more thcn c rebound jrom c deep recession.
.the jcstest rouin sectors oj the econom uere construction, uhich increcsed b :z.; percent
durin the recoter, trcnsport, storce cnd communicctions (;.( percent), mcnujccturin
((.( percent), cnd uholescle cnd retcil trcde cnd repcir sertices (z.; percent).
The impcct oj this rcpid cnd sustcined routh ccn be seen in the lcbor mcrlet cnd in household
potert rctes. Unemploment jell jrom z:. percent in the jirst hclj oj zooz to p. percent jor
the jirst hclj oj zoo;. The emploment-to-populction rctio rose jrom z.8 percent to (.( percent
durin the scme period. And the household potert rcte jell jrom (:.( percent in the jirst hclj oj
zooz to :. percent in the jirst hclj oj zoo;. These cre ter lcre chcnes in unemploment,
emploment, cnd potert rctes.
Hence, LIe ArgenLIne exumpIe cIeurIy conIIrms LIe sIgnIIIcunL ImporLunce oI moneLury eIIecLs In
LIe LrunsmIssIon oI u devuIuuLIon Lo NGDP (und RGDP Ior LIuL muLLer) und uL LIe sume LIme sIows
LIuL LIe compeLILIveness eIIecL Is ruLIer unImporLunL In LIe bIg pIcLure.
TIere ure oLIer exumpIe ouL LIere (LIere ure In IucL muny.). TIe US recovery uILer RooseveIL wenL
oI LIe goId sLundurd In 1q Is exucLIy LIe sume sLory. L wus noL un expIosIon In exporLs LIuL
spurked LIe sIurp recovery In LIe US economy In LIe summer oI 1q, buL ruLIer LIe mussIve
Puge 8 oI 1zq
moneLury eusIng LIuL resuILed Irom LIe Increuse In M und V. TIIs Iesson obvIousIy Is ImporLunL
wIen we Loduy ure debuLe wIeLIer Ior exumpIe Greece wouId beneIIL Irom IeuvIng LIe euro ureu or
wIeLIer one or unoLIer counLry sIouId muInLuIn u pegged excIunge ruLe regIme.
A bit on unish 1q,os IX policy
n my Iome counLry oI Denmurk IL Is oILen noLed LIuL LIe numerous devuIuuLIons oI LIe DunIsI
krone In LIe 1q;os compIeLeIy IuIIed Lo do unyLIIng good Ior LIe DunIsI economy und LIuL LIuL
proves LIuL devuIuuLIons ure bud under cll cIrcumsLunces. TIe DunIsI exumpIe, Iowever, exucLIy
IIIusLruLe LIe probIem wILI LIe LrudILIonuI perspecLIve on devuIuuLIons. Hud DunIsI poIIcy
mukers InsLeud Iud un moneLury upproucI Lo excIunge ruLe poIIcy In 1q;os LIen LIe poIIcIes LIuL
wouId Iuve been ImpIemenLed wouId Iuve been compIeLeIy dIIIerenL.
Denmurk - us muny oLIer Europeun counLrIes - wus sLruggIIng wILI stcjlction In LIe 1q;os -
boLI InIIuLIon und unempIoymenL wus IIgI. Any moneLurIsL wouId LeII you (us rIedmun dId) LIuL
LIIs wus u resuIL oI u neguLIve suppIy sIock (und generuI sLrucLuruI probIems) combIned wILI overIy
Ioose moneLury poIIcy. TIe DunIsI governmenL by devuIuuLIng LIe krone (uguIn und uguIn.) LrIed
Lo Improve compeLILIveness und LIereby brIng down unempIoymenL. However, LIe IIgI IeveI oI
unempIoymenL wus noL due Lo Iuck oI demund, buL ruLIer due Lo suppIy sIde probIems. TIe DunIsI
economy wus noL In u deIIuLIonury Lrup, buL ruLIer In u sLugIIuLIonury Lrup. TIuL Is LIe reuson LIe
devuIuuLIons dId noL work - weII IL worked perIecLIy weII In Lerms oI IncreusIng InIIuLIon, buL IL
dId not brIng down unempIoymenL us LIe probIem wus noL Iuck oI demund (conLrury Lo wIuL Is LIe
cuse mosL pIuces In Europeu und LIe US Loduy).
Conclosion - it's not uboot competitiveness
So Lo concIude, LIe mosL ImporLunL cIunneIs oI excIunge ruLe poIIcy Is moneLury - LIe veIocILy
eIIecL und LIe money suppIy - LIe compeLILIveness eIIecL Is neurIy us IrreIevunL us InLeresL ruLes Is.
CounLrIes LIuL suIIer Irom Loo LIgIL moneLury poIIcy cun euse moneLury poIIcy by unnouncIng u
credIbIe devuIuuLIon or by IeLLIng LIe currency IIouL. ArgenLInu Is u cIeur exumpIe oI LIuL. CounLrIes
LIuL suIIer Irom suppIy sIde probIems - IIke Denmurk In 1q;os - cun noL soIve LIe IundumenLuI
probIems by devuIuuLIon.
Puge q oI 1zq
PS LIe dIscussIon ubove Is noL un endorsemenL oI generuI economIc poIIcy In ArgenLInu uILer zoo1,
buL onIy meunL us un IIIusLruLIon oI LIe excIunge ruLe cIunneI Ior moneLury poIIcy. NeILIer Is IL un
recommenduLIon concernIng wIuL counLry XYZ sIouId sIouId do In Lerms oI moneLury und
excIunge ruLe poIIcy Loduy.
PPS ObvIousIy ScoLL wouId remInd us LIuL LIe ubove dIscussIon Is jusL u vurIuLIon oI wIuL urs E.
O. Svensson Is LeIIIng us ubouL LIe IooI prooI wuy ouL oI u IIquIdILy Lrup.
Puge 6o oI 1zq
The end of Jopon's Long Deflotion
Don't eoer tell me ogoin thot monetorg policg does not
uork! Chuck Norris oisits Jopon
conLInue Lo be compIeLeIy puzzIed LIuL somebody wouId LIInk LIuL cenLruI bunks someIow Iuve
run ouL oI ummunILIon und LIuL moneLury poIIcy Is ImpoLenL. TIe deveIopmenLs In LIe gIobuI
IInuncIuI murkeLs sInce AugusL-SepLember IusL yeur cIeurIy LeII you LIuL moneLury poIIcy Is
exLremeIy poLenL - uIso wIen InLeresL ruLes ure uL LIe Zero ower Bound.
JusL Luke u Iook uL LIIs sLory Irom Jupun Loduy:
1cpcnese shcres rose, uith the Nillei zz Stocl Aterce hecdin jor the hihest close since
September zoo8, cs the en jell cjter cnl oj 1cpcn Goternor Mcsccli Shirclcuc scid he uill
step doun checd oj schedule.
.The Nillei zz cined percent to ::,;;. cs oj :z:8 p.m. in Tolo, hecdin jor the hihest
close since Sept. zp, zoo8, tuo ueels cjter the collcpse oj Lehmcn rothers Holdins Inc. Volume
todc ucs (8 percent cbote the o-dc cterce. The brocder Topix Index cdtcnced z.8 percent
to p.o, uith eiht stocls risin jor ecch thct jell.
.The Topix hcs sured ( percent since elections uere cnnounced on Not. :( on optimism c neu
oternment uill push jor cressite stimulus. The cue is trcdin ct :.:( times bool tclue,
compcred uith z.: jor the Stcndcrd & Poor's oo Index cnd :.( jor the Stoxx Europe oo Index.
(UpduLe: NIkkeI Is ucLuuIIy up q%!)
And Irom unoLIer sLory:
The en slid to its ueclest letel in clmost three ecrs ccinst the dollcr cnd euro on speculction
1cpcn's oternment uill hcsten the selection oj c neu centrcl bcnl chiej to tcle jurther steps to
end dejlction.
Puge 61 oI 1zq
1cpcn's currenc cdded to esterdc's biest drop tersus the euro in more thcn c ueel cjter
cnl oj 1cpcn Goternor Mcsccli Shirclcuc scid he uill step doun on Mcrch :p, clmost three
ueels bejore his term is due to end. Demcnd jor the :;- nction euro ucs supported on prospects
the Europecn Centrcl cnl uill rejrcin jrom ecsin monetcr polic tomorrou. The Austrclicn
dollcr slid cjter dctc shoued the nction's retcil scles unexpectedl jell in December.
InuncIuI murkeLs ure LIe besL IndIcuLors oI LIe moneLury poIIcy sLunce we Iuve - u surgIng
Jupunese sLock murkeL und mucI weuker yen Is u very sLrong IndIcuLIon LIuL Jupunese moneLury
condILIons ure geLLIng decIsIveIy eusIer. EusIer moneLury condILIons meun IIgIer Jupunese nomInuI
GDP - jusL wuIL und see.
TIe murkeL ucLIon In LIe Jupunese murkeLs LIIs mornIng Is yeL unoLIer exLremeIy cIeur
demonsLruLIon oI LIe Chucl Norris ejject - LIuL moneLury poIIcy does noL onIy work LIrougI
prInLIng money, buL uIso LIrougI expecLuLIons. As ScoLL Sumner IIkes Lo suy - moneLury poIIcy
works wILI Iong und vurIubIe lecds. SuId In unoLIer wuy u new Bunk oI Jupun governor Ius noL
even been uppoInLed buL Ie Is uIreudy eusIng moneLury condILIons In Jupun us Murk Curney Is In
LIe UK.
And Lo uII you KeynesIun IIscuIIsLs ouL LIere cIuIIenge you Lo IInd me one sIngIe exumpIe oI
opLImIsm ubouL IIscuI sLImuIus IuvIng moved uny mujor sLock murkeL by q% In u duy!
WIuL we ure seeIng now In LIe US, Jupun und IIkeIy soon In LIe UK Is LIe kInd oI RooseveILIun
ResoIve LIuL brougIL LIe US economy ouL oI LIe GreuL DepressIon In 1q uILer RooseveIL wenL oII
LIe goId sLundurd und LrusL me - moneLury poIIcy does work! n LIe 1qos LIe goId bIoc counLrIes
IuIIed Lo undersLund LIuL - Loduy IL Is LIe ECB - buL IuckIIy Ior Europeuns LIe US und Jupun ure
IeudIng LIe cIurge und Is puIIIng us ouL oI LIIs crIsIs. TIuL Is wIuL LIe gIobuI sLock murkeLs Iuve
been ceIebruLIng sInce AugusL-SepLember. L Is reuIIy sImpIe.
Puge 6z oI 1zq
Jopon's deflotion storg is not reollg o horror storg
Muny economIsLs - IncIudIng some MurkeL MoneLurIsLs - LeII LIe sLory ubouL Jupun`s economy us u
Lrue Iorror sLory und LIere Is no doubL LIuL Jupun`s growLI sLory Ior more LIun 1 yeurs Ius noL
been Loo ImpressIve - und IL Ius cerLuInIy noL been greuL Lo Iuve been InvesLed In Jupunese sLocks
over IusL decude.
Some MurkeL MoneLurIsLs ure expIuInIng Jupun`s uppurenL weuk economIc perIormunce wILI overIy
LIgIL Jupunese moneLury poIIcy, wIIIe oLIers bIume zombIe bunks und conLInued deIeverugIng
uILer LIe bubbIe In Lo 1qqos. , Iowever, IncreusIngIy LIInk LIuL LIese expIunuLIons ure wrong Ior
Jupun.
ObvIousIy, Jupun Ius deIIuLIon becuuse money demund growLI consIsLenLIy ouLpuces money suppIy
growLI. TIuL`s preLLy sImpIe. TIuL, Iowever, does noL necessurIIy Iuve Lo be u probIem In LIe Iong
run II expecLuLIons Iuve udjusLed uccordIngIy. TIe besL IndIcuLIon LIuL LIIs Ius Iuppened Is LIuL
Jupunese unempIoymenL In IucL Is reIuLIveIy Iow. So muybe wIuL we ure seeIng In Jupun Is u versIon
oI George SeIgIn`s producLIvILy norm. um noL suyIng Jupunese moneLury poIIcy Is IunLusLIc, buL
IL mIgIL noL be worse LIun wIuL we ure seeIng In LIe US und Europe.
TIe muIn reuson Jupun Ius Iow growLI Is demogrupIIcs. I you udjusL GDP growLI Ior LIe growLI
(or ruLIer LIe decIIne) In LIe Iubour Iorce LIen one wIII see LIuL LIe Jupunese growLI record reuIIy Is
noL bud uL uII - especIuIIy LukIng InLo uccord LIuL Jupun uILer uII Is u very IIgI-Income counLry.
DunIeI Gros, wIom seIdom ugrees wILI (buL do In LIIs cuse), Ius done LIe muLI. He Ius Iooked
Jupunese growLI over LIe IusL decude und compured Lo oLIer IndusLrIuIIzed counLrIes. Here Is Gros:
Policmclin is ojten domincted b simple lessons lecrned jrom economic histor. ut the
lesson lecrned jrom the ccse oj 1cpcn is lcrel c mth. The bcsis jor the sccre stor cbout 1cpcn
is thct its GDP hcs roun oter the lcst deccde ct cn cterce cnnucl rcte oj onl o. compcred
to :.; jor the US. The dijjerence is cctucll much smcller thcn ojten cssumed, but ct jirst siht c
routh rcte oj o. quclijies cs c lost deccde.Accordin to thct stcndcrd, one could crue thct
c ood pcrt oj Europe clso lost the lcst deccde, since Germcn cchieted cbout the scme routh
rctes cs 1cpcn (o.) cnd Itcl did eten uorse (o.z ), onl Ircnce cnd Spcin perjormed
Puge 6 oI 1zq
someuhct better.ut this picture oj stcnction in mcn countries is mislecdin, beccuse it
lectes out cn importcnt jcctor, ncmel demorcph.Hou should one compcre routh records
cmon c roup oj similcr, deteloped countries? The best mecsure is not otercll GDP routh, but
the routh oj income per hecd oj the uorlin-ce populction (not per ccpitc). This lcst element
is importcnt beccuse onl the uorlin-ce populction represents cn econom's productite
potenticl. Ij tuo countries cchiete the scme routh in cterce WAP income, one should conclude
thct both hcte been equcll ejjicient in usin their potenticl, eten ij their otercll GDP routh
rctes dijjer.When one lools ct GDP,WAP (dejined cs populction ced zo-o), one ets c
surprisin result: 1cpcn hcs cctucll done better thcn the US or most Europecn countries oter
the lcst deccde. The recson is simple: 1cpcn's otercll routh rctes hcte been quite lou, but
routh ucs cchieted despite c rcpidl shrinlin uorlin-ce populction.The dijjerence
betueen 1cpcn cnd the US is instructite here: in terms oj otercll GDP routh, it ucs cbout one
percentce point, but lcrer in terms oj the cnnucl WAP routh rctes - more thcn :. percentce
points, iten thct the US uorlin-ce populction reu b o.8, uherecs 1cpcn's hcs been
shrinlin ct cbout the scme rcte.
So IL Is correcL LIuL Jupunese moneLury poIIcy wus overIy LIgIL uILer LIe Jupunese bubbIe bursLed In
LIe mId-qoLIes, buL LIuL Is prImurIIy u sLory oI LIe qos, wIIIe LIe sLory over LIe IusL decude Is
prImurIIy u sLory oI bud demogrupIIcs.
We cun Ieurn u IoL Irom Jupun, buL LIInk Jupun Is oILen used us un exumpIe oI uII kInd oI IIInesses,
buL Iew oI LIose peopIe wIo puII LIe Jupun-curd reuIIy Iuve sLudIed Jupun. SImIIur Ior me - um
noL experL on LIe Jupunese economy - buL boLI LIe moneLury und LIe deIeverugIng expIunuLIons
Ior Jupun`s Iow growLI durIng LIe pusL decude (noL LIe qoLIes) beIIeve Lo be wrong.
TIe GreuL DepressIon us weII us LIe GreuL RecessIon ure LerrIbIe exumpIes oI LIe dIsusLers LIuL LIe
wrong moneLury poIIcy cun brIng und so Is LIe Jupun crIsIs In LIe mId-qos, buL we need Lo muke LIe
rIgIL urgumenLs Ior LIe rIgIL poIIcIes bused on IucL und noL myLI.
PS In DunIeI Gros` commenL on Jupun Ie mukes some commenLs on LIe eIIecLIveness oI moneLury
poIIcy. He seems Lo LIInk LIuL moneLury poIIcy Is ImpoLenL In LIe presenL sILuuLIon. sLrongIy
dIsugree wILI LIuL us beIIeve LIuL moneLury poIIcy Is In IucL very eIIecLIve In IncreusIng nomInuI
Puge 6q oI 1zq
Income growLI us weII us InIIuLIon. TIe IIquIdILy Lrup Is u myLI In LIe sume wuy LIe Jupun growLI
sLory Is u myLI.
Puge 6 oI 1zq
Bonk of Englond, Mork Corneg ond NCDP
torgeting
Mr. 1oroge mode me hoppg ond then uorried. UK1P
should support NCDP leoel torgeting
I LIere Is unyLIIng LIuL LIe governIng Tory purLy In LIe UK Is IeurIng LIen IL Is LIe UKP. TIe unLI-
EU UKP wunLs Lo Luke LIe UK ouL oI LIe EU, buL IL uIso wunLs someLIIng Iess - moneLury reIorm!
TIIs Is UKP Ieuder NIgeI uruge In LIe CILy AM:
WHEN Mcrl Ccrne tcles oter cs our neu oternor oj the cnl oj Enlcnd, ct this time oj
exceptioncl economic crisis - his uords not mine - he must be jull crmed cnd uorlin to c
clecr politiccl direction jrom the stcrt. Ccrne's jirst dc on the job should be cn economic D-Dc
jor the UK.
Thct is uh I ucnt to be the jirst UK politiccl lecder to commit m pcrt to chcnin the cnl oj
Enlcnd's mcndcte. It's time to put the cnl, uith its increcsin pouers cnd brocdenin
economic recch, on the side - incontrotertibl - oj the strulin people oj ritcin.
The stctus quo is not cn option. ritish toters hcte mcde it clecr in three b-elections, ecch time
uith risin jorce, their jeelin oj intense cner ct the Westminster cnd russels elite. Ulip ccrries
the jlc jor these toters. I'm proud thct I ccn ite toice to their cner, uhile ojjerin them
somethin positite to do uith their tote. ut Ulip ojjers more. We ojjer c juture in uhich ritcin
is jree to otern itselj, to enjorce its oun lcus, to control its borders, cnd to mcle its successjul
uc economiccll - trcdin ct c projit cnd cble to honour promises to its citizens. A jirst cnd
crucicl step is thct ue tcle bccl the commcndin heiht oj our econom - the cnl - cnd put it
to uorl dritin emploment, routh cnd conjidence.
I expect Geore Dsborne to use this udet - three ecrs lcte - to open the debcte on the
objectites oj the cnl, cnd to lc out the options jor chcne. ut I ccll on him to o jurther. He
must put some red ritish mect into the dish. He should cnnounce uhich option he prejers, cnd
Puge 66 oI 1zq
set c jixed timetcble jor the consultction cnd the decision. He must ucrcntee thct, b Ccrne's
jirst dc, the neu jrcmeuorl is in plcce.
Wh do I put this pressure on him? eccuse one oj the mcn jcilures oj this oternment hcs been
its incbilit to tcle the decisions needed to put routh cnd conjidence jirst. The list oj its jellied
jcilures to decide is lon - on ener, ctiction, housin, rocds, cnd injrcstructure intestment.
Neither the public nor businesses lnou uhether to be conjident cnd spend, intest, or hire.
WIen suw Mr. uruge`s commenLs Loduy my response wus wuuw! TIIs Is preLLy IncredIbIe - LIe
TorIes ure comIng under uLLuck Irom LIe rIgIL Lo cIunge LIe munduLe oI LIe Bunk oI EngIund In u
more pro-routh orIenLed dIrecLIon.
So wIuL Is LIe MurkeL MoneLurIsL response? WeII, IL Is eusy. Yes Mr. uruge Is compIeLeIy rIgIL -
LIe BoE`s InIIuLIon LurgeL Is LerrIbIe und sIouId be cIunged. He Is uIso rIgIL LIe LIuL LIe UK
economy needs moneLury sLImuIus In LIe sense LIuL nomInuI GDP Ius IuIIen weII-beIow LIe pre-
crIsIs Lrend IeveI.
However, musL suy LIuL Mr. uruge`s commenLs uIso come ucross us beIng udvocuLIng u sIgnIIIcunL
IeveI oI moneLury ucLIvIsm wIIcI IInd very probIemuLIc. n IucL IL seems IIke uruge Is jusL cuIIIng
Ior moneLury sLImuIus - yes LIuL mIgIL be needed uL LIe momenL, buL IL Is LerrIbIy dungerous II LIe
InsLILuLIonuI Irumework Is noL correcL. We don`L wunL u reLurn Lo LIe InIIuLIonury 1q;os. We wunL u
moneLury consLILuLIon Ior BrILuIn. NoL u IuwkIsI or u dovIsI moneLury poIIcy, buL u neutrcl
monetcr polic. UK moneLury poIIcy Ius been overIy LIgIL so moneLury eusIng sIouId be
weIcomed, buL mucI preIer LIIs Lo Iuppen wILIIn LIe Irumework oI u proper NGDP IeveI LurgeLIng
regIme.
TIereIore, Mr. uruge you ure rIgIL Lo be ouLruged by LIe UK governmenL`s Iuck oI ucLIon on
cIungIng LIe Bunk oI EngIund`s munduLe, buL you sIouId be more cIeur on LIe munduLe you wunL.
Ask Ior un NGDP IeveI LurgeL Ior BrILuIn. L Is In LIe counLry`s besL InLeresL!
