Macro Lit Review 2: Highlights from Late 2022 with George Selgin

George Selgin is a senior fellow and director emeritus of the Center for Monetary and Financial Alternatives at the Cato Institute. George is also a frequent guest of the podcast, and he rejoins David on Macro Musings once again to discuss their top three articles from the past few weeks related to macroeconomics and monetary policy. Specifically, David and George talk about Jerome Powell’s recent criticism of nominal GDP targeting, Lael Brainard’s recent comments regarding FedNow and real-time payments, the debate surrounding the Fed’s campaign against inflation, and a lot more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]

David Beckworth: George, welcome back to the show.

George Selgin: Great to be back again, David.

Beckworth: So the last time you were on the show, we did a top three articles of the past few weeks and it was a big hit. We got a lot of listens and so we're going to do this again, George. But before we get into this, I understand there's some big changes happening in your life, so maybe you could share that with our listeners.

Selgin: Well, yes, David. In two days I'll hop on a plane and go to Granada, Spain where I intend to stay for I don't know how long, indefinitely perhaps. And that'll be my new home.

Beckworth: So this may be one of your last, if not the last in studio recordings we do with you for the podcast.

Selgin: Oh, that depends on whether you ever travel outside of the country to do an occasional live interview.

Beckworth: Okay, okay, alright. I'll have to check with Tyler Cowen, see if I have the budget to travel to Spain to do a podcast recording. I'm sure that may be a tough ask, but I'll try, George. But you'll be in Spain, so you're leaving the US. Now, are you still going to be engaged in work from there?

Selgin: Yes, I'm still working for Cato, only remotely. In fact, what I did was to go to the boss, Peter Goettler, who I think we'll be talking about a little bit later on. I went to Peter and I said, "Peter, I'll take the following big cut in my salary if you let me work wherever I want to." So I made an offer. I put out a number that was substantially below what I was making. And he said yes with such alacrity that I realized I probably could have asked for a raise with the promise that I was going to go away and he might have given me that.

Beckworth: Alright, so he's happy to see you leave the building.

Selgin: Yeah, they're all, everybody's throwing parties.

Beckworth: Well, we're sad to see you leave the states, but glad to hear you will still be engaged in this area. So speaking of Pete Goettler, you guys recently had a Cato Monetary Policy Conference, was a little earlier this year in September, usually in November. But one of the highlights was that you got chair, Jerome Powell, on the program and he was interviewed by Pete, is that right?

Selgin: He was interviewed, yes, by Peter Goettler, yeah.

Beckworth: Yeah, and so there was a great interview that happened. I enjoyed it because it wasn't a typical… I know you guys got some pushback from some people who wanted… what does this mean for the markets, for rate policy? And instead, Pete went into deep policy questions, which I think are interesting. We don't always have to have what's going to happen to rates in the next meeting and such. So it was great to see Pete push him on the dual mandate, on cryptocurrency stablecoins. And one thing that came up that was really, of course, interesting to me, was the question in nominal GDP level targeting. So Pete asked him about that, right?

Selgin: Yes, he did, yes.

Beckworth: And this is the response. I have the transcript here from the interview, and this is what Chair Powell said in return. He said, "I know that Cato is one of the home courts for nominal income targeting along with Mercatus and some others. A lot of well known experts, many of them at your institution, support nominal income targeting. We've looked at that, I've looked at that and really come to the view that nominal income targeting is not the right way to go." So first off, kudos to Cato and Mercatus, we got the mention, the shout-out from Chair Powell. But he wasn't very excited about it. And let me read to you his reasons why. And by the way, this is my first article. We're going to do three articles each, this will be my first article, this discussion with Chair Powell.

Beckworth: So what he says, apparently Pete comes back on and asks a few questions and then Chair Powell responds, "We've got a dual mandate, maximum employment and price stability and it comes down to, is nominal income targeting the best way to promote it? We don't think it is. I don't think it is. And part of that is that it would be very difficult, I think, to explain to the public. The relationship between nominal income targeting to those goals is just a level of complexity that even some economists and policy makers struggle with, let alone their general public. So it seems like it would be a reach to have it to be our fundamental framework." Okay, I'll stop there. What are your thoughts?

Responding to Powell’s Nominal GDP Targeting Opposition

Selgin: Well, I have several thoughts. The first is that the fact that something seems difficult to explain is itself not a very good reason for not doing it, if it's the right thing to do. And the simple fact is that stability of nominal income is really the key to macroeconomic stability. It's not a shortcut, it's not advisable simply because it's a simple rule, which it is in some respects, even if people don't grasp it quickly. It is an ideal. It's an ideal. And anything that departs from that ideal of a stable level or level path for nominal GDP targeting is asking for trouble, either cyclical or too much inflation or too little inflation or deflation. So when we have a theoretical ideal, and I'm willing to go out on a limb and say that it is ideal, and we could talk more about that, then the question shouldn't be whether it's hard to explain why it's ideal, it should be how do we communicate this to the public and how do we best try to approximate it in practice?

The fact that something seems difficult to explain is itself not a very good reason for not doing it, if it's the right thing to do. And the simple fact is that stability of nominal income is really the key to macroeconomic stability.

Selgin: Those should be the only questions. Now personally, I don't think nominal GDP targeting is all that hard to explain. Assuming that people understand what inflation targeting is and one may wonder how many actually do, outside of the economics community. I don't see why it's any harder to explain to people why we want nominal spending to be stable, to not grow excessively and certainly not to shrink over time. I've done so in a number of places, you have, David. It's just saying that if the average person's and firm's earnings are rising too quickly, you get problems with too much purchasing power and excessive short run profits, eventually causing prices and wages to have to go up too much as has been happening lately because of excessive spending amongst some other factors. And if spending shrinks, why people can't pay their bills and firms can't pay their obligations, their debts, they earn less than they laid out in cost.

