Saturday, June 23, 2018

Jawboning Makes a Comeback

What's jawboning? Well, this Smithsonian Institution piece claims that, in the early part of the Great Depression, Herbert Hoover resorted to jawboning. Specifically,
...he convened a series of “conferences” with business leaders urging them to maintain wages and employment through the months to come.
In the article, it's claimed that:
Hoover’s overriding commitment in all his years in government was to prize cooperation over coercion, and jawboning corporate leaders was part of that commitment.
Jawboning was a practice later on as well. This op-ed in the New York Times in 1978, by Russell Baker is a commentary on the jawboning practices of then-President Jimmy Carter:
Better economists than I are saying President Carter is going to have to start jawboning if he wants to Stop inflation. All very well for a President who can jawbone like a champion, but veteran jawbone writers doubt that Mr. Carter has what it takes.

The NBC Nightly News showed films the other night comparing President Carter's jawboning with President Kennedy's. One film showed Mr. Kennedy jawboning the steel industry about a price increase in 1962, and the other showed Mr. Carter jawboning the steel industry about a price increase last Wednesday.

All you could say after watching the Kennedy performance was, “They don't make jawboners like that any more.” What Caruso was to opera, what Babe Ruth was to bats, Jack Kennedy was to jawboning. By comparison, Jimmy Carter sounded like a hambone the steel tycoons might toss into the soup.
So, from Baker's point of view, JFK was really good at the practice of jawboning, which in the early 1960s involved persuading steel industry executives to forego price increases. Baker reasoned, as others did at the time, that Carter should start talking inflation down, presumably by convincing producers to forego price increases.

An approach to controlling inflation that involves talking to the people who set price and wages in order to convince them of the errors in their ways might seem odd in a modern context. We all know that it's the central bank's job to control inflation, right? But, that certainly wasn't a widespread view, or even a majority view, in 1978. Here's one of my favorite James Tobin quotes, from this 1980 Brookings paper: is not possible to do the job [disination] without effective wage and price controls of some kind...there could be worse prospects, and probably they include determined but unassisted monetary disinflation.
Here, Tobin's not discussing jawboning, otherwise known as moral suasion, but outright wage and price controls. He's saying you can't bring inflation down ("it is not possible") through monetary policy alone. But Paul Volcker proved Tobin wrong by engineering an unexpectedly rapid disinflation in the United States. That, more than anything I think, convinced everyone that we should make clear that inflation control is a job for the central bank, and to hold central bankers to account if they don't do a good job.

It may come as a surprise to you (and I missed this myself when it first made the news) that Prime Minister Abe of Japan is attempting jawbone-inflation-control.This story from last December indicates that, in contrast to disinflationary jawboning, Abe wants everyone to increase nominal wages at 3% per year, so as to increase inflation. The reasoning seems to be that, if productivity is going up at a rate of 1% per year, then 3% nominal wage growth will cause firms to increase prices at about 2% per year, and the Bank of Japan will then be achieving its inflation target.

Just in case you haven't been following this, the last 22 years or so of inflation in Japan looks like this - relative to the US:
Since early 2013, the Bank of Japan has had an explicit 2% inflation target, and has tried everything that a conventional central banker might try to get inflation to go up - including policies once thought "unconventional." The BOJ has kept short-term interest rates low - even going into negative territory - and has expanded its balance sheet massively through large-scale asset purchases. It has even pegged the 10-year government bond rate to zero. All to no avail, apparently, as the chart shows no sign of a sustained inflation developing. The American experience since 1996 is indeed a mild, sustained inflation, and the CPI path is not far from a 2% inflation path for the whole 22-year period. Surprisingly, the Fed didn't actually have an explicit 2% inflation target until 2012, but I don't think the US inflation performance is an accident. It seems reasonable to infer that the FOMC was implicitly following a 2% target.

So what does Governor Kuroda of the Bank of Japan think of Prime Minister Abe's jawboning? Well apparently he's more than OK with it. Kuroda is quoted as saying:
The government request for 3 percent wage increase is quite appropriate...
Maybe he's just being polite, but the worst interpretation of Kuroda's comments is that he's abandoning responsibility for his inflation target. Maybe he's willing to think that inflation results from a self-sustaining wage-price spiral, and if inflation stays low, and the BOJ falls short of its 2% inflation target, then that's the fault of the people who set the prices and wages. But who knows?

