Monetary Orthodoxy Research Articles

The existential trilemma of EMU in a model of fiscal target zone

Abstract Objectives Is the Economic and Monetary Union (EMU) truly ‘irreversible’ as stated in the treaties? (i) From the sovereign debt crises of the 2010s, and the outbreak of the COVID-19 pandemic, we draw the lesson that when exposed to large, systemic shocks the EMU faces a trilemma among preserving its irreversibility, monetary orthodoxy and fiscal orthodoxy: irreversibility can only be saved by relaxing one of the twin orthodoxies or both. (ii) We show how central monetary/fiscal backstops to irreversibility can be designed in a consistent manner that minimises their amplitude and mitigates the moral hazard concerns. Methods We present a novel fiscal target zone model of the EMU, where public debt is hit by stochastic shocks and member governments under monetary and fiscal orthodoxy are willing to abide by their commitment to debt stability only up to an upper bound of their feasible fiscal effort. Shocks large enough push the stabilisation fiscal effort beyond the feasibility constraint, in which case a government would opt for default on debt service and breakup of EMU membership—similarly to the abandonment of an exchange-rate agreement. Results For the EMU to be truly irreversible, ramparts for extraordinary times are necessary beside regulations for ordinary times. The alternative to these devices is reformulating the treaties with explicit and regulated exit procedures.

Populism versus Economic Expertise: J. Laurence Laughlin Debates William (Coin) Harvey

William Harvey’s best-selling Coin’s Financial School made the bimetallist case for free coinage of silver through a fictitious debate in which leading bankers, politicians, and economists were humiliated by a young bimetallist. One of Harvey’s targets, J. Laurence Laughlin, challenged Harvey to a real debate, in which populist critique of established authority was confronted with an emphatic defense of monetary orthodoxy and academic expertise by an economist who, though founder of the University of Chicago’s economics department and of the Journal of Political Economy, had a problematic claim to speak for the economics discipline as a whole.

WHAT YOU DON'T KNOW CAN HURT YOU: KNOWLEDGE PROBLEMS IN MONETARY POLICY

Many economists hold that monetary policy missteps played a role in causing or prolonging the 2007–2008 financial crisis. In light of the perceived failure of monetary orthodoxy, models are being theoretically refined and empirically recalibrated. Absent from these technical debates is a recognition of the immense knowledge burdens inherent in monetary policy. We argue that Fed authorities do not have the knowledge required to achieve their own monetary objectives, given their inability to approximately measure or predict changes in the demand for money. Finally, we evaluate the ability of free banking to overcome this knowledge problem. (JEL E42, E52, E58, E61, P16)

What You Don't Know Can Hurt You: Knowledge Problems in Monetary Policy

While the primary causes of the 2007-8 financial crisis are disputed, many economists hold that the monetary policy missteps played a role in causing or prolonging the financial crisis. In light of the perceived failure of monetary orthodoxy, monetary models are being theoretically refined and empirically recalibrated. Absent from these technical debates is a recognition of the immense knowledge burdens inherent in monetary policy. We argue that Fed authorities simply do not, and in all likelihood cannot, have the knowledge required to achieve their own monetary objectives, given their inability to approximately measure or predict changes in the demand for money. Finally, we evaluate the ability of NGDP targeting and free banking to overcome this knowledge problem.

Midas, Transmuting All, into Paper: The Bank of England and the Banque de France During the Revolutionary and Napoleonic Wars

This paper assesses Revolutionary and Napoleonic wartime economic policy. Suspension of gold convertibility in 1797 allowed the Bank of England to nurture British monetary orthodoxy. The Order of the Privy Council suspended gold payments on Bank of England notes and afforded simultaneous protection to the government and the Bank in pursuit of the conflicting goals of price stability and war finance. The government, the Bank of England and the commercial banks formed a loose alliance drawing on due political and legal processes and also paid close attention to public opinion. We suggest that the ongoing solvency of the Bank of England was facilitated by suspension and allowed the Bank to continue to make substantial profits throughout the Wars. It became acceptable for merchants to continue to trade with non-convertible Bank of England notes and for the government to finance the war effort, even with significant recourse to unfunded debt. These aspects combined to create a suspension of convertibility that did not undermine the currency. By contrast, the Assignats debacle had cost the French monetary system its reputation in the last decade of the 18th century and so Napoleonic finance had to evolve within a more rigid and limiting framework.

