Topic: Finance, Banking & Monetary Policy

A Monetary Policy Primer, Part 3: The Price Level

Few people would, I think, take exception to the claim that, in a well-functioning monetary system, the quantity of money supplied should seldom differ, and should never differ very much, from the quantity demanded.  What’s controversial isn’t that claim itself, but the suggestion that it supplies a reason for preferring some path of money supply adjustments over others, or some monetary arrangements over others.

Why the controversy?  As we saw in the last installment, the demand for money ultimately consists, not of a demand for any particular number of money units, but of a demand for a particular amount of monetary purchasing power.  Whatever amount of purchasing X units of money might accomplish, when the general level of prices given by P, ½X units might accomplish equally well, were the level of prices ½P.  It follows that changes in the general level of prices might, in theory at least, serve just as well as changes in the available quantity of money units as a means for keeping the quantity of money supplied in line with the quantity demanded.

But then it follows as well that, if our world is one in which prices are “perfectly flexible,” meaning that they always adjust instantly to a level that eliminates any monetary shortage or surplus, any pattern of money supply changes will avoid money supply-demand discrepancies, or “monetary disequilibrium,” as well as any other.  The goal of avoiding bouts of monetary disequilibrium would in that case supply no grounds for preferring one monetary system or policy over another, or for preferring a stable level of spending over an unstable level.  Any such preference would instead have to be justified on other grounds.

So, a decision: we can either adopt the view that prices are indeed perfectly flexible, and proceed to ponder why, despite that view, we might prefer some monetary arrangements to others; or we can subscribe to the view that prices are generally not perfectly flexible, and then proceed to assess alternative monetary arrangements according to their capacity to avoid a non-trivial risk of monetary disequilibrium.

The Smoot-Hawley Tariff and the Great Depression

[Reprinted with permission from Alan Reynolds, “What Do We Know about the Great Crash?National Review, November 9, 1979]

 Many scholars have long agreed that the Smoot-Hawley tariff had disastrous economic effects, but most of them have  felt  that  it could  not have caused the stock market collapse of  October  1929, since the tariff was not signed into law  until the following June. Today we know that market participants do not wait for a major law to pass, but instead try to anticipate whether or not it will pass and what its effects will be.

 Consider the following sequence of events:

 The Smoot-Hawley tariff passes the House on May   28, 1929.  Stock prices in New   York   (1926=100) drop   from 196 in March to 191   in June.   On June   19, Republicans   on the Senate Finance Committee   meet   to   rewrite   the   bill. Hoping for improvement, the market rallies,  but  industrial production  ( 1967 = 100)  peaks  in  July,  and  dips  very  slightly through  September.  Stocks  rise  to  216  by  September,  hit­ting their peak on  the  third  of  the  month.  The  full  Senate Finance Committee goes to   work  on  the  tariff  the  following day,  moving  it  to  the  Senate  floor  later  in  the   month.

 On October 21, the Senate rejects, 64 to 10, a move to limit tariff increases to agriculture. “A weakening of the Democratic-Progressive Coalition was evidenced on October 23,” notes the Commercial and Financial Chronicle. In this first test vote, 16 members of the anti-tariff coalition switch sides and vote to double the tariff on calcium carbide from Canada. Stocks collapse in the last hour of trading; the following morning is christened Black Thursday.   On  October 28,  a  delegation   of   senators   appeals   to   President   Hoover to help push a tariff  bill  through  quickly  (which  he  does  on the 31st). The Chronicle  headlines  news  about  broker  loans on  the  same  day:  “Recall  of  Foreign  Money  Grows  Heavier-All Europe  Withdrawing  Capital.” The following day is stalemate. Stocks begin to rally after November 14, rising steadily from 145 in November to 171 in April. Industrial production stops falling and hovers around the December level through March.

Competition in (British) Banking

Writing for’s “The Exchange” blog, economists Diane Coyle and Jonathan Haskel suggestthat Britain’s regulators — namely, the Competition and Markets Authority and the Bank of England — have got it wrong on competition in banking.  The authors argue that “the CMA and the BoE” have overlooked “the ruinous effect on competition of the ‘too big to fail’ subsidy” in their recent reports and policy announcements, and that, if anything, it is becoming “harder than ever for new entrants to gain a foothold” in the banking market.

In my view, Coyle and Haskel are right, but their argument doesn’t go far enough.

Japan: The Way Out

“Helicopter money” started out as, and long remained, nothing more than a heuristic device — and a brazenly counterfactual one at that — employed by monetary economists as a means for gaining a better theoretical understanding of the consequences of changes in the stock of money.  “Suppose,” the analysis went, that instead of increasing the monetary base by buying bonds in the open market, central banks dropped new supplies of currency from helicopters, thereby instantly increasing everyone’s money balances.  What would that do to spending and, eventually, to prices?

