Bring back monetarism!
By Scott Sumner
The Economist recently ran an article comparing the economic crises in Turkey and Argentina:
Why Argentine orthodoxy has worked no better than Turkish iconoclasm
Both countries’ currencies have plunged. Only one is taking the prescribed medicine
After discussing Turkey, the article turns to Argentina:
Argentina, by contrast, has stuck much closer to convention. Its finance minister has two economics-related degrees. Its central bank has raised interest rates through the roof (lifting them to 60% on August 30th), and its government has secured prompt and generous assistance from the IMF, which agreed to a $50bn loan in June, the largest in its history. And yet Argentina’s currency has lost over 50% of its value this year (see chart 1).
Why has Argentine orthodoxy yielded such poor results?
The rest of the article is actually quite good, but I worry that this early framing will lead readers astray (as not everyone reads an entire article.)
This opening might lead readers to assume that Argentina has tried a “conventional” tight money policy, and that it failed to prevent the peso from rapidly losing value. But has money actually been tight? Here’s the Argentine monetary base:
So if they’ve been printing money like crazy, then why are interest rates so high? The answer is simple—the Fisher effect. Printing money leads to higher inflation expectations, which leads to higher interest rates. As Milton Friedman pointed out back in 1997, low rates are generally a sign that money has been tight, and high rates are a sign that it has been expansionary.
The article does eventually get to the underlying problems, including excessive government spending, an inability to borrow due to previous sovereign defaults, and the resort to printing money to fill the gap between taxes and spending. But I almost never see a graph for the monetary base in this type of news article, and that’s unfortunate.
There are lots of problems with 1970s-style monetarism. We now know that the money supply is not a reliable indicator of the stance of monetary policy, due to unstable velocity. But there are worse ideas than monetarism, and unfortunately one of those worse ideas (high interest rates imply tight money) has come to dominate the media.