The mute king

Once upon a time there was a king. He was king because his father had been king before him, and his father before that. It was just kings, all the way back.

The king gave orders, which people obeyed, because he was king. The king gave good orders, and because the people obeyed those orders, the kingdom flourished.

Then one day the king became mute.

The king gave orders by raising or lowering the tone of his voice.  One day the king wanted to give an order in an even lower tone. But the king's voice could only go so low. He was unable to give the order everyone knew he needed to give. So the people kept on obeying the last order he had given, even though they knew that this order was no longer the right order for the times. So the kingdom fell into poverty. Most people blamed the times, for requiring the King to give an order in a lower tone than he was able. Others blamed the king, for speaking in too high a voice previously, or for speaking in too low a voice previously, or for not lowering his voice quickly enough while he was still able.

Then one day a small boy had a suggestion: "Why doesn't the Queen give the orders? She has been speaking in a much higher voice, and could easily lower her tone enough to give the right order".

The people were bemused. "Why should anyone obey the Queen? She's not the king! I fail to see any possible mechanism that links the Queen's tone to what is happening out there in the real world. How can the Queen possibly get the King to give orders in a lower tone? Everyone knows he can't lower his voice any lower. Sure, if everyone expected that everyone else would obey the Queen, then each individual would have to be stupid not to obey the Queen too. But why should anyone expect that? Your reasoning is circular. Kings are real flesh and blood, with real kingly powers. Your belief in queens is just fairy tale nonsense. Queens are like Tinkerbell; they only have powers if people believe in them! Tell me what concrete steps the Queen could take to make people obey her orders, and then I will believe you."

The small boy started talking about imaginary worlds where there are no kings, and where queens or even committees gave the orders, and people still obeyed those orders.

But the people just laughed. Those imaginary worlds weren't the real world, where kings gave orders, and people obeyed kings. And the boy's imaginary worlds didn't even include the role of the king's ministers, so they totally ignored the channel through which the king's orders were communicated to the people! Who could possibly take such stories seriously?

(For Henry Kasper, and others.)

Comments

[heija]

I am missing the point :(

[whitfit]

King = nominal interest rate.

Queen = inflation. Need to have expectations of inflation in order to make it work - believe it is flesh and blood.

I think.

[Nick Rowe]

Read Henry Kaspar's post (linked at the bottom of my post). My post is a response to his.

[Nick Rowe]

whitfit: Yep, except the Queen could be almost anything. Price of gold, price of peanuts, price of antique furniture, NGDP futures, price of land, stock market index,...

[Frances Woolley]

nice post.

[Mike G]

Your Queen appears to be giving an order that is unlike any the King has ever given before. Surely people remember history. A Queen ordering a serious change in policy, yet anchoring it on the argument that the King would have given it if only he could speak is not believable I think. It is at best debatable. It is equally plausible that she would be ushered right out the front door for even trying. This might even be done by the King's ministers, who might feel that the potential downsides are not worth engaging in this new, and hence risky, policy.

Alternatively, I would be glad to hear if you know of any instances where a central bank has intentionally and successfully increased inflation expectations, which then led to greater inflation, on a temporary basis.

[W. Peden]

Not only is the Queen incapable of giving orders, but the orders that she will give are dangerous. So it's best not even to ask her.

[Determinant]

I thought this was a parable of NGDP targeting where the King's voice is the interest rate and the Queen's voice is inflation.

The King is the central bank which is having problems at the zero lower bound.

[W. Peden]

Anyway, metaphors aside, I like mechanisms even though I know that the real world is metaphysical. That's why I like Tim Congdon's analysis of QE-

http://www.standpointmag.co.uk/the-unnecessary-recession-features-june-09-tim-congdon-gordon-brown-alistair-darling?page=0%2C0%2C0%2C0%2C0%2C0%2C0%2C0%2C0%2C0%2C5

It amazes me how small a role asset prices and private wealth in general play in macroeconomics. The starting point of analyses is so often some definition of national income (Y = etc. or MV = PY) rather than the old approach of starting with people holding heterogenous portfolios of wealth (both non-human and human, in that having a skill is a form of wealth).

[Nick Rowe]

Frances: thanks!

Mike G: "Your Queen appears to be giving an order that is unlike any the King has ever given before."

Only because it is coming out of the Queen's mouth, and her voice sounds different from the King's voice.

