Working Papers

In Defence of Fractional Reserve Banking

George Selgin defends fractional reserve banking against the fever swamp Austrians:

Free bankers have tried responding to this argument by noting how fractional reserve banking has prevailed under every sort of bank regulatory regime, from the earliest beginnings of banking, not excepting regimes that involved very little regulation, like those of Scotland, Canada, and Sweden, and that lacked even a trace of government guarantees or other sorts of artificial support.  But since some 100-percenters seem unmoved by this approach, I here take a different tack, which consists of pointing out that every significant 100-percent bank known to history was a government-sponsored enterprise, which depended for its existence on some combination of direct government subsidies, compulsory patronage, or laws suppressing rival (fractional reserve) institutions. Yet despite the special support they enjoyed, and their solemn commitments to refrain from lending coin deposited with them, they all eventually came a cropper. What’s more, it was these government-sponsored full-reserve banks, rather than their private-market fractional reserve counterparts, that were the progenitors of later central banks, starting with the Bank of England.

posted on 01 June 2011 by skirchner in Economics, Monetary Policy

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What Would Friedman Do IV?

Yes, Friedman would do QE. A new paper from Ed Nelson:

This paper views the policy response to the recent financial crisis from the perspective of Milton Friedman’s monetary economics. Five major aspects of the policy response are: 1) discount window lending has been provided broadly to the financial system, at rates low relative to the market rates prevailing pre-crisis; 2) the Federal Reserve’s holdings of government securities have been adjusted with the aim of putting downward pressure on the path of several important interest rates relative to the path of short-term rates; 3) deposit insurance has been extended, helping to insulate the money stock from credit market disruption; 4) the commercial banking system has received assistance via a recapitalization program, while existing equity holders have borne losses; and 5) an interest-on-reserves system has been introduced. These five elements of the policy response are in keeping with those that would arise from Friedman’s framework, while a number of the five depart appreciably from other prominent benchmarks (such as the Bagehot-Thornton prescription for discount rate policy, and New Keynesian approaches to stabilization policy). One notable part of the policy response, the TALF initiative, draws largely on frameworks other than Friedman’s. But, in important respects, the overall monetary and financial policy response to the crisis can be viewed as Friedman’s monetary economics in practice.

posted on 30 May 2011 by skirchner in Economics, Monetary Policy

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Fed Glasnost: Australia’s Media Shouldn’t Settle for Less

If it’s good enough for Ben Bernanke, it’s good enough for Glenn Stevens:

Next Wednesday, Federal Reserve Chairman Ben Bernanke will do something no Fed chief has done before: Stand before a room full of journalists after officials conclude a policy meeting and answer questions about the central bank’s decisions…

Fed officials have been preparing carefully, according to people familiar with the process. Mr. Bernanke spent a recent weekend watching videos of European Central Bank President Jean-Claude Trichet and Bank of England chief Mervyn King, parrying reporters’ questions at their regular press conferences.

In February, on the sidelines of a meeting of financial officials in Paris, Mr. Bernanke quizzed Mr. Trichet and other European central bankers on how they manage their press conferences. He’ll do dress rehearsals, with staffers peppering him with questions, as the briefing nears.

Mr. Bernanke’s staff, meanwhile, has spent weeks scripting the mechanics of how the press conference will work.

He will hold his briefing in a big top-floor conference room at the Fed’s Martin building, opposite the central bank’s main cafeteria, where Mr. Bernanke can sometimes be found wandering, tray in hand, to chat with staffers…

In the past month alone, 16 different Fed policy makers have given more than 40 formal addresses, in addition to television, newspaper and newswire interviews. They espouse different views, not only on when to reverse the Fed’s easy-money policies, but how.

As I noted in this op-ed, post-Board meeting and post-CPI press conferences by the RBA Governor would change for the better the media dynamics around inflation and interest rates in Australia.

posted on 21 April 2011 by skirchner in Economics, Monetary Policy

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What Caused the Housing Boom of the 2000s?

Not monetary policy.

posted on 14 April 2011 by skirchner in Economics, House Prices, Monetary Policy

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John Edwards Tipped for the RBA Board

John Edwards has been tipped as an appointment to the RBA Board. John’s Lowy Institute monograph Quiet Boom gives a good insight into the thinking he would bring to monetary policy decision-making. He is critical of the conduct of monetary policy in the late 1980s and early 1990s and directly challenges former RBA Governor Ian Macfarlane’s attempts to re-write the history of this episode. I review Edwards’ and Macfarlane’s interpretations of this episode in this essay.

