Pop Monetary Economics

Paul Krugman has an excellent post demolishing the following claim by William Cohan, in the NYT:

The case for raising rates is straightforward: Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying.

BTW, Krugman’s post is the one to read (not mine) if you only look at one post on this topic.  He carefully walks through an explanation of what’s wrong with this paragraph, in a way that would be recognizable to any competent monetary economist. But in some ways it’s even worse than Krugman assumes.  Here’s Krugman:

The Fed sets interest rates, whether it wants to or not — even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice.

That’s also my view, but I suppose one could argue that from a different perspective if you set the money supply you are letting markets determine interest rates, whereas if you actually target interest rates, then you are “interfering” in the market.  Not exactly my view, but let’s go with it.  Let’s put the best spin on Mr. Cohan’s essay.

Now here’s the big irony.  For the past seven years the Fed hasn’t been targeting interest rates, they’ve been using base control to influence the economy, increasing the monetary base through QE programs.  They switched from interest rate control before 2008 to monetary base control after.  And now Cohan is calling for the Fed to raise interest rates.  That means he wants the Fed to go back to manipulating interest rates.

So the great irony here is that in the paragraph I quoted from above Cohan says:

Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth.

And yet in the essay he’s actually calling for the exact opposite; he wants the market behemoth (the Fed) to start manipulating interest rates, something it hasn’t been doing for the past 7 years.

Unlike quantum mechanics, monetary economics doesn’t seem too hard.  As a result the media produces a non-stop stream of stories on monetary policy that are utter nonsense.  And by “utter nonsense” I don’t mean stories that disagree with my particular market monetarist views (Cohan might be correct that the Fed should raise rates), but rather stories that are simply incoherent, that are completely detached from the field of monetary economics.

We don’t hire plumbers to teach quantum mechanics at MIT.  We don’t put plumbers on the Supreme Court.  But we do put Hawaiian community bankers on the Board of Governors.  It’s not just that our media and Congress and President don’t understand monetary economics, they don’t understand quantum mechanics either.  The real problem is that they don’t even understand that they don’t understand it.  So they have unqualified people write op eds, and sit on the Board of Governors.  People ask me what Trump or Sanders think about monetary policy.  They don’t even know what it is!  What they think doesn’t matter, even if they were to get elected.  Just as it doesn’t matter what their view is on the best trajectory for NASA’s next Saturn bypass.

BWT, I have no problem with Hawaiian community bankers having important policymaker roles at the Fed, but put them on the committee for banking regulation, not monetary policy.

The title of the NYT piece said the Fed needed to “Show Some Spine”.  Over at the Financial Times they want the Fed to “Show Steel.”  (I guess that makes Paul and I wimps.)  Here’s the argument at the FT:

Yet monetary policy cannot confine itself to reacting to the latest inflation data if it is to promote the wider goals of financial stability and sustainable economic growth. An over-reliance on extremely accommodative monetary policy may be one of the reasons why the world has not escaped from the clutches of a financial crisis that began more than eight years ago.

I suppose that’s why the eurozone economy took off after 2011, while the US failed to grow.  The ECB avoided our foolish QE policies, and “showed steel” by raising interest rates twice in the spring of 2011.  If only we had done the same.

Of course I’m being sarcastic, but that points to another problem with the Cohan piece. Rates are not low because of QE (as Cohan implied), indeed Europe didn’t do QE during 2009-13, and that’s why its rates are now lower than in the US, and will probably remain lower.

If this stuff is published in the NYT and FT, just imagine what money analysis is like in the average media outlet, say USA Today or Fox News.

HT:  Tom Brown, Stephen Kirchner

Nationalist–Socialist America

The German tight money policy of the early 1930s led to a surge in vote support for two groups, the nationalists and the socialists.  Today in America the nationalists and the socialists have all the momentum.  Consider:

1.  Dick Cheney might have been the worst Vice President in American history (at least Agnew didn’t do anything.)  Now add to the list his choice to be one heartbeat away from the presidency—Sarah Palin.  Palin is now gushing praise over Donald Trump, who campaigns on the same mix of statism and xenophobia that you see among the neo-fascist parties in Europe, with militarism thrown in.  For years I could take pride in the fact that America largely avoided that particular policy mix.  I don’t think even Pat Buchanan was a militarist.

