Don’t Blame Free Markets When Central Banks Make Mistakes

I don’t like bad monetary policy by central bankers.

I especially don’t like bad monetary policy when central bankers refuse to accept responsibility for their mistakes.

I’ve already written about blame-shifting by the Bank of England.

An even worse example comes from the European Central Bank. And I’m not referring to the vapid statement by the political hack in charge of the ECB.

What’s far worse is that the supposedly professional economists at the ECB produced a study about the recent bout of inflation in the eurozone and pretended that it wasn’t a result of their own bad monetary policy.

That example was so egregious that I even created a meme to mock their lame effort to deflect blame.

Today, I want to do something similar. I’m motivated by a New York Times column by Bret Stephens.

Here are some excerpts.

Why the broad dissatisfaction with an economic system that is supposed to offer unsurpassed prosperity? Ruchir Sharma, the chairman of Rockefeller International and a Financial Times columnist, has an answer that boils down to two words: easy money. …“When the price of borrowing money is zero,” Sharma told me this week, “the price of everything else goes bonkers.” …In theory, easy money should have broad benefits for regular people, from employees with 401(k)s to consumers taking out cheap mortgages. In practice, it has destroyed much of what used to make capitalism an engine of middle-class prosperity… First, there was inflation in real and financial assets, followed by inflation in consumer prices, followed by higher financing costs as interest rates have risen to fight inflation… For wealthier Americans who own assets or had locked in low-interest mortgages, this hasn’t been a bad thing. But for Americans who rely heavily on credit, it’s been devastating.

But it’s not just overall asset inflation and price inflation.

Easy money also distorts relative prices in the economy.

Sharma noted more subtle damages. Since investors “can’t make anything on government bonds when those yields are near zero,” he said, “they take bigger risks, buying assets that promise higher returns, from fine art to high-yield debt of zombie firms, which earn too little to make even interest payments and survive by taking on new debt.” A recent Associated Press analysis found 2,000 of those zombies (once thought to be mainly a Japanese phenomenon) in the United States. …The hit to the overall economy comes in other forms, too: inefficient markets that no longer deploy money carefully to their most productive uses, large corporations swallowing smaller competitors and deploying lobbyists to bend government rules in their favor, the collapse of prudential economic practices. …the worst hit is to capitalism itself: a pervasive and well-founded sense that the system is broken and rigged, particularly against the poor and the young. “A generation ago, it took the typical young family three years to save up to the down payment on a home,” Sharma observes in the book. “By 2019, thanks to no return on savings, it was taking 19 years.”

There’s lots of good information and analysis in the column, but I’m galled at the implication that capitalism deserves the blame.

The column’s title is particularly irksome. How on earth can someone conclude that capitalism went “off the rails” when the topic is how the government’s bad monetary policy has caused damage?

To be fair to the author, editors are usually the ones who decide titles.

But there are parts of the column that rub me the wrong way, such as “dissatisfaction with an economic system that is supposed to offer unsurpassed prosperity” and “the worst hit is to capitalism itself: a pervasive and well-founded sense that the system is broken and rigged.”

Some readers may interpret those passages to mean that free markets somehow have failed.

In reality, our “dissatisfaction” should be the Federal Reserve. And the Federal Reserve is the reason for the “well-founded sense that they system is broken and rigged.”

All of which goaded me to create a new meme.

I’ll close by stating that today’s column isn’t about America’s central bank shifting blame. But it would be very interesting to see what would happen if Jerome Powell (Chairman of the Federal Reserve) was asked what caused America’s recent bout of inflation.

There are three possible options.

1. Admitting the Fed screwed up.
2. Denying the Fed screwed up.
3. Not understanding monetary policy.

I’m guessing we’d get a combination of #2 and #3, but I hope that’s wrong.

The bottom line is the Federal Reserve recently has been a net negative for America.

P.S. Sometimes the blame-shifting is by the politician who appoints the central bankers, as we saw earlier this year in Canada.

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White House Victim-Blaming on Inflation

Economists say inflation is the result of bad monetary policy. The Biden White House, however, says inflation is caused by greedy companies.

I debunk that nonsensical claim in this excerpt from a recent discussion on Let People Prosper.

At the risk of stating the obvious, everything you need to know about inflation is captured in this chart.

Simply stated, the Federal Reserve dramatically increased liquidity in 2020 and 2021.

That meant a lot more money sloshing around the economy, above and beyond what would have been necessary to keep pace with economic activity.

So of course prices spiked.

Biden could have deflected political blame by pointing out the bad monetary policy started when Trump was in the White House.

But since the bad policy continued after he took office, that’s not a persuasive strategy.

Which is why the White House has decided to engage in victim-blaming.

In an article for the New York Times, Nicholas Nehamas, Jim Tankersley and Kellen Browning report on the White House’s blame-shifting strategy.

As high prices at grocery stores, gas pumps and pharmacies have soured many voters on his first term, President Biden has developed a populist riposte: Blame big corporations for inflation, not me. …progressives are urging Mr. Biden to…make “greedflation,” as they call it, a driving theme of his re-election bid. …Inflation soared under Mr. Biden in 2021 and 2022… What Republicans call “Bidenflation” has become one of the president’s biggest political liabilities in his rematch with Mr. Trump. …Mr. Biden has…attacked corporations for pricing practices in certain sectors such as meatpacking, snack foods, concert tickets and gasoline. …Some economists close to his White House disagree that corporations’ raising prices to juice profits is a major driver of inflation. …There are signs that Mr. Biden plans to emphasize this issue more in the coming weeks. …a campaign spokeswoman…said Mr. Biden had “repeatedly taken on corporate greed” and would be “telling that story every day in every possible way on the campaign trail, from ads to door knocking and more.”

I’m not the only one to mock Biden’s strategy.

In her column for the Wall Street Journal, Allysia Finley says Biden and his allies are “inflation deniers” for trying to blame the private sector.

Behold the political left’s version of “stop the steal,” a device that blames corporate greed and malfeasance for inflation. …Democrats from President Biden on down promote this conspiracy theory to dupe voters. …Retailers are getting squeezed by higher costs for products, labor, energy, rent and insurance. Since the start of the pandemic, food prices at stores have increased by 25%, less than the bump in average grocery worker wages (33%) and farm product prices (32%). …Democrats have even introduced the Price Gouging Prevention Act, which would empower the FTC to impose de facto price controls on food, gasoline and other products. The result? Widespread shortages. Mr. Biden has joined his party of inflation deniers. In March he convened a “Strike Force” to “root out and end illegal corporate behavior that raises prices for Americans…” A San Francisco Federal Reserve study last month refuted that inflation has been caused by price-gouging. …What’s fueling inflation? Excessive fiscal and monetary stimulus.

Well said, though I would quibble on two things.

First, I try to avoid using “stimulus” to describe Keynesian fiscal policy or Keynesian monetary policy unless I include “faux” or some other word to express my fundamental disagreement.

Second, bad fiscal policy doesn’t cause inflation.

But I’m digressing. The bottom line for today is that Joe Biden and his allies are wrong to blame businesses. The entire private sector (households and businesses) are the victims of inflation.

P.S. To understand inflation, click here and here. Or, if you want to dive into the issue, click here.

P.P.S. The media doesn’t understand inflation (or pretends not to).

P.P.P.S. Some central bankers don’t understand inflation (or pretend not to).

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Shifting Blame at the ECB

If you asked a reasonably competent economics student to explain why there was a surge of inflation in the eurozone in 2022, that person presumably would be familiar with Milton Friedman’s wisdom and immediately would investigate whether there was a mistake in monetary policy.

Lo and behold, our student would look at the European Central Bank data and say, “what the [expletive deleted], the ECB almost doubled its balance sheet in 2020 and 2021, so of course all that money creation led to rising prices.”

But what if, instead of asking a competent student, you asked some economists at the European Central Bank to answer the same question? Would they reach the obvious conclusion?

Based on a new study from the ECB, it appears the answer is no.

…euro area inflation since 2021 has been driven by both supply and demand factors, with the former playing a primary role. Supply-side shocks were mostly related to energy and food price shocks, partly due to the invasion of Ukraine. At the same time the euro area was hit by an inflationary shock stemming from the combination of pent-up demand for goods and services that accumulated due to subdued spending and excess saving during pandemic lockdowns, and shortages of these goods due to supply chain disruptions. According to the model these shocks exhibit a large degree of persistence; other supply-side shocks, like energy and food, generally have a more temporary impact on price inflation, as those cost-push shocks also reduce income and, hence, aggregate demand.

This is professional malpractice. Though, given the crass blame-shifting by the the political hack who now is in charge of the ECB, I guess we shouldn’t be surprised by such sloppy analysis. For the economics profession, this is sort of like having arsonists investigate fires.

And in case you think I’m selectively excerpting a passage to make the ECB look bad, I invite you to search the study for “balance sheet.” Those two words are completely absent.

Moreover, I did a search for “monetary policy” and got some hits, but none of them were about the ECB’s near-doubling of its balance sheet.

All of which has motivated me to create a meme.

P.S. The ECB is not alone. There’s also been blame-shifting in Canada and the United Kingdom. It’s almost enough to make one think that central bankers shouldn’t be on a pedestal.

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The Non-Relationship Between Tax Cuts and Inflation

The British economy recently has been hammered by rising prices for the same reason that the American economy and the Eurozone economies were hurt by inflation.

Simply stated, central bankers engaged in reckless monetary policy.

And the Bank of England was no exception (even if it doesn’t want to accept responsibility for the damage it caused).

For purposes of today’s column, the main lesson to be learned, as Milton Friedman taught us many years ago, is that “inflation is always and everywhere a monetary phenomenon.”

But lets focus on a practical application of that lesson, which is that politicians should not inaccurately blur the lines between monetary policy and fiscal policy.

I’m motivated to address this issue because of a story, written by Kylie Maclellan and Andy Bruce, that was published last week by Reuters.

British finance minister Jeremy Hunt said…he would not implement tax cuts that would push up inflation… Hunt…hopes will revive the fortunes of both a stagnant British economy and the governing Conservatives… He has been under pressure from some Conservative lawmakers who, alarmed at the opposition Labour Party’s big lead in opinion polls, have demanded he deliver tax cuts. “We do want to bring down the tax burden but we will only do so responsibly,” Hunt told Sky News. “The one thing we won’t do is any kind of tax cut that fuels inflation.” …Hunt’s options are limited after heavy state spending on the COVID-19 pandemic… “If we’re going to be a dynamic, thriving, energetic, fizzing economy, we need to have a lower tax burden,” Hunt told Times Radio, adding that the only way to bring personal taxes down was to spend public money more efficiently.

Mr. Hunt is wrong to imply that tax cuts have anything to do with inflation.

Which leads us to ask why he would create a false linkage. There are two possible explanations.

1. He thinks Keynesianism, with its misguided focus on aggregate demand, is the correct way of understanding the economy.
2. He doesn’t want significant tax cuts and is using inflation as an excuse so that his party can continue to spend more money.

For what it’s worth, both explanations are probably accurate, which explains why the U.K. Conservative Party is in such bad shape and will be resoundingly – and deservedly – defeated in the next election.

Republicans in the United States should (but probably won’t) learn from what’s happening on the other side of the Atlantic.

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Lessons from Reaganomics for the 21st Century, Part IV

When Reagan campaigned for the White House, his economic plan was based on four pillars. I wrote a study about those policies for the Club for Growth Foundation and I wanted to answer two questions.

First, was Reaganomics successful? Second, should similar policies be pursued today?

Today’s column is Part IV of a five-part series.