Puge 6; oI 1zq
The 'Export Price Norm' - monetorg policg in
commoditg exporting countries
Should smoll open economies peg the currencg to
export prices?
NomInuI GDP LurgeLIng mukes u IoL oI sense Ior Iurge currency ureus IIke LIe US or LIe euro zone
und IL muke sense LIuL LIe cenLruI bunk cun ImpIemenL u NGDP LurgeL LIrougI open murkeL
operuLIons or us wILI LIe use oI NGDP IuLures. However, operuLIonuIIy IL mIgIL be mucI Iurder Lo
ImpIemenL u NGDP LurgeL In smuII open economIes und purLIcuIurIy In EmergIng MurkeLs
counLrIes wIere LIere mIgIL be mucI more uncerLuInLy regurdIng LIe meusuremenL oI NGDP und
IL wIII be Iurd Lo InLroduce NGDP IuLures In reIuLIveIy underdeveIoped und IIIIquId IInuncIuI
murkeLs In EmergIng MurkeLs counLrIes.
Iuve eurIIer (see Iere und Iere) suggesLed LIuL u NGDP couId be ImpIemenLed LIrougI munugIng
LIe X ruLe - Ior exumpIe LIrougI u munuged IIouL uguInsL u buskeL oI currencIes - sImIIur Lo LIe
pruxIs oI LIe SInguporeun moneLury uuLIorILIes. However, Ior some LIme Iuve been InLrIgued by u
proposuI mude by JeIIrey runkeI. WIuL runkeI Ius suggesLed In u number oI pupers over LIe IusL
decude Is busIcuIIy LIuL smuII open economIes und EmergIng MurkeLs - especIuIIy commodILy
exporLers - couId peg LIeIr currency Lo LIe prIce oI LIe counLry`s muIn exporL commodILy. Hence,
Ior exumpIe RussIu sIouId peg LIe rubIe Lo LIe prIce oI oII - so u X% Increuse In oII prIces wouId
uuLomuLIcuIIy Ieud Lo u X% upprecIuLIon oI LIe rubIe uguInsL LIe US doIIur.
runkeI Ius Lermed LIIs proposuI PEP - Peg LIe ExporL PrIce. Any proponenL oI NGDP IeveI LurgeL
sIouId reuIIse LIuL PEP Ius some uLLrucLIve quuIILIes.
wouId especIuIIy Irom u MurkeL MoneLurIsL IIgIIIgIL Lwo posILIve IeuLures LIuL PEP Ius In
common In (IuLures bused) NGDP LurgeLIng. IrsL, PEP wouId ensure u sLrIcL nomInuI uncIor In LIe
Iorm oI u X peg. TIIs wouId In reuIILy remove uny dIscreLIon In moneLury poIIcy - sureIy un
uLLrucLIve IeuLure. Second, conLrury Lo Ior exumpIe InIIuLIon LurgeLIng or prIce IeveI LurgeLIng PEP
does noL reucL Lo suppIy sIocks.
Puge 68 oI 1zq
eLs Iuve u cIoser Iook uL LIe second IeuLure - PEP und suppIy sIocks. A key IeuLure oI NGDP
LurgeLIng (und wIuL George SeIgIn us Lermed the productitit norm) Is LIuL IL does noL dIsLorL
reIuLIve murkeL prIces - Ience, un neguLIve suppIy sIock wIII Ieud Lo IIgIer prIces (und Lemporury
IIgIer InIIuLIon) und sImIIurIy posILIve suppIy sIocks wIII Ieud Lo Iower prIces (und benIgn
deIIuLIon). As DuvId EugIe LeucIes us - LIIs ensures PureLo opLImuIILy und Is noL dIsLorLIng reIuLIve
prIces. ConLrury Lo LIIs u neguLIve suppIy sIock wIII Ieud Lo u LIgILenIng oI moneLury poIIcy under u
InIIuLIon LurgeLIng regIme. Under PEP LIe moneLury uuLIorILIes wIII noL reucL Lo suppIy sIock.
Hence, II LIe currency Is peg Lo exporL prIces und LIe economy Is IIL by un Increuse In ImporL prIces
(Ior exumpIe IIgIer oII prIces - u neguLIve suppIy sIock Ior oII ImporLers) LIen LIe ouLcome wIII be
LIuL prIces (und InIIuLIon) wIII Increuse. However, LIIs Is noL moneLury InIIuLIon. Hence, wIuL
InspIred by DuvId EugIe Ius Lermed QuusI-ReuI PrIces (QRP) Iuve noL Increused und Ience
moneLury poIIcy under PEP Is noL dIsLorLIng reIuLIve prIces. Any MurkeL MoneLurIsL wouId LeII you
LIuL LIuL Is u very posILIve IeuLure oI u moneLury poIIcy ruIe.
TIereIore us see IL In Lerms oI suppIy sIocks PEP Is busIcuIIy u vurIuLIon oI NGDP LurgeLIng
ImpIemenLed LIrougI un excIunge ruLe poIIcy. TIe udvunLuge oI PEP over u NGDP LurgeL Is LIuL IL
operuLIonuIIy Is mucI Iess compIIcuLed Lo ImpIemenL. Tuke Ior exumpIe RussIu - unybody wIo
Iuve done reseurcI on LIe RussIun economy ( Iuve done u IoL.) wouId know LIuL RussIun
economIc duLu Is noLorIousIy unreIIubIe. As u consequence, IL wouId probubIy muke mucI more
sense Ior LIe RussIun cenLruI bunk sImpIy Lo peg LIe rubIe Lo oII prIces ruLIer LIun LryIng Lo
ImpIemenL u NGDP LurgeL (uL LIe momenL LIe RussIun cenLruI bunk Is munugIng LIe rubIe u buskeL
oI euros und doIIurs).
PEP seems especIuIIy Lo muke sense Ior EmergIng MurkeLs commodILy exporLers IIke RussIu or
uLIn AmerIcun counLrIes IIke BruzII or CIIIe. ObvIousIy PEP wouId uIso muke u IoL Ior sense Ior
AIrIcun commodILy exporLers IIke ZumbIu. ZumbIu`s muIn exporL Is copper und IL wouId LIereIore
muke sense Lo peg LIe ZumbIun kwucIu uguInsL LIe prIce oI copper.
JeIIrey runkeI Ius wrILLen numerous pupers on PEP und vurIuLIons oI PEP. nLeresLIngIy enougI
runkeI wus uIso un eurIy proponenL oI NGDP LurgeLIng. UnIorLunuLeIy, Iowever, Ie does noL
dIscussIon LIe sImIIurILIes und dIIIerences beLween NGDP LurgeLIng und PEP In uny oI IIs pupers.
Puge 6q oI 1zq
However, us Iur us reud IIs reseurcI IL seems IIke PEP wouId Ieud Lo sLubIIIsuLIon oI NGDP - uL
IeusL mucI more so LIun u normuI IIxed excIunge regIme or InIIuLIon LurgeLIng.
One uspecL wouId especIuIIy IInd InLeresLIng Is u dIscussIon oI sIocks Lo money demund (veIocILy
sIocks) under PEP. UnIorLunuLeIy runkeI does noL dIscuss LIIs Issue In uny oI IIs pupers. TIIs Is
noL enLIreIy surprIsIng us IIs Iocus Is on commodILy exporLers. However, LIe GreuL RecessIon
experIence sIows LIuL uny moneLury poIIcy ruIe LIuL Is noL ubIe In somewuy Lo reucL Lo veIocILy
sIocks ure IIkeIy Lo be probIemuLIc In one wuy or unoLIer.
Iope Lo reLurn Lo PEP und Iope especIuIIy Lo reLurn Lo LIe ImpucL oI veIocILy-sIocks under PEP.
Puge ;o oI 1zq
zooS uos o lorge negotioe demond shock - olso
in Conodo
ScoLL Sumner Ius u IoIIow-up posL on NIck Rowe`s posL ubouL wIeLIer u suppIy sIock or u demund
sIock cuused LIe CunudIun recessIon In zoo8-q. BoLI NIck und ScoLL seem Lo LIInk LIuL LIe
recessIon In some wuy wus cuused by u suppIy sIock.
musL udmIL LIuL reuIIy don`L undersLund wIuL ScoLL und NIck ure suyIng. L Is preLLy cIeur Lo me
LIuL LIe sIock In zoo8-q wus nectite crecte demcnd sIock.
eLs sLurL wILI LIe LexLbook versIon oI u neguLIve uggreguLe demund (AD) sIock). Here Is Iow u
neguLIve demund sIock Iooks In ASJAD modeI (LIe growLI ruLe versIon):
So wIuL Iuppened In Cunudu? Here Is u Iook uL InIIuLIon meusured by IeudIIne CP und by LIe prIce
deIIuLor Ior IInuI domesLIc suIes.
Puge ;1 oI 1zq
BoLI meusures oI InIIuLIon were runnIng IIgIer LIun LIe Bunk oI Cunudu`s oIIIcIuI z% InIIuLIon
LurgeL wIen LIe crIsIs IIL In LIe uuLumn oI zoo8.
However, IL Is preLLy cIeur LIuL InIIuLIon sIowed sIurpIy und dropped weII-beIow LIe z% InIIuLIon
LurgeL In zooq us LIe CunudIun economy wenL InLo recessIon (reuI GDP conLrucLed). L Is Iurd Lo
suy LIuL LIIs Is unyLIIng oLIer LIun u ruLIer Iurge neguLIve AD sIock.
ObvIouIsy InIIuLIon Increused ubove z% In zo11, buL we uII know LIuL u mujor neguLIve suppIy sIock
IIL In zo11 us gIobuI oII prIces spIked. n LIe cuse oI Cunudu LIIs In IucL Is boLI u neguLIve suppIy
sIock und u posILIve demund sIock (remember Cunudu Is un oII exporLer). TIuL suId, LIe rIse In
InIIuLIon wus cerLuInIy noL drumuLIc und sInce zo1z InIIuLIon Ius once uguIn dropped weII-beIow
z% IndIcuLIng LIuL moneLury poIIcy In Cunudu Ius become overIy LIgIL gIven LIe BoC`s z% InIIuLIon
LurgeL.
mIgIL udd LIuL dIIIerenL meusures oI InIIuLIon expecLuLIons (boLI survey und murkeL duLu) ure
LeIIIng LIe exucL sume sLory. nIIuLIon und InIIuLIon expecLuLIons eused sIgnIIIcunLIy In zoo8-q und
once uguIn In zo1z.
And we cun LeII LIe sume sLory II we Iook uL LIe prIce letel. TIe grupI beIow compures LIe Lwo
meusures oI prIces (CP und LIe IInuI domesLIc demund deIIuLor) wILI un z% prIce puLI sLurLIng In
Q zoo8.
Puge ;z oI 1zq
AguIn LIe pIcLure Is cIeur. TIe prIce IeveI - Ior boLI meusures - ure Iower LIun u IypoLIeLIcuI z%
prIce IeveI puLI - IndIcuLIng LIuL Murk Curney und IIs coIIeugues In LIe Bunk oI Cunudu Iuve kepL
moneLury condILIons Loo LIgIL over LIe pusL q- yeurs - muybe becuuse oI u preoccupuLIon wILI LIe
rIsk oI bubbIes. Murk Curney mIgIL be LuIkIng ubouL NGDP IeveI LurgeLIng, buL Ie Is cerLuInIy uIso
speukIng quILe u bIL ubouL mccroprudenticl indicctors (modern cenLruI bunk IIngo Ior bubbIe
rIsk).
ConcIudIng, IL Is very cIeur LIuL LIe CunudIun economy wus IIL by u Iurge neguLIve demund sIock In
zoo8 und InILIuIIy LIe BoC Ius kepL moneLury poIIcy overIy LIgIL und LIe recenL LIgILenIng oI
moneLury condILIons cerLuInIy uIso Iooks probIemuLIc.
Once uguIn IL Is moneLury poIIcy IuIIure und IL Is cerLuInIy noL u neguLIve suppIy sIock, wIIcI Is Lo
bIume Ior LIe CunudIun recessIon und sub-Lrend growLI sInce zoo8. NeedIess Lo suy NGDP LeIIs LIe
exucL sume sLory. sIouId udd LIuL LIe sIze oI LIIs moneLury poIIcy IuIIure Is IuIrIy smuII
compured Lo Ior exumpIe Ior exumpIe wIuL we Iuve seen In LIe euro zone.
Reminding Scott uboot the Somner Critiqoe
GIven LIe very cIeur evIdence oI u neguLIve demund sIock IInd LIIs commenL Irom ScoLL
somewIuL puzzIIng:
Puge ; oI 1zq
eL`s suppose LIuL LIe BOC Iud been LurgeLIng NGDP In zoo8, wIen gIobuI Lrude IeII oII u cIIII.
How wouId LIe CunudIun economy Iuve been uIIecLed? Muny wouId see LIe drop In gIobuI Lrude us
u demund sIock IILLIng Cunudu, us LIere wouId Iuve been Iess demund Ior CunudIun exporLs. n
IucL, IL wouId be un udverse suppIy sIock. Even II LIe BOC Iud been LurgeLIng NGDP, ouLpuL wouId
Iuve probubIy IuIIen. ucLorIes In OnLurIo mukIng LrunsmIssIons Ior curs ussembIed In OIIo wouId
Iuve seen u drop In orders Ior LrunsmIssIons. TIuL`s u reuI sIock. No (pIuusIbIe) umounL oI prIce
IIexIbIIILy wouId move LIose LrunsmIssIons durIng u recessIon. I LIe ussembIy pIunL In OIIo
sLopped buIIdIng curs, LIen LIey don`L wunL CunudIun LrunsmIssIons. I LIe US sLops buIIdIng
Iouses, LIen we don`L wunL CunudIun Iumber. TIuL`s u reuI sIock Lo Cunudu, I.e. un AS sIock.
sImpIy don`L undersLund ScoLL`s urgumenL. A neguLIve sIock Lo exporLs obvIousIy Is u nectite
demcnd shocl. rom LIe perspecLIve oI nomInuI spendIng u neguLIve sIock Lo exporLs Is u neguLIve
sIock Lo money-veIocILy In LIe exucL sume wuy us u LIgILenIng oI IIscuI poIIcy. TIereIore, II LIe BoC
Iud been LurgeLIng NGDP (IL ucLuuIIy uIso goes Ior InIIuLIon LurgeLIng) LIe Sumner Critique wouId
uppIy - LIe BoC wouId oIIseL uny neguLIve sIock Lo exporLs by eusIng moneLury poIIcy (IncreusIng M
Lo oIIseL LIe drop In V). As u consequence domesLIc demund wouId rIse und oIIseL LIe drop In
exporLs. And LIIs obvIousIy uppIIes even II prIces ure sLIcky. Yes, LIe producLIon oI LrunsmIssIons In
OnLurIo drops, buL LIuL Is oIIseL by un Increuse In consLrucLIon oI upurLmenLs In Vuncouver.
However, LIe poInL Is LIuL LIe BoC jciled Lo oIIseL LIe sIock Lo exporLs und us u consequence prIces
Iuve been growIng sIower LIun ImpIIed by BoC`s oIIIcIuI InIIuLIon LurgeL.
TIere Is ubsoIuLIy noLIIng specIuI ubouL Cunudu - ILs moneLury poIIcy IuIIure - LIe IuIIure Is jusL (u
IoL) smuIIer LIun In LIe euro zone or LIe US.
PS couId uIso Iuve used LIe GDP deIIuLor us weII In my exumpIes ubove. TIe sLory Is LIe sume. n
IucL IL Is worse! TIe GDP deIIuLor dropped by more LIun q% durIng zooq. TIe prImury reuson Ior
LIe mussIve drop In LIe GDP deIIuLor Is LIuL LIe prIce oI oII meusured In CunudIun doIIurs dropped
sIurpIy In zoo8-q. As drop In LIe oII prIce obvIousIy Is u neguLIve demcnd sIock us Cunudu Is u oII
exporter. TIe sLory In LIuL sense Is compIeLeIy LIe sume us wIuL Iuppened Lo LIe RussIun economy
In zoo8-q. Hud LIe BoC Iud IoIIowed u vurIuLIon oI un Export Price Norm us LIe Reserve Bunk oI
AusLruIIu Is doIng LIen LIe neguLIve sIock wouId IIkeIy Iuve been mucI smuIIer us wus LIe cuse In
AusLruIIu.
Puge ;q oI 1zq
Puge ; oI 1zq
PEP, NCDPLT ond (hou to oooidJ Russion monetorg
policg foilure
um sILLIng In RIgu uIrporL und wrILIng LIIs. Iuve un eurIy (Loo eurIy!) IIIgIL Lo SLockIoIm. musL
udmIL IL mukes IL sIIgILIy more Iun Lo sIL In un uIrporL wIen you cun do u bIL oI bIoggIng.
Anywuy, Iuve been gIvIng quILe u bIL oI LIougIL Lo LIe JeII runkeI`s Ideu ubouL Peg Lo LIe ExporL
PrIce (PEP). WIuL runkeI`s Is suggesLIng Is LIuL commodILy exporLers IIke RussIu sIouId peg LIeIr
currencIes Lo LIe prIce oI LIe muIn commodILy LIey exporL - In LIe cuse oI RussIu LIuL wouId oI
course be LIe oII prIce.
TIIs Iuve mude me LIInk ubouL LIe moneLury LrunsmIssIon mecIunIsm In un EmergIng MurkeL
commodILy exporLer IIke RussIu und Iow very Iew peopIe reuIIy undersLund Iow moneLury poIIcy
works In un economy IIke LIe RussIun. Iuve, Iowever, Ior more LIun u decude us purL oI my duy-
job spend quILe u IoL oI LIme unuIysIng LIe RussIun economy so In LIIs posL wIII Lry Lo speII ouL
Iow see LIe IusL coupIe oI yeurs economIc deveIopmenL In RussIu Irom u moneLury perspecLIve.
The oil-money nexos und why u higher oil price is u demond shock in Rossiu
SInce LIe end oI communIsm LIe RussIun cenLruI bunk Ius prImurIIy conducLed moneLury poIIcy by
InLervenIng In LIe currency murkeL und currency InLervenLIon remuIns LIe RussIun cenLruI bunk`s
(CBR) mosL ImporLunL poIIcy InsLrumenL. (Yes, know LIIs Is u sImpIIIIcuLIon, buL beur wILI me.)
n LIe presenL RussIun moneLury seL-up LIe CBR munuges LIe rubIe wILIIn u IIucLuuLIon bund
uguInsL u buskeL oI euros (q%) und doIIurs (%). TIe composILIon oI LIe buskeL Ius cIunged over
LIme und LIe CBR Ius gruduuIIy wIdened LIe IIucLuuLIon bund so one cun suy LIuL we Loduy Ius
moved cIoser Lo u munuged or dIrLy IIouL ruLIer LIun u pureIy IIxed currency. However, despILe oI
Ior yeurs IuvIng Iud LIe oIIIcIuI InLenLIon oI movIng Lo u Iree IIouL IL Is very cIeur LIuL LIe CBR Ius u
quILe dIsLIncL Ieur oI IIouLIng. TIe CBR Is noL uIone In LIIs - muny cenLruI bunks uround LIe
worId suIIer Irom LIIs ruLIer IrruLIonuI Ieur. TIIs Is uIso LIe cuse Ior counLrIes In wIIcI LIe cenLruI
bunks oIIIcIuIIy pursue u IIouLIng excIunge ruLe poIIcy. How oILen Iuve you noL Ieurd cenLruI
bunkers compIuIn LIuL LIe currency Is Loo sLrong or Loo weuk?
Puge ;6 oI 1zq
WILI LIe rubIe beIng quusI-IIxed cIunges In LIe money suppIy Is busIcuIIy deLermIned by currency
InIIows und ouLIIows und us oII und gus Is RussIu`s muIn exporLs (uround 8o% oI LoLuI exporLs)
cIunges In LIe oII prIces deLermInes LIese IIows und Ience LIe money suppIy.
eLs suy LIuL LIe gIobuI demund Ior oII Increuses und us u consequence oII prIces Increuse by 1o%.
TIIs wIII more or Iess Ieud Lo un 1o% Increuse In LIe currency InIIow InLo RussIu. WILI InIIows
IncreusIng LIe rubIe wIII Lend Lo sLrengLIen. However, IIsLorIcuIIy LIe CBR Ius noL been Iuppy Lo
see sucI InIIow LrunsIuLe InLo u sLrengLIenIng oI LIe rubIe und us u consequence IL Ius InLervened In
LIe X murkeL Lo curb LIe sLrengLIenIng oI LIe rubIe. TIIs busIcuIIy meuns LIuL LIuL CBR Is prInLIng
rubIe und buyIng IoreIgn currency. TIe IogIc consequence oI LIIs Is LIe CBR ruLIer LIun uIIowIng
LIe rubIe Lo sLrengLIen InsLeud Is uccumuIuLIng ever-Iurger IoreIgn currency reserves us LIe oII
prIce Is IncreusIng. TIIs busIcuIIy Ius been LIe Lrend Ior LIe IusL decude or so.
So due Lo LIe CBR`s X poIIcy LIere Is u more or Iess dIrecL IInk Irom rIsIng oII prIces Lo un
expunsIon oI LIe RussIun money suppIy. As we uII know MV=PY so wILI uncIunged money-veIocILy
(V) un Increuse In M wIII Ieud Lo un Increuse In PY (nomInuI GDP).
