Topic: Finance, Banking & Monetary Policy

Rethinking Monetary Policy – Cato’s 33rd Annual Monetary Conference

monetary policy, federal reserve, plosser, miron, selgin, sumner, john b. taylorMore than two hundred people gathered at the Cato Institute last Thursday for our 33rd Annual Monetary Conference.  Over the course of three addresses and four panel discussions, a distinguished cast of speakers — including St. Louis Fed president James Bullard, Richmond Fed president Jeffrey Lacker, and Stanford economist John Taylor — covered topics ranging from the rights and wrongs of monetary rules, to the ins and outs of the Fed’s long-awaited “exit strategy” from quantitative easing and near-zero interest rates.  If you didn’t make the event, here’s a synopsis.

Can Open Market Operations Save Puerto Rico?

With Puerto Rico’s continuing fiscal strains, some commentators have suggested that one avenue to give Puerto Rico breathing room would be the purchase of Puerto Rican municipal debt as part of Open Market Operations by the Federal Reserve.  The most prominent proponent of this plan is Rensselaer Tech Economics Professor Arturo Estrella.  His proposal can be found here.  The governance of Open Market Operations, which is the buying and selling of securities by the Federal Reserve System, is found in Section 14 of the Federal Reserve Act.

A threshold question is: does the debt of Puerto Rico qualify as allowable investments?  There are essentially three categories of allowable purchases under Section 14:  state/local government debt in the continental United States, foreign government (or agency) debt;  and U.S. Treasury or agency debt.  Professor Estrella spends considerable effort arguing that Puerto Rico is within the definition of “continental” United States and hence qualifies.  Unfortunately, his efforts are in vain as the Federal Reserve Act in Section 1 defines the “continental United States” to mean “the States of the United States and the District of Columbia” which obviously excludes territories like Puerto Rico.

How does Professor Estrella attempt to overcome the very clear language of the Federal Reserve Act?  He argues that “the preponderance of regulatory language in Federal Reserve regulations shows that Puerto Rico is treated in the same way as a state…”  The good professor offers plenty of examples, such as the Truth in Lending Act, carried out by the Fed’s Regulation Z.  What he fails to mention is that the cited regulations are not carried out pursuant to the Federal Reserve Act.  For instance, the Truth in Lending Act actually defines Puerto Rico as a state, which explains why Regulation Z as implemented does so.  Congress regularly chooses different definitions of the same words for different statutes, and it does so intentionally.  That, however, does not allow an agency to pick and choose.  The definitions contained in a statute govern the regulations promulgated under that statute only.

Is Bitcoin Only Valuable to Crooks and Tax Cheats?

It isn’t every day that University of Chicago economists Eugene Fama and Richard Thaler see eye to eye. Fama, who won the Nobel Prize in 2013, is one of the best known proponents of the efficient market hypothesis. Thaler, in contrast, champions behavioral economics. Indeed, Thaler spends a great deal of time criticizing the efficient market hypothesis in his recent book, Misbehaving.

Both economists, however, seem to be on the same side when it comes to bitcoin. Commenting on Fama’s recent interview with the Bitcoin Uncensored podcast, Thaler tweets: “Must say I agree with Fama here. Only value of bitcoin seems to be to crooks& [sic] tax cheats. Negative social value.”

Richard Thaler Tweet

Fama and Thaler are not alone. Many regulators worry that, absent sufficient government oversight, cryptocurrencies like bitcoin will be used to conduct illegal transactions and transfers on a massive scale. For example, Sen. Joe Manchin has claimed that the “clear ends of Bitcoin [are] for either transacting in illegal goods and services or speculative gambling.” Likewise, Sen. Charles Schumer has described bitcoin as “an online form of money laundering.” Some have even warned that bitcoin might be used to fund terrorism. Like Fama and Thaler, many people outside the bitcoin community seem to believe bitcoin is basically for criminals.

But they’re wrong. To date, the black market transactions that trouble Fama, Thaler, and others have been quite limited. Consider Silk Road, the premier bitcoin-for-drugs website in operation from February 2011 to October 2013. The best available evidence suggests there were roughly $1.2 million worth of transactions made on Silk Road each month. More recent estimates put the figure at roughly $4.7 million per month. That modest figure hardly made Silk Road the Amazon of drugs, as Gawker once claimed. Amazon averaged roughly $6,204.2 million per month in 2013. That’s more than 370 times the highest monthly transactions volume estimated for Silk Road. Silk Road was not even the Etsy ($112.32 million per month) of drugs.

One might counter that the volume of transactions on Silk Road was low because so few people were using bitcoin at the time. But the volume of transactions on the Silk Road was also small relative to the total volume of transactions conducted in bitcoin. The monthly transactions volume for the entire bitcoin system averaged just under $16 billion from February 2011 to October 2013. That means that Silk Road transactions were responsible for a measly 0.03 percent of all transactions conducted in bitcoin. In other words, it was not just that few people were using bitcoin, but that of those who did few were buying and selling illegal substances on Silk Road.

