They Just Don’t Work in Practice

Isn't the whole problem that of governments having a monopoly on print money? In the free market, players ultimately settled on gold and silver weights whereas governments declare something of low instrinsic value to be called 'money' (legal tender) and people are forced to trade the government's money. Government money unsurprisingly gets inflated giving the government first dibs on spending it and allowing them to control the economy. Hence as soon as Kubla Khan instituted paper bark money inflation went through the roof allowing him to fund his wildest desires.

"Isn't the whole problem that of governments having a monopoly on print money?"

Didn't you read Selgin's paper? If not, I think you should.

Germany has the same central bank as Spain.

German banks suffered, its housing market remained the same.
Spanish banks prospered, its housing market tanked.

Can you show me why it's the central bank who's to blame for this "financial bust"?

But regarding Pingry's observation:
I am curious to find out what research Prof. Selgin has carried out concerning the repo market, and how he comes to the conclusion that it was the central bank who is to blame for its actions.

He may send it to geckonomist at googlemail.

Geckeconomist: Contrary to what Pingry suggests, I have never claimed that central bank policy alone can account for every aspect of this or any other crisis. My claim is simply that the Fed's low rates helped to fuel the housing boom, and o that extent contributed to the severity of the subsequent bust. (My article isn't about the recent crisis, after all--it merely refers in its opening to the crisis as the most recent instance of a boom-bust cycle in which central banks played a part.) The ECB also contributed to a lessor extent. Of course different policies and financial structures in different countries influenced the extent to which they suffered from the ensuing crisis. In the U.S. case the role of Fanny and Freddy in seeing to it that disproportionate amounts of credit went into sub-prime mortgage-backed securities is of course notorious. But the story is of course much more complicated.

As for the repo market, I haven't done work on it, having nothing to add to what Gary Gorton and others have had to say on the topic; my empirical work on the crisis is limited to studying the bearing of Fed policy on housing prices and such, which has been my particular concern. But to connect the collapse of the repo market to Fed policy via the housing price boom is not so hard to do! Here again, though, it isn't a matter of claiming that "it was the central bank who is to blame." _Partly_ to blame is all--and that's enough.

Pardon me for writing "Fanny and Freddy" for "Fannie and Freddie"! I'd better have my morning coffee before I write again!

Gee, Bernanke says the Fed's policy was "just right" during the boom. Well, no wonder: as an FOMC member he led the charge for keeping the nominal rate so low for so long (and for thus making the real FFR negative). Read the Fed minutes and you'll see. You'll also hear the feeble arguments offered at the time for not raising the rate sooner--arguments rather like your own arguments for inflation targeting, come to think of it! (Very high forecasts for total factor productivity growth were treated, not as an indication of a rising natural rate, but as offering a "free lunch" on continued monetary easing by serving to counter inflation.)

Professor Selgin:

I just wanted to take this opportunity to say "Thank you" for the paper on the "Central Banks as Sources of Financial Instability" -- it was a great read and provided much historical context.

Not that you aren't already busy doing good work, but I would love to see your selection of choice excerpts from those minutes. I'll bet is even better than the "Bernanke was Wrong" video on YouTube.

It isn't just the Central bank: It's tax policy, it's giving away the taxpayers money,...everything that encourges individuals to increase spending through large amounts of debt. And of course, human nature..get rich quick. The power of marketing over intelligent decision making. Running things based on The Ralph Kramden school of economics and investment.

"human nature..get rich quick"

You seem to be describing a political environment which makes this the rational human response.

Henry Hazlitt observed that government's attempts to stabilize things usually de-stabilizes things...

What if we had truth in government policy titles and department naming?

Department of Foreign Aggression
Department of Revenue Extortion
Department to Thwart Justice
Department of Wealth Destruction
etc.

Department of Counterfeiting
Department of Bull$hitting
Department of Labor Restrictions
Department of Power Consolidation
Department of Nanomanagement

There is definite need for a Dept. of Scapegoating.

Thats the sum total of every economist who blames the boom and bust on the free market.

Markets have problems, because market actors are human, but markets also create solutions.

Centralized control of markets creates additional problems and make them systemic.

Department of Nanomanagement
Aren't they all?

Some instead use picomanagement.

I've got first hand experience in the nightmare. Perhaps we should use the prefix femto. Maybe atto. Do I hear zepto? Going once, going twice, there's a bid for yocto! Sold to yocto for 10^-24!

Abbrev: ymanagement.

"More important, the pre-Fed crises can themselves be shown to have
been exacerbated, if not caused, by regulations originally aimed at easing the Union government’s fiscal burden. The U.S. case therefore represents a special instance of the general pattern according to which central banking emerged as an unintended by-product of fiscally motivated government interference with the free development of national financial institutions."

Very fun read this.

