Tag Archives: monetary policy

Monetary Policy: The Best Case Scenario


7. The New Deal and the Post War International Monetary System – Murray N Rothbard

Milton Friedman is said to have mesmerised several countries with a flying visit!?

Milton Friedman visited Australia in 1975. He spoke with government officials and appeared on the  TV show  Monday Conference. Apparently, that was enough for him to take over Australian monetary policy setting for the foreseeable future.


When working at the next desk to the monetary policy section in the late 1980s, I heard not a word of Friedman’s Svengali influence:

  • The market determined interest rates, not the reserve bank was the mantra for several years. Joan Robinson would be proud that her 1975 visit was still holding the reins.
  • Monetary policy was targeting the current account. Read Edwards’ bio of Keating and his extracts from very Keynesian treasury briefings to Keating signed by David Morgan that reminded me of macro101.

See Ed Nelson’s (2005) Monetary Policy Neglect and the Great Inflation in Canada, Australia, and New Zealand who used contemporary news reports from 1970 to the early 1990s to uncover what was and was not ruling monetary policy. For example:

“As late as 1990, the governor of the Reserve Bank rejected central-bank inflation targeting as infeasible in Australia, and cited the need for other tools such as wages policy (AFR, October 18, 1990).”

Bernie Fraser was still sufficiently deprogrammed in 1993 to say that “…I am rather wary of inflation targets.” Easy to then announce one in the same speech when inflation was already 2-3%.


When as a commentator on a Treasury seminar paper in 1986, Peter Boxhall – fresh from the US and 1970s Chicago educated – suggested using monetary policy to reduce the inflation rate quickly to zero, David Morgan and Chris Higgins almost fell off their chairs. They had never heard of such radical ideas.

In their breathless protestations, neither were sufficiently in-tune with their Keynesian educations to remember the role of sticky wages or even the need for the monetary growth reductions to be gradual and, more importantly, credible as per Milton Freidman and as per Tom Sargent’s End of 4 big and two moderate inflations papers.

I was far too junior to point to this gap in their analytical memories about the role of sticky wages, and I was having far too much fun watching the intellectual cream of the Treasury senior management in full flight. At a much later meeting, another high flying deputy secretary was mystified as to why 18% mortgage rates were not reining in the current account in 1989.

Friedman’s Svengali influence did not extend to brainwashing in the monetarist creed that the lags on monetary policy were long and variable. The 1988 or 1989 budget papers put the lag on monetary policy at 1 year, which is short and rapier, if you ask me.

When did Canberra policy makers accept that inflation was a monetary phenomenon?

Australian policymakers from at least 1971 viewed inflation as not a consequence of their monetary policy decisions. There were repeated references by them to wage-price spirals and both unsuccessful (1977) and successful attempts (1981) at wage freezes.


The prices and incomes accord from 1983 onwards was just another 1970s wage tax trade-off. An Incomes policy attributes inflation to non-monetary factors, as did Fraser and Lynch regularly.

• It was not until 1980 that the Fraser government’s monetary policy became genuinely anti-inflationary. With a lag, these changes halved inflation to the mid-single digits by 1983. The implementation lag on the 1975 Monday conference programme must have been long and variable and lasted for a three year window!? Three years out of 20 is hardly a monetarist hegemony!

• Australia had lower CPI inflation in the 1980s than the 1970s, but this was marred by rebounds in 1985–86 and 1988–90 to near 9%.

The monetary policy regime change in the late 1980s was triggered by factors besides rising inflation: a demonic view of currant account.

After several years of high interest rates, the budget papers forecasted a moderate slowing:
• The budget GDP forecast for 1990-91 was 2% with an actual of minus 0.4%; for inflation the actual and forecast were 5.3% versus 6.5%; 1989-90 inflation rate was 8% with GDP growth of 3.3%.

• In 1991-92, the budget GDP forecast was 1.5% with an actual of 2.1%; for inflation the actual and forecast were 1.9% versus 3.8%.

• In 1992-93, the budget papers forecast for inflation 3% for an actual of 1%.

• In 1993-94, the budget forecast for inflation 3.5% for an actual of 1.8%.

The monetarists in the Treasury, entranced as they were by Friedman’s 1975 visit, still had not clicked to the link between a tight monetary policy and low inflation as late as 1993. Australia pursued a stop-go monetary policy from 1971 to the early 1990s.

I worked in the next desk to the monetary policy section in the Prime Minister’s Department in the 1980s. They were determined that market set interest rates, not monetary policy.

