Saturday, May 28, 2016

The Paper Gold Fallacy

George Selgin wrote another of installment of his excellent primer on money.   Nick Rowe has written two blog posts about central bank profits.  Here and here.

Selgin introduces what he says is an old-fashioned distinction between money proper and money substitutes.   He explains that this distinction was initially between gold coin and various claims to gold coin.   That would have included transactions accounts issued by private banks but also redeemable currency issued by a central bank or even the Treasury.    In the U.S. today, however, Federal Reserve notes (and presumably any Treasury currency and the token coinage) count as the money proper while transactions accounts count as money substitutes.    Selgin also counts the the reserve deposits held by banks with the Federal Reserve as a money substitute--a claim to "money proper" the Federal Reserve notes also issued by the Fed.  (Of course, both now and before various other highly-liquid assets might be counted as money substitutes or not--such as overnight repurchase agreements or noncheckable savings accounts or even Treasury bills.)

Rowe discusses the profits a government earns from its central bank.   He claims that most economists see the profits to be the flow of new currency issued by the central bank.   He says that central banks don't account for it that way but rather count it as the interest earnings on their asset portfolio.   When a central bank issues currency, it purchases assets such as government bonds.   The interest on those assets generate a flow of revenue.    Rowe explains that the present value of the two flows of income are the same.

I don't disagree.   Under the first approach, the government only earns profit now from new issues of currency.    The currency issued in the past provided profit in the past, but no additional profit now or in the future.   Under the second approach, the entire currency issue allows profit to be earned now, but any increase in the quantity of currency only adds to profit by the added interest earnings from a larger asset portfolio it allows, not the entire principal amount of the newly issued currency.

I think Rowe's claim that many economists treat the flow of currency issue as profit has an important element of truth.   For example, there is a tradition of thinking about budget deficits as being financed by either money issue or debt.   While I am not aware of many economists describing this money issue as "profit," it is certainly treated as a current source of revenue.   Of course, this source of revenue is often described as an "inflation tax."   If economists were consistent, then, they would say that government spending is financed by a variety of taxes--on income, sales, what have you, and also by an inflation tax.  If government spending is greater than that amount, then it may run a budget deficit, which would always by funded by debt.   That tradition,  of treating money issue as part of "deficit finance" rather than just one of the many sources of tax revenue, appears inconsistent.

Suppose a nation on a gold standard issues redeemable hand-to-hand currency.   Since it is redeemable, it is clearly a liability--a type of government bond.  According to Selgin, it is not "money proper," but rather a money substitute.   If, as is usual, there is no nominal interest rate paid on this currency, the government is borrowing at a zero nominal interest rate.   Whether or not the government is running a budget deficit or budget surplus is really beside the point.   The government funds part of its national debt at a lower interest rate than otherwise.

Central banks, like the Bank of England, started as private banks set up to provide loans to the government.   The central bank issued redeemable hand-to-hand currency with a zero nominal interest rate.   They borrowed at a very low (zero) interest rate.    Then they shared some of that benefit with the government by lending to the government at a low (though positive) interest rate.  

There were plenty of reformers who complained about the share going to the bankers and insisted that the government should cut out the middleman and issue the currency iself.   When the Federal Reserve was set up, the U.S. national debt was being paid off, and there was concern about the inflationary consequences of money-financed budget deficits.   The redeemable currency was supposed to finance "real bills," short term commercial loans, with the benefit shared according to a formula.  The bank-shareholders of the Fed were to get a share of the income compensating them for their capital investment--something considered essential due to the risk of failure.   The government was left as the residual claimant.    Today, the Fed, like nearly all central banks, is effectively nationalized with the earnings going to the government, though even today, the U.S. member banks do earn something.

For many years, the Fed's asset portfolio was almost entirely government bonds.   The U.S. government ran budget deficits and had a large and growing national debt.   The Fed collected interest from the government, but nearly all of that money was given back to the government.   It seemed to be little more than a shell game.   If the increase in base money was less than the budget deficit, the notion that the flow of new money was an alternative to debt as a source of deficit finance seemed plausible enough.    That there has been persistent price inflation over the period makes the term "inflation tax" also quite reasonable.   If the quantity of currency had increased no more than the demand to hold it at constant purchasing power, "inflation tax" might seem like a stretch.   If the quantity of currency increased an even smaller amount, so that it appreciated in value "inflation tax" would seem a misnomer.   But that was hardly the issue during the period of high and rising inflation during the seventies.

Since 2008, there have been some problems with this traditional framing.   First, the increase in the monetary base was greater than the increase in the national debt.   The Fed sold of part of its holdings of government bonds and expanded its balance sheet by purchasing private securities--mortgage backed securities guaranteed by the Federal government.   Finally, the Fed began to pay interest on reserve balances and those reserve balances became the larger part of the Fed's liabilities.   The tangible hand-to-hand currency that pays no interest remains large in absolute value, but no longer is the other form of Fed liabilities trivially small.   Perhaps most importantly, the Fed remains committed to an inflation target, so that it is committed to do something to make sure that the large increase in the monetary base has no more than a minimal impact on inflation.   Most obviously, the large increase in the monetary base is temporary, though the Fed could continue to hold a large asset portfolio by paying a sufficiently high interest rate on reserves or borrowing in some other way.

I find it difficult to characterize the issue of hand-to-hand currency under this scheme as anything other than the Fed funding a portion of its asset portfolio at a low (zero) nominal interest rate and negative real interest rate.   This is profitable for the Fed and these profits are almost entirely transferred to the government.    I am not saying that it is impossible to frame this as the flow of newly-issued currency being profit to the government.  I just don't see that as a helpful framing any more.

Selgin's essay explicitly treats government-issued hand-to-hand currency as "money proper" and states that the banks' reserve balances at the Fed are claims to currency.   This is a bit unconventional.  If anything, the more usual view is that because the Fed adjusts the quantity of currency passively to demand, it is bank reserves that are more important.  Of course, traditionally, it was interest rate on inter-bank lending in the reserve market that was emphasized by the Fed and most monetary economists.  The interest rate paid on those reserves began to receive more attention since 2008.   And the interest rate at which the Fed lends reserves to banks received much more emphasis in years long past and actually played a significant role in Fed policy in 2008 and 2009.

Still, this process of passive adjustment of the quantity of current to demand very much involves banks redeeming reserve balances for currency and making currency deposits as well.   But is Selgin's distinction economically useful?

