Stop Making Sense

Narayana Kocherlakota has a new post entitled, “Trump Starts Making Economic Sense”:

About a month ago, I urged the presidential candidates to explain what policies and leadership they would like to see at the Federal Reserve. So I was glad to see Trump address Fed-related issues in an interview with Fortune magazine last week.

His key comments: “We have to rebuild the infrastructure of our country. We have to rebuild our military, which is being decimated by bad decisions. We have to do a lot of things. We have to reduce our debt, and the best thing we have going now is that interest rates are so low that lots of good things can be done that aren’t being done, amazingly.”

I read this as calling for two forms of fiscal stimulus.

That’s funny, I read the statement “we have to reduce our debt” as calling for austerity. Of course the second half of that sentence is a call for fiscal stimulus.  I attribute the contradiction to either:

1.  Trump having an IQ in the 80 to 85 range, or . . .

2.  Trump being a shameless demagogue.

I would also point out that Mr. Trump was actually discussing fiscal policy, not monetary policy.  That’s a distinction I worked really hard making in my economics classes, back when I taught at Bentley.

Kocherlakota continues:

Another question is whether Trump would be comfortable with the Fed pursuing an inflation target higher than 2 percent (such as the 4 percent target suggested by Professor Larry Ball of Johns Hopkins University). This has been advocated as a way to give the central bank more ammunition to fight future recessions (by generating higher nominal interest rates, it would provide more space to lower them before hitting zero). But it would also give the Fed more room to support fiscal stimulus of the kind suggested by Trump.

I’m not quite sure what Kocherlakota is trying to say here.  The whole point of raising the inflation target to 4% is so that you don’t have to use fiscal stimulus in the first place, not as a way of “supporting” fiscal stimulus.

Undoubtedly all these things that make no sense to me are perfectly clear in the mind of The Donald.  Recall that Trump will pay off the national debt in 8 years, a “making sense” proposal that Kocherlakota does not comment on.  Nor does he comment on the fact that Trump will achieve this miracle by shielding entitlements from cuts, sharply boosting spending on the military and infrastructure and reducing the top tax rate to 25% percent (all while raising taxes on “the rich”) and eliminating taxes entirely on 75 million Americans.  What’s the secret sauce that will make this all possible?


PS.  People have offered three explanations for the rise of Trump, struggling blue-collar workers, trade and immigration.  All three are false.  The Economist reports that Trump voters are skewed toward the over $100,000 group.  A new poll shows surging support for the claim that immigrants help the country.  And other polls show surging support for the view that trade is an opportunity, not a problem.

Sorry Pat Buchanan, the rise of Trump is not about your issues—it’s not about Making America Great Again.  He’ll drop your issues the day he takes office.  It’s about Making Donald Trump Great Again.

PPS.  People think I’m exaggerating when I compare Trump talk to a baby’s “ga ga” talk.  I’m dead serious.  Read this sentence 100 times in a row, until you have it figured out:

We have to reduce our debt, and the best thing we have going now is that interest rates are so low that lots of good things can be done that aren’t being done, amazingly.

Yes, reducing the debt by borrowing more would be amazing.  

Trump says:

I know words, I have the best words

Yes, Trump has some excellent words.  But he does not yet have sentences with meaning.  He needs to work on that before becoming President.  Not just words, words that are grouped together to produce meaning.

Just once, I’d like to hear Trump say:

I am familiar with many terms, I possess a quite sophisticated vocabulary.

Case closed

Last week, I pointed to a Financial Times headline that suggested the yen was falling on rumors of a cut in the interest rate on reserves (which is already negative):

In the long run, you want to rely on a worldview that allows you to make sense out of the myriad news events that are reported each day.  I believe that framework is market monetarism.  Let’s take an example, a headline from today’s FT:

Yen dives on talk of negative rates on loans

If you relied on the mainstream media, that headline would make no sense.  “Wait, weren’t we told on Twitter that Sumner was foolishly attached to the notion that negative IOR was expansionary, despite all indications to the contrary?  If so, how are we to understand this headline?”  On the other hand if you relied on market monetarism, there would be no cognitive dissonance to deal with.  It would all make perfect sense.

Tuesday, Tyler pointed to another FT story, this time claiming the exact opposite:

Ten weeks after BoJ governor Haruhiko Kuroda startled both financial markets and parliamentarians with Nirp, the yen has appreciated by some 8 per cent against the dollar. The stock market has rebounded sharply this month, however the Topix bank index remains 11 per cent lower since the advent of Nirp.

Under such a policy, risk assets were supposed to rise, but instead demand for Japanese government bonds rallied, rewarding the risk averse. Meanwhile, even finance ministry officials concede that the deflationary mindset is more entrenched than ever. There is agreement that Nirp has backfired and such an unsustainable monetary policy cannot support growth, let alone help financial asset prices.

