New Monetarism as a third way beyond Hayek vs. Keynes?

David Glasner is a conservative economist who greatly admires Hayek and even thinks that Hayek’s macroeconomic theories have some merit even if they are weaker than many other theories.  He is part of a small band of conservative economists that is now calling themselves the “New Monetarists” who promote NGDP targeting.  I’d be happy if this would be the direction where a new macroeconomic consensus might be heading.  Monetarism in all its incarnations is completely consistent with Keynesianism and liberals also support it.  The big political difference in macroeconomic preferences of professional economists is that conservative economists tend to put more faith in monetary policy and tax cuts whereas liberals also see that government spending can be effective, particularly during a liquidity-trap recession such as in 2008.  A liquidity trap is when monetary policy becomes relatively ineffective because interest rates approach zero and cannot go lower.  The thing that surprised me the most during the 2008 recession is how conservative economists did very little to promote tax cuts as a fiscal stimulus like they did during the 2001 and 1990 recessions.  About 1/3 of Obama’s stimulus was tax cuts, but few conservatives lauded that historic tax cut even though it was much larger than what Trump later proposed.  (Trump repeatedly lied that his tax cut proposal was “the biggest ever in the history of this country” even though it was considerably smaller than what Obama had just passed.)
Glasner begins by lamenting the recent obsession for treating Keyens and Hayek as the two main macroeconomic schools:

First, it was the Keynes v. Hayek rap video, and then came the even more vulgar and tasteless Keynes v. Hayek sequel video reducing the two hyperintellectuals to prize fighters.  …Then came a debate broadcast by the BBC at the London School of Economics, and then another sponsored by Reuters with a Nobel Prize winning economist on the program arguing for the Hayek side. Now comes a new book by Nicholas Wapshott Keynes Hayek, offering an extended account of the fraught relationship…

…all this Keynes versus Hayek hype creates the terribly misleading impression that the truth must lie with only one side or the other, that one side represents truth and enlightenment and the other represents falsehood and darkness, …All this attention on Keynes and Hayek, two charismatic personalities who have become figureheads or totems for ideological movements that they might not have endorsed at all — and certainly not endorsed unconditionally — encourages an increasingly polarized discussion in which people choose sides based on pre-existing ideological commitments rather than on a reasoned assessment of the arguments and the evidence…

The amazing thing about the original Keynes-Hayek debate is not only that both misunderstood the sources of the Great Depression for which they were confidently offering policy advice, but that Ralph Hawtrey and Gustav Cassel had explained what was happening ten years before the downturn started… Both Hawtrey and Cassel understood that restoring the gold standard after the demonetization of gold that took place during World War I would have hugely deflationary implications if, when the gold standard was reinstated, the world’s monetary demand for gold would increase back to the pre-World War I level (as a result of restoring gold coinage and the replenishment of the gold reserves held in central bank coffers).

The problem is that when there is economic growth, people want more money as a store of value and for making more transactions and if the supply of money (gold) is limited, then its price will go up when the money demand goes up.  That means deflation.  Normally since the Great Depression, the price (value) of money has gone down relative to the value of goods (inflation), but periodic deflation is common under a gold standard.

in 1928, French demand for gold started to increase rapidly just as the Federal Reserve began tightening monetary policy in a tragically misguided effort to squelch a supposed stock-price bubble on Wall Street, causing an inflow of gold into the US

‘Tightening monetary policy’ means that the Fed raised interest rates in the US and that gave foreigners more incentive to buy dollars so they could get the higher interest rates by lending in the US.  Under the gold standard, they had to bring gold to the US to buy dollars, so this increased the gold supply in the US which reduced the gold supply in the rest of the world.  Glasner again:

…other countries rejoining the gold standard were increasing their gold holdings as well, though with a less fanatical determination than the French. The Great Depression was therefore entirely the product of monetary causes, a world-wide increase in gold demand causing its value to increase, an increase manifesting itself, under the gold standard, in deflation.
Hayek, along with his mentor Ludwig von Mises, [claimed] to have predicted the 1929 downturn, having criticized the Fed in 1927, …for reducing interest rates to 3.5%, by historical standards far from a dangerously expansionary rate, as Hawtrey demonstrated in his exhaustive book on the subject A Century of Bank Rate. But it has never been even remotely plausible that a 3.5% discount rate at the Fed for a little over a year was the trigger for the worst economic catastrophe since the Black Death of the 14thcentury.
[Similarly Keynes could not] offer a persuasive explanation for why the world suddenly went into a catastrophic downward spiral in late 1929. References to animal spirits and the inherent instability of entrepreneurial expectations are all well and good, but they provide not so much an explanation of the downturn as a way of talking about it or describing it. Beyond that, the Hawtrey-Cassel account of the Great Depression also accounts for the relative severity of the Depression and for the sequence of recovery in different counties, there being an almost exact correlation between the severity of the Depression in a country and the existence and duration of the gold standard in the country. In no country did recovery start until after the gold standard was abandoned, and in no country was there a substantial lag between leaving the gold standard and the start of the recovery.
So not only did Hawtrey and Cassel predict the Great Depression, specifying in advance the conditions that would, and did, bring it about, they identified the unerring prescription – something provided by no other explanation — for a country to start recovering from the Great Depression. Hayek, on the other hand, …not only advocated precisely the wrong policy, namely, tightening money, …he accepted, if not welcomed, deflation as the necessary price for maintaining the gold standard. (This by the way is what explains the puzzle …of Hayek’s failure to follow his own criterion for a neutral monetary policy, stated explicitly in chapter 4 of Prices and Production: stabilization of nominal expenditure (NGDP).

