Monetary Policy in Action

When I looked at the Financial Times this morning, I was struck by the following article entitled “Booming Sweden Raises Rates”.

Sweden is a small open economy, so the potential for monetary policy to be effective is limited.  But, it is still notable that by aggressively reducing its lending rate to zero and not paying interest on reserves, the Swedish Riksbank has promoted a recovery.  With the recovery come higher interest rates.  Not the other way around.  FOMC, please take note.

20 Responses to “Monetary Policy in Action”


  1. 2 João Marcus Marinho Nunes July 6, 2011 at 10:28 am

    But then you have Marvin (“Inflation Scare”) Goodfriend favoring higher rates:
    “The Fed needs to restore positive real short term interest rates fairly soon. Otherwise higher trend inflation and inflation scares will force the Fed in the future to more than reverse any short-run gains in employment that it might otherwise achieve in the present”.

    http://blogs.wsj.com/economics/2011/07/05/qa-goodfriend-says-fed-should-prioritize-low-inflation/?mod=WSJBlog&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+wsj%2Feconomics%2Ffeed+%28WSJ.com%3A+Real+Time+Economics+Blog%29

  2. 3 David Glasner July 6, 2011 at 11:01 am

    As Hawtrey could have told — and I hope to post some direct quotes from him on this point — trend inflation depends on wage inflation. As of now wage inflation is as low as it has been in a very, very long time. So it is wrong to use justify increasing rates now on the basis of a threat of higher trend inflation at some unspecified future time, when the best indicator of future inflation is low and possibly declining. Goodfriend was also an architect of the Fed’s interest on reserves policy.

  3. 4 Lars Christensen July 6, 2011 at 11:41 am

    David, you are entirely correct. Aggressive monetary easing – or rather making sure that an increase in the money supple to makes up for the drop in velocity – has ensured a swift Swedish recovery. In that regard the comparison with Denmark is very interesting.

    Sweden with a floating exchange rate and inflation targeting has been able to boost M2 growth to around 5% y/y, while Denmark with it’s fixed exchange rate policy have seen M2 drop around 5% over the past year. Sweden has recovered fast from the crisis, while Denmark is still not really growing.

    The explanation to me clearly is the difference in monetary policy in the two Scandinavian countries. Obviously there are other explanations – for example Denmark had a significant housing bubble prior to the crisis, while Sweden did not have a housing bubble, but again here there is a monetary explanation.

    Sweden’s monetary history obviously provides another interesting case (other than the Free Banking experience) and that is the reaction to the Great Depression, where price level targeting pulled Sweden fast out of the crisis.

  4. 5 Benjamin Cole July 6, 2011 at 12:34 pm

    Excellent blog. Keep up the good work.

  5. 6 David Glasner July 6, 2011 at 1:20 pm

    Thanks for your comment, Lars. I am well aware of the Swedish experience in the Great Depression and their rapid recovery when almost everyone was still on the gold standard. Much of the credit for Sweden’s good performance was no doubt due to the great Swedish economist, Gustav Cassel, whose ideas on the Great Depression and the role of the gold standard were very close to Hawtrey’s. I feel a little guilty about focusing the blog on Hawtrey’s work to the exclusion of Cassel, so thank you for providing me an opportunity to make some slight amends to his memory. I hope to make further efforts along those lines in the future.

  6. 7 David Glasner July 6, 2011 at 1:27 pm

    Thanks for the encouragement. I can use all I can get.

  7. 8 David Beckworth July 6, 2011 at 1:48 pm

    I wish more people understood your point about interest rates. But they don’t and thus we have many otherwise thoughtful observers calling for higher interest rates. The world would be a much better place if just this one point were more widely understood.

    BTW, Sweden is also great example of returning nominal spending to its trend growth path: http://macromarketmusings.blogspot.com/2011/06/what-catch-up-growth-under-nominal-gdp.html

    Keep up the great blogging.

  8. 9 David Glasner July 6, 2011 at 2:22 pm

    Like maybe the FOMC, for instance? I’m trying. Thanks for contributing.

  9. 10 Lars Christensen July 6, 2011 at 2:45 pm

    You are welcome David.

    I totally agree concerning Cassel. He was a truly great economist.

    As a monetarist I think that there is another unappreciated economist who deserves a lot more attention and that is Clark Warburton. I am sure he would have been in the “Sumner crowd” of “Quasi monetarists” (to me they are just monetarists…) today.