TIIs IIIusLruLes u very ImporLunL poInL. NormuIIy we Lend Lo ussocIuLe Increuses In oII prIces wILI u
suppIy sIock. However, In LIe cuse oI RussIu und oLIer oII exporLIng counLrIes wILI pegged or
quusI-pegged excIunge ruLes un Increuse In LIe oII prIce wIII be u posILIve demcnd sIock. SuId In
unoLIer oLIer IIgIer oII prIces wIII pusI LIe AD curve Lo LIe rIgIL. TIIs Is uIso wIy IIgIer oII prIces
Iuve noL uIwuys Ieud Lo u IIgIer currenL uccounL surpIus In RussIu - IIgIer oII prIces wIII
boosL prIvuLe consumpLIon growLI und InvesLmenLs growLI LIrougI un Increuse In LIe money
suppIy. TIIs Is noL exucLIy good news Ior LIe currenL uccounL.
TIe poInL LIuL un Increuse In oII prIces Is u demund sIock In RussIu Is IIIusLruLed In LIe grupI
beIow. Over LIe pusL decude LIere Ius been u ruLIer sLrong posILIve correIuLIon cIunges In LIe prIce
oI oII (meusured In rubIe) und LIe growLI oI nomInuI GDP.
Puge ;; oI 1zq
TIIs correIuLIon, Iowever, cun onl exIsL us Iong us LIe CBR InLervenes In LIe X murkeL Lo curb
LIe sLrengLIenIng oI LIe rubIe und II LIe CBR IInuIIy moved Lo u Iree IIouLIng rubIe LIen LIe LIIs
correIuLIon mosL IIkeIy wouId breuk down. Hence, wILI u IreeIy IIouLIng rubIe LIe money suppIy und
Ience NGDP wouId be unuIIecLed by IIgIer or Iower oII prIces.
PIP woold eIIective huve been u 'prodoctivity norm' in Rossiu
So by uIIowIng LIe rubIe Lo upprecIuLe wIen oII prIces ure Increuse IL wIII eIIecLIve sLubIIIse LIe
deveIopmenL LIe money suppIy und LIereIore In NGDP. AnoLIer wuy Lo ucIIeve LIIs dIsconnecL
beLween NGDP und oII prIces wouId be Lo dIrecLIy peg LIe rubIe Lo LIe oII prIce. So un Increuse In
LIe oII prIce oI 1o% wouId dIrecLIy Ieud Lo un upprecIuLIon oI LIe rubIe oI 1o% (uguInsL LIe doIIur).
As LIe grupI ubove sIows LIere Ius been u very cIose correIuLIon beLween cIunges In LIe oII prIces
(meusured In rubIe) und NGDP. urLIermore, over LIe pusL decude oII prIces Ius Increused uround
zo% yeurIy versus LIe rubIe und LIe yeurIy uveruge growLI oI nomInuI GDP Ius been LIe exucLIy LIe
sume. As u consequence Iud LIe CBR pegged pegged LIe rubIe u decude ugo LIen LIe growLI oI
NGDP wouId IIkeIy Iuve uveruged o% per yeur.
WILI NGDP growLI pegged by PEP Lo o% we wouId eIIecLIveIy Iuve Iud wIuL George SeIgIn Ius
Lermed u producLIvILy norm In RussIu wIere IIgIer recl GDP growLI (IIgIer producLIvILy
growLI) wouId Ieud Lo Iower prIces. Remember uguIn - II MV=PY und MV Is IIxed LIrougI PEP
LIen uny Increuse In Y wIII Iuve Lo Ieud Lo Iower P. However, us oII prIces meusured In rubIe ure
IIxed IL wouId onIy be LIe prIces oI non-LrudubIe goods (IocuIIy produced und consumed goods),
Puge ;8 oI 1zq
wIIcI wouId drop. TIIs undoubLedIy wouId Iuve been u mucI beLLer poIIcy LIun LIe one LIe CBR
Ius pursued Ior LIe IusL decude - und u boom und busL wouId Iuve been uvoId Irom zoo Lo zooq.
(And yes, ussume LIuL nomInuI rIgIdILIes wouId not Iuve creuLed Loo Iurge probIems).
Rossiu boom-bost und how tight money cuose the ooS-q crisis in Rossiu
Anybody wIo vIsILs Moscow wIII Ieur sLorIes oI InsuneIy IIgI properLy prIces und especIuIIy durIng
LIe boom yeurs Irom zoo6 Lo wIen crIsIs IIL In zoo8 properLy prIces expIoded In RussIu`s bIg cILIes
sucI SL. PeLersburg und Moscow. TIere Is noL doubL In my mInd LIuL LIIs properLy murkeL boom
wus cuused my LIe very sLeep Increuse In LIe RussIun money suppIy wIIcI wus u dIrecL
consequence oI LIe CBR`s Ieur oI IIouLIng LIe rubIe. As oII prIces wIere IncreusIng und currency
InIIows ucceIeruLed In zoo6-; LIe CBR InLervened Lo curb LIe sLrengLIenIng oI LIe rubIe.
However, LIe boom cume Lo u sudden IuIL In zoo8, Iowever, unIIke wIuL Is LIe common
percepLIon LIe crIsIs LIuL IIL Iurd In zoo8 wus not u consequence oI LIe drop In oII prIces, buL
ruLIer us u resuIL oI too tight monetorg policg. Yes, my IrIends recessIons ure uIwuys und
everywIere u moneLury pIenomenon und LIuL Is uIso LIe cuse In RussIu!
GIobuI oII prIces sLurLed Lo drop In JuIy zoo8 und InILIuIIy LIe RussIun cenLruI bunk uIIowed LIe
rubIe Lo weuken. However, us LIe seII-oII In gIobuI oII prIces escuIuLed In Q zoo8 LIe CBR cIeurIy
sLurLed Lo worry ubouL LIe ImpucL IL wouId Iuve on rubIe. As u consequence LIe CBR sLurLed
InLervenIng very IeuvIIy In LIe X murkeLs Lo IuIL LIe seII-oII In LIe rubIe. ObvIousIy Lo do LIIs LIe
CBR Iud Lo buy rubIe und seII IoreIgn currency, wIIcI nuLuruIIy Ieud Lo drop In LIe RussIun IoreIgn
currency reserves oI uround zoobn doIIurs In Q zoo8 und u very sIurp conLrucLIon In LIe RussIun
money suppIy (Mz dropped uround zo%!). TIIs mIsguIded InLervenLIon In LIe currency murkeL und
LIe moneLury conLrucLIon LIuL IoIIowed Ieud Lo u coIIupse In RussIun properLy prIces und spurked u
mujor bunkIng crIsIs In RussIu - IuckIIy LIe IurgesL RussIun bunks wus noL Loo budIy uIIecLed by LIIs
u number medIum sIzed bunks coIIupsed In IuLe zoo8 und eurIy zooq. As u consequence money
veIocILy uIso conLrucLed, wIIcI IurLIer worsened LIe economIc crIsIs. n IucL LIe drop In reuI GDP
wus LIe IuLesL umong LIe Gzo In zoo8-q.
.und how monetury expunsion brooght Rossiu oot oI the crisis
Puge ;q oI 1zq
As LIe RussIun X reserve wus dwIndIIng In LIe AuLumn zoo8 LIe RussIun cenLruI bunk (probubIy)
reuIIsed LIuL eILIer IL wouId ceuse InLervenIng In LIe X or be Iuced wILI u sILuuLIon wIere LIe X
reserve wouId vunIsI. TIereIore by December zoo8 LIe CBR sLepped buck Irom LIe X murkeL und
uIIowed Ior u sLeeper decIIne In LIe vuIue oI LIe rubIe. As consequence LIe conLrucLIon In LIe
RussIun money suppIy cume Lo un end. urLIermore, us LIe ederuI Reserve IInuIIy sLurLed Lo euse
US moneLury poIIcy In eurIy zooq gIobuI oII prIces sLurLed Lo recover und us CBR now dId noL uIIow
LIe rub Lo sLrengLIen uL LIe sume puce oI rIsIng oII prIces LIe prIce oI oII meusured In rubIe Increuse
quILe u bIL In LIe IIrsL IuII oI zooq.
TIe moneLury expunsIon Ius conLInued unLII Loduy und us u consequence LIe RussIun economy Ius
conLInued Lo recover. n IucL conLrury Lo LIe sILuuLIon In LIe US und LIe euro zone one couId eusIIy
urgue LIuL moneLury LIgILenIng Is wurrunLed IL In RussIu.
Oil prices shoold be incloded in the RLB busket
Iope LIuL my urgumenLs ubove IIIusLruLe Iow LIe RussIun crIsIs oI zoo8-q cun be expIuIned by
wIuL LIe greuL Bob HeLzeI cuIIs LIe monetcr disorder tieu. Iuve no doubL LIuL II LIe RussIun
cenLruI bunk Iud uIIowed Ior u IreeIy IIouLIng rubIe LIen LIe boom (und mIsuIIocuLIon) In zoo6-;
wouId Iuve been reduced sIgnIIIcunLIy und Iud LIe rubIe been uIIowed Lo drop more sIurpIy In IIne
wILI oII prIces In LIe AuLumn oI zoo8 LIen LIe crIsIs wouId Iuve been mucI smuIIer und bunkIng
crIsIs wouId IIkeIy Iuve been uvoIded.
TIereIore, LIe poIIcy recommenduLIon musL be LIuL LIe CBR sIouId move Lo u Iree IIouL oI rubIe
und cerLuInIy LIInk IL wouId muke sense Ior RussIu uIso Lo InLroduce u NGDP IeveI LurgeL.
However, LIe RussIun cenLruI bunk despILe LIe promIses LIuL LIe rubIe soon wIII be IIouLed (uL LIe
momenL LIe CBR suy IL wIII Iuppen In zo1) cIeurIy seems Lo muInLuIn u Ieur oI IIouLIng.
urLIermore, wouId cuuLIon LIuL LIe quuIILy oI economIc duLu In RussIu In generuI Is ruLIer pure,
wIIcI wouId muke u reguIur NGDP IeveI LurgeLIng regIme more cIuIIengIng. AL LIe sume LIme wILI
u reIuLIveIy underdeveIoped IInuncIuI secLor und u generuIIy Iow IeveI oI IIquIdILy In LIe RussIun
IInuncIuI murkeLs IL mIgIL be cIuIIengIng Lo conducL moneLury poIIcy In RussIun LIrougI open
murkeL operuLIons und InLeresL ruLe cIunges.
Puge 8o oI 1zq
As u consequence IL mIgIL be un Ideu Ior RussIu Lo move Lowurds ImpIemenLIng PEP - or ruLIer u
vurIuLIon oI PEP. Toduy LIe CBR munuges LIe rubIe uguInsL u buskeL oI euros und doIIurs und In my
vIew IL wouId muke u IoL oI sense Lo expund LIIs buskeL wILI oII prIces. To begIn wILI oII prIces
couId be InLroduced InLo LIe buskeL wILI u zo% weIgIL und LIen u qo% weIgIL Ior boLI euros und
doIIurs. TIIs Is Iur Irom perIecL und LIe gouI cerLuInIy sIouId sLIII be Lo move Lo u Iree IIouLIng rubIe,
buL under LIe presenL cIrcumsLunces IL wouId be mucI preIerubIe Lo LIe presenL moneLury seL-up
und wouId sLrongIy reduce LIe rIsk oI renewed bubbIes In LIe RussIun economy und us weII us
InsurIng uguInsL u moneLury conLrucLIon In LIe evenL oI u new sIurp seII-oII In oII prIces.
.us um IInIsIIng LIIs posL my LuxI Is purkIng In IronL oI my IoLeI In SLockIoIm so now you know
wIuL you wIII be ubIe Lo wrILe goIng Irom uLvIu Lo Sweden on un eurIy Wednesduy mornIng. uLer
Loduy wIII be doIng u presenLuLIon Ior Dunske Bunk`s cIIenLs In SLockIoIm. TIe LopIcs ure
EmergIng MurkeLs und wIne economIcs! (Yes, wIne economIcs.uILer uII um u proud member Ior
LIe AmerIcun AssocIuLIon oI WIne EconomIsLs).
Puge 81 oI 1zq
The "Export Price Norm" sooed Austrolio from the
Creot Recession
MIILon rIedmun once suId never Lo underesLImuLe LIe ImporLunce oI Iuck oI nuLIons. beIIeve LIuL
Is very Lrue und LIInk LIe sume goes Ior cenLruI bunks. Some nuLIons cume LIrougI LIe sIock In
zoo8-q mucI beLLer LIun oLIer nuLIons und obvIousIy beLLer poIIcy und purLIcuIurIy beLLer
moneLury poIIcy pIuyed u key roIe. However, Iuck cerLuInIy uIso pIuyed u roIe.
LIInk u decIsIve IucLor wus LIe IeveI oI key poIIcy InLeresL ruLe uL LIe sLurL oI LIe crIsIs. I InLeresL
ruLes uIreudy were Iow uL LIe sLurL oI LIe crIsIs cenLruI bunks were - menLuIIy - unubIe Lo euse
moneLury poIIcy enougI Lo counLerucL LIe sIock us mosL cenLruI bunks dId operuLIonuIIy conducL
moneLury poIIcy wILIIn un InLeresL ruLe LurgeLIng regIme wIere u sIorL-Lerm InLeresL ruLe wus LIe
key poIIcy InsLrumenL. ObvIousIy LIere Is no IImILs Lo LIe umounL oI moneLury eusIng u cenLruI bunk
cun do - LIe money buse uILer uII cun be expunded us mucI us you wouId IIke - buL II LIe cenLruI
bunk Is onIy usIng InLeresL ruLes LIen LIey wIII Iuve u probIem us InLeresL ruLes geL cIose Lo zero.
urLIermore, IL pIuyed u key roIe wIeLIer demund Ior u counLry`s currency Increused or decreused
In response Lo LIe crIsIs. or exumpIe LIe demund Ior US doIIurs expIoded In zoo8 IeudIng Lo u
pussIve LIgILenIng oI moneLury poIIcy In LIe US, wIIIe LIe demund Ior Ior exumpIe TurkIsI IIru,
SwedIsI kronu or PoIIsI zIoLy coIIupsed.
As suId, Ior LIe US we goL moneLury LIgILenIng, buL Ior Turkey, Sweden und PoIund LIe drop In
money wus uuLomuLIc moneLury eusIng. TIuL wus Iuck und noLIIng eIse. TIe LIree menLIoned
counLrIes In IucL sIouId gIve reuson Lo be cureIuI ubouL cIeerIng Loo mucI ubouL LIe good cenLruI
bunks - TIe TurkIsI cenLruI bunk Ius done u mIserubIe job on communIcuLIon, LIe PoIIsI cenLruI
bunk mIgIL Iuve engIneered u recessIon by IIkIng InLeresL ruLes eurIIer LIIs yeur und LIe SwedIsI
cenLruI bunk now seems Lo be preoccupIed wILI IInuncIuI sLubIIILy und IouseIoId debL ruLIer LIun
IocusIng on IL`s own sLuLed InIIuLIon LurgeL.
n u recenL posL our IrIend und proIIIIc wrILer orenzo wroLe un InLeresLIng pIece on AusLruIIu und
Iow IL Ius been possIbIe Ior LIe counLry Lo uvoId recessIon Ior z1 yeurs. orenzo puL u IoL oI
empIusIs on moneLury poIIcy. ugree wILI LIuL - us recessIons ure uIwuys und everywIere u
moneLury pIenomenu - LIe key reuson Ius Lo be moneLury poIIcy. However, don`L wunL Lo gIve
LIe Reserve Bunk oI AusLruIIu (RBA) Loo mucI credIL. AILer uII you couId poInL Lo u number oI
Puge 8z oI 1zq
moneLury poIIcy bIunders In AusLruIIu over LIe IusL Lwo decudes LIuL poLenLIuIIy couId Iuve ended
In dIsusLer (see beIow Ior un exumpIe).
LIInk IundumenLuIIy Lwo LIIngs Iuve suved LIe AusLruIIun economy Irom recessIon Ior LIe IusL z1
yeurs.
IrsL oI uII Iuck. AusLruIIu Is u commodILy exporLer und commodILy prIces Iuve been goIng up Ior
more LIun u decude und wIen LIe crIsIs IIL In zoo8 LIe demund Ior AussIe doIIurs dropped ruLIer
LIun Increused und AusLruIIu`s key poIIcy ruLe wus reIuLIveIy IIgI so LIe RBA couId euse moneLury
poIIcy uggressIveIy wILIouL LIInkIng ubouL usIng oLIer InsLrumenLs LIun InLeresL ruLes. TIe RBA
wus no more prepured Ior conducLIng moneLury poIIcy uL LIe Iower zero bound LIun LIe Ied, LIe
ECB or LIe Bunk oI EngIund, buL IL dIdn`L need Lo be us prepured us InLeresL ruLes were mucI IIgIer
In AusLruIIu Lo begIn wILI - und LIe sIurp weukenIng oI LIe AussIe doIIur obvIousIy uIso dId LIe
RBA`s job eusIer. n IucL LIInk LIe RBA Is sLIII compIeLeIy unprepured Ior conducLIng moneLury
poIIcy In u zero InLeresL ruLe envIronmenL. um noL suyIng LIuL LIe RBA Is u bud cenLruI bunk - Iur
Irom IL - buL IL Is noL necessurIIy LIe exumpIe oI u super cenLruI bunk. L Is u cenLruI bunk, wIIcI
Ius done someLIIng rIgIL, buL cerLuInIy uIso Ius been more Iucky LIun Ior exumpIe LIe Ied or LIe
Bunk oI EngIund.
Second - und LIIs Is Iere LIe RBA deserves u IoL oI credIL - LIe RBA Ius been conducLIng IL`s
InIIuLIon LurgeLIng regIme In u ruLIer IIexIbIe IusIIon so IL Ius uIIowed occusIonuI oversIooLIng und
undersIooLIng oI LIe InIIuLIon LurgeL by beIng Iorwurd IookIng und LIuL wus cerLuInIy LIe cuse In
zoo8-q wIere IL dId noL punIc us InIIuLIon wus runnIng Loo IIgI compured Lo LIe InIIuLIon LurgeL.
One oI LIe reusons wIy LIInk LIe RBA Ius been reIuLIveIy successIuI Is LIuL IL eIIecLIveIy Ius
sIudowed u poIIcy oI wIuL JeII runkeI cuIIs PEP (Peg LIe currency Lo LIe ExporL PrIce) und wIuL
(now) LIInk sIouId be cuIIed un ExporL PrIce Norm (EPN). EPN Is busIcuIIy LIe open economy
versIon oI NGDP IeveI LurgeLIng.
I LIe prImury IucLor In nomInuI demund cIunges In LIe economy Is exporLs - us IL Lend Lo be In
smuII open economIes und In commodILy exporLIng economIes - LIen II LIe cenLruI bunk pegs LIe
prIce oI LIe currency Lo LIe prIce oI LIe prImury exporLs LIen LIuL eIIecLIveIy couId sLubIIIze
uggreguLe demund or NGDP growLI. TIIs Is In IucL wIuL beIIeve LIe RBA - probubIy unknowIngIy
Puge 8 oI 1zq
- Ius done over LIe IusL coupIe oI decudes und purLIcuIurIy sInce zoo8. As u resuIL LIe RBA Ius
sLubIIIzed NGDP growLI und LIereIore uvoIded moneLury sIocks Lo LIe economy.
Under u pure EPN regIme LIe cenLruI bunk wouId peg LIe excIunge ruLe Lo LIe exporL prIce. TIIs Is
obvIousIy noL wIuL LIe RBA Ius done. However, by IL`s communIcuLIon IL Ius sIgnuIIed LIuL IL
wouId noL mInd LIe AussIe doIIur Lo weuken und sLrengLIen In response Lo swIngs In commodILy
prIces - und Ience In swIngs In AusLruIIun exporL prIces. Hence, II one Iooks uL commodILy prIces
meusured by LIe so-cuIIed CRB Index und LIe AusLruIIun doIIur uguInsL LIe US doIIur over LIe IusL
coupIe oI decudes one wouId see LIuL LIere busIcuIIy Ius been u 1-1 reIuLIonsIIp beLween LIe Lwo us
II LIe AussIe doIIur Iud been pegged Lo LIe CRB Index. TIuL In my vIew Is LIe key reuson Ior LIe
sLubIIILy oI NGDP growLI over LIe pusL Lwo decude. TIe perIod Irom zooqJ unLII zoo8 Is un
excepLIon. n LIIs perIod LIe AussIe doIIur sLrengLIened Loo IILLIe compured Lo LIe Increuse In
commodILy prIces - eIIecLIveIy IeudIng Lo un excessIve eusIng oI moneLury condILIons - und II you
wunL Lo Iook Ior u reuson Ior LIe AusLruIIun properLy murkeL boom (bubbIe?) LIen LIuL Is IL.
TIIs Is Iow cIose LIe reIuLIonsIIp Is beLween LIe CRB Index und LIe AussIe doIIur (Indexed uL 1oo
In zoo8):
However, wIen LIe GreuL RecessIon IIL und gIobuI commodILy prIces pIummeL LIe RBA goL IL
neurIy perIecLIy rIgIL. TIe RBA couId Iuve punIcked und IIke InLeresL ruLes Lo curb LIe rIse In
IeudIIne consumer prIce InIIuLIon (CP InIIuLIon rose Lo uround % yJy) cuused by LIe weukenIng oI
LIe AussIe doIIur. L dId noL do so, buL ruLIer uIIowed LIe AussIe doIIur Lo weuken sIgnIIIcunLIy. n
Puge 8q oI 1zq
IucL LIe drop In commodILy prIces und In LIe AussIe doIIur In zoo8-q wus more or Iess LIe sume.
TIIs Is In my vIew Is LIe key reuson wIy AusLruIIu uvoIded recessIon - meusured us Lwo consecuLIve
quurLers oI neguLIve growLI - In zoo8-q.
