Alvin Hansen on Monetary Policy

The more you read in the history of macroeconomics and monetary theory, the more you find that current debates are reprises of arguments from 50, 100 or 200 years ago.

I’ve just been reading Perry Mehrling’s The Money Interest and the Public Interest, which  is one of the two best books I know of on this subject. (The other is Arie Arnon’s Monetary Theory and Policy Since David Hume and Adam Smith.) About a third of the book is devoted to Alvin Hansen, and it inspired me to look up some of Hansen’s writings from the 1940s and 50s. I was especially struck by this 1955 article on monetary policy. It not only anticipates much of current discussions of monetary policy — quantitative easing, the maturity structure of public debt, the need for coordination between the fiscal and monetary policy, and more broadly, the limits of a single interest rate instrument as a tool of macroeconomic management — but mostly takes them for granted as starting points for its analysis. It’s hard not to feel that macro policy debates have regressed over the past 60 years.

The context of the argument is the Treasury-Federal Reserve Accord of 1951, following which the Fed was no longer committed to maintaining fixed rates on treasury bonds of various maturities. [1] The freeing of the Fed from the overriding responsibility of stabilizing the market for government debt, led to scholarly and political debates about the new role for monetary policy. In this article, Hansen is responding to several years of legislative debate on this question, most recently the 1954 Senate hearings which included testimony from the Treasury department, the Fed Board’s Open Market Committee, and the New York Fed.

Hansen begins by expressing relief that none of the testimony raised

the phony question whether or not the government securities market is "free." A central bank cannot perform its functions without powerfully affecting the prices of government securities.

He then expresses what he sees as the consensus view that it is the quantity of credit that is the main object of monetary policy, as opposed to either the quantity of money (a non-issue) or the price of credit (a real but secondary issue), that is, the interest rate.

Perhaps we could all agree that (however important other issues may be) control of the credit base is the gist of monetary management. Wise management, as I see it, should ensure adequate liquidity in the usual case, and moderate monetary restraint (employed in conjunction with other more powerful measures) when needed to check inflation. No doubt others, who see no danger in rather violent fluctuations in interest rates (entailing also violent fluctuations in capital values), would put it differently. But at any rate there is agreement, I take it, that the central bank should create a generous dose of liquidity when resources are not fully employed. From this standpoint the volume of reserves is of primary importance.

Given that the interest rate is alsoan object of policy, the question becomes, which interest rate?

The question has to be raised: where should the central bank enter the market -short-term only, or all along the gamut of maturities?

I don’t believe this is a question that economists asked much in the decades before the Great Recession. In most macro models I’m familiar with, there is simply “the interest rate,” with the implicit assumption that the whole rate structure moves together so it doesn’t matter which specific rate the monetary authority targets. For Hansen, by contrast, the structure of interest rates — the term and "risk” premiums — is just as natural an object for policy as the overall level of rates. And since there is no assumption that the whole structure moves together, it makes a difference which particular rate(s) the central bank targets. What’s even more striking is that Hansen not only believes that it matters which rate the central bank targets, he is taking part in a conversation where this belief is shared on all sides.

Obviously it would make little difference what maturities were purchased or sold if any change in the volume of reserve money influenced merely the level of interest rates, leaving the internal structure of rates unaffected. … In the controversy here under discussion, the Board leans toward the view that … new impulses in the short market transmit themselves rapidly to the longer maturities. The New York Reserve Bank officials, on the contrary, lean toward the view that the lags are important. If there were no lags whatever, it would make no difference what maturities were dealt in. But of course the Board does not hold that there are no lags.

Not even the most conservative pole of the 1950s debate goes as far as today's New Keynesian orthodoxy that monetary policy can be safely reduced to the setting of a single overnight interest rate.

The direct targeting of long rates is the essential innovation of so-called quantitative easing. [2] But to Hansen, the idea that interest rate policy should directly target long as well as short rates was obvious. More than that: As Hansen points out, the same point was made by Keynes 20 years earlier.

If the central bank limits itself to the short market, and if the lags are serious, the mere creation of large reserves may not lower the long-term rate. Keynes had this in mind when he wrote: "Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement that can be made in the technique of monetary management. . . . The monetary authority often tends in practice to concentrate upon short-term debts and to leave the price of long-term debts to be influenced by belated and imperfect re- actions from the price of short-term debts." ' Keynes, it should be added, wanted the central bank to deal not only in debts of all maturities, but also "to deal in debts of varying degrees of risk," i.e., high grade private securities and perhaps state and local issues.

That's a quote from The General Theory, with Hansen's gloss.

Fast-forward to 2014. Today we find Benjamin Friedman — one of the smartest and most interesting orthodox economists on these issues — arguing that the one great change in central bank practices in the wake of the Great Recession is intervention in a range of securities beyond the shortest-term government debt. As far as I can tell, he has no idea that this “profound” innovation in the practice of monetary policy was already proposed by Keynes in 1936. But then, as Friedman rightly notes, “Macroeconomics is a field in which theory lags behind experience and practice, not the other way around.”