Lately, however, helicopter money has made its way from the inner recesses of economics textbooks to the financial pages of major newspapers and magazines, where a debate has been joined concerning its merits, not as an abstract analytical tool, but as an actual policy tool for relieving Japan, and perhaps some other economies, of their deflationary woes.  Look, for some examples, here, here, and here.  And see as well this recent blog post by our dear friend Jerry Jordan, written for the Atlas Foundation’s Sound Money Project.

Yet for all the controversy surrounding the suggestion that Japan should actually try dropping money from helicopters (or something close to that), my own response to it consisted, not of either surprise or dismay, but of a strong sense of déja vu.  For I myself wrote an op-ed proposing helicopter money for Japan in the spring of 1997, that is, almost exactly 19 years ago.  I never tried to publish it, in part because I myself couldn’t quite decide just how firmly my tongue was poking my cheek as I wrote it, and because I had then as I do still an abiding dislike of  “clevernomics,” which is the sort of stuff economists write to show just how clever they they can be, rather than because they are seriously trying to help the world along.  Worried that I was myself lapsing into that sort of thing, I stuffed the essay into a file cabinet, where it has been buried ever since.

All the recent writing on the subject has, however, emboldened me to resurrect my dusty old essay and to publish it hereunder its original title.  I don’t pretend that it adds anything to what recent commentators have had to say on the topic.  Consider it a bagatelle, if you like: you’ll get no argument from me.

Administrative Law Judges Are Unconstitutional

The administrative state has ballooned in size and power—essentially having become its own branch of government—and Cato has now filed an amicus brief saying enough is enough.

The Securities and Exchange Commission, no longer content with just regulating securities, has accused a company called Timbervest of fraudulently taking undisclosed real-estate commissions. Timbervest was found liable by an SEC administrative law judge (“ALJ”), but even without getting into the merits of the allegations, there are several problems with this prosecution inquisition.

First, ALJs are executive-branch officers who nonetheless are insulated from removal by the president. Yet Article II of the Constitution, to ensure democratic accountability, vests the president with power over the executive branch—including over quasi-judicial officers like territorial judges—and requires that he “take care that the laws be faithfully executed.” The relevant statute here prevents the president from doing just that by having three levels of officials between the president and the SEC’s ALJs, each of whom can only be removed for cause.

Second, the SEC picked the ALJ who heard this case, even though the Supreme Court has held that there is a reasonable fear of bias when “a man chooses the judge in his own cause.” This problem has become so systemic that a former SEC ALJ felt compelled to speak publicly about how ALJs were pressured to rule in the agency’s favor.

Third, there is a real problem with this matter being in an administrative forum at all. After all, this is real-estate fraud case, of a sort that courts—real courts—have heard since the Founding. Congress can assign new statutory rights that didn’t previously exist for adjudication in an administrative forum (for example, Social Security disability claims), but it can’t take away long-held freedoms without the due process that that only the judiciary can provide. Here the SEC permanently banned Timbervest’s owners from associating with any investment advisers. The Supreme Court has recognized the right of association for the advancement of ideas as a protected First Amendment right, which is not something that can be taken away without at least a jury trial. If the SEC wants to try this case, it needs to do it in a proper Article III judicial proceeding.

Accountability, impartiality, and the right to a day in court before constitutional rights are taken away: is that too much to ask? We hope that the U.S. Court of Appeals for the D.C. Circuit, the court charged with reviewing most administrative-agency actions, agrees that it’s not.

Thanks to legal intern Devin Watkins for his help with Cato’s brief, and this blogpost.

A Monetary Policy Primer, Part 2: The Demand for Money

Although there’s no such thing as a straightforward measure of the quantity of money in an economy, monetary policy is nonetheless about managing that quantity.  How ought it to be managed?  The (misleadingly) simple-sounding answer is: so that it neither falls short of nor exceeds the quantity of money demanded by the public.

So much for a summary of Part 1.  Now for the hard part: dealing with the many questions this summary raises.  How can a central bank manage a quantity without being certain just how to define, let alone measure, that quantity?  How is it possible for the quantity of money supplied to differ from the quantity demanded?  When those things do differ, how can one tell?  Finally, just what does “the demand for money” mean?

A Monetary Policy Primer, Part 1: Money

It occurs to me that, despite the unprecedented flood of writings of all sorts — books, blog-posts, newspaper op-eds, and academic journal articles —  addressing just about every monetary policy development during and since the 2008 financial crisis, relatively few attempts have been made to step back from the jumble of details for the sake of getting a better sense of the big picture.

What, exactly, is “monetary policy” about?  Why is there such a thing at all?  What should we want to accomplish by it — and what should we not try to accomplish?  By what means, exactly, are monetary authorities able to perform their duties, and to what extent must they exercise discretion in order to perform them?  Finally, what part might private-market institutions play in promoting monetary stability, and how might they be made to play it most effectively?

Although one might write a treatise on any one of these questions, I haven’t time to write a thesis, let alone a bunch of them; and if I did write one, I doubt that policymakers (or anyone else) would read it.  No sir: a bare-bones primer is what’s needed, and that’s what I hope to provide.