Bot the RBA coold huve done u lot better
So yes, LIere Is reuson Lo pruIse LIe RBA, buL LIInk orenzo goes Loo Iur In IIs pruIse. A reuson
wIy um scepLIcuI Is LIuL LIe RBA Is mucI Loo Iocused on consumer prIce InIIuLIon (CP) und us
Iuve urgued so oILen beIore II u cenLruI bunk reuIIy wunLs Lo Iocus on InIIuLIon LIen uL IeusL LIe
cenLruI bunk sIouId be IocusIng on LIe GDP deIIuLor ruLIer on CP.
n my vIew AusLruIIu suw wIuL HuyekIun economIsLs cuII reIuLIve InIIuLIon In LIe yeurs prIor Lo
zoo8. Yes, InIIuLIon meusured by CP wus reIuLIveIy weII-beIuved, buL IookIng uL LIe GDP deIIuLor
InIIuLIonury pressures were cIeurIy buIIdIng und becuuse LIe RBA wus overIy Iocused on CP -
ruLIer LIun uggreguLe demundJNGDP growLI or LIe GDP deIIuLor - moneLury poIIcy becume
excessIveIy eusy und LIe Iud LIe RBA noL Iud LIe Iuck (und skIIIs?) IL Iud In zoo8-q LIen LIe
moneLury Induced boom couId Iuve Lurned InLo u nusLy busL. TIe sume sLory Is vIsIbIe Irom
sLudyIng nomInuI GDP growLI - wIIIe NGDP grew preLLy sLeudIIy uround 6% yJy Irom 1qqz Lo
zooz, buL Irom zooz Lo zoo8 NGDP growLI escuIuLed yeur-by-yeur und NGDP grew more LIun
1o% In zoo8. TIuL In my vIew wus u sIgn LIuL moneLury poIIcy wus becomIng excessIve eusy In
AusLruIIu. n LIuL regurd IL sIouId be noLed LIuL despILe LIe neguLIve sIock In zoo8-q und u recenL
IuIrIy murked sIowdown In NGDP growLI LIe ucLuuI IeveI oI NGDP Is sLIII somewIuL ubove LIe
1qqz-zooz Lrend IeveI.
George SeIgIn Ius IorceIuIIy urgued LIuL LIere Is good und bud deIIuLIon. Bud deIIuLIon Is drIven by
neguLIve demund sIocks und good deIIuLIon Is drIven by posILIve suppIy sIocks. George us
consequence oI LIIs Ius urgued In Iuvour oI wIuL Ie Ius cuIIed u producLIvILy norm - eIIecLIveIy
un NGDP LurgeL.
beIIeve LIuL we cun muke u sImIIur urgumenL Ior commodILy exporLers. However, Iere IL Is noL u
producLIvILy sIock, buL u weuILI sIock. HIgIer gIobuI commodILy prIces Is u posILIve weuILI
sIock Ior commodILy exporLers (rIedmun wouId suy IIgIer permunenL Income). TIIs Is sImIIur Lo
u posILIve producLIvILy sIock. TIe wuy Lo ensure sucI weuILI sIock Is LrunsIerred Lo LIe
Puge 8 oI 1zq
consumers In LIe economy Is LIrougI benIgn consumer prIce deIIuLIon (dIsInIIuLIon) und you geL
LIuL LIrougI u sLronger currency, wIIcI reduces ImporL prIces. However, u drop In gIobuI
commodILy prIces Is u neguLIve demund sIock Ior u commodILy exporLIng counLry und LIuL you
wunL Lo uvoId. TIe wuy Lo do LIuL Is Lo uIIow LIe currency Lo weuken us commodILy prIces drop.
TIIs Is wIy LIe ExporL PrIce Norm mukes so mucI sense Ior commodILy exporLers.
TIe RBA eIIecLIve ucLed us II IL Iud un (vurIuLIon oI LIe) ExporL PrIce Norm In zoo8-q, buL cerLuInIy
IuIIed Lo do so In LIe boom yeurs prIor Lo LIe crIsIs. n LIose pre-crIsIs yeurs LIe RBA sIouId Iuve
LIgILened moneLury poIIcy condILIons mucI more LIun IL dId und eIIecLIveIy uIIowed LIe AussIe
doIIur Lo sLrengLIen more LIun IL dId. TIuL wouId IIkeIy Iuve pusIed CP InIIuLIon weII-beIow LIe
RBA`s oIIIcIuI InIIuLIon (CP) LurgeL oI z-%. TIuL, Iowever, wouId Iuve been jusL IIne - LIere Is no
Iurm done In consumer prIce deIIuLIon generuLed by posILIve producLIvILy sIocks or posILIve weuILI
sIocks. WIen you become weuILIIer IL sIouId sIow up In Iow consumer prIces - or uL IeusL u sIower
growLI oI consumer prIce InIIuLIon.
So whut shoold the RBA do now?
TIe RBA munuged LIe crIsIs weII, buL us Iuve urgued ubove LIe RBA wus uIso IuIrIy Iucky und
LIere Is cerLuInIy no reuson Lo be overIy conIIdenL LIuL LIe nexL sIock wIII be IundIed equuIIy weII.
LIereIore LIInk LIere ure Lwo muIn ureus wIere LIe RBA couId Improve on IL operuLIonuI
Irumework - oLIer LIun LIe obvIous one oI InLroducIng un NGDP IeveI LurgeLIng regIme.
IrsL, LIe RBA sIouId muke IL compIeLeIy cIeur Lo InvesLors und oLIer ugenLs In LIe economy wIuL
operuLIonuI Irumework LIe RBA wIII be usIng II LIe key poIIcy ruLe wIere Lo IIL zero.
Second, LIe RBA sIouId be more cIeur In IL communIcuLIon ubouL LIe IInk beLween cIunges In
commodILy prIces (meusured In AussIe doIIurs) und uggreguLe demundJNGDP und LIuL IL consIder
LIe commodILy-currency IInk us key eIemenL In LIe AusLruIIun moneLury LrunsmIssIon mecIunIsm
- expIIcILIy ucknowIedgIng LIe ImporLunce oI LIe ExporL PrIce Norm.
TIe Lwo poInLs ubove couId oI course eusIIy be combIned. TIe RBA couId sImpIy unnounce LIuL IL
wIII conLInue IL`s presenL operuLIonuI Irumework, buL II InLeresL ruLes wIere Lo drop beIow Ior
exumpIe 1% IL wouId uuLomuLIcuIIy peg LIe AussIe doIIur Lo LIe CRB Index und LIen LIereuILer
unnounce moneLury poIIcy cIunges In Lerms oI LIe cIunges Lo LIe AussIe doIIur-CRB purILy.
Puge 86 oI 1zq
AusLruIIun NGDP sLIII remuIns somewIuL ubove LIe oId Lrend und us sucI moneLury poIIcy Is Loo
Ioose. However, gIven LIe IucL LIuL we Iuve been oII-Lrend Ior u decude IL probubIy wouId muke
very IILLIe sense Lo Iorce NGDP buck down Lo LIe oId Lrend. RuLIer LIe RBA sIouId unnounce LIuL
moneLury poIIcy Is now neuLruI und LIuL IL In LIe IuLure wIII keep NGDP growLI uround u % or
6% Lrend (IeveI LurgeLIng). UsIng LIe Lrend IeveI sLurLIng In Ior exumpIe zoo; In my vIew wouId be u
useIuI bencImurk.
L Is preLLy cIeur LIuL AusLruIIun moneLury condILIons ure LIgILenIng uL LIe momenL, wIIcI Is vIsIbIe
In boLI weuk NGDP growLI und LIe IucL LIuL commodILy prIces meusured In AusLruIIun doIIurs ure
decIInIng. urLIermore, IL sIouId be noLed LIuL GDP deIIuLor growLI (yJy) Lurned neguLIve eurIIer
In LIe yeur - uIso IndIcuLIng sIurpIy LIgILer moneLury condILIons. urLIermore, NGDP Ius now
dropped beIow LIe - somewIuL urbILrury - zoo;-1z NGDP Lrend IeveI. AII LIuL couId seem Lo
IndIcuLe LIuL moderuLe moneLury eusIng Is wurrunLed.
ConcIudIng, LIe RBA dId u IuIrIy good job over LIe pusL Lwo decudes, buL Iuck cerLuInIy pIuyed u
mujor roIe In wIy AusLruIIu Ius uvoIded recessIon und II LIe RBA wunLs Lo preserve IL`s good
repuLuLIon In LIe IuLure LIen IL needs Lo Iook uL u Iew deLuIIs (some mujor) In LIe Iow IL conducLs
ILs moneLury poIIcy.
PS couId obvIousIy LeII LIe sume sLory Ior oLIer commodILy exporLers sucI us Norwuy, Cunudu,
RussIu, BruzII or AngoIu Ior LIuL muLLer und LIese counLrIes ucLuuIIy needs LIe Iesson u IoL more
LIun LIe RBA (muybe wILI LIe excepLIon oI Cunudu).
PPS SomeLImes MurkeL MoneLurIsL bIoggers - IncIudIng myseII - probubIy sound IIke II we wIere
onIy runnIng LIIngs LIen everyLIIng wouId be beLLer. wouId sLress LIuL don`L LIInk so. um IuIIy
uwure oI LIe InsLILuLIonuI und poIILIcuI consLruIns LIuL every cenLruI bunker In LIe worId Iuces.
urLIermore, one couId eusIIy urgue LIuL cenLruI bunks by consLrucLIon wIII never be ubIe Lo do u
good job und wIII uIwuys be doomed Lo IuII (jusL usk PeLe BoeLLke or urry WIILe). As everybody
knows Iuve u IoL oI sympuLIy Ior LIuL vIew. However, we need Lo Iuve u debuLe ubouL moneLury
poIIcy und Iow we cun Improve IL - uL IeusL us Iong us we muInLuIn cenLruI bunks. And don`L LIInk
LIe unswer Is beLLer cenLruI bunkers, buL ruLIer wunL beLLer InsLILuLIons. L Is correcL IL mukes u
dIIIerence wIo runs LIe cenLruI bunks, buL LIe InsLILuLIonuI Irumework Is mucI more ImporLunL
Puge 8; oI 1zq
und u dIscussIon ubouL pusL und presenL IuIIures oI cenLruI bunks wIII IopeIuIIy IeIp sIupe LIe
Ideus Lo secure more sound moneLury sysLems In LIe IuLure.
PPPS sIouId suy LIIs posL wus InspIred noL onIy by orenzo`s posL und my Iong LIme LIInkIng LIe
LIuL LIe RBA Iud been Iucky, buL uIso by SuLuros` commenLs Lo my eurIIer posL on MuIuysIu.
SuLuros poInLed ouL LIe dIIIerence beLween LIe GDP deIIuLor und CP In AusLruIIu Lo me. TIuL wus
un ImporLunL ImporL Lo LIIs posL.
Puge 88 oI 1zq
1eor-of-flooting, misollocotion ond the lou of
comporotioe odoontoges
TIe IIrsL commundmenL oI cenLruI bunkIng sIouId be thou shcll not distort relctite prices.
However, cenLruI bunkers oILen Lend Lo IorgeL LIIs - knowIngIy or unknowIngIy. How oILen Iuve we
noL Ieurd sLern wurnIngs Irom cenLruI bunkers LIuL properLy prIces ure Loo IIgI or Loo Iow - or LIuL
u currency Is overvuIued or undervuIued. And In LIe IusL coupIe oI yeurs cenLruI bunkers Iuve even
LrIed Lo munIpuIuLe LIe sIupe oI LIe bond yIeId curve - jusL LIInk oI LIe ed`s operuLIon LwIsL.
CenLruI bunkers ure dIsLorLIng reIuLIve prIces In muny wuys - by Ior exumpIe by LryIng Lo prIck
bubbIes (or wIuL LIey LIInk ure bubbIes). SomeLImes LIe dIsLorLIon oI reIuLIve prIces Is done
unknowIngIy. TIe besL exumpIe oI LIIs Is wIen cenLruI bunks operuLe un InIIuLIon LurgeL. BoLI
George SeIgIn und DuvId EugIe LeucI us LIuL InIIuLIon LurgeLIng meuns LIuL cenLruI bunks reucL Lo
suppIy sIocks und LIereby dIsLorL reIuLIve prIces. n un open economy LIIs wIII Ieud Lo u dIsLorLIon
oI LIe reIuLIve prIces beLween Lrude goods und non-Lruded goods.
As wIII sIow beIow cenLruI bunkers` eugerness Lo dIsLorL reIuLIve prIces Is us IurmIuI us oLIer
dIsLorLIons oI reIuLIve prIces Ior exumpIe us u resuIL oI proLecLIonIsm und wIII oILen Ieud Lo
numerous neguLIve sIde-eIIecLs.
The Ieur-oI-Ilouting - the violution oI the Luw oI compurutive udvuntuges
Iuve recenLIy gIven u bIL oI uLLenLIon Lo LIe concepL oI Ieur-oI-IIouLIng. DespILe beIng oIIIcIuIIy
commILLed Lo IIouLIng excIunge ruLes muny cenLruI bunks Irom LIme Lo LIme InLervene In LIe X
murkeLs Lo munuge LIe currency. As Iuve eurIIer noLed u good exumpIe Is LIe NorwegIun cenLruI
bunk (Norges Bunk), wIIcI oILen Ius InLervened eILIer dIrecLIy or verbuIIy In LIe currency murkeL
or verbuIIy Lo Lry Lo curb LIe sLrengLIenIng oI LIe NorwegIun krone. n MurcI Ior exumpIe Norges
Bunk surprIsIngIy cuL InLeresL ruLes Lo curb LIe sLrengLIenIng oI LIe krone - despILe LIe generuI
mucroeconomIc sILuuLIon reuIIy wurrunLed u LIgILenIng oI moneLury condILIons.
So wIy Is Norge Bunk so IeurIuI oI u LruIy Iree IIouLIng krone? TIe besL expIunuLIon In LIe cuse oI
Norwuy Is LIuL LIe cenLruI bunk`s Ieurs LIuL wIen oII prIces rIse LIen LIe NorwegIun krone wIII
sLrengLIen und Ience muke LIe non-oII secLors In LIe economy Iess compeLILIve. TIIs Is wIuL
Puge 8q oI 1zq
Iuppened In zoo wIen u sIurp upprecIuLIon oI LIe krone cuuse un exodus oI non-oII secLor
compunIes Irom Norwuy. Hence, LIere Is no doubL LIuL IL Is u sub-LurgeL oI NorwegIun moneLury
poIIcy Lo ensure u dIversIIIed NorwegIun economy. TIIs poIIcy Is sLrongIy supporLed by LIe
NorwegIun governmenL`s oLIer poIIcIes - Ior exumpIe mussIve governmenL supporL Ior LIe
ugrIcuILuruI secLor. Norwuy Is noL u EU member - und beIIeve IL or noL governmenL subsIdIes Ior
LIe ugrIcuILuruI secLor Is lcrer LIun In LIe EU!
However, In LIe sume wuy us governmenL subsIdIes Ior LIe ugrIcuILuruI secLor dIsLorL economIc
uIIocuLIon so do InLervenLIon In LIe currency murkeL. However, wIIIe mosL economIsLs ugree LIuL
governmenL subsIdIes Ior uIIIng IndusLrIes Is vIoIuLIng LIe Iuw oI compuruLIve udvunLuges und Ieud
Lo u generuI economIc Iose In LIe Iorm oI Iower producLIvILy und Iess InnovuLIon Iew economIsLs
seem Lo be uwure LIuL LIe Ieur-oI-IIouLIng (IncIudIng IndIrecL Ieur-oI-IIouLIng vIu InIIuLIon LurgeLIng)
Iuve LIe sume ImpucL.
eLs Iook uL un exumpIe. eL suy LIuL oII prIces Increuse by o% und LIuL Lend Lo sLrengLIen LIe
NorwegIun krone. TIIs Is LIe sume us Lo suy LIuL LIe demund curve In LIe oII secLor Ius sIIILed Lo
LIe rIgIL. TIIs wIII Increuse LIe demund Ior Iubour und cupILuI In LIe oII secLor. n u IreeIy mobIIe
Iubour murkeL LIIs wIII pusI up suIurIes boLI In LIe oII secLor und In LIe none-oII secLor. Hence, LIe
none-oII secLor wIII become Iess compeLILIve - boLI us u resuIL oI IIgIer Iubour und cupILuI cosLs,
buL uIso becuuse oI u sLronger krone. As u consequence Iubour und cupILuI wIII move Irom LIe non-
oII secLor Lo LIe oII secLor. MosL economIsLs wouId ugree LIuL LIIs Is u nuLuruI murkeL process LIuL
ensures LIe mosL producLIve und proIILubIe use oI economIc resources. As DuvId RIcurdo LuugIL us
Iong ugo - counLrIes sIouId produce LIe goods In wIIcI LIe counLry Ius u compuruLIve udvunLuge.
TIe unIumpered murkeL mecIunIsm ensures LIIs.
However, II LIe cenLruI bunk suIIers Irom Ieur-oI-IIouLIng LIen LIe cenLruI bunk wIII InLervene Lo
curb LIe sLrengLIenIng oI LIe krone. TIIs Ius Lwo consequences. IrsL, LIe Increuse In proIILubIIILy
In LIe oII secLor wIII be smuIIer LIun IL wouId Iuve been Iud LIe krone been uIIowed Lo sLrengLIen.
TIIs wouId uIso meun LIuL LIe Increuse In demund Ior cupILuI und Iubour In LIe oII secLor wouId be
smuIIer LIun IL wouId Iuve been II LIe krone Iud been uIIowed Lo IIouL compIeLeIy IreeIy (or Iud
been pegged Lo LIe oII prIce). Second, LIIs wouId meun LIuL LIe scuIIng down oI LIe non-oII secLor
wIII be smuIIer LIun oLIerwIse wouId Iuve been LIe cuse - und us u resuIL LIIs secLor wIII demund
Loo mucI Iubour und cupILuI reIuLIve Lo wIuL Is economIcuIIy opLImuI. TIIs Is exucLIy wIuL LIe
Puge qo oI 1zq
cenLruI bunk wouId IIke Lo see. However, LIInk LIe exumpIe preLLy cIeurIy sIows LIuL sucI us
poIIcy Is vIoIuLIng LIe Iuw oI compuruLIve udvunLuges. ReIuLIve prIces ure dIsLorLed und us u resuIL
LIe LoLuI economIc ouLpuL und weIIure wIII be smuIIer LIun wouId Iuve been LIe cuse under u IreeIy
IIouLIng currency.
L Is oILen urgued LIuL II LIe oII prIce Is very voIuLIIe und LIe krone (or unoLIer oII-exporLIng
counLry`s currency) LIereIore wouId be more voIuLIIe und us u consequence LIe non-oII secLor wIII
see Iurge swIngs In economIc ucLIvILy und IL wouId be In LIe InLeresL oI LIe cenLruI bunk Lo reduce
LIIs voIuLIIILy und LIereby sLubIIIse LIe deveIopmenL In LIe non-oII secLor. However, LIIs compIeLeIy
mIsses LIe poInL wILI Iree murkeLs. PrIces sIouId be uIIowed Lo udjusL Lo ensure un eIIIcIenL
uIIocuLIon oI cupILuI und Iubour. I you InLervene In LIe murkeL process uIIocuLIon oI resources wIII
be Iess eIIIcIenL.
urLIermore, LIe cenLruI bunk cunnoL permcnentl dIsLorL reIuLIve prIces. I LIe currency Is kepL
urLIIIcIuIIy weuk by eusIer moneLury poIIcy IL wIII jusL InIIuLed LIe enLIre economy - und us u resuIL
cupILuI und Iubour cosL wIII Increuse - us wIII InIIuLIon - und sooner or IuLer LIe compeLILIve
udvunLuge creuLed by un urLIIIcIuIIy weuk currency wIII be gruduuIIy euLen by IIgIer prIces und
wuges. n un economy wIere wuges und prIces ure downwurd rIgId - us sureIy Is LIe cuse In LIe
NorwegIun economy - LIIs wIII creuLed mujor udjusLmenL probIems II oII prIces drops sIurpIy
especIuIIy II LIe cenLruI bunk uIso Lry Lo curb LIe weukenIng oI LIe currency (us LIe RussIun cenLruI
bunk dId In zoo8). Hence, by LryIng Lo dumpen LIe swIngs In LIe X ruLes LIe cenLruI bunk wIII
ucLuuIIy move LIe udjusLmenL process Irom LIe X murkeLs (wIIcI Is IIgIIy IIexIbIe) Lo LIe mucI
Iess IIexIbIe Iubour und good murkeLs. So even LIougI LIe cenLruI bunk mIgIL wunL Lo curb LIe
voIuLIIILy In economIc ucLIvILy In LIe non-oII secLor IL wIII ucLuuIIy ruLIer Increuse LIe generuI IeveI
oI voIuLIIILy In LIe economy. n un economy wILI IuIIy IIexIbIe prIces und wuges LIe munIpuIuLIon oI
LIe X ruLe wouId noL be u probIem. However, II Ior exumpIe wuges ure downwurd rIgId becuuse
InLervenLIonIsL Iubour murkeL poIIcy us IL Is LIe cuse In Norwuy LIen u poIIcy oI curbIng LIe
voIuLIIILy In LIe X ruLe quILe obvIousIy (Lo me uL IeusL) Ieuds Lo Iower producLIvILy und IIgIer
voIuLIIILy In boLI nomInuI und ruLe vurIubIes.
