Sliding back to the gold standard?
When the Bank of International Settlements was created in 1930, it was hoped that it would provide a progressive voice on monetary policy, pushing back against the passivity of the Fed and the Bank of France. Commenter Emerich directed me to a new report out by the BIS. I don’t know what sort of term to apply, but it certainly is not “progressive”:
For monetary policy, the key is to rebalance the evaluation of risks in the current global stance. The exceptionally accommodative policies in place are reaching their limits. The balance between benefits and costs has been deteriorating (Chapter IV). In some cases, market participants have begun to question whether further easing can be effective, not least as its impact on confidence is increasingly uncertain. Individual incremental steps become less compelling once the growing distance from normality comes into focus. Hence, accumulated risks and the need to regain monetary space could be assigned greater weight in policy decisions. In practice, and with due regard to country specific circumstances, this means seizing available opportunities by paying greater attention to the costs of extreme policy settings and to the risks of normalising too late and too gradually. This is especially important for large jurisdictions with international currencies, as they set the tone for monetary policy in the rest of the world.
Translation: The Fed needs to raise interest rates so that it will have more “monetary space” to cut them in the future, when monetary stimulus is once again needed. Of course this is a very basic error. Monetary space results from the gap between the Wicksellian equilibrium nominal rate and the effective lower bound (zero or slightly below). If central banks tighten monetary policy then the Wicksellian equilibrium rate will decline, even if actual market rates increase, thus reducing monetary space. Indeed back in 2011, the ECB did exactly what the BIS wants the Fed to do, and ended up with far less “monetary space”.
Let’s look at the next paragraph in detail:
Such a policy shift relies on a number of prerequisites. First: a more critical evaluation of what monetary policy can credibly do.
Translation: The BIS wrongly thinks that monetary policy might be unable to boost demand.
Second: full use of the flexibility in current frameworks to allow temporary but possibly persistent deviations of inflation from targets, depending on the factors behind the shortfall.
The BIS understands that its recommendation might cause the Fed to fall short of its policy targets, but is OK with that.
Third: recognising the risk of overestimating both the costs of mildly falling prices and the likelihood of destabilising downward spirals.
The BIS doesn’t see it as a major problem if the central bank falls short of its target, as long as we don’t face a deflationary spiral. What the BIS doesn’t understand is that falling short will lead to precisely the ultra-low rates and bloated balance sheets that the BIS abhors. Furthermore, not hitting your target reduces policy credibility, making monetary policy more difficult to implement in the future.
Fourth: a firm and steady hand – after so many years of exceptional accommodation and growing financial market dependence on central banks, the road ahead is bound to be bumpy.
The BIS understands that the markets will scream bloody murder if the Fed adopts the BIS’s advice, but it wants the Fed to ignore those screams and keep a steady hand on the tiller as they steer toward higher and higher interest rates. In fact, the market screams would be rational forecasts of economic disaster ahead, and should not be ignored by the Fed.
Last: a communication strategy that is consistent with the above and thus avoids the risk of talking down the economy. Given the road already travelled, the challenges involved are great, but they are not insurmountable.
The BIS thinks the “road already travelled” has been ultra-easy money, whereas it’s actually been tight money. The BIS thinks that an upbeat communication strategy by the Fed, i.e. communicating that raising rates is desirable because the economy would otherwise overheat, will reassure the markets. In fact, the markets will assume the Fed is delusional, and asset prices will decline sharply as a result. Fortunately, the Fed is very unlikely to accept the BIS’s advice.
Later in the report the BIS suggests that we are approaching something like the old gold standard:
More generally, there are natural limits to the process – to how far interest rates can be pushed into negative territory, central bank balance sheets expanded, spreads compressed and asset prices boosted. And there are limits to how far spending can be brought forward from the future. As these limits are approached, the marginal effect of policy tends to decline, and any side effects – whether strictly economic or of a political economy nature – tend to rise. This is why central banks have been closely monitoring these side effects, such as the impact on risk-taking, market functioning and financial institutions’ profitability.
