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If we strip off the gold wrappings, it seems to me that this is an argument for fiscal stimulus.

When we consider basics, gold is a commodity that can be increased in supply under some conditions. An increased price of gold is a strong reason to attempt supply increase. Supply increase in the case of gold requires increased mining activity in every aspect of the mining industry. Thus we see that a central bank managed increase in the price of gold would result in fiscal stimulation directed at the mining industry.

Viewed in a fiscal light, changing the price of gold is unlikely to effectively steer the economy in the desired direction--the size of the industry is simply too small. That said, the concept of forward steering using commodity pricing can be easily linked to short term measures of labor utilization.

There is an important second effect that occurs when the price of gold is changed by central bank management. At the time of price change, the existing supplies of gold will have an ownership distribution. All present owners will have a net worth gift from the central bank. There would be NO GIFT for those without present gold ownership.

Hmmmm. I guess we could consider fiscal stimulation to be forward steering. How would we characterize the net worth gift?

I'm sure economists would just love to put the above totally unrealistic stuff "near the top of the money/macro research agenda." That would create hundreds of person years of employment for them. But for those of us concerned doing something useful like creating jobs in a recession, how about this.

1. The state prints money and spends it on the usual public spending items: education etc. 2. If government prefers to boost PRIVATE rather than PUBLIC spending, then print money and give it to households.

Oops. That's not complicated enough. It'll never create hundreds of person years of employment for economists.

>> I have thought about front-wheel steering a bit, in some older posts I can't find now.

2013: On letting the market set interest rates, in a comment:

> Market Fiscalist: think of using interest rates as an instrument as like driving a car with rear-wheel steering (or driving a car in reverse). If you want to make the car go right, you have to make the rear wheels go left. And you can't do that if you are too near the left edge of the road (the ZLB). If you *must* drive the car using rear wheel steering, then you need to stay well away from the edges of the road (adopt a higher inflation target or NGDP target (the latter also has self-equilibrating properties that keeps it nearer the centre of the road automatically, so you need less steering)). Better yet, using front-wheel steering (something other than interest rates).

2009: Interest rate control: maybe theory was right after all?

> Interest rate control is like riding a bicycle. You can't keep the steering fixed and expect to stay upright. You need to keep moving the steering, and move it faster than your tendency to fall over, if you want to stay upright. And also like a bicycle, you need to steer left if you want to turn right. If you want higher nominal interest rates you first need to lower interest rates, so that inflation starts to rise, and expected inflation starts to rise, at which point you can raise interest rates, and raise them higher than originally, so that inflation and nominal interest rates eventually settle down at some new higher level.

> That's how it was supposed to work in practice. Why did it stop working in practice?

Why use asset price inflation to try and stimulate demand? The gold example is interesting, because at least in that case asset price inflation leads to real investment (by someone, not necessarily existing owners of the asset). However, with a basket of stocks, there is no guarantee that anyone will want to issue new stocks: the market for existing securities and the market for new issues are not necessarily well-connected. Moreover, even the issuance of new securities does not guarantee real investment, since companies can issue new stocks and use the money to retire debt (or buy other existing businesses), which does not necessarily stimulate real activity.

I have to agree with other comments: if you want to "drive from the front", then increase or decrease real investment (or real productive activity, however you want to define it) as directly as possible. Either print money and have the government spend it on infrastructure (which is about as real an investment as you can get), or print money and give it to people who are going to spend it directly on goods and services (and who are not likely to just reduce debt or buy other financial securities with asset-price inflation results).

Governments borrowing at "low" interest rates and spending it on infrastructure is a second-best alternative, because they will still be paying the debt back in the future with interest. While it does mean that the government is soaking up capital that would otherwise be contributing to asset price inflation (in other words making a better investment decision than the capital markets, on average), it is still creating a fiscal burden on the future that will limit future flexibility.

Maybe in the future the policy decision could be "In order to keep the economy humming at a target level, how much infrastructure spending should we do this year, and what mix of newly printed money vs. borrowed money should we use?"

