David Beckworth recently linked to a speech given by Milton Friedman at the Bank of Canada. As David highlights, there is a follow-up question where Friedman promotes QE in Japan. However, there is also a particularly insightful comment on Ireland and the Euro. Here is the question and the response:
Michael Bordo: Do you think the recent introduction of the Euro will lead to the formation of other common-currency areas?
Milton Friedman: That’s an interesting question…
I think the Euro is in its honeymoon phase. I hope it succeeds, but I have low expectations for it. I think that differences are going to accumulate among the various countries and that non-synchronous shocks are going to affect them. Right now, Ireland is a very different state; it needs a very different monetary policy from that of Spain or Italy.
On purely theoretical grounds, its hard to believe that it’s going to be a stable system for a long time.
This is precisely the point that I have been making with respect to Ireland. The rapid growth in Ireland should be associated with a higher natural rate of interest. Meanwhile, the European Central Bank’s commitment to inflation is likely to have different consequences in Ireland than Germany. It is likely that ECB policy was too loose — at least in Ireland — for the better part of the decade before the recession began. That is what I was implicitly referencing in this post on Ireland’s money growth.
“Fish don’t feel the water they swim in. (I’ve heard that’s false, but it’s too good to check). Paul Krugman does not feel the Monetarist hegemony he swims in.” That is Nick Rowe in a good post on
fish the role of Monetarism in the New Keynesian model. While I have some quarrels with the monetary transmission mechanism in the NK model, Nick is largely correct in that the core model contains key Monetarist insights.
In the past, I have alluded to the fact that Ireland might fit the monetary disequilibrium story. Thus far, I haven’t been able to track down data beyond 2003, but take a look at Ireland’s money growth from 2003 – 2010:
This clearly isn’t enough evidence to suggest that a monetary disequilibrium approach is relevant to the discussion of Ireland, but these growth rates are particularly telling — and more so if one adds M3 growth, which peaked at 36% during this period.
John McManus has a good piece in the Irish Times. Here is an excerpt:
WHEN THE history of Ireland’s banking and fiscal collapse comes to be written, the role of the European Central Bank may well turn out to be the most controversial.
The question will be whether they really were some sort of honest broker who in the end forced us to confront our predicament or were they in fact the villain of the piece?
Both narratives have some resonance but the former is very much in the ascendant. The weary relief that characterises most people’s response to the arrival of the ECB, the European Commission and the International Monetary to negotiate a loan for Ireland is consistent with the view that time has finally been called by impartial outsiders on our botched effort to sort out the mess we have made of the Irish banks and our finances.
The main elements of the story are that the banks’ problems are so deep that they exceed the fiscal capacity of the State. We cannot borrow enough money from the bond markets to sort them out and also fund the exchequer deficit, so we have no choice but to turn to the European Financial Stability Facility and the IMF.
While the later point is unfortunately true, the role of the ECB in how we came to this sorry pass is worthy of some scrutiny. A more critical analysis might conclude that its policies over the last two years added greatly to our problems and ultimately its own. And it is the ECB’s problems as much as ours that brought things to a head last week.
Read the whole thing.
John McHale on Ireland’s fiscal woes:
The government has pushed the line in recent days that the flair up in the crisis is all about the banks. There is little doubt that the trigger was ECB concern about their large and rising exposure to the Irish banking system. But the idea that the banks are the problem and the state is fine – happily pre-funded as it is through the middle of next year – is nonsense. As it stands, the Irish state is not creditworthy. All else equal, it will become even less creditworthy as it burns through its valuable cash buffer. The vanishing credibility of the ELG guarantee along with the creditworthiness of the state is the major cause of the banks’ increasing reliance on the ECB. The intensified banking crisis is a (very significant) symptom of a deeper problem.
Stephen Williamson writes:
The Fed is trustworthy, in some sense, but I don’t think they will be able to withstand the pressure to do the wrong thing when the time comes to do the right thing.
