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The Myth of Shock-Free Monetary Policy / Artikel mises.org (engl.)

verfasst von - Elli -, 07.07.2004, 18:28

-->Hoffentlich kein Unsinn, habe es nicht gelesen und kann es evtl. nicht beurteilen.

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http://www.mises.org/fullstory.asp?control=1561
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The Myth of Shock-Free Monetary Policy
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by Frank Shostak

[Posted July 7, 2004] 

<img height="121" alt src="http://www.mises.org/images3/light.gif" width="104" align="right" border="0">On
June 30, the Fed lifted its Federal Funds rate target by 0.25% to 1.25%. The
catalyst that brought about the reversal in the trend towards lower rates was
a series of rising economic indicators, including GDP growth, job creation,
and the fear of price inflation.

Only a few months ago, the
prospect of inflation wasn't even discussed by Fed's policy makers. It has now
become an important concern. The yearly rate of growth of the consumer price
index (CPI) jumped from 1.7% in February to 3% in May. Similarly the yearly
rate of growth of the personal consumption price deflator jumped to 2.5% in
May from 1.5% in February.

<img alt src="http://www.mises.org/images3/shostak/07-06-2004/1.gif" border="0" width="259" height="223">

Against all these developments,
Fed policy makers have concluded that the Fed Funds rate target of 1% is far
too low and runs the risk of undermining the central bank's objective of
maintaining price stability and bringing the economy onto a stable growth
path.

In the released statement the Fed
signalled that there are likely to be further increases in the Fed Funds rate
target, however these increases will be gradual. To be sure the Fed also added
that its policy makers will respond to changes in economic prospects as needed
to fulfil its obligation to maintain price stability.

Both the rate decision by the FOMC
and the wording in the Fed's statement were widely expected by financial
markets players. Several months prior to the June 30 meeting, most Fed
officials, including the Fed chairman Alan Greenspan, didn't hesitate efforts
to broadcast their intentions to financial markets.They believe that this
policy of transparency will eliminate unnecessary disruptions and will allow
the US central bank to navigate the economy towards a path of economic
stability and prosperity.

This is all part of a new effort
to conduct monetary policy in the absence of"shocks." This is the
newest vision of monetary utopia that will permit the Fed to expand money and
credit, be the lender of last resort, and maintain the world dollar standard,
without having to face negative consequences.

The goal of shockless monetary
policy also accounts for why the fed funds rate will be raised only
gradually. According to various experts, the Fed should aim at a Fed
Funds rate target of around 4% to 5%, because within this range the Fed Funds
rate is regarded as neutral-neither stimulating nor restraining the economy.

Now, if the"right"
target is within the 4% to 5% range why not to raise the target to this level
immediately? The answer to this is in order to not create shocks, since the
knowledge we possess of an economy's response to changes in interest rates is
not adequate.

Furthermore, this gradual approach
gives individuals plenty of time to adjust to the tighter monetary stance.
This adjustment in turn will neutralize the possible harmful effect that such
a tighter stance may have on the economy. In short, a transparent and gradual
approach will enable the Fed's policy makers to navigate the economy in a
smooth way towards the stable growth path they desire.

But is it possible by means of a
gradual and transparent monetary policy to undo the damage inflicted to the
economy by previous loose monetary policies? According to mainstream economic
thinking it would appear that this is the case. What are the sources of this
way of thinking?

In his various writings the
champion of the monetarist school of thinking Milton Friedman has argued that
there is a variable lag between changes in money supply and its effect on real
output and prices. Friedman holds that in the short run changes in money
supply will be followed by changes in real output.

