Futures targeting at the ECB

Geoff Orwell sent me the following:

The idea that monetary policy could use derivative markets to pursue its objectives has appeared in the literature 3) but has very seldom found application. The need to find new tools for the intractable problem of unanchored inflationary expectations could now provide the incentive to test the idea in practice.

The basic idea is that the European Central Bank could offer an option in which it would pay to counterparties in the contract a certain amount of money if the inflation rate was, over a certain period, lower than a certain level, constituting the strike price of the option. Alternatively, or may be in addition, the European Central Bank could intervene in the inflation swap market, offering a fixed rate of inflation against a floating inflation.

Purchasers of the option or counterparties in the swap would make money if the rate of inflation was lower than, say, the ECB objective of 2.00 per cent over a certain period, corresponding to the “medium term” in the inflation objective. This should raise inflation prospects through a number of channels.

In the financial market, the higher inflationary expectations, coupled with cash purchases of securities under QE (or EAPP – Extended Asset Purchase Program as the ECB calls it), would lower the real rate of interest, thus favouring investment. The entry of a big seller of protection against deflation could not only change the expected value of future inflation, but also shift its entire distribution, reversing the unwelcome tendency presented in Chart 1. As a result, the probability of an extended period of deflation – as perceived by market participants – would fall, improving general sentiment and lifting “animal spirits.” In the product market, incentives to postpone purchases for consumption waiting for lower prices would be offset, since consumers could purchase the protection offered by the European Central Bank against too low inflation, thus compensating for the possibility of lower prices. In the labour market, firms could offer higher wages since they would be compensated, if inflation was too low, by the protection offered by the option or the inflation swaps entered with the ECB. Symmetrically workers would demand higher salaries (or would not accept lower salaries): in a way, it would be as if the Phillips curve had shifted up and to the right. Overall there should be a positive effect from a tool that is directly aimed at the problem: too low inflation.

There would also be “political” advantages, since the use of this tool would raise no question of a possible confusion between fiscal and monetary policy, which is indeed an issue, as there would be no obvious link between action in the derivative market and the funding of government deficits. This should be welcome to the ECB hawks, who could see the reliance of the ECB on QE being reduced. . . .

This post was written jointly by Juliusz Jabłecki, head of monetary policy analysis team at the National Bank of Poland (here in personal capacity) and Francesco Papadia. Madalina Norocea provided research assistance.

This is similar to the NGDP futures targeting concept.  Of course we are a long way from actually implementing this sort of plan, but it’s good to finally see central bank officials talking about the idea.  When I proposed negative IOR in early 2009, that also seemed like a crackpot idea.  And speaking of negative IOR, here’s the latest from Benn Steil and Emma Smith (at the Council on Foreign Relations):

Back in 2013, we showed that the ECB’s monetary transmission mechanism had broken down in the crisis-hit periphery countries.  ECB rate cuts were not being passed on to rate cuts on new loans to businesses.

For all the bad news that has come out of Europe since then, it is noteworthy that this mechanism has now been restored in most periphery countries.  In fact, the link between ECB rates and the rates banks charge on new business loans is now, on average, stronger in the periphery than in the core—as can be seen in the graphic above.  (We use the overnight interbank rate as a substitute for the ECB’s policy rate, as it captures both the ECB’s policy rate and the effects of its QE and lending to banks.)

The turning point was the ECB’s June 2014 announcement of a negative deposit rate and cheap long-term loans to banks—known as targeted long-term refinancing operations, or TLTROs. This is because these new measures have disproportionately benefited periphery banks.

Ezra Klein on Trump and the media

Here’s Ezra Klein on the recent debate:

Here is the conventional wisdom about last night’s presidential debate, as I understand it. Hillary Clinton won in a rout, but that’s largely because Donald Trump flagged after an excellent first 30 minutes in which he hammered away at his strongest issue: trade.

“Donald Trump won the first 25 minutes of the first presidential debate,” writes Ross Douthat at the New York Times, in a representative piece. “He was too bullying and shout-y, too prone to interrupt, but he seized on an issue, trade, where Hillary Clinton was awkward and defensive, and he hammered away at his strongest campaign theme: linking his opponent to every establishment failure and disappointment, and trying to make her experience a liability rather than a strength.”

