Market Monetarism vs. Theo-Monetarism (A guest post by Benjamin Cole)

I have the pleasure of guest hosting a post by Benjamin Cole. Benjamin is well known to everyone that frequents the MM blogs because he always manifests himself in the comments section.

Benjamin Mark Cole has been a financial journalist and author for close to 30 years and has had two books published by Bloomberg, one of which has the suggestive title The Pied Pipers of Wall Street: How Analysts Sell you Down the River, which has been translated to German. He balances “mind and body” by also being a woodworker-furniture maker.

A few months ago I suggested he write a guest post to “vent his frustrations”, after he told me he was dimly aware that monetary stimulus was possible but found most monetarists hopelessly mired in anti-inflation sentiments, and utterly lacking for prescriptions to solve deflationary recessions. But then in 2009 he stumbled on Scott Sumner and in his words: Finally! A monetarist who wanted to use the power of monetarism for good not just to preserve an ascetic lifestyle so as to stymie inflation.

One of the positive externalities of blogging is the number of people you come into contact and establish some rapport. Over time this will certainly cheapen lodging costs when one travels abroad!

Market Monetarism vs. Theo-Monetarism (A guest post by Benjamin Cole)

Monetarism is a bewildering topic for the layman, a field filled with fervent believers, effete pontificators and even dense (and exceedingly fragile) mathematical models. It is foggy, muddy and undulating intellectual terrain, with meager and dubious rewards—until lately.

Now, a new conceptual lens has emerged for those endeavoring to understand the usefulness of monetarism, and that is Market Monetarism, as aptly named by Lars Christensen, a rising Danish economist.  Interestingly enough, Market Monetarism has emerged in the blogs in the last two years, outside the encrusted or partisan confines of academia and think tanks.

As the sunlight of Market Monetarism flattens and dries out the murky macroeconomic landscape, it becomes clear that the schism today in monetarism is not between the many extant sects vying for supremacy (if only in ivory towers), or even between monetarism and Keynesianism, but between the new Market Monetarism and all other older monetarist schools, the latter of which can be fairly clumped together as “Theo-Monetarism.”

Why the bifurcation?

In a nutshell, Market Monetarists advocate a central bank that publicly and transparently targets nominal GDP growth, and with clarity and unmistakable resolve announces the tools and the extent to which they will be used to reach the target NGDP, as primarily manifested by interest rates, quantitative easing and interest on reserves.

Market Monetarists place a premium on regime certainty and a stalwart, apolitical central bank.  The public should never doubt the intent and resolve of the central bank, or that it fully intends to meet its targets, through the sheer power of not printing money, or printing money aggressively, as necessary, in addition to other actions.

Dithering and mumbling do not a successful central bank make.

While the contrasting Theo-Monetarists are a motley crew, in the end they are effectively policy-shamans—usually chanting that low inflation is the universal cure, or that genuflection to gold will yield prosperity, or that worship of paper currency as a store of value is the only ethical, and thus possible, path to take.  A peevish fixation—really an unhealthy obsession–with inflation and a resultant stagnant exchange value of paper currency appears fundamental to all Theo-Monetarists. A favored mantra is “all inflation is theft,” thus equating monetary policy with morality. The only policy tool favored by most Theo-Monetarists is interest rates, or a gold standard.

Inflation is always the Grand Satan in Theo-Monetarist set pieces, usually for reasons that seem spiritual in nature. When asked to detail real costs of inflation, Theo-Monetarists incredibly cite arguments such as workers supplying less labor in response to even moderate inflation, and thus reducing real GDP.  Some Theo-Monetarists contend that consumers will be unable to make informed choices due to upwardly quivering price signals.  One can only conclude that Theo-Monetarists start with a zealous conviction regarding inflation, and work back from there, as enraptured deontologists.

A relative bright spot among Theo-Monetarists is John Taylor, the able and gentlemanly Stanford scholar and GOP solon, and inventor of the “Taylor Rule.”  To Taylor’s credit, within his formulaic prescript for monetary policy is a hat-tip to real GDP growth, though inflation and interest rates get star billing.  Yet at least the Taylor Rule mechanically militates for relative monetary stimulus (through lower interest rates) if real economic growth lags.  The Taylor Rule, however, loses much prescriptive power in times of deep recession, very low interest rates, or deflation, like now (or in Japan since 1992). The Taylor Rule is unable to prescribe quantitative easing or even reduced interest on reserves, or other actions necessary in deflationary recessions (though Taylor has advocated sustained and heavy quantitative easing for Japan).

