Wednesday, October 10, 2007

David Laidler: money or interest? (amv)

Here is an outstanding paper written by David Laidler (outstanding is what Laidler usually does). It is not only a short but excellent review of the history of international monetary policy and theory, he also points out three aspects which I heavily endorse:
  1. That the rise of cost-push theories of inflation and the subordination of the role of money caused the great inflation of the the late 60s and 70s. (In contrast to Laidler I believe that the cost-push myth is still widely believed [e.g. Issing's (!) textbook "Einf├╝hrung in die Geldtheorie"]. It is inherent in the concept of the Phillips curve and still used to "explain," for instance, how the impact of globalization is at least disinflationary. Urk!)
  2. That economists systematically underestimate their responsibility for ill-advised policy. As Laidler mentions: "The above-mentioned lessons about the dangers of applying academic ideas to policy without due caution, that is to say, have not yet quite sunk in." (p. 22)
  3. That one of these dangers lies in the recent fashion to ignore the money supply and instead to focus on the short run interest rate (and closely associated on the term structure). Laidler: "Specifically, the fact that demand for money functions proved insufficiently stable over monthly or even quarterly intervals to provide a basis for regular monetary policy decisions, does not imply that the only variables of any significance for monetary policy under any circumstances are the short interest rates that central banks use as their instruments, but it seems to be widely believed nowadays that this is the case." And he goes on: "Over-exclusive emphasis on the role of interest-rates in monetary policy has already done damage, having, in the 1990s, led the Bank of Japan into thinking that, once short interest rates reach zero, it had exhausted its options, and hence into not tackling promptly and vigorously the credit deadlock which followed the collapse of the “bubble economy”. This erroneous view of the limits of monetary policy is but one implication of what has now evolved into a standard model of the implementation of monetary policy through an interest rate instrument, which, though its daytoday usefulness is not in question, is inconsistent with the empirical evidence generated by the
    monetary history discussed in earlier in this paper." (p. 22-3)