Regulation seems to cause bank crises, not prevent them
City AM's Pete Spence (formerly of this parish) reminded me of Mark Carney's claims in January that free banking systems are more unstable than regulated ones. I'm not so sure. Take a look at these two charts from George Selgin's Are Banking Crises Free-Market Phenomena?, which mark an x for every instance of a banking panic. The first chart is for unfree systems, the second for free systems:
In this case at least, it looks like the evidence is against Mark Carney.
Why we're hoping the wisdom of crowds can beat Mark Carney
Today we've launched two betting markets to try to use the 'wisdom of crowds' to beat government economic forecasters. Here's the press release we sent out:
The Bank of England’s economic forecasts have been wrong again and again. To counter this, the free market Adam Smith Institute is today (Wednesday 28th August) launching two betting markets where members of the public can bet on UK inflation and unemployment rates, taking the government’s experts on at their own game. The markets are designed to aggregate individual predictions about the economy’s prospects to use the ‘wisdom of crowds’ to beat the predictions of government experts.
The launch coincides with Mark Carney’s first major speech as governor of the Bank of England and follows his announcement earlier this month that the Bank will consider both inflation and unemployment when deciding monetary policy.
The markets (which will be run by bookmaker Paddy Power and can be accessed here) offer these odds:
UK Inflation on 1st June 2015 7/1 - 2% or Less 3/1 - 2.01 - 3.00% 9/4 - 3.01 - 4.00% 5/2 - 4.01 - 5.00% 7/2 - 5% or Greater
UK Unemployment rate on 1st June 2015 9/2 - 5% or Less 3/1 - 5.01 - 6.00% 15/8 - 6.01 - 7.00 % 5/2 - 7.00- 8.00% 5/1 - 8% or Greater
Bookmaker odds tend to be far more reliable than expert opinions about sports, politics and the Eurovision Song Contest, because betters have a strong financial incentive to bet in a dispassionate way and betting markets collect the judgments of thousands of different people, eliminating individual biases.
Even if no single member of the public can beat the experts, collecting the local knowledge of thousands of people in betting markets allows for a much broader set of data points, weighted according to the strength of people’s beliefs. The Office for Budget Responsibility already collects around two-dozen expert predictions, but this is nothing like the kind of volume needed for the ‘wisdom of crowds’ effect to take place.
These markets follow the CIA’s attempts to use betting markets to anticipate geopolitical crises, which were short-lived because of public objections. In future, the Adam Smith Institute will use these markets to compare betters’ judgments about the direction of the economy to those of government forecasters.
Sam Bowman, Research Director of the Adam Smith Institute, said: “No individual can know enough about the economy to make a really reliable prediction about it. By combining the local knowledge of thousands of people, betting markets can outpredict any panel of experts. If these markets catch on, the government should consider outsourcing all of its forecasts to prediction markets instead of expert forecasters.”
Rory Scott from Paddy Power said “Mr Carney – forget your fancy financial models; let’s see where the great British public put their pound instead. Failing that, perhaps the solution to topping up the Bank of England coffers is to take advantage of Paddy Power’s 7/1 for inflation to be 2% lower come June 1st 2015.”
Kick the 'wise men' out of the Bank of England
In today's City AM, newly-minted ASI fellow Lars Christensen (aka The Market Monetarist) writes on the 'Carney rule'. The Carney announcement is a tiny step in the right direction, he says, but as long as the 'wise men' of the Monetary Policy Committee are running monetary policy, policy will be erratic and unpredictable, preventing adequate planning by firms and adding to market panic in economic downturns. Instead, we should have a strict rules-based system of nominal GDP targeting:
A much better rule would have been to commit to stabilising the level of nominal GDP (NGDP), a measure of aggregate demand, keeping market expectations of NGDP growth on a 4 or 5 per cent growth path. This should be combined with an open-ended commitment to expanding the money base to hit this target. This would avoid the nitty-gritty of the Carney Rule and be clearer and easier to communicate to markets.
Monetary policy based on the discretion of “wise men” leads to market uncertainty and panicky jolts as investors react to tiny changes in central bankers’ pronouncements. Replacing the MPC with rules-based policy would bring discipline and predictability to the Bank of England far beyond what was outlined yesterday.
I would prefer to have no Bank of England at all, with money emerging from the market as outlined by Hayek in 1976. Having said that, perfect is not the enemy of good — replacing the discretion of 'experts' with predictable, market-led rules would be a huge step in the right direction. If Carney's new rule fails, it may come on to the agenda sooner than we think.
Mark Carney bottles it with baby steps
Mark Carney had the leeway to make radical change here but he's bottled it with baby steps.
The 'Carney rule', promising low interest rates and the possibility of more quantitative easing (QE) until unemployment is low or inflation rises, is definitely an improvement on the current regime. It gives firms clearer guidance on the future stance of policy, removing some of the uncertainty in the world economy today. I expect it to deal with some of today's demand shortage, and more importantly tomorrow's expected demand shortage.
But unemployment and inflation come from both aggregate demand (which the bank can control) and aggregate supply (which it has essentially no control over). Since neither of these numbers distinguish between changes in supply or demand, the Bank is still fumbling in the dark with its guesses over whether a change in inflation comes from demand (which means it should react) or supply (which means it shouldn't). This means firms are still left guessing, and it means that uncertainty still reigns.