Update:  Well that must be one of the most epic brain freezes in my 6 1/2 years of blogging, it was obviously McCain who chose Palin.  Cheney didn’t chose anyone, unless perhaps himself, when he headed Bush’s VP search committee.

2.  The heart of the Democratic Party is now with Bernie Sanders, whatever the polls show.  And let’s not have anyone accuse me of McCarthyism, he calls himself a “socialist.”  When asked, the head of the Democratic Party couldn’t think of a single difference between socialists and Democrats. And please don’t insult my intelligence by talking about Sweden.  Sweden is not a socialist country.  Venezuela is socialist.  When Sanders starts advocating free trade and investment, liberal immigration rules, privatization, zero inheritance tax, 100% nationwide school vouchers, a $0/hour minimum wage rate, then come back to me with your Sweden talk.  For now, he just wants the bad parts of Sweden.

The official Democratic platform now advocates a nationwide $15 minimum wage. Whatever you think of extreme Reagan era supply-side economics, the GOP never went that far off the rails on economic policy.  The GOP platform said consider the gold standard, not adopt the gold standard.  I suppose the Seattle case is debatable, but a nationwide $15 minimum wage law would literally destroy the economy in many low wage/low productivity parts of the country, such as Puerto Rico.  It would also create even more crime, a massive underground economy.

PS.  I hope it goes without saying that neither of these guys will win, but remember what happened to the policy platform of Eugene Debs

The first step is admitting you have a problem

That is, the first step toward NGDP targeting.  Marcus Nunes has a new post that quotes a Jon Hilsenrath story in the WSJ:

JACKSON HOLE, Wyo.—Central bankers aren’t sure they understand how inflation works anymore.

Inflation didn’t fall as much as many expected during the financial crisis, when the economy faltered and unemployment soared. It hasn’t bounced back as they predicted when the economy recovered and unemployment fell.

The conundrum challenges much of what central bankers thought they understood about the world, as well as their ability to do their job. How will they know when to raise or lower interest rates if they’re unsure what causes consumer prices to rise and fall?

“There is definitely less confidence, a lot less confidence” about how inflation works,James Bullard, President of the Federal Reserve Bank of St. Louis, said in an interview here Friday.

The mysterious path of inflation during the crisis and post-crisis era is the main topic at the Federal Reserve Bank of Kansas City’s annual economic symposium here, where Fed officials, academics and global central bankers gather every August to discuss economic issues.

Inflation dynamics are more than an academic issue. Fed officials are considering whether to raise short-term interest rates from near zero, where they have been since December 2008. The Fed’s main sticking point is that inflation has run below its 2% target for 39 straight months. Inflation is lower than central bank objectives throughout the developed world, despite exceptionally low interest rates and other extraordinary measures aimed at driving it higher.

Before raising rates, Fed officials want to be confident inflation will rise to 2%. They have a theory it will. Unemployment is falling—reaching 5.3% in July—and slack in the economy appears to be diminishing. As supplies of labor and productive capacity become more constrained, officials believe wages and prices will rise.

So far, however, there are few indications that’s happening. The Commerce Department reported Friday that U.S. consumer prices rose 0.3% in July from a year earlier, well below the Fed’s goal. Stripping out volatile food and energy categories, officially measured inflation also runs below 2%.

The economy’s performance has “really challenged” the notion of a strong link between unemployment and inflation, Mr. Bullard said on the sidelines of the conference. The existence of such a link was also challenged in the 1970s, an era of high inflation and high unemployment.

Fortunately, there another nominal variable that still does track the business cycle very closely:

Screen Shot 2015-08-29 at 10.42.05 AMMarcus’s post also has some interesting graphs.

PS.  I have a new article on Milton Friedman and the euro, published in Reason magazine.  (Subscribers only, but why wouldn’t you already be a subscriber?)