I describe both Selgin and Rowe's approach as the "paper gold fallacy."   For a government with an entirely irresponsible monetary policy, then the paper gold framing is useful.    In a gold standard country, gold prospectors can pick up gold nuggets and spend them.   What this does to the purchasing power of money is likely to be of little interest to them.   With a fiat currency and a completely irresponsible government, money is printed more or less for free and then spent by the government on whatever it wants.   The "irresponsible" element of this is that the government doesn't worry about what this does to the purchasing power of money.   (It is the evil capitalist speculators causing the inflation say the socialist leaders of Venezuela as they print up money and spend it.)

With a gold standard, the flow of new gold is small relative to the existing stock of gold.   While the rate of change is unlikely to be constant, it is easy to see how some economists would see intentionally limiting the issue of new money to a slow, stable growth rate as a way of imposing responsibility on a government issuing fiat currency.   Rather than just printing up money and spending it willy-nilly with never a thought about what this might do to the purchasing power of money--exactly like our gold prospector--a responsible government might follow a quantity rule limiting the issue of paper money to something like would occur with the quantity of gold.   Just as the quantity of gold rises a slow, somewhat steady rate, the quantity of paper money can increase at a slow, perfectly steady, rate.   This will provide the government with a source of revenue, but it is limited in a responsible way.

Many economists have had a pretty pessimistic view about the prospects of responsible issue of fiat currency.   There are plenty of examples of wildly irresponsible monetary regimes.   And when the last ties to gold went away in the late twentieth central, the major industrialized countries certainly looked pretty irresponsible as the Great Inflation developed.   And other than the tiny remnant who favored a return to redeemability, most advocates of a constrained monetary policy supported a constant growth rate in some measure of the quantity of money.

In my view, economists who were critics of the gold standard in the nineteenth and twentieth central were never advocating an irresponsible monetary policy nor did they advocate a quantity rule for paper currency.   A much more typical view would be that the quantity of money be adjusted to stabilize its purchasing power.   Clearly, any such regime is inconsistent with the government simply printing it up and spending it without constraint.   Creating money cannot be like gold prospectors picking up gold nuggets and just spending them.

And further, adjusting the quantity of money to keep its purchasing power stable is not the same and at least potentially inconsistent with some notion that "responsibility" involves the government just printing money and spending it at a limited rate, more or less like the stock of gold grows at a slow rate.  

In fact, the economics of gold mining does result in the flow of gold adjusting in a way that tends to stabilize its purchasing power.   A higher relative price of gold makes it profitable to expand the production of gold and a lower relative price of gold makes it less profitable to add to the existing stock of gold.   Economists who were critical of the gold standard claimed that adjustments in the quantity of an irredeemable paper money could improve on that process and provide more stability.

If the demand for hand-to-hand currency is always growing, then the issue of currency could well be treated as a source of government revenue even if it is constrained so that its purchasing power be stable. When the demand for currency grows more rapidly, then more revenue would be generated from this source.   When the demand for currency grows more slowly, less revenue would be generated.

But what happens if the demand for currency decreases?   With the irresponsible monetary policy, understood like the gold prospectors spending the nuggets the pick up, then this must means more inflation than otherwise.   In fact, decreases in the real demand for currency is just a step in the predictable process of hyperinflationary collapse.   When a "responsible" monetary policy is understood as a constant growth rate of currency, then a decrease in the demand for currency is also inflationary.   It raises the growth path of the price level.   Under this sort of regime, if we imagine that the demand for currency might fall to zero one day, we are left with puzzles as to why such currency has any value today.

However, there is nothing difficult about handling a decrease in the demand to hold hand-to-hand currency.   Governments and their central banks issued redeemable hand-to-hand currency and the possibility of a decrease in the demand to hold that currency was a constant source of worry.   Central banks hold assets and can sell them off as needed to reduce the quantity of currency (or reserves.)    But even if the government is typically just spending currency at a variable rate according to the rate of increase in the demand for currency, all it needs to do in response to a decrease in the demand for currency is to sell government bonds.

Framing the issue of currency as the government's profit from the central bank might be useful if the demand for currency always grows--even with a responsible monetary policy.  But I don't think that a public finance regime where total government spending changes with the rate of growth in currency demand is sensible.   I am pretty sure that varying other tax rates to stabilize government spending when currency demand grows more or less quickly would be unwise.   Keeping tax rates stable is good policy.  A much more sensible approach would be to sell bonds when currency demand grows more slowly and buy them back when currency demand grows more quickly.   To me, a much better framing of such a scheme is that the government is running a budget deficit all the time and it is funding part of the national debt by issuing a type of debt that has a zero nominal interest rate when it can and funds it with interest bearing debt when it must.   While the interest rate on most types of debt would change to clear the market, the issue of currency would have to adjust with the demand to hold it at a zero nominal interest rate.   (Of course, the nominal and real demand for currency would depend on the nominal anchor.  I favor a stable growth path for nominal GDP rather than a stable price level or modest inflation.)

From this perspective, there is no puzzle at all about what happens if currency demand actually falls.  Just sell more bonds.

And this is why "helicopter money" is meaningless.  If the Treasury issues currency and spends it, it can always withdraw it from circulation by selling bonds.   There is nothing "permanent" about the quantity of any sort of money.  And if the goal is to maintain the purchasing power of money (or have its real purchasing power depreciate at a constant rate), then changes in the quantity of money should not be permanent.

Is the notion that the demand for currency might fall nonsense?  Is it reasonable to follow Rowe's approach at treat the demand for currency as a fixed proportion of nominal GDP?   Perhaps for Canada, but in the U.S. substantial amounts of currency are held in other countries.   What if they start to use Euros?   Further, the "legitimate" use of currency could be substantially replaced by improved electronic payments.   Scott Sumner is always emphasizing that most currency demand is really by criminals (including?) tax evaders.   Suppose some types of vice are legalized or the tax system is improved so that there is less motivation (or ability) to evade taxes even using currency transactions?   It seems to me that substantial reductions in the demand for currency are quite possible.

And, of course, there is the possibility of allowing private banks to issue hand-to-hand currency.   In my view, it really isn't that difficult to pay interest on that currency to those who withdraw it from their banks.   If permitted, this could greatly reduce the demand for government currency.

Treating currency issued by the government as a special type of debt, that allows the government to borrow and a low (zero) nominal interest rate and with our current inflationary policy, at a negative real interest rate, is a much more sensible way to frame this when it is understood that the demand for hand-to-hand currency is not something that is always growing.   And further, a quantity rule for any sort of money, much less currency alone, are not desirable.  And, of course, printing money and just spending it is a recipe for disaster.

