Evidence for Horwitz or Boettke? You Decide.

Steven Horwitz

"In this sense, I believe, we ought as economists think much more about the political significance of institutions which place a restraint on monetary policy and can shelter governments against political pressure, than about the ideal correctness of the policy which might be conducted.  Central banks and ministers of finance will never be able to implement what the economist would regard as the wise policy. They will always have to act under political pressure, and all we can hope to do is to protect them against this political pressure as well as possible."  - Hayek, "The Campagain Against Keynesian Inflation", p. 215.

No one, I hope, would ever accuse me of not thinking about institutions that would restrain monetary policy, nor not thinking more about them than "ideal policies."  Reading Hayek also suggests that monetary policy makers are unlikely to lash themselves to the mast, which I believe is the flaw in Pete's position in our ongoing argument.  Put differently:  If we really endogenize the political process, why would we ever expect central bankers to freeze the monetary base, and therefore what point is there in telling them they should?  If doing so requires somehow making institutional changes that overcome political self-interest, then go all the way and argue for free banking.  If Pete thinks Bernanke can somehow overcome the various temptations without such institutional change and really freeze the base, then why can't he overcome those temptations and try to target nominal GDP in some form?

In any case, Pete can't have it both ways.  If he really thinks the central bank can be convinced to freeze the base without fundamental institutional change that overrides political incentives, then why stop there?  And if he thinks they are able to ignore political incentives and freeze the base, then why can't they ignore political incentives and target MV / nominal GDP?  If neither some sort of MV/nominal GDP target nor freezing the base/money supply is compatible with political incentives, then Pete and I have played to a draw, it seems. 

Note:  I'm ignoring any differential knowledge problems that might arise in freezing the base vs. a nominal GDP target only because that's not the ground Pete's been playing on.  His argument has been predominantly a public choice one from the start, as I read it.  In any case, that's Hayek's point, so that might count that quote as evidence in favor of the argument I make above.

Comments

[von Pepe]

I just had to post the headline from the current lead story on Bloomberg (sorry for taking off topic)

"U.S. Stocks Rise on Fed Stimulus Speculation"

Tiger by the Tail

[George Selgin]

Steve and Pete, I think the dichotomy of frozen base OR free banking is a false one, for two reasons. First and more fundamentally, "free banking" is a banking reform, which as such leaves the question of monetary base control unaddressed. If we are to retain the present dollar standard, we must regulate the supply of base dollars somehow, whether by freezing the stock or by some other (preferably non-discretionary) means. Giving banks freedom to issue their own notes etc. (always including freedom to fail) doesn't itself address the question of how the supply of their reserve asset is to be limited.

Second, a freeze without free banking would almost certainly prove disastrous, because both the velocity of money and the relative demand for currency will continue to fluctuate. In the absence of free banking, such fluctuations will translate into undesirable fluctuations in NGNP that will give rise to calls for abandoning the freeze, forever blackening the reputation of that idea. It's for that reason that Friedman, Timberlake and I always coupled suggestions for freezing B to suggestions for freeing banks.

Of course both a frozen base and free banking are very radical ideas that may be very hard if not impossible to get through political reality. But even putting that aside, and imagining that one or both could succeed, it's important to realize that any victory for one idea in the absence of victory for the other is likely to prove very short lived.

[K Sralla]

"then why can't he overcome those temptations and try to target nominal GDP in some form?"

Steve, this very question gets at the heart of the matter. The key phrase is "some form"? Sumner's form? Yours? Which form?

Ignoring the institutional concerns, under central banking, a nominal GDP target may be unworkable technically, and the wrong NGDP target with the wrong stategy for implimentation will possibly lead to perverse non-linear consequences which cannot be predicted. I am not even sure whether 0 inflation targeting in many situations may not be preferable, while in others, such as where productivity is growing, NGDP targeting is better.

I will let Pete respond for himself, but Pete has certainly gone all the way and called for free banking in his new Cato policy paper. Most readers here probably agree that the private issue of money, even under a free FRB schema, is highly desirable. If only due to the institutional situation, the government monopoly on money must eventually be broken. Leaving the keys to the printing press with central bankers in the face of political pressure is like giving an alchoholic a bottle of booze and asking him not to open the bottle. The temptation nearly always proves to be too great.

[marcus nunes]

True. But Greenspan wasable to have the "Great Moderation" because he "froze" bank reserves which is the lion´s share of the base.

[George Selgin]

Be aware however, Marcus, that there's a large literature questioning the extent to which the Great Moderation was due to enlightened Fed policy as opposed to other factors. Larry White, Bill Lastrapes, and I refer to some of it in our forthcoming J. Macro. paper, "Has the Fed Been a Failure?"

[Barkley Rosser]

Well, the Fed froze the base after 1979 when Carter appointed Volcker as Fed Chair, which led to Carter losing to Reagan in 80, although hostages in Iran, battling with rabbits in swamps, micromanaging the WH tennis court, and having lust in his heart all had something to do with Carter's failure, not to mention Reagan's ability to say "there you go again" at the right moment with that big shit-eating Hollywood grin.

Funny how now the person calling for freezing M is Rick Perry, threatening Bernanke with a treason charge if he will not help crash the economy on Obama's watch so he can get elected. Given his record of increasing public employment faster than private employment was growing in TX, I figure if he gets in, he will turn around, junk the debt deal, ask for QEN, and push up hard on a fiscal stim, maybe with a nice new war somewhere or othere...