I don’t see those limits, but let’s say I’m wrong. In that case the solution is to adopt a higher inflation target, or NGDPLT, so that monetary policy does not become impotent. But the BIS also appears to oppose those ideas. Rather they seem to want to return to the world of the gold standard. Not literally, of course, but in the sense that they are willing to live with a policy regime where the effectiveness of monetary policy is greatly reduced.
The BIS of 2016 holds views that are striking similar to the conservative central bankers of 1930, which the BIS was created to push back against. Their primary focus seems to be using monetary policy to push back against financial bubbles.
If the Fed were to follow their approach right now the entire world would be in a deep depression within 6 months. Instead, the Fed should do the opposite. I’d like to see them cut rates by 50 basis points today, by eliminating IOR. The global economy (NGDP expectations) needs a shot in the arm.
For instance, Brian Donohue recently pointed out that the dividend yield on the S&P500 (2.20%) is now almost has high as the 30 year T-bond yield (2.28%).
And the Fed is still worried about inflation.
PS. The last few days would have been a wonderful time to have a highly liquid and subsidized NGDP futures market. And yet I don’t even see other economists calling for it. Another failure of the economics profession.
Off Topic: Gideon Rachman has a very good post on Brexit.
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27. June 2016 at 12:55
“The last few days would have been a wonderful time to have a highly liquid and subsidized NGDP futures market.”
-A futures market? No. A credible and widely respected NGDP target by the world’s central banks? Definitely.
27. June 2016 at 13:30
Benjamin Cole also had “nice words” for the BIS
https://thefaintofheart.wordpress.com/2016/06/27/brexit-bis-calls-for-tighter-money/
27. June 2016 at 13:37
It seems to me that the extensive use of buybacks over dividends has created some confusion and measurement difficulty on these matters. Adding net buybacks to dividends would double the yield on stocks, and though this is hard to accept for someone looking for conventional cash flow, 2% divs + 2% buybacks where you sell 2% of your shares each year is mathematically the same as a 4% dividend with no buybacks. This should be compared to the return on inflation adjusted bonds, and I think it should not be that uncommon for it to be a higher rate than real bond yields.
27. June 2016 at 13:50
“financial market dependence dependence on central banks”
What does this even mean? Are they implying that there are times when the financial market doesn’t depend on central banks?
That way of thinking makes no sense to me.
27. June 2016 at 14:42
Thanks Marcus.
Kevin, Good point, which makes the point even stronger.
ChargerCarl, I suppose they think monetary policy has been propping up asset prices, whereas just the opposite has been true.
27. June 2016 at 15:07
Who pays these guys? Why are they not fired on the spot? This is worst than zero hedge.
27. June 2016 at 15:28
Excellent blogging. Central banking has become a cult?
27. June 2016 at 15:36
Hm…
27. June 2016 at 15:43
The “disaster” was in fact always the boom, because subsequent corrections were inevitable.
More inflation now to delay those corrections will only make future disasters even more acute.
Sumner, your pleas are irresponsible and uninformed.
27. June 2016 at 15:54
Sadly the “merchants” will not allow a return to the gold standard. They might have to work for a living.
27. June 2016 at 16:15
Major freedom… “More inflation now to delay those corrections will only make future disasters even more acute.”
Why should anyone listen to you about inflation ? you said that the stimulus HAD to result in high inflation…when it didn’t show up you said inflation was hiding in commodities… LOL (only a gold bug would could think that possible. )
So where is that inflation from 2008 hiding now ? where did it go…is it under my bed ??
27. June 2016 at 16:22
Am I banned?
27. June 2016 at 16:22
Apparently not.
27. June 2016 at 16:51
Bill Ellis:
You’re confused if you actually believe what I wrote above was a prediction about consumer prices from the year 2009 to today.
No, that is a straw man. You are conflating me with Peter Schiff.
First, I said stimulus is itself inflation. I define inflation as an increase in the quantity of money. According to this definition, there was actually a large decrease leading up to 2007-2008, and then a NEGATIVE change thereafter where the quantity of money actually decreased, as credit was defaulted on and destroyed the money deposits created on the basis of the expansionary aspect of it.
Second, to the extent I spoke about prices, I never made any predictions about what the consumer price index would be today. I hold that predictions based on constants such as
P(t) = k*M(t-1)
Where
P = prices
M = money supply
t = time
k = constant
To be an impossibility. I have always always always emphasized that the supply of money could change and that the demand for money holding could change (in response to coordination issues for example).