The reception of Fisher's Purchasing Power of Money in England

This article will describe the critical reception of Fisher's book by the Cambrige authors.First, we will begin with a description of the relationship between Fisher (1911) and the British Monetary Orthodoxy. Next, we shall examine the relationship between Fisher (1911) and the Cambridge School and Hawtrey. This will lead into a study of Keynes’ comments on Fisher (1911).We shall show that all referred positively to Fisher. However, they were also critical of Fisher's method and this was to contribute, in turn, to making their own analyses more precise, in particular regarding the role of credit.

Delivering economic stimulus, addressing rising public debt and avoiding inflation

PurposeThe purpose of this paper is to review monetary policy options in countries assumed to be suffering from two common economic problems: deficient private demand and high and rising public debt.Design/methodology/approachThe analytical approach assumes that relevant authorities have decided that new money creation is necessary to address their economic problems. The paper asks the question: how should this new money creation best be deployed to create the required economic stimulus in the context of rising public debt?FindingsThe first finding is that the latest rounds of “quantitative easing” in the USA (QE2) and Japan are likely to be inefficient, largely ineffective and have adverse side‐effects, and that in periphery countries the risk of debt default is being increased by current defensive policy settings. The second finding is that the policy of financing budget deficits by printing new money is likely to be more effective (than “quantitative easing” and current Eurozone policy) in raising demand, output and employment without adding unnecessarily to already high levels of public debt.Practical implicationsThere are very substantial practical policy implications, involving a potential change of monetary policy strategies for two of the world's largest economies and for Eurozone periphery countries. Post‐earthquake reconstruction in Japan could be financed in the manner recommended in this paper.Originality/valueThe originality/value lies in demonstrating that current monetary policy orthodoxy is misplaced, and that an alternative policy strategy has been overlooked and is likely to be more effective.

Clement Juglar and the Monetary Orthodoxy in England and France in the Nineteenth Century

Clement Juglar and the Monetary Orthodoxy in England and France in the Nineteenth Century

Democracia en América Latina apert ura económica, populismo y crisis

After 1979, Latin America adopted broadbased reforms, abandoning import substitution industrialization for an export oriented development strategy and simultaneously adopting democratic forms of government. The new economic policies of open trade, balanced public budgets, monetary orthodoxy, exchange rate neutrality and more competitive and free internal markets are established at the same time that democracies start to operate in the Latin American Republics. What are the interactions between economic and political reforms? Is the simultaneity of economic and political institutions the cause of the disenchantment with democracy at the beginning of the XXI Century? This article analysizes these questions and reaches a negative answer. The thesis that complete and rational transformations are not possible determines that institutions must be transformed by marginal, gradual, evolutionary change, supported by strong coalitions of citizens. The future of democracy and open markets in the region depends on reinforcing political and economic institutional transformations, supported by broad coalitions that piecemeal evolve to more open organizations.

British monetary orthodoxy in the 1870s: A victory for the Currency Principle

Approval of the quantity theory, of the Humean price-specie-flow mechanism (PSFM) and of lender of last resort analysis are characteristics of British monetary orthodoxy in the 1870s. But this does not mean that this orthodoxy achieved a synthesis between the Banking School and the Currency School. On the contrary, we show that it marks the victory of the Currency Principle that, in fact, did evolve after 1847, but did not rejoin Banking School ideas. The PSFM, which is essential to the Currency Principle, cannot be confused with the gold points mechanism described by Thornton and Tooke. The lender of last resort and money market theories developed by Bagehot are compatible with the dichotomy between currency and credit, a characteristic of the Currency Principle, and contrary to the thought of Thornton's and Tooke.