Of course, all of these snide remarks are mostly irrelevant to the question of institutions or whether Steve or Pete is right in their long-running debate...

[Jerry O'Driscoll]

The intentionalist fallacy is at work in this discussion. The fact that, ex post, the base or reserves remained roughly constant does not imply that, ex ante, the FOMC was targetting the base or reserves. It's a non sequitor.

The Fed has never targetted the base. In the beginning of the Volcker era, they were trying to target the monetary aggregates in order to bring inflation down. At the October 1982 meeting, the FOMC abandoned aggregate targetting because the relationship between money and prices had broken down. Bringing down inflation remained the goal.

Things got complicated after the decision to bring the foreign-exchange value of the dollar down. Then the the stock market crash in October 1987 led to the abandonnment of any pretense of long-run policy.

The thing that is difficult for people never in the system to understand is that there is little if any internal discussion on what policy the FOMC is or should be following. At one FOMC meeting a president said it looked to him as if the FOMC were targetting NGDP. He was met with blank stares and silence. It is not as if other FOMC disgreed; they just didn't know there was a policy.

In his Fed history, Meltzer describes it as chronic focus on the short-term. In practice, that means employment except in times of very high inflation (the Volcker era).

The fact that something like the base or reserves stayed constant over some time period is an unintented outcome. For anyone who has worked in the system or studied the Fed's history, it is, at best, amusing that someone would think that the outcome was the product of a policy.

[George Selgin]

The Fed engaged in reserve targeting under Volcker--not a frozen base (since the base includes currency in circulation), and my understanding is that the reserve-targeting regime lasted for only a relatively short phase of the whole "Great Moderation" period.

Also, before the idea catches on that Rick Perry is proposing (whether merely for strategic purposes or in earnest) is also what Friedman and Timberlake proposed, I would like to see evidence that he understands the distinction between B and M1 or M2 (or some broader M), and that it is clearly freezing B that he is toying with.

[Barkley Rosser]

Jerry,

I accept that your characterization of what went on during the Volcker era is more accurate than my somewhat snippy and pokey wisecracks. I would also agree that it is unclear that Perry has any idea about these various distinctions, particularly given the D he reportedly got in Principles of Econ back at Texas A&M (and I have not heard that he was partying hard as we heard of W in his undergrad days).

As for what would have happened during all those episodes if we had had free banking, well, I have no idea whatsoever.

[Barkley Rosser]

My last comment was meant to be addressed to George Selgin as well as Jerry O'Driscoll. Sorry.

[Jerry O'Driscoll]

I don't think Perry is advocating an explicit policy. I suspect that he views Bernanke as political, in the mode of Arthur Burns, and does not want monetary policy to be used to support Obama's re-election.

[Steve Horwitz]

"Of course, all of these snide remarks are mostly irrelevant to the question of institutions or whether Steve or Pete is right in their long-running debate..."

So try not being snide for a change Barkley :)

[K Sralla]

"under central banking, a nominal GDP target may be unworkable technically"

I should clarify that under *any* monetary scheme, a nominal GDP target may be unworkable, since such the target itself indeed implies a monetary policy under central banking.

[Barkley Rosser]

Steve,

Hey, I am not always snide. But I am not going to comment on which of you guys is right, if that is what you are begging for, :-).

[Leonardo Baggiani]

In my humble opinion, Hayek's words are more relevant than debating of freezing vs NGDP.
They say that (wise) economist can elaborate theoretical schemes to guide central banks or other insitutions, but the origin of these entities is political, so reforming them - if ever possible - must start at a political level. To do this we must know the "significance" of institutions.
Institutions are means for a certain elite to manage economic variables. This elite is the expression of a political process where people - considering their interests and the offered political proposals - choose representatives (or blocks of representative) who in turn elect a restricted number of primary "managers". Maybe there is a part of the electoral base which "can suggest" who must be elected by the people or by the first-level representatives (remember: you can desire, and vote, only what you see), which means that the managing elite is a vehicle of particular interests with nothing to do with the necessities of the whole economy as an impersonal entity.

Keeping on telling Bernanke "you are wrong, here is the right policy" is useless as he is simply not interested in finding the best policy but following politically expressed interests (be he the principal or the agent); the same works for all other institutions.

By their very nature, every institution is not a task-force of truth-seeking managers, but an instrument to manage power for certain political (not necessarily general) interests. And to various extents, people themselves may be not interested in making the economy properly run but seeking a kind of rent. This leaves no room for (wise, correct) prescriptions by (e.g. Austrian) economists. Moreover, even with no "subtle powers" working, institutions can be expressions of general preferences, who can prefer to steal wealth from the future instead of living within their possibilities - a myopic but "legitimate" choise by a political point of view.

When we pass from economic theory to re-designing policies, we shall try find a way to "insulate" the politically-born institutions from political influences i.e. convert political institutions into technocratic ones. Which is the tragedy of the current "democratic" organisations.

[Garage Heaters]

When we pass from economic theory to re-designing policies, we shall try find a way to "insulate" the politically-born institutions from political influences i.e. convert political institutions into technocratic ones. I think so.