"Bagehot [held up today as a high priest of central banking] believed that central banks were financially destabilizing and hence undesirable institutions and that it would have been far better had England never created one. He offered his lender-of-last-resort formula not as an ideal, but as a first aid to what was, in his view, a fundamentally unhealthy arrangement, the healthy alternative to which was free banking, with numerous banks issuing their own notes and maintaining their own reserves, as in the pre-1845 Scottish banking system. England needed a lender of last resort not to rescue it from crises inherent in competitive banking, but to limit the severity of crises that were inevitable consequences of the monopolization of currency."

This is what mainstream economists understood in 1873?! Truly economics today is in the pit of a dark age. A lost century.

"If central banks are in fact sources of financial instability, how have they come to be regarded as just the opposite? The explanation resides partly in modern economists’ limited understanding of the workings of competitive currency arrangements, which causes them to assume that such arrangements must necessarily be less stable"

"Limited" because they don't really like to think about economics. Time spent thinking about economics crowds out either their assigned tasks--interpretation of keynesiac models of the (animal) spirit world; or their real passion--social engineering.

Selgin and present company excepted, of course.

Good paper. Marco del Pont, can understand it?. I doubt it !!!...

"The present financial crisis shows how central banks can fuel the financial booms that make severe busts possible..."

So....once again, where is the statistically significant link to validate the claim that monetary policy and central banking are to blame for the boom?

Yeah, that's what I thought.

--Pingry

Well, i don't know about a long term study, but it is pretty obvious that the low interest rates after the dot com crash fueled the housing bubble that was already forming to incredible highs. If the interest rate had been higher, people would have pumped less money into houses. There are plenty of models that show that when interest rates are low, people borrow more money for houses. Plenty of events precede plenty of other events for a multitude of reasons. Most of the econometric models rely on the concept of predictable human behavior. Can econometrics answer for any of it's shortcomings?

Pingry, as usual, "thinks" wrongly: showing a "statistically significant" relationship (for whatever such may be worth) between Fed monetary policy and the housing boom-bust cycle is as easy as shooting fish in a barrel; and yes, I myself have run plenty of numbers on this. Here, for proof, is a link to David Beckworth's post discussing our some of our research on the topic, most of which is in a paper still in progress: http://macromarketmusings.blogspot.com/2010/01/...
Nor is our perspective at all unique: John Taylor has of course written an entire book on the Fed's contribution to the boom and subsequent bust.

By the way: no real econometrician would suppose the validity of a theory to be something that could possibly be settled by referring to a significance test!

Should Pingry be willing to crawl out from under his rock long enough to disclose his true identity and address, I will happily send him oodles of regressions, replete with asterisks.

I thought I won our last argument George...you know, where my argument for inflation targeting was superior to your argument for free banking.

I did, however, manage to get you to finally admit to your bizarre belief that asymmetric information in financial markets was "baseless."

Yeah, that's it....we should really trust banks and the financial system because the globalized system today is exactly the same as in the middle ages...

Oh no, the bubble and crisis had nothing to do with the run up in house prices since the 90's. No, it had nothing to do with financial "innovation". No, it had nothing to do with the shadow banking system, which, at their worst, were rolling over a quarter of their balance sheet every night in the repo market. Oh no, it was not the casino operation at AIG. No, no, no, it wasn't.........

Yeah, that's it...it was all monetary policy. Yeah, no, finance is not destabilizing in the shortrun....Pfff

Yes, I read the blog post previously, and I look forward to this forthcoming paper, but let me say that Bernanke was right.

Should l I even get into the stupidity coming from John Taylor (and Cochrane and Fama) these days?

Indeed, Taylor has probably been the loudest critic of Fed monetary policy, but as I have noted many times here before, he's wrong and Woodford is right.

Monetary policy at the time was appropriate, as Bernanke indicated. And the Fed was justified in keeping the Fed Funds Rate "Too-low-for-too-long" as many of you put it, as Woodford indicated.

The bubble and crisis was not a monetary policy issue.

I have news for you George. These kinds of crises will continue to occur with alarming frequency and devastating consequences for innocent people, not because of monetary policy, but because banking and finance are becoming increasingly dangerous. Do you really trust banks (and other FI's) who are "free banking" to not fail in droves, a la Diamong-Dybvig?

We've really seen far too much reckless "spontaneous order" coming from the financial system which inevitably ends up as spontaneous disorder.

And who emerged back in September 2008 when the financial system was about to fail? Not self-interested buyers, but central banks all over the world, who are getting attacked for a crisis they did not commit.

Come to the darkside George, we have cookies and we're not apologists for catastrophic market failure.

--Pingry

You're using a temporary crisis to push your viewpoint.

"Oh no, the bubble and crisis had nothing to do with the run up in house prices since the 90's."

Housing prices jumped in the 90's due to.... wait for it..... LOW INTEREST RATES! IN THE EARLY 90's INTEREST RATES WERE HIGH THEN FELL DRAMATICALLY ENCOURAGING MORE HOME SALES!

"No, it had nothing to do with financial "innovation"."