Selgin: These seem, to me, rather simple points. It's also not hard to explain why, under certain circumstances, even though stabilizing nominal income growth does not equate with keeping the inflation rate constant, the movements and the inflation rate that would result from nominal income targeting are ones that reflect the true state of scarcity in the economy. So the only time you have prices rising exceptionally fast with nominal income targeting is if goods are unusually expensive to produce, as has been the case since COVID and the Russian invasion of Ukraine. And on the other time you get falling prices is when productivity is growing especially quickly. These things aren't hard to explain. You only have to make the effort. And so I don't think that Powell's argument is very good. I'll just add one more thing.

Beckworth: Sure.

Selgin: As far as we know, as far as the public knows, the only study that the Fed has done in its review of its procedures, especially during the Fed's Fed Listens program, addressing nominal income targeting among other procedures was the one by Lars Svensson where Svensson essentially dismissed it on the basis of a number of presumed shortcomings. Well, I've written a piece in Alt-M about this Svensson article where I think I show that there's no validity to any of the arguments he made. They're all based on fallacies of various kinds. So if that's the best the Fed can do to point to the theoretical flaws of nominal GDP targeting, well they don't have a leg to stand on as far as I can tell.

Beckworth: Yeah. Let me give a concrete example where nominal income targeting would've been easier for the Fed. I'm going to go back to QE2. Ben Bernanke was called before Congress. “Why are you doing QE2?” And he said something along the lines of, "Well, we want to get inflation back up." And that didn't go over well with anyone, particularly the Republicans. They were just up in arms, "Are you kidding me? The recovery's slow and you want to increase the cost of living now?" And what he really meant was he wanted to get nominal income or aggregate demand back is what he really meant to say and had said that, it would've been a whole lot easier. Same thing, the whole post-Great Recession period.

Beckworth: This talk about inflation is running too low to a lot of people is just kind of off-putting as opposed to nominal income growth wasn't where it should be. And the flip side of that is where we are today. We know that, yes, some of the inflation is due to supply side forces, as you mentioned, energy, the war in Russia and Ukraine. But some of it's also due to excess demand that came out of the fiscal stimulus and the Fed putting the gas pedal to the metal for too long. And the question in real time is, well how much do we attribute to each side? And we don't know. But what nominal income targeting does, it says, look, just look at the level relative some trend or target path, bring it down and the rest will sort itself out.

Beckworth: We don't need to worry about what percent is supply side, what percent is demand side. So it would make the Fed's job easier. They could say, "Look, you're right. There's a lot of uncertainty about what's driving inflation. Don't worry about it. Keep your eye on the growth of aggregate demand or nominal income.” So I think both in a low growth period or an excess growth period, it's, in some ways, much easier than trying to wrestle through inflation. And we had Carola Binder on, my colleague right now, a visiting fellow here, and her work's been really great on inflation expectations for households and what drives their thinking is often gas prices and that's not inflation. There's a lot of confusion, even with inflation targeting, I think, that the central bankers take for granted.

Selgin: Yes, absolutely. Let me add two things to that. First on this last point, I think if you ask most people, perhaps I'm wrong, but what's more important to you, to be able to have some confidence in your earnings being stable over time or knowing that some index of prices is stable over time or growing at a constant rate over time? To me, it's pretty obvious that the more immediate concern people have is their earnings. And this is true for businesses as well, being able to predict their earnings. Certainly, people would say, "Well, I'd rather earn more than less." But it's easy enough for us to understand that in the aggregate of course, having everyone earn, nominally, a lot more doesn't really end up being a source of anything but inflation. But I think it's perfectly, to me, intuitive that stability of earnings is really more important for macro stability.

It's easy enough for us to understand that in the aggregate of course, having everyone earn, nominally, a lot more doesn't really end up being a source of anything but inflation. But I think it's perfectly, to me, intuitive that stability of earnings is really more important for macro stability.

Selgin: The other thing I would mention, which is something of a puzzle as far as I'm concerned, is that we've had since 1936, now Keynesian economics has been kind of the cat's meow. And we always come back to that, even though there have been of course important criticisms. But fundamentally, what Keynesian economics boils down to, and it isn't unique in this respect by any means, but it's really what a central component of, this is the idea that what matters for stability is aggregate demand, aggregate demand, not the price level… aggregate demand. NGDP targeting is stabilizing aggregate demand. That's what that means. So how is it we have this disconnect where on the one hand people will say, "Yeah, Keynes, aggregate demand, blah blah blah." And then you talk about nominal GDP targeting and they're like, "Oh, oh we can't do that."

Selgin: It's the same thing. NGDP targeting is the statistical practical counterpart of what The General Theory and other like works say we should be trying to do to keep the economy stable, to avoid bouts of unemployment or inflation because Keynes' perspective was a two-way perspective. He was concerned about inflation, he emphasized the inflation problem when that became a problem during World War II or just before. And he emphasized the unemployment problem when that was the main issue in the '30s. But underlying both of his sets of arguments was the idea that aggregate demand was something that you did not want to see fluctuating too much or varying in undesirable ways. And that translates into nominal GDP targeting.