• In Part I, we reviewed Reagan’s successful record of spending restraint and explained why the same approach is needed today, particularly to control entitlements.
• In Part II, we examined Reagan’s much-needed supply-side tax reforms and said the same insights are needed today to address the problem of double taxation.
• In Part III, we looked at Reagan’s track record on red tape, noting that he arrested the growth of regulatory restrictions and regulatory budgets and urged the same policies today.

For Part IV, let’s look at Reagan’s approach to inflation.

We’ll start with Figure 14 from the study, which shows how inflation dramatically increased during the 1970s.

That was the problem Reagan faced when he took office.

Here’s some of what I wrote in the study.

The United States was plagued by double-digit inflation when Reagan was elected. Rising prices were a problem throughout the 1970s, and the problem became particularly acute during the Carter Administration (see Figure 14), with prices climbing by nearly 50 percent in just four years. …The Federal Reserve deserved the blame for the surge in prices. The central bank created too much liquidity, motivated in part by a belief in Keynesian monetary policy and in part by a desire to appease politicians who like the sugar high of easy money. To make a bad situation worse, prices were increasing faster than income, which meant that the average household was falling behind. According to the Census Bureau, when Reagan took office in 1981, both median and mean household income was several hundred dollars lower than when Carter took office in 1977.

Here’s what Reagan achieved.

Unlike other presidents, who favored the sugar high of easy money, Reagan understood that the Federal Reserve needed a restrictive policy to bring inflation under control. He supported Chair Paul Volcker’s efforts to slow monetary growth even when it became politically unpopular. He courageously did what was best for the nation, even though it hurt his party in the 1982 mid-term elections. …Reagan’s courage paid dividends. The inflation rate came down very quickly. As shown Figure 15 below, inflation was down to about 4 percent in 1988:

Here’s the chart showing what Reagan achieved.

As I did with Part I, Part II, and Part III, let’s now consider whether Reagan’s policies are still relevant today.

In the case of monetary policy, the answer clearly is yes. The Federal Reserve (and other central banks) recklessly expanded their balance sheets during the pandemic. In effect, they repeated the mistakes of the 1970s, albeit for a different reason.

Regardless of the reason for bad policy, the solution is the same. Replicate Reagan’s courage and bring inflation under control.

The bottom line is that Reaganism was the right approach in the 1980s and it is the right approach today.

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Central Banks, Politicians, and Inflation: Part II

I wrote yesterday about the two big reasons that central banks – such as the Federal Reserve in Washington – impose misguided monetary policy.

1. They create too much money because they want to artificially goose the economy with Keynesian monetary policy, especially during election season.
2. They create too much money because they want to finance more government spending based on the nutty idea of modern monetary theory (an approach that has failed in places like Turkey, Argentina, or Sri Lanka).

In Part II, let’s consider whether there are ways to block or discourage irresponsible monetary policy.

For hard-core libertarians, the answer is easy. Just abolish the Fed and rely on the private sector to produce competing currencies.

That approach actually used to exist in some nations in the 1800s and earlier, and it has a good track record.

But don’t hold your breath expecting that kind of radical reform. Politicians are not going to surrender their power over a key variable in the economy.

Another option is a gold standard.

That approach to exist before World War I and also has a good track record.

But it’s also not terribly realistic, especially since there are good reasons to think governments today wouldn’t implement and maintain it in a sensible manner.

So most proponents of good policy today focus on more targeted reforms, most of which are designed to discourage central bankers from imposing inflationary policy.

But not everyone favors anti-inflation policies. In an editorial about various GOP economic proposals, the Washington Post criticizes any limits on the powers of the Federal Reserve.

Even worse is the rising urge to attack the Federal Reserve. While in office, Mr. Trump mused publicly about firing Fed Chair Jerome H. Powell. Entrepreneur Vivek Ramaswamy wants to restrict the Fed’s mandate to “stabilize the dollar & nothing more.” Mr. Pence wants to end the Fed’s dual mandate — minimizing inflation and maximizing employment — in favor of an inflation-fighting-only mission. Mr. DeSantis vows to “rein in” the Fed and stop its development of a digital currency. Since the early 20th century, Fed independence has undergirded U.S. prosperity; meddling with the central bank would cause immediate and immense economic harm.

The editorial is wrong. If you want to know whether the Fed has “undergirded U.S. prosperity,” just watch this video and you’ll quickly learn the Fed has been a destabilizing force, producing boom-bust cycles (and the busts are always worse than the booms).

Regarding some of the specific ideas cited in the editorial, Pence and Ramaswamy are right to say that the Fed should focus solely on price stability, which is just another way of saying we should not have Keynesian monetary policy.

And kudos to DeSantis for opposing a central bank digital currency. Governments would have vast new powers to abuse if cash was eliminated.

P.S. If you want some Fed humor, we have a Who-is-Ben-Bernanke t-shirt, this Fed song parody, some special Federal Reserve toilet paper, Ben Bernanke’s hacked Facebook page, and the famous “Ben Bernank” video.

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Central Banks, Politicians, and Inflation: Part I

Most people (though not all) understand that inflation is the result of bad monetary policy.

That’s the easy part to grasp.

What’s more difficult is figuring out why politicians and their central bankers impose bad monetary policy.

1. Are they creating too much money because they want to artificially goose the economy with Keynesian monetary policy, especially during election season?
2. Are they creating too much money because they want to finance more government spending with modern monetary theory, like Turkey, Argentina, or Sri Lanka?

My rule of thumb has been that developed nations make Mistake #1 and developing nations make Mistake #2.

But that may be changing because of irresponsible fiscal policy in richer nations.

For instance, the European Central Bank has been propping up Italy, financing a big chunk of that nation’s deficit spending.

And I worry something similar may be happening the United States.

The incentive doesn’t even require a belief in a nutty idea like Modern Monetary Theory. Government can profit from inflation in a more subtle way, as I wrote way back in 2011.

Let’s expand on that column, thanks to a a new study from the International Monetary Fund.

Authored by Daniel Garcia-Macia, it crunches a bunch of data to develop estimates of how governments benefit from unexpected inflation.

This paper has shown that inflation surprises help to reduce deficits temporarily and debt ratios persistently. Deficit-to-GDP ratios decline as the nominal values of the economy’s output and of tax bases generally rise, generating more revenues. …an unexpected bout of inflation will erode part of the real value of government debt persistently, both owing to the initial improvement in fiscal balances and the nominal GDP denominator effect. …Unexpected inflation may offer some breathing room for debt ratios but attempts to keep surprising markets and economic agents have historically proven futile or harmful. …Another important dimension is which budget items are automatically or de facto indexed for inflation and by which mechanism.

Here’s a look at different fiscal variables and how unexpected inflation during a two-year period.

What politicians presumably care about are the first two charts on the first row. You can see that inflation leads to more tax revenue, especially from taxes on income and profits.

I fear that they are less concerned (if at all) about the fact that inflation is bad for taxpayers and bad for the economy.

Sadly, there’s not much people can do to protect themselves from inflation. Unless, of course, we figure out an alternative to central banks.

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Turkey’s Screwy Version of Modern Monetary Theory

What’s the track record of Modern Monetary Theory (MMT), which is based on using money-printing by central banks to finance bigger government?

This quack theory is ideal for politicians like Bernie Sanders and AOC, but what happens when countries follow that approach.

The results are not positive.

• It was a miserable failure in Zimbabwe.
• It was a miserable failure in Argentina.
• It was a miserable failure in Sri Lanka.
• It was a miserable failure in Venezuela.

And now we know it is a miserable failure in Turkey (or Türkiye), where inflation has climbed so high that Jimmy Carter and Joe Biden seem like hard-money advocates by comparison.

Here are some excerpts from Desmond Lachman’s column in the New York Post last month, which explains that the country’s populist president is finally realizing that there’s no free lunch.

With Turkey’s inflation surging and a balance-of-payments crisis looming, President Recep Tayyip Erdogan has been forced to backpedal hard on his highly unorthodox economic policy by finally allowing the central bank to hike interest rates to a jaw-dropping 25%, a 7.5 percentage-point jump. This makes it all too likely that the chickens of Erdogan’s prolonged period of economic mismanagement will soon come home to roost in the form of a very hard Turkish economic landing. …In recent years, Erdogan’s economic policy approach has rested on his strongly held belief that far from helping to combat high inflation, high interest rates were inflation’s principal cause. This induced him over the past year to pressure the central bank to progressively more than halve interest rates to 8.5% at a time when inflation was climbing to as high as 60%. …Aside from causing the economy to overheat and inflation to soar, Erdogan’s approach caused the currency, the Turkish lira, to plummet and Turkey’s balance of payments to deteriorate.

I don’t want the Turkish people to suffer, but there is a silver lining to their misfortune.

As explained in an article in the U.K.-based Economist, some politicians and bureaucrats in other nations have been thinking that Erdogan’s policy could be a role model.

Turkey’s economy does not obviously inspire emulation. Over the past five years it has been battered by soaring annual inflation, which hit 86% in October. …last month the currency plummeted to an all-time low against the dollar. To make matters worse, Recep Tayyip Erdogan, Turkey’s president, is about to make good on some expensive promises following an unexpected election victory in May. The bill will probably plunge the government…deep into the red. …Mr Erdogan…insists that lowering interest rates is the key to fighting inflation, rather than tightening the screws. …This chaos reflects the upside-down monetary policy pursued by Mr Erdogan. …This has not stopped Mr Erdogan’s ideas catching on in the finance ministries of the developing world. “I truly wonder whether classical theories are the way to continue,” muses Ken Ofori-Atta, Ghana’s finance minister, who is one of several African ministers pondering such ideas. “We have to get rates low and growth going,” shrugged another at a recent summit on green finance in Paris. In the past month, officials in Brazil and Pakistan have expressed similar sentiments.

Let’s hope that politicians and bureaucrats in other nations now realize that financing big government with a printing press (sometimes referred to as fiscal dominance) is a bad idea.

And if they learn that lesson, maybe the next step is teaching them that it’s also a bad idea to finance big government with higher taxes or red ink.

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Argentina and Dollarization

I wrote earlier this month about the shocking first-place finish by a libertarian in Argentina’s presidential primary.

Today, let’s take a close look at what is arguably Javier Milei’s most radical proposal, which is to eliminate his country’s central bank and instead adopt the US dollar as the national currency.

The first thing to understand about “dollarization” is that it is not an untested theory. Panama has been using the dollar for more than 100 years.

And Ecuador and El Salvador have been dollarized for more than 20 years.

There are also nations that use the euro, as well as many nations that explicitly link (“peg”) their currencies to dollars or euros.

So there is no debate about whether dollarization works. Instead, the issue is whether it would be appropriate for Argentina.

At the risk of understatement, the answer is a resounding yes. Argentina has a chronic problem of bad monetary policy, mostly because the government uses the printing press to finance wasteful spending.

Dollarization would end that possibility.

In a column for Bloomberg, Professor Tyler Cowen explains why Argentina will be better off without its own currency.

The case for dollarizing is straightforward: Since 1980, by one measure, Argentina has had an average annual inflation rate of more than 200%. Significant portions of the economy already have moved to the use of dollars, and for that matter crypto. Why not go all the way and give the economy a stable currency, one which its politicians cannot manipulate? Argentines would find it easier to safeguard their savings, economic calculations would be easier, and foreign investors would be encouraged. …For whatever reasons, Argentina’s political economy has some features that are not conducive to monetary stability and fiscal responsibility, and so further fine-tuning is unlikely to fix the problem. A drastic step is necessary. Three Latin American economies — Panama, Ecuador and El Salvador — have already moved to explicit dollarization. …They have all moved from regimes of very high periodic inflation to relative monetary stability. None appears likely to return to its national fiat currencies anytime soon. …Argentina…has been losing ground since the 1920s, when it was one of the richest nations in the world. …it needs dramatically better public policy. At this point, doing nothing, or continuing on the same path, is more risky than chancing some radical reforms.