Even more interesting, the importance of the rate structure as a tool of macroeconomic policy was recognized not only by the Federal Reserve, but by the Treasury in its management of debt issues. Hansen continues:

Monetary policy can operate on two planes: (1) controlling the credit base - the volume of reserve balances- and (2) changing the interest rate structure. The Federal Reserve has now backed away from the second. The Treasury emphasized in these hearings that this is its special bailiwick. It supports, so it asserts, the System's lead, by issuing short- terms or long-terms, as the case may be, according to whether the Federal Reserve is trying to expand or contract credit … it appears that we now have (whether by accident or design) a division of monetary management between the two agencies- a sort of informal cartel arrangement. The Federal Reserve limits itself to control of the volume of credit by operating exclusively in the short end of the market. The Treasury shifts from short-term to long-term issues when monetary restraint is called for, and back to short-term issues when expansion is desired.

This is amazing. It’s not that Keynesians like Hansen  propose that Treasury should issue longer or shorter debt based on macroeconomic conditions. Rather, it is taken for granted that it does choose maturities this way. And this is the conservative side in the debate, opposed to the side that says the central bank should manage the term structure directly.

Many Slackwire readers will have recently encountered the idea that the maturities of new debt should be evaluated as a kind of monetary policy. It's on offer as the latest evidence for the genius of Larry Summers. Proposing that Treasury should issue short or long term debt based on goals for the overall term structure of interest rates, and not just on minimizing federal borrowing costs, is the main point of Summers’ new Brookings paper, which has attracted its fair share of attention in the business press. No reader of that paper would guess that its big new idea was a commonplace of policy debates in the 1950s. [3]

Hansen goes on to raise some highly prescient concerns about the exaggerated claims being made for narrow monetary policy.

The Reserve authorities are far too eager to claim undue credit for the stability of prices which we have enjoyed since 1951. The position taken by the Board is not without danger, since Congress might well draw the conclusion that if monetary policy is indeed as powerful as indicated, nonmonetary measures [i.e. fiscal policy and price controls] are either unnecessary or may be drawn upon lightly.

This is indeed the conclusion that was drawn, more comprehensively than Hansen feared. The idea that setting an overnight interest rate is always sufficient to hold demand at the desired level has conquered the economics profession “as completely as the Holy Inquisition conquered Spain,” to coin a phrase. If you talk to a smart young macroeconomist today, you’ll find that the terms “aggregate demand was too low” and “the central bank set the interest rate too high” are used interchangeably. And if you ask, which interest rate?, they react the way a physicist might if you asked, the mass of which electron?

Faced with the argument that the inflation of the late 1940s, and price stability of the early 1950s, was due to bad and good interest rate policy respectively, Hansen offers an alternative view:

I am especially unhappy about the impli- cation that the price stability which we have enjoyed since February-March 1951 (and which everyone is justifiably happy about) could quite easily have been purchased for the entire postwar period (1945 to the present) had we only adopted the famous accord earlier …  The postwar cut in individual taxes and the removal of price, wage, and other controls in 1946 … did away once and for all with any really effective restraint on consumers. Under these circumstances the prevention of price inflation … [meant] restraint on investment. … Is it really credible that a drastic curtailment of investment would have been tolerated any more than the continuation of wartime taxation and controls? … In the final analysis, of course,  the then prevailing excess of demand was confronted with a limited supply of productive resources.

Inflation always comes down to this mismatch between “demand,” i.e. desired expenditure, and productive capacity.

Now we might say in response to such mismatches: Well, attempts to purchase more than we can produce will encourage increased capacity, and inflation is just a temporary transitional cost. Alternatively, we might seek to limit spending in various ways. In this second case, there is no difference of principle between an engineered rise in the interest rate, and direct controls on prices or spending. It is just a question of which particular categories of spending you want to hold down.

The point: Eighty years ago, Keynes suggested that what today is called quantitative easing should be a routine tool of monetary policy. Sixty years ago, Alvin Hansen believed that this insight had been accepted by all sides in macroeconomic debates, and that the importance of the term structure for macroeconomic activity guided the debt-issuance policies of Treasury as well as the market interventions of the Federal Reserve. Today, these seem like new discoveries. As the man says, the history of macroeconomics is mostly a great forgetting.


[1] I was surprised by how minimal the Wikipedia entry is. One of these days, I am going to start having students improve economics Wikipedia pages as a class assignment.

[2] What is “quantitative about this policy is that the Fed buys a a quantity of bonds, evidently in the hopes of forcing their price up, but does not announce an explicit target for the price. On the face of it, this is a strangely inefficient way to go about things. If the Fed announced a target for, say, 10-year Treasury bonds, it would have to buy far fewer of them — maybe none — since market expectations would do more of the work of moving the price. Why the Fed has hobbled itself in this way is a topic for another post.

