CIAO DATE: 10/2013
Volume: 33, Issue: 3
Fall 2013
Editor's Note (PDF)
James A. Dorn
This issue of the Cato Journal features the papers from Cato's 30th Annual Monetary Conference-Money, Markets, and Government: The Next 30 Years-which was held in Washington on November 15, 2012. After 30 years, it is well to recall F. A. Hayek's advice: "All those who wish to stop the drift toward increasing government control should concentrate their effort on monetary policy."
Anna Jacobson Schwartz: In Memoriam (PDF)
George S. Tavlas
This issue of the Cato Journal is dedicated to Anna Jacobson Schwartz, who passed away on June 21, 2012, at the age of 96. Anna was an economic historian whose scholarship was marked by, among other things, dedication, tenacity, and perseverance. Her career spanned three quarters of a century. When Anna was about 90, her son Jonathan complained (somewhat tongue-in-check) that he had thought about retiring, but did not feel comfortable doing so while his mother was still working. In 1936, she began collaborating with A. D. Gayer and W. W. Rostow on a study of fluctuations in the British economy between 1790 and 1850. The study was not published until 1953, although most of the work on the study had been completed by the early 1940s. Anna joined the National Bureau of Economic Research in 1941 and remained there for the rest of her life, continuing to go to her office until shortly before her death. She published her first NBER paper in 1947 with Elma Oliver, and her last with Michael Bordo and Owen Humpage in 2012. Her collaboration with Milton Friedman on A Monetary History of the United States, 1867–1960 began in 1948 and was not completed until 1963. The underlying objective of Anna’s scholarship throughout her career was to use historical evidence, which she assembled with meticulous attention to accuracy, to understand the workings of the economy better.
Monetary Policy during the Past 30 Years with Lessons for the Next 30 Years (PDF)
John B. Taylor
The 30th anniversary of the Cato Institute’s monetary conference series provides an excellent opportunity to take stock of what we have learned about monetary policy in the past 30 years and to draw lessons for the next 30 years.
Fed Policy: Good Intentions, Risky Consequences (PDF)
Charles I. Plosser
The last five years have been an extraordinary time for the global economy and monetary policymakers. The financial crisis and the severe global recession that followed have tested our resolve, our patience, and our economic theories. To restore the health of ailing financial markets and economies, central banks have driven shortterm interest rates to essentially zero, expanded their balance sheets to unprecedented levels, and engaged in market interventions that have blurred the lines between monetary policy and fiscal policy.
The Conduct of Monetary Policy (PDF)
Kevin Warsh
The Federal Reserve’s independence is essential to the conduct of monetary policy. But while the Fed is independent within government, it is not independent of government. The grant of authority to the Fed comes from Congress, to which the Fed is ultimately accountable. In my view, the Fed was granted significant powers by Congress, but those powers were not unlimited. The grant of authority was constrained. So by my measure, the Fed is a powerful institution, but a bounded one.
The Fed Needs to Change Course (PDF)
David Malpass
This article describes the Federal Reserve’s monetary policy, examines its economic impact, and discusses possible exits. Federal Reserve policy is on the wrong course: it is harming economic growth, hurting savers, damaging markets, setting dangerous precedents and misallocating capital away from job-creating parts of the economy. The Fed’s September 2012 policy change, in which it announced a third round of quantitative easing (QE3), was a major increase in the aggressiveness of monetary policy and, in my view, another drag on economic growth.
Avoiding the Next Crisis: Can Central Banks Learn? (PDF)
Robert L. Hertzel
Any effort to avoid future recessions must rest on an organized way to learn from the past. However, the absence of such efforts within central banks renders such learning problematic and makes likely the recurrence of episodes of recession and financial market turmoil. Critical to learning is the use by policymakers of models to evaluate the past performance of monetary policy. These models should not be the complicated, multiequation models favored by the forecasting departments of central banks. Rather, they should be simple models that require policymakers to take a stand on the basic issues in monetary economics: the nature of the price level (monetary or real) and how well the price system works to maintain output at potential (full employment). They should serve as a safeguard to the understandable tendency of central bankers to attribute economic disturbances exclusively to real shocks rather than monetary shocks.
Should Policy Attempt to Avoid Financial Crises? (PDF)
Jeffrey A. Miron
The 2008 financial crisis and the 2007–09 recession have predictably spurred interest in how policy can avoid financial crises. A prior question, however, is whether policy should avoid financial crises. The answer might seem obvious. But I argue here that if policymakers focus on avoiding crises, they will generate undesired side effects and typically fail to avoid crises in any case. My argument has four steps. First, avoiding crises is not, in and of itself, the right goal for policy. Second, as a matter of theory, the costs of crises are not necessarily large. Third, as a matter of evidence, the costs of crises do not seem to be enormous. Fourth, whatever the costs of crises, anti-crisis policies might be worse than the disease.