Patrick Horan makes similar points in an article he wrote for National Review.

Perhaps Milei’s most controversial economic proposal is to abandon the Argentine peso, close the central bank, and adopt the U.S. dollar as the country’s new currency. …Embracing another country’s currency (the dollar being the most common) is a radical move, but it has been done before. Panama has used the dollar since 1904. Ecuador and El Salvador dollarized in 2000 and 2001. These are examples of official dollarization, in which the government formally adopts the dollar. …Typically, an economy dollarizes because high inflation has seriously weakened the local currency. For example, economists have estimated that roughly half of all transactions in inflation-ravaged Venezuela and Lebanon in the past two years have been conducted in dollars. …Argentina suffers from severe inflation. Since February, the year-over-year inflation rate has exceeded 100 percent. Also, …many Argentines already deal in dollars. …Dollarization would mean that the government would no longer be able to turn to monetary policy, a tool Argentine governments have repeatedly misused, to fund imprudent fiscal policy. …dollarization would bring an end to Argentina’s inflationary woes. Also, since monetizing deficits would no longer be an option, dollarization could also motivate policy-makers to pursue pro-market, pro-growth reforms.

In a column for the Wall Street Journal, Max Raskin focuses on the economic benefits that accrue when a government no longer has the ability to finance wasteful spending by printing money.

Mr. Milei has promised to close the central bank and dollarize the economy—a process that would essentially outsource the country’s monetary policy to the Federal Reserve. …my recent co-authored research in the Journal of Financial Stability and Brown Journal of World Affairs demonstrates the economic gains that can be had for a country that chooses to forgo its monetary prerogative. Currency competition, especially through liberalizing legal-tender laws, restrains the inflationary impulses of a central bank. If foreign currencies are able to be used and not taxed or regulated disfavorably, then the central bank will have less power to inflate because of consumer choice. …Argentina used to be one of the most developed and wealthiest countries in the world, but a century of state intervention in the economy has shown how dangerous it is to disrupt the normal functioning of markets. Even a selfish government that’s keen on reaping increased tax revenue from growth should have an interest in making a commitment to monetary liberalization.

Let’s close with some excerpts from an article that Marcos Falcone authored for the Foundation for Economic Education.

This article was published back on May 5, well before Milei’s shocking first-place finish in Argentina’s presidential primary, and it has some good information on how Ecuador has benefited from dollarization.

Initially, those who supported the elimination of the peso were viewed as crazy: How could a nation deprive its 45 million inhabitants of their currency? But Argentina is a country with never-ending inflationary conditions: The current annual inflation rate is over 100 percent and rapidly accelerating, while many fear that hyperinflation—which the country experienced multiple times during the 20th century—is coming back. …the use of dollars would not be an imposition by the government, but merely a recognition of the current state of affairs. Dollarization has, in some aspects, already occurred. …pesos lose value more rapidly than dollars, euros, or other currencies. This happens, in turn, because the government continues to print money to finance its deficit. …adoption of the dollar has helped other countries stabilize, like Ecuador. …inflation has ceased to be a problem in this country… not even a strong populist leader like Rafael Correa was able to overturn dollarization, as the dollar itself was always more popular than him.

By the way, the adoption of the euro currency has some parallels for dollarization.

Consider the cases of Italy and Greece, which habitually suffered from high inflation.

Joining the euro was a positive step for those nations because it meant their governments no longer could print money to finance wasteful spending.

Sadly, this story does not have a happy ending. The European Central Bank has become politicized in recent years and is now indirectly printing money to subsidize wasteful spending by the Italian and Greek governments.

Fortunately, I don’t think the US Federal Reserve would adopt bad monetary policy to help Argentina (though the Fed certainly is capable of adopting bad monetary policy for other reasons).

P.S. One reason to support cryptocurrencies is that they provide an option for people in nations with terrible monetary policy (Sri Lanka being a recent example).

P.P.S. Nations are less likely to dollarize if the US government engages in global bullying.

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Bidenomics Producing Disaster in Argentina

The U.K.-based Economist calculated a few years ago that Taiwan has been the world’s fastest growing economy over the previous 100 years.

That’s not a big surprise since it started poor and is following the tried-and-true recipe for becoming rich.

Meanwhile, the world’s worst-performing economy over the same period has been Argentina.

And it seems that may be the case for the next 100 years (though Venezuela will be a strong contestant for that ignoble achievement).

Mary Anastasia O’Grady warns in her Wall Street Journal column that Argentina is on the verge of another economic meltdown.

Margaret Thatcher famously quipped that the trouble with socialism is that “you eventually run out of other people’s money.” …Argentina’s central bank is printing more pesos than the m arket wants to hold because the government, which is broke, needs them to pay its bills. This isn’t new in Argentina. Successive governments have generated repeated bouts of high inflation for decades. …Capital controls exacerbate shortages of hard currency. …Stagnating Argentine economic growth is no mystery. …On Aug. 13 Argentines vote in primaries for presidential candidates, and this issue is front and center. Yet promises of a cure are short on details, probably because it would mean upending the long tradition of Peronist populism that has bankrupted the country.

Why is Argentina such a mess? The short-run answer is modern monetary theory. The long-run answer is Peronism, named after the populist (and statist) Juan Peron, who took power in 1946.

Indeed, much of Argentina’s decline occurred after World War II (Argentina was one of the world’s 10-richest countries as recently as 1948).

The bottom line is that there is very little reason for hope, especially with the IMF subsidizing Argentina’s profligacy (and it does not help that the supposedly right-wing parties also like big government).

P.S. Writing for Law & Liberty, Marcos Falcone of Fundación Libertad explained that Argentina’s march in the wrong direction was aided and abetted by a constitution that evolved in the wrong direction.

…the 1853 Constitution…purposefully followed the model set by the American Founding Fathers so as to establish the kind of rule of law that a classically liberal society would need. …internal, bureaucratic barriers to free trade were to disappear; that no privileges would be extended by the government to anyone; and that private property was an inviolable right. …Ever since its inception, though, the Argentine Constitution has suffered from several changes…new articles incorporated into the Argentine Constitution have recognized social and collective ‘rights,’ the enforcement of which depends on increased government intervention. …Article 14 bis of the Constitution,…added in 1957…guarantees the existence of a minimum wage, mandates ‘fair’ salaries for workers, …and effectively bans the state from dismissing public employees. …The 1994 Convention…added the concept of ‘environmental rights’ in a way that implies proactive government intervention. 

P.P.S. Ms. O’Grady also wrote a must-read column in 2021 about the dependency problem in Argentina.

P.P.P.S. What’s tragic is that there is a success story on the other side of the Andes Mountains.

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Government Failure, Captured in One Tweet

After eight years of being head of the International Monetary Fund, where she seemingly specialized in pushing for bailouts, bigger government, and higher taxes (conveniently, her lavish salary was tax exempt), Christine Lagarde was rewarded for her mistakes by being appointed president of the European Central Bank in 2019.

Amazingly, she may be an even bigger failure as a central banker. Within just a couple of years, inflation became a major problem in the eurozone (the various nations that use the euro currency).

Yet, as noted by this tweet, Ms. Lagarde apparently is mystified by what has happened while she’s been in charge.

Imagine what would happen to any senior manager in a private business if he/she would give this explanation about missing the only item listed in his/her job description.

pic.twitter.com/OJJdY9NNh3

— Michael A. Arouet (@MichaelAArouet) July 4, 2023

For what it is worth, I think this tweet is much too kind.

It implies Lagarde deserves blame merely for being caught by surprise, for “missing” the signs that inflation was about to become a big problem.

Sort of like we might be upset with a park ranger who fell asleep in his tower and didn’t see the fire starting in the forest.

But Largarde is more akin to an arsonist. Check out this chart, which shows the European Central Bank’s balance sheet, which is a good measure for how much money is being created.

Lagarde was appointed in 2019, which is when the ECB pivoted to an easy-money policy.

Heck, she doubled the size of the ECB’s balance sheet. So she was an arsonist who first doused the forest with gasoline.

Milton Friedman must be spinning in his grave.

P.S. I was worried about the ECB’s easy-money approach about 10 years ago, but that episode was trivial compared to what’s happened during Lagarde’s reign.

P.P.S. But at least Ms. Lagarde can feel confident that the IMF is carrying on her legacy.

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Joe Biden and Inflation

I have an old-fashioned belief that it’s important to be truthful when analyzing public policy. I criticize Republicans when they’re wrong and I criticize Democrats when they’re wrong. And I also praise politicians from both parties in those rare moments when they do good things.

My disdain for empty partisanship explains why I wrote back in 2022 that Joe Biden should not be blamed for high inflation.

I explained that the Federal Reserve was the culprit. America’s central bank panicked during the pandemic and dramatically increased its balance sheet. In simpler terms, they created a huge amount of new money in the economy.

And they continued with that flawed policy even after it became apparent the world wasn’t coming to an end.

The good news is that inflation is now coming down. Catherine Rampell of the Washington Post wants Joe Biden to get the credit. But she explains that he deserves credit for something he didn’t do rather than any of his policies. Here are some excerpts from her column.

…what do Democrats say is moderating price growth…? The White House credits “Bidenomics.” What that means is unclear; administration officials tout vague platitudes about “building the economy from the middle out and bottom up,” as well as big, recently passed industrial policies… But if you instead define Bidenomics as “respecting Federal Reserve independence and not interfering with Fed decisions even when they’re unpopular,” then sure: Great job, Bidenomics! …The president has been terrific at staying out of the Fed’s way, something presidents don’t always do.

I don’t always agree with Ms. Rampell, but I think this analysis is correct.

The Fed made a mess with bad monetary policy and only the Fed can fix that mistake. Biden, as Rampell noted, “has been terrific at staying out of the Fed’s way.”

If you want to understand the economics of why inflation is beginning to abate, this chart from the St. Louis Federal Reserve provides the answer. Simply stated, the Fed finally has started to withdraw some of the excess money it dumped into the economy.

By the way, while the Fed is finally doing the right thing, the central bank does not deserve praise. The nation could have avoided the pain of inflation if the Fed hadn’t started the boom-bust cycle in the first place.

P.S. Other central banks made the same mistake.

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The Federal Reserve and “Fiscal Dominance”

Appearing on Vance Ginn’s Let People Prosper, I discussed spending caps, entitlement reform, past fiscal victories, and potential future defeats.

For today, I want to highlight what I said about monetary policy.

The above segment is less than three minutes, and I tried to make two points.

First, as I’ve previously explained, the Federal Reserve goofed by dramatically expanding its balance sheet (i.e., buying Treasury bonds and thus creating new money) in 2020 and 2021. That’s what produced the big uptick in consumer prices last year.

And it’s now why the Fed is raising interest rates. Part of the boom-bust cycle that you get with bad monetary policy.

Second, I speculate on why we got bad monetary policy.

I’ve always assumed that the Fed goofs because it wants to stimulate the economy (based on Keynesian monetary theory).

But I’m increasingly open to the idea that the Fed may be engaging in bad monetary policy in order to prop up bad fiscal policy.

To be more specific, what if the central bank is buying government bonds because of concerns that there otherwise won’t be enough buyers (which is the main reason why there’s bad monetary policy in places such as Argentina and Venezuela).

In the academic literature, this is part of the discussion about “fiscal dominance.” As shown in this visual, fiscal dominance exists when central banks decide (or are forced) to create money to finance government spending.

