Topic: Finance, Banking & Monetary Policy

Iceland: Hayek Got It Right

According to recent reportage in The Economist, “Many economists point to Iceland as a case study of what should be done during an economic crisis: devalue your currency, impose capital controls and avoid excessive austerity.” Not so fast.

Capital controls are for the birds. Nobelist, Friedrich Hayek, got it right in his 1944 classic, The Road to Serfdom:

The extent of the control over all life that economic control confers is nowhere better illustrated than in the field of foreign exchanges. Nothing would at first seem to affect private life less than a state control of the dealings in foreign exchange, and most people will regard its introduction with complete indifference. Yet the experience of most Continental countries has taught thoughtful people to regard this step as the decisive advance on the path to totalitarianism and the suppression of individual liberty. It is, in fact, the complete delivery of the individual to the tyranny of the state, the final suppression of all means of escape—not merely for the rich but for everybody.

Sorry Taxpayers, Paying You Back Is Bad for My Bliss

If I had more time I’d write at greater length about this already infamous New York Times op-ed on student loans – which conspicuously fails to mention that the writer apparently got all of his degrees from pricey Columbia University – but the piece largely condemns itself. What I think is worth contemplating is how far out of mainstream thinking its sentiments are. Alas, maybe not that far.

No doubt most of the public wouldn’t support people not repaying their student loans just because they don’t like them, but the idea that freely chosen debt should be forgiven or curtailed is getting lots of play, from President Obama’s push for programs that would lead to forgiveness for big borrowers, to Senator Elizabeth Warren’s private debt buy-up proposal. And calls for free college are roughly the equivalent of calls for loan forgiveness. No, they aren’t saying that borrowers should renege on commitments they’ve already made, but they are saying that the college cost burden should be dropped even more squarely on the shoulder of taxpayers going forward.

Of course the ultimate problem, beyond the immediate, crushing cost, is that the more you have other people pay for students’ decisions, the more wasteful those decisions will tend to be. And even at current subsidy levels, those decisions are very, very wasteful. But that’s what happens when politicians decide taxpayers should never get in the way of a student’s bliss.

Rick Perry Is Right: Kill the Export-Import Bank and Cut Corporate Taxes

Former Texas governor Rick Perry announced his candidacy for the 2016 GOP presidential nomination earlier today. Many recall his 2012 bid, which came to a rather spectacular end when Gov. Perry, on live television, forgot the name of the third federal agency he promised to eliminate if elected president. However, in a recent WSJ op-ed, Gov. Perry redeemed himself by offering a real candidate for elimination: the Export-Import Bank.

The Export-Import Bank (Ex-Im) provides financing and loan guarantees at below-market rates to foreign purchasers looking to buy products from American exporters. For example, if Emirates Air wants to buy planes from Boeing, Ex-Im can provide a loan guarantee, reducing the interest rate Emirates will pay, and thus incentivizing Emirates to buy from Boeing rather than Airbus.

Ex-Im’s supporters claim that these subsidies create jobs and finance domestic economic growth. But, they fail to consider the ensuing downstream effects, which Bastiat termed “ce qu’on ne voit pas”–that which is unseen. As the Cato scholar Daniel Ikenson makes clear, every dollar Ex-Im provides to subsidize foreign purchasers of U.S.-produced products discriminates against U.S. consumers of the same products. For example, when Emirates receives a subsidy for planes because it is a foreign company, Emirates gets a leg up on Delta.

Venezuela: Not Hyperinflating—Yet

Although Venezuela’s inflation has soared (see: Up, Up, and Away), Venezuela is not experiencing a hyperinflationary episode–yet. Since the publication of Prof. Phillip Cagan’s famous 1956 study The Monetary Dynamics of Hyperinflation, the convention has been to define hyperinflation as when the monthly inflation rate exceeds 50%.

I regularly estimate the monthly inflation rates for Venezuela. To calculate those inflation rates, I use dynamic purchasing power parity (PPP) theory. While Venezuela’s monthly inflation rate has not advanced beyond the 50% per month mark on a sustained basis, it is dangerously close. Indeed, Venezuela’s inflation rate is currently 45% per month (see the accompanying chart).

If inflation moves much higher, the legacy of Hugo Chavez’s Bolivarian Revolution will be that Venezuela joins the rather select hyperinflation club as the 57th member. Yes, there have only been 56 documented hyperinflations

Venezuela's Monthly Inflation Rates

Ten Things Every Economist Should Know about the Gold Standard

At the risk of sounding like a broken record (well, OK–at the risk of continuing to sound like a broken record), I’d like to say a bit more about economists’ tendency to get their monetary history wrong. In particular, I’d like to take aim at common myths about the gold standard.

