Sunday, March 2, 2014

Will The Real Mr. Roosevelt Please Stand Up? (Obliquity & Monetary Policy)

Earlier this week I posted on Brazil's hyperinflation (here, here and my personal favourite, here). Although those posts were partially for pure intellectual interest, I've been wondering what practical relevance that history has for today's world. No doubt there are countries like Venezuela and Argentina who still face hyperinflation. But these countries are fairly small and unusual. Indeed, it seems that persistent low inflation (bordering on deflation) is of greater concern in the advanced economies, particularly Europe. Does Brazil's hyperinflationary history hold any lessons for today's Europe?

I think it does, and I don't think this will be too controversial: Changing expectations about inflation or deflation requires a credible commitment from the monetary authorities. In Brazil, a commitment to a hard exchange rate target lacked credibility in the absence of fiscal restraint and economic reform such as privatization of state-owned entities. Furthermore, stop-and-go policies reduce the credibility of future actions since economic actors justifiably expect them to be reversed quickly. It happened in Brazil, and I worry that it's happening in Europe. In the Eurozone, low inflation and inflationary expectations are a reflection of the ad hoc nature of monetary stimulus.

I posted on deflation earlier this week, arguing that we can think of "deflation" as a loss of confidence in one's prospects and pricing power, which is much closer to its everyday sense of the word. This obviously complicates the identification of deflation from the "simple" technical measure of a price index (not so simple in reality). But the real world is much more complex than can be captured completely in a single measure. Consider this my plea for obliquity in policy-making. In John Kay's excellent book of the same name (which is a must-read for anyone like me who's a sucker for the thinking about thinking genre), he says, "Obliquity describes the process of achieving complex goals indirectly." Later, he writes, "Good decision making is pragmatic and eclectic. Oblique approaches rely on a tool kit of models and narratives rather than any simple of single account. To fit the world into a single model or narrative fails to acknowledge the universality of uncertainty and complexity."

I'm starting to think that the ECB is hamstrung (perhaps fatally) by its single mandate on price stability allied with a deference to the Bundesbank-influenced inflation-phobia. It's one thing to defend flexible inflation targeting, but inflexible inflation targeting (and failing!) is another altogether. Marcus Nunes has done a superb post arguing for nominal GDP as the best indicator of monetary policy. Perhaps it's too much to ask for a single indicator that reflects something as complex as the stance of monetary policy. I've praised market monetarism in the past for being an oblique method of judging policy, with its reference to various asset prices. (In fact, I can  foresee a situation where NGDP might conflict with other indicators, and I think pragmatic market monetarists would have to step back from a singular focus on NGDP in such a case. But we're a long way from that now.)

There is one point in Kay's obliquity that I'm not totally clear on, best illustrated by his description of Roosevelt. He first lauds Roosevelt for his approach as one of "bold, persistent experimentation." "Try something," Roosevelt said. "If it fails, admit it frankly, and try another."" But it gets a bit confusing when he talks about Roosevelt the commander-in-chief. "Both Roosevelt and Lincoln understood that to approach their goals too directly would risk failure to achieve them. Their obliquity caused frustration to many around them, and to many historians who record their careers today. As we read a modern account of Roosevelt gently edging his country towards the inevitable war, we wonder constantly: "Why doesn't he get on with it?" Roosevelt, like Lincoln before him, understood that the scope of his authority was inescapably limited by the imprecision of his objectives, the complexity of his environment, the unpredictability of the reactions of others and the open-ended nature of the problems he faced. All these factors mean that even the most powerful men in the world must proceed by choosing opportunistically from a narrow range of options."

Will the real Mr. Roosevelt please stand up? Was he a cautious, oblique tinkerer, or a bold visionary filled with the "Rooseveltian resolve" that monetary historians admire? I suppose one could argue "both", and that that was precisely his strategic brilliance, which allowed him to select the right option for the right set of circumstances. But what prescriptions are there for someone like Mario Draghi, who must act boldly despite the political and institutional realities of the ECB? I'm starting to think that credit-focused policies (of the kind suggested by Jacob Kirkegaard and Francesco Papadia are viable Plan B's to increase the monetary base. But in some matters, cautious tinkering is insufficient. The Fed's unemployment-linked guidance was decidedly second best from a market monetarist/NGDPLT standpoint, but it had the effect of providing the sort of credible commitment to monetary expansion that was needed, powerfully shifting the regime away from ad hoc QE and twisting. David Beckworth posted recently on how the Fed failed in 2008 because they failed to change the expected path of monetary policy. I can't agree enough, and that's why more may be needed from the ECB than credit programmes.

A man of Draghi's intelligence, experience and political savvy doesn't need my advice. But I can't resist giving it, so let me again cherry-pick Kay's work to buck up Draghi's courage should it be flagging. Kay cites Francis Cornford: "The Principle of the Dangerous Precedent is that you should not now do an admittedly right action for fear you, or your equally timid successors, should not have the courage to do right in some future cases, which, ex hypothesi, is essentially different, but superficially resembles the present one. Every public action which is not customary, either is wrong, or, if it is right, is a dangerous precedent. It follows that nothing should ever be done for the first time." My guess is that the Eurozone will probably be at risk of monetary instability as long as the single mandate defies obliquity. In the here and now, though, Draghi and his colleagues are quickly approaching the point when they must decide which Mr. Roosevelt they want, or need, to be. 

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