If a CB pegs the value of it currency to gold, but wants to also peg the price level, then it has to manipulate the price of gold by varying its supply to achieve both ends. But why would it bother pegging its currency to gold (apart from habit, or because its global norm) rather than just pegging its currency to the price level directly and adjusting the supply of its currency to achieve this end ?

I'm therefore not getting the advantages of pegging the price level via a stock price index over just doing it directly. As long as the CB steers clear of adjusting the supply of its currency by buying things that are very close substitutes for currency then I suspect that it probably doesn't matter much how it does the adjusting. Running a bigger fiscal deficit by lowering taxes financed by new money, or buying into stocks indexes with new money , would both be very likely to have a direct affect on the price level.

Pretty good analogy I think.

Similar to your old ladder one.

Here’s something that puzzles me about not thinking about monetary policy in terms of interest rates:

One reason for front wheel steering is to escape the zero lower bound of interest rates, given the nastiness of the interest rate dilemma. That is a good reason to have front wheel steering at least as an option.

But once you’ve escaped the lower bound, you’re back in a zone where the central bank has no choice but to understand and conduct its operational effect on interest rates – i.e. consciously administering a policy interest rate that applies to either or both the trading of bank reserve positions (e.g. fed funds rate) or the interest rate earned on bank reserves (e.g. Fed IOR while super-excesses are still outstanding).

And if the central bank is back to actively conducting interest rate setting in a positive interest rate environment, you’ve returned to back wheel steering behavior de facto. It simply exists as a result of normal central bank operations. So you’re either back at exclusive back wheel steering, or a world of active 4 wheel steering.

(The Fed’s exit strategy from QE implicitly includes 4 wheel steering – because it has to manage both the back wheel steering of interest rate increases and the front wheel steering of going into reverse on QE reserves.)

Why not stop, and back up. If we consider reverse as going in the other direction on income inequality, this would increase consumer demand, and thus enable one to steer away from the lower bound. Analogies are always dangerous unless one explores their limits and pays attention to where they break down. But it is a fun analogy, dependent on the nut holding the wheel.

Roger and Ralph and Civilitas: fiscal policy is like calling a breakdown truck to drag the car sideways. We can do better than that. Fiscal policy has its own job to do, and cannot properly do two jobs at once.

Majro: thanks for finding those! Good Lord, I had totally forgotten I had already used the front wheel steering metaphor 3 years ago!

MF: In principle, we could imagine the central bank buying and selling CPI baskets of goods at a fixed price, and storing them in the basement. But storing haircuts (in the real, not financial sense) is tricky, plus baskets of wheat don't pay dividends and are costly to store. Buying land or houses and renting them out might work, but central banks aren't usually very experienced in the landlord business.

JKH: we need to think through how the standard payments operations system would need to be modified. And I might not be very good at that. But suppose you took the current BoC system, and simply replaced the overnight rate target with a market-determined rate, and indexed the rates on negative and positive balances to 50bp above and below the previous day's market rate?? Or even today's market rate??

John: We can't reverse time. Expectations look forwards.


On "we could imagine the central bank buying and selling CPI baskets of goods at a fixed price, and storing them in the basement". CBs who practice inflation targeting are in effect tying their currency to a CPI baskets of goods, but this doesn't mean they have to keep real goods in the basement. They just have to adjust the quantity of their money held by the public to keep its value equal to whatever baskets of goods it has chosen. In my view they could in theory do this just by varying the size of the budget deficit/surplus and funding it with new money (or by destroying old money for a surplus). This would be a bad idea in practice as people wouldn't like govt taxes and spending to be constantly changing with every change in money demand. So they tend to use OMO, but any asset purchase that created a hot potato effect would work just as well. It is a bit unfortunate that the thing CBs most like to buy (risk-free bonds) is also the one thing most likely to get the car stuck up against the wall if they drive interest on them to zero.

MF: Yep. Especially: "It is a bit unfortunate that the thing CBs most like to buy (risk-free bonds) is also the one thing most likely to get the car stuck up against the wall if they drive interest on them to zero."

