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Thank you!

Government continues to make the pretend payments under the assumptions that a new coordination level will be reached, and the payments will then become sustainable.

What would it look like if we made the leap? Government would have been making smaller pretend payments, and fewer of us would have called them unsustainable.

As an expert in achieving higher levels of coordination,the author needs a statement about what kind of government action works. When we do achieve higher coordination, we have bigger economy and likely a bigger government under any ratio rule.

4. Misdiagnosing the Sickness and Cure

Pete, this section was kind of a dissapointment. I think as much as you are reluctant, you must wade into the monetary policy debate in this section with *both feet*, despite your great respect for the work of your friends Selgin, White, and Horwitz. You are not communicating clearly an idea that I think you hold (i.e. that the recent fed response of greatly expanding the monetary base is treating symptoms of the disease which expresses itself in the temporary yet acute increased demand to hold money) and in doing so the fed is serving as a kind of enabler in masking the real problem or even making the patient sicker. This would sort of work like a positive feedback loop in dynamical systems. Bad fiscal + monetary policy yields distortions, the symptoms of which are treated by corrective monetary countermeasures which actually feed back into the distortion and make them worse. I think you have failed to spell out a lucid technical case why such a policy is bad for the patient. If it is your position (and I'm not 100% sure it is), you must make at least a semi-technical case why the fed should have let the money stock collapse in 2008-2009, instead of trying to re-inflate. Correspondingly, you must play some "what if" games to give evidence why doing so might have caused the patient to finally face the real disease, and not simply medicate for cancer with lots of asprin. But might letting the money supply fall have caused policy to lurch into even worse areas that would have been very unintended? Maybe instead of mearly catching a tiger by the tail, we get Hayek's "strong man" and a true "planner". I'm sure you've thought deeply about some of this, but the reader is left wondering.

Further to K. Sralla's comments. The debate over QE1 and QE2 is occurring as though it were a blackboard exercise. The question is NOT whether a central bank should keep MV constant. The question is whether what the Fed did was monetary policy and whether it followed anything like a Bagehot rule.

I submit the answer is no to both questions. The Fed engaged in credit allocation, which is more properly thought of as fiscal policy. And the Fed did not provide liquidity to the financial markets, but loans to specific banks to prop them up.

I'm still struggling to see how the provision of liquidity was possible at the time. There had been an over-extension of fiduciary media (liabilities), and the banks were facing an onslaught of loan bankruptcies. It seems to me that the monetary contraction of 2008 was one predominately led by a fall in the supply of money. Isn't it natural that banks reduce their liabilities? Isn't it natural that in an unstable environment, where bad assets are artificially maintained rather than liquidated and banks are still in highly uncertain positions, these same banks will be more careful when increasing their liabilities?

It seems to me that there's more to our problems than the demand for money, and that monetary expansion doesn't strike the root of these problems.

Credit expansion is the problem. Gold money will not stop massive credit expansion while fractional reserve banking exists. Even competitive currencies won't help much. We tried that in the US for much of the 19th century without much benefit. Even the threat of failure doesn't seem to stop some bankers from going to extremes. Free banking might work if consumers understood why FRB is so unstable and had to buy their own deposit insurance.

Another solution I haven't heard is to promote Hayek's fourth generation of monetary theory. Current monetary theory is stuck in the 19th century fear of inflation/deflation. Neither is the problem; they’re symptoms. The real problem is the distortion of relative prices between capital and consumer goods.

Some posters over at Free Exchange (The Economist) are experts in control theory and have related the problem to poorly timed feedback. CPI inflation occurs too late in the cycle to provide timely feedback as a guide to policy. That's why policy tends to be pro-cyclical. The feedback needs to occur much earlier. Tracking the effects of loans on the relative prices of capital and consumer goods as Hayek suggested would provide timely feedback. If the Fed acted appropriately on that feedback, then policy could be counter-cyclical and in that case would be better than gold or free banking. And it would be a solution that might get a hearing under the current paradigm.

@ McKinney: "Tracking the effects of loans on the relative prices of capital and consumer goods as Hayek suggested would provide timely feedback."

True but how do you suggest we go about tracking these effects on relative prices? I believe Hayek was being figurative when he made this suggestion.

"If the Fed acted appropriately on that feedback"

Assuming such knowledge is even attainable (which I doubt that it is in any useful way) we must still rely on a sound discretionary judgment by a few elites, on a matter of market-timing, to better guess the self-coordinating actions of market participants. The market is not a machine that can be fine-tuned.

"Even the threat of failure doesn't seem to stop some bankers from going to extremes."

Some bankers is better than all as the consequences of our current paradigm would suggest.

"The question is NOT whether a central bank should keep MV constant"

But I think many agree that holding MV constant is a very difficult task indeed. In the world of partial differential equations, small errors one way or another cascade into economic crises. Given this reality and the past tendency of central banks to always err on the side of inflation, it seems that Pete is arguing that a truly independent fed should not even try to hold MV constant during the bust, but rather it should be allowed to fall. In other words, the increased demand to hold money should be satisfied by the increased purchasing power of the currency, with all the problems inherent in such a strategy. Pete's reasoning? As I understand his argument, its because he thinks the juggling trick must be ended at its source. Runaway Keynesian fiscal policy cannot continue if its cost of borrowing is very very high. When the fed undertakes open market operations, it is enabling (possibly unintentionally) the juggling act to continue to the point of no return.