Selgin: I'll just add one other quick footnote. If you read The General Theory very carefully, there is a point in the book where he considers whether stabilizing the nominal wage index, so to speak, would be superior to trying to stabilize the general price level. And he wavers back and forth and then ultimately he comes out for price level stabilization. I've written an article about this. Well, I think he made the wrong choice because as I've been saying, the key in The General Theory throughout most of the book is stability of aggregate demand. That is not always the same thing as stability of some price level measure. It's more consistent with stability of factor price index or wage index, which is NGDP targeting. So he got that wrong, Keynes just blew it. But the rest of the book is consistent with NGDP targeting.

Beckworth: Well, there we go. A broad tent for nominal GDP targeting. So okay, that's my first article. George, will move on to yours. And I'll just briefly mention in the show notes for all the other objections to nominal targeting, we’ll place a link to my article that's titled, *Facts, Fears and Functionality of Nominal GDP Targeting* where I do address some of the concerns that Chair Powell had and others do. So I understand George, your first article is going to be responding to a speech by Chair Lael Brainard from I believe August 29th on FedNow. Is that right?

Responding to Lael Brainard Regarding FedNow and Real-time Payments

Selgin: Yes. That's one of the three articles. I picked an article covering each of my main pet peeves about current monetary and payment system developments. So this was a speech, it is really sort of a speech that's boosting FedNow, which is now scheduled to come online sometime in the spring or summer of 2023. And I guess my main complaint about the speech is it makes all kinds of claims for the uniqueness of FedNow, for how it's going to solve the problem of instant payments that betray, I won't say misunderstanding, but that misinform the public about the true state of play in the realm of fast or real time retail payments. First of all, this is not a unique scheme, this is not an original scheme, it's not a particularly technologically innovative scheme. It is the Fed's counterpart to a plan that was first put into effect by the Clearing House, or TCH, private payment system operator that's been around longer than the Fed, since 1853 and their system is called RTP.

Selgin: It was established in 2017, almost six years ago, it's been up and running. It is fast, a real time retail payment system. It now encompasses 75% in value terms of all the deposits in the United States and 61% of the number of deposits. So it's not ubiquitous, but it has, I'm going to say, about 250 participants. FedNow had about less than half as many last month when it did its trial, it had some provisional participants doing the dry run so to speak. So RTP has come out first, is more well developed. It also has the big banks, almost all the big banks are part of it, which is not surprising since many of them, the biggest ones, are also the owners of TCH. So she's selling this thing as if it were something unique and original and it's not. It's a johnny-come-lately version of real time payments.

Selgin: Second, she says, "Oh, we've been cooperating with RTP all along to achieve interoperability." Well, that's not true either. If the Fed wanted to cooperate in achieving two interoperable real time payment systems, assuming that having two interoperable systems is better than just having one ubiquitous system, then they would've been cooperating with them in that way in 2017 or earlier, which of course would've required them to tell RTP that they were planning to build the parallel system. In fact, they didn't reveal it until RTP had gone ahead with its plan with the blessing of the Federal Reserve in 2017. Then they surprised them with the announcement that they were going to get into the business a couple of years later, almost three years later. And of course that's no way to do an interoperable system and that's no way to cooperate.

Selgin: I should add that the Fed had not only given its blessing to the RTP plan, but it had invited the Clearing House and numerous other stakeholders in private payments to develop some kind of plan for real time payments. It just so happens that RTP was one that stepped up to the plate whose plan was approved and given extremely high marks on all criteria by the Fed and other people who were assessing these different proposals. So the story being sold to the public here is really, I think, misleading. It's a myth. I'll also add, and this is something that people understand network economies should appreciate, that this is a clear case where a single network is efficient, the network economies are such that the best thing is to have one network that includes all the banks, as well, ideally, as some non-bank participants. And what happened when FedNow came into the picture suddenly, was that it arrested the progress towards ubiquity or completeness of any one network.

Selgin: It created a situation where now those banks that had not yet joined RTP had a choice they had to make, "Do we join this or do we join this other network? Or do we ultimately join both?" Which is expensive because there are connecting fees, up front costs, capital costs, especially if the networks aren't interoperable. And so the result was to stifle the progress towards ubiquity, which is exactly the opposite of what the Fed had claimed that its policies were about. It was all about trying to get an ubiquitous real time payments network up as fast as possible. So here we are now with two incomplete networks, well one not up and running quite yet, instead of one complete network. But now of course the other side of all this was the fear of community bankers, particularly that they would get a raw deal from RTP, even though RTP had already had its pricing strategies, had already renounced volume discounts, had already contracted with banks for these no volume discount rates.

Selgin: So the Fed argued that it needed to be in the picture, otherwise there'd be a tendency, eventually for RTP to switch to volume discounting favoring the big banks. Well, there's a very good article by a guy named Thomas Wade for the American Actions Forum and he explains the history behind the Fed's other main involvement in electronic digital payments, which is the ACH system. To make a long story short, it was the Fed that having gotten itself involved in ACH payments, mostly because the Fed had a computer that could handle things and nobody else had one at the time. Otherwise, it was a private market innovation. It was the Fed that introduced volume pricing to get the big banks on board with its own portion of ACH. Now there were, at first, three or four private ACH overseers, then the Fed got involved. And now there's just the Fed and the Clearing House now in ACH.

Selgin: The Fed introduced volume payments to get the big banks on board. How is the Fed going to get the big banks on board with FedNow? I think, if I were a gambling person, which I'm not, I think the risk of the Fed being the one that ultimately pushes for volume discounts is pretty high. And the Fed is not subject to antitrust enforcement, whereas it would've been very easy, it would be very easy to use antitrust enforcement and other pressure from the Fed as regulator of payment utilities to keep TCH honest and to keep its monopoly RTP system, except if that's what we had ended up with from switching to volume discounts. They had all kinds of ways to do it. So I think this whole thing is bad news, a waste of taxpayer's money because they've spent millions creating a parallel system we didn't need, to guard against volume discounts that are now as likely to be implemented by the Fed in the future as by the private network. There, I'm done.