"Choosing Irving Fisher's method for steering the car (the monetary policy instrument)"

I think this is misleading. It's true that in terms of dollar liabilities gold domestically held is devalued/appreciated in relative terms by changing the gold price but this is as true with domestic holdings of foreign currencies and adjusting the exchange rate.

The primary purpose of changing the domestic currency price of gold is to manage the country's international exchange rate. In this sense it is more different to stock market index targeting than you're acknowledging. the exchange rate between "equity dollar liabilities" and dollars is just a much less meaningful one than the exchange rate with foreign currencies.

You may be interested to know FYI that the Federal Reserve's pension fund invests in commercial real estate.


Nathan: fair point. If all the other countries are on the gold standard, then when you raise the price of gold you are ipso facto devaluing your nominal exchange rate. But nevertheless it would still be true in a closed economy (or if all central banks did it together) that raising the price of gold (which is a real commodity with an industrial demand) would be loosening monetary policy and raising the equilibrium price level.

(I'm not sure how open the US economy was in the 1930's)

@Nick: fair enough. On the other hand, this seems fiscal to me. In the sense that government spending on biophysical assets (both currently produced and not currently produced) should be classified as fiscal policy regardless of the government agency doing the spending. For example, the MMT "buffer stock" policy of hiring workers at a fixed price and private employers having the option to hire people out of the "buffer stock" by offering a "better deal" seems to me to clearly be fiscal policy.

However, under your classification schema here it seems that if the Federal Reserve ran this program (or at least directly wrote the checks) it would be treated as monetary policy.

Nathan: The MMT plan is theoretically good. It's like the gold standard would be, if there were a gold mine in every town, where any worker could grab a shovel and mine his own gold if he couldn't find a better job, and increase the money supply by doing it. A great automatic stabiliser with a nominal anchor. The problem is that labour and jobs are not homogenous, like gold. Though Morgan Warstler's UberForWelfare is a sorta variant that is maybe worth thinking about.


I didn't advocate "fiscal policy": I advocated printing money and spending it, and/or cutting taxes. That obviously contains a fiscal element: e.g. increased public spending is "fiscal". But it is also monetary: the stock of base money in the private sector's hands rises.

Just give me the printing press!

I would crank out fresh $100 bills in my basement, and then go out and spend them on all the things I like. For example I might buy a few very nice cars (some front wheel drive and some rear wheel drive) and a nice case of overpriced single malt whisky to go with it. I could spend money on all sorts of ridiculous things and stimulate the economy very nicely. If that didn't work I'd go around breaking windows and anything else. Perhaps start a war or two. North Korea needs a kick in the rear, let's go stimulate them for a while.

You might think there's some issue that I get so many nice things without doing a stick of work in my life, but I must cite the great Paul Krugman, "Economics is not a morality play."

If it's for the greater good, I'm willing to make that sacrifice.

Because stocks are front-wheel steering, and bonds are rear-wheel steering. If a central bank wants to raise the general price level, it would raise the price of stocks, but lower the price of bonds.

I prefer to think of it as alcohol driven steering: don't worry too much where the wheels are, because I'm having an astoundingly good time. Remember, it's all for your own good! You do want to end this recession don't you? Well then, don't ask any questions. Hurry up and hand me that printing press.


Setting the bank rate based on market rates does not really change the basic story. The period 1980 to 1996 is illustrative. The bank rate floated against the t bill rate. And notwithstanding the market rate determination of the bank rate, the Bank of Canada in fact had very close control over the general direction of the t bill rate (not its precise pattern of short term market volatility) in two ways: it directly controlled the level of excess reserves in the banking system, which had a powerful effect on t bills rates (hot potato monetarism at its purist); and it intervened both in the market and at treasury bill tenders to have a powerful direct effect on the t bill rate itself. Lots of volatility, but that that bill rate ended up going in the direction that the BOC wanted it go, and therefore the bank rate did the same thing.

There were several big interest cycles in this period in which rear wheel steering was obvious (although the zero lower bound was nowhere sight). The Bank of Canada had to get rates up before they could get them down etc.