The Political Economy of Hegemonic Decline

The Challenge of Hegemony: Grand Strategy, Trade, and Domestic Politics. By Steven E. Lobell. Ann Arbor: University of Michigan Press, 2003. 256 pp., $55.00 (ISBN: 0-472-11312-7). The literature on hegemonic stability and power transition asserts that imperial overstretch and differential growth rates respectively cause hegemons to decline and challengers to rise. That literature does not, however, provide a systematic theory to explain how hegemons will react to challenge and decline (see, for example, Gilpin 1981; Organski and Kugler 1980; and Kennedy 1989). The Challenge of Hegemony by Steven Lobell fills this gap with a comprehensive theory of the political economy of hegemonic decline. Lobell offers a “second image reversed plus second image” theory to explain how declining hegemons respond to challengers. He argues that economic strategies pursued by rising states that challenge the status quo will affect the shape and strength of domestic political coalitions within the declining hegemon. Liberal states that challenge the status quo will create incentives that strengthen liberal internationalists within the hegemon, who will push for a strategy of accommodation. As a consequence, the declining hegemon will be more likely to cede control of contested regions to the liberal challenger and concentrate on managing its political and economic decline by reducing defense spending, pursuing fiscal and monetary orthodoxy, negotiating arms limitation agreements, creating free trade pacts, and reducing direct taxation. In contrast, imperial states that challenge the status quo will strengthen the hands of economic nationalists, who will lead the hegemon to pursue a strategy of punishment. In this case, the hegemon will tend to resist challengers in all regions, increase military spending, and maintain preferential trading relations. Central to Lobell's thesis …

Thomas Tooke, Henry Thornton, and the Development of British Monetary Orthodoxy

The first half of the nineteenth century in Great Britain was one of nearly continuous controversy over monetary issues. The Restriction of Cash Payments and the Bullion Controversy dominated the first two decades. After Resumption in 1821, a series of banking crises kept monetary issues on the front burner, until they boiled over again in the Currency-Banking Controversy of the 1840s. Of the many writers contributing to the monetary literature during the period, few contributed so much as Thomas Tooke. Long recognized as a collector of economic data without peer in his era, Tooke's reputation as an economic theorist has grown in recent years (cf. Laidler 1972; Arnon 1991; M. Smith 2001). Readers of Tooke's works have long known that his views on monetary theory changed radically from the 1820s to the 1840s, when he adopted a starkly anti-quantity theory approach. In his early years as a collector of economic data, Tooke allied himself with David Ricardo in the effort to return Great Britain to the gold standard. But though both subscribed to the quantity-theory/price-specie-flow-mechanism (QT-PSFM) framework for analyzing the economy's adjustment to monetary disturbances, their theoretical approaches differed in important respects. The differences were great enough to lead Arnon (1989, 1991) to conclude that Tooke and Ricardo should be viewed primarily as political, not theoretical, allies and to suggest that Tooke's approach shared greater affinities with the work of moderate bullionists than with Ricardo (Arnon 1991, pp. 48, 58, 108).

Don Patinkin and the origins of postwar monetary orthodoxy

Don Patinkin's Money, Interest, and Prices (1956) set the ground rules of postwar monetary discourse, for better or worse. A close look at the intellectual origins of the book in Patinkin's own life shows it to emerge equally from the Old Chicago School of Simons/Mints/Knight and the Cowles Commission of Lange/Marschak/Haavelmo. Patinkin's conception of money as essentially an outside asset is argued to emerge from the historical context of war finance, and is contrasted with the Gurley-Shaw conception of money as a form of inside credit.

The institutional paradoxes of monetary orthodoxy: reflections on the political economy of central bank independence

There can be no doubting the increasing importance of central banks to processes of international economic management.1 Whilst the names of prominent central bankers may be less well known than those of politicians, and whilst the functions their banks perform receive scant public recognition, the decisions taken by central bankers have a significant bearing on the conduct of everyday life.