If there’s one monetary history topic that tends to get handled especially sloppily by monetary economists, not to mention other sorts, this is it. Sure, the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. But these things don’t excuse the errors many economists commit in their eagerness to find fault with that “barbarous relic.”

The false claims I have in mind are mostly ones I and others–notably Larry White–have countered before. Still I thought it would be useful to address them again here, because they’re still far from being dead horses, and also so that students wrapping-up the semester will have something convenient to send to their misinformed gold-bashing profs (though I urge them to wait until grades are in before sharing!).

For the sake of those who don’t care to wade through the whole post, here is a “jump to” list of the points covered:

  1. The Gold Standard wasn’t an instance of government price fixing. Not traditionally, anyway.
  2. A gold standard isn’t particularly expensive. In fact, fiat money tends to cost more.
  3. Gold supply “shocks” weren’t particularly shocking.
  4. The deflation that the gold standard permitted wasn’t such a bad thing.
  5. It wasn’t to blame for 19th-century American financial crises.
  6. On the whole, the classical gold standard worked remarkably well (while it lasted).
  7. It didn’t have to be “managed” by central bankers.
  8. In fact, central banking tends to throw a wrench in the works.
  9. “The “Gold Standard” wasn’t to blame for the Great Depression.
  10. It didn’t manage money according to any economists’ theoretical ideal. But neither has any fiat-money-issuing central bank.

Venezuela’s Inflation: Up, Up, and Away

Like the 2009 Oscar award-winning Pixar film Up, Venezuela’s annual inflation rate has soared sky high (see the chart below). On December 31, 2014, Venezuela’s bolivar traded at a VEF/USD rate of 171 and the implied annual inflation rate stood at 169%. In May of 2015, Venezuela’s bolivar collapsed and the implied annual inflation rate broke the 500% barrier. On May 28, 2015, the VEF/USD rate was 413, a 59% depreciation in the bolivar since January 1st. Not surprisingly, the implied annual inflation rate stood at a staggering 495%.

Venezuela's Annual Inflation Rates

Evaluating Quantitative Easing

In my prior post, “The Futility of Stimulus,” I examined whether Federal Reserve Policy has provided economic stimulus. I employed standard measures of money-supply growth to evaluate the question. I concluded that Federal Reserve policy has resulted in less expansion of the money supply than would normally be expected. The weakness of the current economic expansion testifies to that.

In this post, I employ an alternative measure of monetary stimulus. I rely on a recent lecture at the University of Nevada Reno by Professor John Taylor of Stanford University. With a series of charts, he made a convincing case that successive rounds of Quantitative Easing provided no monetary stimulus. Taylor looked at the interest-rate channel, particularly longer-term interest rates. If monetary policy stimulates the economy through real capital investment, then we must look to longer-term interest rates.

Taylor specifically examined the effects on 10-year Treasury yields of each round of Quantitative Easing by the Fed. In each case, there was an announcement effect. When the Fed announced a new round of bond purchases, interest rates on 10-year Treasuries did drop. As QE was executed, however, the 10-year rate recovered to its previous level or even moved higher. On the assumption that rates on corporate bonds price off Treasuries, there was no measurable effect on investment and economic growth. Again, the weakness of the economic expansion is consistent with Taylor’s argument.

There is policy background here. Taylor is the author of a monetary rule, which others have dubbed the Taylor Rule. It is a rule for adjusting short-term interest rates (the Fed Funds rate) to changes in inflation and real economic activity. The Taylor Rule calculates that the Fed Funds should by 1.5 percent versus the current reality of near-zero. Taylor did not advocate an immediate increase to that level, but the beginning of gradual increases.

What of the economic recovery? If Taylor is correct, then low short-term interest rates have not contributed to the economic expansion and raising them will not slow economic growth.

Have very low short-term interest rates had any effect? Janet Yellen recently hinted they might have contributed to unsustainably high equity prices. I will not argue with the Fed Chair on that point, but only suggest that other financial bubbles may also have been financed by Fed policy. To repeat a hackneyed phrase (nonetheless accurate), Wall Street has benefited but not Main Street.

To sum up, following Taylor’s analysis of the interest-rate channel, I conclude that Fed policy has not stimulated economic growth. It has had consequences, which some would consider undesirable. Taylor has provided a reasonable case for beginning to raise interest rates. I doubt that will happen soon. But the debate should continue.

[Cross-posted from]