From the BOC website:

A History of the Key Interest Rate

Over the years, the Bank of Canada has adjusted the way it sets its key interest rate. Following is a brief history of the key rate from the Bank's founding in 1935 until the present.
Bank Rate

March 1935 to November 1956

The original key interest rate was the Bank Rate. This is the minimum rate of interest that the Bank of Canada charges on one-day loans to financial institutions. Between March 1935 and November 1956, the Bank Rate was fixed, set directly by the Bank.

November 1956 to June 1962

The Bank Rate became a floating rate, set at 25 basis points above the average yield on 3-month treasury bills at the federal government's weekly auction.

June 1962 to March 1980

The Bank Rate was again fixed, set directly by the Bank.

March 1980 to February 1996

The Bank Rate was returned to a floating rate, set at 25 basis points above the average yield on 3-month treasury bills at the federal government's weekly auction.
22 February 1996 to Present

Since 1996, the Bank Rate has been set by the Bank at the top of its operating band for the overnight rate (see next column.) This provides a clearer indicator of monetary policy intentions, because the Bank's influence on the overnight rate is more direct than on 3-month Treasury bill rates.

December 2000

The Bank began setting the level of the Bank Rate—and with it, the target for the overnight rate—on eight fixed dates per year.

After I hit send on my last, it occurred to me you might come back and say that they wouldn't intervene in the interest rate market if on front wheel drive.

That's an interesting question. My guess is that the market would take t bill rates where they want based on monetary policy objectives for inflation, and roughly the same thing would happen in terms of an observed rear wheel drive behavior for interest rates.

I mean steering, not drive

JKH: "My guess is that the market would take t bill rates where they want based on monetary policy objectives for inflation, and roughly the same thing would happen in terms of an observed rear wheel drive behavior for interest rates."

That's my guess too (minus your terrible confusion re drive wheels vs steering wheels!). In "equilibrium" we would see pretty much the same relationship between interest rates and everything else. It is only the "out-of-equilibrium" (whatever that means) behaviour which would be different.

Monetary policy has "rear wheel steering" only if central banks limit their "steering" to non-negative interest rates. But they have QE available. Why did the Fed abandon QE before the price level trend was restored? There is a political economy mystery here. We know QE was unpopular with media macro pundits, but go along with them?


My critique about reversing were prompted by your comment about Phillips model, which is a true hydraulic analog, whereas to nit pick a little, the steering/wall example is far more metaphor than model. The flow analog which is the basis of the Phillips model is a representation of financial stocks (tanks) and flows (pipes and valves) and as such, follows control laws, and enables the solution of both linear and non-linear problems simply by altering the shapes of the slotted graphs that control the relationships of stocks and flows. Thus, one can perform experiments with the device. My favorite example, and perhaps relevant to this discussion, occurs in the Cambridge demonstration of the restored Phillips machine…."Let's turn off the banking sector" http://www.sms.cam.ac.uk/media/1094078

In looking at things like the car/wall/steering basis for understanding, I look to see if there are any control laws that fit the postulated mechanism under a wide range of conditions. The limits of the car's ability to move relative to the wall is largely determined on the angle and velocity at which it approaches the wall, not to mention the solidity of the wall. For instance, if you approach the wall at 90 degrees going forward, you will reach a point at which the turning radius will not allow you to turn away from the wall, whereas if you reverse into the wall (not a time dependent act, but approaching an interest rate limit caused other economic circumstance?), you merely drive away from the wall. To go towards a more Phillips like analog, you would have to add mass and velocity to the model along with a host of other factors invoked by a true physical analog.

I suspect that there is far too much reification of the zero lower bound and that it is not so much a barrier as a point at which there is a control reversal, a common situation in aircraft stability, and was well known to Phillips who used early aeronautical company computers in his 1954 paper on stability policy. It would be interesting to see if the folks at Cambridge would run some zero lower bound simulations.

It's possible to do some very simple internally consistent physical analogs, and I'll be happy to send you my $2.49 (u.s.) banking stability/business cycle simulator, which was a great hit with a class of MBA students some years ago.

Long time reader, first time commenter.