Who to believe, the FT, or the FT?  Answer, the FT.  Today’s Financial Times provides the results of about as dramatic an event study as you could ever want:

Yen surges and stocks hit as BoJ stands pat

So much for the theory that negative IOR is contractionary.  And the concurrent fall in global stock markets puts another nail in the theory of “currency wars” and “beggar-thy-neighbor”.  The failure of the BOJ to devalue the yen is going to hurt the US and European economies.

Why so much confusion?  Because people forget that while a lower policy rate is expansionary on any given day, low rates are also an indication that money has been too tight.  This paradox is resolved if we make the (quite plausible) assumption that when the Wicksellian natural rate is falling, the policy rate usually tends to fall more slowly, making policy effectively tighter (as in 2008).  And when the Wicksellian rate is rising, the policy rate usually tends to rise more slowly, making policy effectively looser (as in the 1970s.)

It doesn’t take a genius to understand that you evaluate a policy’s effect by looking at the immediate market reaction, not market moves in the following weeks, which could be caused by 101 factors.  Oh wait, I guess it does take a genius.

Here’s a graph showing the fall in the yen last week on rumors of a rate cut, and the more than 3% gain today on the market disappointment at the BOJ’s inaction:

Screen Shot 2016-04-28 at 8.53.33 AMA few weeks ago, I did a post suggesting that the BOJ appears to be giving up on its 2% inflation target.  I suggested that this meeting would give us an answer:

What should Japan do?  I suppose they should do whatever they want to do.  It doesn’t make much sense to target inflation at 2% if you don’t want to target inflation at 2%.

The more interesting question is what should they want to do?  I’d say NGDPLT. But they seem to have other ideas.

Either way, we should have an answer by the end of the month.

Today we got the answer.  The FT also reports the following:

The BoJ also changed its guess of when inflation will reach 2 per cent from the “first half of fiscal 2017” to “fiscal 2017”. Any further delay would mean admitting Mr Kuroda will not reach the target during his term in office.

The whole point is to not adjust the forecast, but rather to adjust the policy instruments.  A very disappointing performance by Mr. Kuroda.  That’s not to say it couldn’t be worse, he has gotten Japan out of its nearly two-decade bout of deflation. But he’ll need to be far more aggressive at the July meeting if he doesn’t want to lose all credibility.  As it is, the BOJ lost a significant amount of credibility today.  Here’s Bloomberg:

A majority of economists surveyed by Bloomberg had predicted some action to counter a strengthening yen that had cast a shadow over the outlook for wage gains and investment spending. The explosion of volatility shows how investors have singled out central banks as the key driver for global financial markets.  .   .   .

“It’s the central banks that still set the course,” said Jan Von Gerich, chief strategist at Nordea Bank AB in Helsinki. “Even slight deviations from what people are expecting are enough to trigger market moves.” .   .   .

“The BOJ had an opportunity to at least temporarily short-circuit the yen trend but failed to act,” said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. “It has provided the green light for further yen strength in the near-term.”

2 questions for IT fans

This post is aimed at economists who know more about formal monetary models than I do.  I am interested in why so many economists seem to favor inflation targeting, whereas price level targeting seems preferable to me.  I am especially interested in whether the models used to compare these two policy regimes incorporate pertinent facts about the real world.

Models often contain “shocks”, which temporarily throw the economy off course.  One question I have is:

1.  Does the size of shocks in these models depend on the type of monetary regime?

Let me explain with an example.  We are back in June 2008, about to be hit by a severe banking crisis.  In my view the severity of the banking crisis depends to a great extent on whether the central bank is doing growth rate or level targeting.  Under level targeting, investors will expect the economy to bounce back strongly after any severe crisis, and hence asset prices will not fall anywhere near as sharply in the short run.  And with asset prices being more stable, the financial crisis (i.e. the “shock”) will be much milder.

Under level targeting of prices, investors would have expected the price level (PCE) to be about 22% higher in the 10 years after June 2008.  We are now almost 8 years past June 2008, and the price level has rising by 8%.  It looks like it will be about 11% or 12% higher after 10 years, not the 22% expected under level targeting.  Thus under level targeting, investors would have expected a far more expansionary monetary policy over the past 8 years.  That would have made the 2008 financial crisis much milder.  For a recent example of the role of expectations, look at how Brazilian asset prices have been recovering under expectations of impeachment.  Brazil is a mess, but investors are already looking beyond the current inept government.

2.  Is the governing board of the central bank (in these models) split between hawks and doves under inflation targeting, under price level growth rate targeting, or under both?

There is only one correct answer.  Under IT, central banks are split between hawks and doves, and under price level targeting they are not.  Indeed under level targeting the terms “hawk” and “dove” have no meaning.  The only difference is the aggressiveness in which they want to return to the trend line.

Because there is no hawk/dove split under price level targeting, markets have less uncertainty about where the price level will be in the future.  In contrast, under IT you may have some people viewing 2% inflation as a target, and others viewing it as a ceiling.  Or they may differ in terms of whether they’d rather risk erring on the side of too much inflation, or too little.  In contrast, under price level targeting the long run inflation rate is essentially identical regardless of whether the central bank views the target as symmetrical or as a ceiling.