Is this an argument against QE or an argument against the Fed? I think it is the latter and I think this is the source of disagreement among conservatives that Ramesh Ponnuru has been highlighting. (By the way, I have no idea whether Williamson should be considered a conservative — likely not. I am not even sure I should be considered a conservative — although I have been classified as such. However, we are both market-oriented guys, so let’s not quarrel about labels.)
The source of right-wing opposition to quantitative easing seems to have more to do with skepticism of the Fed than the potential effectiveness of policy. I am plenty skeptical of the Fed. David Beckworth and I are currently working on a project to examine nominal spending crashes in the last century. We find significant evidence that these are caused by monetary factors and suggest that had the Fed acted to stabilize the monetary base, these crashes could potentially have been avoided. In addition, I think that the Fed played a major role in creating the housing boom.
Nonetheless, I do not let my skepticism of the Fed dissuade me from what the right policy is in the current situation. If we need further monetary easing to stabilize nominal income, then that is the policy the Fed should undertake. In fact, my skepticism of the Fed is part of the reason that I advocate an explicit nominal income target that coincides with QE. That pre-commitment helps shape expectations and requires the Fed to follow through on its promise.
If one’s skepticism of the Fed trumps the proposed policy, isn’t this just an argument against the Fed? If one recognizes that further monetary easing is necessary and yet continues to argue against QE because they don’t trust the Fed, then it is time for a debate about whether or not the Fed should exist and, if so, in what capacity.
I am probably one of the only people on the planet who has an open mind toward competition in currency and other alternative monetary institutions while simultaneously advocating QE. I will not, however, let my skepticism of the Fed prevent me from advocating what I believe is the correct policy.
Charles Evans responded in an interview with the WSJ to criticisms levied at the Fed and quantitative easing:
–On the weaker dollar and backlash from foreign officials about U.S. monetary policy: Mr. Evans acknowledges that the dollar is affected by the Fed’s easy money policy. But he said that if the Fed is successful at spurring economic growth, that could in turn push the dollar higher. He adds that while he is paying attention to global developments and criticisms from abroad, his primary concern is the U.S. economy. “I’m focusing on the domestic economy. Other central banks have to focus on their economies.”
–On why the Fed needs to stick to its 2% inflation objective, even if that means raising inflation a little when it’s low: Bonds and loans taken out by borrowers for many years have been taken out with the expectation of about 2% inflation. If inflation is allowed to get much lower than that, as he says it is now, it will effectively raise the cost of borrowing for these individuals and firms. “An entire spectrum of debt” is premised on this level of inflation, he says. “It is our job,” he said, to provide the level of inflation the Fed has committed to in the past, not less.
–On the recent pickup in commodities prices: Mr. Evans sees the rise as something that economists call a “relative price change,” a case in which prices for one set of goods or services are rising but not others. Commodities prices are rising globally because of demand from emerging markets, he says, but the U.S. faces downward inflation pressure in other areas because the domestic economy is so weak. “U.S. monetary policy is not leading to anything unusual in commodity prices, but world-wide global demand is having a big effect on that,” he says.
Welcome to those of you visiting the site via Ramesh Ponnuru’s post on The Corner.
Here are some posts on monetary theory and policy that might be of interest:
– The Monetary Base: Context Matters
– The Monetary Base: Part II
– On the Paradox of Thrift and Liquidity Traps
– Thinking About Monetary Policy
– Can Money Be Tight if the Fed Does Nothing?
– Inflation is a Monetary Phenomenon, But This Isn’t Inflation
– Measurement Before Theory, (Parts 2 and 3)
And one on whether the stimulus package would be successful (written in February 2009):
– The Stimulus Will Fail
Frequent readers know that I am fascinated with the story that is Ireland — both the past two decades of robust growth and their current predicament. (See here and here.) In that regard, the Irish Examiner has an excellent overview of the current situation in Ireland coupled with dueling commentaries on whether Ireland can solve the problem on their own.