I suggest you read the biography of keating by john edwards(?) – his economic advisor in the late 1980s.

Edwards quotes from numerous Treasury briefings to Keating. the Treasury remembered their Keynesian educations well, as did those at DPMC. the prices and incomes accord was very Keynesian: inflation as a non-monetary phenomenon

Mentioning Friedman’s name in the 1980s at job interviews would have been extremely career limiting. Not much better in the early 1990s. Back in the late 1980s, Friedman was graduating from ‘a wild man in the wings’ to just a suspicious character in policy circles.

If you name dropped Hayek in the 1980s and 1990s, any sign of name recognition would have indicated that you were been interviewed by people who were very widely read.

% of New Zealand mortgages that were fixed and floating since 2004

Despite the best efforts of the libertarian paternalists to sell the other people are stupid fallacy, ordinary New Zealanders are quite nimble at moving between fixed and floating rates depending upon their forecasts of the future of interest rates. Price controls on floating rate mortgages, as suggested by the New Zealand Labour Party, would make this more difficult, not easier.


Source: S8 Banks: Mortgage lending ($m) – Reserve Bank of New Zealand.

% industrialised countries at zero or near zero central bank interest rates

Compliance by the Fed with the Taylor rule

Greg Mankiw on the zero influence of modern macroeconomics on monetary policy making

Two of my brothers studied economics in the early 1970s and then went on to different paths in law and computing respectively. If Greg Mankiw is right, my two older brothers could happily conduct a conversation with a modern central banker. Their 1970s macroeconomics, albeit batting for memory, would be enough for them to hold their own.


Source: AEAweb: JEP (20,4) p. 29 – The Macroeconomist as Scientist and Engineer – Greg Mankiw (2006).

I would spend my time arguing with a central banker that Milton Friedman may be right and central banks should be replaced with a computer. The success of inflation targeting is forcing me to think more deeply about that position. In particular the rise of pension fund socialism means that most voters are very adverse to inflation because of their retirement savings and that is before you consider housing costs are much largest proportions of household budgets these days.

ABCT insights are predominantly a theory of unsustainable credit-induced booms


via What Austrian business cycle theory does and does not claim as true | Institute of Economic Affairs

A severe commentary

I don’t place much weight on criticisms of forecasting errors. If someone is any good at forecasting the economy, they would be fabulously rich through trading on their own account rather than working in a central bank.

The fact that Reserve Banks can’t forecast with any greater accuracy than anybody else is a bit of an indictment considering they have inside knowledge of the future course of monetary policy.

By the way, I wrote my masters sub thesis on official forecasting errors.

croaking cassandra

Plenty of commentaries have remarked on the very low inflation numbers out this morning.

None (that I have seen) has highlighted what a severe commentary these numbers are on the Reserve Bank’s conduct of monetary policy over the last few years.

Reciting the history in numbers gets a little repetitive, but:
• December 2009 was the last time the sectoral factor model measure of core inflation was at or above the target midpoint (2 per cent)
• Annual non-tradables inflation has been lower than at present only briefly, in 2001, when the inflation target itself was 0.5 percentage points lower than it is now.
• Non-tradables inflation is only as high as it is because of the large contribution being made by tobacco tax increases (which aren’t “inflation” in any meaningful sense).
• Even with the rebound in petrol prices, CPI inflation ex tobacco was -0.1 over the last year…

View original post 1,600 more words

Has New Zealand been in deflation since 2012?

All agree that the consumer price index (CPI) is biased and overstates inflation. In 1996, economists hired by the Senate Finance Committee estimated that the U.S. CPI overstates annual inflation by 1.1% (Boskin et al. 1996). That estimated CPI bias has not gotten smaller with time. It is now up to 1.5%, even 2%.

One of the rationales for the inflation target of the Reserve Bank of New Zealand of 0-2% was the 2% was to account for the consumer price index was biased upwards. Targeting 0% would lead to mild deflation when inflation was properly measured.

The main biases in the consumer price index everywhere come from how to handle changes in the quality of goods and services and how to deal with completely new goods and services.

I thought I might see what happened if I took this one and a half percentage point annual bias in the CPI estimated for the USA and adjusted the New Zealand CPI inflation rates available at the Reserve Bank of New Zealand’s website over the last 20 years or so with this number.


If these consumer price index bias adjustments are correct, and they are roughly correct, inflation came to a dead stop  in New Zealand after the global financial crisis in 2008, spiked again, and then moved into deflation in 2012. If anything, there’s been a mixture of price stability and the deflation since 2012.