If by financial innovation, you mean letting people use their own money (or the money given to them) the way that they want to. Their is no evidence that returning the wall between investment banks and commercial banks would help the economy at all. Yes, thinks were risky, but risk creates growth. Billions were pulled out of poverty, but now millions in the already rich world are having to move into apartments and you want to say that this system is a failure.

"Oh no, the bubble and crisis had nothing to do with the run up in house prices since the 90's. No, it had nothing to do with financial "innovation". No, it had nothing to do with the shadow banking system, which, at their worst, were rolling over a quarter of their balance sheet every night in the repo market. Oh no, it was not the casino operation at AIG. No, no, no, it wasn't........."
Oh yes, it had everything to do with those things. But those were the EFFECTS, in fact they WERE the boom. Blaming them for the boom is like blaming increased temperatures on warming. Monetary policy was the cause.

Yeah, that's it....we should really trust banks and the financial system because the globalized system today is exactly the same as in the middle ages...

Because, really, it is much better to trust banks and the financial system running government.

Pingry wrote:

Oh no, the bubble and crisis had nothing to do with the run up in house prices since the 90's. No, it had nothing to do with financial "innovation". No, it had nothing to do with the shadow banking system, which, at their worst, were rolling over a quarter of their balance sheet every night in the repo market. Oh no, it was not the casino operation at AIG. No, no, no, it wasn't.........

I think the best response to this sort of argument is to quote something else Pingry said:

Do you not understand the need for statistical/econometric testing to validate a claim?

So where is your "statistical/econometric testing" data supporting the claims you made (by implication) in the first quote I provided?

You seem to be long on denouncing a lack of data from others but woefully short on supplying data that supports your own claims.

Exactly.

For instance, this:

"Do you really trust banks (and other FI's) who are "free banking" to not fail in droves, a la Diamong-Dybvig?"

It all comes to the fact that Pingry doesn't "trust" free-banking. He is clearly not seeking statistical evidence. When Prof. Selgin offered to send him the evidence, instead of seeking that evidence, he asked questions like the one I quoted above.

So your solution is what? Turn the banking system over to the government? Let all decisions on loans be political?

That is the statist solution to everything: turn it over to government.

Pingry has no data. He asks questions like this one: Do you really trust banks (and other FI's) who are "free banking" to not fail in droves, a la Diamong-Dybvig?


If he really wanted data, he would have crawled out from under the rock and asked for it. He is married to Ben Bernanke, and, at the moment, not considering a divorce. Get it?

we're not apologists for catastrophic market failure

You're apologists for catastrophic monetary policy.

Let us assume that the central bank cannot create a boom. Then why would it ever lower interest rates or even have a policy? It would have no effect. The fact of that the central bank DOES act means that it has the ability to create "booms". Whether this is from an "equilibrium" or "trough" is irrelevant.

Do you not understand the need for statistical/econometric testing to validate a claim?

This is what drives me crazy about you Austrians...Real economists demand empirical work, and in return we get watered down logic because ABCT types reject math.

"Let us assume that the central bank cannot create a boom.."

Or, let us assume that people making grandiose claims about monetary policy causing the housing bubble actually have the huevos to at least attempt to test their hypothesis instead of giving out lectures of bogus macro.

Yes, I know all about the Calvo-style sticky prices, and a "boom" (What an ambiguous word for Austrians who pride themselves on qualitative logic without math!). Your argument is weak anyway because you need to unambiguously define what a boom is (and here is where numbers come handy..) and then you have to deal with the ramifications of the rational expectations revolution.

Weak, weak, weak.

So, let's try this again. Provide the quantitative stuff, because the qualitative stuff is so weak.

--Pingry

I use neoclassical macro, also. It is useful like psychology, which is also a fuzzy pseudo science. Only Micro can be trusted for accuracy.

Macro is useful, but like psychology, if you start to believe your own hubris and trust your theories and models completely to understand human activities, you'll get burned every time.

I am very interested in this argument.

On the one hand, I am not impressed by econometric models because so many economists with impeccable credentials who rely on them have made such awful predictions (e.g. Ben Bernanke and his predictions about the housing market earlier in this decade*). I tend to believe, like Hayek and Mises, that accurate mathematical modeling of a complex system involving humans is impossible.

On the other hand, Pingry makes a good point. Let me paraphrase: "those who eschew econometric models end up sounding like scholastics."

I have found that I cannot win a macroeconomic argument with anyone based purely on logic because the debate isn't about logical constructs, it's about the real world. I may begin by arguing logic, but someone will inevitably challenge my logic, as Pingry has done here to Selgin, and then I'll be forced to reference some historical event that proves my point. I'll inevitably have to compare the economic variables of the past event and the present situation, control for changes and so on. And, if I don't do it formally in a mathematical model, I do it informally in an intuitive model.

* Note: I am not saying that I know whether Bernanke caused the bubble, just that what he said about the danger of a housing bust proved wrong.