I think this whole thing is bad news, a waste of taxpayer's money because they've spent millions creating a parallel system we didn't need, to guard against volume discounts that are now as likely to be implemented by the Fed in the future as by the private network.

Beckworth: Okay, remind us again why the legacy networks were so inefficient.

Selgin: Oh yeah. Well, so first of all, I should have mentioned that the take up on RTP has been disappointing. It's like 40 million dollars in transactions.

Beckworth: So there's a lot of banks that have connected, but they're not using it a lot.

Selgin: The demand for it isn't high. And so having two networks like that, it's possible that there'll be a pair of white elephants. And the thing is that, as Aaron Klein has quite properly complained about many times, is that we have people who wait days for a check to clear or for other payments to settle, so that they have their accounts credited. It's these multi-day delays that are really costly. Usually, if you can get payment credit within a day, within 24 hours, that's fine. Most people don't need instant payments, which besides that have their own risks. They tend to be irreversible. So if there's something dishonest or something wrong, it's hard to undo it. And it also is very costly because they have to be fully funded by reserves. There can be no netting out of amounts during the day, so that the amount of settlement media of liquidity required for the thing to operate is reduced.

Selgin: So what we really needed, I think, what would've been the low hanging fruit that should have been picked by the Fed to make payments much more efficient, with relatively little cost, was to just make sure we could have legacy payments like ACH completed as often as possible within one day. Now, why wasn't that the case? Simply because the Fed's net settlement systems, wholesale settlement systems, which is FedWire and the National Settlement Service are closed on weekends and holidays. That's it. And for years, for years the Fed has been promising that it would do something about it. It did introduce, after long delays, a third interday payments window on ACH, great, that was something. But it never got around to seeing to it that payments were done at least on one of the weekend days, like on Saturday. Saturday would be key. They don't even have to do it on Sunday, just Saturday.

Selgin: And it would be nice if they didn't close on holidays. That's all perfectly technologically possible. Your listeners will understand that there's nothing special about Saturday, things can happen on Saturday that happen on Friday, using the exact same technology. So the Fed not only promised to do this, but whenever it asks for comment on it as well as comment on having a retail payment, it always got 100% support for having, ideally, 24/7, 365 settlement services. No one was against this, community banks, big banks, NACHA, you name it, everybody favored that. Not everybody favored FedNow. So when they got this feedback, guess what they did? They said, "Well we're going to do FedNow. Oh 24/7, 365 settlements? Well, we're still thinking about that. Maybe we'll ask for public feedback later on."

Selgin: They just asked for it. This is literally what they said, David. They had just put out comment, they'd gotten the comment and they said, "Well maybe we'll get some comment." So basically, this was their way of not doing it. And at the same time, they’re proceeding with a much more difficult and dubious venture of creating a second parallel real time retail payment system that there was no good reason to create. And I think, being a cynical person, that the reason they didn't want to go ahead with 24/7, 365 settlement, which would've improved the legacy payment systems and done away with all the really long delays... Hi Aaron, is that they knew that if they did that, they could not create adequate support for FedNow, support was limited as it was. But if they had proceeded with that reform at any time, that simpler reform, nobody would've felt the need, certainly for a second real time payments network and that would've been that. So anyway, I think that people need to be aware that they're being sold a bill of goods in real time-

Beckworth: Well George, we look forward to seeing what happens with FedNow and these legacy payments. And hopefully even though you're in Spain, you'll still stay on top of this issue. Okay, let's go to my second article here. And this is one from, coming to the surveys, the Ipsos survey. And they've been looking at, I should say, top concerns across the world and they do this global survey and I'm looking at one from September 2022. And they've been tracking, I think, these questions from 2020. So they do lots of surveys, but they've gone out and done a global one where they go out and survey 29 countries, around 20,000 people are asked what's the biggest worry or the top concern? And of course early 2020 it was COVID, after that it was unemployment.

Beckworth: But things have changed dramatically. So starting in early 2022 and late 2021, what you see in this survey is inflation begins to jump up as issue number one. And right now it is, it's about 40%, unemployment's around 25% and everything else is way below it. So you see this acceleration of inflation across the world being a top concern and it really tracks, I think, the increase in the inflation rate we've seen around many countries. And it's interesting that this tells us that people really hate inflation. It's something that everyone experiences. Not everyone experiences unemployment at the same time, even during the Great Recession, some people had jobs, some didn't. But everyone experiences inflation. And once it gets to these higher levels and is sustained, it becomes enemy number one for the body politic.

What we really needed, I think, what would've been the low hanging fruit that should have been picked by the Fed to make payments much more efficient, with relatively little cost, was to just make sure we could have legacy payments like ACH completed as often as possible within one day.

Beckworth: And I did a tweet where I shared this and I've shared this before from earlier months on this. But I wrote, “inflation is still polling as the top concern across 29 countries. This is why the fight against inflation continues to be waged so aggressively, the body politic wants it.” Now I got a bunch of people who agreed with it and some who hated it. Some people said, "Yeah, well why don't they ask the folks if they're willing to engage in sharp recessions to end the inflation." So there's some pushback against this. But what's interesting, George, is if you go back to the 1970s, Gallup did a poll and when inflation was becoming sustained and entrenched, it was also issue number one. It was higher than any other issues of the day you could think of, Watergate, Vietnam, crime, this was the number one issue in the '70s.