Returning to Selgin, I see the identification of currency as "money proper" as simply another aspect of the paper gold fallacy.   There is no reason to expect that the quantity of currency will behave like the quantity of gold.   And it almost certainly shouldn't behave like the quantity of gold.   The quantity of currency should adjust according to the demand to hold it.    If the central bank is treated as autonomous, it is a liability of the central bank.   Just as a private bank can and should adjust the quantity of hand-to-hand currency according to the demand to hold it, so should the central bank adjust the quantity of hand-to-hand currency it issues according to the demand to hold it.   If the central bank's balance sheet is consolidated with the rest of the government, then hand-to-hand currency is a type of government debt and the amount issued can and should adjust with the demand to hold it.   That is, with the desire to lend to the government in that particular way.

In my view, most payments are made with transactions accounts.   When these payments are cleared, they are redeemed with balances at the central bank.   I think that today, the most important element of redemption is with the reserve balance portion of the Fed's balance sheet.   To me, emphasizing hand-to-hand currency is the tail wagging the dog.

I think the paper gold fallacy (framing) has served some economists poorly in recent years.   The huge increase in the quantity of reserves was supposed to cause hyperinflation.  Why?  Because of an implicit assumption that it was permanent.   Just as newly discovered gold nuggets would be permanent.    Well, it might be, but it doesn't have to be and most market participates clearly don't believe it will be.

But more importantly, even though governments and central banks have no redemption requirement for hand-to-hand currency, they should act as if they do.  That is, treating the issue of new currency as profit and not worrying about its purchasing power should be seen by everyone for what it is--irresponsible.


Monday, May 23, 2016

Variable Interest on Reserves and Volatility of Short Term Interest Rates

JP Koning commented on my last post suggesting that floating interest rates on reserves would lead to "incredible" volatility in short term interest rates.

First, I must admit that the institutional framework I described is consistent with the Fed doing interest rate smoothing as much as it desires.   I don't favor such a policy, but it would be possible.

If, instead, we consider a k percent rule for reserves (including k=0,) then a floating interest rate on reserves would tend to increase the volatility of short term interest rates relative to what would occur with a fixed interest rate on reserves, including keeping it at zero.

In my view, the added variability of short interest rates would be desirable to the degree it reflects changes in the supply or demand for credit.  This is equivalent to variation in the short run Wicksellian natural interest rate.   In that situation, a fixed interest rate on reserves, much less a policy of adjusting the quantity of reserves to smooth short run interest rates, is disequilibrating.   It is keeping the market rate from tracking the natural interest rate and creating undesirable short run fluctuations in aggregate nominal expenditures.

However, to the degree that shifts in the demand to hold money (or reserves) is creating short run fluctuations in interest rates, interest rate smoothing is exactly what should occur.  The quantity of reserves would be adjusted to the demand to hold them without creating short run distortions in interest rates or, more importantly, in expenditures on output.    If changes in the quantity of reserves are not permitted due to a quantity rule, then keeping the interest rate on reserves fixed would at the very least dampen the undesirable changes in other interest rates and in spending on output.  That would be the least bad option.

Since if favor allowing the monetary authority (or central bank) to make changes in the quantity of reserves more or less continually, I see no particular value in a market process that would lessen the harm given a fixed quantity of reserves.   (I favor index futures convertibility as a constraint.)

Anyway, my view on what would happen with a fixed quantity of reserves is that borrowing and expenditure plans would be slightly postponed or perhaps hastened based upon changes in short term interest rates.   Suppose that there is an increase in the demand for bank credit and banks demand more reserves.   This raises the interest rate banks must pay for reserves.   If the interest rate the central bank pays on reserves balances is fixed, even at zero, this will result in some banks reducing the amount of reserves they desire to hold.

If there are no reserve requirements, this effect is given its maximum possible effect.   It is this short run liquidity effect that is emphasized in money and banking theory--at least since Keynes.

If the interest rate on reserves rises in this situation, then the liquidity effect disappears.   The interest rate must rise until the quantity of bank credit demanded is back to its initial level, or else new deposits are attracted, for example by selling negotiable certificates of deposit.   Short run credit markets must clear.

Considering the effects on the demand for output, if some want to borrow from banks to purchase more output then others must be deterred from borrowing from banks so that they purchase less output.  Or else, others might be induced to lend more to banks, thus saving and spending less on output.  This added saving would reduce the demand for output, offsetting the increased demand for output by borrowers.

Certainly, it is possible that this would all occur by responding to changes in short term interest rates.   However, we can easily imagine spikes in interest rates being avoided by rationing.  Borrower would be told that funds are not immediately available and that because money is tight, you must wait a few days before making the planned purchase.  Low interest rates might well result in lots of calls to potential borrowers stating that funds are available now.

But, what if the problem is that the banks have no additional credit demand but simply decide that holding more reserves is a better policy.   Those traders in the money market office have made one mistake due to "too clever" manipulations too many.   What should happen is that the monetary authority create additional reserves.   But if it fails to do so, then efforts to obtain more reserves by selling securities or else temporarily restraining lending will tend to raise interest rates.   If the interest rate on reserves is fixed, then this raises the opportunity cost of holding reserves.   Some bank or other releases reserves.  While this increase in interest rates is disequilibrating, if the interest rate on reserves increases as well, then there will be no release in reserves!  There is no tendency for higher interest rates to result in a lower demand for reserves.  Only as expenditure on output (or really, lower output or lower prices) result in lower demand for reserves, will there be a return to monetary equilibirium.   The liquidity effect is gone and we are back to a pre-Keynesian world where nominal income must adjust so that the demand to hold money (or reserves) matches the given quantity.

But, of course, the quantity is not given and the monetary authority should expand the quantity of reserves in this situation so that there is no impact on short term interest rates or expenditures on output.

So, what is the effect on volatility of interest rates?   I think that they will fluctuate however much the monetary authority wants them to fluctuate.   Hopefully, they will fluctuate with changes in the short run natural interest rate only.   But nothing in the regime prevents the a central bank from changing the quantity of money to intentionally create monetary disequilibirum to smooth interest rates.  

Saturday, May 21, 2016

Interest on Reserves

George Selgin testified before a Congressional Committee about the Fed's policy of paying interest on reserves.

I agree with much of what he said.

Implementing interest on reserves in 2008 explicitly aimed at restricting aggregate demand and inflation was foolish.  It helped lead to disaster.

Further, paying banks to hold onto money rather than lend it is not wise during a financial crisis.

I also agree that a policy of paying interest on required reserves with no interest on excess reserves is better right now than the status quo.

On the other hand, I think reserve requirements are a bad policy and so that makes any distinction between required reserves and excess reserves irrelevant except as a compromise.