But the real Achilles Heel of the Taylor Rule is its tunnel-vision on the monetary ship’s rudder, not the destination or speed. The Taylor Rule holds that mechanisms, not goals, are paramount—indeed there is no goal of economic growth.  The Taylor Rule has faith that a properly set rudder will guide at best speed to the desired shore—and don’t mind economic cross currents, or the fact that the hull is taking on water.

Nor does the Taylor Rule contain a diktat for central bank clarity and transparency, or for transparent central bank goals.  The public might quite reasonably fear unexpected or unanticipated central bank actions even under the Taylor Rule—indeed, central bank may become rudderless in times of deflation and recession, just when an alert, respected and transparent central bank is most needed—thus promoting regime uncertainty. In the end, the Taylor Rule has faith the economy will recover, given rules-driven interest rates and low inflation.  For all of its crippling weaknesses, the Taylor Rule is the best the Theo-Monetarists have to offer.  And the slope downhill is steep from there.

Theo-Monetarists are often intellectual puzzles, spending decades pursuing something called Modern Monetary Theory, or New Monetary Theory (when not unearthing reasons to praise the exalted element AU).  These present-day offshoots of Old Monetarism recognize the importance of the money supply, but then stop short of concrete policy prescriptions, especially for deflationary recessions.  They are like doctors who say a patient needs blood, but not too much, and do not prescribe transfusions but only extended rest and keep the leeches ready.  Again, unbounded faith in the questionable presumption that all inflation is bad seems to be the sole informing thought of New or Modern Monetarists, so again they are really Theo-Monetarists.

The ecclesiastic nature of the inflation-fixated Theo-Monetarists is all the more pronounced in light of the ongoing epic failure of the Bank of Japan and the Nippon economy.  If ever low interest rates and scant inflation or mild deflation were tried, it has been in Japan, since 1992.  The results are that industrial production has plunged by 20 percent in the last two decades, the stock market has tumbled by 75 percent, and property is down by 80 percent and still falling.  This rotten result was obtained in a nation with a dedicated and educated work force, and perhaps the world’s most advanced culture, marked by low crime rates, and strong sense of ethics.  Moreover, Japan spends almost nothing on national defense (versus 6 percent in the USA), and 4 percent of GDP on health (versus 16 percent in the USA).  Still their economy is rotting and becoming over-indebted.  The Theo-Monetarists cheer the rising yen, which traded in the mid-120s to the dollar in 1992, and is now in the mid-70s.

While Japanese banks have been chided for not writing down bad loans—thus allowing a putative cathartic excretion and epiphany to take place—in fact Nippon banks are continually accumulating more new bad real estate loans, as property values sink into the toilet decade after decade.   Deflation cuts property values but not the value of nominal loans.  One must assume that a powerful bondholding class has emerged in Japan, determined to preserve mild deflation, even at the cost of asphyxiating the economy.  It is monetary quicksand—and Theo-Monetarist Utopia, the idyll they wish for America.

By sharp contrast, in the United States, industrial production since from 1992 to 2008 roughly doubled, while real per capita incomes rose by one third.  Stocks and real estate generally rallied, until the Great Deflationary Recession of 2009-10.  From 1992 to 2008, inflation was nearly always between 2 percent and 6 percent, as measured by the CPI.  The United States prospered mightily with moderate inflation for 20 years, an irrefutable historical artifact.  That superb track record does not impress the Theo-Monetarists.  They would have preferred the Japan model.

Of course, Theo-Monetarists are not the only active menace to U.S. prosperity. There have long been the fiscalists (usually called Keynesians), led presently by the brilliant Paul Krugman.  Remarkably, last year even Krugman acknowledged that an adrift Federal Reserve Board, passively tightening the money supply (as it is) could suffocate the economy and easily offset stimulative federal spending—spending that Market Monetarists would argue is just monetarism in disguise, if accommodated by the Fed. Market Monetarists contend that monetary stimulus directly injected into the private sector is generally better than federal stimulus.

Today the United States stands at a fork in the road—will we obtain good economic growth in the next decade, or mimic Japan?  The flag of the Rising Sun looms larger with each passing day.

It is often noted that Fed Chief Ben Bernanke visited Japan in the late 1990s on an advisory mission.  What we didn’t know was that it was the Bank of Japan advising Bernanke, not the other way around.

Let us hope Bernanke chooses Market Monetarism in 2012, and not Theo-Monetarism.

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