Author Archive for John P. Cochran

Fed Liquidity and the World Economy

404px-Currency_Exchange.svgNoah, commenting on “For More Jobs and Stability, Set the Economy Free”, points to second  important observation in the linked commentary by Kevin Warsh – the spillover effect of Fed Policy, with significantly negative long run consequences, on the world economy. From his comment:

The piece by Kevin Warsh that was linked in the article (“Finding Out Where Janet Yellen Stands”) included this important observation:

“The Fed makes domestic decisions for the domestic economy. Yes, but the U.S. is the linchpin of an integrated global economy. Fed-induced liquidity spreads to the rest of the world through trade and banking channels, capital and investment flows, and financial-market arbitrage. Aggressive easing by the Fed can be contagious, inclining other central banks to ease as well to stay competitive. The privilege of having the dollar as the world’s reserve currency demands a broad view of global economic and financial-market developments. Otherwise, this privilege could be squandered.”

The Fed is not just picking winners and losers domestically, it is doing so globally. While the winners fill their pockets, the losers get increasingly restless and increasing aware that the screwing they are getting is not random but has a very definite source.

As is often the case, Austrian influenced economists have been on the leading edge. Those wonkish types interested  more detail first see the Fertig Prize winning article Monetary Nationalism and International Economic Stability by Andreas Hoffmann and Gunther Schnabl. The abstract:

ABSTRACT: This paper describes the international transmission of boom-and-bust cycles to small periphery economies as the outcome of excessive liquidity supply in large center economies, based on the credit cycle theories of Hayek, Mises, and Minsky. We show how too-expansionary monetary policies can cause overinvestment cycles and distortions in the economic structure on both the national and the international level. Feedback effects of crises in periphery countries on center countries trigger new rounds of monetary expansion in center countries, which bring about new credit booms and international distortions. Crisis and contagion in globalized goods and financial markets indicate the limits of purely national monetary policies in countries, which provide the asymmetric world monetary system with an international currency. This makes the case for a monetary policy in large countries that takes responsibility for its long-term effects on goods and financial markets in both the center and the periphery countries of the world monetary system.

Other good work on the topic is by Metro State’s Nicolas Cachanosky:

The effects of US monetary policy on Colombia and Panama (2002-2007)


  • Studies international      effects on two small economies with different forex regimes.
  • Studies how these two      economies react to US monetary policy.
  • Relative capital      intensive sectors are more sensitive to US monetary policy.
  • This common      characteristic can explain business cycle co-movements.


U. S. Monetary Policy’s Impact on Latin America’s Structure of Production (1960-2010)” which extends ABCT and capital-based macroeconomics in the international arena, especially as it applies to the ‘periphery’.

The abstract:

I study the effects of U.S. monetary policy on Latin America’s structure of production prior to two recent economic crises. I find that changes in the Federal Funds rate produced uneven effects across economic sectors. Those industries that are more capital intensive and relative long-term projects are more sensitive to changes in the Federal Funds rate than projects that are less capital intensive and relative short-term in duration. Therefore, periods of loose monetary policy resulted in a misallocation of resources that has been costly to correct during the bust. This result finds a particular pattern of economic distortion during an unsustainable boom.

Also by Andreas Hoffmann’s “Zero Interest Rate Policy and the Unintended Consequences on Emerging Markets.

The abstract:

In response to the subprime crisis and Great Recession central banks in advanced economies have cut interest rates towards zero and increased monetary accommodation to step-up domestic growth. In this paper I attempt to describe the unintended consequences of the low interest rate policies in emerging markets. I argue based on the Mises-Hayek business cycle theory that the current low interest rate policy in advanced economies may have planted the seeds for new bubbles and gave rise to interventionist cycles in emerging markets. I show that capital flows to high-yielding emerging markets translate into monetary expansion in emerging markets. In the face of buoyant capital inflows fear of floating forces emerging markets to follow the interest rate policy of advanced economies. The monetary expansion triggers mal-investment and over-borrowing. To stem against arising inflationary pressure and kill-off speculative capital inflows empirical evidence suggests that emerging market governments increasingly repress financial markets. International financial markets disintegrate. I conclude that the monetary policy of the large advanced economies is incompatible with financial integration and globalization

