Tuesday, May 13, 2008

Defunct economist and price stability

The defunct economist whose slaves today’s practitioners of price stability are is Keynes himself!

The infamous, eloquent ending passage (p. 383) of J. M. Keynes’s The General Theory describes: “…the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men … are usually the slaves of some defunct economist.”

Keynes’s A Tract on Monetary Reform – dedicated to the Governors and Court of the Bank of England in 1923 – argues for why the Treasury and the Bank of England “should adopt the stability of sterling prices as their primary objective” (p. 147).

Of course, the book simultaneously advocates the policy of flexible exchange rates: stability of sterling prices “would not prevent them aiming at exchange stability as a secondary objective.” The Fed “failing to keep dollar prices steady, sterling prices should not…plunge with them merely for the sake of maintaining a fixed parity of exchange” (p. 147).

Keynes clearly gives credit to Irving Fisher as “the pioneer of price stability as against exchange stability,” but he doubts Fisher’s policy approach based on automatic index adjustments: “If we wait until a price movement is actually afoot before applying remedial measures, we may be too late.”

Keynes quotes Hawtrey’s Monetary Reconstruction (1922) “It is not the past rise in prices but the future rise that has to be counteracted”, points to “the, often more injurious, short-period oscillations”, warns not “advisable to postpone action until it was called for by an actual movement of prices” and adapts Fisher’s approach by presenting the idea of price stability in terms of an official index number, the price of a standard composite commodity:

“It would promote confidence … (if) the authorities were to adopt this composite commodity of a standard of value in the sense that they would employ all their resources to prevent a movement of its price by more than a certain percentage in either direction away from the normal”.

Keynes favored “a general judgment of the situation based on all the available data” in the regulation of the bank steering rate over a cut-and-dry formula and in detail described what in essence comprises the economic and monetary analysis that the European Central Bank (ECB), or the Fed or the Bank of England for that matter, bases it decisions on.

“The main point is that the objective of the authorities, pursued with such means as are at their command, should be the stability of prices.” (p. 149)

Keynes was too optimistic of the power of economic ideas over vested interests: “Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas”.

Nothing explains better than vested interests the 70 year chain of monetary policy disasters all over the world, up to Black Wednesday or the 13 percent drop of the GDP from 1990 to 1993 in Finland’s banking crisis.

Keynes was right in the long run. The ideas which civil servants and politicians applied to monetary management during the 1990’s were definitely not the newest in the perspective of his A Tract on Monetary Reform. But the ideas were new to many economic scribblers and still are not accepted by agitators.

Unlike Keynes’s “practical men, who believe themselves to be quite exempt from any intellectual influences”, today’s central bankers know Keynes, Irving Fisher and results of academic research. Apart from charlatans, they are nobody’s intellectual slaves, but independent thinkers and professionals of the highest caliber.

(All italics here are as in the original text!)

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