Further, I would like to see the demand for reserves by banks be independent of interest rates.  The best way to do that is to both pay interest on reserves and make that interest rate vary with market interest rates.

One policy would be for the Fed to pay less on reserves than market determined T-bill yields.   When T-bill yields change, the Fed would need to promptly adjust the interest rate it pays on reserves.   It makes reserves into a type of money market account.

Given the liquidity and safety of T-bills, they are a close substitute to reserves for banks.   If the T-bill rate rises, that would tend to increase the opportunity cost of holding reserves if the rate paid on reserves was fixed, even at zero.   This would lower the demand to hold reserves.   If the interest rate paid on reserves rises in proportion, there would be no impact on the demand for reserves.

More relevant to today, if the T-bill rate should fall, this would reduce the opportunity cost of holding reserves and raise the demand for them if the interest rate on reserves were fixed, including at zero.   If the interest rate on reserves instead fell as well, then there would be no tendency for lower interest rates to raise the demand for reserves.

In my view, given the current very low interest rates on T-bills, the appropriate interest rate on all reserves is negative.   If this creates too much of a burden on required reserves, then reserve requirements should be reduced, preferably to zero.

An alternative policy is to treat reserves like a mutual fund claim on the Fed's asset portfolio, while charging banks a management fee.   The yield banks would earn on reserves would change with the yield on the Fed's asset portfolio--presumably with the yields on assets that banks can hold directly.   This would make the banks' demand for reserves independent of interest rates as well.

Such a policy would expose the banks to credit risk on the Fed's balance sheet.   While I don't think it is desirable for the Fed to expose banks to risk by purchasing risky assets, I consider the alternative of the Fed providing interest bearing zero risk assets to the banks while itself holding risky assets to be even worse.

With such a policy, I think a "bills only" policy for the Fed's asset portfolio would be feasible.  (At least ignoring currency for a moment.)   This would make the mutual fund type reserves pretty much equivalent to the money market account reserves.   The yield banks earn on reserves would be slightly less than the interest rate that can be earned on the T-bills the Fed would hold in its asset portfolio.

I favor keeping the interest rate the Fed pays on reserves below T-bill rates (or having the Fed charge banks an ample "management fee.")   Part of the reason is to harness the stabilization process that Selgin himself discovered.   The difference between the interest rates banks can obtain on earning assets and the interest rate they receive from the Fed is the opportunity cost of holding reserves.   Banks must weigh that against the transactions costs of adjusting their reserve position by trading securities.   This determines the reserve balance that it is most profitable for banks to hold.   However, it also depends on the variance of gross clearings by banks which in turn depends on aggregate nominal expenditure.   If nominal expenditure grows at a slow steady rate, this should keep the demand for bank reserves also growing at a slow steady rate.   Normally, then, the Fed could maintain monetary equilibrium by keeping the quantity of bank reserves growing at a slow, steady rate.

As I understood Selgin's first version of the argument, he claimed that a fixed quantity of bank reserves would result in fixed equilibrium level of nominal expenditure on output.   The version I describe above has a slightly different emphasis but is based on the same reasoning.    

However, if the Fed is providing an asset with a fixed interest rate and no risk, then shifts in market interest rates or even the risk of bank assets will cause fluctuations in the demand for reserves interfering with the process described above.   Of course, it would simply require that the Fed manipulate the quantity of reserves.   More risk or lower market interest rates, the Fed would need to create more reserves for the banking system.   Less risk or higher market interest rates, the Fed would need to create fewer reserves.  In my view, it is better to avoid the need to make these sorts of adjustments in the quantity of reserves, and so that is the rationale for the mutual fund type reserves.

I have always had less confidence than Selgin in the process he discovered.  I think there is an important element of truth in the argument, but I don't favor either a fixed quantity of reserves or a constant growth path for reserves.   And so, I also favor index futures convertibility--more or less like Scott Sumner's proposals.   (Oddly enough, I also favor more central bank discretion than either of them!)

Finally, I reject any notion that the Fed or any other central bank should create "costless" reserves, paying interest on the reserves equal to "the" interest rate.   I have no idea why anyone would think that having the central bank manage all credit allocation would be desirable or wise.

Tuesday, April 12, 2016

Luddites and All That

Scott Sumner responded to the attack on free trade by asking if there will now be an attack on technological advance.   Well, Scott, where have you been?   The attack on "automation" and "robots" has occurred in parallel with the attack on free trade.

I think it is for the exact same reason.   In 2008, there was a deep recession and a very significant increase in unemployment.   The recovery that started in 2009 was very gradual and has only recently resulted in a return to full employment.  Long periods of time with weak labor markets result in the growth of bad economic ideas.   We are now suffering from the consequences of competition of low wage foreign workers, or maybe it is some more reasonable version of "unfair trade practices."   Or it is the long awaited time when labor will be replaced by machines destroying all of our jobs.

A student at Friday's meeting of The Citadel Libertarian Society stated with complete confidence that robots will lead to mass unemployment in the next thirty or forty years.   He explicitly stated that there is only so much that can be produced.

I think the first thing to keep in mind about the introduction of robots, other sorts of automation, or more simply, of labor saving technology is that the total production of goods and services not only can increase, but almost certainly will increase.

When someone states that "soon" robots (or other machinery) will have taken 90% of the "jobs," the baseline assumption should be that the remaining 10% of "jobs" remaining to humans will be enough so that every human who wants a job will have one, and that total output will be approximately 10 times more than was being imagined.  

Of course, "numbers of jobs done by machines" versus "number of jobs available for humans" is probably not the best way to think about growing real income and output due to improvement in technology.    It is fundamentally based upon the fallacy of thinking of the number of jobs as being fixed and each job as providing a flow of income like manna from heaven.   If more of the jobs are done by machines, then there are fewer jobs left for humans.    It is the same fallacy applied when thinking about those low wage Chinese workers taking "our" jobs through imports or the immigrants from central Mexico taking "our" jobs.

If, instead, jobs are recognized as productive activity, then people working provide added output which is what generates their income.   Robots (or other machinery,) or Chinese in export industries, or Mexican immigrants do not stop other people from working to produce output too.

It might seem that the amount that can be produced is limited by demand.   Sure we could produce more shoes, but who would want to buy them?   There only a limited number of jobs needed to produce shoes.   While in truth there are billions of people in this world who would like to have more shoes, there is no doubt that the amount of shoes that can be sold for an amount covering the cost of production of them is limited at any particular time.