The visual is from a report by Eric Leeper for the Mercatus Center. Here’s some of what he wrote.

…a critical implication of fiscal dominance: it is a threat to central bank success. In each example, the central bank was free to choose not to react to the fiscal disturbance—central banks are operationally independent of fiscal policy. But that choice comes at the cost of not pursuing a central bank legislated mandate: financial stability or inflation control. Central banks are not economically independent of fiscal policy, a fact that makes fiscal dominance a recurring threat to the mission of central banks and to macroeconomic outcomes. …why does fiscal dominance strike fear in the hearts of economists and financial markets? Perhaps it does so because we can all point to extreme examples where fiscal policy runs the show and monetary policy is subjugated to fiscal needs. Outcomes are not pleasant. Germany’s hyperinflation in the early 1920s may leap to mind first. …The point of creating independent central banks tasked with controlling inflation…was to take money creation out of the hands of elected officials who may be tempted to use it for political gain instead of social wellbeing.

A working paper from the St. Louis Federal Reserve Bank, authored by Fernando Martin, also discusses fiscal dominance.

In recent decades, central banks around the world have gained independence from fiscal and political institutions. The proposition is that a disciplined monetary policy can put an effective brake on the excesses of political expediency. This is frequently achieved by endowing central banks with clear and simple goals (e.g., an inflation mandate or target), as well as sufficient control over specific policy instruments… Despite these institutional advances, the resolve of central banks is chronically put to the test. … the possibility of fiscal dominance arises only when the fiscal authority sets the debt level.

The bottom line is that budget deficits don’t necessarily lead to inflation. But if a government is untrustworthy, then it will have trouble issuing debt to private investors.

And that’s when politicians will have incentives to use the central bank as a printing press.

P.S. Pay attention to Italy. The European Central Bank has been subsidizing its debt. That bad policy supposedly is coming to an end and things could get interesting.

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Understanding Keynesian Economics

While speaking last week at the Acton Institute in Michigan, I responded to a question about the perpetual motion machine of Keynesian economics.

For purposes of today’s column, let’s try to understand the Keynesian viewpoint.

First and foremost, they think spending drives the economy, whether consumer spending or government spending.

Critics like me argue that the focus should be on income and production. We want to increase saving, investment, entrepreneurship, and labor supply. Simply stated, money has to be earned before anyone spends it.

Keynesian economists, by contrast, think it is very important to distinguish between the long run and short run. In the long run, they generally would agree with the previous paragraph.

But they would argue that “stimulus” policies can be desirable in the short run if there is an economic downturn.

More specifically, they argue you can stop or minimize a recession with fiscal Keynesianism (politicians borrowing in order to boost spending) and/or monetary Keynesianism (the central bank creating money to boost spending).

I then point out that Keynesianism has a history of failure when looking at real-world evidence.

• It didn’t work for Hoover.
• It didn’t work for Roosevelt.
• It didn’t work for Japan.
• It didn’t work for Europe.
• It didn’t work for Obama.
• It didn’t work for Biden.

It’s also worth pointing out that Keynesians have been consistently wrong with predicting economic damage during periods of spending restraint.

• They were wrong about growth after World War II (and would have been wrong, if they were around at the time, about growth when Harding slashed spending in the early 1920s).
• They were wrong about Thatcher in the 1980s.
• They were wrong about Reagan in the 1980s.
• They were wrong about Canada in the 1990s.
• They were wrong after the sequester in 2013.
• They were wrong about unemployment benefits in 2020.

As you might expect, Keynesians would claim I’m misreading the evidence. They would argue that their policies prevented even-deeper recessions. Or that periods of spending restraint prevented the economy from growing faster.

So you can see why the debate never gets settled.

I’ll close with the observation that Keynesian policies actually can impact the economy. As I pointed out in the video, we can artificially boost overall consumption and spending in the short run if politicians finance a so-called stimulus by borrowing money from overseas. And we can lure people and businesses into borrowing and spending in the short run by having a central bank create more money.

But that’s sugar-high economics, the kind of approach that only helps vote-buying politicians.

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Bank Failures and the Federal Reserve’s Recipe for Hangover Economics

Want to know who to blame for the failure of Silicon Valley Bank, Signature Bank, and the general turmoil in the banking sector?

Poor management is part of the answer, of course, but the Federal Reserve also should be castigated because of bad monetary policy.

Why?

Because the central bank’s easy-money policy created artificially low interest rates, but those policies also produced high inflation, and now interest rates are going up as the Fed tries to undo its mistake.

Inspired by my “magic beans” visual, here’s a new one that shows the Fed’s boom-bust cycle.

By the way, the center box (higher prices) also includes asset bubble since bad monetary policy sometimes leads to financial bubbles instead of (or in addition to) higher consumer prices.

And higher interest rates can occur for two reasons. Most people focus on the Federal Reserve tightening monetary policy as it tries to reverse its original mistake of easy money. But don’t forget that interest rates also rise once lenders feel the pinch of inflation and insist on higher rates to compensate for the falling value of the dollar.

But let’s not digress too much. The focus of today’s column is that the Fed goofed by creating too much money in 2020 and 2021. That’s what set the stage for big price increases in 2022 and now economic instability in 2023.

Joakim Book of Reason shares my perspective. Here are excerpts from his article.

The Federal Reserve is in the unenviable position of achieving its mandate by crashing the economy. …it’s something that happens as an unavoidable outcome of slowing down an economy littered with excess money and inflation. …This hiking cycle, the fastest that the Fed has embarked upon in a generation, was always likely to break something. And break something they did over the weekend…Silicon Valley Bank (SVB), which faced the second-largest bank run in U.S. history. …this pushes the Fed into a very delicate position: risk systemic bank runs, or roll back the hikes and quantitative tightening that caused this mess, printing money for an even hotter inflation.

The Wall Street Journal also has the right perspective, editorializing that the current mess was largely caused by bad monetary policy.

Cracks in the financial system emerge whenever interest rates rise quickly after an easy-credit mania, and the surprise is that it took so long. …This week’s bank failures are another painful lesson in the costs of a credit mania fed by bad monetary policy. The reckoning always arrives when the Fed has to correct its mistakes. …We saw the first signs of panic in last year’s crypto crash and the liquidity squeeze at British pension funds. …nobody, least of all central bank oracles, should be surprised that there are now bodies washing up on shore as the tide goes out.

This tweet also notes that monetary policy is to blame.

What's the main monetary lesson from SVB?

Wrong: See what inflation-fighting does? It can cause a financial crisis. So give up and adjust the inflation target to 4%.

Right: Inflation must be fought ASAP. The longer the delay, the bigger the pain.
P.S. Don't print so much money! pic.twitter.com/2XgkpTXiO0

— Dror Goldberg (@DrorGoldberg) March 13, 2023

Finally, I can’t resist sharing some excerpts from Tyler Cowen’s Bloomberg column. He pointed out last November that the Austrian School has some insights with regards to the current mess.

The Austrian theory…works something like this: Investors expected that very low real interest rates would hold. They committed resources accordingly, and now forthcoming rates are likely to be much higher. That means the economy is stuck with malinvestment and will need to reconfigure in a painful manner. …The basic story here fits with the work of two economists from Austria, Ludwig Mises and Nobel laureate Friedrich von Hayek, and thus it is called the Austrian theory of the business cycle. The Austrian theory stresses how mistaken expectations about interest rates, brought on by changes in the rate of inflation, will lead to bad and abandoned investment projects. The Austrian theory has often been attacked by Keynesians, but in one form or another it continues to resurface in the economic data.

Needless to say, proponents of the Austrian School are not big fans of central banking.

If you want to learn more about Austrian economics, click here and here.

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Deficit Spending and Inflation

In this segment from a December interview, I explain that budget deficits are most likely to produce inflation in countries with untrustworthy governments.*

The simple message is that budget deficits are not necessarily inflationary. It depends how budget deficits are financed.

If a government finances its budget deficits by selling bonds to private savers and investors, there is no reason to expect inflation.**

But if a government finances its budget deficits by having its central bank create money, there is every reason to expect inflation.

So why would politicians ever choose the second option? For the simple reason that private savers and investors are reluctant to buy bonds from some governments.

And if those politicians can’t get more money by borrowing, and they also have trouble collecting more tax revenue, then printing money (figuratively speaking) is their only option (they could restrain government spending, but that’s the least-preferred option for most politicians).

Let’s look at two real-world examples.

• Consider the example of Japan. It has been running large deficits for decades, resulting in an enormous accumulation of debt. But Japan has very little inflation by world standards. Why? Because governments bonds are financed by private savers and investors, who are very confident that the Japanese government will not default..
• Consider the example of Argentina. It has been running large deficits for decades. But even though its overall debt level if much lower than Japan’s, Argentina suffers from high inflation. Why? Because the nation’s central bank winds up buying the bonds because private savers and investors are reluctant to lend money to the government.

If you want some visual evidence, I went to the International Monetary Fund’s World Economic Outlook database.

Here’s the data for 1998-2022 showing the average budget deficit and average inflation rate in both Japan and Argentina.

The bottom line is that prices are very stable in Japan because the central bank has not been financing Japan’s red ink by creating money.

In Argentina, by contrast, the central bank is routinely used by politicians as a back-door way of financing the government’s budget.

*To make sure that my libertarian credentials don’t get revoked, I should probably point out that all governments are untrustworthy. But some are worse than others, and rule-of-law rankings are probably a good proxy for which ones are partially untrustworthy versus entirely untrustworthy.

**Borrowing from the private sector is economically harmful because budget deficits “crowd out” private investment. Though keep in mind that all the ways of financing government (taxes, borrowing, and money creation) are bad for prosperity.

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Central Bankers Dodging Blame

The great Milton Friedman repeatedly explained that rising prices are an inevitable consequence of easy-money policies by central banks.

That’s a lesson everyone should have learned about 50 years ago when the Federal Reserve unleashed the inflation in the 1960s and 1970s (also blame Lyndon Johnson and Richard Nixon for appointing the wrong people).

And we should have learned another lesson when the Fed (with strong support from Ronald Reagan) then put the inflation genie back in the bottle in the 1980s.

But today’s central bankers must have been very bad students.

Writing for National Review, E.J. Antoni explains that we are once again bearing the inevitable cost of bad monetary policy.

…central banks are allowing interest rates to rise in an effort to belatedly respond to a crisis they helped cause. …the global economic downturn has been baked into the cake for months. …central banks around the world laid the groundwork for economic pain when they decided to finance trillions of dollars in unfunded government spending in 2020. As those central banks continued — and in some cases accelerated — their excessive money creation throughout 2021 and into 2022, a global downturn became inevitable. …History shows that high levels of inflation almost always lead to recession …once inflation became apparent central bankers persisted with their earlier course, feeding inflation, rather than starving it. If they had acted earlier, far less drastic treatment would now be required. …there is no way around the harsh reality that the bill is coming due for the last two years of monetary malfeasance.

Well said. Easy-money policy is like having six drinks at the bar. The consequences – rising prices, financial bubbles, and recessions – are akin to the hangover.

However, while I agree with the above article, I don’t agree with the title. It should be changed to: “Economies Can’t Avoid the Consequences of Central Bank Actions.”

Why the new title?

For the simple reason that central bankers are actually very capable of dodging responsibility for their mistakes.

For instance, has anyone heard the head of the Federal Reserve, Jerome Powell, apologize for dumping $4 trillion of liquidity into the economy in 2020 and 2021, thus creating today’s big price increases in the United States?

A more glaring example comes from the United Kingdom, where the former Governor of the Bank of England wants to blame Brexit. I’m not joking. Here are some excerpts from a Bloomberg story.