His colleague, Maggie Haberman, made much the same point. “Trump has a strong case to make on trade, when he makes it,” she tweeted. “He made it once and then chased shiny objects for most of the debate.”

Of course, I said the same thing yesterday.  I can’t even imagine what Douthat and Haberman were thinking, as Trump’s comments on trade were shockingly ignorant and nonsensical. He made a complete fool of himself.  Over at Econlog I pointed out that he seems to be getting advice on trade from an economist who doesn’t even know the basics.  Klein has an interesting explanation:

There’s a deep tension in the way the media judges presidential debates. On the one hand, we know that our coverage affects the public’s ultimate view of the event — in that way, we are key participants in the debate, not merely observers of it.

But that knowledge is uncomfortable. It’s not the role we are meant to play. The press wants to reflect reality, not shape it.

And so we attempt, peculiarly, to recast ourselves as observers of voter reactions we can’t observe. We judge the debate based not on what we think to be true about it but on what we think the public will think to be true about it. And so we end up asking not whether the candidates made good arguments given what we know to be true but whether they made good arguments given what we imagine voters know to be true. And once you’re in that mindset, a section where Trump sounded good can be a win even if nothing he said made sense — after all, fairly few voters are trade policy or labor market experts.

But the public isn’t relying on us to tell them what we thought they thought watching the debate. They’re relying on us to tell them what we found when we compared the candidates’ answers to reality, and to the best analysis on offer from experts, so they can make a better-informed judgment on what actually happened in the debate. And sometimes there’s a very big gap between how good a candidate’s answers sounded and how good his or her answers actually were.

That’s the case for Trump’s opening section last night. He was speaking on the issues where he’s supposed to be strongest — his whole pitch is he’s a businessman who knows how the economy really works and what is really needed to fix it — and he showed he didn’t have any real idea what he was talking about. Voters deserve to know that.

Here’s the great irony; the media is almost universally biased against Trump (excluding Fox News.)  And that’s because media people can recognize a demagogue.  But despite this bias, they are actually helping Trump by trying to be “evenhanded”, to direct equal amounts of criticism both ways. They don’t seem willing to come right out and say that the things Trump says are idiotic, and that his advisors are incompetent people who don’t know their subject.  Instead they praise his strong “performance” in the first 30 minutes.

PS.  Notice that my posts on Trump, which are admittedly very poorly done, are actually doing the job that Klein says the press should be doing, but isn’t. I’m telling people that the content of Trump’s remarks are idiotic.  I wish the press would do its job, so I could get back to monetary policy.

HT:  Last Men and Overmen, who has the following to say:

So you have several levels. One the most basic, the media is ignorant of economics. Sumner gets to the deeper level: the media cares only about style. But Klein brings it home: the reason the media cares more about style is they are in denial that they shape the news, they aren’t just pure observers of it.

The classic case of this was 2000 where most voters thought Gore won the first debate with Bush, the media reaction focused on Gore’s alleged sighs. The polls ultimately went W’s way.

Update:  I strongly recommend this piece from the FT, which could be enjoyed equally by Trump fans or foes.  It shows how the mood in Britain has shifted in a Trump-like direction, as it has elsewhere in the developed world.  And yet Trump isn’t even mentioned.

China is rebuilding America

Here’s the Los Angeles Times:

Winston Yan stood atop the largest real estate project of its kind in downtown Los Angeles, a monstrous patchwork of glass and concrete next to the 110 Freeway, and marveled at the bustle of workers, construction vehicles and cranes 38 stories below.

The scope of development in this mixed-use project, called Metropolis, is unprecedented for L.A. but quite familiar to Yan. As an architect and executive for Chinese real estate giant Greenland, he’s witnessed firsthand China’s dramatic urbanization in recent decades.

“It reminds me of what’s happening in Beijing and Shanghai,” said Yan, chief technical officer for Greenland’s U.S. subsidiary. “Now it’s happening here.” . . .