But the "cost of production" is an opportunity cost.   The reason "costs" do and should limit the production of shoes (and anything else) is that labor and other resources must be pulled from the production of other valuable goods and services.   The whole problem of costly production is due to a need to use labor and other resources to produce other goods and services.

Further, from a "macro" perspective, an increase in the output generates a matching increase in real income, which allows for an increase in the demand for shoes.   If we consider an increase in shoe output alone, the added income for the entire economy is relatively small and the impact of that on shoe demand is also likely to be small.    But when considering growing output throughout the economy and growing real incomes, the demands for all sorts of goods increases.   For the most part, it is the increase in the "supplies" of other goods and services that results in more demand for shoes.   And the increase in the supply of shoes mostly generates an increase in demand for other goods and services.   

Now, this process most certainly will make shifts of labor from producing some goods rather than other goods necessary if resources are to be allocated to produce what people want to buy most.   This is why technological progress is a source of unemployment.   Creative destruction does destroy some firms and some jobs and even whole industries and vocations.   But it generates expansions in sales and demand for other firms and jobs.  Sometimes new industries and vocations are created.

I think the most likely course over the next thirty or forty years will be much the same.   Higher real incomes but with a need to change jobs sometimes.   Further, those who do need to change jobs may take a temporary loss in real income.   But what they will be able to buy with their new job will gradually be more and better, surpassing where they were before.   And if not for them, their children or grandchildren.    

It is not impossible that the demand for human labor in general will fall off due to technological change.  However, it is easy to be confused.   For example, suppose using robots becomes cheaper than using human workers in some industry.  Simple supply and demand suggests that the reduced demand for human labor results in lower wages.   However, the increased supply of the products due to the fact they are now cheaper to produce implies that these lower wages now have added purchasing power.   If, as is conventional, this is all supposed to be done in real terms, this just shows that the impact of substituting machinery for labor has ambiguous effects on real wages--the goods and services that can be purchased with labor.

An alternative perspective is that real output and real income rises, but improvement in labor saving technology results in a reduction in the share of real income going to labor and an increase in the share of real income that goes to other sorts of resources.  Call that investment income for now.   Since real income has increased and investors get a larger share, then that is an unambiguous improvement for them.   But labor has a smaller share of the bigger pie.   That is ambiguous and could either result in higher or lower real labor incomes.

Further, the very same improved automation--best understood as cheaper robots (or other machinery) increases the demand for complementary labor.   That tends to raise the share of income going to labor and reduce the share going to investment income.   

 Finally, even if the net effect of innovation is to provide equipment that substitutes rather than complements labor, that is only a problem if the demand for human labor falls and the supply of human labor doesn't fall as much or more.   Suppose growing productivity and higher real incomes causes people to work fewer hours per day, days per week, weeks per year, or years during their life.     While the technological progress might allow machinery to be substituted for labor, if the reduction in labor supply is greater than the reduction in labor demand, the result would be an increase in real wages.

Consider a scenario where the demand for labor falls off more rapidly than the supply, and the result is that despite growing total output, the share of that output going to those working falls off so rapidly that real wages fall.   The only way to make a decent living, then, would be to save, accumulate assets, and earn investment income.   In other words, it would be necessary to own robots--perhaps a fraction of one or else several.   (Shares of stock in a robotic operation or bonds funding a robot operation is more realistic.)   If we imagine someone born into such a world with nothing but their own mind and hands, they might have difficulty earning enough to survive, much less save enough to "retire" on investment income.

Aside from there not being many productive tasks for humans in this scenario, it would seem that the robots would also need to be quite expensive compared to their output.   Otherwise, it would be relatively easy to purchase a share of a robot and have a good income.   Also, there would need to be plenty of demand for the output of the robots.   The robot owners would need to have a large demand for some kind of output rather than be nearly satiated for material goods and services.  If not, these robots would have a low opportunity cost for endeavors like producing consumer goods or even building additional robots for the poor still working for a living.

The most plausible "nightmare" scenario is where automation substitutes for human labor but scarce natural resources limit the expansion of aggregate output and income.   Suppose the world depends on depleting fossil fuels.   Those owning claims to these land resources would earn a growing share of income.   Claims to "capital" like the robots wouldn't generate much income nor would human labor.

Nick Rowe pointed out that the development of mechanization in the twentieth century didn't result in draft horses remaining fully employed along with the new fangled tractors.   The employment of horses in production fell off.   His point was that human labor could also become obsolete.

I think that he was correct.  However, it seems to me that the reason horses became unemployed is that the human labor needed to direct them was too expensive--the opportunity cost was too high.   However, another factor and more relevant to a possible world where human labor becomes obsolete would be that the opportunity cost of using the agricultural land with horse powered equipment was too high.

It is not the fabulously wealthy "post scarcity" world that generates the problem.  It is rather a world of scarcity where human labor is not very scarce.   If such a future develops, perhaps a quasi-Georgian approach of sharing out the rents from this natural resource would be the least bad option.

Further, in the happier future, where nuclear fusion or solar power or whatever creates plenty of energy, and nothing else of true significance creates a binding constraint, and if it really was true that there was so little use for human labor that investment income is necessary to thrive, then I would think that bringing children into such a world without providing them with a trust fund would be irresponsible.   Providing your child with a "good education" so that they will get a "good job" would no longer be responsible or reasonable.    As for those irresponsible or unlucky (which would include arriving into this world with insufficient net worth,) perhaps providing tax funded trust funds for their children would be the least bad option.   In our imaginary world of plenty, that should be a small expense.

I don't think that trying to switch to a system of sharing consumption is likely to be desirable, even in such a world.  Nor do I see much point in trying to  make consumption or incomes equal.   Further, replacing markets to allocate resources with central planning would not be necessary and probably not desirable.   Even if information processing technology makes managing an entire world economy manageable or even more efficient than competition, I am not sure that putting human survival in the hands of a single artificial intelligence would be wise.   Having multiple ones compete is probably better.

But most importantly, it would be foolish to make major economic reforms now based upon what might happen in  the distant future.   Human labor remains the most valuable resource, and there are billions of people who are desperately poor.   For many years, the most likely scenario is that technological improvement will raise real wages and bring the majority of people out of poverty and into a decent standard of living.

For generations, people in market economies have put up with the uncertainties of creative destruction with the result that those of us in the developed world are very well off materially by historical and world standards.   Sometimes, some people must start over, and when they do, they are still much better off materially than most people in the developing world or anyone from a century ago.   Continuing with the market system not only will improve the material well being of our descendants, but also will benefit those in the rest of the word who are in desperate need.

Tuesday, March 29, 2016

Are Trade Deficits Dangerous?