In any case, when central bankers can't do what they claim to be able to do - control inflation - you can see how all hell can break lose. Before we know it, Japan could have wage and price controls, which have a rather sorry history, including the Anti-Inflation Board (1975-1979) in Canada.

I hate to repeat myself, but what the heck. Monetarism works as an approach to disinflation. Reducing the rate of growth in total central bank liabilities in a sustained fashion has to reduce inflation. Unfortunately, increasing the rate of growth in central bank liabilities is not a sufficient condition for inflation to increase. A necessary and sufficient condition for inflation to increase in a sustained fashion is a permanent increase in short-term nominal interest rates. Balance sheet expansion with the interest rate on reserves kept low will increase central bank liabilities alright, but will not increase inflation - this just amounts to a swap of interest bearing (albeit at low or negative interest rates) central bank reserves for other interest-bearing assets (or even ETFs, in the BOJ case), and can't doing anything to create a sustained inflation. That's more than obvious from Japanese experience. The BOJ can't increase inflation by staying the course (more quantitative easing, continued low or negative interest rates). It has to increase its policy rate - nothing more complicated than that - and sustaining that increase in the policy rate will induce higher inflation. Easy.

Tuesday, June 19, 2018

What Does "Serious" Mean?

A week ago I wrote this in a tweet:
I'm puzzled by the infatuation with NGDP targeting. We have good reasons to care about the path for the price level and the path for real GDP. Idea seems to be that if you smooth Py that you get optimal paths for P and y. That's hardly obvious, and doesn't fall out of any serious theory I'm aware of.
The proximate cause of that outburst was this blog post by David Beckworth who, as you might know, is a proponent of nominal GDP (NGDP) targeting.

I've written before about NGDP targeting - for example I found this post from six years ago. It turns out that not much has changed since then. My views haven't changed, and the promoters of NGDP targeting are more or less the same ones that were around six years ago - and I don't get the sense they've come up with anything new to tell us. In any case, though, I wanted to find out for sure, and that's what my tweet was about. It basically says: "I don't think you have a good argument, but in case you do, please tell me about it." I tried to provoke Beckworth a bit to get an answer out of him, but he just called me a troll.

But, at last, some degree of success, as George Selgin has gone to considerable trouble to research the economics literature to come up with what he thinks are "serious" arguments that would support NGDP targeting. The first order of business for George is to complain about my use of the word "serious:"
I'm not exactly sure what Stephen means by a "serious theory." But if he means coherent and thoughtful theoretical arguments by well-respected (and presumably "serious") economists, then there are all sorts of "serious theories" out there to which he might refer, with roots tracing back to the heyday of classical economics. Indeed, until the advent of the Keynesian revolution, a stable nominal GDP ideal, or something close to it, was at least as popular among highly-regarded economists as that of a stable output price level, its chief rival.
"Serious" means that a good case has been made, where "good" means a theory with conclusions that follow from reasonable assumptions, and some notion that this works empirically. Good science basically. Unfortunately, in economics there is plenty of bad science to wade through, and some of that bad science finds its way into reputable journals, and is written by economists with fancy titles working at reputable academic and non-academic institutions. That's why I qualified my statement with "serious." I know there's a mountain of economics writing arguing that NGDP targeting is the cat's meow. But anyone could find mountains of writing in economics about any number of crappy ideas. I want to know about the good stuff. And I'm not going to be convinced by the reputations of the people promoting the ideas or the popularity of the ideas. Everyone has to make their case, and we don't do science by opinion poll.

So, what's an example of a serious idea, related to monetary policy rules? Well, one of these is Friedman's constant money growth rule. Friedman had a theory to back that up in "The Role of Monetary Policy." That's a coherent theory, but it's all in words. Like many things that Friedman did, you can also formalize it, which is - more or less - what Lucas did. There was also a formidable empirical project, Friedman and Schwartz's Monetary History of the United States, which Friedman used to support the theory. With everything laid out like that, we're able to argue about the assumptions, the conclusions, and the evidence. Serious stuff. Friedman was convincing enough that central banks actually implemented his ideas. Some of that was a success (the Volcker disinflation) and some was not (ongoing inflation control).