Iuve used LIe NorwegIun economy us un exumpIe. sIouId sLress LIuL mIgIL us weII Iuve used
Ior exumpIe BruzII or RussIu - us LIe cenLruI bunks In LIese counLrIes Lo u mucI Iurger degree LIun
Puge q1 oI 1zq
Norges Bunk suIIers Irom u Ieur-oI-IIouLIng. couId In IucL uIso Iuve used LIe ECB us LIe ECB
IndIrecLIy suIIers Irom u Ieur-oI-IIouLIng us LIe ECB Is LurgeLIng InIIuLIon.
um noL uwure oI uny reseurcI on LIe consequences Ior producLIvILy oI Ieur-oI-IIouLIng, buL um
sure IL couId be un InLeresLIng ureu oI reseurcI - wonder II Norge Bunks Is uwure Iow bIg LIe
producLIve Iose In LIe NorwegIun economy Ius been due Lo IL`s poIIcy oI curbIng oII prIce drIven
swIngs In LIe krone. um preLLy sure LIuL LIe RussIun cenLruI bunk und LIe BruzIIIun cenLruI bunk
Iuve noL gIven LIIs mucI LIougIL uL uII. NeILIer Ius mosL oLIer EmergIng MurkeL cenLruI bunks
LIuL IrequenLIy InLervenes In LIe X murkeLs.
PS do need Lo suy Iow Lo uvoId LIese probIems? Yes you guessed rIgIL - NGDP IeveI LurgeLIng or
by peggIng LIe currency Lo LIe oII prIce. I you wunL Lo sLuy wILI In u InIIuLIon LurgeLIng Irumework
LIen cenLruI bunk cenLruI bunk sIouId uL IeusL LurgeL domesLIc demund InIIuLIon or wIuL
eurIIer InspIred by DuvId EugIe Ius Lermed QuusI-ReuI InIIuLIon (QRP).
PS Toduy um spendIng my duy In ondon - wroLe LIIs on LIe IIIgIL. beL u cerLuIn Germun
cenLruI bunker wIII be IIgI on LIe ugendu In my meeLIngs wILI cIIenLs.
Puge qz oI 1zq
Morkets, moneg ond the tronsmission
mechonism
Cideon Cono, o time mochine ond the liguiditg trop
Here Is u quoLe Irom u rundom urLIcIe Irom LIe IInuncIuI medIu In zoo8:
Centrcl bcnls cround the uorld cre rcpidl depletin their cmmunition cs interest rctes hecd to
unpcrclleled lous
L Is quILe common LIuL IL Is cIuImed LIuL cenLruI bunks uround LIe worId ure ouL oI ummunILIon
becuuse InLeresL ruLes ure cIose Lo zero und LIuL LIere LIereIore ure no more opLIons Ior moneLury
sLImuIus. MurkeL MoneLurIsL obvIousIy dIsugrees sLrongIy wILI LIuL ussessmenL, buL we ure up
uguInsL u Iong runnIng LrudILIon.
eLs jump InLo u LIme mucIIne und IusLbuck Lo 1q. TIIs Is US congressmun T. AIun GoIdsborougI
supporLIng ederuI Reserve cIuIrmun MurrIner EccIes In CongressIonuI IeurIngs on LIe BunkIng
AcL oI 1q:
Governor EccIes: Under present circumstcnces, there is ter little, ij cn, thct ccn be done.
Congressmun GoIdsborougI: You mecn ou ccnnot push on c strin.
Governor EccIes: Thct is c ter ood uc to put it, one ccnnot push on c strin. We cre in the
depths oj c depression cnd. beond crectin cn ecs mone situction throuh reduction oj
discount rctes, there is ter little, ij cnthin, thct the reserte orcnizction ccn do to brin cbout
recoter
TIere Is now doubL LIuL even In 1q LIe sILuuLIon wus quILe desperuLe, buL noL us desperuLe us IL
wus beIore LIe US wenL oII goId In 1q.
So IurLIer buck Lo 1qz.
Puge q oI 1zq
n 1qz LIe US economy Is deep In depressIon, unempIoymenL Is mussIveIy IIgI und deIIuLIon Ius
never been sLronger.
TIe sILuuLIon Is desperuLe Ior presIdenL Hoover. No muLLer wIuL Ideus Ie comes up wILI noLIIng
works und Ie sLunds no cIunce oI wInnIng LIe upcomIng presIdenLIuI eIecLIons.
TIe cIuIrmun oI LIe ederuI Reserve Eugene Meyer Is LeIIIng Hoover LIuL Ie sIouId use IIscuI
poIIcy Lo boosL LIe economy, buL LIuL moneLury poIIcy IoosenIng Is no opLIon.
BuL LIen IL uII becomes very scI-II - Meyer Is beumed up by ScoLLy (Sumner) und repIuced by
ZImbubweun cenLruI bunk governor GIdeon Gono.
We need u IILLIe be more scI-II: Everybody In 1qz knows LIe repuLuLIon oI GIdeon Gono us u money
prInLIng psycIo cenLruI bunker.
So wIuL Iuppened wIen Gono Is beumed buck Lo 1qz? WeII, everybody knows LIuL Ie doesn`L cure
ubouL uny sLrIngs on money poIIcy - Ie jusL prInL money IIke u mud mun und everybody knows LIuL
Ie creuLed IyperInIIuLIon In IIs prevIous job. So wIuL wouId you expecL? TIey wouId oI course
expecL InIIuLIon! And LIey wouId expecL LIe US Lo gIve up LIe goId sLundurd very IusL - uILer uII
GIdeon Gono Is noL exucLIy Bob MurpIy. And Ie probubIy wouId so wILI In mInuLes oI urrIvIng
buck In 1qz.
WIuL Iuppens now? Everybody reuIIse LIuL LIe vuIue oI cusI wIII noL conLInue Lo Increuse so LIere
wIII be no reuson Lo Iourd cusI. RuLIer suddenIy LIe doIIurs ure burnIng IoIes In peopIe pockeLs.
And LIe sume goes Ior bunks und corporuLIons: We don`L wunL doIIur unymore. TIIs Is LIe IoL
poLuLo eIIecL In moneLury LIeory. Money demund coIIupse reIuLIve Lo LIe money suppIy. TIuL Is
moneLury IoosenIng!
So moneLury poIIcy works wILI Iong und vurIubIe EADS - In IucL wILI LIme wurpIng Ieuds.
usL Iorwurd Lo zo11. TIe gIobuI economy Is on LIe verge oI u new depressIon - LIe LuIk oI u debL-
deIIuLIon conLInues neurIy Iour yeurs InLo LIe GreuL RecessIon. An economIcs proIessor ScoLLy
sLurLs bIoggIng ubouL moneLury poIIcy. HIs bIg Iero Is GIdeon Gono - LIe ed cIuIrmun wIo In
Puge qq oI 1zq
1q puIIed ouL LIe US Irom LIe GreuL DepressIon und wILI IL LIe resL oI LIe worId. Nobody wouId
remember HILIer und we wouId sLIII be LuIkIng ubouL LIe GreuL Wur ruLIer LIun WorId Wur 1.
And no GIdeon Gono wus never u good cenLruI bunk und Ie wouId probubIy Iuve sLoIen LIe US goId
reserve once Ie Iunded buck In 1qz. TIIs Is noL un endorsemenL oI InIIuLIonIsL poIIcIes or Insune
cenLruI bunkers, buL un IIIusLruLIon oI LIe ImporLunce oI wIuL expecLuLIons meun Ior moneLury
poIIcy eIIecLIveness.
PS uILer GIdeon Gono becume ed cIuIrmun Hoover won LIe presIdenLIuI cumpuIgn und becume
LIe IongesL servIng US presIdenL ever und becume u mucI Ioved presIdenL In LIe RepubIIcun purLy.
TIey cuII IIm: TIe presIdenL wIo undersLood moneLury poIIcy. And LIe RepubIIcun purLy Is
Iorever gruLeIuI Lo Hoover Ior never IuvIng InLroduced SocIuI SecurILy. And mosL ImporLunL PuuI
Krugmun wouId Iook preLLy sLupId wIen Ie wenL on und on ubouL LIe IIquIdILy Lrup.
PPS IuckIIy GIdeon Gono wus noL beumed buck Lo 1q;q.
PPPS I you wunL Lo reud u LruIy Insune book on moneLury poIIcy Iuve u Iook uL GIdeon Gono`s
musLerpIece: ZImbubwe`s CusIno Economy: ExLruordInury Meusures Ior ExLruordInury
CIuIIenges.
Puge q oI 1zq
"Ben Volcker" ond the monetorg
tronsmission mechonism
um IncreusIngIy reuIIsIng LIuL u key probIem In LIe MurkeL MoneLurIsL urgumenLs Ior NGDP IeveI
LurgeLIng Is LIuL we Iuve noL been very cIeur In our urgumenLs concernIng Iow IL wouId ucLuuIIy
work.
We urgue LIuL we sIouId LurgeL u cerLuIn IeveI Ior NGDP und LIen IL seems IIke we jusL expecL IL Loo
Iuppen more or Iess by ILseII. Yes, we urgue LIuL LIe cenLruI bunk sIouId conLroI LIe money buse Lo
ucIIeve LIIs LurgeL und LIIs couId done wILI LIe use oI NGDP IuLures. However, sLIII LIInk LIuL we
need Lo be even cIeurer on LIIs poInL.
TIereIore, we reuIIy need u MurkeL MoneLurIsL LIeory oI LIe moneLury LrunsmIssIon mecIunIsm. n
LIIs posL wIII Lry Lo skeLcI sucI u LIeory.
Combining "old moneturist insights with rutionul expectutions
TIe IIsLorIcuI debuLe beLween oId keynesIuns und oId moneLurIsLs pIuyed ouL In LIe IuLe 1q6os
und LIe 1q;os busIcuIIy wus cenLre uround LIe SJM modeI.
TIe debuLe ubouL LIe SJM modeI wus boLI empIrIcuI und LIeoreLIcuI. On LIe Iund keynesIuns
und moneLurIsLs wIere debuLIng LIe Iow Iurge LIe InLeresL ruLe eIusLIcILy wus oI money und
InvesLmenLs respecLIveIy. Hence, IL wus more or Iess u debuLe ubouL LIe sIope oI LIe S und M
curves. n mucI oI especIuIIy MIILon rIedmun wrILIngs Ie seems Lo uccepL LIe overuII SJM
Irumework. TIIs Is someLIIng LIuL reuIIy IrusLruLes me wILI mucI oI rIedmun`s work on LIe
LrunsmIssIon mecIunIsm und oLIer moneLurIsLs uIso crILIcIzed rIedmun Ior LIIs. PurLIcuIurIy KurI
Brunner und AIIun MeILzer were crILIcuI oI rIedmun`s moneLury Irumework und Ior IIs
compromIses wILI LIe keynesIuns on LIe SJM modeI.
Brunner und MeILzer InsLeud suggesLed un uILernuLIve Lo LIe SJM modeI. n my vIew Brunner und
MeILzer provIdes numerous ImporLunL InsIgILs Lo LIe moneLury LrunsmIssIon mecIunIsm, buL IL
oILen becomes unduIy compIIcuLed In my vIew us LIeIr poInLs reuIIy ure reIuLIveIy sImpIe und
sLruIgIL Iorwurd.
Puge q6 oI 1zq
AL LIe core oI LIe Brunner-MeILzer crILIque oI LIe SJM modeI Is LIuL LIere onIy ure Lwo usseLs In
LIe SJM modeI - busIcuIIy money und bonds und II more usseLs ure IncIuded In LIe modeI sucI us
equILIes und reuI esLuLe LIen LIe concIusIons druwn Irom LIe modeI wIII be drusLIcuIIy dIIIerenL
Irom LIe sLundurd SJM modeI. L Is especIuIIy noLubIe LIuL LIe IIquIdILy Lrup urgumenL breuks
down LoLuIIy wIen more LIun Lwo usseLs ure IncIuded In LIe modeI. TIIs obvIousIy uIso Is key Lo LIe
MurkeL MoneLurIsL urgumenLs uguInsL LIe exIsLence oI LIe IIquIdILy Lrup.
TIIs meun LIuL moneLury poIIcy noL onIy works vIu LIe bond murkeL (In IucL LIe money murkeL). n
IucL we couId eusIIy ImugIne u LIeoreLIcuI worId wIere InLeresL ruLes dId noL exIsL und moneLury
poIIcy wouId work perIecLIy weII. mugInIng u SJM modeI wIere we Iuve Lwo usseLs. Money und
equILIes. n sucI u worId un Increuse In LIe money suppIy wouId pusI up LIe prIces oI equILIes. TIIs
wouId reduce LIe IundIng cosLs oI compunIes und Ience Increuse InvesLmenLs. AL LIe sume LIme IL
wouId Increuse IoIdIoIds weuILI (II LIey IoId equILIes In LIeIr porLIoIIo) und LIIs wouId Increuse
prIvuLe consumpLIon. n LIIs worId moneLury poIIcy works perIecLIy weII und LIe LIere Is no
probIem wILI u zero Iower bound on InLeresL ruLes. TIrow In LIe reuI esLuLe murkeL und u IoreIgn
excIunge murkeLs und LIen you Iuve Lwo more cIunneIs by wIIcI moneLury poIIcy works.
Hence, LIe MurkeL MoneLurIsL perspecLIve on moneLury poIIcy LIe IoIIowIng dIcLum IoIds:
"Monetury policy works throogh muny chunnels
Keynesiuns ure still obsessed uboot interest rutes
usL Iorwurd Lo LIe debuLe Loduy. New KeynesIuns Iuve mosLIy uccepLed LIuL LIere ure wuys ouL oI
LIe IIquIdILy Lrup und LIe work oI Ior exumpIe urs E. O. Svensson Is key. However, wIen one reuds
New KeynesIun reseurcI Loduy one wIII reuIIse LIuL New KeynesIuns ure us obsessed wILI InLeresL
ruLes us LIe key cIunneI Ior LIe LrunsmIssIon oI moneLury poIIcy us LIe oId keynesIuns were. WIuL
Ius cIunged Is LIuL New KeynesIuns beIIeve LIuL we cun geL uround LIe IIquIdILy Lrup by pIuyIng
uround wILI expecLuLIons. OId KeynesIuns ussumed LIuL economIc ugenLs Iud buckwurd IookIng or
sLuLIc expecLuLIons wIIIe New KeynesIuns ussume ruLIonuI expecLuLIons - Ience, Iorwurd-IookIng
expecLuLIons.
Hence, New KeynesIuns sLIII see InLeresL ruLes uL beIng uL LIe core oI moneLury poIIcy mukIng. TIIs
Is us probIemuLIc us IL wus o yeurs ugo. Yes, IL Is IIne LIuL New KeynesIun ucknowIedges LIuL
Puge q; oI 1zq
ugenLs ure Iorwurd-IookIng buL IL Is IIgIIy probIemuLIc LIuL LIey muInLuIn LIe nurrow Iocus on
InLeresL ruLes.
n LIe New KeynesIun modeI moneLury poIIcy works by IncreusIng InIIuLIon expecLuLIon LIuL pusIes
down reuI InLeresL ruLes, wIIcI spurs prIvuLe consumpLIon und InvesLmenLs. MurkeL MoneLurIsLs
cerLuInIy do LIInk LIIs Is one oj mcn chcnnels by wIIcI moneLury poIIcy work, buL IL Is cIeurIy noL
LIe mosL ImporLunL cIunneI.
Roles ure ut the centre oI the trunsmission mechunism
MurkeL MoneLurIsL sLresses LIe ImporLunce oI moneLury poIIcy ruIes und Iow LIuL ImpucLs ugenLs
expecLuLIons und Ience LIe moneLury LrunsmIssIon mecIunIsm. Hence, we ure more Iocused on LIe
Iorwurd-IookIng nuLure or moneLury poIIcy LIun LIe oId moneLurIsLs were. n LIuL regurd we ure
sImIIur Lo LIe New KeynesIuns.
L exucLIy becuuse oI our uccepLunce oI ruLIonuI expecLuLIons LIuL we ure so obsessed ubouL NGDP
IeveI LurgeLIng. TIereIore wIen we dIscuss LIe moneLury poIIcy LrunsmIssIon mecIunIsm IL Is key
wIeLIer we ure In worId wILI no credIbIe ruIe In pIuce or wIeLIer we ure In u worId oI u credIbIe
moneLury poIIcy ruIe. BeIow wIII dIscussIon boLI.
Irom no credibility to u credible NGP level turget
eLs ussume LIuL LIe economy Is In bud equIIIbrIum. or some reuson money veIocILy Ius
coIIupsed, wIIcI conLInues Lo puL downwurd pressures on InIIuLIon und growLI und LIereIore on
NGDP. TIen enLers u new credIbIe cenLruI bunk governor und Ie unnounces LIe IoIIowIng:
wIII ensure LIuL u good equIIIbrIum Is re-esLubIIsIed. TIuL meuns LIuL wIII 'prInL` wIuLever
umounL oI money Is needed so Lo muke up Ior LIe drop In veIocILy we Iuve seen. wIII noL sLop LIe
expunsIon oI LIe money buse beIore murkeL purLIcIpunLs uguIn IorecusLs nomInuI GDP Lo Iuve
reLurned Lo IL`s oId Lrend puLI. TIereuILer wIII conducL moneLury poIIcy In sucI u IusIIon so NGDP
Is muInLuIned on u % growLI puLI.
eLs ussume LIuL LIIs new cenLruI bunk governor Is credIbIe und murkeL purLIcIpunLs beIIeve IIm.
eLs cuII IIm Ben VoIcker.
Puge q8 oI 1zq
By IssuIng LIIs sLuLemenL LIe credIbIe Ben VoIcker wIII IIkeIy seL In moLIon LIe IoIIowIng process:
1) Consumers wIo Iuve been IourdIng cusI becuuse LIey wIere expecLIng no und very sIow growLI
In LIe nomInuI Income wIII ImmedIuLeIy reduce LIere IoIdIng oI cusI und Increuse prIvuLe
consumpLIon.
z) CompunIes LIuL Iuve been IourdIng cusI wIII sLurL InvesLIng - LIere Is no reuson Lo Iourd cusI
wIen LIe economy wIII be growIng uguIn.
) Bunks wIII reuIIse LIuL LIere Is no reuson Lo conLInue uggressIve deIeverugIng und LIey wIII
expecL mucI beLLer reLurns on IendIng ouL money Lo compunIes und IouseIoIds. L cerLuInIy no
Ionger wIII be puyIng oII Lo puL money InLo reserves wILI LIe cenLruI bunk. endIng growLI wIII
ucceIeruLe us LIe money muILIpIIer Increuses sIurpIy.
q) nvesLors In LIe sLock murkeL knows LIuL In LIe Iong run sLock prIces Lruck nomInuI GDP so u
promIse oI u sIurp Increuse In NGDP wIII muke sLocks mucI more uLLrucLIve. urLIermore, wILI u
% puLI growLI ruIe Ior NGDP InvesLors wIII expecL u mucI Iess voIuLIIe eurnIngs und dIvIdend IIow
Irom compunIes. TIuL wIII reduce LIe rIsk premIum on equILIes, wIIcI IurLIer wIII pusI up sLock
prIces. WILI IIgIer sLock prIces compunIes wIII InvesL more und consumers wIII consume more.
) TIe promIse oI Ioser moneLury poIIcy uIso meuns LIuL LIe suppIy oI money wIII Increuse reIuLIve
Lo LIe demund Ior money. TIIs eIIecLIveIy wIII Ieud Lo u sIurp seII-oII In LIe counLry`s currency. TIIs
obvIousIy wIII Improve LIe compeLILIveness oI LIe counLry und spurk exporL growLI.
TIese ure IIve cIunneIs und dId noL menLIon InLeresL ruLes yeL.und LIere Is u reuson Ior LIuL.
nLeresL ruLes wIII NCREASE und so wIII bond yIeIds us murkeL purLIcIpunL sLurL Lo prIce In IIgIer
InIIuLIon In LIe LrunsILIon perIod In wIIcI we go Irom u bud equIIIbrIum Lo u good equIIIbrIum.
Hence, LIere Is no reuson Ior LIe New KeynesIun InLeresL ruLe IeLIsI - we goL uL IeusL IIve oLIer
more powerIuI cIunneIs by wIIcI moneLury poIIcy works.
Monetury trunsmission mechunism with u credible NGP level turget
Ben VoIcker Ius now wILI IIs unnouncemenL brougIL buck LIe economy Lo u good equIIIbrIum. n
LIe process Ie mIgIL Iuve needed InILIuIIy Lo Increuse LIe money buse Lo convInce economIc ugenLs
LIuL Ie meunL busIness. However, once credIbIIILy Is esLubIIsIed concernIng LIe new NGDP IeveI
Puge qq oI 1zq
LurgeL ruIe Ben VoIcker jusL needs Lo Iook serIous und credIbIe und LIen expecLuLIons und LIe
murkeL wIII Luke cure oI LIe resL.
mugIne LIe IoIIowIng sILuuLIon. A posILIve sIock Increuse LIe veIocILy oI money und wILI u IIxed
money suppIy LIIs pusIed NGDP ubove IL LurgeL puLI. WIuL Iuppens?
1) Consumers reuIIse LIuL Ben VoIcker wIII LIgILen moneLury poIIcy und sIow NGDP growLI. WILI
LIe expecLuLIon oI Iower Income growLI consumers LIgILen LIeIr beILs und prIvuLe consumpLIon
growLI sIows.
z) nvesLors uIso see NGDP growLI sIowIng so LIey scuIe buck InvesLmenLs.
) WILI LIe ouLIook Ior sIower growLI In NGDP bunks scuIe buck LIeIr IendIng und Increuse LIeIr
reserves.
q) SLock prIces sLurL Lo drop us expecLuLIons Ior eurnIngs growLI Is scuIed buck (remember NGDP
growLI und eurnIngs growLI Is sLrongIy correIuLed). TIIs sIows prIvuLe consumpLIon growLI und
InvesLmenL growLI.
) WILI expecLuLIons oI u LIgILenIng oI moneLury condILIons pIuyers In LIe currency murkeL send
LIe currency sLrong. TIIs Ied Lo u worsenIng oI LIe counLry`s compeLILIveness und Lo weuker exporL
growLI.