"Alternatively, I would be glad to hear if you know of any instances where a central bank has intentionally and successfully increased inflation expectations, which then led to greater inflation, on a temporary basis."

Roosevelt, 1932. Central bank of Sweden 193? (actually, trying and succeeding in preventing deflation, rather than in creating inflation strictly). The Bank of Canada over the last 20 years: half the time it is trying to reduce inflation (prevent inflation rising above 2%); the other half the time it has been trying to increase inflation (prevent inflation falling below 2%).

W. Peden: "Not only is the Queen incapable of giving orders, but the orders that she will give are dangerous. So it's best not even to ask her."

For a minute there I missed the irony, and was about to argue with you!

"It amazes me how small a role asset prices and private wealth in general play in macroeconomics."

The one asset price that does play a role, and far too big a role, is the price of very short term government loans, P=1/(1+i), where i is THE nominal interest rate.

[Sina Motamedi]

Very good.

[W. Peden]

Nick Rowe,

"The one asset price that does play a role, and far too big a role, is the price of very short term government loans, P=1/(1+i), where i is THE nominal interest rate."

I agree. Also, while MV = PY at least has one asset (M) even this asset is very heterogenous (money that can be used to purchase non-financial goods i.e. M1 is obviously qualitatively different from a big measurement of private sector liquidity e.g. the monster that was M5 in the UK, and both are similar yet different from a narrowly defined broad money measurement like America's M2 or the historically important £M3 in the UK. Even notes and coin (and notes & notes and coin & coin) have some qualitative differences.

All this means that understanding, say, the gold-buying programme of FDR is difficult today.

[Kelvin]

"Your Queen appears to be giving an order that is unlike any the King has ever given before. Surely people remember history."

I'd say that kings have been giving orders of their own accord rather recently. They were more like transmitting the words of the oracle of the Bretton Forests for decades before, and reading the sacred ores themselves before that.

[nemi]

If anyone but Nick would have written that story, I would assume that the King referred to monetary policy and that the queen was fiscal policy

[K]

Nick: the people listened to the king because the generals listened to the king. If the generals will do what the queen says, then the people will listen to the queen. The limits of their command are exactly equal to the limits of their potential use of force. We listen to Mark Carney, not out of convention, but because he controls the path of the short rate. Since, for example, he doesn't control the price of carbon emissions, we don't care about his pronouncements on global warming. But if he did, we would. Concete steppes, indeed.

[reason]

Nick,
I don't really care about this argument. As far as I'm concerned almost everyone would agree that if we did the following the outcome would be better than what we have at the moment (I'm talking about the US or Euro zone here not Canada).
1. Give every citizen a permanent smallish taxable monthly dividend (say $50)
2. Finance the gift with interest free borrowings from the Central Bank
3. Promise to increase VAT (or some other broad based tax) by 0.5% when unemployment/NGDP or whatever reaches some agreed target.

Call it monetary policy if you like, call it fiscal policy if you like - I don't mind.

So why aren't we doing it?

[Paul Friesen]

This seems to me to miss the point completely. The economy is not responding to orders from anyone. It's responding to the amount of money in it.

If interest rates hit zero, the central bank has just lost the ability to inject more money by conventional means. It can print more money, but since it can only print money for lending, if more money is not borrowed, the money it prints can't get out into the real economy. It just piles up as bank reserves, as we see in the U.S. now. Unless somebody borrows it and spends it on something that employs somebody, it won't do any good. And if interest rates can't drop any further, there is no way to stimulate more borrowing. One rational way is for the government to borrow it, but if that doesn't happen, we have a liquidity trap.

There are other conceivable ways around this. The C.B. could print bills and throw them out of helicopters or bury them in old mines for people to dig up (not original ideas). The basic problem is not lack of the right command. It's lack of money in real people's pockets and bank accounts.

[reason]

Paul Friesen,
"The C.B. could print bills and throw them out of helicopters" ...
This is just a less beaurocratic version of what I said. Ben seems to have forgotten this suggestion. He parked the helicopter on Wall Street instead.

[Min]

Henry Kaspar (from his blog): "My trouble with the modern view is: how can the central bank create inflation expectations when the economy is stuck in the liquidity trap? "

As I have remarked before, it appears that economics does not have a theory of psychological expectations. (Hence the talk of metaphysics.)

