Recent discussion of monetary policy

Commenter SDOO sent me the following:

Kocherlakota quoted you on Twitter re: Fed, ECB, BoE and BOJ getting together next week.

That’s quite an honor.  Stephen Kirchner sent me a couple of FT articles.  The first contains some extremely interesting information on the zero lower bound, which is looking less and less like a lower bound:

But the Bank of Japan’s set-up for negative rates, which apparently follows the Swiss National Bank’s, casts doubt on the premise that the nominal cost of holding cash is zero. As we have explained, if a private Japanese bank wishes to exchange its central bank reserves for cash, the BoJ will adjust the portion of its reserves to which negative rates apply by the same amount. That means any extra cash that a bank wishes to hold will cost it as much as if it kept it on deposit at the central bank.

But what really matters is what the public wants to do. JP Koning nicely explains the “hot potato effect” of pushing central bank reserve rates below zero: banks will bid down rates on other assets in the financial system as they try to swap reserves for cash. Ultimately, they will be forced to lower rates on deposits below zero as well, so that customers will have to pay to keep their money on deposit. This is where the liquidity trap is really supposed to snap shut: will there not be a run for cash as depositors refuse to pay banks to hold their money?

But consider two things. First, it is not as if depositors as a class actually have a legal right to convert all their money to cash as it is. You cannot present a debit card at the Bank of England and demand cash. Indeed, even your own bank limits how much cash you can withdraw, as Frances Coppola has pointed out. Just read the fine print of your account terms of service.

And how could private banks honour mass withdrawals of cash even if they wanted to? No law provides for the central bank to swap client deposits for cash; only central bank reserves. And despite the huge growth of reserves in recent years, these still amount to only a fraction (about one-fifth in the UK) of bank deposits. So, to honour customers’ demands, banks would have to borrow more reserves from the central bank, which could impose terms as onerous as it wished. Onerous enough that banks would try to pass the cost on to customers. As my colleague Richard Milne argues in an analysis of Danske Bank’s success — its market value now exceeds that of Deutsche Bank — Danske is thriving because it has adapted to Denmark’s negative rates, in part by indeed passing them on to customers.

Second, the BoJ’s and SNB’s set-ups to neutralise banks’ incentive to hold cash instead of reserves can be exactly duplicated by the banks themselves vis-à-vis their customers. You want to take cash out of your account? Be our guest, but we will keep track of your total balance of net cash withdrawn and charge you the same interest on that balance as we charge on your deposits. This can be implemented through one of the regular “updated terms and conditions” that our banks seem to impose on us unilaterally every so often.

Read the whole thing.  This article (by Martin Sandbu) confirms my claim back in 2009 that the central bank could impose negative IOR on vault cash, but it also provides lots of options that I never contemplated.  More evidence that central banks never really tried very hard, which is obvious now that the Fed is no longer at the zero bound (and should have been obvious during 2008-12 when the ECB was above the zero bound.)

The second FT article is an odd one, with some good stuff:

December 16 2015 may go down as the date of one of the most monumental policy errors in history. The financial markets were nervously anticipating that the US Federal Reserve would raise the interest rate for the first time in nearly a decade — but few grasped the inadequacy of the data driving the decision.

The Fed had never before initiated a tightening cycle when the manufacturing sector was shrinking. . . .

The bond market, meanwhile, sees no shades of grey in the data; it is shifting rapidly from pricing in one rate hike this year towards pricing in the possibility of the next move being a rate cut, all but ridiculing the Fed’s insistence that four rate hikes would come to pass in 2016.

Tellingly, Fed officials are softening their tone on the number of times the rate might rise this year. “Don’t fight the Fed” — the idea that markets ultimately benefit from the Fed’s decisions — has become a cliché. The truth is the Fed has never dared fight the markets.

There’s that term ‘dare’ again, which Tyler Cowen mentioned a few weeks back (and I quoted in a recent post.) Unfortunately this generally good article (by Danielle DiMartino Booth) is marred by one dubious claim:

With hindsight, few dispute that the Fed missed an opportunity to raise rates in 2014. No doubt, tightening policy at that stage would have created its own messy side-effects. That said, the benefits would have been significant.

First, for example, commodity prices might not have risen so high or so fast without the cheap money flowing from the US to emerging markets. Property prices worldwide might not be as frothy had investors not sought refuge in the sector from what they rightly recognised as risky valuations in equity and bond markets. And “fragile” would not now be the word for financial markets and economies worldwide.