6) nLeresL ruLes und bond yIeIds DROP on LIe expecLuLIons oI LIgILer moneLury poIIcy.
AII LIIs Iuppens wILIouL Ben VoIcker doIng unyLIIng wILI LIe money buse. He Is jusL sILLIng uround
repeuLIng IIs dogmu: TIe cenLruI bunk wIII conLroI LIe money buse In sucI u IusIIon LIuL
economIc ugenLs uwuy expecL NGDP Lo grow uIong LIe % puLI we uIreudy Iuve unnounced. By
now Ie mIgIL us weII been repIuced by u compuLer.
Puge 1oo oI 1zq
The ultimote sign of recooerg - no reoson to freok out
ohout higher hond gields
TIIs Is Irom CNBC.com:
U.S. Treusurys prIces eused Ior u second duy uILer jobIess cIuIms duLu suggesLed soIId ImprovemenL
In LIe Iubor murkeL, wIIIe sLocks` guIns undermIned LIe uppeuI oI Iower-rIsk governmenL debL.
TIe Treusury DepurLmenL uucLIoned $1 bIIIIon oI reopened o-yeur bonds on TIursduy uL u IIgI
yIeId oI .zq8 percenL. TIe bId-Lo-cover ruLIo, un IndIcuLor oI demund, wus z.q, LIe IowesL IeveI
sInce AugusL.
n LIe wIen-Issued murkeL, consIdered u proxy Ior wIere LIe bonds wIII prIce uL uucLIon, o-yeur
bonds were yIeIdIng ubouL .zq percenL. TIe uucLIon IoIIowed soIId demund In LIe suIes oI $z1
bIIIIon oI reopened 1o-yeur noLes on Wednesduy und $z bIIIIon oI LIree-yeur noLes on Tuesduy.
US bond yIeIds conLInue Lo IncI IIgIer. To me LIuL Is LIe uILImuLe sIgn LIuL ecsier moneLury
condILIons Is pusIIng up nomInuI GDP (und very IIkeIy uIso reuI GDP).
BuL um uIruId LIuL we wIII soon Ieur somebody wurn us LIuL IIgIer bond yIeIds wIII kIII LIe
recovery. BuL we oI course know LIuL wIen bond yIeIds cnd equILy prIces ure rIsIng In puruIIeI LIen
IL Is normuIIy u very good sIgn oI IIgIer crecte demcnd und LIuL Is oI course exucLIy wIuL we
need.
So II we uvoId LIe bIggesL IuIIucy In economIcs und usk uh bond yIeIds ure rIsIng LIen we sIouId
IInd u IoL oI comIorL In LIe IucL LIuL US sLock prIces ure rIsIng us weII.
And IInuIIy LIere Is some Kenesicns ouL LIere LIuL cun expIuIn Lo me wIy gIobuI sLock prIces
conLInue Lo IncI up, bond yIeIds ure rIsIng und LIe US consumer seems compIeLeIy
unuIIecLed despILe oI LIe IIscuI cIIII ( LoId you so!) und LIe sequesLer. MurkeL MoneLurIsLs oI course
Iuve un unswer - IL Is monetcr polic domincnce - moneLury poIIcy cun clucs oIIseL uny ImpucL
on uggreguLe demund Irom u IIscuI sIock. L Is very sImpIe - und Is LIe posILIve spIn on LIe Sumner
Critique. (Here Is u modeI LexLbook KeynesIun sIouId be ubIe Lo undersLund).
Puge 1o1 oI 1zq
PS yes you goL IL rIgIL - um very opLImIsLIc boLI on LIe murkeLs und on LIe recovery uL IeusL In LIe
US ( Iuve been opLImIsLIc Ior u wIIIe - see Iere und Iere). My onIy Lwo Ieurs ure LIuL LIe ECB
once uguIn wIII do someLIIng sLupId or LIuL we wIII Iuve u repeuL oI LIe mIsLukes oI 1q6;-; -
premuLure moneLury LIgILenIng Irom LIe Ied. LuIIun poIILIcs Is, Iowever, noL keepIng me uwuke uL
nIgIL.
UpduLe: wroLe ubove my worry wus LIe ECB. sIouId Iuve suId LIe EUJM. TIe Lerms Ior LIe
EUJM buII ouL oI Cyprus scure me quILe u bIL. So mucI Ior LIe ruIe oI Iuw.
Puge 1oz oI 1zq
Tight moneg = lou gields - olso during the
Creot Recession
Anybody wIo ever reud unyLIIng MIILon rIedmun suId ubouL moneLury poIIcy sIouId know LIuL
Iow InLeresL ruLes und bond yIeIds meun LIuL moneLury poIIcy Is tiht ruLIer LIun eusy. And wIen
bond yIeIds drop IL Is normuIIy u sIgn LIuL moneLury poIIcy Is becomIng LIgILer ruLIer LIun eusIer.
Here Is rIedmun on wIuL Ie cuIIed LIe interest rcte jcllcc In 1qq;:
AILer LIe U.S. experIence durIng LIe GreuL DepressIon, und uILer InIIuLIon und rIsIng InLeresL ruLes
In LIe 1q;os und dIsInIIuLIon und IuIIIng InLeresL ruLes In LIe 1q8os, LIougIL LIe IuIIucy oI
IdenLIIyIng LIgIL money wILI IIgI InLeresL ruLes und eusy money wILI Iow InLeresL ruLes wus deud.
AppurenLIy, oId IuIIucIes never dIe.
UnIorLunuLeIy LIe oId IuIIucy Is sLIII noL deud und IL Is sLIII very common Lo ussocIuLe Iow InLeresL
ruLes und Iow bond yIeIds wILI eusy moneLury poIIcy. JusL LIInk oI LIe ECB`s InsIsLence LIuL IL`s
moneLury poIIcy sLunce Is eusy.
n my prevIous posL demonsLruLed LIuL uII LIe mujor cIunges In LIe S&Poo over LIe pusL Iour
yeurs cun be expIuIned by cIunges In moneLury poIIcy sLunce Irom eILIer LIe ECB or LIe ederuI
Reserve (und Lo some exLenL uIso PBoC). Hence, IL Is noL unImuI spIrILs, buL ruLIer moneLury poIIcy
IuIIure LIuL cun expIuIn LIe voIuLIIILy In LIe murkeLs over LIe pusL Iour yeurs.
WIuL IoIds Lrue Ior LIe sLock murkeL IoIds equuIIy Lrue Ior LIe bond murkeL und LIe deveIopmenL
In LIe US IIxed Income murkeLs over LIe pusL Iour yeurs compIeLeIy conIIrms MIILon rIedmun`s
vIew LIuL LIgILer moneLury poIIcy Is ussocIuLed wILI Iower bond yIeIds. See LIe grupI beIow. Green
cIrcIes ure moneLury eusIng. Red cIrcIes ure moneLury LIgILenIng. (See more on eucI evenL In my
prevIous bIog posL)
LIInk LIe grupI very cIeurIy sIows LIuL rIedmun wus rIgIL. Every LIme eILIer LIe ECB or LIe
ederuI Reserve Iuve moved Lo LIgILen moneLury poIIcy Iong
und wIen LIe sume cenLruI bunks Iuve moved Lo euse moneLury poIIcy yIeIds
JudgIng Irom LIe IeveI oI US bond yIeIds
poIIcy In LIe US (und LIe euro zone) cun IurdIy be suId Lo be
moneLury poIIcy remuIns excessIveIy LIgIL In boL
LIe ed nor LIe ECB seem Lo ucknowIedge us LIey sLIII seem Lo be oI LIe ImpressIon LIuL us Iong
InLeresL ruLes ure Iow moneLury poIIcy Is eusy. wonder wIuL rIedmun wouId Iuve suId? WeII,
IucL um preLLy convInced LIuL Ie wouId Iuve been very cIeur und wouId Iuve been urguIng wILI
LIe MurkeL MoneLurIsLs LIuL moneLury dIsorder Is Lo bIume Ior LIIs crIsIs und we onIy wIII move ouL
oI LIe crIsIs once LIe ed und LIe ECB move Lo IundumenLuIIy euse moneLury
u ruIe bused moneLury poIIcy ruLIer LIun LIe presenL zIg
PS See uIso my eurIy posL on LIe connecLIon beLween moneLury poIIcy und LIe bond
murkeL: Understcndin jincncicl mcrlets uith MV=PY
UpduLe: ScoLL Sumner jusL mude me uwure oI one oI IIs posL uddressIng LIe sume LopIc. See
UpduLe z: Juson Ruve Ius kIndIy remInded me oI LIIs MIILon rIedmun
wILI LIe InLeresL ruLe IuIIucy.
k LIe grupI very cIeurIy sIows LIuL rIedmun wus rIgIL. Every LIme eILIer LIe ECB or LIe
ederuI Reserve Iuve moved Lo LIgILen moneLury poIIcy Iong-Lerm US bonds yIeIds Iuve dropped
und wIen LIe sume cenLruI bunks Iuve moved Lo euse moneLury poIIcy yIeIds Iuve Increused.
JudgIng Irom LIe IeveI oI US bond yIeIds - und Germun bond yIeIds Ior LIuL muLLer
poIIcy In LIe US (und LIe euro zone) cun IurdIy be suId Lo be eusy. n IucL IL Is very cIeur LIuL
moneLury poIIcy remuIns excessIveIy LIgIL In boLI LIe US und LIe euro zone. UnIorLunuLeIy neILIer
LIe ed nor LIe ECB seem Lo ucknowIedge us LIey sLIII seem Lo be oI LIe ImpressIon LIuL us Iong
InLeresL ruLes ure Iow moneLury poIIcy Is eusy. wonder wIuL rIedmun wouId Iuve suId? WeII,
Ly convInced LIuL Ie wouId Iuve been very cIeur und wouId Iuve been urguIng wILI
LIe MurkeL MoneLurIsLs LIuL moneLury dIsorder Is Lo bIume Ior LIIs crIsIs und we onIy wIII move ouL
oI LIe crIsIs once LIe ed und LIe ECB move Lo IundumenLuIIy euse moneLury
u ruIe bused moneLury poIIcy ruLIer LIun LIe presenL zIg-zuggIng.
PS See uIso my eurIy posL on LIe connecLIon beLween moneLury poIIcy und LIe bond
Understcndin jincncicl mcrlets uith MV=PY - c lool ct the bond
UpduLe: ScoLL Sumner jusL mude me uwure oI one oI IIs posL uddressIng LIe sume LopIc. See
UpduLe z: Juson Ruve Ius kIndIy remInded me oI LIIs MIILon rIedmun urLIcIe
Puge 1o oI 1zq
k LIe grupI very cIeurIy sIows LIuL rIedmun wus rIgIL. Every LIme eILIer LIe ECB or LIe
Lerm US bonds yIeIds Iuve dropped
Iuve Increused.
und Germun bond yIeIds Ior LIuL muLLer - moneLury
eusy. n IucL IL Is very cIeur LIuL
I LIe US und LIe euro zone. UnIorLunuLeIy neILIer
LIe ed nor LIe ECB seem Lo ucknowIedge us LIey sLIII seem Lo be oI LIe ImpressIon LIuL us Iong
InLeresL ruLes ure Iow moneLury poIIcy Is eusy. wonder wIuL rIedmun wouId Iuve suId? WeII,
Ly convInced LIuL Ie wouId Iuve been very cIeur und wouId Iuve been urguIng wILI
LIe MurkeL MoneLurIsLs LIuL moneLury dIsorder Is Lo bIume Ior LIIs crIsIs und we onIy wIII move ouL
oI LIe crIsIs once LIe ed und LIe ECB move Lo IundumenLuIIy euse moneLury condILIons und udopL
PS See uIso my eurIy posL on LIe connecLIon beLween moneLury poIIcy und LIe bond
mcrlet
UpduLe: ScoLL Sumner jusL mude me uwure oI one oI IIs posL uddressIng LIe sume LopIc. See Iere.
urLIcIe, wIIcI uIso deuIs
Puge 1oq oI 1zq
Monetorg disorder - not onimol spirits - coused the
Creot Recession
I one IoIIows LIe IInuncIuI medIu on u duIIy busIs us do LIere Is umpIe room Lo geL boLI depressed
und IrusLruLed over LIe coveruge oI LIe IInuncIuI murkeLs. OILen murkeL movemenLs ure descrIbed
us beIng very IrruLIonuI und LIe descrIpLIon oI wIuL Is IuppenIng In LIe murkeLs Is oILen bused on
un undersLundIng oI economIc ugenLs us somebody wIo Iuve Iuge mood swIngs due Lo wIuL
Keynes Lermed unImuI spIrILs.
SwIngs In LIe IInuncIuI murkeLs creuLed by LIese unImuI spIrILs LIen uppurenLIy ImpucL LIe
mucroeconomy LIrougI LIe ImpucL on InvesLmenL und prIvuLe consumpLIon. n LIIs undersLundIng
murkeLs move up und down bused on ruLIer IrruLIonuI mood swIngs umong InvesLors. TIIs Is wIuL
RoberL HeLzeI Ius cuIIed LIe murkeL dIsorder-vIew. L Is murkeL ImperIecLIons und purLIcuIurIy
LIe unImuI spIrILs oI InvesLors wIIcI creuLed swIngs noL onIy In LIe murkeLs, buL uIso In LIe
IInuncIuI murkeLs. Bob obvIousIy In IIs new book convIncIngIy demonsLruLes LIuL LIIs LIeory Is
grossIy IIuwed und LIuL unImuI spIrILs Is noL LIe cuuse oI neILIer LIe voIuLIIILy In LIe murkeLs nor
dId unImuI spIrILs cuuse LIe presenL crIsIs.
TIe GreuL RecessIon Is u resuIL oI numerous moneLury poIIcy mIsLukes - LIIs Is LIe monetcr
disorder-tieu - ruLIer LIun u resuIL oI IrruLIonuI InvesLors beIuvIng us drunken IooIs. TIIs Is very
eusy Lo IIIusLruLe. JusL Iuve u Iook IIrsL uL S&Poo durIng LIe GreuL RecessIon.
Puge 1o oI 1zq
The 6-, phuses oI the Greut Recession - so Iur
We cun busIcuIIy spoL sIx or seven overuII pIuses In S&Poo sInce LIe onseL oI LIe crIsIs. n my vIew
uII oI LIese pIuses or sIIILs In murkeL senLImenL cun eusy be sIown Lo coIncIde wILI moneLury
poIIcy cIunges Irom eILIer LIe ederuI Reserve or LIe ECB (or Lo some exLenL uIso LIe PBoC).
We cun sLurL ouL wILI LIe very unIorLunuLe decIsIon by LIe ECB Lo IIke InLeresL ruLes In JuIy zoo8.
SIorLIy uILer LIe ECB IIke LIe S&Poo pIummeLed (und yes, yes eImun BroLIer coIIupses In LIe
process). TIe Iree IuII In S&Poo wus Lo some exLenL curbed by reIuLIveIy sLeep InLeresL ruLe
reducLIons In LIe AuLumn oI zoo8 Irom uII oI LIe mujor cenLruI bunks In LIe worId. However, LIe
drop In LIe US sLock murkeLs dId noL come Lo un end beIore MurcI zooq.
Murch-April ooq: TAI und dollur swup lines
However, Irom MurcI-AprII zooq LIe US sLock murkeLs recovered sLrongIy und LIe recovery
conLInued uII LIrougI zooq. So wIuL Iuppened In MurcI-AprII zooq? DId uII InvesLors suddenIy
ouL oI LIe bIue become opLImIsLs? Nope. rom eurIy MurcI LIe ederuI Reserve sLepped up ILs
eIIorLs Lo Improve ILs roIe us Iender-oI-IusL resorL. TIe de IucLo coIIupse oI LIe ed prImury deuIer
sysLem In LIe AuLumn oI zoo8 Iud eIIecLIve mude IL very Iurd Ior LIe ed Lo IuncLIon us u Iender-
Puge 1o6 oI 1zq
oI-IusL-resorL und eIIecLIveIy LIe ed couId noL provIde suIIIcIenL doIIur IIquIdILy Lo LIe murkeL. See
more on LIIs LopIc In George SeIgIn`s exceIIenL puper L Street: cehoticn Prescriptions jor c
z:st-Centur Mone Mcrlet.
Here especIuIIy LIe Lwo LIIngs ure ImporLunL. IrsL, LIe so-cuIIed Term AucLIon ucIIILy (TA). TA
wus IIrsL InLroduced In zoo;, buL wus expunded consIderubIy on MurcI q zooq. TIIs Is uIso LIe duy
LIe S&Poo boLLomed ouL! TIuL Is cerLuInIy no coIncIdence.
Second, on AprII q wIen LIe ed unnounced LIuL IL Iud opened doIIur swup IInes wILI u number oI
cenLruI bunks uround LIe worId. BoLI meusures sIgnIIIcunLIy reduced LIe Iuck oI doIIur IIquIdILy. As
u resuIL LIe suppIy oI doIIurs eIIecLIveIy wus Increused sIurpIy reIuLIveIy Lo LIe demund Ior doIIurs.
TIIs eIIecLIveIy ended LIe IIrsL moneLury conLrucLIon durIng LIe eurIy sLuge oI LIe GreuL RecessIon
und LIe resuILs ure very vIsIbIe In S&Poo.
TIIs us IL very cIeur Irom LIe grupI ubove LIe ed`s eIIecLs Lo Increuse LIe suppIy oI doIIur IIquIdILy
In MurcI-AprII zooq compIeLeIy coIncIdes wILI LIe begInnIng oI LIe up-Ieg In LIe S&Poo. L wus
noL unImuI spIrILs LIuL LrIggered LIe recovery In S&Poo, buL ruLIer eusIer moneLury condILIons.
Junoury-April o1o: Swup lines expiry, Chinese monetury tightening und Ied ruises
discoont rute
TIe doIIur swup IInes expIred ebruury 1 zo1o. TIuL couId IurdIy be u surprIse Lo LIe murkeLs, buL
noneLIeIess LIIs seem Lo Iuve coIncIded wILI LIe S&Poo begInnIng Lo Ioose sLeum In LIe eurIy purL
oI zo1o. However, IL wus probubIy more ImporLunL LIuL specuIuLIon grew In LIe murkeLs LIuL gIobuI
cenLruI bunks couId move Lo LIgILen moneLury condILIons In respond Lo LIe conLInued recovery In
LIe gIobuI economy uL LIuL LIme.
On Junuury 1z zo1o LIe PeopIe`s Bunk oI CIInu Increused reserve requIremenLs Ior LIe CIInese
bunks. n LIe IoIIowIng monLIs LIe PBoC moved Lo LIgILen moneLury condILIons IurLIer. OLIer
cenLruI bunks uIso sLurLed Lo sIgnuI IuLure moneLury LIgILenIng.
Even LIe ederuI Reserve sIgnuIed LIuL IL mIgIL be reversIng IL`s moneLury sLunce. Hence, on
ebruury 18 zo1o LIe ed Increused LIe dIscounL ruLe by zbp. TIe ed InsIsLed LIuL IL wus noL
Puge 1o; oI 1zq
moneLury LIgILenIng, buL judgIng Irom LIe murkeL reucLIon IL couId IurdIy be seen by InvesLors us
unyLIIng eIse.
OveruII LIe ImpressIon InvesLors mosL Iuve goL Irom LIe ucLIons Irom PBoC, LIe ed und oLIer
cenLruI bunks In eurIy zo1o wus LIuL LIe cenLruI bunks now wus movIng cIoser Lo InILIuLIng
moneLury LIgILenIng. NoL surprIsIngIy LIIs coIncIdes wILI LIe S&Poo sLurLIng Lo move sIdewuys In
LIe IIrsL IuII oI zo1o. TIIs uIso coIncIdes wILI LIe Greek crIsIs becomIng u murkeL LIeme Ior LIe
IIrsL LIme.
Aogost , o1o: Ben Bernunke unnoonces QI und stock murket tukes oII uguin
By mId-zo1o IL Iud become very cIeur LIuL LuIk oI moneLury LIgILenIng Iud bene premuLure und LIe
ederuI Reserve sLurLed Lo sIgnuI LIuL u new round oI moneLury eusIng mIgIL be IorLIcomIng und
on AugusL z; uL IIs now Iumous Juckson HoIe speecI Ben Bernunke busIcuIIy unnounced u new
round quunLILuLIve eusIng - LIe so-cuIIed QEz. TIe ucLuuI poIIcy wus noL ImpIemenLed beIore
November, buL us uny MurkeL MoneLurIsL wouId LeII you - IL Is LIe Chucl Norris ejject oI moneLury
poIIcy: MoneLury poIIcy muInIy works LIrougI expecLuLIons.
TIe quusI-unnouncemenL oI QEz on AugusL z; Is preLLy cIoseIy connecLed wILI unoLIer up-Ieg In
S&Poo sLurLIng In AugusL zo1o. TIe ucLuuI upLurn In LIe murkeL, Iowever, sLurLed sIIgILIy
bejore Bernunke`s speecI. TIIs Is probubIy u reIIecLIon LIuL LIe murkeLs sLurLed Lo unLIcIpuLe LIuL
Bernunke wus IncIIng cIoser Lo InLroducIng QEz. See Ior exumpIe LIIs news urLIcIe Irom eurIy
AugusL zo1o. TIIs obvIousIy Is un exumpIe oI ScoLL Sumner`s poInL LIuL moneLury poIIcy works wILI
Iong und vurIubIe lecds. Hence, moneLury poIIcy mIgIL be workIng bejore IL Is ucLuuIIy unnounced II
LIe murkeL sLurL Lo prIce In LIe ucLIon beIoreIund.