Chinese developers such as Greenland, Oceanwide and Shenzhen Hazens are pouring billions into the neighborhood, adding thousands of new residential units in soaring skyscrapers that will fundamentally change the city’s skyline. Since 2014, Chinese developers have been involved in at least seven of 18 land deals downtown in excess of $19 million, according to real estate firm Transwestern.

“When all these megaprojects are finished, they’re going to have to reshoot the postcard picture of downtown L.A.,” said Mark Tarczynski, executive vice president for Colliers International’s L.A. office.

This is the flip side of America’s CA deficit with China.  When countries like China runs a CA surplus, their domestic saving exceeds their domestic investment.  This excess saving flows overseas to finance investment projects in countries like America and Australia, where saving falls short of investment.  Hence Chinese money is rebuilding America.

As you might expect, Trump is horribly confused on this point.  Here’s Matt Yglesias, discussing the recent debate:

  • He also said the Chinese “are using our country as a piggy bank to rebuild China,” which isn’t even how piggy banks work, much less the US-Chinese economic relationship.

Trump has it exactly backwards.  Over at Econlog, I discuss the economist who has been feeding Trump this sort of misinformation about basic economic identities.  Yglesias also points to lots of Trump lies.  The phony stats are perhaps to be expected, but the bald faced denials of saying things that he actually did say, sets a new (low) bar for American politics:

  • “Donald thinks that climate change is a hoax perpetrated by the Chinese,” Clinton said. He protested. “I did not. I do not say that.” But it turns out he did.

  • “You even at one time suggested that you would try to negotiate down the national debt of the United States,” Clinton charged, to which Trump flatly replied, “Wrong.” But it turns out he did.

I actually recall him saying the second point, just a few months ago.  As with his public support for the Iraq War, truth means absolutely nothing to Trump.  In fairness, Clinton is also somewhat dishonest–Trump nailed her on the TPP.

As for Trump’s bizarre conspiracy theories on all sort of issues, I don’t even know what to say. (Chinese hoax?  Seriously?)  This sort of mental illness in a normal person might be viewed as amusing.  When the man with his finger on the nuclear triggers suffers from bizarre irrational delusions that foreign countries are trying to hurt us  . . . well that can’t be good, can it?

PS.  It’s kind of sad that wealthy Americans cannot seem to put aside the savings required to finance our investment spending, and instead we need to rely on the savings of poor Chinese.

PPS.  I didn’t watch the debate, because I find them unwatchable (and not just this one.)  Let me give you an example.  The press thought Trump did a mediocre job, but most agree that he was pretty strong during the first 15 minutes or so.  But if you look at the transcript, his first 15 minutes were just appalling, one lie after another, one inane statement about trade after another.  The piggy bank quote above.  The claim that Mexico’s VAT is a trade barrier, etc., etc.  Almost nothing he said was true, almost everything showed a complete lack of understanding of basic economics.  And this is what the press considers a “strong” performance.  It’s clear to me that the press is either too dumb to understand content, or cares only about style when making these judgments.  And maybe style is all that matters.  But in that case, why waste 90 minutes watching a debate?  There are much more entertaining ways to pass one’s time, like watching paint dry.

PPPS.  This caught my eye:

The Conference Board says that its consumer confidence index rose to 104.1, up from 101.8 in August. It was the strongest reading since the index stood at 105.6 in August 2007, four months before the beginning of the Great Recession of 2007-2009.

Not bad, for a country where “some great economists” think the unemployment rate is as high as 42%.

Seriously, we really need to stop talking like the US economy is still in “recession” and needs “stimulus”.  We do need a new monetary policy regime, but not because the current unemployment rate is too high.  We need a STABLE monetary regime. And supply-side policy reform (which neither candidate is advocating.)

Was the so-called “monetarist experiment” ever tried?

Jim Glass left this response to my (italicized) claim:

1. The Fed said it would start targeting the money supply, but it did not do so …. 1979-82 told us essentially nothing about the long run effect of money supply targeting. It wasn’t even tried.