However, in the long-run changes
in money will only have an effect on prices. All this means that changes in
money with respect to real economic activity tend to be neutral in the
long-run and non-neutral in the short-run. Thus according to Friedman,

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">

In the short-run, which may be
as much as five or ten years, monetary changes affect primarily output. Over
decades, on the other hand, the rate of monetary growth affects primarily
prices.<a id="_ftnref1" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftn1" name="_ftnref1">[1]</a>

[/i]

According to Friedman because of
the difference in the time lag the effect of the change in money supply shows
up first in output and hardly at all in prices. It is only after a longer time
lag that changes in money start to have an effect on prices. This is the
reason why in the short-run money can grow the economy, while in the long-run
it has no effect on the real output.

In short, according to Friedman
changes in money supply affect nominal economic activity. However, on account
of the difference in the time lag the monetary effect shows itself first in
real output and hardly at all in prices.

According to Friedman, the main
reason for the non-neutrality of money in the short-run is the variability in
the time lag between money and the economy. Consequently, he believes that if
the central bank were to follow a constant money rate of growth rule this
would eliminate fluctuations caused by variable changes in the money supply
rate of growth. In other words, the constant money growth rule could also make
money neutral in the short-run and the only effect that money would have is on
general prices only.

Thus according to Friedman,

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">

On the average, there is a close
relation between changes in the quantity of money and the subsequent course
of national income. But economic policy must deal with the individual case,
not the average. In any case, there is much slippage. It is precisely this
leeway, this looseness in the relation, this lack of mechanical one-to-one
correspondence between changes in money and in income that is the primary
reason why I have long favoured for the USA a quasi-automatic monetary
policy under which the quantity of money would grow at a steady rate of 4 or
5 per cent per year, month-in, month-out.<a id="_ftnref2" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftn2" name="_ftnref2">[2]</a>

[/i]

In his Nobel lecture Robert Lucas
raised an issue with this. According to Lucas,

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">

If everyone understands that
prices will ultimately increase in proportion to the increase in money, what
force stops this from happening right away?<a id="_ftnref3" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftn3" name="_ftnref3">[3]</a>

[/i]

Consequently, Lucas has suggested
that the reason why money does generate a real effect in the short run is not
so much due to the variability of monetary time lags but more bound up with
whether money changes were anticipated or not. If monetary growth is
anticipated then people will adjust to it rather quickly and there will not be
any real effect on the economy. Only unanticipated monetary expansion can
stimulate production.

Moreover, according to Lucas,

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">

Unanticipated monetary
expansions, on the other hand, can stimulate production as, symmetrically,
unanticipated contractions can induce depression.<a id="_ftnref4" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftn4" name="_ftnref4">[4]</a>

[/i]

Both Friedman and Lucas are of the
view, although for slightly different reasons, that it is desirable to make
money neutral in order to avoid unstable and therefore unsustainable economic
growth. The current practice of Fed policy makers seems to incorporate the
ideas of Friedman and Lucas into the so-called transparent monetary policy
framework. This framework accepts Lucas's view that anticipated monetary
policy can lead to stable economic growth. This framework also accepts that a
gradual change in monetary policy in the spirit of Friedman's constant money
growth rule, could reinforce the transparency.

But does it all make much sense?
If unexpected monetary policies can cause real economic growth, what is wrong
with this? Why not constantly surprise people and cause more real wealth?

Money, expectations and
economic growth

What is required for economic
growth is a growing pool of real savings, which funds various individuals that
are engaged in the build-up of capital goods. An increase in money, however,
has nothing to do as such with this. On the contrary this increase only leads
to consumption that is not supported by production of real wealth.
Consequently, this leads to a weakening in the real pool of savings, which in
turn undermines real economic growth. All that printing money can achieve is a
redirection of real savings from wealth generating activities towards
non-productive wealth consuming activities. So obviously there cannot be any
economic growth as a result of this redirection.

Unanticipated monetary growth will
undermine real economic growth via the dilution of the pool of real funding.
Why is it then that one observes that rising money is associated with a rise
in economic indicators like real GDP? All that we observe in reality is an
increase in monetary spending - this is what GDP depicts. In other words,
the more money that is printed, the higher GDP will be (see chart).