What about terrorism? The U.S. Treasury Department itself has found no evidence of bitcoin’s widespread use in funding terrorism. That really shouldn’t come as a surprise. Terrorist groups have much more convenient ways to secure funding outside of legitimate banking channels. Moreover, to the extent that terrorists are located in developing regions, they would encounter the same hurdles to adopting bitcoin that others in developing countries face.

If they aren’t buying cocaine or funding terrorists, what are users doing with all that bitcoin? Answer: a lot of things. They are purchasing flights, Xbox games, and, well, anything sold on They are paying college tuition. They are ordering satellite television. They are purchasing premium memberships on dating sites and then using Yelp! to find a romantic coffee shop or trendy bar that—you guessed it—accepts bitcoin. They are sending remittances to family members around the world at a fraction of the usual cost. They are donating to support art, open source projects, and foundations. A better question would be: what aren’t they doing with bitcoin?

Contrary to popular opinion, bitcoin is not basically for criminals. It is barely for criminals. In that respect, it resembles ordinary cash—that is, Federal Reserve notes. As a matter of fact, the case is probably stronger for eliminating cash than bitcoin. Harvard economist Ken Rogoff has claimed more than half of all cash in circulation is used to hide transactions from tax or law enforcement authorities. More formal estimates by Edgar Feige suggest roughly 48 percent of cash held by the public is employed in the domestic underground economy. For those interested in transacting outside the law, cash—not bitcoin—is king.

In short, most bitcoin users seem to be a lot like you and me, if perhaps a bit more tech savvy. They want to purchase legal goods and services and remit funds as cheaply and conveniently as possible. To the extent that bitcoin is more effective than traditional payment mechanisms for making some transactions, it lowers transaction costs, encouraging production and exchange.

In other words, Thaler is wrong: bitcoin has a positive social value.

[Cross-posted from]

Happy Birthday, Anna

nna Schwartz, memoriam, birthday, economist, monetaryWere she still alive, Anna Schwartz, one of the last centuries’ greatest monetary economists, would have celebrated her 100th birthday today.

Alas, we must commemorate the date without her. To do so, I repost here remarks I made upon her death in 2012. In what has become a prolonged era of unconventional monetary policy, the loss of her expertise and wisdom is even more sorely felt than it might have been otherwise. Still all of us, and the economics profession especially, are much better off thanks to her straightforward and uncompromising scholarship.

Happy Birthday, Anna.


She was one of my intellectual heroes, Anna was — together with Milton and Leland, David Laidler, Sir Alan Walters, and Dick Timberlake. Old monetarists all, come to think of it. Now only three are left; and, no, they do not make them like that any more.

I met Anna at NYU. Back then the NBER occupied the 8th floor of 269 Mercer Street. NYU’s economics department was on the 7th floor. Of course I went to meet her. She turned out to be very nice, so I got the bright idea to ask her to serve as an external member of my dissertation committee. I had the impression that I was one of very few NYU Ph.D. candidates to think of doing that, which struck me as odd. But then a lot of things about NYU, and about the economics business generally, struck me (and still strike me) as odd.

Anna gave me some good advice; indeed, apart from Larry White (who was my supervisor, and who I talked to almost daily) she was my most helpful adviser at NYU. Naturally I don’t remember much about the particular advice she gave me. But I do distinctly remember her telling me that, once I got into the business, I had better write about stuff besides free banking if wanted to survive. I took Anna’s advice, and still found it rough going. Had I not listened to her I’m sure I would have had to give up.

I’m also pretty sure that it was only thanks to Anna that some of the the free banking stuff that did make it into the better journals got through: she was one of the few persons who was both greatly respected by the editors of those journals and willing to give the free bankers a hearing. Indeed, Anna was more than sympathetic: she was, or she became, one of us. I am reasonably certain that she played a very large, if not crucial, part in encouraging Milton to revise his thinking on the topic, as he did when he and Anna published their 1986 JME paper “Has Government Any Role in Money?”. That Anna’s views on the proper scope of government interference in banking became progressively more radical I have no doubt. For example, while in a 1995 Cato Journal article she and Mike Bordo took the conventional line that you couldn’t have a stable banking system without some sort of deposit insurance, when I questioned her about this stand a few years ago Anna claimed that she had since rejected that view, having come to believe instead that the moral hazard arising from deposit guarantees ultimately caused such guarantees to do more harm than good.

