AIER: The Fiscal Fed

Economists often make a distinction between fiscal policy and monetary policy. Fiscal policy involves the use of taxing, spending, and borrowing power. It allocates resources across specific industries and economic actors. Fiscal policy has traditionally been the responsibility of Congress and the Treasury.

Monetary policy involves adjusting the money supply, setting administered interest rates, or exhibiting influence on money demand or non-administered interest rates. It intends to provide monetary stability for the economy and liquidity to financial markets. Monetary policy has traditionally been the responsibility of the Federal Reserve.

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AIER: A Keynesian Path Would Be the Wrong Path for the U.S. Economy

To get through the current crisis, Jared Bernstein argues, we must look to Keynes. It is an old argument, reapplied to our current context. The old argument is straightforward: the free market cannot fix itself. It follows, then, that we should not expect the economy to automatically recover once the pandemic outbreak is over. A more effective approach, Bernstein and others following in the tradition of Keynes maintain, would see the market managed by the savvy hand of the state.

Yet, how precisely the state should manage the economy is unclear. And the idea that capitalism is “not to be overthrown but to be ‘wisely managed’” is a dangerous one.

As Friedrich A. Hayek explained in a famous 1945 essay on The Use of Knowledge in Society, governments are unable to acquire the requisite knowledge to allocate resources effectively. The knowledge required is decentralized–of a particular time and place. Indeed, it is often tacit, meaning it cannot even be articulated by those possessing it. 

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SMP: In Argentina, Inflation Is Still a Monetary Phenomenon

Peronism is returning in Argentina. On December 10, Alberto Fernández assumed the presidency of Argentina. The office of vice president is now held by none other than Cristina Fernández de Kirchner, who served as president for two consecutive terms between 2007 and 2015. It was under her tenure that Argentina entered a period of stagflation (stagnation with inflation). 

After four years with Mauricio Macri at the helm and a failed implementation of inflation targeting, Argentina’s inflation rate is once again reaching its highest level since the hyperinflation of the late 1980s. If one takes Fernandez’s pronouncements seriously, the prospects of seeing disinflation in the short and medium terms are slim.

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SMP: The IMF and Argentina: Same Dance, Same Results

Argentina is in trouble again. Even after a substantial aid package from the International Monetary Fund (IMF), it is struggling to service its sovereign debt. One should not be surprised: when you keep employing the same policies, you are likely to end up with similar outcomes. This, however, is not the lesson Harvard economist Ken Rogoff draws from Argentina’s experience. Instead, he calls for even more aid flows to Argentina.

Rogoff is right to criticize President Macri’s decision to cut the fiscal deficit gradually, rather than attacking the issue more forcefully early on. That strategy ultimately required Macri to seek help from the IMF. But he is wrong to characterize the Macri tax cuts and liberalization efforts as “Big Bang reforms.” The tax cut was marginal at best. And, while capital controls were lifted under Macri, more comprehensive measures of economic freedom show no significant improvements. 

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AIER: What Should MMT Learn from Argentina?

The last few weeks have seen a spike in commentaries surrounding modern monetary theory (MMT). A column by Prof. Stephanie Kelton, Andres Bernal, and Greg Carlock at Huffington Post and an endorsement from Representative Alexandria Ocasio-Cortez (D-N.Y.) have triggered negative responses by a number of reputable economists. George Selgin, Larry Summers, Paul Krugman, and Ken Rogoff (just to name a few) have all expressed concerns (to put it mildly) about the implications of applying MMT.

A common thread in these (and other) responses is that it is not clear what MMT really stands for. Advocates of MMT seem to use conventional terms in unconventional ways, and that creates confusion. On top of this, what exactly MMT means changes as time goes by, thereby adding frustration to confusion.

At its core, MMT maintains that a government cannot go broke as long as it can issue its own currency. Large fiscal deficits can be paid for by “printing money” (or, more technically, monetizing deficits). Standard monetary theory maintains that such a policy causes inflation. MMT, in contrast, holds that such a policy is not inflationary, because there are idle resources.

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AIER: That Magical Two Percent

Paul Volcker takes issue with the Federal Reserve’s two-percent inflation target. He wonders why Fed officials have become so focused at a level of decimal precision on a target that cannot be hit so precisely. It is an old point, but one worth making.