<img alt src="http://www.mises.org/images3/shostak/07-06-2004/2.gif" border="0">

So-called real GDP is merely
nominal GDP deflated by a meaningless price index. Hence so-called observed
economic growth is just the reflection of monetary expansion and has nothing
to do with real economic growth, which cannot be measured by quantitative
methods. After all, it is not possible to establish a meaningful total by
adding potatoes and tomatoes. So while unanticipated monetary growth cannot
grow the economy it definitely produces a real effect by undermining the pool
of real savings and thereby weakening the real economy.

Likewise anticipated money growth
cannot be harmless to the real economy. Even if the money rate of growth is
fully anticipated there is always someone who gets it first.

For instance, consider the
individual who fully expects the future course of monetary policy. This
individual now decides to borrow $1000 from a bank. The bank obliges and lends
him the $1000, which the bank has created out of"thin air". Now,
since this money is unbacked by any previous production of real wealth it will
set in motion an exchange of nothing for something, or a redirection of real
savings from wealth generators towards the borrower of the newly created
$1000. This redirection and hence real negative effect on the pool of savings
cannot be prevented by an individuals' correct expectation of monetary
policies.

Even if the money is pumped in
such a way that everybody gets it instantaneously, changes in the demand for
money will vary - after all every individual is different from other
individuals. In other words there will always be somebody who will spend the
newly received money before somebody else. This of course will lead to the
redirection of real wealth to the first spender from the last spender.

We can thus conclude that
regardless of expectations, loose monetary policy will always undermine the
foundations of the real economy while tight monetary policy will work to
arrest this process. Hence monetary policy can never be neutral.

Furthermore, it is not possible by
means of loose monetary policy to set in motion a so-called unsustained
economic growth as suggested by Friedman and other writers. Unsustained
economic growth requires a corresponding increase in savings, which at any
point in time is given. Loose monetary policy can only weaken savings and
thereby weaken economic growth. Economic booms, Mises emphasized, are not
about prosperity but economic impoverishment. (See also"Economic
Growth and Its Causes: Comment on Holcombe")

Can a gradual tightening
prevent an economic bust?

Since monetary growth, whether
expected or unexpected, gives rise to the redirection of real funding it means
that any monetary tightening slows down this redirection. In short, various
economic activities which sprang-up on the back of strong monetary pumping
will now on account of a tighter monetary stance get less real funding. This
in turn means that these activities are given less support and run the risk of
being liquidated. It is the liquidation of these activities what an economic
bust is all about.

Obviously, then, the tighter
stance that the Fed has decided to adopt must put pressure on various false
activities, or various artificial forms of life. Hence the tighter the Fed
gets the slower the pace of redirection of real savings will be, which in turn
means that more liquidation of various false activities will take place. In
the words of Ludwig von Mises,

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">

The boom brought about by the
banks' policy of extending credit must necessarily end sooner or later.
Unless they are willing to let their policy completely destroy the monetary
and credit system, the banks themselves must cut it short before the
catastrophe occurs. The longer the period of credit expansion and the longer
the banks delay in changing their policy, the worse will be the consequences
of the malinvestments and of the inordinate speculation characterizing the
boom; and as a result the longer will be the period of depression and the
more uncertain the date of recovery and return to normal economic activity.<a id="_ftnref5" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftn5" name="_ftnref5">[5]</a>

[/i]

The suggestion that it is possible
to avoid the outcome of previous loose monetary policies by means of
transparent policies is erroneous. It is not possible to avoid the effects of
a given cause, which in turn means that it is not possible to avoid the
damage that past monetary printing has inflicted.

Consequently, the currently
emerging view that the Fed can lift interest rates to the 4%-5% range without
any disruption doesn't hold water. Obviously if the pool of savings is still
expanding then this may mitigate the severity of the bust. However, given the
current high levels of debt in the economy it is quite likely that the US
economy may already have a stagnant or perhaps falling pool of real savings.