Why Keynesians Don’t Understand the Macro Economy

Frank Hollenbeck, in “Why Keynesian Economists Don’t Understand Inflation”  argues that a fundamental shift in macro theorizing, shifting from the transaction version of the equation of exchange to the income form  of the equation, particularly in theorizing about the demand for money is wrong theory and hence leads to bad policy and a inherent inability to understand inflation and its consequences properly.  He summarizes:

Yet, the original, non-Keynesian quantity theory of money clearly shows that the demand for money is to conduct all possible transactions, and not just those that make up nominal income. Money is linked to prices of anything that money can buy, consumer goods, stocks, bonds, stamps, land, etc. From this, an average price cannot be measured since appropriate weights are not obtainable. The use of the simplified, Keynesian version in economic textbooks and by the professional economist has caused immense damage. When your theory is wrong, your policy prescriptions will likely also be wrong.


Fred Glahe

One of the few textbooks to highlight problems with macroeconomic modeling based on the income form of the quantity equation’s was my mentor Fred R. Glahe’s Macroeconomics Theory and Policy. The discussion is around p. 221 in the linked 3rd edition. This edition was one of the few (only) texts that had a section on Austrian business cycle theory. The text was also one of the best in highlighting hidden assumptions in Keynesian analysis.

The problems with the simplified Keynesian version is foundational, and is the result of basing macroeconomics on national income product concepts as Hayek attempted to show beginning in the late 1920s.

Fred and I discuss the implications of the use of the income form of quantity equation (almost all ‘modern’ macro) in our book The Hayek-Keynes Debate pages 114-117.

We conclude:

These models [Keynesian and modern macro] focus on aggregates. Hayek’s model [capital structure] cannot be expressed or understood in terms of such aggregates. All the key features of Hayek’s analysis are absent in models that use the national income concept as a starting point for macroeconomic analysis.

Roger Garrison (Natural Rates of Interest and Sustainable Growth) provides an excellent discussion highlighting the “variations on a the theme” (ABCT) that was evident in the two most recent boom-bust cycles, the and housing, that he attributes to the Fed’s ‘learning by doing’ policy of the Great Moderation. He highlights how the use of aggregate data lead Fed policy makers to have a blind eye toward the how interest rate manipulation generates  malinvestments, overconsumption, and capital consumption and impedes sustainable recovery:

The inattention to the effect of manipulating interest rates on the allocation of resources traces to the high level of aggregation that dominates the thinking of today’s macroeconomists. Hayek’s earliest work in monetary theory (Hayek [1928] 1975) is an extended demonstration that the whole process of a credit-driven boom and subsequent bust is concealed within the macroeconomic aggregates that populate the equation of exchange.

For more detail see Mark Skousen’s The Structure of Production with a New Introduction. pp. xi–xxxix or  How Measuring GDP Encourages Government Meddling.

Lange Anticipates Higgs

mqdefaultOver at Econlog Bryan Caplan explains “Socialism Was Born Bad: The Case of Oskar Lange” Both Don Boudreaux (at Café Hayek on March 25, 2014) I (on a Facebook share of the post) noticed  that the “clarity of thought [which] led him [Lange]directly to a totalitarian vision that he gladly embraced” also provided arguments that support regime uncertainty as a potential major culprit in generating economic stagnation and preventing normal recovery from a recession.

My comment:

Lange’s quotes on why gradualism in the transition to socialism would fail in the economic sphere -undermine property rights and cause economic collapse – support Robert Higgs’s concept of regime uncertainty.