Is it really true that “few” dispute this claim?  I certainly do.  I’m not saying it’s impossible, counterfactuals are always tricky, but it certainly should not represent the conventional wisdom at this point, unless I’m missing something.

BTW, Just to be clear I am currently much more worried about NGDP growth than jobs.  I still think a recession is unlikely for the US in 2016.  Rather I worry that if NGDP growth and long-term rates stay low, the Fed will be ill-prepared for the next recession—unless it shifts to NGDPLT.  And let’s face it; no one can predict recessions.

PS.  I have a new article in The Fiscal Times discussing my Depression book, and its implications for current policy debates.

PPS.  Over at Econlog I have a new post on a talk given by James Bullard.

PPPS.  I will be giving a couple talks at the Warwick Economics Summit this weekend, so my blogging may tail off for a few days.

Pen pals

Stephen Kirchner sent me an excellent article from The Telegraph, discussing monetary policy in Britain. It linked to some recent letters, which are triggered whenever the BoE misses it’s inflation target by a wide margin:

Mark Carney

Governor

The Bank of England

Threadneedle Street

London

EC2R 8AH

Dear Chancellor:

In November I wrote a fourth letter to you when CPI inflation remained more than one percentage point below the 2% target. Three months later, as expected, that is still the case: . . .

There’s much more. And here’s Osborne’s reply:

The Rt Hon George Osborne

Chancellor of the Exchequer

HM Treasury 1

Horse Guards Road

London

SW1A2HQ

Dear Mark,

CPI Inflation

Thank you for your letter of 4 February on behalf of the Monetary Policy Committee (MPC) regarding December’s CPI inflation figure, written under the terms of the MPC remit. As expected at the time of your previous open letter in November 2015, inflation has remained around zero in the past few months, triggering a fifth open letter for inflation falling more than 1 percentage point below target. . . .

The Government’s commitment to the current regime of flexible inflation targeting, with an operational target of 2% CPI inflation, remains absolute. The target is symmetric: deviations below the target are treated the same way as deviations above the target. Symmetric targets help to ensure that inflation expectations remain anchored and that monetary policy can play its role fully. . . .

The MPC have revised down their forecast for real GDP growth and CPI inflation in the short term, implying weaker nominal growth. This, combined with threats from the international environment, mean we face the risk of a weaker outlook for nominal GDP. If realised this could present challenges for tax receipts in the future, and reinforces the importance of delivering our plan to achieve a surplus on the public finances by the end of the Parliament.  (emphasis added)

The article that linked to these letters is by Allister Heath, and it’s well worth reading. Here are a few highlights:

At the start of the year, investors expected the first interest rate hike to take place this October; the financial turmoil had pushed this back to March 2018 by the end of this week, helping to explain the pound’s weakness. After Thursday’s inflation report, the markets now expect the first rate hike to take place in August 2018. It’s an astonishingly quick shift – the fastest and greatest since the height of the eurozone crisis – which few have fully digested yet. . . .

The first sentence in the Inflation Report repeats, like a tired and utterly implausible mantra, that “the Bank of England’s Monetary Policy Committee sets monetary policy to meet the 2pc inflation target and in a way that helps to sustain growth and employment”. Who in the City and the financial markets really thinks that this is what this is about anymore? It may be that the MPC actually still believes it is doing this. It is certainly going through all the motions, producing all of the usual fan charts, even though their predictive ability has turned out to be embarrassingly limited. . . .

So here are a few suggestions. First, the Governor and MPC members should cease to give any sort of guidance about the path of interest rates. So far, all such interventions have merely injected noise into the system and made markets less, rather than more, efficient at processing information. Second, if the Chancellor wants the Bank to target a growth rate for nominal GDP then he should say so. He should scrap the intellectually bankrupt CPI target and replace it by a nominal GDP growth rate. Third, the Bank should be more open about the extreme difficulty of deciphering the economy. There would be no shame in admitting, for once, that nobody really understands what is going on.

At some point economic policymakers will admit the obvious—it’s all about NGDP. Inflation targeting was a mistake. It’s really just a matter of time.

PS.  Nobody does street addresses better than the British.  And I’m going to Britain this weekend.

Update.  Marcus Nunes directed me to an excellent James Alexander post, which discusses the sharp fall in British NGDP growth (down to 1%.)

 

In a better world

It’s weeks like these that clearly expose that the world’s central banks are still living in the 20th century—the world of long data lags for GDP and crude Keynesian models.  Eventually they will arrive in the 21st century, and it will all be about asset prices.