The issue with inflation targeting is not merely one of precision, however. Just as important is how such a target is interpreted for policy making. Is it a symmetric target, in which case the Fed will try its best to achieve two-percent inflation each period? Is it contingent on past performance, in which case the Fed might try to make up for over- or under-shooting its target and thereby achieve two-percent inflation on average? Or, is it not really a target at all, but rather a ceiling—an upper bound on the rate of inflation that the Fed deems acceptable?

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SMP Essay Contest

The Sound Money Project Essay Contest is designed to promote scholarship in monetary and macro- economics. More specifically, it aims to encourage those working at the cutting edge of the discipline to consider the monetary institutions that would reduce nominal disturbances and promote economic growth.

Prompt:
In 1971, President Richard Nixon ended convertibility, thereby eliminating the last vestiges of the gold standard. The classical gold standard, which prevailed from 1873 to 1914, had anchored inflation expectations, enabled longterm contracting, and promoted international trade. This historical experience has prompted several reconsiderations of resumption over the years, including the Gold Commission in 1980, the International Financial Institution Advisory Commission of 1998, and, more recently, calls for a Centennial Monetary Commission. What are the merits of returning to the gold standard? Is such a system feasible today?

Prizes:
First Prize $10,000
Second Prize $2,000
Third Prize $1,000

Winners will also be invited to participate in the Sound Money Project annual meeting in Great Barrington, Massachusetts.

Eligibility:
The contest is open to graduate students, post-graduates, untenured professors, and tenured professors from any discipline. Former winners and current AIER fellows are ineligible. Former entrants are eligible, but must submit new essays.

Rules:
Essays must be the sole and original work of the entrant and not previously published. They should be in the format of a scholarly article. Any standard citation format (e.g., MLA, APA, Chicago, Harvard, etc.) is acceptable. Essays may either be written specifically for the contest or arise from previous work (e.g., term papers, dissertations, research projects, etc.). Essays shorter than 4,000 words or longer than 12,000 words will not be considered. AIER-affiliated scholars are ineligible.

Submission Instructions:
Please submit your paper here.

Deadline: March 1, 2019

Go to the SMP Essay Contest websiste.

SMP: The Problem with Stable Coins

To illustrate the problem, Eichengreen offers three scenarios. In the first scenario, a cryptocurrency issuer maintains 100 percent dollar backing for coins in circulation. This is similar to how a currency board works. Since such an arrangement requires the issuer attract and hold dollars in order to expand the supply of coins, the cryptocurrency will not be subject to a speculative attack. However, this also means the issuer cannot invest those dollars since it must hold all of them to back the cryptocurrency.

Price volatility is a big problem in the crypto world. Widespread adoption is unlikely without a good monetary rule that reduces volatility. But, as Barry Eichengreen notes in a recent Project Syndicate article, stable coins like Tether, Sagacoin, and Basis have their own issues.

Unable to earn interest on the float, a cryptocurrency issuer would find it challenging to profit while holding 100 percent dollar reserves. It would also struggle to offer a competitive return and, hence, attract customers. Why would one exchange a widely used dollar for an illiquid cryptocurrency, which is harder to use and does not offer a competitive interest rate?

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AIER:Elastic Cryptocurrency Supplies: A Step in the Right Direction

A major shortcoming of bitcoin and most other cryptocurrencies is the way in which their supplies are governed. With a perfectly inelastic supply over the relevant time horizon, a change in demand is entirely reflected by a change in the cryptocurrency’s price. Since demand shocks are relatively common, this means that cryptocurrencies are subject to high price volatility.

Volatility can be a desirable feature for a financial investment that tries to capture capital gains. But it is a major impediment to cryptocurrencies becoming more widely accepted as a medium of exchange. Hence, the observation that bitcoin and other cryptocurrencies have become financial assets does not mean they are necessarily on the path to becoming new monies.

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SMP: Gunther Schnabl on Exit Strategies from Unconventional Monetary Policy

In a recent paper, Gunther Schnabl discusses the environment that ultra-low interest rates have produced and the challenges of exiting such an environment. Schnabl brings up a number of interesting issues, including how low interest rate policies keep zombie banks alive and distort labor markets. The policies come at the expense of investment in capital goods and research and development, which fuels growth in rich countries.

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