What we really need is a truly rule-based system that takes discretion away from nine 'wise men' and uses market forecasts to create real stability. That system is nominal income targeting.
Allister Heath lays out his Mark Carney wishlist
In a video out this morning, City A.M. editor Allister Heath calls on Mark Carney to bring the Bank of England into the twentieth century by reforming regulation to emphasise greater interaction with the financial sector, opening up its culture to something less dictatorial, and monetary policy to something more like Nominal GDP Targeting or a Productivity Norm.
Welcome Mark Carney, now here's what you need to do
Today Mark Carney becomes the new governor of the Bank of England, gaining oversight not only of UK monetary policy, but also financial regulation, as part of the Bank's newly-expanded responsibilites. When George Osborne revealed he had managed to persuade Carney to take on the role there was great fanfare and excitement. This was firstly because the Canadian economy has performed relatively well through the recession and secondly because Carney has shown himself open to innovations in central banking, though he has not implemented any in his time at the helm of the Bank of Canada.
Carney talked up the benefits of targeting the level of demand in the economy—though only for exceptional times—in a recent speech. And one would expect that the chancellor, for the £870,000 he has agreed to pay Carney, is open to significant change, notwithstanding the insignificance of the minuscule changes he himself made to the BoE's remit in the budget. Put together, these facts give cause for some optimism for someone like me, who supports targeting the level of demand.
So instead of speculating on what the superstar economist actually will do, I will outline the basics of what Mark Carney should—and could do:
I. Target levels instead of rates—this means bygones are not expected to be treated as bygones, and market actors do not worry about worse-than-expected outcomes because the central bank has committed to sorting them out
II. Target NGDP (demand) instead of inflation—this means supply moves don’t lead to the wrong sorts of tightening or loosening of monetary policy, also means demand is stabilised directly, instead of an arbitrary part of the outcome of demand; stable demand means no recessions caused by nominal factors and no unsustainable booms
III. Target the forecast instead of the outcome—this is what matters for expectations, which are basically all that matters for employment contracts, loan/debt contracts, investment etc. etc. Expectations are the key, so it’s insane to ignore them
IV. Target market, not internal forecasts—set up an NGDP-linked bond, like the RPI-linked bond, and target the spread between the vanilla bond and the linked bond to get an objective idea of where to aim. Guesses where people have skin in the game are systematically better than the relatively costless estimates produced by private consultancies and the Bank’s internal team. But even if they’re wrong it doesn’t matter because expectations are all that count, and the spread between the bonds IS the market expectation. Driving that to a particular point is success, regardless of what happens.
In general the road ahead must be one of rules and discipline, not the translucent discretion of nine unelected barons.They must keep demand steady so we can focus on improving the supply capacity of the economy, and so there is no excuse for fiscal stimulus, with all its flaws. If you still need convincing, read Scott Sumner's 2011 Adam Smith Institute monograph "The Case for NGDP Targeting".
The poverty we can relieve
The Joseph Rowntree Foundation (JRF) has a new report out today that takes a look at living costs for the poor and the cost of achieving a 'socially acceptable standard of living' in modern Britain. The report continues their excellent approach to poverty measurement, which looks at the cost of a basket of goods that most people would consider necessary to have a decent standard of living.
This approach is very reasonable, and does a good job of contextualising domestic poverty without being led to the sort of absurdities of straightforward relative poverty measures, which, for example, "improve" every time someone wealthy goes bankrupt or leaves the country. The JRF’s method is quite a neat combination of the best elements of relative and absolute measures of poverty.
It's important to remember that poor people in the UK are still very rich by global standards. But that's not to say that their problems aren't still important and worth trying to solve by allowing more wealth to be created. There are some things we can do to help people in poor countries, such as removing barriers to trade and migration, which would also be good for poor people in the UK, but that shouldn’t stop us caring about relatively less poor people in the UK.
The JRF is right to highlight the fact that rises to the cost of living hit the poorest the hardest. I think it's probably a mistake, however, for anyone to assume that benefits cuts are the main causes of the living standards squeeze for the poor. They might be a factor in declining or stagnating incomes (not as much as the overall economic climate, though), but they don't explain why the cost of living is rising so rapidly.
Paradoxically, things like 'affordable housing' requirements can actually end up hurting people in need of affordable housing. They disincentivise higher-end developments and cause the demand for those homes to be pent-up in the existing housing stock – so, in other words, instead of building new houses for the rich, existing affordable homes are converted to accommodate them, reducing available units for people who need cheaper homes. Liberalizing the planning system so that supply can meet demand would do a lot to reduce the cost of living for the poor.
I also think it's crazy and inhumane that we tax minimum wage workers so much. A full time worker on NMW earning just under £13,000 a year will have to pay more than £1,300 of that in tax. That's a scandal.
And of course a lot of the problems facing people on low incomes are due to the overall economic climate. If Mark Carney really does implement a nominal GDP target, the resulting economic recovery and job creation will mitigate some of the worst problems facing people at the bottom of British society.