April und Joly o11: The ICB's cutustrophic rute hikes
TIe upLurn In LIe S&Poo IusLed LIe remInder oI zo1o und conLInued InLo zo11, buL commodILy
prIces uIso IncIed up und wIen Lwo mujor neguLIve suppIy sIocks (revoIuLIons In NorLIern AIrIcu
und LIe Jupunese TsunumI) IIL In eurIy zo11 IeudIIne InIIuLIon Increused In LIe euro zone. TIIs
LrIggered LIe ECB Lo Luke LIe neur cuLusLropIIc decIsIon Lo Increuse InLeresL ruLes LwIce - once In
AprII und LIen uguIn In JuIy. AL LIe sume LIme LIe ECB uIso sLurLed Lo scuIe buck IIquIdILy
progrums.
Puge 1o8 oI 1zq
TIe murkeL movemenLs In LIe S&Poo Lo u very Iurge exLenL coIncIde wILI LIe ECB`s ruLe IIkes.
TIe ECB IIked LIe IIrsL LIme on AprII ;. SIorLIy LIere uILer - on AprII zq - LIe S&Poo reucIed IL`s
zo11 peuk. TIe ECB IIked Ior LIe second LIme on JuIy ; und even sIgnuIed more ruLe IIkes! SIorLIy
LIereuILer S&Poo sIumped. TIIs obvIousIy uIso coIncIded wILI LIe euro crIsIs IIurIng up once
uguIn.
September-ecember o11: "Low Ior longer, Operution twist und LTRO - cleuning
op yoor own mess
TIe re-escuIuLIon oI LIe Europeun crIsIs goL LIe ederuI Reserve InLo ucLIon. On SepLember q zo11
LIe OMC unnounced LIuL IL wouId keep InLeresL ruLes Iow uL IeusL unLII zo1. NoL exucLIy u poIIcy
LIuL Is In LIe spIrIL oI MurkeL MoneLurIsm, buL noneLIeIess u sIgnuI LIuL LIe ed ucknowIedged LIe
need Ior moneLury eusIng. nLeresLIngIy enougI SepLember q zo11 wus uIso LIe duLe wIere LIe
three-month centered motin cterce oI S&Poo boLLomed ouL.
On SepLember z1 zo11 LIe ederuI Reserve IuuncIed wIuL Ius come Lo be known us OperuLIon
TwIsL. Once uguIn LIIs Is cerLuInIy noL u kInd oI moneLury operuLIon wIIcI Is Ioved by MurkeL
MoneLurIsLs, buL uguIn uL IeusL IL wus un sIgnuI LIuL LIe ed ucknowIedged LIe need Ior moneLury
eusIng.
TIe ed`s ucLIons In SepLember preLLy mucI coIncIded wILI S&Poo sLurLIng u new up-Ieg. TIe
recovery In S&Poo goL IurLIer ImpuLes uILer LIe ECB IInuIIy ucknowIedged u responsIbIIILy Ior
cIeunIng up LIe mess uILer LIe Lwo ruLe IIkes eurIIer In zo11 und on December 8 LIe ECB
InLroduced LIe so-cuIIed -yeur Ionger-Lerm reIInuncIng operuLIons (TRO).
TIe ruIIy In S&Poo Ience goL more momenLum uILer LIe InLroducLIon oI LIe -yeur TRO In
December zo11 und LIe ruIIy IusLed unLII MurcI-AprII zo1z.
The present downtorn: Huve u look ut ICB's new colluterul roles
We ure presenLIy In LIe mIdsL oI u new crIsIs und LIe medIu uLLenLIon Is on LIe Greek poIILIcuI
sILuuLIon und wIIIe LIe need Ior moneLury poIIcy eusIng In LIe euro zone IInuIIy seem Lo be movIng
up on LIe ugendu LIere Is sLIII very IILLIe ucknowIedgemenL In LIe generuI debuLe ubouL LIe
Puge 1oq oI 1zq
moneLury cuuses oI LIIs crIsIs. BuL uguIn we cun expIuIn LIe IusL downLurn In S&Poo by IookIng uL
moneLury poIIcy.
On MurcI z LIe ECB moved Lo LIgILen LIe ruIes Ior bunks` use oI usseLs us coIIuLeruI. TIIs busIcuIIy
coIncIded wILI LIe S&Poo reucIIng ILs peuk Ior LIe yeur so Iur on MurcI 1q und In LIe perIod LIuL
Ius IoIIowed numerous Europeun cenLruI bunkers Iuve ruIed ouL LIuL LIere Is u need Ior moneLury
eusIng (wIo ure LIey kIddIng?)
Conclosion: its monetury disorder und not unimul spirits
Above Iuve LrIed Lo sIow LIuL LIe mujor ups und downs In LIe US sLock murkeLs sInce zoo8 cun
be expIuIned by cIunges moneLury poIIcy by LIe mujor cenLruI bunks In LIe worId. Hence, LIe
voIuLIIILy In LIe murkeLs Is u dIrecL consequence oI moneLury poIIcy IuIIure ruLIer LIun IrruLIonuI
InvesLor beIuvIor. TIereIore, LIe besL wuy Lo ensure sLubIIILy In LIe IInuncIuI murkeLs Is Lo ensure
nomInuI sLubIIILy LIrougI u ruIe bused moneLury poIIcy. L Is LIme Ior cenLruI bunks Lo do some souI
seurcIIng ruLIer LIun bIumIng unImuI spIrILs.
TIIs In no wuy Is u IuII uccounL oI LIe cuuses oI LIe GreuL RecessIon, buL ruLIer meunL Lo sIow LIuL
cIunges In moneLury poIIcy - ruLIer LIun unImuI spIrILs - ure uL LIe cenLre oI murkeL movemenLs
over LIe pusL Iour yeurs. Iuve used LIe S&Poo Lo IIIusLruLe LIIs, buL u sImIIur pIcLure wouId
emerge II LIe sLory wus LoId wILI US or Germun bond yIeIds, InIIuLIon expecLuLIons, commodILy
prIces or excIunge ruLes.
Appendix: Some Key monetury chunges doring the Greut Recession
JuIy zoo8: ECB IIkes InLeresL ruLes
MurcI-AprII zooq: ed expund TA und InLroduces doIIur swup IInes
Junuury-AprII zo1o: Swup IInes expIry, CIInese moneLury LIgILenIng und ed ruIses dIscounL ruLe
AugusL z; zo1o: Bernunke unnounces QEz
AprII und JuIy zo11: TIe ECB IIke InLeresL ruLes LwIce
Puge 11o oI 1zq
SepLember-December zo11: ed unnounces poIIcy Lo keep ruLe very Iow unLII LIe end oI zo1 und
InLroduces operuLIon LwIsL. TIe ECB InLroduces LIe -yeur TRO
MurcI zo1z: ECB LIgILens coIIuLeruI ruIes
Puge 111 oI 1zq
The root of most follocies in economics: 1orgetting to osk
WHY prices chonge
Even LIougI um u Dune und work Ior u DunIsI bunk Lend Lo noL IoIIow LIe DunIsI medIu Loo
mucI - uILer uII my IIeId oI work Is InLernuLIonuI economIcs. BuL cun`L compIeLeIy uvoId reudIng
DunIsI newspupers. My greuLesL IrusLruLIon wIen reud LIe IInuncIuI secLIon oI DunIsI
newspupers undoubLedIy Is LIe Lendency Lo reuson Irom dIIIerenL prIce cIunges - Ior exumpIe
cIunges In LIe prIce oI oII or cIunges In bond yIeIds - wILIouL dIscussIng LIe courses oI LIe prIce
cIunge.
TIe besL exumpIe undoubLedIy Is cIunges In (morLguge) bond yIeIds. Denmurk Ius been u suIe
Iuven In LIe IInuncIuI murkeLs so wIen LIe euro crIsIs escuIuLed In zo11 DunIsI bond yIeIds
dropped drumuLIcuIIy und sIorL-Lerm governmenL bond yIeIds even Lurned neguLIve. TIuL LypIcuIIy
LrIggered LIe IoIIowIng Lype oI IeudIIne In DunIsI newspupers: Dcnish homeouners benejit jrom
the euro crisis or The euro crisis is ood neus jor the Dcnish econom.
However, doubL LIuL uny DunIsI Iomeowner IeIL especIuIIy Iuppy ubouL LIe euro crIsIs. Yes, bond
yIeIds dId drop und LIuL cuL LIe InLeresL ruLe puymenLs Ior Iomeowners wILI IIouLIng ruLe
morLguges. However, bond yIeIds dropped Ior u reuson - u sIurp deLerIoruLIon oI LIe growLI
ouLIook In LIe euro zone due Lo LIe ECB`s Lwo unwurrunLed InLeresL ruLe IIkes In zo11. As Denmurk
Ius u pegged excIunge ruLe Lo LIe euro Denmurk ImporLed LIe ECB`s moneLury LIgILenIng und
wILI IL uIso LIe prospecLs Ior Iower growLI. or LIe Iomeowner LIuL meuns u IIgIer probubIIILy oI
becomIng unempIoyed und u prospecL oI seeIng IIs or Ier properLy vuIue go down us LIe DunIsI
economy conLrucLed. n LIuL envIronmenL Iower bond yIeIds ure oI IILLIe consoIuLIon.
Hence, LIe DunIsI IInuncIuI journuIIsLs IuIIed Lo usk LIe crucIuI quesLIon uh bond yIeIds dropped.
Or suId In unoLIer wuy LIey IuIIed Lo IIsLen Lo LIe udvIce oI ScoLL Sumner wIo uIwuys LeIIs us not to
recson jrom c price chcne.
TIIs Is wIuL ScoLL Ius Lo suy on LIe Issue:
M suestion is thct people should neter recson jrom c price chcne, but clucs stcrt one step
ecrlier-uhct ccused the price to chcne. Ij oil prices jcll beccuse Scudi Arcbic increcses
Puge 11z oI 1zq
production, then thct is bullish neus. Ij oil prices jcll beccuse oj jcllin AD in Europe, thct miht
be expcnsioncr jor the US. ut ij oil prices cre jcllin beccuse the euro crisis is increcsin the
demcnd jor dollcrs cnd louerin AD uorlduide, conjirmed b jclls in commodit prices, US
equit prices, cnd TIPS sprecds, then thct is becrish neus.
LoLuIIy ugree. WIen we see u prIce cIunge - Ior exumpIe oII prIces or bond yIeIds - we sIouId usk
ourseIves uh prIces ure cIungIng II we wunL Lo know wIuL mucroeconomIc ImpucL LIe prIce
cIunge wIII Iuve. L Is reuIIy ubouL IIgurIng ouL wIeLIer LIe prIce cIunge Is cuused by demund or
suppIy sIocks.
The euro strength is not necessorilg hod neus - more on the currencg uor thot is
not o uor
A very good exumpIe oI LIIs generuI IuIIucy oI IorgeLLIng Lo usk wIy prIces ure cIungIng Is LIe
ongoIng dIscussIon oI LIe currenc ucr. rom LIe perspecLIve oI some Europeun poIIcy mukers -
Ior exumpIe LIe rencI presIdenL HoIIunde - LIe Bunk oI Jupun`s recenL sIgnIIIcunL sLeppIng up oI
moneLury eusIng Is bud news Ior LIe euro zone us IL Ius Ied Lo u sLrengLIenIng oI LIe euro uguInsL
mosL oLIer mujor currencIes In LIe worId. TIe reusonIng Is LIuL u sLronger euro Is IurLIng
Europeun compeLILIveness und Ience wIII IurL Europeun exporLs und LIereIore Iower Europeun
growLI.
TIIs oI course Is u compIeLe IuIIucy. Even IgnorIng LIe IucL LIuL LIe ECB cun counLerucL uny
neguLIve ImpucL on Europeun uggreguLe demund (LIe Sumner crILIque uIso uppIIes Ior exporLs) we
cun see LIuL LIIs Is u IuIIucy. WIuL LIe currency wur worrIers IuII Lo do Is Lo usk wIy LIe euro Is
sLrengLIenIng.
TIe euro Is oI course sLrengLIenIng noL becuuse LIe ECB Ius LIgILened moneLury poIIcy buL
becuuse LIe Bunk oI Jupun und LIe ederuI Reserve Iuve sLepped up moneLury eusIng.
WILI LIe ed und LIe BoJ sIgnIIIcunLIy sLeppIng up moneLury eusIng LIe growLI prospecLs Ior LIe
IurgesL und LIe LIIrd IurgesL economIes In LIe worId Iuve greuLIy Improved. TIuL sureIy Is good
news Ior Europeun exporLers. Yes, Europeun exporLers mIgIL Iuve seen u sIIgIL erosIon oI LIeIr
compeLILIveness, buL um preLLy sure LIuL LIey IuppIIy wIII uccepL LIuL II LIey ure LoId LIuL
Jupunese und US uggreguLe demund - und Ience ImporLs - wIII ucceIeruLe sLrongIy.
Puge 11 oI 1zq
nsLeud oI jusL IookIng uL LIe euro ruLe Europeun poIIcy mukers sIouId consuIL more LIun one prIce
(LIe euro ruLe) und Iook uL oLIer IInuncIuI murkeL prIces - Ior exumpIe Europeun sLock prIces.
Europeun sLock prIces Iuve In IucL Increused sIgnIIIcunLIy sInce AugusL-SepLember wIen LIe
murkeLs sLurLed Lo prIce In more uggressIve moneLury eusIng Irom LIe ed und LIe BoJ. Or Iook uL
bond yIeIds In LIe so-cuIIed PGS counLrIes - LIey Iuve dropped sIgnIIIcunLIy. BoLI sLock prIces
und bond yIeIds In Europe Ience ure IndIcuLIng LIuL LIe ouLIook Ior LIe Europeun economy Is
ImprovIng ruLIer LIun deLerIoruLIng.
The oil price follocg - grouth is not hod neus, hut uor in the Middle Eost is
A very common IuIIucy Is Lo cry woII wIen oII prIces ure rIsIng - purLIcuIurIy In LIe US. TIe worsL
versIon oI LIIs IuIIucy Is cIuImIng LIuL ederuI Reserve moneLury eusIng wIII be undermIned by
rIsIng oII prIces.
TIIs oI course Is compIeLe rubbIsI. I LIe ed Is eusIng moneLury poIIcy IL wIII Increuse uggreguLe
demundJNGDP und IIkeIy uIso NGDP In u IoL oI oLIer counLrIes In LIe worId LIuL dIrecLIy or
IndIrecLIy Is sIudowIng ed poIIcy. Hence, wILI gIobuI NGDP rIsIng LIe demund Ior commodILIes Is
rIsIng - LIe gIobuI AD curve Is sIIILIng Lo LIe rIgIL. TIuL Is good news Ior growLI - noL bud news.
SuId unoLIer wuy wIen LIe AD curve Is sIIILIng Lo LIe rIgIL - we ure movIng uIong LIe AS curve
ruLIer LIun movIng LIe AS curve. TIuL sIouId never be u concern Irom u growLI perspecLIve.
However, II oII prIces ure rIsIng noL becuuse oI LIe ed or LIe ucLIons oI oLIer cenLruI bunks - Ior
exumpIe becuuse oI Ieurs oI wur In LIe MIddIe EusL LIen we Iuve Lo be concerned Irom u growLI
perspecLIve. TIIs kInd oI LIIng oI course Is wIuL Iuppened In zo11 wIere LIe Lwo mujor suppIy
sIocks - LIe Jupunese LsunumI und LIe revoIuLIons In NorLIern AIrIcu - pusIed up oII prIces.
AL LIe LIme LIe ECB oI course commILLed u IuIIucy by reusonIng Irom one prIce cIunge - LIe rIse In
Europeun HCP InIIuLIon. TIe ECB unIorLunuLeIy concIuded LIuL moneLury poIIcy wus Loo eusy us
HCP InIIuLIon Increused. Hud LIe ECB InsLeud usked uh InIIuLIon wus IncreusIng LIen we wouId
IIkeIy Iuve uvoIded LIe ruLe IIkes - und Ience LIe escuIuLIon oI LIe euro crIsIs. TIe AD curve
(wIIcI LIe ECB eIIecLIveIy conLroIs) Iud not sIIILed Lo LIe rIgIL In LIe euro ureu. nsLeud IL wus LIe
AS curve LIuL Iud sIIILed Lo LIe IeIL. TIe ECB`s IuIIure Lo usk wIy prIces were rIsIng neurIy cuused
LIe coIIupse oI LIe euro.
Puge 11q oI 1zq
The moneg supplg follocg - the follocg committed hg troditionol monetorists
TrudILIonuI moneLurIsLs suw LIe money suppIy us LIe besL und mosL reIIubIe IndIcuLor oI LIe
deveIopmenL In prIces (P) und nomInuI spendIng (PY). MurkeL MoneLurIsLs do noL dIsugree LIuL
LIere Is u crucIuI IInk beLween money und prIcesJnomInuI spendIng. However, LrudILIonuI
moneLurIsLs Lend(ed) Lo uIwuys see LIe quunLILy oI money us beIng deLermIned by LIe suppIy oI
money und oILen dIsregurded cIunges In LIe demund Ior money. TIuL mude perIecLIy good sense
Ior exumpIe In LIe 1q;os wIere LIe eusy moneLury poIIcIes were LIe muIn drIver oI LIe money
suppIy In mosL IndusLrIuIIzed counLrIes, buL LIuL wus noL LIe cuse durIng LIe GreuL ModeruLIon,
wIere LIe money suppIy becume endogenous due Lo u ruIe-bused moneLury poIIcIes or durIng LIe
GreuL RecessIon wIere money demund spIked In purLIcuIurIy LIe US.
Hence, wIere LrudILIonuI moneLurIsLs oILen IuII - AIIun MeILzer Is probubIy LIe besL exumpIe Loduy
- Is LIuL LIey IorgeL Lo usk uh LIe quunLILy oI money Is cIungIng. Yes, LIe US money buse
expIoded In zoo8 - someLIIng LIuL worrIed MeILzer u greuL deuI - buL so dId LIe demund Ior buse
money. n IucL LIe suppIy oI buse money IuIIed Lo Increuse enougI Lo counLerucL LIe expIosIon In
demund Ior US money buse, wIIcI eIIecLIveIy wus u mussIve LIgILenIng oI US moneLury condILIons.
So wIIIe MurkeL MoneLurIsLs IIke myseII cerLuInIy LIInk money Is exLremeIy ImporLunL we ure
skepLIcuI ubouL usIng LIe money suppIy us u sInguIur IndIcuLor oI LIe sLunce oI moneLury poIIcy.
TIereIore, II we unuIyse money suppIy duLu we sIouId consLunLIy usk ourseIves wIy LIe money
suppIy Is cIungIng - Is IL reuIIy LIe suppIy oI money IncreusIng or Is IL LIe demund Ior money LIuL
Is IncreusIng? TIe besL wuy Lo do LIuL Is Lo Iook uL murkeL duLu. I murkeL expecLuLIons Ior InIIuLIon
ure goIng up, sLock murkeLs ure ruIIyIng, LIe yIeId curve Is sLeepenIng und gIobuI commodILy prIces
ure IncreusIng LIen IL Is preLLy reusonubIe Lo ussume gIobuI moneLury condILIons ure geLLIng eusIer
- wIeLIer or noL LIe money suppIy Is IncreusIng or decreusIng.
InuIIy sIouId suy LIuL my IrIends Bob HeLzeI und DuvId uIdIer wouId objecL Lo LIIs
cIurucLerIzuLIon oI LrudILIonuI moneLurIsm. TIey wouId suy LIuL oI course one sIouId Iook uL LIe
buIunce beLween money demund und money suppIy Lo ussess wIeLIer moneLury condILIons ure eusy
or LIgIL. And wouId ugree - LrudILIonuI moneLurIsLs knew LIuL very weII, Iowever, wouId uIso
urgue LIuL even MIILon rIedmun Irom LIme Lo LIme IorgoL IL und becume overIy Iocused on money
suppIy growLI.
Puge 11 oI 1zq
And IInuIIy IuppIIy wIII udmIL commILLIng LIuL IuIIucy very oILen und sLIII remuIn commILLed Lo
sLudyIng money suppIy duLu - uILer uII beIng u MurkeL MoneLurIsL meuns LIuL you sLIII ure q% oId-
scIooI LrudILIonuI moneLurIsL uL IeusL In my book.
PS muybe LIe rooL oI uII bud economeLrIcs Is LIe uIso IorgeLLIng Lo usk WHY prIces cIunge.
Puge 116 oI 1zq
Monetorg historg - lessons for todog
Denmork ond Noruog uere the P11CS of the
Scondinooion Currencg Union
As LIe euro crIsIs conLInues specuIuLIon oI un evenLuuI breuk-up oI LIe euro uIso conLInues. TIere
ure numerous exumpIes In moneLury IIsLory oI currency unIons breukIng up. One Is LIe breukup oI
LIe ScundInuvIun Currency UnIon In 1qzq.
Iuve Iound un InLeresLIng puper on LIIs ImporLunL evenL In ScundInuvIun moneLury IIsLory. n IIs
zooq-puper The Decline cnd Icll oj the Sccndincticn Currenc Union :p:( - :pz(: Etents in the
Ajtermcth oj World Wcr I KrIm TuIIu dIscusses LIe reuson Ior LIe coIIupse oI LIe ScundInuvIun
Currency UnIon.