Note that stabilization of nominal expenditure (NGDP) is precisely the policy that the author (Glasner) and other New Monetarists promote. Keynes, Friedman, and many others have had similar ideas, but they did not promote them as monomaniacally as the New Monetarists do.  Keynes mostly ignored his own earlier monetary theories when he wrote about the Great Depression and Hayek was principally a gold bug:

…Faced with a conflict between maintaining the gold standard and following his own criterion for neutral money, Hayek, along with his friend and colleague Lionel Robbins in his patently Austrian book The Great Depression, both opted for maintaining the gold standard.
Not only did Hayek make the wrong call about the gold standard, he actually defended the insane French policy of gold accumulation in his lament for the gold standard after Britain wisely disregarded his advice and left the gold standard in 1931. In his paper “The Fate of the Gold Standard”  Hayek mourned the impending demise of the gold standard…
So what do we learn from this …tale? Hawtrey and Cassel did everything right. They identified the danger to the world economy a decade in advance. They specified exactly the correct policy for avoiding the danger. ….Within a year and a half, both Hawtrey and Cassel concluded that recovery was no longer possible under the gold standard. And as countries, one by one, abandoned the gold standard, they began to recover just as Hawtrey and Cassel predicted. So one would have thought that Hawtrey and Cassel would have been acclaimed and celebrated far and wide as the most insightful, the most farsighted, the wisest, economists in the world. Yep, that’s what one would have thought.
Did it happen? Not a chance. Instead, it was Keynes who was credited with figuring out how to end the Great Depression, even though there was almost nothing in the General Theory about the gold standard and 30% deflation as the cause of the Great Depression.  [Keynes should have known better as he] vilified Churchill in 1925 for rejoining the gold standard at the prewar parity when that decision was expected to cause a mere 10% deflation.
But amazingly enough, even when economists began looking for alternative ways to Keynesianism of thinking about macroeconomics, Austrian economics still being considered too toxic to handle, almost no one bothered to go back to revisit what Hawtrey and Cassel had said about the Great Depression.
This makes it appear that Glasner thinks that Hawtrey and Cassel were toxic Austrians, but Ralph Hawtrey was a colleague and close friend of Keynes who was greatly influential in the development of Keynesian economics and Gustav Cassel was a Swede who was also greatly influential on Keynes.  Back to Glasner:
So Milton Friedman was considered to have been daring and original for suggesting a monetary explanation for the Great Depression and finding historical and statistical support for that explanation. Yet, on the key elements of the historical explanation, Hawtrey and Cassel either anticipated Friedman, or on the numerous issues on which Friedman did not follow Hawtrey and Cassel — in particular the international gold market as the transmitter of deflation and depression across all countries on the gold standard, the key role of the Bank of France (which Friedman denied in the Monetary History and for years afterwards only to concede the point in the mid to late 1990s), the absence of an explanation for the 1929 downturn, the misplaced emphasis on the contraction of the US money stock and the role of U.S. bank failures as a critical factor in explaining the severity of the Great Depression — Hawtrey and Cassel got it right and Friedman got it wrong.
So what matters in the success in the marketplace of ideas seems to be not just the quality or the truth of a theory, but also (or instead) the publicity machine that can be deployed in support of a theory to generate interest in it and to attract followers who can expect to advance their own careers in the process of developing, testing, or otherwise propagating, the theory. Keynes, Friedman, and eventually Hayek, all had powerful ideologically driven publicity machines working on their behalf. And guess what? It’s the theories that attract the support of a hard core of ideologically motivated followers that tend to outperform those without a cadre of ideological followers.
That’s why it was very interesting, important, and encouraging that Scott Sumner has shifted the debate over the past two years away from the tired old Keynes vs. Hayek routine. …Scott is reviving the Hawtrey-Cassel pre-Monetarist tradition, of which Friedman’s is a decidedly inferior, and obsolete, version. It just goes to show that one person sometimes really can make a difference, even without an ideologically driven publicity machine working on his behalf. Just imagine what Hawtrey and Cassel could have accomplished if they had been bloggers.
I agree with Glasner that Hayek’s macroeconomics is mostly useless, and the Hawtrey-Cassel tradition has a lot of merit, but it is very much a part of the Keynesian tradition in both the development of Keynes’ thoughts and in the modern incarnation so it is misleading to suggest that it is somehow the diametric opposite of Keynesianism.  Although Keynes didn’t focus upon the gold standard and monetary policy in his General Theory of Employment, Interest and Money in 1936, that is because the countries he was writing for had already left the gold standard and monetary policy loses its effectiveness in a liquidity trap like the world faced in 1936.  Keynes had focused on monetary policy in his earlier works like A Treatise on Money which he published in 1930.  I agree with Glasner except that I don’t have a problem with using fiscal policy for stimulating the economy, particularly during a liquidity trap.
Similarly, Brad Delong thinks Glasner should be more open to fiscal policy, particularly during a liquidity trap:
  1. The Federal Reserve and the ECB and the Bank of England …flooded the North Atlantic economy with liquidity [for over] four years. Yet it [was not] enough to produce a healthy recovery. Cassel and Hawtrey took it for granted that enough monetary ease–buying enough short-term bonds for gold or other forms of rock-solid cash–would do the job. But today it looks as though balance-sheet depressions are more stubborn beasts, that simple liquidity-provision by the government is not enough, and that proper handling may require banking and fiscal policy …as well.
  2. Related to [the above], I think that Cassel and Hawtrey are not enough. I think that their exclusive focus on monetary liquidity misses large aspects of the picture. You need to think along Bagehot-Minsky-Kindleberger lines about safety and risk and along Wicksellian lines about the savings-investment balance as well. And, historically, the traditional road from the quantity theory of money to those concerns has been the Keynes-Hicks-Tobin road.
Posted in Macro

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