Back to the countryside, once again

Tyler Cowen recently linked to this story in The Guardian, and wondered whether it was an indication of a Chinese recession:

China’s Workers Abandon the City as Beijing Faces an Economic Storm 

Labour disputes are rising and some workers are leaving for the country amid fears a crashing economy could cause political and social unrest

Liu Weiqin swapped rural poverty for life on the dusty fringes of China’s capital eight years ago hoping – like millions of other migrants – for a better future.

On Thursday she will board a bus with her two young children and abandon her adopted home.

“There’s no business,” complained the 36-year-old, who built a thriving junkyard in this dilapidated recycling village only to watch it crumble this year as plummeting scrap prices bankrupted her family.

And here’s The Guardian in May 2009, a year when China experienced 9.2% real GDP growth:

Unemployment forces Chinese migrants back to the countryside

Factory to farm: millions who had enjoyed a taste of city freedom are returning to their villages

Until a week ago, Liu Xiao was part of the Pearl river delta’s army: one of the thousands of workers streaming along a Shenzhen road, gulping down breakfast, texting, lighting a final cigarette, teasing friends and swapping gossip – rushing rushing rushing to the factory for another shift making bras, computers and plastic toys for the world.

Today she waits patiently at the railway station across town. This region was the motor of China’s economic boom, but plummeting exports have forced it to slow and millions of those who kept it running have given up and gone home. Liu Xiao is one of the latest to return to the countryside: in her case to a village of just 200 people a 10-hour ride – and a world away – from Shenzhen.

So will 2015 be a repeat of 2009?  Not entirely, the trend rate of growth in China is now lower, and the risks of recession really are higher than in 2009.  But the similarity of these two articles should provide a cautionary note.  Adam Smith said, “there is a great deal of ruin in a nation”, and there are very few countries where that aphorism is more apt than China.

PS.  Here is an excellent article on the situation in China.  It points out that the Chinese government is tightening monetary policy to stabilize the yuan.  That’s not the right move at a time like this.

PPS.  This is a really good article on why Chinese stock market regulation is so inept.

PPPS.  This article suggests that as of August 25, 2015, the consensus forecast of economists is that China will have 6.9% growth this year and 6.7% next year.  That makes Tyler and I China bears, as we both expect less growth than the consensus. For some reason it makes me feel better to be on the same side as Tyler.  (I forecast about 6% going forward, and Tyler expects a very bad recession.)  Willem Buiter forecasts, 4% on official figures, in reality even less.  He says it will drag the world into a mild recession.

August 25, 2015

The main downside risk to the economy in the short term is that high volatility in the stock markets could translate into turmoil in the financial sector. On the other hand, a sooner-than-anticipated recovery in real estate and further action from authorities could spur growth in the next months. Panelists maintained their GDP projections for 2015 at the previous month’s 6.9%. Next year, the panel foresees growth at 6.7%.

But if China’s growth goes negative, I don’t think Tyler will let me get away with “I predicted less growth than the consensus, and I was right!!”

HT:  Marcus Nunes

Bob Murphy on Efficient Markets

Bob Murphy is frustrated, but he’s lashing out at the wrong theory:

I understand the Efficient Markets Hypothesis, and I think it’s a very good way to take a first crack at the markets. The thing that annoys me about many EMH proponents is that they think they are being empirical and scientific, when they often are clearly able to explain any outcome in their framework. Steady growth? Just what EMH predicts. Massive crash? Just what EMH predicts. In practice, the EMH is non-falsifiable, which is ironically the criticism many of its proponents level at others.

The EMH is most certainly “falsifiable.”  It’s been tested in many ways.  Some people even claim that it has been falsified, although I’m not convinced.  In the tests that I think are the most relevant the EMH comes out ahead.  (Stocks respond immediately to news, stocks follow roughly a random walk, indexed funds outperformed managed funds, excess returns are not serially correlated, or not enough to profit from, etc., etc.) I assure you that if stocks responded to news with a 12-hour lag, or were clearly far from being a random walk, even Fama would reject the EMH.  BTW, is ABCT refutable? If so, how?  (I don’t regard refutability as the most important test of a theory–usefulness and coherence are better tests in many fields.)