As I have suggested previously, if the government is not going to re-appoint McKibbin, it could at least give thought to appointing an overseas economist to the Board. Here is an interview with Adam Posen, a US economist appointed to the Bank of England’s Monetary Policy Committee. He takes his job very seriously:

“If I have made the wrong call, not only will I switch my vote, I would not pursue a second term. They should have somebody who gets it right and not me. I am accountable for my performance.”

Meanwhile, Peter Diamond’s nomination to the Fed is being held up by Senate Republicans, revenge for the Democrats blocking Bush nominee Randall Kroszner. As Hassett notes:

This is what we have come to: In the minds of our politicians, partisan manoeuvring and score-settling far outweigh the desire to populate government with skilled individuals.

posted on 29 March 2011 by skirchner in Economics, Monetary Policy

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RBA Drags the Chain on Transparency

Fed Chair Bernanke joins overseas counterparts in holding post-FOMC meeting press conferences:

Chairman Ben S. Bernanke will hold press briefings four times per year to present the Federal Open Market Committee’s current economic projections and to provide additional context for the FOMC’s policy decisions.

In 2011, the Chairman’s press briefings will be held at 2:15 p.m. following FOMC decisions scheduled on April 27, June 22 and November 2. The briefings will be broadcast live on the Federal Reserve’s website. For these meetings, the FOMC statement is expected to be released at around 12:30 p.m., one hour and forty-five minutes earlier than for other FOMC meetings.

The introduction of regular press briefings is intended to further enhance the clarity and timeliness of the Federal Reserve’s monetary policy communication. The Federal Reserve will continue to review its communications practices in the interest of ensuring accountability and increasing public understanding.

In this op-ed, I made the case for the RBA Governor to hold a press conference following each Board meeting and CPI release. Apart from the gains to monetary policy transparency, this would serve to reduce politicians’ media space in public debates over interest rates and inflation.

posted on 25 March 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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Fed Bloggers

The Federal Reserve Bank of New York has launched a new blog, Liberty Street Economics, following in the footsteps of the Atlanta Fed’s Macroblog. From their introductory post:

We have created this blog to augment our existing publications by providing a way for our economists to engage with the public about economic issues quickly and frequently. Further, the less technical style that we are striving for in the blog posts should make the insights from our research informative to a broader audience…

There are some topics that you will not find in the Liberty Street Economicsblog. We will not be blogging on the next policy move of the Federal Open Market Committee (FOMC) or other issues that only the FOMC or other policymakers could know. And the blog posts will not necessarily reflect the official opinion of the Federal Reserve Bank of New York or the Federal Reserve System.

I wouldn’t hold your breath waiting for the RBA to start blogging.

posted on 22 March 2011 by skirchner in Economics, Monetary Policy

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Bernanke is Not a ‘Money Printer’

Frederic Mishkin is in Australia and will be presenting at the Reserve Bank on Thursday. He was interviewed by Alan Kohler for Inside Business:

ALAN KOHLER: So therefore do you join those who call Ben Bernanke a money printer?

PROFESSOR RICK MISHKIN: No, so… I don’t at all. The purpose here is not to print money and to just not worry about future inflationary consequences.

There is, however, an issue that when you have a balance sheet which is this large - and particularly in long-term assets and even more so in housing assets - the Fed is now involved in the most politicised of all financial markets in the US. The Federal Reserve and also the government has been involved in very large transactions to help the economy and bail outs.

The government’s not going to lose a penny on everything but one - the Fannie and Freddie, a couple [sic] of hundred billion dollars. So again, this is an indication of how crazy some of our policies have been.

Economists didn’t get - we missed a lot of things in this crisis, we got a lot of things wrong. Much to trusting for example of the quality of prudential supervision, which by the way in your country was done much, much better than in many other places, so you know, I don’t know whether you’re just lucky or good but…


posted on 14 March 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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John Taylor versus Bernanke and Greenspan

John Taylor has accused Ben Bernanke of mis-representing him in testimony before Congress over Taylor’s preferred version of his eponymous rule. This is a rather bizarre dispute, because naming rights aside, there can never be a definitive formulation of the Taylor rule. The Taylor rule depends on assumptions about unobservable variables such as the equilibrium real interest rate and potential output. There are dozens of methodologies for recovering these latent variables, all of which have strengths and weakness, but none of which yield definitive answers, especially not in the real time setting in which monetary policy is actually made. Alan Greenspan was always very careful to highlight the implications of uncertainty in relation to these variables, whereas Taylor seems untroubled by this issue in his recent commentary on Fed policy.