I never said inflaon was “hiding in commodities”. I may have said stock and bond prices have increased, which is true and certainly not “hidden”.
Are you a broken record? You have already said this. Literally word for word. I have already responded to it, so no point in doing it again.
27. June 2016 at 16:52
Bill Ellis:
There is no reason for me to listen and take heed to what you say…about anything really…in part because you could not even engage the point I made. You are unable to even comprehend the theory.
27. June 2016 at 19:26
Hyun Song Shin is notorious for his stupid views on inflation and monetary policy. Most of his research involves “global liquidity” idea, i.e. capital flows and their granular details. In other words, a perfect bean counter for the BIS.
Likely a horrendous choice for central banker, in deflationary countries like Korea.
27. June 2016 at 19:46
I realize that the previous comment looks a bit like random ad-hominem. Apologies. I have grave concerns about the BIS research department’s odd views, but it might not be the main author of the report you mention above.
27. June 2016 at 21:18
“temporary but possibly persistent deviations of inflation from targets”: this is gold! Pun not intended.
28. June 2016 at 00:36
There’s nothing wrong with a gold standard. Money is neutral, so gold, silver, fiat will all work. In fact, an alternate hypothesis to Sumner’s “Great Depression ended when US went off the gold standard in 1933/34” is simply that Roosevelt’s ‘fireside chats’ and bank holidays ended bank run contagion (a common feature in any fractional reserve banking scheme, be it paper or gold) and the ‘fever broke’. Once it broke in the USA, UK, it broke in the rest of the world. That’s why Argentina going off gold earlier than the USA did *not* stop its economy from further decline. Ockham’s Razor, something Sumner does not shave with. Instead Sumner delights in metaphysical variables (“Wicksellian equilibrium rate”) that cannot be measured and can only be interpreted by Sumner, the high priest of “[a]nother failure of the economics profession.”
28. June 2016 at 04:50
Ray Lopez:
Is money neutral? More like in-gear.
When the Spaniards brought back gold from the New World, and even more importantly, opened up silver mines (with forced labor), there was a century-long boom in Spain.
BTW, you have probably read that there was inflation too. Yeah, about 1% to 1.5% a year. Big du-du.
Gold and silver were just hunks of pretty metal, treated as money, Just like printing money today.
I disagree that money is neutral. Printing money when there is excess capacity is stimulative, and then new capacity opens up to meet demand.
The number of cases in which new money has bolstered economic development are innumerable, including even counterfeit money in the Old West (of Estados Unidos).
In rare cases, printing too money does lead to hyperinflation. The hyper-inflation weenie-hysterics got lucky with Zimbabwe. Before the African nut-kingdom, they were forced to drag out Weimar Republic over and over again.
Print more money!
28. June 2016 at 06:27
Even an economics neophyte like me can understand that “raising rates now so we can lower them later” means we have run out of ideas. Its like destroying the village so we can save it (kill all the imbedded communists by incinerating the village so they cannot control the village—-or tighten money now to seek recession so we can ease later out of recession).
Since the ECB can put forth idiotic ideas, I may as well give it a try. I assume even though it is not directly observable, the “natural” rate of interest can perhaps be found by trial and error by seeking to impact money supply until you get the result you want—lets say 6% NGDP. So lets increase the flow of money into the markets.
On a side note, why does the Fed insist on having massive reserves (which in theory could lead to large increases in money supply, while simultaneously paying (I believe) the high side of the Fed Funds rate (50bps). Obviously these are designed to offset each other. I think this is either a form of “capital padding” to get risk free profits to banks to increase capital for the next “financial crisis”—-or just another stupid thing which gives the Fed “options” later (we have been doing this for 8 years—when is “later”).
When Yellen was asked why she is paying 50bps, she said something like “well its not that
much higher than Fed Funds and anyway, eventually Fed Funds will get higher.
I think I can be put in front of Congress with a Fed Chairman uniform on and sound no more absurd than her. For 8 years we have dripped along (we have had growth and supposed increase in employment but the latter is just number manipulation—its not really that true—less people are working as a percent of the whole)
When are we going to get ticked off at this crap? Financial businesses have done spectacular, high tech marches to Moore’s law, all entrepreneurs cannot be stopped, but its just too little. And Hillary is next on the docket.