An attack on trade deficits.

Well, at least in certain circumstances.

There are several inconsistencies--or really a "bait and switch" rhetoric.

It starts with the claim that countries with trade surpluses are stealing away labor demand from countries with trade deficits.

This is not true and it is based on simplistic Keynesian thinking.   What the trade surplus countries are doing is providing additional saving which allows for additional investment--spending on capital goods.   There is no particular reason to suppose that increased demand for capital goods--machines, equipment, and buildings, is any less labor intensive than the production of import competing or export goods.

It may in fact be that growing trade has reduced the demand for some types of labor    It is even possible that it could reduce the demand for labor in general.   But that has nothing to do with trade deficits.    That is, even if the U.S. ran a trade surplus, the same effect could occur.   For example, suppose the U.S. imports furniture and t-shirts and exports wheat and corn.   It runs a trade surplus with the difference used by U.S. investors to build foreign factories (so they can better produce the furniture and T-shirts.)    Farmers in Kansas and South Dakota earn higher incomes.   Factory workers in small towns in North and South Carolina earn less.   They have to find new work--maybe moving to Kansas and providing services to the farmers.   Retired farmer Jones who rents some of his land to Farmer Smith enjoys some of the greater prosperity.   It is certainly possible that the effect is an increase in share of income going to the owners of farm land (most of whom are farmers) and less going to labor.    And if those ex-factory workers stick around in their hometowns in Appalachia, it is very likely that the effect will be lower incomes for them.

However, it is also possible for the opposite to occur.   For example, the U.S. could sell lumber to Japan and import cars.   Suppose the U.S. runs a trade deficit because Japanese investors are buying newly-constructed buildings in the U.S.   It is certainly possible that the construction of buildings and production of lumber is more labor intensive than the production of cars.

More importantly, a trade deficit and associated net capital inflow makes it less likely that trade would result in a reduction in the share of income going to labor.   The added capital investment, by providing additional supplies of a complementary factor, should raise labor demand.

The argument that trade between developing and modern economies results in a reduction in labor demand involves economizing on capital goods.   According to the argument, the modern economy has lots of capital--plenty of sophisticated machinery--that is absent from the developing economy.   By shifting production of goods that require less capital to the developing economy and production that requires more capital to the modern economy, the result is an increase in total production and an increase in the value of capital in the modern economy.   While the demand for labor in the modern economy could either increase or decrease, the labor share decreases--"labor" gets a smaller share of a bigger pie.   The bigger share of a bigger pie going to capital is clearly an improvement.  A smaller share of a larger pie going to labor could go either way.   If the well being of workers is your concern, what happens is of key importance.   (For a Marxist, the distribution of income between capital and labor is all that matters, so even if a smaller share of a bigger pie is more--who cares, there is more exploitation.)

Trade, in this way, provides a substitute for shifting capital from the modern economy to the developing economy.   If capital is actually moving the opposite direction, as happens with a trade deficit, that will tend to offset this process.

So, if the concern is that trade with Mexico or China is adversely impacting the demand for labor relative to capital, then a trade deficit and net capital inflow should be celebrated!    On the other hand, one would expect that if differential capital to labor ratios are really very important in the development process, the advanced economies not only should be exporting relatively capital intensive products to the developing world, they should also be running trade surpluses and their savings should be shifted to profitable capital investment in developing countries.

I don't want to entirely dismiss these processes regarding the optimal allocation of capital and how it impacts labor and capital, but I do think it all comes from a long tradition of focusing on a growing capital stock as the key source of economic growth.   In my view, the key source of economic growth is instead improvement in technology.   The ability of developing countries to change their production processes to reflect improved technology allows them to produce more output and earn more income.   The capital they have becomes substantially more productive.

After asserting that countries with trade surpluses compel other countries to consume more, the author takes that back--recognizing what is correct.   Countries with trade surpluses invest less than they save and countries with trade deficits invest more than they save.   The problem here, I think, is a mixture between old Keynesian thinking that investment is fixed and new Keynesian models that have no investment.

In the "workhorse" new Keynesian model, there is no investment at all.   Interest rates play a key role, however, and can only relate to consumer loans.   A saver/lender consumes less than income and a dissaver/borrower consumes more than income.   Of course, with their representative agent models, no one ends up saving or lending at all.  Everyone just consumes what they earn.    Still, it appears that the go to assumption about trade deficits is that they represent dissaving--consuming more than income.   Well, they can, but they don't have to.

Anyway, after making this false statement about trade deficits requiring dissaving, it is immediately reversed, noting as an aside that yes, a net capital inflow can be used for capital investment.   And then we get a list of bad investments that have occurred.   What evidence is there that it was the net capital inflow that funded the "bad investments?"  Of course, in hindsight, bad investments are a waste!   The market system punishes investors who make bad investments with losses.

Then we get a version of the "global savings glut" story.   The notion is that interest rates have been low worldwide because there is a "global savings glut."   The countries with trade surpluses--which are saving more than they invest--are exacerbating this problem.   It is really back to crude Keynesianism.   The paradox of thrift purportedly shows that saving is bad  and results in poverty.   Well, it isn't that bad, because here we have the recognition that added saving results in lower interest rates and more investment.

But the investment due to the lower interest rates are supposedly these wasteful and bad investments--bubbles.   But in reality, bubbles are alternatives to low interest rates.   It is rational to take more risk when safe interest rates are lower.   If you can earn a higher yield, it is sensible to take part of the benefit in terms of greater safety.   Turn that around and the result is lower yields makes taking higher risks reasonable.

But that doesn't make bubbles rational.   To motivate more sound investment, lower interest rates are necessary.  If there is a bubble, the demand for investment is irrationally high, allowing for more investment at higher interest rates.   With no bubbles, interest rates must be lower to generate the appropriate amount of sensible investment.

Further, the interest rates that most businesses have to pay to fund capital investment are not "crazy low."   The only interest rates that are "crazy low" are short term U.S. government guaranteed instruments.

The U.S. has had massive budget deficits, which is a reduction in U.S. saving.   That we run trade deficits and obtain a net capital inflow means that these deficits have a smaller negative impact on U.S. capital investment than otherwise.   If the U.S. started to run modest budget surpluses and so gradually pays off the U.S. national debt, would the U.S. still have a trade deficit?  Perhaps.  If so, let us hear complaints about other countries saving too much then.

Finally, all that said, it is bad for foreign countries to manipulate their economies to accumulate large official foreign exchange reserves.   But it is mostly bad for their people.