Beckworth: And so one takeaway I have, and this is what I put in the tweet is, you know what? The body politic, the public doesn't like inflation. And at some point people in government respond to that in advanced economies. And so our dear friend Nathan Tankus has had a tweet. I thought was a good point, fair criticism. So Nathan, thank you for being critical of my tweet and giving us something to talk about here on the show. But he noted, "There's a funny inconsistency here. The main models that defend central bank independence do it on the basis that there is time inconsistency where the public wants overly expansionary policy that will cause accelerating inflation. But suddenly when central bank interest rates hikes are criticized, the argument is actually this is all very popular, which implies that an executive branch would do it all of their own volition."

Beckworth: Let me summarize, I think what he's trying to say here is that we invoke time inconsistency models because it says that policymakers, I don't think so much the public, but the policymakers can't commit to policies that are consistent over time keeping inflation down. If they say they're going to keep it down today, then in the future someone's going to cheat and they can't commit to stopping that. And as a result, we have to give central banks independence because they can't control themselves. But what I'm saying, which may or may not go against it, I want to hear your thoughts. What I'm saying is people want price stability, they really do and the central banks are responding to it. So what are your thoughts, George? Is there a tension here I'm overlooking? Or does Nathan have a good point?

The Debate Surrounding the Fed’s Current War on Inflation

Selgin: Well, it's a little bit of both. First of all, to those of us who lived through the inflation of the '70s and early '80s, there's absolutely nothing, nothing surprising about what the polls today are saying about public opinion about inflation. It was notoriously so back then, and it is precisely because it's so that you can have a Paul Volcker. Paul Volcker was, let's say, if not applauded, he was tolerated when he tightened to end inflation, even though it was in that case an exceedingly costly inflationary policy. And this isn't to apologize for how it was done or to say that it couldn't have been done in a less harmful way. But the reality is that it was done and it couldn't have been done if public opinion had been other than what it was, that is that the people hadn't been so fed up with inflation and with broken promises to bring it down.

Selgin: So it's true that if you ask somebody, "Do you want to be unemployed in order to end inflation?" Their answer would certainly be no. Of course, nobody wants to pay that price. On the other hand, it was in fact the case that inflation had become the number one issue. No president was going to be able to perform well without taking it on or trying to in some meaningful way. So it was a very difficult situation. Now I think, unfortunately, we're in that sort of situation now where the public is prepared to bear some high cost or put up with some high cost policies that do bring inflation down and politicians are bound to respond to that. As far as time inconsistency is concerned, I want to push back against this idea that time inconsistency is an argument for central bank independence. It's not.

Selgin: That somehow has developed as a myth. Time inconsistency is an argument for tying the central banker's hands and somehow having them commit to a policy that restrains their independence. That doesn't mean that they're doing whatever the government, whatever the executives say, wants them to do that. That's not what's required. What's required is that nobody can tell them to change from some given policy. It's written in the Constitution or the central bankers are all going to get fired if the inflation rate exceeds a certain... Something that imposes meaningful costs on them for deviating from a set policy, that's what's needed to solve the problem.

As far as time inconsistency is concerned, I want to push back against this idea that time inconsistency is an argument for central bank independence. It's not. That somehow has developed as a myth. Time inconsistency is an argument for tying the central banker's hands and somehow having them commit to a policy that restrains their independence.

Beckworth: So rules-based.

Selgin: It's an argument for rules-based policies, not an argument for central bank independence. And I don't know, this idea that it was is a mistake. It's not construing what the whole time inconsistency literature is really pointing to. Now of course we don't have a rule bound central bank, so we have time inconsistent policy. But those who argue that the Federal Reserve is responsible for ending inflation and that it should take steps to do it aren't contradicting themselves if they also say that it would be nice if we had rules that constrain central banks so that we didn't get into inflationary situations like this in the first place. You and I of course, believe that such a rule would be a nominal income targeting regime that has some kind of teeth to it, so that central bankers couldn't pay lip service to it and then change their mind.

Selgin: Now I don't say that it's easy to come up with such a thing, but there you go. So given that we don't have any such hard and fast rule, it's not being inconsistent to first of all say, "Well, we've gotten here because we have central banks that are not bound by rules that prevent them from goosing the economy and getting to a high inflation situation as a result." Not that that's the full story of what's happened this time around. Supply shocks tend to be part of the story of inflation getting out of hand. But there's nothing wrong with them appealing to time inconsistency as an explanation for how central banks sometimes lose control of inflation while at the same time appealing to public opinion polls, let's say people don't like inflation, as a reason for having central banks do something about it. I don't see any inconsistency with that. Maybe I'm missing something more subtle, but I just don't see.

Beckworth: Okay, well fair enough. Well let's go into your second article and let's do the Fed Master Account development because that's a nice segue from your first story, which was on FedNow, both related to payments, the infrastructure behind payments. So what's the latest in the master accounts that you want to report on?