Don Boudreaux’s comment:

Bryan Caplan reflects on the origins of “market socialism.” (The excerpts in Bryan’s post from Oskar Lange suggests that, had he lived long enough, Lange perhaps would have – and certainly should have – endorsed at least the thrust of Bob Higgs’s account of regime uncertainty.)

The argument which appears to be a pre-endorsement of regime uncertainty is from Lange’s “On the Economic Theory of Socialism” (Review of Economic Studies, 1937 HT to Bryan Caplan):

Unfortunately, the economist cannot share this theory of economic gradualism. An economic system based on private enterprise and private property of the means of production can work only as long as the security of private property and of income derived from property and from enterprise is maintained. The very existence of a government bent on introducing socialism is a constant threat to this security. Therefore, the capitalist economy cannot function under a socialist government unless the government is socialist in name only.

Robert Higgs provided clarification on what regime uncertainty entails that is highly relevant in today’s lawless policy environment as evidenced most recently in two Wall Street Journal editorials; ObamaCare Delay Number 38 and The Suh-and-Settle Nominee. People and rhetoric matter. Per Higgs:

Regime uncertainty pertains to more than the government’s laws, regulations, and administrative decisions. For one thing, as the saying goes, “personnel is policy.” Two administrations may administer or enforce identical statutes and regulations quite differently. A business-hostile administration such as Franklin D. Roosevelt’s or Barack Obama’s will provoke more apprehension among investors than a business-friendlier administration such as Dwight D. Eisenhower’s or Ronald Reagan’s, even if the underlying “rules of the game” are identical on paper. Similar differences between judiciaries create uncertainties about how the courts will rule on contested laws and government actions.

For another thing, seemingly neutral changes in policies or personnel may have major implications for specific types of investment. Even when government changes the rules in a way that seemingly strengthens private-property rights overall, the action’s specific form may jeopardize particular types of investment, and apprehension about such a threat may paralyze investors in these areas. Moreover, it may also give pause to investors in other areas, who fear that what the government has done to harm others today, it may do to them tomorrow. In sum, heightened uncertainty in general — a perceived increase in the potential variance of all sorts of relevant government action — may deter investment even if the mean value of expectations shifts toward more secure private-property rights.

Given Lange’s prestigious standing in mainstream economics, due at least in part for his erroneous arguments in the calculation debate, it is too bad more economists don’t recognize the negative impact of regime uncertainty on investment, employment, and prosperity during the on going Bush-Obama-Fed Great Stagnation.


Quote of Note

Today’s Wall Street Journal highlights Mises:

Notable & Quotable

Economist Ludwig von Mises on the supremacy of consumer interests over producer interests in a market economy.

Ludwig von Mises, “Nation, State, and Economy” (1919):

One of the great ideas of [classical] liberalism is that it lets the consumer interest alone count and disregards the producer interest. No production is worth maintaining if it is not suited to bring about the cheapest and best supply. No producer is recognized as having a right to oppose any change in the conditions of production because it runs counter to his interest as a producer. The highest goal of all economic activity is the achievement of the best and most abundant satisfaction of wants at the smallest cost. . . .

Preferring the producer interest over the consumer interest, which is characteristic of antiliberalism, means nothing other than striving artificially to maintain conditions of production that have been rendered inefficient by continuing progress. Such a system may seem discussible when the special interests of small groups are protected against the great mass of others, since the privileged party then gains more from his privilege as a producer than he loses on the other hand as a consumer; it becomes absurd when it is raised to a general principle, since then every individual loses infinitely more as a consumer than he may be able to gain as a producer. The victory of the producer interest over the consumer interest means turning away from rational economic organization and impeding all economic progress.

Unfortunately, instead of Mises’s system of consumer sovereignty, mercantilism─what Smith labeled a system of privilege a restraint─still dominates even the most market oriented economies.

Mortgage Market Roulette

454px-IOF-32-REV-4Following the Fed meeting last week, I was interviewed by Thomas Ressler, editor of Inside the CFPB (Published by Inside Mortgage Finance Publications) focusing on the impact of Fed policy on MBS and the housing market.

