Monday, June 17, 2013

Charles Plosser’s Monetary Offenses

Charles Plosser is a distinguished economist who heads the Philly Fed. He has all the credentials one could desire. Whatever a man like Plosser says should be heard and considered, and should not be dismissed out of hand. Plosser is a hard money man, a hawk. Readers may recall my view that all the world’s problems have been caused by hard money, so you will appreciate that Mr. Plosser and I stand on opposite sides of the monetary policy divide. But it would be stupid to dismiss his views as misguided per se, because he is not some autodidact from the Ozarks. He is a serious economist.

Now, here is what Plosser recently said in an interview on Bloomberg TV:
“When governments don't work, people are out of work, economies aren't growing, easy money turns out to be the easy thing to do. It's the one thing that governments can do because they can't simply do what they're expected to do. And it's dangerous. In a funny sort of way, and you're not going to like this, central banks around the world have become something of enablers of dysfunctional democratic systems. And the day of reckoning will come and all of you have got to think about it. And that's the great unwinding. It will happen here, it will happen around the world…It's easier to print money than it is to raise taxes or cut spending. And when that happens, we know that that usually ends in a not very pretty place. And I think that it's very dangerous for us to think that monetary policy is a solution."

That is the voice of hard money fundamentalism. The voice of Andrew Mellon, Paul Volcker, Jens Weidmann and Mario Draghi. There is not the slightest genuflection to monetarism: “it's very dangerous for us to think that monetary policy is a solution."

But what exactly is Plosser saying? I would translate his remarks as follows:
“The goal of economic policy should be to maximize the ability of markets to function. Rigidities and frictions must be demolished. Governments should balance their budgets and then get out of the way. The best way to allow markets to work is to stop manipulating them, and provide price stability and nothing more. The magic of the marketplace will take over from there and create prosperity without inflation or deflation.”
How could anyone who is not a socialist not agree with that? Isn’t it almost axiomatic if one is a follower of Adam Smith or Milton Friedman? Yes, it’s almost axiomatic but it’s not axiomatic. There is still room in the capitalist house for monetarism.

The antimonetarist argues that money is just a yardstick, and thus doesn’t matter. Markets can function under any monetary environment. The same incentives create the same responses. Money is an illusion, irrelevant. The classic monetarist riposte to this argument is: “If money doesn’t matter, then all the world’s commerce could be conducted using a single penny”, which makes the point rather well. 

As I have argued before, we live in a nominal world. Dad doesn’t come home from work and say “Hey honey, I got a nominal raise today but in real terms my salary is falling.” Nobody says “We bought our house for $200,000 in 1970, and just sold it for $190,000 in 1970 dollars.” Money matters because that’s how people who don’t live in Latin America think. (Latin Americans have a much more informed understanding of what money is and isn’t, but even down there money still matters.)

Secondly, debts are denominated in nominal money. If you owe $100,000 on your house, and they shrink the money supply to a penny, you are in big trouble.Whereas if they quadruple the money supply, you will have done quite well. Money matters because that’s what debts are denominated in.

If you still think money doesn’t matter, consider this: what do you think the odds are that the eurozone can experience 4% real growth with 0% nominal growth? It’s just hard to imagine rapid growth in the face of deflation. If deflation doesn’t matter, how do you explain the collapse of the price level between 1929 and 1932--coincidence?

Monetarists say that not only does money matter, it’s all that matters. Plosser disagrees. He’s a Mellonist who would fit right in at the ECB. But he is 100% wrong. It was Mellonists like Plosser who Irving Fisher was talking about in 1933:
"If even then our rulers should still have insisted on 'leaving recovery to nature' and should still have refused to inflate in any way, and should vainly have tried to balance the budget and discharge more government employees, to raise taxes, to float, or try to float, more loans, they would soon have ceased to be our rulers."

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