Here Is LIe ubsLrucL:
n 18;, Denmurk, Norwuy und Sweden Iormed LIe ScundInuvIun Currency UnIon (SCU) und
udopLed LIe goId sLundurd. TIe UnIon worked IuIrIy smooLIIy durIng LIe nexL LIIrLy yeurs und wus
purLIy exLended unLII 1q1q. TIe ouLbreuk oI WorId Wur LrIggered u serIes oI evenLs LIuL evenLuuIIy
wouId Ieud Lo LIe IormuI cunceIIuLIon oI LIe unIon In 1qzq. TIe suspensIon oI converLIbIIILy und LIe
exporL proIIbILIon on goId In 1q1q, opened excIunge ruLe LensIons wILIIn LIe unIon, und ucLed us u
IIrsL nuII In LIe SCU`s coIIIn. AILIougI LIe counLrIes de IucLo Iud LIeIr currencIes vuIued uL
dIIIerenL ruLes exLernuIIy, LIe LreuLy oI 18; mude LIem LrudubIe uL pur wILIIn LIe unIon. TIIs
conIIIcL, beLween de IucLo sILuuLIon und de jure reguIuLIon, opened urbILruge opporLunILIes Ior LIe
pubIIc; buL uIso resuILed In opporLunIsLIc beIuvIour In LIe reIuLIon beLween LIe ScundInuvIun
CenLruI Bunks. TIIs sLudy oI LIe breuk-up oI LIe SCU IInds LIuL LIe goId sLundurd IuncLIoned us u
unIIyIng sLruILjuckeL on moneLury poIIcy und wus un ImporLunL prerequIsILe Ior u moneLury unIon
wILIouL u common cenLruI bunk. L uIso cIuIIenges eurIIer work on LIe breuk-up oI LIe SCU, by
suggesLIng LIuL LIe mosL ImporLunL IucLor beIInd LIe cenLrIIuguI LensIons wILIIn LIe Currency
UnIon wus LIe Improved SwedIsI buIunce oI Lrude IoIIowIng LIe ouLbreuk oI Word Wur . TIe IucL
LIuL wurLIme Lrude perIormunce dIIIered beLween LIe LIree counLrIes mude LIe currency ureu Iuce
Puge 11; oI 1zq
un usymmeLrIc exLernuI sIock LIuL requIred un excIunge-ruLe udjusLmenL - cuusIng LIe IuII oI LIe
unIon.
WIuL Is LIe ImpIIcuLIon Ior LIe euro zone? WeII, um noL sure, buL IL mIgIL be InLeresLIng Lo Iuve u
cIoser Iook uL LIe InLernuI Lrude ImbuIunce In LIe ScundInuvIun currency unIon und compure LIuL Lo
LIe ImbuIunces LIuL we Iuve seen buIId In LIe euro zone durIng LIe boom-yeur prIor Lo zoo8. BoLI
Denmurk und Norwuy suw booms (und bubbIes) durIng LIe IIrsL WorId Wur yeurs und LIe eurIy
1qzos. n LIuL sense Denmurk und Norwuy Iooked IIke Loduy`s PGS, wIIIe Sweden wILI IL`s
IncreusIng Lrude surpIus wus LIe Germuny oI LIe ScundInuvIun currency unIon. n my prevIous posL
descrIbed Iow Insune moneLury LIgILenIng In Norwuy und Denmurk uILer 1qzq Ieud Lo depressIon,
wIIIe Sweden uvoIded depressIon.
Puge 118 oI 1zq
"The Bocon Stondord" (the P1C PECJ uould hooe sooed
Denmork from the Creot Depression
Even LIougI um u DunIsI economIsL um cerLuInIy no experL on LIe DunIsI economy und Iuve
cerLuInIy noL spend mucI LIme bIoggIng ubouL LIe DunIsI economy und Iuve no pIuns Lo cIunge
LIuL In LIe IuLure. However, Ior some reuson Loduy cume Lo LIInk ubouL wIuL wouId Iuve been LIe
ImpucL on LIe DunIsI economy II LIe DunIsI krone Iud been pegged Lo LIe prIce oI bucon ruLIer
LIun Lo goId uL LIe onseL oI LIe GreuL DepressIon In 1qzq. eLs cuII IL the Bocon Stondord - or u
LIe PIG PEG (LIunks Lo MIkueI Bonde NIeIsen Ior LIuL suggesLIon).
Toduy Iess LIun 1o% oI DunIsI exporL revenues comes Irom bucon exporL - buck durIng In LIe
1qzos IL wus mucI more sIzubIe und ugrIcuILuruI producLs domInuLed exporL revenues und
Denmurk`s muIn LrudIng purLner wus GreuL BrILuIn. SInce bucon prIces und oLIer ugrIcuILuruI
producL were IIgIIy correIuLed (und sLIII ure) LIe bucon prIce probubIy wouId Iuve been u very good
proxy Ior DunIsI exporL prIces. Hence, u LIe PG PEG wouId busIcuIIy Iuve been sImIIur Lo JeII
runkeI`s Peg LIe ExporL PrIce (PEP) proposuI (see my eurIIer posLs on LIIs Ideu Iere und Iere).
WIen LIe gIobuI crIsIs IIL In 1qzq IL puL sIgnIIIcunL downwurd pressure on gIobuI ugrIcuILuruI prIces
und In Lwo yeurs mosL ugrIcuILuruI prIces Iud been IuIved. As u consequence oI LIe mussIve drop In
ugrIcuILuruI prIces - IncIudIng bucon prIces - LIe crIsIs puL u serIous neguLIve pressures on LIe
DunIsI krone peg uguInsL goId. Denmurk Iud reIuLIveIy successIuIIy reInLroduced LIe goId sLundurd
In 1qz;, buL wIen LIe crIsIs IIL LIIngs cIunged drumuLIcuIIy.
nILIuIIy LIe DunIsI cenLruI bunk (Dunmurks NuLIonuIbunk) deIended LIe goId sLundurd und us u
resuIL LIe DunIsI economy wus IIL by u sIurp moneLury conLrucLIon. As urgued In my posL on
RussIun moneLury poIIcy u neguLIve sIock Lo exporL prIces Is noL u suppIy sIock, buL ruLIer u
nectite demcnd shocl under u IIxed excIunge ruLe regIme - IIke LIe goId sLundurd. SuId In
unoLIer wuy LIe DunIsI AD curve sIIILed sIurpIy Lo LIe IeIL.
TIe sIock Iud serIous consequences. Hence, DunIsI economIc ucLIvILy coIIupsed us mosL pIuces In
LIe worId, unempIoymenL spIked drumuLIcuIIy und sLrong deIIuLIonury pressures IIL LIe economy.
Puge 11q oI 1zq
TIIngs goL even worse wIen LIe BrILIsI governmenL In 1q1 decIded Lo gIve up LIe goId sLundurd
und evenLuuIIy LIe DunIsI governmenL decIded Lo IoIIow LIe Ieud Irom LIe BrILIsI governmenL und
uIso gIve up LIe goId sLundurd. However, unIIke Sweden LIe DunIsI uuLIorILIes IeIL very
uncomIorLubIe Lo go IL`s own wuys (IIke Loduy.) und IL wus unnounced LIuL LIe krone wouId be re-
pegged uguInsL sLerIIng. TIuL sLrongIy IImILed LIe expunsIonury ImpucL oI LIe decIsIon Lo gIve up
LIe goId sLundurd. TIereIore, IL Is cerLuInIy no coIncIdence LIuL SwedIsI economy perIormed mucI
beLLer LIun LIe DunIsI economy durIng LIe 1qos.
TIe DunIsI economy, Iowever, sLurLed Lo recovery In 1q. Two evenLs spurred LIe recovery. IrsL,
DR`s decIsIon Lo gIve LIe goId sLundurd IeIped LIe US economy Lo begIn puIIIng ouL oI LIe
recovery und LIuL IeIped gIobuI commodILy prIces wIIcI cerLuInIy IeIped DunIsI ugrIcuILuruI
exporLs. Second, LIe so-cuIIed Kcnslercde Areement - u poIILIcuI ugreemenL numed uILer LIe
Iome uddress oI LIen PrIme MInIsLer TIorvuId SLuunIng In LIe sLreeL KunsIergude In CopenIugen
- Ieud Lo u devuIuuLIon oI LIe DunIsI krone. BoLI evenLs eIIecLIveIy were moneLury eusIng.
Whot uould the Bocon stondord hooe done for the Donish economg?
WIIIe moneLury eusIng evenLuuIIy sLurLed Lo puII Denmurk ouL oI LIe GreuL DepressIon IL dIdn`L
Iuppen beIore Iour yeur InLo LIe crIsIs und LIe recovery never becume us ImpressIve us LIe
deveIopmenL In Sweden. Hud Denmurk InsLeud Iud u ccon Stcndcrd LIen LIIngs wouId IIkeIy
Iuve pIuyed ouL In u sIgnIIIcunLIy more posILIve wuy. Hence, Iud LIe DunIsI krone been pegged Lo
LIe prIce oI bucon LIen IL wouId Iuve been uuLomuLIcuIIy devuIued uIreudy In 1qzq und LIe
gruduuI devuIuuLIon wouId Iuve conLInued unLII 1q uILer, wIIcI rIsIng commodILy prIces (und
bucon prIces) gruduuIIy wouId Iuve Ieud Lo u LIgILenIng oI moneLury condILIons.
n my vIew Iud Denmurk Iud LIe PIG PEG In 1qzq LIe crIsIs wouId been mucI more sIorL-IIved
und LIe economy wouId IusL Iuve recovered Irom LIe crIsIs. UnIorLunuLeIy LIuL wus noL LIe cuse
und Iour yeurs wus wusLed deIendIng un InsuneIy LIgIL moneLury poIIcy.
Monetury diseqoilibriom leuds to interventionism
TIe DunIsI uuLIorILIes` decIsIon Lo muInLuIn LIe goId sLundurd und LIen Lo re-peg Lo sLerIIng Iud
sIgnIIIcunL economIc und socIuI consequences. As u consequence LIe pubIIc supporL Ior
InLervenLIonIsL poIIcIes grew drumuLIcuIIy und eIIecLIveIy Iuy LIe IounduLIon Ior wIuL cume Lo be
Puge 1zo oI 1zq
known us LIe dunIsI WeIIure SLuLe. Hence, LIe Kcnslercde Areement noL onIy Ieud Lo u
devuIuuLIon oI LIe krone, buL uIso Lo u sIgnIIIcunL expunsIon oI LIe roIe oI governmenL In LIe DunIsI
economy. n LIuL sense LIe KunsIergude AgreemenL Ius puruIIeIs Lo DR`s poIIcIes durIng LIe GreuL
DepressIon - moneLury eusIng, buL uIso more InLervenLIonIsL poIIcIes.
Hence, LIe DunIsI experIence Is un exumpIe oI MIILon rIedmun`s urgumenL LIuL moneLury
dIsequIIIbrIum cuused by u IIxed excIunge ruLe poIIcy Is IIkeIy Lo Increuse InLervenLIonIsL
LendencIes.
Bon uppeLILe - or us we suy In DunIsI telbelomme.
Puge 1z1 oI 1zq
Rememher the mistokes of 1pj;? A lesson for todog's
policg mokers
SInce LIe ECB InLroduced IL`s -yeur TRO on December 8 LIe sIgns LIuL we ure emergIng Irom LIe
crIsIs Iuve grown sLronger. TIIs Ius been vIsIbIe wILI sLock prIces reboundIng sLrongIy, Iong US
bond yIeIds Iuve sLurLed Lo IncI up und commodILy prIces Iuve Increused. TIIs Is uII sIgns oI eusIer
moneLury condILIons gIobuIIy.
We ure now u coupIe oI monLIs InLo LIe murkeL recovery und especIuIIy LIe recovery In commodILy
prIces sIouId soon be vIsIbIe In US und Europeun IeudIIne InIIuLIon und wIII IIkeIy soon begIn Lo
enLer InLo LIe communIcuLIon oI cenLruI bunkers uround LIe worId. TIIs Ius remInded me oI LIe
recession in the depression In 1q;. AILer DR guve up LIe goId sLundurd In 1q LIe gIobuI
economy sLurLed Lo recover und by 1q; US IndusLrIuI producLIon Iud busIcuIIy reLurned Lo LIe
1qzq-IeveI. TIe eusIng oI gIobuI moneLury condILIons und LIe IoIIowIng recovery Iud spurred gIobuI
commodILy prIces und by 1q; poIIcy mukers In LIe US sLurLed Lo worry ubouL InIIuLIonury
pressures.
However, In LIe second IuII oI 1q6 US economIc ucLIvILy und LIe US sLock murkeL wenL InLo u Iree
IuII und InIIuLIonury concerns soon dIsuppeured.
TIere ure u number oI compeLIng LIeorIes ubouL wIuL LrIggered LIe 1q; recessIon. wIII especIuIIy
IIke Lo IIgIIIgIL LIree moneLury expIunuLIons:
1) MIILon rIedmun und Annu ScIwurLz In LIeIr Iumous Monetcr Histor IIgIIIgILed LIe IucL LIuL
LIe ederuI Reserve`s decIsIon Lo Increuse reserve requIremenLs sLurLIng In JuIy 1q6 wus wIuL
cuused LIe recessIon oI 1q;.
z) DougIus rwIn Ius - In un exceIIenL workIng puper Irom IusL yeur - cIuImed LIuL IL wus noL LIe
ed, buL ruLIer LIe US Treusury LIuL cuused LIe LIe recessIon us LIe Treusury moved uggressIveIy
Lo sLerIIIze goId InIIows InLo LIe US und LIereby cuused LIe US money suppIy Lo drop.
) WIIIe 1) und z) regurd dIrecL moneLury ucLIons LIe LIIrd expIunuLIon regurds LIe cIunge In LIe
communIcuLIon oI US poIIcy mukers. Hence, GuuLI B. EggerLsson und BenjumIn PugsIey In un
exLremeIy InLeresLIng puper Irom zoo6 urgue LIuL IL wus LIe communIcuLIon ubouL moneLury und
Puge 1zz oI 1zq
excIunge ruLe poIIcy LIuL cuused LIe recessIon oI 1q;. As ScoLL Sumner urgues moneLury poIIcy
works wILI Iong und vurIubIes lecds. EggerLson und PugsIey urgue exucLIy LIe sume.
n my vIew uII LIree expIunuLIons cIeurIy ure vuIId. However, wouId probubIy quesLIon rIedmun`s
und ScIwurLz`s expIunuLIon on IL`s own us beIng enougI Lo expIuIn LIe recessIon oI 1q;. Iuve
LIree reusons Lo be sIIgILIy skepLIcuI ubouL LIe rIedmun-ScIwurLz expIunuLIon. IrsL, II Indeed LIe
LIgILenIng oI reserve requIremenLs cuused LIe recessIon LIen IL Is somewIuL odd LIuL LIe murkeL
reucLIon Lo LIe unnouncemenL oI LIe LIgILenIng oI reserve requIremenLs wus so sIow Lo ImpucL LIe
sLock murkeLs und LIe commodILy prIces. n IucL LIe unnouncemenL oI LIe Increuse In reserve
requIremenLs In JuIy 1q6 dId noL Iuve uny vIsIbIe ImpucL on sLock prIces wIen LIey were
InLroduced. Second, IL Is uIso noLubIe LIuL LIere seems Lo Iuve been IILLIe reIerence Lo LIe Increused
reserve requIremenL In LIe US IInuncIuI medIu wIen LIe coIIupse sLurLed In LIe second IuII oI 1q;
- u yeur uILer LIe InILIuI Increuse In reserve requIremenLs. TIIrd, CuIomIrIs, Muson und WIeeIock
In puper Irom zo11 Iuve demonsLruLed LIuL bunks uIreudy wIere IoIdIng Iurge excess reserves und
LIe Increuse In reserve requIremenLs reuIIy wus noL very bIndIng Ior muny bunks. TIuL suId, even II
LIe Increuse In reserve requIremenL mIgIL noL Iuve been uII LIuL bIndIng IL noneLIeIess senL u cIeur
sIgnuI ubouL LIe ed`s InIIuLIon worrIes und LIereIore probubIy wus noL IrreIevunL. More on LIuL
beIow.
Doug rwIn`s expIunuLIon LIuL IL wus ucLuuIIy LIe US Treusury LIuL cuused LIe LroubIe LIrougI goId
sLerIIIzuLIon ruLIer LIun LIe ed LIrougI IIgIer reserve requIremenLs In my vIew Ius u IoL oI merIL
und sLrongIy recommend Lo everybody Lo reud Doug`s puper on Gold Sterilizction cnd the
Recession :p;-8 In wIIcI Ie presenLs quILe sLrong evIdence LIuL LIe goId sLerIIIzuLIon cuused LIe
US money suppIy Lo drop sIurpIy In 1q;. TIuL beIng suId, LIuL expIunuLIon does noL IIL perIecLIy
weII wILI LIe prIce ucLIon In LIe sLock murkeL und commodILy prIces eILIer.
Hence, beIIeve we need Lo Luke InLo uccounL LIe combined cctions oI LIe oI LIe US Treusury
(IncIudIng commenLs Irom PresIdenL RooseveIL) und LIe ederuI Reserve cuused u murked sIIIL In
expecLuLIons In u sLrongIy deIIuLIonury dIrecLIon. n LIeIr zoo6 puper EggerLsson und PugsIey The
Mistcle oj :p;: A Genercl Equilibrium Anclsis muke LIIs poInL IorceIuIIy (even LIougI Iuve
some reservuLIons ubouL LIeIr dIscussIon oI LIe moneLury LrunsmIssIon mecIunIsm). n my vIew IL
Is very cIeur LIuL boLI LIe RooseveIL udmInIsLruLIon und LIe ed were quILe worrIed ubouL LIe
Puge 1z oI 1zq
InIIuLIonury rIsks und us u consequence IncreusIng sIgnuIed LIuL more moneLury LIgILenIng wouId
be IorLIcomIng.
n LIuL sense LIe 1q; recessIon Is u depressIng remInder oI LIe sLrengLI oI LIe oI LIe Chucl Norris
ejject - Iere In LIe reserve Iorm. TIe IucL LIuL InvesLors, consumers eLc were Ied Lo beIIeve LIuL
moneLury condILIons wouId be LIgILened cuused un Increuse In money demund und Ied Lo
un pcssite LIgILenIng oI moneLury condILIons In LIe second IuII oI 1q; - und LIIngs obvIousIy
were noL mude beLLer by LIe ed und US Treusury ucLuuIIy LIen uIso cctitel LIgILened moneLury
condILIons.
The risk oI repeuting the mistukes oI 1q, - we did thut in o11! Will we do it uguin in
o1 or o1?
So wIy Is uII LIIs ImporLunL? Becuuse we rIsk repeuLIng LIe mIsLukes oI 1q;. n 1q; US poIIcy
mukers reucLed Lo rIsIng commodILy prIces und InIIuLIon Ieurs by LIgILenIng moneLury poIIcy und
even more ImporLunL creuLed uncerLuInLy ubouL LIe ouLIook Ior moneLury poIIcy. AL LIe LIme LIe
ederuI Reserve IuIIed Lo cIeurIy sLuLe wIuL nomInuI poIIcy ruIe IL wunLed Lo ImpIemenLed und us u
resuIL cuused u spIke In money demund.
So wIere ure we Loduy? WeII, we mIgIL be on LIe wuy ouL oI LIe crIsIs uILer LIe ederuI Reserve und
purLIcuIurIy LIe ECB IInuIIy cume Lo ucknowIedged LIuL u eusIng oI moneLury condILIons wus
needed. However, we ure uIreudy IeurIng voIces urguIng LIuL rIsIng commodILy prIces ure posIng un
InIIuLIonury rIsk so moneLury poIIcy needs Lo be LIgILen und us neILIer LIe ed nor LIe ECB Ius u
very cIeurIy deIIned nomInuI LurgeL we ure doomed Lo see conLInued uncerLuInLy ubouL wIen und II
LIe ECB und LIe ed wIII LIgILen moneLury poIIcy. n IucL LIIs Is exucLIy wIuL Iuppened In zo11. As
LIe ed`s QEz pusIed up commodILy prIces und LIe ECB moved Lo premuLureIy LIgILen moneLury
poIIcy. To muke muLLers worse exLremeIy uncIeur sIgnuIs ubouL moneLury poIIcy Irom Europeun
cenLruI bunkers cuused murkeL purLIcIpunLs Ieur LIuL LIe ECB wus scuIIng buck moneLury eusIng.
TIereIore we cun onIy Iope LIuL LIIs LIme uround poIIcy mukers wIII Iuve Ieurned LIe Iesson Irom
1q; und noL premuLureIy LIgILen moneLury poIIcy und even more ImporLunL we cun onIy Iope LIuL
cenLruI bunks wIII become mucI more cIeur regurdIng LIeIr nomInuI LurgeLs. Any murkeL
moneLurIsL wIII oI course LeII you LIuL cenLruI bunkers sIouId noL Ieur overdoIng LIeIr moneLury
Puge 1zq oI 1zq
eusIng II LIey cIeurIy deIIne LIeIr nomInuI LurgeLs (preIerubIy u NGDP IeveI LurgeL) - LIuL wouId
ensure LIuL moneLury poIIcy Is noL LIgILened premuLureIy und u weII-LImed exIsL Irom moneLury
eusIng Is ensured.
PS Iuve un (very uncIeur!) Ideu LIuL LIe so-cuIIed Tripcrtite Areement Irom SepLember 1q6 b
LIe US, GreuL BrILuIn und runce Lo sLubIIIze LIeIr nuLIons` currencIes boLI uL Iome und In LIe
InLernuLIonuI X murkeLs mIgIL Iuve pIuyed u roIe In cuusIng u cIunge In expecLuLIons us IL
busIcuIIy LoId murkeL purLIcIpunLs LIuL LIe duys oI currency wur und compeLILIve devuIuuLIons Iud
come Lo un end. MIgIL LIIs Iuve been seen us u sIgnuI Lo murkeL purLIcIpunLs LIuL cenLruI bunks
wouId not compeLe Lo Increuse LIe money suppIy? TIIs Is jusL u IypoLIesIs und Iuve done
ubsoIuLeIy no work on IL, buL muybe some young scIoIur wouId IIke Lo pIck you LIIs Ideu?