I was lucky to be able to talk to Anna at length on several occasions during the last few years, thanks to Walker Todd, who arranged for her to visit the American Institute for Economic Research while I was there as a summer fellow. What I remember most about those conversations was how very candid and uncompromising they were: Anna never held a punch, and when she threw one, it landed square on target. Not that Anna wasn’t generous with praise: it’s just that, whatever she thought, she always came right out with it. She’d lived long enough, I suppose, to earn that. In any event it meant that talking to her was really a blast. (If only I could repeat all that I heard!)

Now, with all the dominoes lined-up from Greece to Brussels and beyond, and ready to start toppling at any moment, how I wish that this tough and uncompromising monetarist was still among us! No one can say just what she’d have made of it all; but whatever she made you can bet she would have served it up straight.

[Cross-posted from]

What Is “Optimal” Monetary Policy?

On Thursday, November 12th, Cato hosts its 33rd Annual Monetary Conference. This year’s conference theme is “Rethinking Monetary Policy.” I will be presenting a paper on “Monetary Policy: The Knowledge Problem.”

The knowledge problem in conducting monetary policy, or any other government policy, is that the required knowledge is simply not available to policymakers. The knowledge is not available in any one place, nor can it be assembled in a form that would enable policymakers to formulate an “optimal” policy.

My paper focuses on Friedrich Hayek because he first formulated the knowledge problem. He argued that knowledge is inherently dispersed and localized across the population of economic agents. It is not possible to assemble the totality of knowledge existing in society in any one mind or place. Moreover, what the totality of individuals knows far exceeds what any policymaker can know, no matter his expertise and wisdom.

In order to formulate an optimal policy, a monetary authority must predict how alternative policy actions will affect the plans of millions of people. That information is unavailable. Assuming it exists in an economic model doesn’t make it so.

It is the conceit of central bankers (or at least most) that they can acquire the knowledge needed to conduct optimal monetary policy. In his Nobel Prize lecture, Hayek called that “The Pretence of Knowledge.”

In my paper, I also detail Milton Friedman’s contribution to the knowledge problem in monetary policy. That contribution has been under-appreciated in the literature.

Some problems cannot be solved. The knowledge problem is one such. But it can be mitigated, and I conclude my paper by discussing how that might happen. I suggest, as did Hayek and Friedman, that a monetary rule works best.

(If you would like to see this paper presented, you can register here. With several central bankers on the distinguished line up, including St. Louis Fed President James Bullard, Richmond Fed President Jeffrey Lacker, and Bank of Mexico Deputy Governor Manuel Sánchez, this year’s conference is a particularly interesting place to discuss the knowledge problem in the context of central banking. If you cannot attend, the conference papers will appear in a forthcoming edition of the Cato Journal).

[Cross-posted from]

The Monetary Base and Total Reserves: Fed Confusions and Misreporting

The monetary base is the only magnitude that the Fed directly controls. It consists of currency held by the general public (including both Federal Reserve notes and Treasury coin) and the total aggregate reserves of banks and other depositories (whether held in the form of vault cash or deposits at one of the regional Federal Reserve banks).

Some would translate this control over the base into direct Fed control over total reserves, but that is not strictly correct. Even though the Fed initially increases (or decreases) the base by increasing (or decreasing) reserves, the general public and the banks determine how much of the base is ultimately held instead in the form of currency in circulation. Thus, it would seem desirable to have the Fed report the base and its two components accurately. Yet the Fed’s reported measures of total reserves exclude significant amounts of bank vault cash. Even with changes in the Fed’s monthly releases implemented in July 2013, the problem has not been rectified. Moreover, there also remains a minor omission from the total base that while not yet serious could become so in the future. More important, once the Fed began paying interest on reserves in 2008, it dramatically altered the monetary relevance of its base and reserve measures.

The Courage to Refuse

Last week I attended a talk and panel discussion at Brookings, in which Roger Lowenstein discussed his new book on the Fed’s origins. I have much to say about that book, and I eventually plan to say some of it here. But for the moment my concern is with another book, this one concerning, not the Fed’s origins, but its recent conduct. I mean Ben Bernanke’s The Courage to Act.

So why bring up the Brookings event? Because, in the course of that Federal Reserve love-fest, someone made a passing reference to those crazy people who actually want to limit the Fed’s emergency lending powers. Having seen the Fed save the economy from oblivion, such people, one of the panelists observed (I believe it was former Fed Vice Chairman Donald Kohn), are determined to make sure it can never save it again! At this, the audience chuckled approvingly.

Well, mostly it did. My own reaction was more like a bad attack of acid reflux. Is it really possible, I asked myself (as I struggled to keep my gorge from rising), that nobody here takes the moral hazard problem seriously? Do they really suppose that Senators Warren and Vitter and others seeking to limit the Fed’s bailout capacity are doing so because they like financial meltdowns and couldn’t care less if the U.S. economy went to hell in a hand-basket?