Labour Finance Spokesman David Parker still talks about giving the Reserve Bank “other targets” than just leaning against inflation. He’d like them to also meddle with our money to lean against (in no particular order) our high exchange rate, rising unemployment, slowing GDP growth, falling savings rates and the quality of chardonnay in Grey Lynn.
Why worry about him and his ramblings? Because this ardent inflationist is very likely to be the next Finance Minister.
TI have my own problems with the phony price stability pursued by the Reserve Bank. There’s clear evidence the policy of price stability always leads to more instability. Or worse. Learning nothing however from the lessons of the past suggesting using monetary policy to “target” cherished policies can achieve anything beyond instability, in this penetrating interview with Alex Tarrant (good work, Alex) Parker admits he leans himself towards either “nominal GDP targeting” or targeting the prices of a basket of export commodities instead of the CPI–both ideas espoused by his new hero Jeffrey Frankel.
This, to Parker and to Frankel, would be “modern central banking.” And he’s probably right. Using monetary policy to tinker with “targets,” boost exports and bail out failure probably is thought “modern” by those who never learned the reasons for the failures of antediluvian mercantilism. Or who still remain blind to
the role of central banks in this crisis, let alone the very concept of monetary central planning, of the idea that some ‘wise men and women’ in Frankfurt, Washington, ]Wellington] or London can fix the supply of base money and certain prices (interest rates) in order to control, guide and manage overall economic performance. Like [so many of the chattering classes, Parker] is in awe of the power elite that supposedly runs our economies and our societies to our benefit. Difficult times only seem to require more determined politicians and more determined central bankers. And when central planning fails, the central planners simply need a new plan. Or a new target.
Not surprisingly, [Parker] is an advocate of nominal GDP targeting, the new fad in monetary central planning. There is allegedly nothing wrong with monetary policy. The central bankers only need a new target, and, naturally, a more comprehensive one. [FT journalist and] trained mathematician Münchau lectures us how this works:
“This is a debate about nominal income targeting, where a central bank no longer stabilises the inflation rate directly but focuses instead on stabilising nominal gross domestic product. You can think of nominal GDP as the sum of real GDP and inflation. If real growth falls, the central bank would thus have to drive up inflation. Conversely, if real growth rises, the central bank would have to bear down on inflation much harder than it would do under the pure inflation targeting regime used by central banks such as the ECB.”
There is a dangerous naivete about all of this, a blindness toward real-life complexity. There is also a kind of narrow-mindedness, of which Münchau accuses the central bank critics, but of which he himself is the prime example. Münchau and other advocates of GDP-targeting are consistent macro-economists, which means they necessarily ignore many important micro-economic phenomena.
Here is the prime fallacy behind the nominal GDP target and, in fact, all of Münchaus’ argument: It tacitly assumes that money is neutral, which money never is.
Those paragraphs above come from a great piece by Detlev Schlicter: “The fallacy of nominal GDP targeting” appearing at his blog Paper Money Collapse. Schlicter points out the abject fantasy of believing the “easy money” of central banks can be used to produce stability. The fantasy focuses on price indexes and statistical constructs while ignoring the real world; ignoring, for example, that
when new money is injected into the economy, it does not raise all prices simultaneously and to the same degree but some faster than others, and some more than others.
This is important and has far-reaching consequences. ‘Easy money’ does not just directly affect growth and inflation, or any desired combination of the two. It does not just affect the statistical average of prices, the price level, or the statistical aggregate of economic transactions, real GDP, or any other statistical macro-variable. ‘Easy money’ always means changes in relative prices, changes in resource allocation, and changes in income and wealth distribution. In particular, ‘easy money’ lowers interest rates, which are crucial in a market economy for coordinating investment activity with the public’s time preference, i.e. the public’s propensity to save and thereby support and sustain the capital stock. Monetary expansion means distorted interest rate signals and thus necessarily capital misallocation. This fundamental insight is the basis of all monetary theories of the business cycle, that is, of the insight that monetary expansion leads to booms that must be followed by busts. Every monetary expansion creates distortions, the liquidation of which cause the next recession. Every monetary expansion creates economic instability. This was already the basis of the business cycle theories of the British Classical economists of the Currency School in the 19th century, but more importantly, it was the basis of the so far most convincing business cycle theory, the one developed by Ludwig von Mises in 1912 and 1924, a theory that is now widely known as the Austrian Theory of the Business Cycle.
This theory explains why modern fiat money central banks can never be a source of ‘stability’, whether that means the stability of the inflation rate or the stability of nominal GDP. Central banking, whether old fashioned or modern, is always a source of instability. This theory also explains why modern central banking has now maneuvered us into a veritable economic cul de sac. Repeated attempts over the past decades to buy near-term economic growth at the price of persistent marginal debasement of money has now left us with such a distorted and over-indebted economy that any further monetary expansion has to be ever more scarily aggressive to even cut through the thicket of accumulated imbalances and have any effect on inflation and GDP, whether real or nominal.
Here’s a target for the central bank: stop printing new money.
That would be a target they should manage.