Macroeconomics: Plus ca Change, Plus ca Meme Chose...
links for 2010-03-09

Macroeconomics: Against the Sufficiency of Inflation Targeting

Slip a derivative and this argument, summarized here in 1844 by John Stuart Mill, is Michael Mussa's argument against providing a lexicographic preference to inflation targeting:

John Stuart Mill on The Currency Question: Within the last few years another doctrine has sprung up, of which Colonel Torrens was, as we have said, the originator, Mr. Loyd, Mr. Norman, and Mr. McCulloch among the chief propounders, and to which Sir Robert Peel and his cabinet have become proselytes. According to this doctrine, the check of convertibility acts too slowly, and admits of great mischief from excess of issues before it begins to operate. Convertibility, it is contended, is a security only against permanent depreciation. When an increased issue of paper has sunk the value of the currency below its regular proportion to the currencies of other countries, the exchanges turn, gold becomes an article of export, and, to obtain it, notes are returned upon the Bank. But the increase of issues has, in the meantime, raised prices; which, when the excess of paper is removed, relapse to their former level. This is already a mischief; it deranges mercantile calculations, creates unexpected gains to some at the expense of others, and adds to the gambling character in a certain degree inherent in all the great operations of commerce. But the evil seldom ends here. All advance of prices tends to encourage speculation; especially when the same cause which creates the advance (being increased issues made by bankers, in the form of increased advances to their customers) occasions, as its very first effect, a reduction of the rate of interest. The conjunction of rising markets and a low rate of interest leads to speculative purchases, by which the rise itself is heightened and prolonged. The rise, however, not being grounded on any permanent cause of increased price (such as a deficiency of supply); in proportion to its continuance, the fall, when the tide turns, is from a greater height, and also to a lower depth. Those who during the rise of prices obtained credit upon the apparently increasing value of the goods which they held, are only enabled to fulfil their engagements by parting with the goods at almost any sacrifice, and prices sink for a time as much below their accustomed rate as they had previously been raised above it. To avert these evils, in the opinion of Colonel Torrens and Mr. Loyd, and we may now add of Sir Robert Peel, something more than convertibility is necessary...

And here is Mill channeling his inner Hyman Minsky:

As the notions of persons unacquainted with trade on what constitutes a commercial crisis are generally rather vague and obscure, we will, before going further, state as distinctly as possible what are its principal characteristics. A commercial crisis is the recoil of prices, after they have been raised by speculation higher than is warranted by the state of the demand and of the supply. Speculation is almost always set in motion by something which affords apparent grounds for expecting either an extra demand or a deficient supply. But the anticipation may, in the first place, be erroneous; in the second, however rational it may be, the speculation (especially where the prospect of gain is considerable) is very likely to be overdone, each speculator conducting his operations as if he alone knew the circumstances on which the hope of profit is grounded. The rise consequent upon the speculative purchases attracts new speculators, insomuch that, paradoxical as it may appear, the largest purchases are often made at the highest price. But at last it is discovered that the rise has gone beyond the permanent cause for it, and purchases cease, or the holders think it is time to realise their gains. Then the recoil comes; and the price falls to a lower point than that from which it had risen, because the high price has both checked the demand, and, by stimulating production or importation, called forth a larger supply. Besides, many of those who during the high price have contracted engagements, which they trusted to a further rise for giving them the means of fulfilling, are unable to hold on until the crisis is past, but must sell at any sacrifice. When this series of effects is confined to some one article of commerce, individuals may be ruined, but the mercantile world generally is not disturbed. When, however, as in 1825 and at several other periods in the present century, the opening of new markets, or some expected deficiency of supply extending to various important articles, has set speculation at work in several great departments at once, the spirit is apt to become general, and other commodities rise in price without any reasonable cause whatever. In such cases, the ultimate revulsion is most extensive and calamitous.

As long as the seasons vary, as markets fluctuate, and men miscalculate, or the passion of gain (as in gamblers) over-rides their calculations, so long will these alterations of ebb and flow, these "cycles," as Colonel Torrens calls them, "of excitement and depression,"[8] continue. They are worse in America than in England, because American commerce is conducted in a more gambling spirit; they are worse at Liverpool than in London, for the same reason. But whatever aggravates the natural fluctuations of the markets, or creates fluctuations when they would not otherwise exist, increases both the frequency and the destructiveness of such convulsions.

I understand that those who do not remember history are condemned to repeat it. But why in the Holy Name of the One Who Is are those of us who do remember history condemned to repeat it with them?