We're now in a world in which most "serious" central banks are inflation-targeters. Typically, they're targeting inflation at 2%, and manipulating a short-run target for an overnight nominal interest rate to hit the inflation target. Some central banks - the Bank of Canada in particular - have have been successful inflation targeters. The Bank of Canada has been doing this since 1991, and they haven't deviated much from a 2% inflation path over the last 27 years. This chart shows just the last 20 years, as I was comparing Canada to Japan in a talk I gave:
In the inflation targeting game, that's pretty good. In Canada's case, inflation targeting has proved to be feasible, it's easily understood, it's conducted in a way that promotes central bank independence, and it appears to be compatible with good economic performance in other dimensions.

So what's to complain about? I think we can make a case that central banking should be conservative - this isn't a venue where we should treat experimentation lightly. To change procedure we have to think that something's going wrong with the current approach, and that switching gears is highly likely to give us an improvement. In Canada, the Bank reviews its agreement with the government of Canada every 5 years, and thinks about whether it's doing the right thing. The agreement won't be reconsidered until 2021, but the Bank is already mulling this over - a process which involves economic research and consultation with the public. Serious work, I think.

Is the work that George references in his blog post serious? George thinks so, but of course George's and my views of what is serious might differ. I may not be as ignorant of the work as George thinks - I've already seen much of it - so you might guess that I'm putting some or all of it in the non-serious bin. To take some examples:

1. McCallum 1987: McCallum was an early promoter of NGDP targeting. From the paper, this looks like some kind of modified monetarism. McCallum won't write a model down. He says we don't have agreement on what the model is, so apparently his policy rule is somehow agnostic. But he goes ahead anyway to run an "atheoretical" regression, and uses the estimated coefficients to simulate the performance of his rule. Yikes. Definitely not serious - a multitude of sins in that one.

2. Garin, Lester, Sims: This starts with a boilerplate New Keynesian (NK) model and ultimately expands this into a "medium scale" model. This is complicated enough that's it's not going to be amenable to analysis - pencil and paper techniques. The authors estimate and calibrate the parameters in the model and then evaluate the performance of alternative policy rules, according to the welfare loss relative to what would occur in an identical economy with flexible wages and flexible prices. So, this is serious work. There's a model that is formally laid out, there are references to the related literature, there is an attempt to measure the welfare effects of alternative policy rules given the model at hand. The authors report, in Table 7, that the welfare loss for NGDP targeting is .11% of GDP, from inflation targeting .86%, from output gap targeting .03%, and from a Taylor rule .24%. So, if we were living in this model NK world, then the best we could do is to target the output gap. This of course makes perfect sense, since the output gap is the deviation of output from output in the flexible wage/price equilibrium, so the welfare criterion is in fact the output gap. And NGDP targeting is second best, and certainly much better than pure inflation targeting or a Taylor rule.

But, once we're past the actual exercise at hand we can start to ask questions. What's the model leaving out that might be germane to the problem at hand? What else could we do with this model that might lead us to different conclusions? First, the model has sticky-price and sticky-wage frictions, but we know there are other frictions of importance for monetary policy - financial frictions in particular. Surely we don't think that this NK model will tell us anything about what to do in a financial crisis, for example. I might like to know what would happen under a naive policy. That's a little difficult here as we have to worry about determinacy issues, but indeterminacy isn't stopping most NK modelers. They typically ignore the global indeterminacy that's staring them in the face. The naive policy would be a useful benchmark, as this would give us a measure of how costly price and wage stickiness is. My guess is the welfare loss in these models is very small - not enough to justify the cost of running the Fed, I think.