    What is your view on Warburton?

  10. 11 Cantillon Blog July 6, 2011 at 2:57 pm

    Hello David,

    Thank you for pointing me to your blog – nicely done, and I like your approach of a thoughtful take on contemporary matters. There seems to be a tremendous misallocation of attention amongst the commentariat these days – everyone gets caught up in the noise, discussing things in a fragmented manner; yet there is a shortage of more reflective discussion writing from a coherent and integrated perspective.

    Wrt Sweden, I haven’t looked at the details for a little while. But when inferring lessons about the suitability of different policies from Sweden’s relative performance, presumably one ought to consider differences in production mix. In other words Swedish exports, like those of Germany, are an important part of the economy and have been oriented towards those regions and sectors of the economy that have lately been booming. So it might not be a matter of a percent here or there on the lending rate that explains its recent relatively good performance.

  11. 12 David Glasner July 6, 2011 at 8:32 pm

    Lars, We are getting along so well that I am reluctant to risk disappointing you, but I am not at all sympathetic to Monetarism, i.e., the monetary theory and policy espoused by Milton Friedman and his followers and fellow-travelers. Warburton anticipated Friedman’s views, but I can’t recall reading anything he wrote. My main dissent from Monetarism is that its interpretation of the money supply process (a total confusion of money demand and money supply factors expressed in the so-called money multiplier) is theoretically incoherent. On top of which this grafted on to the most naive version of the Keynesian model in which the money supply is assumed to be exogenously determined by the monetary authority, leading Friedman to his infamous three percent rate of growth rule for the money supply, leading in turn to the discrediting of Monetarism in the wake of the 1983 recovery when Friedman, alarmed by high rates of growth of the monetary aggregates mispredicted the course of the recovery as badly as Keynesians mispredicted the course of the economy in the 1970s on the basis of the naive Phillips Curve. I also think that Friedman’s explanation of the Great Depression (borrowed, I gather, from Warburton) was a huge retrogression from the explanation offered by Hawtrey and Cassel in the 1920s and 1930s before and as events were unfolding. So if Hawtrey was the most underrated economists of the 20th century, Friedman might be in the running for the alternative title. But tjhat would just be for his monetary economics. His microeconomics and his theory of the consumption function were very good. And he had great ability to apply price theory to analyze real empirical problems, which was the great contribution of Chicago school economics. Also like Karl Popper, he was more than a little bit hypocritical in his intolerance of views contrary to his own. His treatment of Fischer Black while Black was at the University of Chicago in the early 1970s was simply disgraceful. Perry Mehrling discusses this episode in his excellent biography of Black. I am afraid that I have not given you a response that will please you, but Scott Sumner likes Friedman a lot more than I do and we are still friends.

  12. 13 David Glasner July 6, 2011 at 8:40 pm

    Thanks for your kind words. About Sweden, your words of caution about inferring too much from Sweden’s stellar performance are well taken. I was thinking of something along those lines when I included my caveat about the limitations of monetary policy for a small open economy. Nevertheless, I think that Sweden’s rapid recovery does tell us something important about the potential for monetary policy to promote recovery.

  13. 14 docmerlin July 7, 2011 at 5:05 am

    The US has very very open capital markets and we have very high access to foreign capital markets. We also import a massive quantity of foreign goods, why is’t the US a “small country” wrt is-lm?

  14. 15 Cantillon Blog July 7, 2011 at 9:01 am

    At the risk of stating the obvious, the share of net trade in GDP (and magnitude of fluctuations in GDP growth over longer periods that result from variations in net trade) is small for the US. This is not the case for Sweden.

    I am willing to bet, and indeed _I am betting_, that the present gloom over the US economy is excessive and that we will see a pretty decent recovery from here. Stabilization in gasoline prices will support growth of real disposable incomes; labour market is continuing to improve (there is a limited possibility for productivity growth to continue at such a high rate); rising rents are already beginning to put a floor under housing prices (focus on voluntary sales, not forced liquidations/foreclosures).

    Just because the recovery has disappointed so far does not mean that it will continue to do so.

    In fact the very large degree of pessimism (39% of Americans think that the economy will never fully recover!) is a warning that the risks are that we have very positive surprises ahead.