When "foreign exchange" was gold bullion, then when any one country accumulated more, other countries would have less.   Aside from devaluation, equilibrium required a deflation of prices and incomes.   Usually, such deflation was very painful with reduced output and employment.   If unexpected, there was a transfer from borrowers to lenders as well--a transfer that did not reflect the agreed sharing of risk of particular production processes.

In the twentieth century, there were efforts to have countries work together to avoid this sort of problem.   However, the end of the gold standard has solved these problems.   These traditional concerns about "trade surplus" countries just don't apply.    It is an artifact of a bad monetary order.

And that brings us to today.    In the late 20th century, the Fed doubled-down on its traditional fixation on interest rate targeting--focusing on short and safe rates.  It adopted inflation targeting.   The interest rate target results in problems when short and safe interest rates are very low.   But that is a self-inflicted wound.  Further, inflation targeting has generated slow recoveries ever since it was adopted.  These slow recoveries appear to create problems with short and safe interest rates, but the real problem has been the populist backlash due to years of weak labor markets.   Just now, the foreigners are taking all the jobs, or maybe it is the robots.    Sure.....that's the problem.   It happens with every recession and with a weak recovery, it just lasts longer.

Friday, February 19, 2016

The South Carolina Primary

I still plan to vote for Rand Paul.   The Republican leadership claims that they told the South Carolina Election Commission that Paul suspended his campaign, which means that my vote for him will be counted.  I saw an email from the Election Commission saying that he "resigned" from the election, which means that he will be on the ballot but the votes won't count.   I guess I will see tomorrow.  (P.S.  Just voted.  No signs saying that anyone withdrew.)

Why stick with Paul?  I sure don't see eye-to-eye with him on every issue.   But there are no other good options.

Cruz claims that he should inherit the "Liberty vote."   I actually heard him speak in person, I spoke a few words with him face to face, and Kathy and I have a picture with him.  He was at The Citadel a few years ago at an event for the Free Enterprise Foundation.   I don't remember too much, but his remarks sounded good to me.

Also, the attack ads on Cruz saying that he is "anti-defense" make me want to vote for him.   Is willing to cut excessive defense spending?  Good.    Has some concern for the 4th amendment?  Good.

But it is not enough.  (Also, it sure suppresses my willingness to vote for the candidates of the campaigns that generate the attacks--Rubio, Bush and Kasich.)

In my view, Cruz seems to be too much of a hawk, but he has said a few things that sound at least slightly realist in his foreign policy views.

My problem with Cruz is that he panders too much to the Christian Coalition/Moral Majority or whatever we call that faction these days.   He is running to be President of Evangelical Christians.

It is a bit humorous that he began his campaign at Liberty University.  It didn't do Cruz much good.  I received a robo-call from President and son of the founder, Jerry Falwell, supporting Donald Trump.   My wife is from Lynchburg, Virgina and I once waited on Falwell's uncle Gene (twin of Liberty University founder Jerry) at my father-in-law's feed and seed store.   But I visit Peakland Baptist when I am up there, not Thomas Road Baptist Church.

When can we expect there to be a Donald  Trump Chair of Free Enterprise (or more accurately, of crony capitalism) at Liberty University?

None of the other candidates are much better on the social issues.   They all are fully committed to a futile effort for government to promote traditional moral values by using law enforcement to punish sin.   But Cruz wears this on his sleeve.   Cruz leads with these social issues.   It makes him impossible for me to stomach.   He won't let me forget that I believe in personal liberty and he doesn't.

I don't like Cruz's position on immigration.   I appreciate his earlier support for legalization of  status (guest worker program) without citizenship (voting and welfare "rights.")   But he says that his support for that was just a legislative ploy and that he really doesn't favor providing for some kind of legal status for illegal immigrants.   So, either he is a liar or else he supports having an permanent illegal workforce here.

I am not too concerned with Republican political strategy.   But I think this is one of the problems that most Republican elected officials have with Cruz.   They don't think motivating Christian conservatives even more to vote Republican is a good strategy.   It will chase away other, more moderate voters.  (Which on these issues, they are clearly right about me.)   They also don't like Cruz because of his history of claiming that he is the only "true" conservative and the others are all sell outs.   It hurts their feelings.  I sometimes think that this is a case where the truth hurts, but it sure won't help Cruz "unite the party" and win in November.

Also, the fact that Cruz stood by while Trump acted the fool for months was awful.  It seemed as if as long as Trump insulted Bush, Cruz had no problem.   That Cruz has finally begun to stand up to Trump's nonsense, particularly his effort use his corporate lawyers to threaten suits to violate the first amendment, is great.   Finally.

What about Rubio?

When I see the attack ads claiming he is soft of immigration, that makes me want to vote for him.   I don't favor a pathway to citizenship--welfare "rights" and voting rights.   I do favor legalization of workers (guest worker status.)   I can understand a compromise, and if the path to citizenship is long and hard enough, it might be worth it to get legalization.  

The problem with Rubio is that he is a neo-con's neo-con.   No evidence of foreign policy realism.   Instead policeman of the world and nation-building.   I think it is delusional.    A futile effort to remake all of the world in America's image by military force.     I have no interest in having my students be killed, or worse, come back maimed, due to grandiose visions of what is possible in Iraq, Syria, Libya or Iran.  I have even less interest in that happening to my son.  In my opinion, one tour in Afghanistan was enough.

I am not at all pleased that Rubio has remained silent about Trump and has joined in with Trump to claim that Cruz is a liar and using dirty tricks.   An alliance of convenience, no doubt.

I can understand why Rubio is irritated with Cruz when Cruz makes out that there is a big difference between them--Rubio is the sell out, while Cruz is the principled conservative.  Of course, there isn't really that much difference.

Bush?  Kasich?

I appreciate Bush finally challenging Trump a bit.   Watching ad after ad bashing Rubio (for well over a month now,) when there is not much difference between Bush and Rubio was a bit sickening.  What a waste.   Aside from Trump, Bush has the most Republican voters who will never support him and the highest unfavorability rating from the general public,   Maybe it is immigration (and Bush's record on immigration is no problem for me) or common core.  But I think it is the Bush name.

But Bush keeps it up.   If Trump wins the Republican nomination, or worse, it will be the fault of Bush and his ego.

I did look at Kasich.   I remember him from when he was in Congress years ago.  I had a positive impression.   I don't like his campaign approach.   No problem with being positive, I guess.   But his emphasis of his "establishment" approach to foreign policy is only marginally better than Rubio's full-frontal neo-conservatism.    And his attacks on Cruz as being anti-defense because of a hint of applying fiscal conservatism to defense (something Kasich used to do,) turns me off.