The big difficulty here, I think, is indeterminacy. In simple NK models - Benhabib et al. for example - we know that a Taylor rule central banker can get stuck at the zero lower bound. The alternative policy rules considered in the paper are, as the authors argue, alternative Taylor rules - set the nominal interest rate with a particular target in mind, and alternative coefficients. For NGDP targeting, in the model the central bank sets the nominal interest rate each period to peg NGDP to a constant. I would like to know exactly what sort of rule that produces, and I would like to know about the global properties of the model - not just an approximation around the steady state. The indeterminacy issue is important, as "Taylor rule perils" can explain why some central banks have had trouble hitting inflation targets (the Bank of Japan in particular). NGDP targets aren't going to do any better if they are subject to the same perils - a problem not addressed in the paper. So, the jury is out on Garin-Lester-Sims.

3. Sheedy 2014: What I like about this paper is that it takes nominal intertemporal contracts seriously. My suspicion is that NK people are barking up the wrong tree in emphasizing potential inefficiencies in nominal spot market contracts (and it's not like labor contracts are typically spot contracts anyway). Debt contracts at, for example, 3-month, 1-year, 10-year, or 20-year horizons are subject to inflation risk for those horizons. So, if the central bank can make prices predictable over long horizons, that should reduce risk in credit markets substantially, and should make those markets work more efficiently. But in Sheedy's model, smoothing nominal income is apparently a good way to insure against this uninsured risk. And Sheedy's model is quite special. Indeed, it's addressing a monetary policy issue in a 3-period model - that's not a serious approach to monetary economics in my opinion. It's hard to model valued central bank liabilities in a sensible way in a finite horizon model. My guess is that, if you developed this idea in a serious monetary model, that an optimal policy rule might look like price level targeting. Someone would have to do the work though.

Conclusion? Well, some seriousness alright, but I still don't see NGDP targeting "falling out of any serious theory." I'm not yet ready to tell any central bankers (in case they're asking) that they should drop their inflation targets and adopt NGDP targeting.

Wednesday, June 13, 2018

Sovereign Money, Narrow Banks, Digital Currency, etc.

The recent Vollgeld (full money) or sovereign money referendum in Switzerland, which was just voted down, is quite interesting, as it raises several fundamental issues in monetary economics and central banking. What's money? Is "money" a useful concept to be bandying about? Who should have the right to issue money? What's a bank? Are banks inherently unstable? What's a central bank for anyway?

I read a few blog pieces and news reports on Vollgeld. Some of the blog pieces, like David Beckworth's, contained essentially nothing I could agree with. Others, like one by Morgan Ricks, were pretty interesting.

What was the Vollgeld proposal? In Switzerland, as you may know, they like referenda. These are conducted for all three levels of government, and there are typically several a year at the federal level. If you're upset about something, and can get enough people to sign a petition, the initiative is sent to the electorate (you won't have to wait for an election), and it's either voted up and made law, or voted down. This specific initiative - Vollgeld - was a proposal that would have banned private banks from the retail payments business. Under Vollgeld, a private bank could still issue various liabilities - long-term debt, short-term paper, savings accounts, for example, but presumably not accounts subject to payment by debit card or check. What was the reasoning? Apparently, we shouldn't trust private banks. They're risky - I assume in both the institutional and systemic sense. And there seems to be some notion that giving a private financial institution the right to issue "money," is giving it monopoly power. Why should we be endowing these elite bankers with special privileges?

But what are people to do if the banks can't provide them with transactions services? The Vollgeld proposal was to transfer that provision to the central bank, which would be then be in the business of setting up accounts, issuing debit cards, making sure accounts aren't overdrawn, filling ATMs with cash, etc. And why not, the Vollgeld proponents might say. After all, those elite bankers have had checking accounts (i.e. reserve accounts) with the Swiss National Bank since that institution was set up. Surely it would be more democratic if reserve accounts were available to everyone.

On the face of it, Vollgeld seems not so different from traditional narrow banking proposals, which have been around for a coon's age. The weird thing is that narrow banking proposals usually came from the right wing, while Vollgeld appears to be a lefty proposal. Milton Friedman, for example, had a narrow banking proposal - the 100% reserve requirement. Friedman thought that controlling the stock of money is everything, and if each unit of transactions deposits were backed by one unit of central bank reserves, the central bank could perfectly control the total stock of money - reserves plus transactions accounts plus central bank-issued currency. So, with Friedman's proposal the private banks could still issue the transactions accounts, not the central bank, but it's effectively the same as a Vollgeld-type proposal. And the rationale isn't so different. The Vollgeld people are concerned that a private institution is issuing what they think is a public good - money - and Friedman agrees, basically (or would if he were still with us).

