Archive for November 2013


James Bullard on monetary policy in 2008

James Bullard makes some good bullet points in a PowerPoint presentation:

Recessions are dated only long after the fact by an unofficial “NBER dating committee.”

The recession during this period was later dated as beginning in December 2007.

Incidentally, this is 10 months before Lehman-AIG.

However, during 2008 there was a debate as to whether the U.S. was in recession or not.

Based on the data at the time, the outcome of that debate was far from clear.

The real GDP data suggested that Fed easing had mitigated thecrisis up to mid-2008 and that the U.S. had perhaps avoided recession.

As of early August 2008, the growth picture for the U.S. economy according to available real-time data was relatively good.

In particular, estimates of real GDP growth were modest but positive for 2007 Q4, 2008 Q1, and 2008 Q2.
There was no recession according to the conventional definition of two consecutive quarters of negative GDP growth.

As of July 10, 2008, forecasts for the second half of 2008 were for continued modest growth.

According to today’s data, real GDP growth in the first quarter of 2008 was steeply negative, but this information was not available at that time.

There was a good case to be made that the “muddle through” scenario, which had apparently been correct for an entire year, would continue through the end of 2008.

That’s right.  As late as August 2008 both markets and economists thought we would avoid a recession. The collapse occurred in the second half of 2008. Then he makes a point I’ve been trying to get across for 5 years:

My argument is that the economy slowed substantially during the summer of 2008, greatly exacerbating the financial crisis and leading many financial firms to fail.

This slowing of the economy, however, was not readily apparent during the summer of 2008.

This is a crucial point.  Because the collapse of GDP was not known in real time, economists assume the post-Lehman intensification of the crisis was an exogenous shock, and causation went from financial crisis to subsequent recession.  Good to see a top Fed official recognize the reverse causation.

However I don’t like this:

But the rate cuts of early 2008 evidently did little to prevent the ï¬nancial panic, and may have exacerbated the situation to some degree … a point to which I will now turn.

I hate to see policymakers create ad hoc theories that are not consistent with market reactions.  The markets reacted very negatively to the smaller that expected rate cut of December 2007.  Bullard should stick with the tried and true—cutting the fed funds rate creates more AD than not cutting the fed funds rate target.  And more AD makes the crisis smaller.

Nick Rowe has a new post providing a partial defense on Mandel’s claim that a lack of goods innovation is the real AD problem.  I actually had thought of the same possibility as Nick, but didn’t discuss it.  The idea is that less innovation creates saving, which reduces velocity.  The reason I did not discuss this possibility is that if this is what Mandel had in mind, then he should not have responded to Matt Yglesias’s argument as he did.  Yglesias was essentially arguing that too little stimulus is the real problem.  If Nick Rowe’s interpretation of Mandel is correct, then too little policy stimulus is the real problem, as you’d want the Fed to offset any fall in velocity.  But I now regret not discussing that possibility.  It didn’t seem like the issue Mandel was getting at, but if Nick Rowe thought it was, then it is certainly possible I was wrong.

Tyler Cowen links to a blog post by Daniel Davies.  I disagreed with everything in the post, from beginning to end.  But it all seems to boil down to this:

  • So there is a structural shortage of domestic demand

There can’t be a structural shortage of demand, because demand is a nominal concept.  I wasn’t familiar with Mr Davies so I checked a few of his other posts. Yup, he’s a very smart guy, much smarter than me. So take this for what it’s worth.  Demand is fundamentally a nominal concept.  I don’t think any of the factors mentioned by Mandel, Davies, Tyler Cowen or anyone else matter for demand in a world where the inflation target is 5%.  Not even a tiny bit.

They matter a lot for secular RGDP growth stagnation, but not for demand.  And I still don’t think most people get that point.  The real problem is nominal.  Not China, not Germany, not lack of innovation, not income inequality, not debt, not housing, not banking, not deregulation, not current accounts, not fiscal policy, not serial bubbles, not wage stagnation, not anything real.  The real problem is not enough NOMINAL GDP, hence tight money.

(Oddly, I think Paul Krugman agrees with me on this point, but I can’t quite be sure.)

PS.  Don’t worry George; I don’t support a 5% inflation target.

PPS.  Of course there is also the “Great Stagnation.”  But that’s a different problem.

HT:  Vaidas

Reasoning from a price change, on steriods.

Here’s CNBC:

Let’s say that the market believes Bernanke’s theory about the effectiveness of forward guidance in boosting the speed of the economy. In that case, the market should react to by raising longer-term interest rates sooner than it would otherwise””because it should expect to pass the Fed’s economic condition thresholds for higher short-term rates sooner.