I don’t understand you here. Certainly money supply targeting wasn’t tried over a long run, so one can’t see any long-run effect of it. But why do you say money supply targeting wasn’t adopted at all?

Volcker in his 1992 memoir “Changing Fortunes” explained why the Fed in 1981 had to change policy to money supply targeting from interest rate targeting, and went into considerable detail about the political resistance from the Reagan Administration that he had to overcome to do it, and the political ploys he used to do so. I don’t see why he’d make up such a detailed story about something that never happened.

Plus, looking at the M1 numbers for the period from Fred, one sees that after rising steadily pretty much from beginning of time, M1 peaked at $429 billion on 4/20/81, three months before the start of the recession, then went down a little bit, then bounced down a tiny tad and back up again repeatedly to hit pretty much exactly $429b again on 7/6, 8/10, and 10/12 thru 10/26 without ever going at all over $429b (or going below $423b). So on the dates three months before the recession started and then three months after it started, M1 was $429b, exactly unchanged. If the money supply wasn’t being targeted during that period, all those $429b numbers are a heck of a coincidence.

It’s certainly possible that the Fed was paying more attention to M1 than before.  I agree with that claim.  But there can be no dispute that they did not adopt Friedman’s proposal of a steady 4% growth rate in the money supply.  Indeed money growth actually became much less stable during 1979-82, which shows that Volcker moved policy even further away from Friedman’s ideal.  Now of course in a different sense you could say monetarism was adopted, as he used a tight money policy to control inflation.  That policy was a success.

But a money growth rule?  It’s never even been tried.  (And I hope it never will be tried, as it’s probably a lousy idea.)


Trump would raise taxes on struggling middle class families, so that billionaire real estate developers could get a massive tax cut.

Dylan Matthews has a great new post showing that Trump’s new tax plan would devastate the sort of Americans who have been struggling hardest with the new economy:

Batchelder provides several examples of families that would see their taxes go up under Trump’s plan. The biggest hikes number in the thousands of dollars, and are concentrated among single parents:

  • A single parent with $75,000 in earnings, two children in school, and no child care costs (because the kids are in school) would pay $2,440 more.
  • A single parent with $50,000 in earnings, three children in school, and child care costs of less than $6,000 would pay $1,188 more.
  • A married couple with $50,000 in earnings, two kids in school, and no child care costs would pay $150 more because of the bottom bracket’s increase from 10 to 12 percent.

Batchelder helpfully summarizes this in two tables, one for single parents:

Table: Single parent families facing tax increases under Trump

What will Trump do with this money that he takes from our struggling middle class? Slash income taxes from 40% to 15%, for (non-corporation) billionaire real estate developers like, well . . . like Trump himself.  Here’s Binyamin Appelbaum:

Mr. Trump proposed last year to sharply reduce the corporate rate to 15 percent, from 35 percent, and to apply the same rate to passthrough income. Democrats sharply criticized that proposal as a giveaway to the owners of passthrough businesses, a group that includes many real estate developers like Mr. Trump, because they would not need to pay a second round of taxes on dividends. The Tax Foundation says it would cost the government about $1 trillion over 10 years.

You should read the entire piece, it’s probably the most hilarious news article I’ve read in years.  (And Appelbaum is a deeply serious reporter.)

The Trump people aren’t even pretending that any of this is serious.  They basically admit to the reporters that it’s all a lie. I’m beginning to feel sorry for Larry Kudlow, he has no idea what he’s hitched his wagon to.

If the Clinton campaign were smart (which I increasingly doubt), then between now and election day they do nothing but run commercials of real people, showing how much their taxes would go up under Trump’s plan.  His tax people are so incompetent they don’t even know how to lie properly. They just handed her a juicy issue, on a silver platter.  Now watch her flub it.

This caught my eye:

The easiest short sales I’ve ever had in my life were the stocks and bonds of Donald J. Trump’s companies. … It was like numerous ocean liners hitting many icebergs repeatedly.  —   Jim Chanos, Kynikos Associates

Like his business career, a Trump presidency will be very good for Trump himself, and very bad for the companies country he runs.