Now, a liquidity trap sounds a lot like a suboptimal equilibrium (or quasi-equilibrium. It's not forever, is it?) One way to get out of a suboptimal equilibrium is to change the payoffs. Attempts to change expectations probably won't work, else it would not be an equilibrium in the first place, right? Then the right question is, how can the central bank change the payoffs? (If indeed it can.)

Changing interest rates does change payoffs. But how low can you go? Is it a mistake for the Fed to pay interest on reserves? Should they penalize excess reserves?

How about direct action? Can the CB affect saving by buying up savings vehicles? (Or, as Nick Rowe has suggested, buy everything? ;))

[W. Peden]

reason,

I'm sure the answer is not so different from why American policymakers were generally so ineffectual in the 1930s.

I hope it takes less than 30 years for someone to write an influential critique of Fed policy this time around.

[Dan Kervick]

Meanwhile, the Hundred Dukes of the realm had storehouses filled with treasure. A million subjects screamed, "We don't need orders from the royal family! We don't need high voices or low voices! We don't need statements of this kind or that kind! We need only actions! We need treasure! Then the kingdom will prosper!"

But the king's ministers would not hear the voices of the people.

"The treasure belongs to the dukes," said one. And it is written in the books of old, 'Thou shalt not take what belongs to the dukes.' "

"But surely the prosperity of a million is more important than the possessions of a hundred!" the people cried.

"Taking the treasure will not help to improve the prosperity of the kingdom," said another minister, known for his mastery of Arithmatick, "because moving the treasure from the dukes' storehouses to the hovels of the people will leave the kingdom with the same total amount of treasure. And the industry and revels of the people making abundant use of their new treasure will leave no room for the revels of the dukes."

"Surely you are joking, Minister!" cried the people.

"Taking the treasure will not help at all," said a third minister, one named Rheequardho, "because you people know we will tax you next year to take the treasure back, and so you will only hoard the treasure upon that expectation."

"Then don't tax us!" cried the people. "Just give us the treasure!"

Finally a fourth minister said, "We must not take the dukes' treasure, because we are conducting a long experiment to prove that the prosperity of the kingdom and the creation of its treasure responds entirely to subtle modulations in the voices of the King and Queen. We believe that any blows to the kingdom's prosperity can always be rectified by having the King or the Queen say something else, or say something longer, or shorter, or higher-pitched, or lower-pitched. If we take the dukes' treasure, even if that works, we will ruin the experiment!"

The fourth minster then reminded the other ministers, in a lower voice, that the Council of Ministers are all paid by the dukes, and had always had great admiration for the dukes.

At this point, the people were crestfallen, and they realized the nature of their predicament. "Verily," said one, "this kingdom is plagued by some very bad and stupid ministers, with their besotted doctrine of the alchemy of royal voices."

And at that point, the cries of the people ceased. The people returned to their hovels and picked up their axes.

[Paul Friesen]

Reason: Your idea is certainly a more practical and fair way to do it. Australia did that at the beginning of the recession. And China's huge stimulus plan included lots of subsidies for people to buy things, also fair and practical.

Dan Kervick: Dead on!

[reason]

Dan Kervick - brilliant!

[Nick Rowe]

The historians tell me that the Great Depression led to nazism, fascism, and strengthened communism. Sounds right to me. None of those three ended well. And looking at Europe especially, I see the same forces at play today. All the more reason to get monetary policy fixed.

[Umkc Economists]

If the Queen had the King by the b@lls, she could simply put the squeeze on and, voila! High voice is back.

[Greg Ransom]

Let's eliminate the king -- and see what happens ...

[Nick Rowe]

Umkc: This is a family blog! ;)

Greg: I think that money is a natural monopoly/monarchy. There will always be a king. I see this as following straight from Menger. We all want to converge on the same medium of exchange that everyone else is using.

[Jacques René Giguère]

Nick: And the people in their hovels said "Verily, there can't be more than one king. And so, the Prince of NGDPLPT, cousin thirteen-time removed and thusly in the line of succesion should something untoward happen to the King, could have the blessing of the Bishop and the fealty of the peoples. Let's go meet the King. And don't forget our axes. And approching the Palace shout to the Guard that if things continue, they won't get their thirty pieces of silver. And bring torches and pitchforks too."