Former Bank of England Governor Mark Carney pointed to Brexit as a key reason why the UK central bank is now having to hike interest rates in its struggle to contain inflation. Alongside rising energy prices and a tight labor market, Britain’s exit from the European Union added to the economic headwinds for the UK, according to Carney. “In the UK, unfortunately, we’ve also had in the near term the impact of Brexit, which has slowed the pace at which the economy can grow,” Carney said in an interview with BBC Radio 4’s “Today” program on Friday. …“The economy’s capacity would go down for a period of time because of Brexit, that would add to inflationary pressure, and we would have a situation, which is the situation we have today, where the Bank of England has to raise interest rates despite the fact the economy is going into recession.”

This is galling.

Brexit did not cause inflation. The finger of blame should be pointed at the Bank of England.

Like the Fed, the BoE dramatically expanded its balance sheet starting in the spring of 2020.

And, like the Fed (and the European Central Bank), it maintained an easy-money policy for the remainder of the year and throughout 2021 – even after it became very clear that the pandemic was not going to cause an economic crisis.

To be fair, Carney left the Bank of England in early 2020, so it’s possible he might not have made the same mistake as Andrew Bailey, who took his place.

But Carney blaming Brexit shows that, if nothing else, he is willing to prevaricate to protect the BoE’s reputation.

What makes his analysis so absurd is that he almost surely would have made the same claims regardless of what happened after Brexit.

• Boris Johnson delivered Brexit, but then proceeded to enact bad policies such as higher taxes and more spending. The economy weakened and Carney says this is why the BoE is being forced to raise interest rates.
• But if Johnson had enacted good policy (the Singapore-on-Thames scenario), the economy would be performing much better. In that case, Carney doubtlessly would have claimed interest rates needed to rise because of overheating.

In reality, of course, interest rates are going up because the BoE is trying to undo its easy-money mistake.

Too bad Carney isn’t man enough to admit what’s really happening. Maybe a woman would be more honest.

P.S. The current Governor of the BoE, Bailey, also likes shifting blame since he wants people to think that Liz Truss’ proposed tax cuts were responsible for financial market instability – even though his easy-money policies are the real culprit.

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European Fiscal Policy Week, Part IV: Bad U.K. Monetary Policy Leads to Bad U.K. Fiscal Policy

I was excited about the possibility of pro-growth tax policy during the short-lived reign of Liz Truss as Prime Minister of the United Kingdom.

However, I’m now pessimistic about the nation’s outlook. Truss was forced to resign and big-government Tories (akin to big-government Republicans) are back in charge.

As part of my “European Fiscal Policy Week,” let’s take a closer look at what happened and analyze the pernicious role of the Bank of England (the BoE is their central bank, akin to the Federal Reserve in the U.S.).

Let’s start with a reminder that the Bank of England panicked during the pandemic and (like the Federal Reserve and the European Central Bank) engaged in dramatic monetary easing.

That was understandable in the spring of 2020, perhaps, but it should have been obvious by the late summer that the world was not coming to an end.

Yet the BoE continued with its easy-money policy. The balance sheet kept expanding all of 2020, even after vaccines became available.

And, as shown by the graph, the easy-money approach continued into early 2021 (and the most-recent figures show the BoE continued its inflationary policy into mid-2021).

Needless to say, all of that bad monetary policy led to bad results. Not only 10 percent annual inflation, but also a financial system made fragile by artificially low interest rates and excess liquidity.

So how does any of this relate to fiscal policy?

As the Wall Street Journal explained in an editorial on October 10, the BoE’s bad monetary policy produced instability in financial markets and senior bureaucrats at the Bank cleverly shifted the blame to then-Prime Minster Truss’ tax plan.

Bank of England Governor Andrew Bailey is trying to stabilize pension funds, which are caught on the shoals of questionable hedging strategies as the high water of loose monetary policy recedes. …The BOE is supposed to be tightening policy to fight inflation at 40-year highs and claims these emergency bond purchases aren’t at odds with its plans to let £80 billion of assets run off its balance sheet over the next year. But BOE officials now seem confused about what they’re doing. …No wonder markets doubt the BOE’s resolve on future interest-rate increases. Undeterred, the bank is resorting to the familiar bureaucratic imperative for self-preservation. Mr. Cunliffe’s letter is at pains to blame Mr. Kwarteng’s fiscal plan for market ructions. His colleagues Jonathan Haskel and Dave Ramsden —all three are on the BOE’s policy-setting committee—have picked up the theme in speeches that blame market turbulence on a “U.K.-specific component.” This is code for Ms. Truss’s agenda. …Mr. Bailey doesn’t help his credibility or the bank’s independence by politicizing the institution.

In a column for Bloomberg, Narayana Kocherlakota also points a finger at the BoE.

And what’s remarkable is that Kocherlakota is the former head of the Minneapolis Federal Reserve and central bankers normally don’t criticize each other.

Markets didn’t oust Truss, the Bank of England did — through poor financial regulation and highly subjective crisis management. …The common wisdom is that financial markets “punished” Truss’s government for its fiscal profligacy. But the chastisement was far from universal. Over the three days starting Sept. 23, when the Truss government announced its mini-budget, the pound fell by 2.2% relative to the euro, and the FTSE 100 stock index declined by 2.2% — notable movements, but hardly enough to bring a government to its knees. The big change came in the price of 30-year UK government bonds, also known as gilts, which experienced a shocking 23% drop. Most of this decline had nothing to do with rational investors revising their beliefs about the UK’s long-run prospects. Rather, it stemmed from financial regulators’ failure to limit leverage in UK pension funds. …The Bank of England, as the entity responsible for overseeing the financial system, bears at least part of the blame for this catastrophe. …the Truss government…was thwarted not by markets, but by a hole in financial regulation — a hole that the Bank of England proved strangely unwilling to plug.

Last but not least, an October 18 editorial by the Wall Street Journal provides additional information.

When the history of Britain’s recent Trussonomics fiasco is written, make sure Bank of England Governor Andrew Bailey gets the chapter he deserves. …The BOE has been late and slow fighting inflation… Mr. Bailey’s actions in the past month have also politicized the central bank…in a loquacious statement that coyly suggested the fiscal plan would be inflationary—something Mr. Kwarteng would have disputed. …Meanwhile, members of the BOE’s policy-setting committee fanned out to imply markets might be right to worry about the tax cuts. If this was part of a strategy to influence fiscal policy, it worked. …Mr. Bailey may have been taking revenge against Ms. Truss, who had criticized the BOE for its slow response to inflation as she ran to be the Conservative Party leader this summer. Her proposed response was to consider revisiting the central bank’s legal mandate. The BOE’s behavior the past month has proven her right beyond what she imagined.

So what are the implications of the BoE’s responsibility-dodging actions?

• First, we should learn a lesson about the importance of good monetary policy. None of this mess would have happened if the BoE had not created financial instability with an inflationary approach.
• Second, we should realize that there are downsides to central bank independence. Historically, being insulated from politics has been viewed as the prudent approach since politicians can’t try to artificially goose an economy during election years. But Bailey’s unethical behavior shows that there is also a big downside.

Sadly, all of this analysis does not change the fact that tax cuts are now off the table in the United Kingdom. Indeed, the new Prime Minister and his Chancellor of the Exchequer have signaled that they will continue Boris Johnson’s pro-tax agenda.

That’s very bad news for the United Kingdom.

P.S. There used to be at least one sensible central banker in the United Kingdom.

P.P.S. But since sensible central bankers are a rare breed, maybe the best approach is to get government out of the business of money.

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Understanding Inflation and the Federal Reserve

Today’s column is about inflation and I want to start by recycling this clip from an interview back in April.

The main message is that the Federal Reserve deserves the blame for inflation.

America’s central bank created dramatically expanded its balance sheet starting in early 2020. This meant lots of extra liquidity sloshing around the economy and that inevitably led to rising prices.

As Milton Friedman explained, inflation is “always and everywhere on monetary phenomenon.”

So why am I regurgitating this type of analysis? Because someone sent me a PolitiFact article from April that supposedly does a “fact check” on the claim that Biden’s spending contributed to inflation.

What shocked me is that the article never mentions the Federal Reserve or monetary policy. I’m not joking.

We decided to look at how much of an impact Biden’s spending had on prices. …some economists, including Larry Summers, a top official under President Barack Obama, warned that the bill would lead to inflation. Fiscal conservatives joined in the warning. …How much of this can be put at Biden’s feet? Some, but not all of it, experts say. …The post-COVID-19 inflation story is more complicated than just federal spending. Other forces, including changes in the labor market, rising global energy and commodity prices, supply chain dysfunction and the war in Ukraine have all contributed to higher prices. …Russia’s attack on Ukraine disrupted a world economy that was still sorting itself out after COVID. Sanctions aimed at cutting Russia’s energy revenues sent oil and gas prices soaring. The war’s crippling hit on Ukraine’s agricultural sector, combined with sanctions (Russia is a major wheat producer), has raised the prices of basic goods like wheat and sunflower oil. …none of the experts we reached, liberal and conservative, said Biden’s actions were responsible for all of the inflation. Past government spending, COVID’s disruptions to labor markets, energy prices and supply-chains also played significant roles. Most recently, the war in Ukraine has made a challenging situation worse.

This is nonsense. At the risk of being boring and wonky, the factors mentioned in the article are important, but they will only change relative prices in the absence of bad monetary policy.

In other words, energy prices may increase, but that will be offset by declines in other prices. Unless, of course, the central bank is creating too much liquidity, thus enabling an increase in the overall price level.

I’ll close with a caveat. Bad monetary policy sometimes will cause rising asset prices (a bubble) rather than rising consumer prices. Both outcomes are examples of inflation, but only the latter shows up when the government releases monthly data on the consumer price index.

That being said, is it possible that some of Biden’s (and Trump’s) spending policies led to more price inflation rather than more asset inflation?

Yes, but that’s merely shifting the deck chairs on the monetary Titanic. And it doesn’t change the fact that it is gross economic malpractice for PolitiFact to write about inflation without mentioning the Federal Reserve or monetary policy.

P.S. Here’s a humorous video about the Federal Reserve and here’s a serious tutorial video about the Federal Reserve.

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Inflation Is Caused by Bad Government Policy

Milton Friedman wisely observed that inflation is always the result of bad monetary policy by central banks. And I echoed that point last month in remarks to the European Resource Bank meeting in Stockholm.

This topic deserves more attention, particularly given the depressing inflation numbers just released this morning by the Bureau of Labor Statistics.

Some of our friends on the left want to downplay these bad numbers. In large part, they are motivated by a desire to shield President Biden from political damage. And I sympathize with them since Biden was not in the White House when the Federal Reserve decided to dump lots of liquidity into the U.S. economy.

Here’s a chart showing the Federal Reserve’s balance sheet over the past decade. It’s easy to see the Fed’s panicked response to the pandemic in early 2020.

But I don’t sympathize with folks who claim that inflation is just something random.

Some of them want to blame Putin. Or the pandemic. Or “corporate greed.” Or maybe even space aliens.

I also wonder about this tweet from Ian Bremmer. He points out that inflation is showing up everywhere, regardless of which political party (or coalition) is running a government.

But I can’t tell what he means by his final line (“wild guess it’s not the govt”).

Is he saying that we should focus on the actions of central banks, not the partisan composition of a nation’s government? If so, I agree.

Or is he saying that we should not blame any part of government? If so, I completely disagree.

Central banks may have varying levels of day-to-day independence, but they are government entities. They were created by politicians and run by people appointed by politicians.