His summary of our discussion:

More broadly speaking, Fed watcher John Cochran, emeritus professor of economics at Metropolitan State University of Denver, agreed that one of the first things that needs to happen to attract private capital back into the MBS market is for the Fed’s footprint in the space to shrink. However, given the drop-off in new issuance, the Fed’s share of the pie may actually be increasing.

It’s true that the Fed is reducing its purchases somewhat, but “the trend seems to show that they’re buying a larger and larger percentage of total new securities issued,” Cochran said. “So I’m not really certain when and how private money is going to be attracted in on a significant basis when we’re really overly dependent on these extremely low rates and holding onto, in the Fed’s balance sheet, significant portions of these MBS.”

He also shares the concern that the housing market is on the verge of another bubble because of the low interest-rate environment. “What part of a bubble don’t people understand, where they’re looking at returns to 2007, 2008 housing prices as a sign of recovery?” the professor said

In our discussion sumarized in the last paragraph I refered  Mr. Ressler to the excellent Housing Bubble 2.0 by David Stockman posted at . If you haven’t seen it is well worth a read.

Even with tapering QEIII is a large intervention is important credit markets and is still an ineffective (relative to its stated goals) and long term harmful mondustrial policy.

After being relatively stable from  September 2013 through December 2013, both the monetary base and bank excess reserves restarted their upward trend in January. Fed while slowing purchases on long end must be very active on short end again to maintain near zero interest.

ABCT and US Monetary Policy Effects in Latin America

The effects of US monetary policy on Colombia and Panama (2002-2007)

More good work from Metro State’s Nicolas Cachanosky


  • Studies international effects on two small economies with different forex regimes.
  • Studies how these two economies react to US monetary policy.
  • Relative capital intensive sectors are more sensitive to US monetary policy.
  • This common characteristic can explain business cycle co-movements.


I study the economies of Colombia (floating exchange rate) and Panama (dollarized) to illustrate how the monetary policy of a large economy can export capital structure distortions to small open economies that follow different exchange rate regimes. The paper contributes to the literature on international business cycles in two ways. First, it adds to recent research that extends the Mises-Hayek business cycle theory to an international context. Second, most current research abstracts from effects on the production structures of emerging market economies when analyzing the transmission of monetary policy shocks. This paper seeks to fill this gap by studying structural effects of U.S. monetary policy on the economies of Colombia (floating exchange rate) and Panama (dollarized.)


The Dogs of Inflation

413px-Petit_Journal_Janvier_25_1914_Loup_&_EnfantKeynesians Again Revive the Phillips Curve Folly

Robert Higgs has provided a most applicable biblical passage that very aptly describes the continuing knee jerk revival of the Keynesian follies during this Fed-Bush-Obama
Great Recession and Great Stagnation

“As a dog returneth to his vomit, so a fool returneth to his folly.” Psalm 26:11.

Frank Shostak, in his excellent Mises DailyInflation Does Not Produce Economic Growth,” identifies another culprit, Chicago Federal Reserve Bank’s Charles Evans.

For an in depth critic of the Phillips Curve from an Austrian perspective see Adrian Ravier’s excellent Dynamic Monetary Theory and the Phillips Curve with a Positive Slope.

The “more inflation” argument keeps coming back which is why it continually must be whacked down. Salerno’s and my attempts from two years ago are here  and here. Krugman, Mankiw, Bernanke and Company were then the dogs of more inflation. How soon given hidden rot in labor market news before Ms. Yellen joins them?

Out of Poverty: Powell’s Most Recent Work in the Misesian Tradition

OutofPovertyPowellPete Boettke at Coordination Problem highlights the excellent work by Ben Powell in the Misesian tradition (links added).

