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Source link: http://archive.mises.org/14832/stable-prices-or-sound-money/

Stable Prices or Sound Money

December 1, 2010 by

John B. Taylor (Stanford University) and Representative Ryan provided some interesting commentary dated November 30 at the Investors.com a site powered by Investor’s Business Daily on QEII (quantitative easing 2) and the role of the Fed, “Refocus the Fed on Price stability Instead of Bailing Out Fiscal Policy”. The commentary is most likely based on Taylor’s longer paper, “Swings in the Rules-Discretion Balance,” prepared for 40th anniversary of Phelps micro foundations volume, November 20, 2010, Columbia University.

Taylor and Ryan argue that the Fed, post 2000, began veering from a successful rules based approach to monetary policy that was responsible for the long period, 1981-2002, known as the “Great Moderation” where improved monetary policy contributed to improved economic performance and a more stable economy.
Austrians should find much to agree with in their underlying analysis of current Fed policy.

“Quantitative easing [both I and II] is part of a recent Fed trend toward discretionary … monetary actions.”
“The Fed’s decision to hold interest rates too low for too long from 2002 to 2004 exacerbated the formation of the housing bubble.”

“while the Fed did help to arrest the ensuing panic in the fall of 2008, its subsequent interventions have done more long-run harm than good [some Austrians agree with the former, most support the latter].”

“QE1 failed to strengthen the economy, which has remained in a high-unemployment, low-growth slump, and there is no convincing evidence that QE2 will help either. On the contrary, QE2 will create more economic uncertainty, stemming mainly from reasonable doubts over whether the FED will know exactly when and how to contract its balance sheet after such an unprecedented expansion.”

Taylor and Ryan go on to argue for eliminating the “dual mandate” of the Fed, eliminating the high employment goal and focusing on a goal of long-term price stability within a framework of economic stability, including clear reporting and accountability requirements. Within this framework the Fed would still retain some flexibility during a crisis to provide liquidity and serve as lender of last resort. Per Taylor and Ryan, such a change in focus would “lay the monetary foundation for strong and sustained economic growth and job creation.” Such a recommendation is perhaps not too far from Hayek’s position in the 1970s where he argued (Unemployment and Monetary Policy, Cato, 1979, p. 17 and 18),

“Though monetary policy must prevent wide fluctuations in the quantity of money or the volume of the income stream, the effect of employment must not be a dominating consideration. The primary aim must again become the stability of the value of money [emphasis original]. But (p. 18), “to avoid severe liquidity crises or panics, the monetary authority must be given some discretion.”

While such reforms may be a short run improvement over policy which from mid 1990s forward generated not 1 but 2 significant boom-busts periods, it most likely is not optimal. In a very interesting working paper, “Has the Fed Been a Failure?” (Cato see: http://www.cato.org/pub_display.php?pub_id=12550), Selgin, Lastrapes, and White point reform in another direction. Contra Taylor, the Great Moderation was perhaps not as great as Taylor implies. The improvement was temporary and ‘appears to be due to factors other than improved monetary policy.” Their conclusion, ‘the real hope for a better monetary system lies in regime change.” Austrians should have a strong comparative advantage in discussion of what the foundations of this regime change should look like. Reform should go much further with a goal of sound money, not a goal of stable prices. A good starting point would be Salerno’s recently released volume, Money, Sound and Unsound.


George Selgin December 1, 2010 at 4:20 pm

Although I appreciate the plug to my, Larry’s, and Bill’s paper, I should note that we refer in it’s title to the “Fed,” not the “FED.” As I’ve said elsewhere, the word is an abbreviation, not an acronym standing for “F******g Economic Disaster” or something like that.

Bogart December 1, 2010 at 5:30 pm

We can call the grade D documentary out of the discussion above (It would be for PBS as I doubt anyone would willingly pay to see it): “The Monetarists Revenge” or how about “The Next Depression Caused by Monetary Policy Too” or “Hindsight, Its really 20-20″.

When will the economic and the political folks, outside the more humble Austrian types, learn that the central planning of any economic system or part of any economic system simply does not work and will always end with the people involved in that system being worse off?

If any of these models really worked so well as to be used in the formation of policy then they would work so well that the writers could 1. Use them to make millions predicting industry trends, and then copyright them and make tens millions on the lecture circuit by teaching people how to invest. Instead they actually stick it to us by using the results of these models to make real policy decisions. These decisions end in busts that hurt the lowest people on the economic latter the worst and end making us poorer. Then these same folks proceed to make tens of millions on the lecture circuit talking about how great it is to live the political high life starting as an associate professor.

Craig December 1, 2010 at 6:56 pm

When will the economic and the political folks . . . learn that the central planning of any economic system or part of any economic system simply does not work and will always end with the people involved in that system being worse off?

I suppose that will only happen when the political and economic folks (in that order) experience personally the consequences of said planning.

We probably shouldn’t hold our aggregate breath.

J. Murray December 2, 2010 at 6:30 am

I never have gotten a solid answer out of Keynesians and Moneterists as to what “stable pricing” is supposed to actually mean. Does that mean each and every product and service on the market should remain static on how many Dollars trade for it? Does it mean that the computer hardware industry is failing because pricing declines year after year?

Gene Berman December 2, 2010 at 10:50 am

Bogart (and Craig):

Exactly right. The Fed is best viewed as (though entirely “legal”) an “intruder” in the market, which is, in the main, made up of participants each seeking to buy (what they want or need) and to sell (what they’ve produced or bought previously). Like the market participant intent on fraudulently parting some from their money by various methods such as “pump and dump,” the Fed seeks to change the “shape of the market” from whatever it happens to be at a particular moment to another that it thinks it would prefer–from whatever viewpoint it happens to hold at the time.

“The market” is, at any given time, the composite “picture” of economic activity; every instance of economic activity influences the market to some extent but, though changing constantly, the “picture” at any given time suggests to each participant what his action(s) should be. The activity of the Fed (and other central banks around the world) rearranges the picture, suggesting other actions than would have been considered maximizing in the absence of such intrusion). It might well be said that the very existence of these entities and their ability to interfere (blurring the picture) with the
market “picture” is, in itself, one of the chiefest imperfections of the market itself.

The existence of “the market” is what enables people–everywhere–to make the best-informed decisions as to their immediate (and future-oriented) actions and rewards those who interpret the data (no matter how limited in scope) correctly and penalizes (makes poorer) those who do not. The
Fed (and the others mentioned) has as its principal object the thwarting of the market’s proper function.

The market grows (both larger and more-closely-integrated) the greater the degree of economic cooperation (specialization of tasks and activities by those men and pieces of land best suited) attained. But the very fact of such high degree of coordination neccesarily implies even greater vulnerability to disruption than heretofore. The very greatest economic (and, therefore, human)
catastrophes are yet in the future. Like those of the past century or so, they will be caused by inappropriate, market-thwarting activities, especially of central bank (especially the Fed) policy.

The only solution–preventative–to such future catastrophe (with death toll dwarfing those of wars!)
is: SOUND MONEY, the absence (and prevention) of which is the reason for the existence of the Fed.

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