And inflation is happening in many nations because various central banks all made similar mistakes.

For instance, Bremmer mentions Germany and Italy. Those are euro countries and you can see that the European Central Bank made the same mistake as the Fed. It panicked at the start of the pandemic and then never fixed its mistake.

Bremmer also mentioned the United Kingdom. Well, here’s the balance sheet data from the Bank of England.

Once again, you can see a big spike in the amount of liquidity created when the BoE expanded its balance sheet.

And, just as was the case with the Fed and the ECB, the BoE did not fix its mistake once it became apparent than the pandemic was not going to cause a global economic collapse.

P.S. I suggested in the video that the ECB is partly motivated by a desire to prop up decrepit welfare states in nations such as Italy and Greece. This is a point I’ve been warning about for many, many years.

P.P.S. While Biden is not to blame for the outbreak of inflation, it’s also true that he is not part of the solution and has not used his appointment power to push the Fed in a more sensible direction.

P.P.P.S. If you have the time and interest, here’s a 40-minute video explaining the Federal Reserve’s track record of bad monetary policy.

P.P.P.P.S. If you’re constrained for time, I recommend this five-minute video on alternatives to the Federal Reserve and this six-minute video on how people can protect themselves from bad monetary policy.

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The European Central Bank: Subsidizing Profligacy, Creating Bubbles

Earlier this year, I pointed out that President Biden should not be blamed for rising prices.

There has been inflation, of course, but the Federal Reserve deserves the blame. More specifically, America’s central bank responded to the coronavirus pandemic by dumping a lot of money into the economy beginning in early 2020.

Nearly a year before Biden took office.

The Federal Reserve is not the only central bank to make this mistake.

Here’s the balance sheet for the Eurosystem (the European Central Bank and the various national central banks that are in charge of the euro currency). As you can see, there’s also been a dramatic increase in liquidity on the other side of the Atlantic Ocean.

Why should American readers care about what’s happening with the euro?

In part, this is simply a lesson about the downsides of bad monetary policy. For years, I’ve been explaining that politicians like easy-money policies because they create “sugar highs” for an economy.

That’s the good news.

The bad news is that false booms almost always are followed by real busts.

But this is more than a lesson about monetary policy. What’s happened with the euro may have created the conditions for another European fiscal crisis (for background on Europe’s previous fiscal crisis, click here, here, and here).

In an article for Project Syndicate, Willem Buiter warns that the European Central Bank sacrificed sensible monetary policy by buying up the debt of profligate governments.

…major central banks have engaged in aggressive low-interest-rate and asset-purchase policies to support their governments’ expansionary fiscal policies, even though they knew such policies were likely to run counter to their price-stability mandates and were not necessary to preserve financial stability. The “fiscal capture” interpretation is particularly convincing for the ECB, which must deal with several sovereigns that are facing debt-sustainability issues. Greece, Italy, Portugal, and Spain are all fiscally fragile. And France, Belgium, and Cyprus could also face sovereign-funding problems when the next cyclical downturn hits.

Mr. Buiter shares some sobering data.

All told, the Eurosystem’s holdings of public-sector securities under the PEPP at the end of March 2022 amounted to more than €1.6 trillion ($1.7 trillion), or 13.4% of 2021 eurozone GDP, and cumulative net purchases of Greek sovereign debt under the PEPP were €38.5 billion (21.1% of Greece’s 2021 GDP). For Portugal, Italy, and Spain, the corresponding GDP shares of net PEPP purchases were 16.4%, 16%, and 15.7%, respectively. The Eurosystem’s Public Sector Purchase Program (PSPP) also made net purchases of investment-grade sovereign debt. From November 2019 until the end of March 2022, these totaled €503.6 billion, or 4.1% of eurozone GDP. In total, the Eurosystem bought more than 120% of net eurozone sovereign debt issuances in 2020 and 2021.

Other experts also fear Europe’s central bank has created more risk.

Two weeks ago, Desmond Lachman of the American Enterprise Institute expressed concern that Italy had become dependent on the ECB.

…the European Central Bank (ECB) is signaling that soon it will be turning off its monetary policy spigot to fight the inflation beast. Over the past two years, that spigot has flooded the European economy with around $4 trillion in liquidity through an unprecedented pace of government bond buying. The end to ECB money printing could come as a particular shock to the Italian economy, which has grown accustomed to having the ECB scoop up all of its government’s debt issuance as part of its Pandemic Emergency Purchase Program. …the country’s economy has stalled, its budget deficit has ballooned, and its public debt has skyrocketed to 150 percent of GDP. …Italy has had the dubious distinction of being a country whose per capita income has actually declined over the past 20 years. …All of this is of considerable importance to the world economic outlook. In 2010, the Greek sovereign debt crisis shook world financial markets. Now that the global economy is already slowing, the last thing that it needs is a sovereign debt crisis in Italy, a country whose economy is some 10 times the size of Greece’s.

Mr. Lachman also warned about this in April.

Over the past two years, the ECB’s bond-buying programs have kept countries in the eurozone’s periphery, including most notably Italy, afloat. In particular, under its €1.85 trillion ($2 trillion) pandemic emergency purchase program, the ECB has bought most of these countries’ government-debt issuance. That has saved them from having to face the test of the markets.

And he said the same thing in March.

The ECB engaged in a large-scale bond-buying program over the past two years…, as did the U.S. Federal Reserve. The size of the ECB’s balance sheet increased by a staggering four trillion euros (equivalent to $4.4 billion), including €1.85 trillion under its Pandemic Emergency Purchasing Program. …The ECB’s massive bond buying activity has been successful in keeping countries in the eurozone’s periphery afloat despite the marked deterioration in their public finances in the wake of the pandemic.

Let’s conclude with several observations.

• First, many European countries are at risk because politicians, year after year, have spent too much money (Italy is just the tip of the iceberg).
• Second, the ECB has enabled much of that spending by buying a lot of the government debt issued by Europe’s profligate nations.
• Third, there’s now a bubble thanks to the combination of bad fiscal policy by national governments and bad monetary policy by the ECB.
• Fourth, some economic misery is unavoidable, but the damage can be limited if governments impose Swiss-style spending caps.
• Fifth, the political elite in Europe do not want spending restraint and instead prefer very bad policies such as “debt mutualization.”

So if politicians won’t adopt good policies and their bad policies won’t work, what’s going to happen?

At some point, national governments will probably default.

That’s an unpleasant outcome, but at least it will stop the bleeding.

Unlike bailouts and easy money, which exacerbate the underlying problems.

P.S. For what it is worth, I do not think a common currency is necessarily a bad idea. That being said, I wonder if the euro can survive Europe’s awful politicians.

P.P.S. While I think Mr. Buiter’s article in Project Syndicate was very reasonable, I’ve had good reason to criticize some of his past analysis.

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Blame the Federal Reserve

Back in 2015, I explained to Neil Cavuto that easy money creates the conditions for a boom-bust cycle.

It’s now 2022 and my argument is even more relevant.

That’s because the Federal Reserve panicked at the start of the pandemic and dumped a massive amount of money into the economy (technically, the Fed increased its balance sheet by purchasing trillions of dollars of government bonds).

As the late, great Milton Friedman taught us, this easy-money, low-interest-rate approach produced the rising prices that are now plaguing the nation.

But that’s only part of the bad news.

The other bad news is that easy-money policy sets the stage for future hard times. In other words, the Fed causes a boom-bust cycle.

Desmond Lachman of the American Enterprise Institute explains how and why the Federal Reserve has put the country in a bad situation.

Better late than never. Today, the Federal Reserve finally took decisive monetary policy action to regain control over inflation that has been largely of its own making. …The Fed’s abrupt policy U-turn is good news in that it reduces the likelihood that we will return to the inflation of the 1970s. However, this does not mean that we will avoid paying a heavy price for the Fed’s past policy mistakes in lost output and employment. …One might well ask what the Fed was thinking last year when it kept interest rates at their zero lower bound and when it let the money supply balloon at its fastest pace in over fifty years at a time especially when the economy was recovering strongly… One might also ask what the Fed thought when it continued to buy $120 billion a month in Treasury bonds and mortgage-backed securities throughout most of last year when the equity and the housing markets were on fire?

The relevant question, he explains, is whether we have a hard landing…or a harder landing.

If the Fed sticks to its program of meaningful interest rate hikes and balance sheet reduction over the remainder of this year, there would seem to be an excellent chance that we do not return to the inflation of the 1970s. However, there is reason to doubt that the Fed will succeed in pushing the inflation genie to the bottle without precipitating a nasty economic recession. One reason for doubting that the Fed will succeed in engineering a soft economic landing is that there is no precedent for the Fed has done so when it has allowed itself to fall as far behind the inflation curve as it has done today. …there is a real risk that higher interest rates might be the trigger that bursts today’s asset and credit market bubbles. Should that indeed happen, we could be in for a tough landing. Milton Friedman was fond of saying that there is no such thing as a free lunch. This is a lesson that the Fed might soon relearn as last year’s economic party gives way to a painful economic slump.

Let’s hope we have a proverbial “soft landing,” but I’m not holding my breath.

Especially with Biden pursuing other bad policies (FWIW, I don’t blame him for today’s price spikes).

P.S. As explained in this video from the Fraser Institute, Friedrich Hayek understood a long time ago that feel-good government intervention leads to a feel-bad economic hangover.

P.P.S. Here’s my video on the Federal Reserve, which also explains that there might be a good alternative.

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Sri Lanka’s Failed Experiment with Modern Monetary Theory

No sensible person wants to copy the big-spending policies of failed welfare states such as Greece.

Unfortunately, many politicians lack common sense (or, more accurately, they are motivated by short-run political ambition rather than what’s in the long-run best interest of their nations).

So if they decide that they politically benefit by spending lots of other people’s money, they have to figure out how to finance that spending.

One option is to use the central bank. In other words, finance big government with the figurative printing press.

This is what’s know as Modern Monetary Theory.

From a theoretical perspective, it’s crazy. And if Sri Lanka is any indication, it’s also crazy based on real-world evidence.

In an article for The Print, based in India, Mihir Sharma looks at that government’s foolish monetary policy.

Cranks are considered cranks for a reason. That is the lesson from Sri Lanka… How did this tiny Indian Ocean nation end up in such straits? …the Rajapaksas turned Sri Lanka’s policymaking over to cranks… The central bank governor at the time, Weligamage Don Lakshman, informed the public during the pandemic that nobody need worry about debt sustainability…since “domestic currency debt…in a country with sovereign powers of money printing, as the modern monetary theorists would argue, is not a huge problem.” Sri Lanka is the first country in the world to reference MMT officially as a justification for money printing. Lakshman began to run the printing presses day and night; his successor at the central bank, Ajith Nivard Cabraal, who also denied the link between printing money and inflation or currency depreciation, continued the policy. …Reality did not take long to set in. By the end of 2021, inflation hit record highs. And, naturally, the clever plan to “increase the proportion of domestic debt” turned out to be impossible… Proponents of MMT will likely say that this was not real MMT, or that Sri Lanka is not a sovereign country as long as it has any foreign debt, or something equally self-serving.

Professor Steve Hanke of Johns Hopkins University also discussed Sri Lanka’s crazy monetary policy in an article for National Review. And he also offered a way to reverse the MMT mistake.

This slow-motion train wreck first began in November 2019 when Gotabaya Rajapaksa won a decisive victory in the country’s presidential elections. …In total control, President Rajapaksa and his brother Mahinda, the prime minister, went on a spending spree that was financed in part by Sri Lanka’s central bank. The results have been economic devastation. The rupee has lost 44 percent of its value since President Rajapaksa took the reins, and inflation, according to my measure, is running at a stunning 74.5 percent per year. …What can be done to end Sri Lanka’s economic crisis? It should adopt a currency board, like the one it had from 1884 to 1950… Most important, the board could not loan money to the fiscal authorities, imposing a hard budget on Ceylon’s fiscal system. The net effect was economic stability — and while stability might not be everything, everything is nothing without stability.