  15. 16 gabe July 7, 2011 at 10:55 am

    yep all this bigger governemnt is going to help the economy right Cantillon? We don’t have a gold standard today so a great depression is impossible. We also know how to end the depression…print lots of money and increase aggregate demand through more government! This economy is going to be awesome soon.

  16. 17 gabe July 7, 2011 at 11:02 am

    monetary theory is easy….there are only two options.

    “Loose policy”(which makes everything nice and is the reason we have modern technology today) and “tight policy”(which is needed if wages start to increase quicker than the price of food/energy/education and health care).

    Right now we desperately need loose monetary policies.

    Any examination of why we need to have a central bank and why we need to have one central power with monopoly rights on currency creation is unscientific. Of course we need to have the interest rates and credit markets controlled by central planners. Russia proved that central planning is the way to go, look at how good the Russians are at math.

  17. 18 David Glasner July 7, 2011 at 4:23 pm

    Docmerlin, You are right that in some sense the US is also a small open economy, which limits the effectiveness of monetary policy to some degree, e.g., insulating the economy from external shocks by some offsetting monetary policy. But even a small open economy with a flexible exchange rate has control over its price level. I guess the distinction between and a small and a large open economy is how large is the non-tradable sector. If a small economy is integrated into a larger one, then a very large proportion of transactions will be between people in the economy and people outside. In a large open economy, there will be a larger proportion of transactions between people within the economy. That’s about all I can think of now.

    Cantillon, I think that there are some reasons for optimism, as you suggest, a spontaneous improvement in expectations could do the trick. However, it is unhealthy for an economy to have near zero interest rates unless real interest rates are clearly positive which they are not. Until inflation expectations are increased to promote economic expansion I am afraid that there is a good chance that real interest rates will continue to be near zero or negative.

    Gabe, If you mean that easy money would allow the economy to expand without the need for a major expansion in the role of government in society, I agree with you.

  18. 19 Cantillon Blog July 7, 2011 at 8:22 pm

    I can certainly say that this is the first time anyone has ever attempted to make fun of my perspective for being overly statist – the internet can be the strangest place.

    I think that although it is early days yet Obama did not mark as he seemed to the end of the US free market model; instead I believe that he marked the final chapter in the Progressive ascendancy and the beginning of a significant Reaction organized around peasant cultural capital. (The Tea Party constituency performing the role of the barbarians in Ibn Khaldun’s model of civilizational cycles). So if regime uncertainty held back hiring in 2009, I think any prospective effect from here should be substantially attenuated. Only good things can ultimately come out of the debt ceiling related discussions.

    I think that anyone believing a depression is primarily about Fisherian debt deflation might perhaps benefit from a finer, more detailed study of previous episodes. As Mills wrote (not JSM) there are periods of exuberance followed by periods of more subdued mood. That is just the nature of humans in society – night follows day – and printing money will substitute new problems for those of Fisherian debt deflation.

    As a general point, I think people with a particular political perspective do themselves a disservice by viewing economic events exclusively through that prism, Just because one disapproves of policy enacted in the US since 2008 ought not to mean that one necessarily expects a depressed economy stretching out into the distant future. Certainly in financial markets, sticking to ideology is one of the many ways to lose money quickly.

    I do not really have any wish to persuade you – in my business, being right is its own reward and time will no doubt tell which of us is correct.

    David – with respect to price expectations, I think it’s terribly dangerous to speak of increasing inflationary expectations being a good thing in themselves without considering which prices it is of which we speak. I think perhaps one important set of expectations is that relating to hone prices in relation to the financing rate. Ie when will owning a home become a positive carry trade again. I think that time is not very far away. But I think that is a different question from expectations about changes in the cost of living.

  19. 20 David Glasner July 8, 2011 at 8:49 am

    Cantillon, you wrote:

    I think it’s terribly dangerous to speak of increasing inflationary expectations being a good thing in themselves without considering which prices it is of which we speak. I think perhaps one important set of expectations is that relating to hone prices in relation to the financing rate. Ie when will owning a home become a positive carry trade again. I think that time is not very far away. But I think that is a different question from expectations about changes in the cost of living.

    In this comment, you are being true to your namesake, and it is a valid point to make. On the other hand, I think that the general movement of prices, abstracting from the composition of the individual price movements, can play a key role in decisions about how much money people want to hold And it is decisions whether to hold money or to spend it that havwe a very big role in determining the trajejctory of economic activity.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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