This talk by Bank of Canada Governor Mark Carney from Thursday is of note mostly for the fact that he explicitly addresses both Austrian criticisms of central bank policy and the position taken by NGDP targeters like Scott Sumner. The bit on the Austrians is below. He does a decent job of explaining the argument, but a not so good job, I would argue, on what it implies.
Second, the stronger critique of the Austrian school is that inflation targeting can actively feed the creation of financial vulnerabilities, especially in the presence of positive supply shocks. For example, in an environment of increased potential growth resulting from higher productivity, inflation-targeting central banks may be compelled to respond to the consequent “good” deflation by lowering interest rates. From the Austrian perspective, this misguided response stokes excess money and credit creation, resulting in an intertemporal misallocation of capital and the accumulation of imbalances over time. These imbalances eventually implode, leading to crisis and “bad” deflation.
As I will argue later, this critique places monetary policy in a vacuum divorced from broader macroprudential management. Moreover, it offers only a counsel of despair for current problems: liquidate, liquidate, liquidate.
(For the NGDP crowd, there’s plenty on that later in the talk.)
Clearly “liquidate” is part of the necessary solution, but it’s not all and as many of us have tried to point out, it’s not a counsel of despair. It’s instead a caution that central banks cannot solve the problems they created, any more than an arsonist makes a good firefighter. It’s only a counsel of despair if you think that central banks and and the rest of the government macro apparatus is the only process by which economic coordination takes place. Getting out of the way of the millions of decentralized decision-making units who have to actively and creatively engage in recalculation and resource reallocation would allow them to initiate real recovery. That’s a counsel of hope if only we are humble enough to see it. And that, of course, is in addition to the necessary monetary reforms that move us toward a more decentralized competitive banking system.
It might seem strange that the boss of the Bank of Canada would feel compelled to address the Austrian argument. Sure Austrian ideas are more in the air than they used to be, but it might help that the head of research at the Bank of Canada and chief advisor to the Governor is the father of one of my current students. We’ve had him to campus to give a couple of talks and I’ve spent some time chatting with him (and his daughter was in my AEH course last fall). The language of “good” and “bad” deflation is terminology that I have used quite a bit (George Selgin too), so I can’t help but wonder if my connection isn’t a contributing factor. If not, then I’m guilty of no more than suffering from my usual case of inflated ego.
(Cross-posted at Coordination Problem)