[3] I am not the world’s biggest Larry Summers fan, to say the least. But I worry I’m giving him too hard a time in this case. Even if the argument of the paper is less original than its made out to be, it’s still correct, it’s still important, and it’s still missing from today’s policy debates. He and his coauthors have made a real contribution here. I also appreciate the Hansenian spirit in which Summers derides his opponents as "central bank independence freaks."

The Dressmaker

An interesting fact about the world we live in is that, for all the talk about robots replacing human labor, every item of clothing you own was made by a human being sitting at a sewing machine. In fact, you could argue that the whole idea of a robot revolution is, like most science fiction fantasies, simply a literalization of a current social fact -- in this case, the disappearance of manual workers from the social world of rich Westerners. Everyone who writes about the Star Trek future works in a building where living people empty the trash cans and scrub the toilets; but since they are never required to treat those people as human beings, they might as well be robots. In some cases I would go a step further, and say the robot revolution expresses a wish: The wish that the people whose bodies create the conditions for our existence could be dismissed from humanity once and for all.

Robot fantasies are everywhere. Much rarer is work that reveals the human hands behind the commodities. I'm a big fan of David Redmon's Mardi Gras: Made in China. Especially striking in that movie is the contrast between the way the American importer of mardis gras beads talks about the Chinese workers who produce them, and the way the factory manager in China does. In the imagination of the importer, the Chinese workers are antlike automatons, with no desire except for labor. The factory has a high fence around it, he explains, in order to keep out all the eager workers who would otherwise sneak in to join the assembly line. For the manager, on the other hand, discipline is the overriding problem. He says he only hires young women because they are more obedient, but even so they are constantly refusing to comply with his orders, distracted by friendships and love affairs, sneaking out of their dormitories. They must be punished often and harshly, he says, otherwise they won't work. The change in perspective once you pass that sign that says "No admittance except on business" is no different than 150 years ago.

I don't know of any similar tracing of the path of an ordinary piece of clothing from the shopfloor to the display racks, though there must be some. But I just read a nice piece by Roberto Saviano on the origins of one extraordinary piece of clothing, in a sweatshop in southern Italy. Here's an excerpt -- it's a bit long but worth reading.

From Gomorrah, by Roberto Saviano:

The workers, men and women, came up to toast the new contract. They faced a grueling schedule: first shift from 6 a.m. to 9 p.m., with an hour’s break to eat, second shift from 9 p.m. to 6 a.m. The women were wearing makeup and earrings, and aprons to protect their clothes from the glue, dust, and machine grease. Like Superman, who takes off his shirt and reveals his blue costume underneath, they were ready to go out to dinner as soon as they removed their aprons. The men were sloppier, in sweatshirts and work pants. ...

One of the winning contractor’s workers was particularly skilled: Pasquale. A lanky figure, tall, slim, and a bit hunchbacked; his frame curved behind his neck onto his shoulders, a bit like a hook. The stylists sent designs directly to him, articles intended for his hands only. His salary didn’t fluctuate, but his tasks varied, and he some how conveyed an air of satisfaction. I liked him immediately, the moment I caught sight of his big nose. Even though he was still young, Pasquale had the face of an old man. A face that was constantly buried in fabric, fingertips that ran along seams. Pasquale was one of the only workers who could buy fabric direct. Some brandname houses even trusted him to order materials directly from China and inspect the quality himself. ...

Pasquale and I became close. He was like a prophet when he spoke about fabric and was overly fastidious in clothing stores; it was impossible even to go for a stroll with him because he’d plant himself in front of every shop window and criticize the cut of a jacket or feel ashamed for the tailor who’d designed such a skirt. He could predict the longevity of a particular style of pants, jacket, or dress, and the exact number of washings before the fabric would start to sag. Pasquale initiated me into the complicated world of textiles. I even started going to his home. His family—his wife and three children—made me happy. They were always busy without ever being frenetic.

That evening the smaller children were running around the house barefoot as usual, but without making a racket. Pasquale had turned on the television and was flipping channels, but all of a sudden he froze. He squinted at the screen, as if he were nearsighted, though he could see perfectly well. No one was talking, but the silence became more intense. His wife, Luisa, must have sensed something because she went over to “the television and clasped her hand over her mouth, as if she’d just witnessed something terrible and were holding back a scream. On TV Angelina Jolie was treading the red carpet at the Oscars, dressed in a gorgeous garment. One of those custom-made outfits that Italian designers fall over each other to offer to the stars. An outfit that Pasquale had made in an underground factory in Arzano. All they’d said to him was “This one’s going to America.” Pasquale had worked on hundreds of outfits going to America, but that white suit was something else. He still remembered all the measurements. The cut of the neck, the circumference of the wrists. And the pants. He’d run his hands inside the legs and could still picture the naked body that every tailor forms in his mind—not an erotic figure but one defined by the curves of muscles, the ceramics of bones. A body to dress, a meditation of muscle, bone, and bearing. Pasquale still remembered the day he’d gone to the port to pick up the fabric. They’d commissioned three suits from him, without saying anything else. They knew whom they were for, but no one had told Pasquale.