Recent Fed Master Account Developments

Selgin: So just to step back and provide a little context to connect these two discussions, the thing we were talking about before with the legacy payments was about having the Fed extend the operating hours of its wholesale settlement practices and as a way to allow the legacy payments to continue on weekends and holidays. The master account controversy has to do with broadening access to the Federal Reserve's wholesale payment services, which presently are pretty much confined to ordinary insured depository institutions. There are plenty of payment service providers, retail payment service providers that exist already, but do not have direct access to the wholesale settlement facilities of the Fed if they have to operate through bank correspondence. A number of these firms have gotten banking licenses of some kind, including particularly special purpose banking depository institution licenses that make them legally eligible for Fed Master accounts because right now the Federal Reserve Act doesn't allow you to be eligible, with few exceptions, unless you're a chartered depository institution

Selgin: So some have gotten those special charters, but the Fed hasn't granted them master accounts. It has sat on some of their applications for a long time and we're talking years. Okay, in the meantime, the Federal Reserve had been working on developing new guidelines for applicants for master accounts. And the extensive purpose of its doing so was to clarify the rules. So we would have some definite ideas of what the requirements are, what it will take to have an account granted. The hope was that it would eliminate both the uncertainty about the requirements for an eligible institution to gain a master account, even if it wasn't an ordinary insured bank, full-fledged bank, that the new guidelines would provide the clarity and would also provide certainty about how long it would take to get an account. By the way, for ordinary banks, these accounts, master accounts were granted typically within 10 days of an application being filed, okay? So the difference between how ordinary banks have been treated and have always been treated and how some of these special purpose banks that want master accounts have been treated, is stark. It's night and day-

Beckworth: Light years apart.

Selgin: Light years apart. Anyway, so after a great deal of fanfare, the Fed finally published, after soliciting comments from people, including myself and many others, the Fed finally published the results of its overview and the new guidelines. And the bottom line is that the new guidelines hardly improve anything. They distinguish between three tiers, I believe that's the term the Fed uses, of applicants. And things are pretty cut and dry for the first two tiers. But for the tier three applicants, which would pretty much include all the ones that have been wanting to get master accounts but can't, those are the only ones where we need clarity and we need certainty. When it gets comes to the tier three, basically the guidelines leave everything vague. And at most it says what's necessary, but it doesn't say what's sufficient and it doesn't say, “you can expect if you've met these criteria, you will get your master account within 10 days” or within two months or within a year or something.

Selgin: Of course, that means that from the point of view of a payments FinTech business, let's say, even if it has gone through all the hoops to get a special purpose banking charter, whether from a state like Wyoming or from the OCC, has no more of an idea of how long or if ever it will take to get the actual account than it would've had under the old guidelines such as they were. Nothing has changed. From a business point of view of course, this is fatal because private businesses can't afford to go through a lot of trouble and have a business plan, especially one that really won't work unless they have a master account at the Fed, without having the slightest way to gauge their prospects of getting a master account in a timely fashion. So I say the Fed has gone through this big dog and pony show and what it has offered ultimately, to the kinds of firms that most needed guidance on the principles or procedures or rules for getting master accounts, is a big fat goose egg.

The Fed has gone through this big dog and pony show and what it has offered ultimately, to the kinds of firms that most needed guidance on the principles or procedures or rules for getting master accounts, is a big fat goose egg.

Beckworth: So if George Selgin is the principal and the Fed is one of his students, he's giving failing grades on both FedNow and master accounts on the report card.

Selgin: Yeah, but they’d do these businesses more of a favor if they'd written, “if you're not in tier one or tier two, forget it. Forget it, don't even try.” That would've actually been a kinder-

Beckworth: Well let’s see how this emerges because it is a political issue. I mean, one of the reasons they did these comments, right, is because of all the developments in Wyoming… is it the Kraken Bank or Kraken Financial Firm?

Selgin: Started with Kraken and there've been a bunch of others. And I've proposed, if I may plug some of my own work… And Dan Awrey has had a similar idea.

Beckworth: He's been on the show.

Selgin: Yes, of course, all the good people have been on the show and then I've been on it a bunch of times. But that the Fed should at least allow a fast track for those FinTechs with special purpose charters of any sort to get master accounts granted to them, provided they do two things. First, commit to backing… this is particularly for stablecoins, backing their payment liabilities 100% with master account balances, safest reserve medium in the world. And second, that they isolate these reserves. They make them bankruptcy remote, which means simply that should the firm fail for any reason, because it has other activities that could make it fail, the reserves would be there for the holders of those liabilities and for no one else.

Selgin: And this would be a fail safe system as far as any risk of loss on the part of the holders of these private payment media. And it's particularly important for stablecoins. And what's sad is that what we have now is a regulatory regime where the safest possible stablecoins are not legal. That is, it's not possible for you to be an issuer of stablecoins backed 100% by Federal Reserve liabilities because the Fed won't let you. And then you have people running around at the Fed saying, "Oh these stablecoin issuers are dangerous. So we need central bank digital currency." But I'll talk about that more next.

Beckworth: Okay, well I'm going to move on to my final story, George, and I'm going to throw you a curve ball here. I'm going to bring up something that's happened over the past few days. So we are recording this September 28th and a lot of interesting things are happening right now in the United Kingdom. Just to recap briefly here, and I'm not going to go into all the details because by the time this show comes out, I'm sure things will have changed, but the Bank of England has done several relatively large interest rate hikes, 50 basis points. I mean, across the world we're seeing this as the central banks follow the Fed. And then what happened recently is the new prime minister, Liz Truss, came out with a new tax cut plan already running big deficits and the pound fell about 6%. I mean, markets were like, this is unsustainable, you cannot go and live recklessly like this with fiscal imbalances.

Beckworth: And as a result, government bond yields shot through the roof. They started going up and then what happened, I believe today or yesterday, is the Bank of England stepped in and started buying up government bonds to bring the yields down. Now why are they doing that? Because as the government bonds go down in value… the yields go up, they go down in value. There's all these pension funds and companies in the UK that are having problems. And so they're trying to prevent a financial crisis. So what's fascinating is the Bank of England is effectively inverting its own yield curve. It's pushing up the short end, short-term rates, trying to lower the long term. So it's intentionally and actively inverting its own yield curve in order to hold off a financial crisis in these pension funds. But at the same time, we know inverted yield curves mean lower net interest income, which can also lead to financial problems.