I'm not sure I understand what constitutes front steering as opposed to rear steering. Suppose that the government issued a security that paid a fixed amount semi-annually forever. Also suppose that the central bank made a market in the security and used the price in this market as the interest rate is controls. For an finite price of this security, the internal rate of return is positive. Does this mean that such a policy is front steering?

Nick, you say (and you're right) that if there is a gold standard in other countries as well, then manipulating the price of gold is the same thing as targeting the exchange rate. So would you then agree that targeting the exchange rate, gold standard or not, is a front-wheel steering regime?

Tom: the front wheel steering metaphor means you move the wheels in the same direction you want the whole car to go, not the opposite direction. A better analogy might be a broomstick held in one hand. If you hold the top of the broomstick, it's front-wheel steering. If you balance it upright in the palm of your hand, it's read-wheel steering (you move your hand south at first, if you want the broomstick to move north). If you want higher interest rates, you must first reduce interest rates, then raise them above where they were at first, after the economy starts to grow faster.

Jeff: yes.

In a fiat money world, you can always depreciate your currency. Since that is front steering, i.e., it always 'works', it follows that there is no such thing as a liquidity trap. Monetary policy is never impotent. All of the anguishing about liquidity traps, and all of the models that feature or imply them, are worthless. All of the economists touting such models are incompetent. And so are the financial commentators and central bankers who listen to them.

Sounds about right to me.


In legal terms, you are 100% correct about the non-existence of the liquidity trap in a fiat world. Japan's central bank could buy the world if it wanted to, or at least attempt to do so until depreciation of the yen kicked in.

However, in practical terms, the things that central banks would need to do in order to get out of their liquidity traps would anger bondholders and lead to inflation and higher interest rates (the exact opposite of what is intended--see the stagflation crisis of the 1970s/early '80s).

This part is never mentioned. It is merely implied every time central banks complain that they have "run out of ammo." What they should really say is, they have run out of ammo that they can use without angering bondholders. I wish central banks would be more explicit about this.

To use the steering metaphor, there IS NO WALL to the right. There is actually another driver to the right (bondholders) who are up for a game of chicken (abstain from giving out loans except at higher interest rates to take into account currency depreciation) if the central bank really wants to veer right (increase the money supply of its own accord). The central bank knows (from the 1970s) that the bondholders' withdrawal of cheap credit will cancel out the central bank's monetary stimulus. In other words, the central bank doesn't want to play this game of chicken because it knows that it will always lose. But the central bank doesn't want to admit to being a wimp and a loser, so it denies that there is a game of chicken at all. Instead, it tries to convince everyone that there is actually an wall of concrete to the right. And then the central bank complains about being "stuck" along this wall. It is very misleading and a big obstacle to clear thinking on this subject.

But Matthew, higher inflation is just what the Japanese central banks says it wants!

Bondholders can't "withdraw cheap credit". I don't even know what that means. The very nature of a bond is that it represents credit that has already been granted, and the repayment schedule is fixed in stone. The bond issuer may effectively cancel the bond by buying it back from a bondholder, but this is at the initiative of the borrower, not the lender.

It's true that safe bond prices will fall if the central bank pursues easy money. And current bondholders won't like that. So what? Is this supposed to be a novel insight?

The Japanese central bank is outright lying, then. If it wanted higher inflation, it could get it. What it is really doing is apologizing to one side with, "We really are doing all we can" while promising to the bondholders and pensioners out of the other corner of their mouths, "Don't worry, we've got your back. Don't worry, there will be no inflation." That is exactly the kind of misleading obfuscation that I am complaining about. Japan's central bank should just be up-front and admit that it doesn't want higher inflation.

And what I mean by "withdraw cheap credit" is a refusal to make new loans, except at higher interest rates to take into account expected depreciation. It's not about current bondholders or existing loans, but rather future bondholders and new loans going forward. The threat is a shortage of new bonds and new bondholders willing to loan money at low interest rates. If it takes higher interest rates to coax bondholders to put out new loans, either the loans don't get made because businesses and consumers won't want to borrow at those higher rates, and money supply will suffer despite the Central Bank's best efforts, or the loans do get made, but their higher rates cut into net profit rates and disposable income and become unsustainable.

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