What if the recession wasn’t real? What if the UK economy could return to its former growth path quickly and almost without any cost? And what if all that was needed to start this process was a short statement from Bank of England governor Mervyn King?
A growing number of economists believe just that. They are called ‘market monetarists’. And, led by Bentley University’s Scott Sumner (read his great blog, TheMoneyIllusion), their ideas are suddenly being endorsed by some of the biggest names in economics and banking.
What they imagine is a world without central bankers. A world where monetary policy is managed by machines. Where Keynesian stimulus spending and wrenching business cycles are a thing of the past.
It’s all got to do with something called NGDP.
Forget interest rates
Currently the Bank of England steers the economy by adjusting interest rates to hit a target inflation rate of 2% (as measured by the consumer price index). This worked well enough during the ‘great moderation’, a golden, self-congratulatory 25 year period for macroeconomists and central bankers when inflation (by mainstream measures at least) was low and recessions were mild.
But since 2008 their interest rate lever has stopped working. 0% rates have not been sufficient to spur spending and growth. So what’s the solution?
Market monetarists say that central banks should instead target a given rate of nominal gross domestic product (NGDP) growth instead of a given rate of inflation. NGDP is simply the sum of all spending in the economy in a year – it’s what you’d get if you didn’t bother to adjust GDP for inflation. A central bank might pick a target of, say, 5% NGDP growth, consisting of 2.5% desired inflation plus the 2.5% long-run trend growth in output. But how would it work in practice?
The economy depends on Mervyn King’s credibility
Well, say the market monetarists, imagine two possible states: an optimistic state where the people expect good times, prosperity and growth; and an otherwise identical but pessimistic state where the people are uncertain and fearful about their economic future. The citizens in the optimistic state will invest, borrow and spend freely which will lead to prosperity; uncertainty and fear in the pessimistic state will lead to self-fulfilling stagnation.
However, the poorer world could become the richer one, with a collective change of mindset. Here is where our market monetarist central bank comes in. Its role is as the great persuader. It creates those expectations of prosperity.
To change minds, the market monetarist central bank must be credible. Let’s say that the Bank of England is not perfectly credible, in that its board of governors is divided between policy hawks (those who want to tighten monetary policy) and doves (those who want to loosen it). People might reasonably doubt its commitment to reflating the economy. How would the Bank of England persuade the economy back to health?
First the Bank would need to set an explicit target for NGDP growth. It would have to promise to buy unlimited quantities of assets (using newly created money) to achieve this target. As it set about its task, month by month, trillion by trillion, people would come to accept its commitment to the policy and begin to spend in the expectation of future inflation. The expected numbers would drive the real numbers. Spending would rise and the real resources of the economy would be fully employed, which would achieve the Bank’s 5% NGDP growth target.
Hang on – what about hyperinflation?
Is market monetarism, then, nothing more than a justification for money printing? According to the theorists, it’s the promise that matters – not the asset purchases. Asset purchases are no more than a means to the end of justifying the promise. If people believe that the central bank will keep printing until it achieves its desired target (let’s say it’s 5% NGDP), then the promise will work. The central bank can then end its asset-buying when it hits the 5% target – or even reverse it if necessary.
What about quantitative easing (QE)? QE looks like a market monetarist policy, and it doesn’t look like a success. But Nick Rowe of Carleton University argues that Western central banks missed the point with current QE policies – they printed the money without making the promise. Nobody who looks at the Federal Reserve’s divided board, for example, expects it to print unlimited assets to reflate the US economy.
So expectations of inflation stay low, growth stays low, returns stay low, interest rates stay low and the bloated money supply sits on the banks’ balance sheets with nowhere to go. QE hasn’t worked because it has been piecemeal.
NGDP targeting implies that inflation can be a good thing – if it raises overall spending and incomes and thus, demand. In demand-deficient economies, more paper money can mean more real growth. Scott Sumner, a scholar of the Great Depression, points, for example, to the fact that much of the world inflated its way out of the trough in 1933 by leaving the gold standard and allowing prices to rise.
The chart below shows how this worked: the countries whose currencies weakened the most between 1929 and 1933 also saw the greatest gains in industrial production. For example, Finland and Denmark saw the value of their currencies just about half, while production rose by more than 20%. (The black line loosely shows the relationship between the exchange rate and industrial production).
Changes in exchange rates and industrial production, 1929-1935
What market monetarism does not say is that monetary policy can induce ever-higher levels of growth. Growth is always subject to supply-side constraints (ie your existing stock of factories and workers can only generate so much activity), after which point new money stimulates prices and not output.
Economist John Taylor worries about the specifics of the plan. He notes that it is unclear exactly what instruments NGDP targeting proponents would use to raise inflation expectations. And Amity Schlaes at Bloomberg wonders whether inflation would come to dominate the 5% growth in nominal output.
Enter Ben Bernankbot and RoboKing
And this is where we get to the ‘market’ part of market monetarism (MMT for short). Ultimately, the logic of MMT leads to a world without central bankers.
If a market for NGDP futures were established (ie enabling investors to bet on where they thought economic growth was heading), then the central bank could simply conduct whatever monetary policy directed the NGDP futures price towards the stated NGDP growth target.
In the end, the NGDP futures markets could replace central bankers. In this world, monetary policy could be managed by a computer, conducting whatever policy nudged NGDP futures markets onto the target. In fact, saying that monetary policy is managed by a robot isn’t quite accurate – really it’s being managed by the markets, which is what advocates of scrapping central banks altogether often say is what should be happening.
It’s an appealing vision. The western world is stuck for solutions, and desperate. Sumner offers an easy answer, and in practice we suspect it’d be a lot harder to implement. But if you must have a central bank, then increasing the market’s role in setting rates, and shrinking the influence of politics, and fallible human central bankers, on the process, can only be a good thing.