Bloggers >>>>>>>>>> Central banks
By Scott Sumner
Over the past 6 years the blogging world (especially market monetarists) has been highly critical of central banks. Outsiders might have trouble discerning who’s right. After all monetary policy is highly complicated. Why should we care about the views of a bunch of guys wearing pajamas, sitting in their basement typing away with two fingers? Central banks are full of talented economists from elite universities.
But this isn’t one of those he said/she said situations. We know who has been right, because the central bank have consistently changed policy, and done so in the direction the market monetarists (and to be fair some Keynesians as well) recommended. First the Fed. Then the Bank of England and the Bank of Japan. More recently the Riksbank admitted it screwed up. And today we see the ECB admitting that they have messed up badly:
FRANKFURT (Reuters) – The European Central Bank slashed its forecasts on Thursday for growth and inflation over the next two years, saying the outlook had deteriorated since its last staff forecasts were published in September.
It forecast 2014 inflation at 0.5 percent, rising slightly to 0.7 percent next year and 1.3 percent in 2016.
The ECB is a bit vague about their inflation target, but it’s believed to be around 1.9%. So their policy will continue to fall well sort of this target, as it has in recent years. We told you so. (And they are still too optimistic.)
I don’t think this is just luck. The blogging world is highly competitive, whereas central banks are cumbersome monopolies. After a while people tune out bloggers than consistently cry wolf, predicting hyperinflation. In contrast, failed central banks face no competition. The following quotation is a perfect illustration of why we must take monetary policy out of the hands of government bureaucrats, and let market forces set interest rates and the money supply:
By lowering its forecasts, which show how the ECB expects the economy to develop, the euro zone central bank will heighten expectations that it will take further steps to bolster the bloc’s flagging economy.
ECB President Mario Draghi recently threw the door open for drastic measures to prevent growth and inflation from sliding further and expectations are rising that a move could come as soon as the first three months of next year.
As soon as next year, eh? Under a “target the forecast” policy regime, central banks would not lower their inflation target; they’d change their monetary policy enough so that they still expected to hit their target. It would be analogous to a ship captain who adjusted the steering as soon as she noticed the ship drift off course. The actual ECB is like a captain that takes a three-hour nap before getting around to adjusting the steering, and then does so far too passively. The BOJ is far from perfect, but at least they moved quickly when they saw inflation falling below target. But even Japan could do better with a market-based policy regime, as the markets in Japan saw that monetary policy would undershoot 2% inflation well before the central bank did.
Of course it’s unlikely that we’ll be able to abolish central banks in the near future. Is there any policy regime that would overcome bureaucratic inefficiencies? Fortunately there is—it’s called level targeting. Under level targeting, market forces begin to push prices and NGDP closer to target whenever policy accidentally drifts off course. It’s a near perfect policy for a world of incompetent central banks. In contrast, hoping for better leaders will not work. People like Ben Bernanke and Mark Carney are as qualified as anyone in the world to run a central bank. But central banks are bigger than any individual, and can only work effectively with the right policy regime in place. That means NGDP targeting, level targeting.
BTW, the ECB also predicts that Europe will never recover from the recession:
Staff cut their prediction for economic output in the euro zone to 0.8 percent this year, 1.0 percent in 2015 and 1.5 percent in 2016.
Ten years ago Europe was much poorer than the United States. In recent years, it has fallen even further behind. And the ECB now predicts that in the years to come Europe will fall still further behind. Europe was once an inspiring model for the American left. Now it seems stuck in a semi-permanent depression.
Shorter version of post: MMs believe in market forecasts. Anyone who thinks we are wrong can get rich betting against us. What other school of thought will make that offer?