I think this following passage from Scott is a tad slippery:

Murphy seems to suggest that the fact that Austrian economists were not surprised by the volatility is a point in their favor. But why? Who was surprised? If you had asked me a year ago “Do you expect occasional volatility, up and down?” I would have said yes, and also that I had no idea when that volatility would occur, or in which direction the market would move.

Look, there was nonstop coverage of this on NPR when it happened. They were trotting out all kinds of people, including Austen Goolsbee, to make sure Americans kept their money in Wall Street. I’m not making this up, give me a break.

Monday showed the biggest intraday point swing in history. (Granted, you would want to look at percentage swing for a better comparison, but I can’t find such a ranking.)

And according to this guy’s analysis, by one measure of market volatility–the VVIX–Monday blew the previous record out of the water:

Bob should not rely on NPR for his stock analysis.  And you really should look at percentages, not absolute changes.  He talks like the US just experienced a stock market crash, at a time when the market less than 10% below its all time high! Monday was not a particularly big deal in terms of stock market history.  Yes, the volatility was unusually large by the standards of 2015, but this has been an unusually placid year.  Back in 2008 we had weeks and weeks of non-stop action that was roughly as volatile as Monday.  I’d guess that one could find many hundreds of days throughout stock market history where the stock market fell by as much as it did on Monday.

But let’s say I’m completely wrong, and stocks were historically volatile.  Even then Bob’s wrong, as he completely misunderstood my quote.  By “more of the same” I merely meant the most likely outcome for the market was what we have observed in the past.  There are periods of stability and periods of volatility.  If the S&P is at 2108, and someone asks me where I expect it to be in two weeks, I’d say 2108, or maybe 2109 (to reflect a gradual upward trend.)  But that does NOT mean I actually expect the stock market to equal precisely 2109 in two weeks time.  Rather it reflects the fact that I view it as being equally likely to rise or fall.  I actually think it far more likely that it would be considerably higher or lower than at that specific point estimate.  Bob’s frustrated that I’m not making market forecasts that can be refuted, but that’s because I don’t think it’s possible to forecast the market.

And I feel the same about the business cycle.  The US has recessions every 5 or 10 years, China less often.  We don’t know when the next one is coming.  Usually I’m right, because any given year I say that growth is more likely than a recession, and when the recession actually occurs then I’m wrong.  I was wrong in 2008, as I did not predict a recession in 2007.

Now if last year Bob had said there’d be a crash on August 24, 2015 and it happened, then more power to him.  But as far as I can tell he simply posts “I told you so” blog posts after every minor pull back, before the market again soars to new heights.  Then another modest pullback, and another “I told you so.”  I honestly don’t know what we are to make of all that.  Does the Austrian model provide some key to predicting the stock market?  If not, why talk about stock moves as if they support the model?

If you want to say I’m a broken clock, or that we should wait and see what things look like in three years, etc., that’s fine. But come on, don’t act like predicting “more of the same” two weeks ago is consistent with what just happened.

Bob doesn’t tell his readers that the link is to me discussing the Chinese business cycle, not the US stock market.  Some might even say that’s misleading, as his post implies it applies to the US stock market.  But I won’t complain; I stand by my previous “more of the same” as being a wise prediction, and I’ll apply it to the US, to China, to stocks or business cycles.  Whatever Bob wants.  And if I visit the Sands casino and I predict that the little bouncing ball will land on a red or black, and it ends up on the green 0 or 00, I’ll stand by my prediction that red or black were the most likely outcomes. That I made a wise prediction.

In most areas of life we judge competence by track record.  Doctors, lawyers, engineers, etc.  But that doesn’t work for market forecasters.  Track record tells us nothing about the competence of stock pickers.  It doesn’t tell us whether their future predictions will be better than those with a poor record.  And I think that really frustrates people.  It goes against common sense than past performance is not an indicator of competence. But it just isn’t.  I think that might be why Bob is exasperated by my placid agnosticism.

PS.  Obviously I do know that volatility is serially correlated.  I hope readers don’t think I’m THAT stupid.  Thus it goes without saying that for the Chinese market a “more of the same” prediction two weeks ago implies a prediction of continued high levels of volatility.  Which is what happened.  You may disagree with me, but please don’t assume I’m a complete moron.