Saturday, September 19, 2015

Julien Noizet on Monetary Policy

This is part 3 in an interview series with Julien Noizet. For more about Julien, see the first post.

The interview questions are:
Why do you think inflation has been low in US after the 2008 recession?
What is the most important thing economists get wrong about the way banks work? 
What are your thoughts on NGDP targeting?
What are your thoughts on free banking?

FH: What are your thoughts on NGDP targeting?

JN: I am definitely open to the idea. I believe NGDP targeting would be a strong improvement on the current inflation targeting dogma. It would lead to a more stable economic framework, would at last (in theory) release central bankers from error-prone discretionary policies, respecting the concept of the rule of law. While not my ideal, I still see NGDP targeting as a step in the right direction.

Nevertheless, many questions remain. Some theoretical ones: what is the appropriate NGDP growth level to target? Proponents disagree for now (some say 2/3%, some 4/5%). My fear is that it remains easy to trigger an Austrian-like business cycle despite having NGDP on a stable growth path, in particular if this growth exceeds trend productivity growth, resulting in inflation. As some critics have pointed out, NGDP targeting ignores the sub-components of NGDP, and indeed, no one could have spotted the imminent crisis in 2007 by looking at the NGDP trajectory alone. NGDP stories can explain the bust, but not the boom.

A Hayek rule (i.e. maintaining NGDP stable rather on a certain growth trend) would seem to me preferable. And it is also the sort of NGDP outcome that a free banking system would generate according to economists such as Selgin and White.

Some practical questions: NGDP targeting seems to me to fall into the ‘policy design in a vacuum’ trap again. It ignores the micro effects of banking regulation and accounting on the transmission mechanism. It is unsure that central banks could stick to their NGDP growth target as a result.

FH: What are your thoughts on free banking?

JN: This is my ideal. The track record of free banking is crystal clear: it has been more stable than any other banking system in history. Under free banking, banks are not constrained or incentivised by any monetary policy or specific regulation devised by any central authority. While there are occasionally bank failures, systemic crisis rarely if ever occur. It is banking under a pure laissez-faire form: market actors identify potential lending opportunities (and their associated risks) free of exogenous constraints that distort their decision-making process. Prices consequently convey the information they are supposed to, as described by Hayek, markets are allowed to coordinate and the capital allocation process becomes more efficient, free of malinvestments.

There remains a great divide between Austrian scholars on whether or not fractional reserve free banking (FRB) should be outlawed. While I don’t see how forbidding FRB qualify as libertarian, and I am unconvinced by the arguments that FRB is economically damaging, I believe the solution resides in letting the market decide. In a free market world, entrepreneurs would be free to open 100%-reserve banks and advertise them as such. If their business model is more solid than FRB banks and convinces customers, large-scale FRB will naturally disappear.

Nevertheless, FRB free banking has the advantage of permitting the issuance of liquid private currencies whose supply fluctuates with money demand. Bank failures have occurred in 19th century US a number of times as banks did not have the flexibility to expand and then contract their note issuance. It is unsure, if we accept that some prices are downward sticky in the short run, how 100%-reserve banking would cope with such monetary disequilibrium.

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