Ben Powell‘s Out of Poverty, is a classic example of praxeological reasoning and the purpose of political economy in the hands of a skilled thinker influenced by Mises’s approach. Listen to his discussion of the book, he treats the ends of the critics of sweatshops as given, he deploys straightforward analysis of the effectiveness of the chosen means for the attainment of those given ends, and demonstrates in a non-normative yet powerful way how the critics and policy makers influenced by the critics are in fact engaged in counter-productive policies from their own point of view. Graduate students and young economists take notice, this is how you are supposed to be doing (as opposed to talking) praxeology.

Don’t get me wrong, it is vitally important for young scholars (and old) to engage in pure theory, and to also engage in intellectual history and methodological discussions to refine our understanding of praxeology, but ultimately the purpose of theory is found in the application to history and contemporary history (also known as public policy). Ben Powell is demonstrating to young scholars (and old) how to engage in sound economic reasoning and engage a hot-botton issue in contemporary public policy. Mises, no doubt, would be thrilled to see how his approach to the sciences of man is being developed and utilized by a masterful economist.

For the video of Powell’s presentation of his new book go here

Support the Battle of Ideas; Not Tyrants

Today at the Circle Bastiat Ron Paul offers sage commentary on the Ukraine where he asks and answers with a resounding NO, “Can we afford the Ukraine?

A good follow up appears in the Wall Street Journal where William Easterly argues that both U.S. and private aid is misguided and misspent. Too much ‘aid’ supports tyrants and is contra-productive in supporting freedom and developing prosperity. See

William Easterly: How About Aiding Freedom Instead of Autocrats?


Attributing development success to autocrats misreads the evidence on autocracy and development. Academic researchers running statistical tests on historical data find that prosperity in the West is largely due to individuals realizing their own political and economic rights.


The good news is that the long-run trend is toward the spread of freedom, as people assert their own rights. Western humanitarians should support them in the battle of ideas, not fight against them by giving spurious intellectual justification and financial support to their oppressive rulers.

Even better; support the battle for liberty entirely through voluntary means. MI is a good place to begin.

Bubble-Boom and the Necessary Role of Central Banking

President_Barack_Obama_meets_with_Federal_Reserve_Chairman_Ben_Bernanke_4-10-09In a perceptive comment on yesterday’s Daily, “Bernanke’s Legacy: A Weak and Mediocre Economy”, mkm writes:

Whilst the Fed and Bernanke had a role in the 2008 financial collapse, we should not forget the other actors who were probably more culpable than them. They will include the social pressure groups who pushed for the 70% house ownership policy; the politicians who supported it for electoral reasons; the credit institutions who encouraged and stoked it for person gain; the Government and Legislative institutions who failed in their duty to control it; and the accounting/legal authorities who failed to have in place mechanisms/accounting rules and practices appropriate to control the malfeasance which has been well documented in the past. This is not just a matter for economists.

However, without central bank actions or other special privileges for fractional reserve banks which allow sustained credit creation, bubbles are relatively self-contained with most damage limited to those who make bad ‘investment‘ decisions.

Roger Garrison, as he often is, is right on in his analysis of the relative role of the mortgage-housing  specific aspects of the recent crisis and the role of the Fed. From his Alchemy Leveraged: The Federal Reserve and Modern Finance:

Unsound as these policies were, they were not the principal cause of the financial crisis. Again, Dowd and Hutchinson are right in identifying the expansion-prone Federal Reserve as the principal institutional cause. Had the Fed provided no fuel for the boom, federal housing policy, though perverse, would not have been unsustainable. The mortgage market would have had to compete with all other markets for the funds that savers provided. There would have been a continuing bias in favor of the mortgage market, and the ongoing rate of foreclosures would have been higher. House prices would have been higher (because houses and mortgage loans are complements), but they would not have been high and rising. Practitioners of modern finance would have paid due attention to the higher VaR, which would have reflected the expectation of an ongoing higher foreclosure rate. Conversely, had the federal government not enacted legislation and created institutions that rigged mortgage markets so as to increase home ownership, credit expansion by the Fed would nonetheless have created an artificial boom, which inevitably would have ended in a bust.


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