If I understand him correctly, in Pete's mind, the political economy tiger of the debt-debasement cycle in the long run is more dangerous than the monetary deflation tiger in the short run. This is where I think he might flesh these ideas out with some thought experiments. If he is right, then the Monetarist has served as an unwitting enabling partner to the Keynesian, and together have created the perfect storm leading us toward the crackup boom.

Maybe I'm missing his main points completely, but this is how I have interpreted his arguments. Maybe he could pop in and clarify.

complexphenom, yeah, it would require some work. What are grad students working on that would be more important? What are universities for? Hayek suggested a direction for new research; he didn't say the solution was easy. However, with the incredible amount of data available I don't see that it would be such an impossible problem.

Yes, the solution hinges on the discretion of the elite accepting and understanding the research, but there you posit a practical objection, not a theoretical one. Hayek's idea has a chance of implementation, whereas a gold standard or free banking have as much chance as a snowball in hell. If you don't mind working on ideas that have no chance whatsoever of being implemented but are ideologically pure, that's fine. Some of us are more practically minded.

And neither the gold standard with fractional banking or free banking provide a limit to credit expansion. For all the rhetoric, free banking doesn't have a significantly better history than central banking. And even if the effect is significant statistically, it's a small effect. The experience of the US in the 19th century is discouraging.

@Pete: I have brought this up before, but here goes again: Reflexive pronouns - myself, himself, herself, itself, themselves, ourselves, yourself, yourselves- should be used only when they refer back to another word in the sentence.

So, please: "by Chris Coyne and me." Using myself wrongly gives the wrong impression. Did you never get marked down for this? Even in New Jersey?

Jule Herbert,

Please stop "using [your]self wrongly" in public. Thank you.

I stand corrected. Pete: Quit using "myself" incorrectly.

By the by, on a slightly related note. Coordination sometimes works, it is not always a problem.

It is no secret that I am not an economist, and I am very reluctant to demonstrate ignorance in front of very well-read economists, however, I want to make a point that I think needs to be pointed out from outside the profession. The modern language of macroeconomics uses terms that natural scientists do not, but decribe similar phenomena. When we talk about institutional rules (ie Bagehot's rule or any other), the goal of such institutional rules is to move "boundary values". If I may use a word picture, it is like building a levee along a river to make it flow where we want. Bagehot likely had no conception of the mathematics of this in the 19th century. Hayek did brilliantly understand this in the mid-20th century, but did not use modern mathematical language. So when he is speaking of a "knowledge problem" I interpret this as communicating in non-mathematical language of our inability to initialize present conditions accurately, and thus a "planner" can have very little possibility of knowing what move to make that gives the intended result.

A weakness of institutional rules governing a *fundamentally flawed institution* in a social setting is that they "leak", and aren't built high enough or long enough to keep a flood from going right over the banks. They often seem effective when the river is flowing with a trickle. In fact, I read somewhere that it has been argued that Bagehot's rule would not even have prevented some of the very objectionable practices that the fed has engaged in since the 2008 crises.

Now if what I have said is right, the only effective rule which will keep the fed from enabling runaway fiscal policy is to tie its hands completely in terms of its ability to print. Now this is *NOT* an argument against FR free banking (which I am inclined to accept based on the fine work of those scholars mentioned above), yet rules such as Bagehot's I do not believe will be effective in stopping the cycle Pete is outlining in his paper. In a flood, the water will flow right over the levee like it is not even there.

"Coordination sometimes works, it is not always a problem."

Speaking of which, with the New Year approaching, can we admit that it's been fun, but it's time to change the blog's name back to Austrian Economists?

"change the blog's name back to Austrian Economists?"

Hmm.. since Hayek we have a line of math and model that takes his theory much farther then anything we have for the DSGE theory like Stiglitz. Hayek is now more mathematically precise than anyone else in the game.

We need Congress to not raise debt ceiling. God wins in all foxholes. If God won more often, and we let true charity be a individual chose not Government’s role we would be better off. Example stimulus, cash for clunkers and Dept of Ed. at Federal level when each state has own.



1. You assert in the opening section that "government spending intended to maintain stability, avoid deflation, and stimulate the economy leads to significant increases in the public debt." However you do not anywhere make a distinction between debt incurred for these purposes and debt incurred for other purposes. I understand you are alluding to the incentivization created by these goals as being a key source of the problem, but since you never elaborate on how public debt for other purposes might avoid the cycle you are discussing, it seems an unnecessary distinction.

2. The section on public debt- inflation cycle is simply inadequate to the task of describing why public debt leads to inflation. You assert that it is in the interests of governments to borrow now and pay back later using debased currency, but you make no attempt to describe how this debasement might be intentional or inevitable. If you could make the case for why public debt must necessarily lead to inflation either alone or through inadvertent connection to an otherwise independent monetary policy, this paper would be much stronger. I think this is what you are intending to do, but the argument could be strengthened and clarified greatly.

Thanks for posting.


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