by Richard Schulman
The annual Cato Monetary Conference is arguably the most important regular event for discussing new ideas about central bank policy and monetary reform. Despite this status, this year’s conference received no media coverage. The editors of mainstream media, who determine what does and doesn’t get covered in the daily press, apparently give no credence to Lord Keynes’ well-known comment that
The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.
This lack of coverage is the more surprising given the fact that the economics writers of the same press are themselves the slaves, conscious and unconscious, of the ideas of the defunct Keynes.
It is with that motivation that we review here several of the most noteworthy ideas presented at Cato’s monetary conference.
The conference began with the keynote presentation by Richard Clarida, vice chairman of the Federal Reserve System. He presented the good news – habitually underplayed by the mainstream press — that
Wages today are increasing broadly in line with productivity growth and underlying inflation. Also of note, and receiving less attention than it deserves, is the material increase in labor’s share of national income that has occurred in recent years as the labor market has tightened.
The bad news, Clarida reports, is that “natural interest rates appear to have fallen in the United States” and that this “increases the likelihood that a central bank’s policy rate will hit its effective lower bound (ELB) in future economic downturns.” Effective lower bound is Fedspeak for what is elsewhere called the “reversal interest rate.” This is what Princeton economics professors Brunnermeier and Koby call “the rate at which accommodative monetary policy “reverses” its intended effect and becomes contractionary for the economy.”
The other bad news, Clarida concedes, is that the Phillips curve “appears to have flattened” and that this “increases the cost, in terms of lost economic output, of reversing unwelcome increases in longer-run inflation.”
This means that the Fed and other central banks are not going to have any useful tools left in case the economy suffers a downturn or inflationary outbreak.
Calomiris: the Fed’s two missteps
Columbia Business School professor Charles Calomiris in his presentation noted that the Fed, as the nation’s monopoly currency provider, makes the entire economy vulnerable to missteps. These missteps, he said, have two sources: political pressures from Congress or the President and mistakes by the Fed itself. Of the two, Calomiris believes the most common Fed mistakes are those blunders the Fed itself makes. Calomiris’ important book Fragile by Disease documents twelve system-wide US banking crises created by government regulation since 1840, in contrast to regulation-free Canada that had none. Since 1914, the Federal Reserve has superintended monetary and banking regulation with accountability for two systemic financial crises, in 1929-1933 and 2008.
Selgin: Fed needs a rule; NGDP recommended
George Selgin led off the fourth panel by noting that complaints about the Fed’s legitimacy – and potential for harm as the nation’s monopoly base money provider – could be lessened if more of its powers were devolved to the private sector. The main reason this hasn’t happened is the prevalence of myths surrounding the supposed failures of earlier free banking periods – myths that the Fed and its orbiting network of economists have sedulously cultivated. The stability of Scottish free banking up to 1850 and Canadian banking prior to 1914 or 1935 give the lie to those myths. So called 19th century free banking in the US wasn’t free but punitively regulated, causing frequent crises.
But, Selgin argued, one couldn’t simply dissolve the Fed and expect markets to instantly generate alternative institutions as some libertarians have proposed. Free markets are good for evolving institutions but not creating them instantly from scratch. He said that a Fed committed to following a rules-based framework of nominal gross-domestic-product (NGDP) targeting would be a useful transitional measure.
William Nelson, chief economist at the Bank Policy Institute and second speaker of Cato’s fourth panel, said he’d be happy just getting the Fed back to its pre-2008-crisis policy framework. It should reduce the huge portfolio it began accumulating during quantitative easing and after. The Fed should no longer accept Treasury deposits at the Fed. Cash, Nelson said, belongs in the private sector.
Steve Hanke’s challenging talk
Steve Hanke, the fourth panel speaker, is an applied economist at Johns Hopkins University and director of Cato’s Troubled Currency Project. Of the four panel speakers, his proposals were the most far-reaching and politically challenging. For Hanke, the crucial dichotomy is good money vs sovereign money. The latter, government-controlled money, invariably leads to currency instability.
Currency instability, he continued, is a profound threat to free societies. It creates boom-bust cycles, inflations, hyperinflations, and depressions. Governments, whose regulatory interference causes the instability, use the economic crises they create to expand their powers at the expense of civil and economic liberties.
Central banks in particular are the prime sources of currency disorders. Their popularity is recent. Before the end WWII, there were only forty or so of them. But after Bretton Woods and the creation of the World Bank and IMF, the latter two institutions encouraged post-colonial countries to set up central banks so as to create consulting opportunities for World Bank-IMF staff and institutional prestige.
Most of the resulting new central banks, Hanke said, are worthless and destructive. They should be replaced by currency boards, which do away with a country’s power to manipulate its own national currency. Instead, 100% of the country’s reserves must be in a stable currency such as the dollar and fully redeemable in it. This prevents a country’s government from financing itself with unbacked paper. Those countries with currency boards have better growth, minimal inflation, and lower national debt.
Currency boards based on government gold-standard currencies would be better but difficult to establish, and there would still be the risk of governments ditching the standard in time of war or emergency. Currency boards based on the two leading currencies used in world trade, the US dollar and euro, would be easier to establish. There would just have to be an agreement between the Fed and the European Central Bank (ECB) to loosely govern the exchange rate between the two currencies. This could be accomplished by an agreement that if the euro depreciated so that one euro bought less than $1.20, the Fed would buy euros to bring the euro’s value above $1.20. Conversely, if the dollar depreciated so that one euro exchanged for more than $1.40, the ECB would buy dollars to bring the US currency back to within the $1.20 to $1.40 band. This exchange agreement would have a positive effect on investment and growth by reducing inflation-, interest-rate, and exchange-rate risk.
Hanke did not go into the risk of a concerted Fed-ECB agreement to inflate. But he did discuss currency-board systems that could escape the risk of US-EU mismanagement. Private sector currency boards with gold reserve backing could accomplish this – as implemented, for example, by a Libra or a bitcoin company.
Hanke noted that the attack on the Libra was orchestrated by the Fed, fearing that the Libra might replace it.
While it’s too much to expect the reader’s congressman or senator to begin agitating for any of Cato’s proposals for reforming or replacing the Fed, the more the Cato speakers’ proposals excite media discussion and better understanding of how well free banking worked in the past, the closer we’ll get to some useful political action.
Videos of the entire Cato monetary conference may be viewed here.
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