Trump.  You must be kidding.

There is no doubt, I will put a good bit of effort fighting Trump if he is the Republican nominee regardless of who opposes him.

OK.  He is not the least bit neoconservative on foreign policy.  Good.

But what is he?   Invade and take their oil?    Kill their families?   Torture works?   It is like the return of Genghis  Khan.   Normal for the pre-modern era.   And, of course, that was what was "special" about the Axis powers in World War II.   A return to the "ethics" of international relations from an earlier era.   The winners exploit the losers and are proud of it.   Open and uncompromising evil--Donald Trump.

So, Rand Paul it stays.

Sunday, February 14, 2016

Negative Interest Rate Naysayers

Maybe I will turn into a Marxist.

Just kidding.

Still, when I read Bill Gross attacking negative interest rates, it makes me wonder.

I am a free market economist, and as far as I am concerned, the interest rate is a price.   The correct interest rate is the one that equates quantity supplied and quantity demanded.   If the supply of apples is so great compared to the demand that market clearing requires that people be paid to haul them away, then that is the least bad option.  

With interest rates, however, the relevant coordination is saving and investment.   Saving is that part of income not spent on consumer goods and services.   And investment is spending on capital goods.   If the interest rate that results in saving and investment matching up is less than zero, then that is the "right" interest rate.

Now, I certainly would agree that if there are government policies that discourage investment, then repealing them is a good idea.   That should raise investment demand and so raise the interest rate that coordinates saving and investment.   But I don't see how using monetary policy to keep nominal interest rates high, even above zero, is ever helpful.

And make no mistake--the Fed's policy of paying interest to banks for holding reserves is a policy aimed at keeping nominal interest rates up.

Situations where some real interest rates need to be less than zero for some period of time seem entirely plausible to me.    Since I don't see persistent inflation as desirable, that means that some nominal interest rates should sometimes be less than zero.   Situations where all real interest rates should be persistently negative seem pretty implausible to me.  In fact, I think excessive focus on a steady state, or worse, for those of the "Austrian" bent, thinking about the evenly-rotating economy, misses the point as to why negative nominal interest rates are sometimes coordinating.

It is the short and safe ones that should sometimes be negative.   It is pretty unlikely that the long and risky ones (or the expected rate of return on the typical real capital investment) should be negative.

Why Marxist?

Because negative interest rates mean that the wealthy can earn no income from merely holding wealth--postponing consumption--when this occurs.    And I wonder if the complaints we hear from people like Bill Gross are not gripes about the need to make risky commitments to earn capital income.    The "capitalists" are promoting their "class" interest in creating an economy where they can earn a riskless real rate of return.

But really, (as usual) I blame the Fed.   And, of course, their new Keynesian enablers.   The Fed likes to manipulate interest rates, so new Keynesian macro is about manipulating interest rates.   They are seeking to keep inflation and unemployment low.   So new Keynesian macro is a kind of social engineering about manipulating interest rates to optimize an objective function of deviations of inflation from target and real output from potential.  

Bill Gross can say that negative interest rates will fail to create jobs.   Isn't that what the Fed says it is trying to do with low interest rates?  Create jobs?

What the Fed can do and should be trying to do is control total spending on output.  Nominal GDP is probably the least bad measure.   Keeping spending growing at a slow, steady rate is the least bad goal.

There is good reason to believe that a drop, or even a slowdown, of spending on output will result in the "destruction" of jobs.  Or, more exactly, a tremendous slowdown in new hires, which results in net decreases in total employment and a rapid run-up of the unemployment rate.

If that has happened, there is good reason to believe that a prompt reversal and recovery of spending will result in a rapid increase in new hires and a reduction in the unemployment rate.   There have now been three recessions that have occurred with the Fed's policy of inflation targeting, which means no reversal and catch-up.  The recoveries have been very slow and gradual.   (I believe it is the misnamed "jobless" recoveries can be blamed for both Sanders and Trump.)   Fed thinking was little different during the Great Depression.  Sure, they wanted the deflation to end, but then they wanted prices to stabilize at the new low level.   Having prices recover would be "inflation."   Stagnation for years.

Maintaining or returning to an appropriate path of spending on output should never be understood as trying to create jobs or even control inflation.    Market forces must be allowed to control employment as well as the variety of prices and wages in the economy and the levels and rates of changes of indices of consumer or other prices.

In traditional monetary orders, chiefly metallic standards, the market process that generated recoveries from recession involved negative real interest rates and reflation.   Spending on output falls off, prices fall, with deflation causing a lower price level.   As the price level falls below its long run equilibrium, it is expected to rise again.  That is, there is expected inflation-- a reflation of prices.   Even if nominal interest rates cannot fall much below zero, the expected reflation makes real interest rates negative.   Now, this might not be all interest rates.  Risky long term bonds might have positive real interest rates.   But short and safe real interest rates might well be very negative.  This is the market force that causes the economy to bounce back rapidly.

A central bank that seeks to provide paper currency or deposit accounts that are perfectly safe and "free" keeps nominal interest rates from falling as low as they would if the only alternative was gold or silver coin. Worse, if the central bank pays interest on deposits, they can create an arbitrary floor on nominal interest rates well above zero.

And, if the central bank is committed to preventing any reflation, which it can do, even under a gold standard by accumulating sufficient gold reserves--then it keeps real interest rates from turning negative as well.   Inflation targeting under the sort of regime we have today is a commitment to prevent reflation.

I am aware that there is a market process that adjusts to a permanent increase in the equilibrium relative price of gold.   The level of prices and wages are permanently lower.   With an outside money like gold, it can even result in a permanent increase in the interest rate that coordinates saving and investment by a permanent decrease in saving supply.   Wealth held in the form of gold is worth more, and so there is less reason for saving.  

At one time, that was the key to my understanding of the market forces that generated recovery from recession.  (I haven't favored the deflationary wringer as an actual policy for several decades now.)  It is not clear that this market process works when there is no gold or silver base money and there is inflation targeting.   In my view, there is no real outside money.  It is all inside money--some mixture of government and private debt.

Today, I definitely take the view that negative nominal interest rates are better than allowing deflation and then reflation to generate the appropriate changes in real interest rates.    Sure, keeping expected nominal GDP on target might allow for long run price stability with even the shortest and safest nominal interest rates never falling to less than zero.   But it is better that all nominal interest rates be free to adjust with supply and demand.    Having an interest rate targeting central bank keep interest rates above market clearing levels is a bad policy.   Making sure that those holding wealth can always earn a risk less rate of return is not a goal that justifies price fixing.