What's Wrong with the Fed? What Would Restore Independence? (PDF)
Allan H. Meltzer
On September 1, 1948, Allan Sproul, president of the Federal Reserve Bank of New York, commented on Fed independence:
I don’t suppose that anyone would still argue that the central banking system should be independent of the Government of the country. The control which such a system exercises, over the volume and value of money is a right of Government and is exercised on behalf of Government, with powers delegated by the Government. But there is a distinction between independence from Government and independence from political influence in a narrower sense. The powers of the central banking system should not be a pawn of any group or faction or party, or even any particular administration, subject to political pressures and its own passing fiscal necessities [Letter to Robert R. Bowie, in Meltzer 2003: 738].
Few would disagree with Sproul’s statement. The greater problem is not agreeing about the desirability of independence. It is finding institutional arrangements to achieve it and retain it if it is achieved.
Federal Reserve Independence: Reality or Myth? (PDF)
Gerald P. O'Driscoll Jr., Thomas F. Cargill
The Federal Reserve was founded in 1913 during the Wilson administration to end banking panics and depressions, and was part of the Progressive agenda for a more activist role of government (see Kolko 1963). By the 50th anniversary, the conventional wisdom was that the Fed’s performance was overall satisfactory, especially after the Treasury-Federal Reserve Accord of 1951 that permitted independent monetary policy. While the decision to double reserve requirements in 1937 was judged a policy error, the Federal Reserve was not held responsible for the Great Depression.
Balance Sheet Crises: Causes, Consequences, and Responses (PDF)
Steven Gjerstad, Vernon L. Smith
Balance sheet crises, in which the prices of widely held and highly leveraged assets collapse, pose distinctive economic challenges. An understanding of their causes and consequences is only recently developing, and there is no agreement at all on effective policy responses. A preliminary purpose of this article is to examine in detail the events that led to and resulted from the recent U.S. housing bubble and collapse, as a case study in the formation and propagation of balance sheet crises. The primary objective of the article is to evaluate similar events around the world with a view toward assessing the economic performance of countries that have pursued varied alternative policies.
Antifragile Banking and Monetary Systems (PDF)
Lawrence H. White
“Fragility” is the well-known property of being easily breakable, of failing under moderate stress. The opposite property is “antifragility,” a term coined by Nassim Nicholas Taleb (2012a) and the title of his recent book. Taleb (2012b) defines antifragility as the property exhibited by “things that gain strength from stressors and get stronger from failure, like evolution.” An antifragile thing or system is stressloving. What doesn’t kill it makes it stronger. We exercise, for example, because our muscles grow stronger from moderate stress. Robustness, an intermediate concept, is the property of being unaffected either way by moderate stresses. Taleb illustrates the threefold distinction this way: We stamp “handle with care” on a package containing something fragile; we needn’t stamp any instructions on a package containing something robust, because it won’t be affected by handling; but we would stamp “please handle roughly” on a package containing something antifragile, because such handling would make it emerge stronger.
The Case for Simple Rules and Limiting the Safety Net (PDF)
Thomas Hoenig
For the last 100 years, government officials and bank CEOs have insisted that new policies, rules, and laws—combined with greater market discipline, resolution schemes, and enhanced supervision— would ensure that future financial crises, should they occur, would be more effectively handled. In the United States, the creation of the Federal Reserve System and Federal Deposit Insurance Corporation are examples where such assurances were given to the public. More recently, the FDIC Improvement Act of 1991 and other legislation were intended to end public bailouts of failing banks and, in particular, prevent the moral hazard problem inherent in “too big to fail.” Such assurances seem even more significant following a U.S. Treasury (1991) study that found that “too big to fail” resolution policies used for six of the largest banks cost taxpayers more than $5 billion (in current dollars). If only the cost of the six largest bailouts in this recent crisis were just $5 billion. Unfortunately, it was many times greater.
The Gold Standard, the Euro, and the Origins of the Greek Sovereign Debt Crisis (PDF)
Harris Dellas
The entry of Greece into the eurozone in 2001 was widely expected to mark a transformation in the country’s economic destiny. During the decade of the 1980s, and for much of the 1990s, the economy had been saddled with double-digit inflation rates, double-digit fiscal deficits (as a percentage of GDP), large current-account imbalances, very low growth rates, and a series of exchange rate crises. Adoption of the euro—the value of which was underpinned by the monetary policy of the European Central Bank (ECB)—was expected to produce a low-inflation environment, contributing to lower nominal interest rates and longer economic horizons, thereby encouraging private investment and economic growth. The elimination of nominal exchange-rate fluctuations among the former currencies of members of the eurozone was expected to reduce exchange rate uncertainty and risk premia, lowering the costs of servicing the public sector debt, facilitating fiscal adjustment, and freeing resources for other uses.
Why the Euro Failed and How It Will Survive (PDF)
Pedro Schwartz
The great hopes that surrounded the euro at its birth have failed to come true. It was intended to be a currency as sound as the deutschemark and also a symbol of European unity. It is now reeling under the blows of a prolonged financial crisis and creating discord among the members of the European Union. Clearly, the design of the new money was defective. What its flaws were has been generally misdiagnosed: I will suggest that even if euro- members had kept by the rules of the game the euro could not have worked as intended.