To summarize, I’m asking those who know the literature on IT whether existing models take relevant real world considerations into account.  If not, perhaps someone should create more realistic models.

Masterpieces at bargain prices

I’ve always been interested in the visual arts, especially painting, film and architecture.  For some reason, painting has much more prestige than the other two.  Many film masterpieces from the first half of the 20th century are lost forever, as no one spent the small amount of money necessary to preserve them.  Buildings such as the Imperial Hotel in Tokyo were torn down and replaced, despite being widely recognized as masterpieces.

A relatively high income professional (doctor, business executive, etc.) cannot afford to buy even a mediocre painting by a famous painter from the 1890s, but can easily afford to buy and live in an architectural masterpiece.  I recently ran across a good example, as Frank Lloyd Wright’s excellent Winslow House from 1893 recently saw a price cut to $1.375 million, a price that would not bat an eye in my home town of Newton, MA, even if it were an ugly colonial.  And let’s not even talk about LA.
Screen Shot 2016-04-24 at 5.49.54 PMAt first I thought the low price might reflect a run down interior, which was out of step with the times.  Wright’s buildings often deteriorated over time, due to poor quality construction.  But a slideshow over at Huffington Post shows a beautiful interior, with a nice updated kitchen.  (It’s worth checking out).

Part of the low price reflects the fact that Chicago suburbs are cheaper than Boston suburbs.  And yet, there are obviously lots of affluent people in the Chicago area, and many fans of Wright’s architecture.  The house has been on the market for years, with no takers.  Why don’t I buy it?  I could never convince my wife to move to Chicago.  But if you already live in Chicago, that’s not a valid excuse.

PS.  I wrote this a few days ago, but it looks like a sale is now pending.  The house is over 5000 sq. feet.Screen Shot 2016-04-24 at 6.10.11 PM

Does debt slow growth?

Maybe, but I’m not too clear on exactly how.  Here’s the Financial Times:

Others believe the People’s Bank of China will retain its ability to ward off crisis. By flooding the banking system with cash, the PBoC can ensure that banks remain liquid, even if non-performing loans rise sharply. The greater risk from excess debt, they argue, is the Japan scenario: a “lost decade” of slow growth and deflation.

Michael Pettis, professor at Peking University’s Guanghua School of Management, says rising debt inflicts “financial distress costs” on borrowers, which lead to reduced growth long before actual default.

“It is wrong to assume that ‘too much debt’ is bad only if it causes a crisis, and this is a typical assumption made by almost every economist,” Prof Pettis wrote in a draft of an forthcoming paper shared with the Financial Times.

“The most obvious example is Japan after 1990. It had too much debt, all of which was domestic, and as a consequence its growth collapsed.”

Distress costs include increased labour churn as employees migrate to financially stronger companies; higher financing costs to compensate for increased default risk; demands for immediate payment from jittery suppliers; and loss of customers who worry a company may not survive to provide aftersales service.

Many are now concerned that China’s debt could lead to a so-called balance-sheet recession — a term coined by Richard Koo of Nomura to describe Japan’s stagnation in the 1990s and 2000s. When corporate debt reaches very high levels, he observed, conventional monetary policy loses its effectiveness because companies focus on paying down debt and refuse to borrow even at rock-bottom interest rates.

The final paragraph discusses the ineffectiveness of monetary policy.  Obviously I don’t agree with that; monetary policy is always and everywhere highly effective. So if the mechanism is supposed to be “less AD”, then I’d say debt is nothing to worry about.

The preceding paragraph discusses some possible supply-side mechanisms, but they don’t seem powerful enough to have large macroeconomic effects.  I suspect that Japan’s slow growth has been a mixture of tight money (low NGDP growth), low population growth, and low productivity growth.  Only the productivity growth could be plausibly linked to debt, and even there the connection is tenuous.

The article also has a graph putting China’s debt in perspective, total debt as a share of GDP:

Screen Shot 2016-04-24 at 9.13.03 AMNotice that China’s debt ratio is almost identical to the US.  But the FT also mentions two reasons to worry:

1.  Their debt ratio is quite high for a developing country.

2.  Their debt ratio is increasing rapidly.

I’m not too worried about the first point, as China is a very unusual developing country. But the second point does seem like a cause for concern.  Will the economy be able to shift away from high levels of debt formation, without triggering a recession?  I honestly have no idea.  My best guess is that China will have a financial crisis and recession at some point in the next 20 years, but I have no idea when.

As always, NGDPLT would make the debt crisis (if it does occur) much less severe.

PS.  Note that China bears have been concerned about debt for many years now, and so far their predictions have not proved accurate.

PPS.  Here’s the debt breakdown by sector:

Screen Shot 2016-04-24 at 9.31.08 AM

PPPS.  Over at Econlog I have a new post, explaining what would make me doubt the truth of market monetarism.