In Japan the tailor of the bride to the heir to the throne had had a state reception given in his honor. A Berlin newspaper had dedicated six pages to the tailor of Germany’s first woman chancellor, pages that spoke of craftsmanship, imagination, and elegance. Pasquale was filled with rage, a rage that it’s impossible to express. And yet satisfaction is a right, and merit deserves recognition. Deep in his gut he knew he’d done a superb job and he wanted to be able to say so. He knew he deserved something more. But no one had said a word to him. He’d discovered it by accident, by mistake. His rage was an end in itself, justified but pointless. He couldn’t tell anyone, couldn’t even whisper as he sat looking at the newspaper the next morning. He couldn’t say, “I made that suit.” No one would have believed that Angelina Jolie would go to the Academy Awards wearing an outfit made in Arzano, by Pasquale. The best and the worst. Millions of dollars and 600 euros a month. Neither Angelina Jolie nor the designer could have known. When everything possible has been done, when talent, skill, ability, and commitment are fused in a single act, when all this isn’t enough to change anything, then you just want to lie down, stretch out on nothing, in nothing. To vanish slowly, let the minutes wash over you, sink into them as if they were quicksand. To do nothing but breathe. Besides, nothing will change things, not even an outfit for Angelina Jolie at the Oscars.

Pasquale left the house without even bothering to shut the door. Luisa knew where he was going; she knew he was headed to Secondigliano and whom he was going to see. She threw herself on the couch and buried her face in a pillow like a child. I don’t know why, but when Luisa started to cry, it made me think of a poem by Vittorio Bodini. Lines that tell of the strategies southern Italian peasants used to keep from becoming soldiers, to avoid going off to fill the trenches of World War I in defense of borders they knew nothing of.

At the time of the other war, 
peasants and smugglers
put tobacco leaves under their arms
to make themselves ill.
The artificial fevers, the supposed malaria
that made their bodies tremble and their teeth rattle
were their verdict
on governments and history.

That’s how Luisa’s weeping seemed to me—a verdict on government and history. Not a lament for a satisfaction that went uncelebrated. It seemed to me an amended chapter of Marx’s Capital, a paragraph added to Adam Smith’s The Wealth of Nations, a new sentence in John Maynard Keynes’s General Theory of Employment, Interest and Money, a note in Max Weber’s The Protestant Ethic and the Spirit of Capitalism. A page added or removed, a forgotten page that never got written or that perhaps was written many times over but never recorded on paper. Not a desperate act but an analysis. Severe, detailed, precise, reasoned. I imagined Pasquale in the street, stomping his feet as if knocking snow from his “boots. Like a child who is surprised to discover that life has to be so painful. He’d managed up till then. Managed to hold himself back, to do his job, to want to do it. And do it better than anyone else. But the minute he saw that outfit, saw that body moving inside the very fabric he’d caressed, he felt alone, all alone. Because when you know something only within the confines of your own flesh and blood, it’s as if you don’t really know it. And when work is only about staying afloat, surviving, when it’s merely an end in itself, it becomes the worst kind of loneliness.

I saw Pasquale two months later. They’d put him on truck detail. He hauled all sorts of stuff—legal and illegal—for the Licciardi family businesses. Or at least that’s what they said. The best tailor in the world was driving trucks for the Camorra, back and forth between Secondigliano and Lago di Garda. He asked me to lunch and gave me a ride in his enormous vehicle. His hands were red, his knuckles split. As with every truck driver who grips a steering wheel for hours, his hands freeze up and his circulation is bad. His expression was troubled; he’d chosen the job out of spite, out of spite for his destiny, a kick in the ass of his life. But you can’t tolerate things indefinitely, even if walking away means you’re worse off. During lunch he got up to go say hello to some of his accomplices, leaving his wallet on the table. A folded-up page from a newspaper fell out. I opened it. It was a photograph, a cover shot of Angelina Jolie dressed in white. She was wearing the suit Pasquale had made, the jacket caressing her bare skin. You need talent to dress skin without hiding it; the fabric has to follow the body, has to be designed to trace its movements.

I’m sure that every once in a while, when he’s alone, maybe when he’s finished eating, when the children have fallen asleep on the couch, worn-out from playing, while his wife is talking on the phone with her mother before starting on the dishes, right at that moment Pasquale opens his wallet and stares at that newspaper photo.