Narrow Banking in its extreme form has from time to time entered the realm of economic quackery. Murray Rothbard, for example, not only did not trust private banks to create money, he didn't trust the central bank either. Rothbard apparently had some influence on Ron Paul and the End the Fed movement. Basically, Rothbard wanted to re-establish the gold standard, and have a 100% reserve requirement - in gold.

The typical benefits attributed to narrow banking - other than what Friedman had in mind - can be found in some of the concerns of the Vollgeld proponents. Banking is sometimes thought to be inherently unstable - an idea that might occur to you if you were a student of US banking history, for example. A remedy for this problem, instituted first in the United States, is deposit insurance. But, we know that deposit insurance breeds another problem - moral hazard. Banks will take too much risk, if they're not somehow prevented from doing so. So one regulatory intervention breeds others - capital requirements for example. Solution: Adopt narrow banking and transactions deposits are safe - you can do away with deposit insurance.

What's the problem with that? Well, in typical narrow banking proposals, a concern is that the legal restriction on banks makes financial intermediation less efficient. That is, through the wonders of asset transformation, conventional private banks convert illiquid loans and other illiquid assets into liquid transactions deposits. This intermedation process is an efficient way to channel savings into productive investment. If people are forced to hold their transactions balances in accounts backed by central bank or government liabilities, then real interest rates will be higher on loans and other private debt instruments, and there will be less capital accumulation.

The other problem is that narrow banking rules, including Vollgeld, can be skirted by private financial intermediaries. This is a standard game in the financial sector. Some regulator puts restrictions on some type of financial intermediary activity, and some enterprising banker finds a way to design a financial product that performs roughly the same function as what is being regulated, but the new product falls outside of the regulation. In the United States, money market mutual funds came into being because of regulations on transactions deposits at commercial banks. Sweep accounts were devised to get around reserve requirements and the prohibition of the payment of interest on demand deposits. The shadow banking sector grew because costs were lower than in regulated commercial banking.

A curious feature of Switzerland is that, if the Swiss National Bank were to issue transactions accounts, this would actually not be narrow banking in the usual sense. To illustrate why, consider Canada (if you dare). In Canada, for example, most of the assets held by the Bank of Canada are obligations of the government of Canada, and the balance sheet is small, at 6.5% of GDP. So, if the Bank of Canada issued transactions accounts to consumers, that would be a narrow banking activity, provided nothing changed in the composition of the Bank's asset portfolio. The Swiss National Bank, by contrast, holds a portfolio that includes a large amount of equity, and the majority of the portfolio is not denominated in Swiss currency. The Swiss National Bank holds the sovereign debt of other countries in Europe, North America, and Asia, and it holds private debt. Further, the balance sheet of the Swiss National Bank is very large, at 117% of Swiss GDP at the end of 2017.

So, if Vollgeld had passed, what the SNB would be doing would not be narrow banking as traditionally envisioned. In fact, the Swiss National Bank, given its large and unusual asset portfolio, wouldn't look like any bank I know of under Vollgeld. It would have been some sort of stock mutual fund/foreign currency-denominated bond fund offering transactions accounts. Though the Swiss National Bank is currently well-capitalized, I doubt if it would pass the regulatory scrutiny of any bank regulator. In any case, the Swiss National Bank campaigned actively against Vollgeld.

Another curious aspect of Vollgeld was that the movement was driven in part by the idea that banking should be democratized. Somehow private banks were thought to be falling short in the public service department. But the residents of Switzerland already have the option of holding transactions accounts - and savings accounts too - in a government financial institution. If you've been to Switzerland, you should know what this is - it's the Swiss post office, Swiss Post. From their web site, it appears that Swiss Post also offers financial services related to pensions and real estate. Wikipedia says Swiss Post is the country's second-largest employer, and Post Finance, its financial arm, is the fifth largest retail financial institution in Switzerland. So, given that there is already a government-owned option in retail payments services, why would the Vollgeld people want to take the extra step of banning private retail payments outright? Beats me.