Beckworth: So it's a big mess over there. But I don't want to spend too much time on that because again, by the time this show comes out, this may all be dated. But Greg Ip, our friend at the Wall Street Journal had an article and I want to speak to that because it touches on this development and the title of his article is, *The Return of Inflation Makes Deficits More Dangerous.* And then first few lines here, “it is tempting to see the market's backlash against the British government's proposed income tax cut as a uniquely British problem. That would be a mistake. The markets are sending a deeper message, it's a more dangerous world for deficits.” So he argues in this piece that deficits do matter, they can have a bearing on inflation. And one of the things he talked about is, look, we're in a different world than we were pre-2020, the amount of government debt's gone up. And then he says that world is over, inflation in many countries is too high and structural forces threaten to keep it there.

Beckworth: So I want to step back from the argument he is making in just ask this question, what really drives trend inflation? What's a good theory for the inflation rate, beyond supply shocks, beyond things that we've seen in the past few years? And if you read his article, he links when he says, structural forces threaten to keep inflation high. I'm like, okay, what are these structural forces? So you click the link and you go to another article by Nick Timiraos and this article's titled, *Jerome Powell’s Dilemma: What if the Drivers of Inflation Are Here to Stay?* And this is where I want to have some fun with you, George, because he lists three things that could cause inflation to stay high. And let's just restate, what is inflation? It's the rate of change, the growth rate in the price level. It's a rate, it's not the level. And I’ll tell you right now, just to kind of cut to the chase, I think there's confusion here between the price level and the growth rate we're going to be touching on.

Selgin: I saw your tweet to that effect.

Beckworth: Yes, and so Nick and Greg, by his endorsement of this, they point to three things. First off, the decline in globalization, trade flows. So maybe that happens, maybe it doesn't. I've read some other accounts that take different forms. But let's just say for the sake of argument, globalization is at a lower level than it was before. That strikes me as a one-time pop on the price level. Would you agree? It shouldn't affect the growth rate of the price level, it should affect maybe the level itself, or could you see globalization affect inflation on a permanent basis?

Identifying the True Drivers of Inflation

Selgin: Well, if it affects the rate of real output, let's say it reduces the rate of real output and I think it could, then one would expect, other things equal, that prices could rise at a higher rate in turn. So it really boils down to whether you think the effect on output is a level effect or a growth rate effect. And I do think you could make a case that certain scenarios of deglobalization would affect the real growth rate, yes.

Beckworth: All right, okay. So I got to step back here and say… it’s possible.

Selgin: And now I'm not saying that it’s an impossibility, but…

Beckworth: It's possible. Okay, so the growth rate is permanently lowered because of this negative globalization show.

Selgin: Imagine that it reduces the value of the world's capital stock, for example. That would-

Beckworth: Okay, I guess then also though it's-

Selgin: Or productivity.

Beckworth: Yeah, the productivity. I guess you could make that argument. Then the next thing though would be then how does the central bank respond to that? I mean, in theory they could permanently offset it too, but that's a different discussion. Okay, let's go into number two, commodity prices. Commodity prices might stay permanently elevated. Now today we actually see commodity prices crashing as central banks are tightening around the world. Can commodity prices permanently raise the inflation rate?

Selgin: Not unless they permanently keep going up.

Beckworth: Yeah, see I think that one's a little bit more clear case that the rate of inflation shouldn't be influenced by commodity prices. It's going to be a price level effect. Okay, let's go to the last one. And this one is probably the most contested one and one that I disagree with. But I think you can make an argument and this is a labor market story. And Nick draws from the August 2020 book, The Great Demographic Reversal by your friend Charles Goodhart and colleague Manoj Pradhan.

Beckworth: And they argue that the low inflation since the 1990s had less to do with central bank policies and more to do with the addition of the hundreds of millions of low wage Asian and Eastern European workers. And now that's going to be reversed with the aging of the planet and such. Now one view is with the aging of the planet, people get more risk averse, they're more cautious. They buy securities, it lowers real rates, lowers R star and that actually can lower inflation. Look to Japan, they've been having this for a decade or so, in Japan we have low inflation. Goodhart argues it could go the other direction. What do you think?

Selgin: Well, so Goodhart is making a supply side argument, which is also an argument about reduced rate of output, reduced growth rates. And like the first argument, it's a possibility, it's certainly a possibility. I am somewhat doubtful that the aging population thing works on a global scale. I think there may be a subtle fallacy of composition going on here. It is true that if you have changes in the demographics, they can change the comparative advantage of different countries and shift your manufacturing and other labor intensive industries elsewhere. It doesn't follow that if everybody's getting older every place, that you're going to have-

Beckworth: Well, that's an interesting point.

Selgin: ... less real growth because… Obviously if you may have a smaller percentage of employed persons, but as long as people have needs, then somebody's going to fulfill them somewhere, as long as there are people who are willing to work. So it could be that we all are living in retirement and very happy, but that would have to be because we've already accumulated a lot of stuff.

Beckworth: There could also be a general equilibrium story too, in the sense that labor supply declines. It makes it more attractive to invest in capital, machines, robots fill in, maybe fill the gap, offset any decline. Okay, for the sake of time, let's move on to your final and third piece. And I believe you're going to speak to the ECB president, Christine Lagarde's recent comments on free banking.

Responding to Christine Lagarde on Free Banking

Selgin: Yeah. I don't remember if she used the term free banking itself, but she certainly was alluding to the US free banking episode when she argued that we need a central bank digital currency because if we rely on private substitutes, then the central banks of the world will lose their nominal anchors, their ability to anchor their monetary systems. And then she made a reference to those terrible private currency issuers of the 19th century. And this is something that your listeners will know gets my hackles up because whenever central bankers and their apologists talk about private currency, inevitably the only thing they seem to know about it, and I mean private circulating money, not deposits. The only example they seem to be aware of or examples are the so-called free banking episodes of the Antebellum United States. And they invariably don't know very much about those.