For readers who are not familiar with currency boards, it basically means creating a hard link with another nation’s currency – presumably another nation with a decent history of monetary restraint.

It’s what Hong Kong has with the United States (even though U.S. monetary policy over time has been less than perfect).

A currency board is not quite the same as “dollarization,” which is actually adopting another nation’s currency, but it’s a way of making sure local politicians have one less way of ruining an economy.

Let’s conclude with a story from the U.K.-based Financial Times, written by Tommy Stubbington and Benjamin Parkin. They provide some grim details about Sri Lanka’s plight.

Sri Lanka owes $15bn in bonds, mostly dollar-denominated, of a total $45bn long-term debt, according to the World Bank. It needs to pay about $7bn this year in interest and debt repayments but its foreign reserves have dwindled to less than $3bn. …Sri Lanka has never defaulted and its successive governments have been known for a market-friendly approach. …Sri Lanka has previously entered 16 programmes with the IMF.

By the way, I can’t help but comment about a couple of points in the article.

The reporters claim that Sri Lanka has been “known for a market-friendly approach.”

To be blunt, this is nonsense. I’ve been dealing with international economic policy for decades and no supporter of free markets and limited government has ever claimed the country was anywhere close to being a role model for good policy.

And if you peruse the latest edition of Economic Freedom of the World, you’ll see that Sri Lanka has very low scores, far below Greece and only slightly ahead of Russia.

And you can click here to see that it has always received dismal scores.

But maybe it’s “market-friendly” by the standards of left-leaning journalists.

I also can’t resist noting that Sri Lanka has already received 16 bailouts from the International Monetary Fund, according to the article.

This is further evidence that it’s not a market-oriented nation.

And it’s also evidence that IMF intervention does not make things better. In many cases, it’s akin to sending an arsonist to put out a fire.

P.S. The Mihir Sharma article also discusses the Sri Lankan government’s crazy approach to agriculture.

Last April, the government followed through on a campaign promise to transition Sri Lanka to organic farming by banning the import and use of synthetic fertilizers. More than two-thirds of Sri Lanka’s people are directly or indirectly dependent on agriculture; economists and agronomists warned that a transition to organic farming on that scale would destroy productivity and cause incomes to crash. …Unsurprisingly, the cranks were wrong. The production of rice — the basic component of Sri Lankans’ diet — and of tea — the country’s main export — sank precipitously.

Needless to say, it’s not a good idea for politicians to deliberately hurt a nation’s agriculture sector.

Just like it’s not a good idea for politicians in places like the United States to deliberately subsidize the sector. The right approach is to be like New Zealand and have no policy.

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The Economics of Greed

Looking back on the 2008 financial crisis, it seems clear that much of that mess was caused by bad government policy, especially easy money from the Federal Reserve and housing subsidies from Fannie Mae and Freddie Mac.

Many of my left-leaning friends, by contrast, assert that “Wall Street greed” was the real culprit.

I have no problem with the notion that greed plays a role in financial markets, but people on Wall Street presumably were equally greedy in the 1980s and 1990s. So why didn’t we also have financial crises during those decades?

Isn’t it more plausible to think that one-off factors may have caused markets to go awry?

I took that trip down Memory Lane because of a rather insipid tweet from my occasional sparring partner, Robert Reich. He wants his followers to think that inflation is caused by “corporate greed.”

For what it’s worth, I agree that corporations are greedy. I’m sure that they are happy when they can charge more for their products.

But that’s hardly an explanation for today’s inflation.

After all, corporations presumably were greedy back in 2015. And in 2005. And in 1995. So why didn’t we also have high inflation those years as well?

If Reich understood economics, he could have pointed out that today’s inflation was caused by the Federal Reserve and also absolved Biden by explaining that the Fed’s big mistake occurred when Trump was in the White House.

I don’t expect Reich to believe me, so perhaps he’ll listen to Larry Summers, who also served in Bill Clinton’s cabinet.

But I won’t hold my breath.

As Don Boudreaux has explained, Reich is not a big fan of economic rigor and accuracy.

P.S. Reich also blamed antitrust policy, but we have had supposedly “weak antitrust enforcement” since the 1980s. So why did inflation wait until 2021 to appear?

P.P.S. In addition to being wrong about the cause of the 2008 crisis, my left-leaning friends also were wrong about the proper response to the crisis.

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Don’t Blame Joe Biden for High Inflation

I’m more than happy to condemn Joe Biden for his bad policy proposals, such as higher tax rates, fake stimulus, red tape, and a bigger welfare state.

But as I discuss in this segment from a recent interview, he bears very little blame for today’s high inflation rate.

If you want to know who is responsible for 8.5 percent inflation, the highest in four decades, this chart tells you everything you need to know.

Simply stated, the Federal Reserve has created a lot more money by expanding its balance sheet (which happens, for example, when the central bank purchases government bonds using “open market operations”).

Notice, by the way, that the Fed dramatically expanded its balance sheet beginning in March 2020. That was almost one year before Biden was inaugurated.

At the risk of stating the obvious, Biden does not have the power of time travel. He can’t be at fault for a monetary policy mistake that happened when Trump was president.

That being said, I don’t want anyone to think that Biden believes in good monetary policy.

• Biden has never made any sort of statement favoring monetary restraint by the Fed.
• Neither the president not his senior advisors have urged the Fed to reverse its mistake.
• Biden renominated Jerome Powell to be Chairman of the Fed’s Board of Governors.
• None of Biden’s other nominees to the Federal Reserve have a track record of opposing easy money.

The bottom line is that the Fed almost surely would have made the same mistake in 2020 if Biden was in the White House.

But he wasn’t, so he gets a partial free pass.

P.S. Speaking of time travel, Paul Krugman blamed Estonia’s 2008 recession on spending cuts that took place in 2009.

P.P.S. Here’s my two cents on how people can protect themselves in an inflationary economy.

P.P.P.S. Only one president in my lifetime deserves praise for his approach to monetary policy.

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Blame the Federal Reserve

The good thing about being a policy-driven libertarian is that I don’t feel any need to engage in political spin.

I can praise Democrats who do good things and praise Republicans who do good things. And also criticize members of either party (sadly, that’s a more common task).

It also means I don’t believe in blaming politicians for things that are not their fault. For example, NBC just released a poll showing that Joe Biden has low marks for economic policy.

Some of that is appropriate (his fiscal policy is atrocious, to cite one reason), but I think the answers to this question show that the president is getting a bum rap on one issue.

Why am I letting Biden off the hook about monetary policy?

For the simple reason that the Federal Reserve (the “Fed”) deserves the blame. The central bank’s inflationary policies are the reason that prices are rising.

One can claim that Joe Biden is partly to blame because he recently re-nominated Jay Powell, the current Chairman of the Fed. But, if that’s the case, then Donald Trump also is partly to blame – or even more to blame – because he nominated Powell in the first place.

Moreover, as illustrated by this chart, the Fed’s mistake that led to rising prices occurred in early 2020.

Simply stated, the Fed pumped lots of liquidity into the system. That set the stage for today’s price increases (as Milton Friedman told us, there’s always a lag between decisions about monetary policy and changes in prices).

If you look closely, you’ll notice that this massive monetary intervention began nearly one year before Biden took office.

Given his support for Keynesian fiscal policy, I suspect Biden also believes in Keynesian monetary policy. As such, we presumably would have had the same policy if Biden had been elected in 2016.

In other words, Biden would have been just like Trump. At least on this issue.

But none of that changes the fact that Biden’s actions since becoming president have very little to do with today’s price increases.

Let’s close with a few additional observations about the aforementioned polling results.

• The folks at NBC deserve some criticism for failing to give people the option of choosing the Federal Reserve’s monetary policy. I’m guessing this was because of ignorance rather than bias.
• The people who blamed “corporations increasing prices” obviously didn’t pay attention in their economics classes. Rising prices are a symptom of inflation, not the cause.
• The people who blamed Putin for inflation are even more ignorant. At the risk of stating the obvious, a Russian invasion in February of 2022 obviously wasn’t responsible for rising prices in 2021.

P.S. The inflation-recession cycle caused by bad monetary policy could be avoided if the Fed was constrained by some simple rules.

P.P.S. Or maybe, just maybe, we should reconsider the role of central banks.

P.P.P.S. For what it’s worth, very few politicians have the intelligence and fortitude to support good monetary policy.

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The Most Important Thing to Understand about Inflation

Every few years (2012, 2015, 2019), I warn that easy-money policies by the Federal Reserve are misguided.

But not just because such policies eventually can lead to price inflation, which now has become a problem in the United States.

Bad monetary policy also can lead to asset inflation. In other words, bubbles. And it’s no fun when bubbles burst.

The obvious lesson to be learned is that central banks such as the Fed shouldn’t try to steer the economy with Keynesian-style monetary policy.

I’m motivated to write about this issue because the Washington Post recently invited some people to offer their ideas on how to fight inflation.

Some of the ideas were worthwhile.

• Michael Strain recommended trade liberalization.
• Brian Riedl recommended spending restraint.
• Matt Darling recommended deregulation.

Some of the ideas were bad, or even awful.

• Robert Hockett recommended industrial policy.
• Lauren Melodia recommended government-subsidized child care.
• William Spriggs recommended class-warfare taxation.
• Lindsay Owens recommended antitrust intervention.
• Todd Tucker recommended price controls.

If asked to contribute, what would I have suggested?

Being a curmudgeonly libertarian, I would have channeled the spirit of Milton Friedman and pointed out that bad monetary policy by central banks is the cause of inflation. Simply stated, it is appropriate to blame central banks if there are sustained and permanent increases in the overall price level.

And the only way to fix inflation is for central banks to unwind the policy mistakes that caused the problem in the first place.

Some of the respondents did mention the need for Federal Reserve to rectify its mistakes, so I’m not the only one to think monetary policy is important.

But I’m very fixated on assigning blame where it belongs, so I would not have mentioned any other factor.

For instance, in an article just published by the Austrian Economics Center in Vienna, Robert O’Quinn and I explain that bad fiscal policy does not cause inflation.

Are we seeing higher levels of price inflation because of fiscal profligacy?  Some Republican U.S. Senators and Representatives have blamed this acceleration of price inflation on Biden’s blowout of federal spending. There are many good reasons to criticize Biden’s spending spree. It is not good for the economy to increase the burden of government spending and push for higher tax rates… But that does not necessarily mean deficit spending is inflationary. …Price inflation occurs when the supply of money exceeds the demand for money… Notably, none of the mechanisms that central banks use for monetary policy (buying and selling government securities, setting interest rates paid on reserves, loans to financial institutions, etc) have anything to do with federal spending or budget deficits.  The Fed and other central banks can maintain price stability regardless of whether governments are enacting reckless fiscal policies.

In the article, we cited Japan as an example of a country with huge levels of debt, yet prices are stable.

By contrast, prices are rising in the United States because of Keynesian monetary policies by the Federal Reserve (often with the support of politicians).

What’s causing inflation, if not budget deficits and government debt? …central banks have been pursuing an inflationary policy. But they’ve been pursuing that approach not to finance budget deficits, but instead are motivated by a Keynesian/interventionist viewpoint that it is the role of central banks to “stimulate” the economy and/or prop up the financial market with easy-money policies.