For all central banks in the world, changing technology, and evolution in retail payments has become an important issue - if not the key issue for the future of central banking. Central-bank-issued currency is losing ground to debit and credit cards in retail payments, in spite of the fact that currency outstanding has in some instances increased. Here's the currency/GDP ratio for the US:
So, that bottomed out at about 4.1% in the 1980s, and currently stands at 8.1%. But, about 80% of that is in $100 denominations. As people like Ken Rogoff like to point out, the primary liability of most central banks - what finances the asset portfolio of a small-balance-sheet central bank like the Bank of Canada - is being used as a means of payment and store of wealth by criminals. Getting rid of large denominations, or withdrawing all currency from circulation, would increase the cost of committing crime, and might make us all better off (except the criminals of course).

But, currency is still used intensively, in legitimate ways, by a significant fraction of the population, who tend to reside in the bottom tail of the income distribution. And currency can be useful when everything else fails - computer networks go down, or the power fails altogether. We don't want to shortchange the poor (literally), or shoot ourselves in our collective foot. A possibility is that central banks could issue some form of digital currency, which is what most people are considering, I think, when they discuss "sovereign money," not the more draconian Vollgeld approach.

So, if central banks were to issue a new type of liability, what form could that take? Well, it could be a kind of cryptocurrency. As with Bitcoin, for example, central banks could issue a liability that could be exchanged in decentralized fashion, on a distributed ledger. While central banks may be able to correct some of the potential stumbling blocks associated with cryptocurrencies, what we know about blockchain technology currently suggests that it can't handle a large volume of transactions, and that it is far too costly - in pure energy costs - to provide the correct incentives. So, a central bank digital currency would have to be centralized - a stored-value-card technology for example. But then the central bank would have to provide an interface whereby value could be downloaded and uploaded at decentralized locations. Possibly this could be done through the private banking system, and possibly central bank digital currency could compete with privately-issued digital currencies.

But why should the central bank be in the business of retail payments at all? Why not leave that entirely to the private banking system? Indeed, there were historical instances of stable and successful private money systems. For example, before 1935 in Canada, retail means of payment consisted of small denomination government of Canada paper notes and coins, larger denomination paper notes issued by private chartered banks, and transactions deposits at those same chartered banks. If currency is an anachronism, we could do away with it, and leave the retail payments market to private financial institutions, perhaps with some constraints requiring that basic services be provided to low-income people.

What would monetary policy be in a world in which the central bank doesn't issue liabilities that Milton Friedman would recognize as "money?" Here, it's helpful to get away from the idea that there is some stuff we should call "money," and that such stuff is produced through magic - creation from "thin air," apparently. Those ideas - propagated sometimes by otherwise-respectable economists - aren't helping us much, and are seriously misleading. In reality, assets exist on a multidimensional spectrum, and the central bank's ability to execute what we think of as monetary policy - inflation control, crisis intervention, smoothing of financial conditions to enhance real economic activity - could be unimpeded even if the central bank does not issue a retail payments instrument.

Central banking works because the central bank is transforming assets - its a bank after all, which has assets and liabilities that differ according to maturity and liquidity. As long as the asset transformation is something that can't somehow be undone by private actions, it works. Governments issue interest-bearing debt for which close private sector substitutes don't seem to exist. For example, in the US, the repo market loves Treasury securities. So, we might imagine central banks issuing an array of interest bearing obligations - from overnight assets like the reverse repos issued by the Fed, to three month bills, to 10-year bonds - to finance a portfolio of government debt. In principle, those central banks should be able to target short-term market interest rates, just as they do now.

I've touched on a host of questions that central banks need to know the answers to, and there is some urgency in providing answers. Unfortunately, we can't get the answers by running a regression, as these are fundamental questions having to do with institutional design and technologies that we have little or no experience with. This is where theory comes in, and part of why it's useful - sometimes the only game in town. Get out your models, monetary theorists!