The Euro at a Crossroads (PDF)
Wolfgang Munchau
It was one of the author’s predictions in 1998 that the eurozone would end up teaching us more about economics compared to what economics could teach us about the eurozone. While many of the author’s predictions of that year did not hold, including the forecast that the euro would challenge the dollar as the world’s foremost reserve currency, this particular prediction ultimately turned out to be correct. A monetary union is a hybrid between a fixed exchange rate system and a unitary state, one that is fully captured neither with closed-economy macro models nor classical international macro models of fixed exchange rates.
Lessons from the European Crisis (PDF)
Jurgen Stark
Two episodes in the recent past have caused crisis management in Europe to migrate to a new level. First, the establishment of a permanent funding instrument, the European Stability Mechanism (ESM), on October 9, 2012, to finance crisis and problem countries in the euro area. Second, the decision taken by the Governing Council of the European Central Bank at the beginning of September 2012 to purchase Italian and Spanish government bonds on the secondary market on an unlimited scale—the Outright Monetary Transactions (OMTs).
The Renminbi's Prospects as a Global Reserve Currency (PDF)
Eswar Prasad, Lei Ye
Popular discussions about the prospects of China’s currency, the renminbi, range from the view that it is on the threshold of becoming the dominant global reserve currency to the concern that rapid capital account opening poses serious risks for China. A number of recent academic studies have pointed to the renminbi’s rising importance in the international monetary system, although these studies are divided on the renminbi’s prospects of becoming a dominant global reserve currency (see Eichengreen 2011a, Subramanian 2011, Frankel 2012, and Yu 2012).
Does Internationalizing the RMB Make Sense for China? (PDF)
Yukong Huang, Clare Lynch
The last time a Chinese currency was used as an international medium of exchange was four centuries ago, when China’s share of global GDP in PPP terms was nearly 30 percent (about twice its current level), the country was a major global trading power, and Chinese copper coins circulated throughout East Asia to India and even beyond (Horesh 2011). In the following centuries, silver dollars and paper bills replaced copper coins and China’s share of external trade declined. Now, with China’s return to the position of largest global trader and second-largest economy in the world, it is not surprising that discussion of internationalizing China’s currency has resumed.
Capital Freedom in China as Viewed from the Evolution of the Stock Market (PDF)
Zhiwu Chen
Since reforms started in 1978, China has made commendable progress in achieving capital freedom and individual liberty. Prior to 1978, private enterprises with more than eight employees were prohibited and there were no capital markets. Private entrepreneurs were labeled “capitalist tails,” and political movements were launched frequently to “cut the capitalist tails.” For several decades, Chinese citizens could only obtain employment and economic means from government organizations and state-owned enterprises, which strictly limited individual liberty. Today there are more than 10 million privately owned enterprises, making up more than 80 percent of each year’s employment growth. As a result of less regulation and more room for entrepreneurship, it is relatively easy to register and start a business. Public equity offering opportunities and bank financing are also increasingly available to private firms as well. Chinese, young and old, can choose among jobs provided by government organizations, SOEs, private businesses, and foreign-owned firms. As capital freedom has increased, the rise of the individual and liberty is one of the highlights achieved in China’s development over the past 35 years.
The Immigrant War (PDF)
Alex Nowrasteh
Some journalists possess a deep knowledge of political and policy debates. Their job is to follow the political developments of a certain policy, report on its effects, and write about it over the course of decades. It’s only natural, after so much experience, that they would want to transform their observations and reactions into books that illuminate opaque topics. Vittorio Longhi’s The Immigrant War fails at this.
Africa's Third Liberation: The New Search for Prosperity and Jobs (PDF)
Marian L. Tupy
The new millennium has been good to Africa. Its economy grew at an average annual rate of 4.9 percent between 2000 and 2008. Then came the financial crisis and growth dipped to 2 percent. Since 2009, the International Monetary Fund estimates growth has averaged 5.4 percent. Between 2001 and 2010, six out of the ten fastest growing economies were in Africa. This trend, the Fund predicts, will continue.
Two Cheers for Anarchism: Six Easy Pieces on Autonomy, Dignity, and Meaningful Work and Play (PDF)
Jason Kuznicki
I often tell aspiring libertarians that they both can and should learn from people who are far removed from them ideologically. Indeed, if they fail to do so, then they are neglecting a vital part of their self- education. When asked whom I have in mind, I almost always mention James C. Scott. Two of Scott’s earlier books, Seeing Like a State and The Art of Not Being Governed, are fascinating intellectual excursions for people of the libertarian bent, as well as for many others.
How China Became Capitalist (PDF)
James A. Dorn
In 1981, shortly after China began to liberalize its economy, Steven N. S. Cheung predicted that free markets would trump state planning and eventually China would “go ‘capitalist’.” He grounded his analysis in property rights theory and the new institutional economics, of which he was a pioneer. Ronald Coase, a longtime professor of law and economics at the University of Chicago and Cheung’s colleague during 1967–69, agreed with that prediction. Now the Nobel laureate economist has teamed up with Ning Wang, a former student and a senior fellow at the Ronald Coase Institute, to provide a detailed account of “how China became capitalist.”