I really do think we need just a bit of a battering ram to loosen up the Ramparts
28. June 2016 at 06:53
(we have had growth and supposed increase in employment but the latter is just number manipulation—its not really that true—less people are working as a percent of the whole)
If they made no changes to the mode of compiling or defining the metric, it is not a manipulation. It may be that people do not quite understand the significance of the metrics used, but that’s a different problem. The employment-to-population ratio of working-aged males is about 10% lower than it was in 2007 and has only recovered slowly the last 7 years. That doesn’t sound good. OTOH, it underwent an abiding drop of about 15% during the period running from 1950 to 1980, something that was in part an indication of affluence.
28. June 2016 at 06:57
Financial businesses have done spectacular,
Unless I’ve misinterpreted the stats issued by the Bureau of Economic Analysis, the share of value added attributable to the insurance business has hardly changed during the post-war period. That to the real-estate business increased considerably but then hit a plateau around 1985. That attributable to finance had a similar advance, then hit a plateau around 1998. Some economists were saying (I think Arnold Kling may have been one) that finance in the U.S. was hypertrophied, but we have a proportionately smaller financial sector than Britain.
28. June 2016 at 08:58
Major freedom…if you are going to keep lying about what you said …well, then no… there is no point to having a discussion with you.
So you didn’t say that the stimulus would necessarily cause inflation ? OKAAAAY
SO now you must be saying that stimulus spending can be done without causing inflation… Right ?
you can’t have it both ways…
28. June 2016 at 09:50
Major freedom…
We had a large stimulus and it did not result in inflation.. Right ?
so how about today ? could we undertake a large stim program, and the debt it would cause, without triggering inflation ? Or would you be back to your doomsaying ?
If you know how to spend without causing inflation…what is your opposition to deficit spending ?
28. June 2016 at 13:03
https://www.google.com/url?sa=t&source=web&rct=j&url=http://www.people.hbs.edu/dscharfstein/Growth_of_Finance_JEP.pdf&ved=0ahUKEwjOwe6pzsvNAhWMPD4KHYxWBJwQFggjMAM&usg=AFQjCNFoiWB7M0mJRkMmnrBH21aANiN43Q&sig2=oNnmV1ZIVj4N5_K2r-3imQ
28. June 2016 at 13:05
the cut and paste above is for Art Deco
28. June 2016 at 13:15
Art D
your 1950 to 1980 employment example is not applicable to 2007. First, the decline was due to the convoluted stats created by employment during the 40s and early 50s due to war.
second,if you think we have lower employment because of greater affluence, ask the people below the medium income line what they think of that theory.
Maybe I am misunderstandIng your poInt — would not be the first time.
t
28. June 2016 at 20:23
@Ben Cole–you are quite wrong about New World silver ‘saving’ Spain. See Spanish real wages 1300-1850 (data from Alvarez-Nogal & de la Escosura 2013). Spanish real wages reached a peak in 1425, after the Black Death, and before the discovery of the New World, then steadily declined until 1800. Also, you should be aware that even our host admits money is neutral long term. Surely 100 years, the date which the New World silver mines were most productive, is ‘long term’? Surprised Nunes hired a turkey (farmer) like you to write for him, but then again he probably pays you nothing.
29. June 2016 at 05:41
Ray, So you really don’t know that the fastest growth in industrial production in American history (March to July 1933) occurred during a period when much of the banking system was shut down?
Michael, The easiest way to determine the natural rate of interest is to peg NGDP futures prices. Then the actual interest rate will equal the natural rate.
Ray, You do realize that the neutrality of money doesn’t imply that gold inflows did not help Spain, don’t you?
29. June 2016 at 10:13
your 1950 to 1980 employment example is not applicable to 2007.
Not quite, no. As indicated.
Casey Mulligan has been writing on the problems labor markets have been having the last 7 years. His blog doesn’t get much traffick, though.
Your complaint was that the unemployment statistic had been manipulated. Unless they changed the mode of data gathering or the definitions, it has not.