One problem is what might be called “central banker hours”.  Even when they make a serious error, they don’t bother to correct it until much later.  Partly because they meet only once every six weeks (and why is that?), and partly because they don’t like to admit errors.

In a better world the risk of recession and the risk of the economy overheating would always be evenly balanced.  And I mean always, every single day of the year.  Does it sound like the risks are balanced today?

As the global economy falters, sapping demand for everything from consumer electronics to cars to commodities, investors are anxiously awaiting surveys on the services sector in China and the Unites States – the world’s biggest two economies – due later in the day.

If we hooked Janet Yellen and Stanley Fischer up to a lie detection machine, do you think that in their heart of hearts they are equally worried about a recession and a 1960s-style inflationary boom in the near future?

Or how about 10-year bond yields plummeting to 1.83%, from about 2.2% when they “raised” interest rates in December.  I hope all you Austrians who whined about “artifically low rates” being set by the Fed are pleased to have gotten your way.

In a better world our central bankers would not tell us that a 0.5% interest rate is “still very accommodative”, when our intro to money textbooks tell us that low interest rates do not mean money is accommodative.  Here’s Mishkin’s textbook:

1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.

2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

I expect more than EC101 errors from the elite economists at the Fed.

In a better world the Fed, ECB, BoE and BOJ would not wait six weeks. They’d get together next week to discuss a coordinated plan to reflate the global economy.  Just the announcement of such a meeting would do wonders.

In a better world the Fed would not raise rates after a year of 2.9% NGDP growth, and then mumble something about a “strong dollar” hurting manufacturing.  Gee, I wonder why the dollar is so “strong”?

In a better world the Fed would not try to arrogantly tell the markets where rates should be, but rather would meekly take its marching orders from the markets.  In other words, I don’t agree with Tyler:

If I were at the Fed, I would consider a “dare” quarter point increase just to show the world that zero short rates are not considered necessary for prosperity and stability.  Arguably that could lower the risk premium and boost confidence by signaling some private information from the Fed.

I’m increasing doubtful of the view that the Fed knows something the markets don’t and increasingly accepting of the exact opposite view.

In a better world the Fed would take off its blindfold, and create and subsidize NGDP, RGDP, and unemployment rate prediction markets.

In a better world we’d have level targeting.

In a better world the people who argued for a rate increase would not assume that it’s necessarily the first step toward pushing rates higher one, two, and three years in the future.  Instead they would understand that a more expansionary monetary policy would be a better way to promote durably higher rates.

In a better world people would not ask how a measly 1/4% interest rate increase could have major effects, they’d understand that interest rates are not monetary policy, and that a huge change in the stance of monetary policy might be accompanied by a tiny change in interest rates.  Recall the US in 1937, the ECB in 2008, and the ECB in 2011, all tiny increases in interest rates, all accompanied by much tighter monetary policy.

PS.  I added election odds to the “Sites I Visit” at right, for you political junkies.  As I predicted late last night, Rubio surged higher.  Indeed he surged by much more than I expected, and is now the strong favorite to win the nomination.  Of course Hillary Clinton is still the most likely to win the election.

PPS.  Tomorrow we finally cut the cord, so if you are someone who knows me then throw away the phone number.  In a better world I would not have to pick up the phone every 15 minutes to deal with telemarketers who ignore the fact that I’m on the do not call list, and then have to tell them what I think of their operation.  From now on, cell phone and email are the only way to reach me.

PPPS.  In a better world the NBA would move out the three point line so far that only Curry could hit them.

Is it 1985-86 again?

See if this sounds familiar. Halfway through a long expansion, industrial production levels off, after years of rapid growth. This is blamed on two factors, declining oil prices and a strong dollar.  I could be describing the past year, or I could be describing 1985-86:

Notice how industrial production leveled off for a couple years, before resuming its rise:

Screen Shot 2016-02-02 at 1.01.16 PMAnd here is the oil price, which fell gradually in the 1982-85 period and then plunged in 1985-86:

Screen Shot 2016-02-02 at 1.00.55 PM

And here is the trade-weighted dollar, which soared in value, and then plunged:Screen Shot 2016-02-02 at 1.00.42 PM

My hunch is that the dollar was more important than oil.  Tight money led to a slowdown in NGDP growth and a strong dollar.  NGDP growth (year over year) slowed from 12.4% in 1984 Q1, to only 4.9% 1986 Q4. Eventually the Fed eased policy, and NGDP accelerated.  The 1980s boom resumed.  It actually eased a bit too much in the late 1980s, which set up the 1990-91 recession.

Does this mean that history will repeat? No. But it’s an interesting comparison.