Whenever central bankers and their apologists talk about private currency, inevitably the only thing they seem to know about it...The only example they seem to be aware of or examples are the so-called free banking episodes of the Antebellum United States. And they invariably don't know very much about those.

Selgin: And the rest of the world might not have had a 19th century as far as their understanding of the history of private currency is concerned. And this is a ridiculously blinkered perspective. More than anything else, it simply demonstrates that you can be a central banker and not know very much monetary history. That's the main thing it demonstrates. But let's step back a bit, I want to say something about this anchoring thing. Of course, private currencies, for the most part with the exceptions of would be currencies like Bitcoin, but for the most part, private currencies have been private IOUs like bank deposits and early on redeemable bank notes. They've been claims to some fundamental money, they've been redeemable IOUs. So they're anchored by the scarcity of that fundamental money. That's true. In the past though, in the 19th century, the anchor was gold or silver for the most part.

Selgin: It was the fact that there was only so much gold and silver money in the world and a bank had to have a certain amount of it or it would default, it would fail because to not pay gold or silver usually meant failure for a commercial bank. So the anchor was gold and silver. The idea that central banks were anchoring things back then is absurd. It's absurd. In fact, central banks tended to loosen the anchor as it were because unlike ordinary commercial banks, because of their special privileges and relations with governments, they, over time, discovered that they could suspend payment of their IOUs with impunity, which ordinary commercial banks couldn't. And the history of the changeover over time, from gold and silver monies to fiat money basically was a history of central banks reneging on their promises, that is weighing anchor to gold. Angela Redish has a very good article about this called *Anchors Aweigh.*

Selgin: But inevitably, the transition is from a pluralistic or multi-bank redeemable currency system, the currencies are redeemable in gold and silver to one where central bank dominates and its IOUs tend to be treated as approximate reserves by the other banks to the next stage where that central bank suspends payments. And the next thing you know you've got fiat money. That's a kind of rough outline of the history of how we got to where we are today. So there's no anchoring going on in that history by central banks. It's the central banks are weighing anchor. So I wanted to get that off my chest. This isn't an argument for returning to the gold standard, of returning to a silver standard. It isn't saying that today our monetary systems aren't anchored by the scarcity of fiat money, but that's just a matter of the central banks not creating too much of this stuff. That's what they have to do to anchor it.

Selgin: And of course they don't do a very good job all the time, as is clear right now. The Federal Reserve is not doing a good job anchoring the dollar. The Great Britain isn't doing a very good job anchoring the pound and so on and so forth. And there of course many worse examples. So it takes a certain amount of brass gall for the head of the ECB, for example, to be talking about how important it is for central banks to maintain and to anchor their monetary system in today's circumstances, let alone in the 19th century where more often than not they were responsible for weighing anchor. The other thing Lagarde said was that somehow if central banks don't issue central bank digital currencies, but let the private markets apply alternatives like stablecoins and, as I've argued before, you can have safe stablecoins if central bankers allow it, that somehow not issuing that particular form of central bank retail liability would also undo the anchor that central banks supposedly supply.

I really want to emphasize the point for your listeners that when you hear some expert talking about private currency and alluding to the US free banking experience, you are listening to somebody who doesn't know very much about the history of private currencies.

Selgin: And that's absolute nonsense. It suffices for the central banks to limit the supply of reserve media to anchor their fiat monetary systems. They could allow any number of substitutes to be issued. Any kinds of substitutes that are redeemable substitutes, redeemable claims to reserve money as long as the banks are constantly redeeming, as long as the issuers of private money are redeeming one another's IOUs actively, through the clearing system. That's going to tie down the supply of those IOUs, provided of course that the supply of the reserve medium itself is limited. It's when that isn't limited that you have no anchor. So pretty much everything I heard in that speech seemed wrong to me. But I really want to emphasize the point for your listeners that when you hear some expert talking about private currency and alluding to the US free banking experience, you are listening to somebody who doesn't know very much about the history of private currencies.

Selgin: Let them bring up the Scottish case, Scottish banking or the Canadian banking system or any number of other examples before they talk about just how bad or good private paper currencies were in the past or else they should keep quiet because cherry picking the worst examples and not recognizing how regulations affected those, because the worst free banking cases in the United States were bad because of regulation, not because of the lack of it, is just cheating. if I were giving a talk about how dangerous central banks are and I just talked about Weimar Germany... Anybody can do that, but is it really fair? We need to look at the big picture and to see what the overall record is. That's not asking too much.

Selgin: And yet, as I said, most central bankers and a lot of their apologists, people like Paul Krugman and Gary Gorton, when they talk about private currency, they cherry pick the worst episodes and ignore everything else. Oh, one last thing, she also said something about how under private currency in the United States, I think she was alluding to the United States, we had crisis after crisis after crisis in the 19th century. The history of crises in the United States before the Fed is a history of stupid government regulations, first on state banks and then on the national banks, created during and after the Civil War and how those unwise regulations created instability. All good monetary historians are aware of this and anybody who claims that this was the free market going crazy in money and banking doesn't know their monetary history or knows it, but isn't saying the truth.

Beckworth: Okay. Well with that, our time is up. George, thank you again for coming on our show and safe travel as you head to Europe.

Selgin: Thanks a lot, David. I look forward to our Spanish episode.

Beckworth: Okay.