I’ll close by observing that there can be a link between bad fiscal policy and inflation.

In basket-case nations such as Venezuela, Zimbabwe, and Argentina, politicians periodically use central banks to finance some of their excessive spending.

Some governments, particularly in less-developed countries, cannot easily borrow money and they rely on their central banks to finance their budget deficits. And that is clearly inflationary.

Because of changing demographics and poorly designed entitlement programs, it’s possible that the United States and other western nations eventually may get to this point.

Heck, I speculated just a couple of days ago that the European Central Bank may be doing this with Italy.

But the United States hasn’t yet reached that “tipping point.” There are still plenty of investors willing to buy the federal government’s debt (especially since the dollar is the world’s reserve currency).

The bottom line is that we should pursue good fiscal policy because it makes sense. And we should pursue good monetary policy because it makes sense. But the two are not directly connected.

P.S. On the topic of inflation, Ronald Reagan deserves immense praise for standing firm for good policy in the 1980s.

P.P.S. On the topic of the Federal Reserve, the central bank also should be criticized for interfering with the allocation of credit. And financial repression as well.

P.P.P.S. On the topic of basket-case economies, let’s hope that the American policy makers don’t embrace “modern monetary theory.”

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How Can People Protect Themselves from Bad Monetary Policy?

In the libertarian fantasy world, we would have competing private currencies. In the real world, we have a government central bank.

And central banks have a track record of bad monetary policy, so here’s my two cents on how people can try to protect their household finances.

The above video is a clip from a longer presentation I made as part of “Libertarian Solutions,” an online program put together by the folks at Liberty International.

And I should point out that I goofed around the 3:28 mark of the video, when I meant to say “not planning to take it all out in 2009” (a dumb mistake, but not as bad as the time I said “anals” rather than “annals” on live TV).

That correction aside, I was tasked with discussing how people can prosper in spite of bad government policy, and, as you can see, I did not pretend to have any uniquely brilliant investment strategies.

So I focused on explaining the risks of bad monetary policy, especially the way that central banks (and other government policies) create boom-bust cycles in the economy.

If I had more time, I could have talked about additional threats, such as the crackpot idea of “modern monetary theory.”

And I probably should have found some time to explain the notion of “financial repression” since that’s a government policy that has a very direct adverse effect on people trying to build wealth.

One final point. While I’m very hopeful that they may somehow help people protect their personal finances, you’ll notice that I didn’t recommend cryptocurrencies such as Bitcoin. This is for two reasons.

1. I don’t know enough about how they work to competently discuss the issue.
2. I fear that governments will have the power, desire, and ability to squash the market.

Needless to say, I hope I’m wrong about the second point.

P.S. A classical gold standard could block central banks from engaging in bad monetary policy, but returning to that type of system is almost as unlikely as a shift to private currencies.

P.P.S. While I’m obviously not a big fan of the Federal Reserve, other nations have even worse experiences with their central banks, which is why “dollarization” makes sense for many developing countries.

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A Gold Standard vs. the Federal Reserve’s Fiat Money

I’m not a big fan of the Federal Reserve, mostly because of its Keynesian monetary policy.

Incumbent politicians often applaud when the central bank intervenes to create excess liquidity and artificially low interest rates. That’s because the Keynesian approach produces a short-run “sugar high” that seems positive.

But such policies also create boom-bust conditions.

Indeed, the Federal Reserve deserves considerable blame for some of the economy’s worst episodes of the past 100-plus years – most notably the Great Depression, 1970s stagflation, and the 2008 financial crisis.

So what’s the solution?

I’ve previously pointed out that the classical gold standard has some attractive features but is not politically realistic.

But perhaps it’s time to reassess.

In a column for today’s Wall Street Journal, Professors William Luther and Alexander Salter explain the differences between a gold standard and today’s system of fiat money (i.e., a monetary system with no constraints).

Under a genuine gold standard, …Competition among gold miners adjusts the money supply in response to changes in demand, making purchasing power stable and predictable over long periods. The threat of customers redeeming notes and deposits for gold discourages banks from overissuing… Fiat dollars aren’t constrained by the supply of gold or any other commodity. The Federal Reserve can expand the money supply as much or as little as it sees fit, regardless of changes in money demand. When the Fed expands the money supply too much, an unsustainable boom and costly inflation follow.

They then compare the track records of the two systems.

…nearly all economists believe the U.S. economy has performed better under fiat money than it would have with the gold standard. This conventional wisdom is wrong. The gold standard wasn’t perfect, but the fiat dollar has been even worse. …in practice, the Fed has failed to govern the money supply responsibly. Inflation averaged only 0.2% a year from 1790 to 1913, when the Federal Reserve Act passed. Inflation was higher under the Fed-managed gold standard, averaging 2.7% from 1914 to 1971. It has been even higher without the constraint of gold. From 1972 to 2019, inflation averaged 4%. …the Fed…has also become less predictable. In a 2012 article published in the Journal of Macroeconomics, George Selgin, William D. Lastrapes and Lawrence H. White find “almost no persistence in the variance of inflation prior to the Fed’s establishment, and a very high degree of persistence afterwards.” …One might be willing to accept the costs of higher inflation and a less predictable price level if a Fed-managed fiat dollar reduced undesirable macroeconomic fluctuation. But that hasn’t happened. Consider the past two decades. The early 2000s had an unsustainable boom, as the Fed held interest rates too low for too long.

There was also a column on this issue in the WSJ two years ago.

James Grant opined about (the awful) President Nixon’s decision to make Federal Reserve policy completely independent of the gold anchor.

Richard Nixon announced the suspension of the Treasury’s standing offer to foreign governments to exchange dollars for gold, or vice versa, at the unvarying rate of $35 an ounce. The date was Aug. 15, 1971. Ever since, the dollar has been undefined in law. …In the long sweep of monetary history, this is a new system. Not until relatively recently did any central bank attempt to promote full employment and what is called price stability (but is really a never-ending inflation) by issuing paper money and manipulating interest rates. …a world-wide monetary system based on the scientifically informed discretion of Ph.D. economists. The Fed alone employs 700 of them.

But Grant says the gold standard worked reasonably well.

A 20th-century scholar, reviewing the record of the gold standard from 1880-1914, was unabashedly admiring of it: “Only a trifling number of countries were forced off the gold standard, once adopted, and devaluations of gold currencies were highly exceptional. Yet all this was achieved in spite of a volume of international reserves that, for many of the countries at least, was amazingly small and in spite of a minimum of international cooperation . . . on monetary matters.” …Arthur I. Bloomfield wrote those words, and the Federal Reserve Bank of New York published them, in 1959.

The new approach, which Grant mockingly calls the “Ph.D. standard,” gives central bankers discretionary power to do all sorts of worrisome things.

The ideology of the gold standard was laissez-faire; that of the Ph.D. standard (let’s call it) is statism. Gold-standard central bankers bought few, if any, government securities. Today’s central bankers stuff their balance sheets with them. In the gold-standard era, the stockholders of a commercial bank were responsible for the solvency of the institution in which they held a fractional interest. The Ph.D. standard brought the age of the government bailout and too big to fail.

By the way, the purpose of today’s column isn’t to unreservedly endorse a gold standard.

Such as system is very stable in the long run but can lead to short-term inflation or deflation based on what’s happening with the market for gold. And those short-term fluctuations can be economically disruptive.

I was messaging earlier today with Robert O’Quinn, the former Chief Economist at the Department of Labor (who also worked at the Fed) and got this reaction to the Luther-Salter column.

Which is better matching the long-term growth of the economy and the demand for money? The profitability of gold mining or central bank decision-making? A good monetary rule may be better than a classical gold standard. The difficulty is sustaining a good rule.

The ;problem, of course, is that I don’t trust politicians (and their Fed appointees) to follow a good rule.

• Especially in a world where many of them believe in Keynesian boom-bust monetary policy.
• Especially in a world where many of them think the Fed should prop up or bailout Wall Street.
• Especially in a world where many of them might use the central bank to finance big government.
• Especially in a world where many of them support a “war against cash” to empower politicians.

The bottom line is that we have to choose between two imperfect options and decide which one has a bigger downside.

P.S. Since a return to a classical gold standard is highly unlikely (and because the libertarian dream of “free banking” is even more improbable), the best we can hope for is a president who 1) makes good appointments to the Fed, and 2) supports sound-money policies even when it means short-run political pain. We’ve had one president like that in my lifetime.

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The Federal Reserve, Inflation, and Asset Bubbles

Having been exposed to scholars from the Austrian school as a graduate student, I have a knee-jerk suspicion that it’s not a good idea to rely on the Federal Reserve for macroeconomic tinkering.

In this interview from yesterday, I specifically warn that easy money can lead to economically harmful asset bubbles.

 

Since I don’t pretend to be an expert on monetary policy, I’ll do an appeal to authority.

Claudio Borio of the Bank for International Settlements is considered to be one of the world’s experts on the issue.

Here are some excerpts from a study he recently wrote along with three other economists. I especially like what they wrote about the risks of looking solely at the price level as a guide to policy.

The pre-crisis experience has shown that, in contrast to common belief, disruptive financial imbalances could build up even alongside low and stable, or even falling, inflation. Granted, anyone who had looked at the historical record would not have been surprised: just think of the banking crises in Japan, the Asian economies and, going further back in time, the US experience in the run-up to the Great Depression. But somehow the lessons had got lost in translation… And post-crisis, the performance of inflation has repeatedly surprised. Inflation…has been puzzlingly low especially more recently, as a number of economies have been reaching or even exceeding previous estimates of full employment. …the recent experience has hammered the point home, raising nagging doubts about a key pillar of monetary policymaking. …Our conclusion is that…amending mandates to explicitly include financial stability concerns may be appropriate in some circumstances.

Here’s a chart showing that financial cycles and business cycles are not the same thing.

The economists also point out that false booms instigated by easy money can do a lot of damage.

Some recent work with colleagues sheds further light on some of the possible mechanisms at work (Borio et al (2016)). Drawing on a sample of over 40 countries spanning over 40 years, we find that credit booms misallocate resources towards lower-productivity growth sectors, notably construction, and that the impact of the misallocations that occur during the boom is twice as large in the wake of a subsequent banking crisis. The reasons are unclear, but may reflect, at least in part, the fact that overindebtedness and a broken banking system make it harder to reallocate resources away from bloated sectors during the bust. This amounts to a neglected form of hysteresis. The impact can be sizeable, equivalent cumulatively to several percentage points of GDP over a number of years.

Here’s a chart quantifying the damage.

And here’s some more evidence.

In recent work with colleagues, we examined deflations using a newly constructed data set that spans more than 140 years (1870–2013), and covers up to 38 economies and includes equity and house prices as well as debt (Borio et al (2015)). We come up with three findings. First, before controlling for the behaviour of asset prices, we find only a weak association between deflation and growth; the Great Depression is the main exception. Second, we find a stronger link with asset price declines, and controlling for them further weakens the link between deflations and growth. In fact, the link disappears even in the Great Depression (Graph 4). Finally, we find no evidence of a damaging interplay between deflation and debt (Fisher’s “debt deflation”; Fisher (1932)). By contrast, we do find evidence of a damaging interplay between private sector debt and property (house) prices, especially in the postwar period. These results are consistent with the prevalence of supply-induced deflations.

I’ll share one final chart from the study because it certainly suggest that the economy suffered less instability when the classical gold standard was in effect before World War I.

I’m not sure we could trust governments to operate such a system today, but it’s worth contemplating.

P.S. I didn’t like easy money when Obama was in the White House and I don’t like it with Trump in the White House. Indeed, I worry the good economic news we’re seeing now could be partly illusory.

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