PS.  While writing this I forget that Caroline Baum made a similar observation in her book “Just What I Said“, where she pointed out:

This isn’t the first time that a change in oil prices has been regarded as a tax increase or tax cut and anointed with the ability to help or hinder economic growth. Time-trip back to early 1986, when oil prices plunged to $10 a barrel in April from $30 at the end of 1985. This was hailed as good news – a tax cut! – for consumers, which was guaranteed to boost US economic growth.

It didn’t turn out that way.  Following the plunge in oil prices, gross domestic product growth slipped to an anemic 1.7% in the second quarter of 1986 . . .

Ah, recall the days when 1.7% RGDP growth was anemic, not above trend.

 

Are we again misdiagnosing the problem?

Back in 2008, most people misdiagnosed the economic crisis.  A recession that was caused by tight money was wrongly assumed to be caused by a housing slump.  The housing slump was partly exogenous (due to other factors) and partly endogenous (aggravated by tight money.)

Now we have a (much milder so far) global economic slowdown that is being attributed to the collapse of oil prices, a “problem” that is partly exogenous (fracking, the Saudi’s fighting back, etc.) and partly endogenous (slower NGDP growth reducing oil demand).   Falling oil prices are clearly a problem for oil exporting countries, but they also benefit oil importers.  Is there a Keynesian savings/investment mechanism here?  I don’t see how, the oil exporters are massively reducing their saving rates.  The only even halfway plausible story is “reallocation” as jobs are lost in oil production faster than they can be created elsewhere.  That’s possible, but that’s a negative supply shock, which would raise inflation.  Do you see inflation sweeping the globe?  Me neither.

The following is from a Quartz article that attributes the global economic slowdown to falling oil prices:

We live in a time of bad forecasting of all types. Examples include the failed predictions of political pollsters gauging a host of critical elections around the globe, and the delusionary thinking that led to the last American economic catastrophe wreaked on the world—the 2008 mortgage crisis. It’s hard to predict events, as Philip Tetlock described last year (paywall) in his book Superforecasting.

I would love for someone to explain how the American economic “catastrophe” wreaked havoc on the world back in 2008.  The Great Recession ended up being worse in Europe than the US. The US housing shock might produce some incidental damage in other regions such as Europe and Asia, but surely not as bad as in the US.  And if it were a negative supply shock then global inflation would have risen in 2009.  Most people, including me, strongly believe the global recession was a negative demand shock.  But how could a subprime crisis in America reduce AD in Europe?  The ECB controls the path of AD in Europe, and they didn’t even hit the zero bound until 2013.  Obviously the eurozone recession was mostly caused by tight money.

Falling oil prices didn’t cause NGDP growth in the US to slow to 2.9% in 2015, the Fed did.  Falling oil prices didn’t cause China’s official NGDP growth rate to fall to 5.8% in 2015, their decision to peg to a strongly appreciating dollar did.

This is a never-ending battle.  There is an economic slowdown.  At the same time one industry stands out because it is going through wrenching changes.  Before it was housing, now it’s oil. There’s always something.  Because pundits don’t understand how monetary policy drives NGDP, they simply assume that whatever industry is in the headlines is what’s causing the economic slump. In some ways this is even worse than 2008.  At least then the slumping housing industry was in the US, so you can sort of imagine how people would be fooled into thinking that it might directly impact our GDP.  But regions like the eurozone import almost all of their oil.  For decades we’ve been taught (correctly) that importing nations benefit from lower oil prices.  And now we simply throw out mainstream theory and assume that for some magical reason importing nations are suddenly now hurt by cheap oil.  Why are the stock prices of European firms that import their oil falling along with stock markets in the oil exporters?

At the beginning of 2014, the world was marveling in surprise as the US returned as a petroleum superpower, a role it had relinquished in the early 1970s. It was pumping so much oil and gas that experts foresaw a new American industrial renaissance, with trillions of dollars in investment and millions of new jobs.

Two years later, faces are aghast as the same oil has instead unleashed world-class havoc: Just a month into the new year, the Dow Jones Industrial Average is down 5.5%. Japan’s Nikkei has dropped 8%, and the Stoxx Europe 600 is 6.4% lower. The blood on the floor even includes fuel-dependent industries that logic suggests should be prospering, such as airlines.

Heh world, don’t abandon EC 101, it’s the NGDP, stupid.

And please, can we have our NGDP futures markets now!?!?!?!?

PS.  I have a new post at Econlog that addresses the question of why easier money sometimes raises long-term rates, and at other times lowers them.