Market Monetarism is not Really Free Market

Or at least not in its current incarnation. (And why market monetarists are a lot more like Milton Friedman, who actually influenced policy and intellectual development in a profound way, than Murray Rothbard who is snubbed as a neo-confederate pariah).

Because many monetarists like Scott Sumner, Lars Christensen, etc. have very pronounced market sympathies, they occasionally get defensive about their support for nominal income targeting. Most recently, Christensen went out of his way to argue that easy money is not a bailout. I’m a fan of a nominal income target, and I’m also generally a fan of “free minds and free markets“. And while market monetarism is a shining example of the latter former, I don’t think it hits the former latter. Here’s why.

Regulation:

If there’s one thing classical liberals and libertarians hate more than taxes, it’s regulation. But it is frankly absurd to think monetary policy should be used to smooth the business cycle without smart rules in place. Without any regulation, under such a regime, a housing bubble would force the central bank to increase rates and pummel the economy into recession. This hardly sounds fair to the job creator entrepreneur in Silicon Valley that can’t get funding for his new idea because the animal spirits on Wall Street have been on a credit binge. I’m not sure where monetarists like Sumner fall on necessity of deposit insurance, but with such deeply ingrained federal institutions, it is ridiculous to think a nominal target would be tolerated without sound regulation.

Monetary policy is a hammer, not a scalpel. That means if we’re using it aggressively, we better wear safety goggles.

Inflation…



…is a capital tax, and Sumner agrees:

After all, when prices rise, incomes usually rise as well. Instead, many economists would argue that high inflation is a sort of tax on capital: Our tax system punishes savers during high-inflation periods like the 1970s, as people must pay taxes on capital earnings that merely reflect price increases driven by inflation. The result is reduced saving and investment.

Anyone who reads his blog knows that Sumner is no fan of an inflation target. And reasonably so: a supply-shock under this policy would force deflation on other goods and services. Considering the nominal rigidity of wages, this would be a particularly tricky and dangerous situation. However, in periods of stagnation like today, a nominal target can be sustained only with more inflation, that is a higher effective target to close the gap from current nominal income to trend.

Using a central bank to spur consumption and devalue savings is functionally similar to a tax-and-spend fiscal policy. Now, unless money is directly deposited everyone’s checking account, rent seeking is a problem, too. The discount window gives bankers free money which are then invested in riskier assets. The inflation is socialized and the benefits are, well, privatized.

To be fair, this is actually an exception to the rule. If central banks never let nominal expenditures fall in the way they did, above-trend inflation would never be necessary (unless real, long-term growth permanently falls).

Free Banking:

Austrians are notorious for thinking a gold standard is a good idea. But perhaps their most charming idea is the idea of competitive banks each issuing notes which would be traded on the open market. Today, the government has absolute monopoly on the issue and transaction of currency.

And like any other monopolist, setting the price – the interest rate – is the sole provenance of our central bank. Again, to be fair, if NGDP was targeted via a futures market, it’s fair to say the power of each member of the FOMC is significantly reduced. (As Sumner recently put it to Noah Smith, this would be liked increasing the FOMC size to millions, where good votes are incentivized and bad ones penalized).

However, I think a NGDP target should be executed more conservatively. Market efficiency is predicated on selfish, profit-maximizing agents, that would vote/trade based on the best information available. Is it not possible that those with asymmetric information and huge market power (TBTF banks) can manipulate the interest rate, somehow? Maybe my logic here is flawed, but it leads me to my final point…

Theory of the Second Best

In 1956, Richard Lipsey and Kelvin Lancaster proved that if one of many conditions of optimality cannot be satisfied, it is possible that the next-best alternative involves changing other conditions from what was otherwise optimal. In their words:

The general theorem for the second-best optimum states that if there is introduced into a general equilibrium system a constraint which prevents the attainment of one of the Paretian conditions, the other Paretian conditions, although still attainable, are, in general, no longer desirable.

By having a government, and by modern extension a central bank, we violate one of the many classically liberal optimality conditions. Once we have centralized governance, it is not at all clear that, except in specific cases (such as a too-high income tax), a linear movement towards free markets is desirable. This brings me in full circle to regulation. We have a set of institutions based on our social contract to protect small savings (FDIC) and provide for the needy. As our welfare state continues to grow due to social pressures, the linear movement in certain sectors towards libertarianism seems ever more imprudent.

I say this, reading Scott Sumner’s remarks on free banking (he’s sympathetic) and Lars Christensen’s argument that a nominal target is on the way to privatizing the Fed. (Shh! Don’t tell the lefties). As our system of money, government, and social contract becomes more complicated by the day, I cannot believe that free banking is our next best alternative.

A standard, non-futures market, target broadly asserts the currency monopoly. As a supporter, I clearly believe that monetary policy is at its best when calming the nominal business cycle. But it is difficult to see how this intervention is philosophically different from fiscal policy. It might be economically more efficient, but many libertarians – including market monetarists – frame opposition to Keynesian spending on moral grounds. This is wrong.

It is important to remember that Sumner, Christensen, and MMs in general support easier money and a nominal target ipso facto. While they would prefer a futures market, it is not a precondition for the policy. Somewhat similarly, I might prefer a consumption tax to finance government expenditures, this is not a precondition for my belief. (I’m okay with deficits and/or more income taxes, at least morally if not economically).

Remember, none of this is a criticism of market monetarism in general, or nominal targeting in specific. But I take issue that some of the more progressive monetarists believe their policy is by the fact more libertarian than fiscal policy, and I think that is indefensible on moral grounds. Atop, I mentioned something about Milton Friedman. Because, unlike Austrian neo-confederates at the Ludwig von Mises Institute, he had remarkable influence from Christensen, to Sumner, to Larry Summers. His advocacy for a negative income tax is the bedrock for one of America’s most successful welfare programs, the Earned Income Tax Credit (as progressive economist Brad DeLong forcefully argues).

The echoes of Scott Sumner’s work is heard across the world, and across the political spectrum. It has earned a New York Times op-ed from Christina Romer, discussion at the Federal Reserve, and rapid acceptance across the blogosphere.

This is because the work is fundamentally pragmatic, sensible, and forceful. There are libertarians and “true” free marketers out there. And they are irrelevant. Monetarists can defend their policy on the grounds of potential success (it has never been tried before, after all) rather than market virtues.

Market Pragmatists, perhaps?