In this regard home mortgages as a
percentage of disposable income rose to a new record high of 80.9% in Q1 from
80.2% in the previous quarter. Furthermore, consumer credit as a percentage of
disposable income stood at a near record high of 21.1% in May against the all
time record of 21.3% reached in September 2003.

<img alt src="http://www.mises.org/images3/shostak/07-06-2004/3.gif" border="0"> <img alt src="http://www.mises.org/images3/shostak/07-06-2004/4.gif" border="0">

Additionally the personal savings
rate remains under pressure. It fell to 2.2% in May from 2.6% in the previous
month. Note that in October 1981 the savings rate stood at 12.5%.

<img alt src="http://www.mises.org/images3/shostak/07-06-2004/5.gif" border="0">

The only reason why the economy
continues to march ahead is on account of the positive flow of funding from
the rest of the world. Thus in Q1 the balance on the US current account was in
deficit by $145 billion against a deficit of $127 billion in the previous
quarter. As a percentage of nominal GDP the current account deficit stood at
5.1% in Q1 against 4.5% in Q4.

Although the present emerging
tighter stance is likely to produce pain, there is currently no other
alternative that can prevent the decimation of economy's real foundations
brought about by extremely loose monetary policy. However, we suggest that one
shouldn't exclude the possibility that if the economy were to plunge on
account of the emerging tighter interest rate stance that the Fed may make a
quick reversal of its stance. Whether this possible reversal would arrest the
plunge will be determined by the availability of real savings from the rest of
the world.

<img alt src="http://www.mises.org/images3/shostak/07-06-2004/6.gif" border="0"> <img alt src="http://www.mises.org/images3/shostak/07-06-2004/7.gif" border="0">

The popular view that transparent
monetary policies will allow the Fed to tighten its stance without any
disruptions is based on erroneous ideas. There is no such thing as a"shock-free"
monetary policy any more than a monetary expansion can ever be truly neutral
to the market. Regardless of policy transparency once a tighter monetary
stance is introduced, it sets in motion an economic bust. The severity of the
bust is conditioned by the length and magnitude of the previous loose monetary
stance and overall economic health. 

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<hr align="left" width="33%" SIZE="1">
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Frank Shostak is an adjunct
scholar of the Mises Institute and a frequent contributor to Mises.org. He
maintains weekly data on the AMS for subscribers through Man
Financial, Australia. Send him MAIL and
see his outstanding Mises.org Daily
Articles Archive. Comment on this article on the
Mises
Economics Blog.

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<hr align="left" width="33%" SIZE="1">
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<div id="ftn1">
<a id="_ftn1" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftnref1" name="_ftn1">[1]</a> Milton
Friedman The Counter-Revolution in Monetary Theory. Occasional
Paper 33, Institute of Economic Affairs for the Wincott Foundation.
London: Tonbridge, 1970.

</div>
<div id="ftn2">
<a id="_ftn2" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftnref2" name="_ftn2">[2]</a> Milton
Friedman The Counter-Revolution in Monetary Theory

</div>
<div id="ftn3">
<a id="_ftn3" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftnref3" name="_ftn3">[3]</a> Robert
E. Lucas, Jr Nobel Lecture:Monetary Neutrality, Journal of Political
Economy, 1996, vol. 104,no. 4

</div>
<div id="ftn4">
<a id="_ftn4" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftnref4" name="_ftn4">[4]</a> Ibid.

</div>
<div id="ftn5">
<a id="_ftn5" title href="http://www.mises.org/fullstory.asp?control=1561&R=The+Myth+of+Shock%2DFree+Monetary+Policy&rng=66828#_ftnref5" name="_ftn5">[5]</a> Ludwig
von Mises, The"Austrian" Theory of the Trade Cycle. The
Ludwig von Mises Institute 1983.

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The Myth of Shock-Free Monetary Policy / Artikel mises.org (engl.) - - Elli -, 07.07.2004, 18:28