The Taylor rule can also be given a backward or forward-looking specification. Monetary policy is supposed to be forward-looking, so forecasts for inflation and the output gap are more relevant to judging the appropriateness of policy than contemporaneous or lagged values. Again, these forecasts are necessarily subject to considerable uncertainty. Insert the Federal Reserve Board’s staff forecast for inflation and the output gap circa 2003 into a reasonably parameterised Taylor rule and you will get different implied policy settings than if you use historical data, not least because the historical values will have been influenced by the stance of policy, which in turn was influenced by the forecast.

Taylor’s 1993 rule was an outstanding contribution and most economists have embraced it, but they have also significantly improved upon it. John Taylor’s 1993 specification may be his own, but it is far from definitive and may not be the optimal or efficient rule. Taylor should concede this much at least.

posted on 03 March 2011 by skirchner in Economics, Monetary Policy

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The Irrelevance of Fed Policy to House Prices

In my CIS Policy Monograph Bubble Poppers, I was dismissive of the notion that Fed policy had anything to do with the US house price boom and bust of last decade. The Reinharts take this Fed irrelevance proposition much further in a new NBER Working Paper:

We take a close look at the responses of asset markets to changes in the short-term policy interest rate since the founding of the Fed in 1914. Changes in the federal funds rate have no systematic effect on either long-term interest rates or housing prices over nearly a century. Indeed, since the mid-1990s the policy rate had a negative relationship with long-term interest rates. This is consistent with a global view of capital markets where massive cross-border flows shape the availability of domestic credit and asset prices. The evidence casts doubts on arguments that a moderately different monetary policy path might have mattered.

I tried telling the same story to John Taylor once, without much success. Maybe the Reinharts will be more convincing.

posted on 02 March 2011 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy

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The Central Bank of Eve Online

An inflation hawk tackles virtual commodity price inflation. The virtual world would seem to be a good place to test the macroeconomic implications of alternative monetary regimes.

posted on 11 February 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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Mises Supported Fractional Reserve Banking

The bits of Mises Huerta de Soto forgot.

posted on 03 February 2011 by skirchner in Austrian School, Classical Liberalism, Economics, Monetary Policy

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Posen on Monetary Policy Activism and Asset Price Cycles

We have previously linked to Adam Posen’s work critical of suggestions that central banks should adopt an activist approach to managing asset price cycles. Here’s Posen’s talk at last year’s Cato Institute Monetary Policy Conference.

posted on 20 January 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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Five More Years

Peter Martin rounds-up opinion in favour of re-appointing Warwick McKibbin to another five-year term on the Reserve Bank Board, including some supportive comment from me.

As Chris Joye notes, there is no reason why Ross Garnaut could not be appointed to one of the other looming vacancies on the Board, allowing both Warwick and Ross to serve concurrently. That would certainly liven-up Board meetings and move the Board closer to an MPC-style model of decision-making. The government should eventually move to separate monetary policy decision-making from the Board, as I argue in this article.

In the UK, the government was brave enough to appoint an American, Adam Posen, to the BoE’s MPC. The logistics of having a foreigner other than a kiwi attending monthly RBA Board meetings would be difficult, and the local media reaction would be nothing short of hysterical, but there is no reason why foreign talent should not be considered. A foreigner would actually be significantly less conflicted as a monetary policy decision-maker than many of the existing external Board members.

While my first foreign pick would be Don Brash, my guess is he would be unwilling to serve under the existing RBA governance model. All the more reason to change it.

posted on 17 January 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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The Quant Easing Counter-Factual

Not pretty:

model simulations indicate that the past and projected expansion of the Federal Reserve’s securities holdings since late 2008 will lower the unemployment rate, relative to what it would have been absent the purchases, by 1½ percentage points by 2012.  In addition, we find that the asset purchases have probably prevented the U.S. economy from falling into deflation.

posted on 12 January 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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