Tuesday, October 11, 2011

Monetary Policy, pt II

More an addendum to the last post, especially regarding to the connection between monetary policy and fiscal policy.

David Frum has gotten into the act over last week or so, specifically criticizing the hard money tendencies of the Republican Party. Now, in the main I agree with Mr. Frum. In particular, I support Mitt Romney relative to Gov Perry in no small part because of the reasons mentioned by Mr. Frum. But the issue is a little more complicated than Mr. Frum allows, for reasons that are worth being made explicit to illustrate the connection between monetary policy and trust in governance.

It is a very fundamental requirement of any successful economy to have a credible currency and loose money threatens the integrity of the currency. There are the well-known historical cases of the Weimar Republic and Zimbabwe where the economies were brought to ruination because of a debased currency as well as many other less spectacular examples. The Establishment is completely dismissive of these concerns but frankly the comparisons are less outlandish for me. Let's listen to the Establishment from an outsider's point of view.

The outsider hears, "We're going to do the same things that caused economic collapse in Weimar Germany and Zimbabwe but we're not going to suffer the collapse like they did because we're smarter and we'll execute better. We'll be able to do this in spite of the fact that there are no immediate plans to meaningfully cut government spending and consequently no apparent opportunity to go back to a tighter monetarily policy. Trust us." Given that Americans' trust in institutions is at all time low, is it really surprising that this train of thought isn't getting much traction? On the other hand, even if a tight money policy is not promoting growth or employment, at least it is preserving the dollar as a store of value.

On a side note, it is worth noting that of the Republican Presidential candidates, Rep. Ron Paul is the most extreme hard-money candidate. The gold standard is not necessarily spoken of as a hard money policy but undoubtedly it is. This is a feature for many Paul supporters but I suspect this just flies over the heads of many others. Because nobody actually expects Paul to win the nomination, the isolationist/non-interventionist types don't have to trouble themselves too much about it. There's not anything particularly good or bad about this, except to point out that it's not just the media who believes Rep. Paul has no chance to win the nomination. In their heart of hearts, the Ronulans know it too.

Populism, Perry, Monetary Policy

There's been very little direct debate about monetary policy in American political culture, but the undercurrents of it are everywhere. Most prominently, Texas Gov. Rick Perry suggested that it would be treasonous for Federal Reserve Bank Chairman Ben Bernanke to start a new round of quantitative easing before the election.

Yet there's one interesting counterpoint that as far as I know has drawn no comment at all from the blogosphere. During the Bryan era at the beginning of the 20th century, the populist faction of American politics favored soft money. Now, they favor hard money. Politically speaking, this tends to be associated with the Tea Party faction of conservative Republicans, but it's important to note that in the country at large this plays out mostly as a populist vs. elite issue, as Tyler Cowen and others have pointed out.

Back to Perry again. He has been roundly criticized (fairly, I think) for the reckless and inflammatory nature of his accusations against Mr. Bernanke. But as I think about it, it's worse than that. As the saying goes, it's worse than a crime, it's a mistake. The verdict on the performance of the Fed under this crisis will end up in macro textbooks some generations from now. We don't have to withhold our judgment till then. However, we should also get clear on what we should expect Mr. Bernanke and the Fed to accomplish. The subtext of Perry's accusations is that the us honest Americans are doing what we're supposed to, but the Washington elites are screwing everything up. But in this particular case at least, it's a bad rap: government spending and regulatory mismanagement, under the leadership of both parties and supported by the voters, has overburdened the economy and has left the monetary authorities without any good options.

This is especially topical today in light of the news that Thomas Sargent (and Christopher Sims) have won the most recent Nobel Prize for economics. As Professor Cowen summarizes,
One of his most important (and depressing) papers is Sargent, Thomas J. and Neil Wallace (1981). “Some Unpleasant Monetarist Arithmetic“. Federal Reserve Bank of Minneapolis Quarterly Review 5 (3): 1–17. The main idea of this paper is that good monetary policy requires good fiscal policy. Otherwise the fight against inflation will not be credible. This is probably his most important paper.