People get quite hot and bothered with deflation. The New Zealand economy has been in a deflationary phase since the beginning of 2012  but it is recently grown so quickly that  it is referred to in the media as the rock-star economy.

Breathless journalism aside , fears of inflation are just a legacy of the great depression in the 1930s. The only depression where deflation was accompanied by mass unemployment was the Great Depression. Mild deflation with good growth is a common phenomena as Atkinson and Kehoe found:

Are deflation and depression empirically linked? No, concludes a broad historical study of inflation and real output growth rates.

Deflation and depression do seem to have been linked during the 1930s. But in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link.

The three lags on monetary policy

There are large uncertainties about the size and timing of responses to changes in monetary policy. There is a close and regular relationship between the quantity of money and nominal income and prices over the years. However, the same relation is much looser from month to month, quarter to quarter and even year to year. Monetary changes take time to affect the economy and this time delay is itself highly variable. The lags on monetary policy are three in all:

  1. The lag between the need for action and the recognition of this need (the recognition lag)

  2. The lag between recognition and the taking of action (the legislation lag)

  3. the lag between action and its effects (the implementation lag)

These delays mean that is it difficult to ascertain whether the effects of monetary policy changes in the recent past have finished taking effect.

Secondly, it is difficult to ascertain when proposed changes in monetary policy will take effect. Thirdly, feedbacks must be assessed. The magnitude of the monetary adjustment necessary to deal with the problem at hand is never obvious.

It is common for a central bank to act incrementally. The central bank makes small adjustments to monetary conditions over time as more information is available on the state of the economy and forecasts are updated.

Most discussions on monetary policy focus on the implementation lag. This lag depends on the fundamental characteristics of the economy.

A long and variable implementation lag means that it is difficult for central banks to ascertain what is happening now or forecast what will happen. Central banks may stimulate the economy after it is well on the way to recovery and tighten monetary policy when the economy is already going into a recession.

In his classic A Program for Monetary Stability, published in 1959, Milton Friedman summarised his empirical findings on length and variability of the lags on monetary policy:

on the average of 18 cycles, peaks in the rate of change in the stock of money tend to preceded peaks in general business by about 16 months and troughs in the rate of change in the stock of money to precede troughs in general business by about 12 months. For individual cycles, the recorded lead has varied between 6 and 29 months at peaks and between 4 and 22 months at troughs.

With lags as variable as those estimated by Friedman, it is difficult to see how any policy maker could know which direction to adjust his policy, much less the precise magnitude needed. Long lags greatly complicate good forecasting. A forecaster cannot know what the state of the economy will be when his policy takes effect.

Many Keynesians, Friedman notes, advocate “leaning against the wind.” By this they mean, in some sense, that the monetary (and fiscal) authorities should try to balance out the private sector’s excesses rather than passively hope that it adjusts on its own.

Friedman tested the Fed’s success at leaning “against the wind” by checking whether the rate of money growth has truly been lower during expansions and higher during contractions. He admits that this method of grading he Fed’s performance is open to criticism, but decides to go ahead and see what turns up. He finds that Fed has – for the periods surveyed – been unsuccessful.

By this criterion, for eight peacetime reference cycles from March 1919 to April 1958. Actual policy was in the ‘right’ direction in 155 months, in the ‘wrong’ direction in 226 months; so actual policy was ‘better’ than the [constant 4% rate of money growth] rule in 41% of the months.

Nor is the objection that the inter-war period biased his study is good since Friedman found that:

For the period after World War II alone, the results were only slightly more favourable to actual policy according to this criterion: policy was in the ‘right’ direction in 71 months, in the ‘wrong’ direct in 79 months, so actual policy was better than the rule in 47% of the months. [2]

One of the best ways to parry a metaphor is with another metaphor. Keynesians have a host of metaphors in their rhetorical arsenal; one frequently voiced is that a wise government should “lean against the wind” when choosing policy. Friedman counters:

We seldom know which way the economic wind is blowing until several months after the event, yet to be effective, we need to know which way the wind is going to be blowing when the measures we take now will be effective, itself a variable date that may be a half year or a year or two from now. Leaning today against next year’s wind is hardly an easy task in the present state of meteorology.

By scrutinising the practice of monetary policy over the decades, Friedman manages to produce objections that both Keynesians and non-Keynesians must take seriously. A key part of any response to Friedman rests on the ability of forecasters to do their jobs with tolerable accuracy.