Exchange Rate Rules and Economic Policy Choices: Lessons from the Spanish and Italian Experiences of the ERM

Turbulence in international financial markets has led to renewed calls for fixed exchange rate arrangements in several parts of the world. Proponents of such arrangements often cite the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS), which from 1979 until 1993 tightly pegged the currencies of member states, as a model, arguing that it produced convergence toward sound economic policies while attributing its collapse in 1992-93 to exogenous factors (the rise in interest rates caused by German unification and some perverse incentives for currency investors entailed in the 1991 Maastricht Treaty). Taking issue with this view, this article argues that the ERM's crisis was at least partly attributable to the system's own rules of adjustment. The basis for this argument lies in an analysis of the policy strategies pursued by governments in two of the ERM's higher-inflation members (Italy and Spain) in the four-year period prior to the crisis. With the lifting of capital controls, ERM rules actually bolstered the ability of these two governments to sustain an unbalanced macroeconomic policy-mix (that is, a restrictive monetary stance without commensurate fiscal restriction) for an extended period of time, while at the same time they limited the room for expansion for governments that were committed to a more balanced policy course. The result was an acute dissociation of exchange rates from the ‘fundamentals’ of member economies that increased speculative pressures, eroded the system's credibility, and set the basis for the crisis. The experience of Spain and Italy in the ERM suggests that, in the absence of capital controls, fixed exchange rate systems that are premised too heavily on the pursuit of monetary orthodoxy in an anchor currency country, are likely to fail.

In the name of the Market: how the European Commission paved the way for monetary union

The advent of economic and monetary union (EMU) is often interpreted as the logical outcome of structural trends, macroeconomic consensus, or grand geopolitical bargains. This article argues, however, that such views miss an essential dimension of the EMU process, namely the political strategy developed within the European Commission in order to achieve that goal. As part of their integrationist agenda, Commission officials selectively marshaled the political and economic significance of Europe's emerging Single Market. Thus, over time, they induced key actors to re-articulate their preferences in terms of monetary union. The article discusses the two main facets of the Commission's strategy, i.e. the politics of monetary sovereignty and the politics of monetary orthodoxy.

William Huskisson and the bullion controversy, 1810*

The debate concerning the return to the gold standard in England during and in the aftermath of the Napoleonic Wars, and the subsequent resumption of convertibility in 1819, played a significant role in British monetary orthodoxy. Its impact culminated in the 1925 decision to return to gold at prewar parity. Examining the contribution of William Huskisson - one of the authors of the Bullion Report - to the bullion controversy I argue that he played a major role in shaping British monetary policy of the nineteenth century.

The Place of J. S. Mill in the Development of British Monetary Orthodoxy

The Place of J. S. Mill in the Development of British Monetary Orthodoxy

The Sterling-Dollar-Franc Triangle: Monetary Diplomacy 1929–1937

The late interwar years encompass a full spectrum of international monetary conflict and cooperation. Why did Great Britain, France, and the United States cooperate in some periods and not in others? First, the transience of monetary cooperation and conflict is explained in part by inherent characteristics of gold exchange and floating monetary systems. Second, environmental changes—swings between prosperity and depression, between peace and the threat of war, and between monetary orthodoxy and inflationist heresy—altered the strategic setting confronting the central monetary powers. Third, the actions of governments both followed from and shaped the circumstances that they confronted. Through strategies of composition across issues and decomposition across time and actors, nations deliberately fostered the emergence of cooperation by altering the context of monetary diplomacy.

J. Laurence Laughlin and the Quantity Theory of Money

In this paper the issues raised in the turn-of-the-century American debate over the quantity theory of money are examined. J. Laurence Laughlin of Chicago,the leading antiquantity theorist, provoked the controversy with theoretical and empirical criticisms of the quantity theory, while Irving Fisher emerged as the chief defender of the monetary orthodoxy. Laughlin argued that issues of convertible paper money would not raise prices or the money supply but would instead lead to losses of monetary gold. His position was regarded as incompatible with the classical neutrality-of-money theorem. To identify the fundamental sources of disagreement between Laughlin and the quantity theorists, the neutrality-of-money proposition is decomposed into two components the neutrality proposition per se and the assumed causal role of money.