Obviously this makes forward guidance at least somewhat self-defeating.

As economist Warren Mosler points out, this has an ironic consequence: forward guidance will only work if the market doubts its effectiveness.

What would happen if rates were low because the public didn’t expect the policy to be effective?


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Is the zero bound the “real problem?” (i.e. the nominal problem)

I recently received the following email:

Hi Scott,

Quick question. Hypothetically, if it were possible for central banks to cut rates below 0%, do you think we would have still experienced the Great Recession? 

I’m not saying central banks can’t do that, I’m just imagining a hypothetical universe where it was a lot easier to do so, even if that’s just a matter of 0% not being a psychological lower bound.

Sina Motamedi

My initial reaction is; “no, we would not have experienced the Great Recession.”  Ben Bernanke and Janet Yellen say that’s inhibited the Fed. But the honest answer is “I don’t know,” because there is lots of evidence pointing to the zero bound not being the real problem.

1.  Other countries such as the eurozone and Sweden have experienced similar recessions, or worse, despite being above the zero bound for the vast majority of the past 5 years.  You can write off the eurozone because of the cluelessness of the institution under Trichet, but Sweden is not so easy to write off.  They did some very sound monetary policy in the first couple years of the recession, and then mysteriously gave up. And Sweden has a long tradition of great expertise in monetary policy and progressive policymaking.  I have no idea what went wrong; even Lars Svensson seems totally mystified.

2.  The discussion in the US has not been what you’d expect if economists actually thought the zero bound had caused the Great Recession.  To begin with, the only reason the Fed has not cut IOR further is that they are worried about the “break the buck” problem in the MMMF industry.  But if that trivial institutional quirk were widely seen as preventing the sort of faster NGDP growth required to avoid a Great Recession, there would have been massive demand for reform of the system.  Recall that the Fed got Congress to immediately give them authority for IOR in 2008 when they told Congress they needed it.  As far as I know reform of the MMMFs was not even a part of Dodd-Frank.  I see no evidence that mainstream economists, pundits, bloggers, etc, lose sleep over the break-the-buck problem, which prevents negative IOR.

3.  Negative IOR (on all reserves including vault cash) might lead to massive private cash hoarding.  This could be reduced by making it more costly to hoard cash; say by only printing $1 and $2 bills.  These cost 5.4 cents to produce, so the total cost of printing an extra $3 trillion in this sort of currency would be $80 to $160 billion in printing costs.  (And our models assume fiat money is produced at zero cost!)  But in practice, if we ever went down this road we would produce far less than $3 trillion, (indeed far less than $300 billion) and in any case that sum is dwarfed by the cost of recession.

So what’s really going on here?  My hunch is that lots of economists haven’t really thought through what they believe.  At a certain level they believe the zero bound is the problem, but if pushed with solutions they fall back on other arguments.  Those on the right would talk about “structural problems.”  Those on the left would argue that highly negative rates would just blow up asset bubbles and lead to more income inequality.  Very few economists actually believe the zero bound is the cause of the Great Recession, because very few believe that excessively tight money is the cause of the Great Recession.

And among the very few who do believe that excessively tight money is the problem (myself, Paul Krugman, etc.) even we don’t talk about replacing ER with $1 bills, which would be a logical policy if the zero bound really was the problem. Krugman talks about fiscal stimulus instead.  In my case I don’t discuss these ideas because they are completely beside the point.  Yes, $3,000,000,000 $3,000,000,000,000 in one dollar bills would probably “work,” but it would be an insane policy to implement.  That’s because if the Fed really wanted to have faster NGDP growth it would be doing other things.  It would not be contemplating tapering; instead it would announce that QE would rise by 10% each month.  It would lower the unemployment threshold to 3.5%, or better yet remove it entirely.  It would do level targeting.

It would be crazy to contemplate printing lots of $1 bills.

PS.  I will not respond to any comments discussing the $1 bill idea.  If you think it’s worth discussing you’ve missed the entire point of the post.  It’s a joke.

PPS.  Miles Kimball is a rare exception to my claim that economists don’t treat the zero bound as being the real problem.

PPPS.  A quick reply to Arnold Kling on Summers.  Arnold says:

Think of an economy with three assets: money, risk-free Treasuries, and physical capital. What I heard Larry saying was that because of the savings glut and the low price of computers, the full-employment real return on physical capital is negative. That is a silly idea and a false idea, but that is what I heard Larry say. Ben Bernanke heard the same thing.

I am pretty sure that what Summers meant is that the real return on physical capital has fallen to the level where the real return on T-bills is negative if inflation is 2%.  But I am not certain.  In any case that’s the only assumption needed to motivate his other claims. So if he didn’t say that, he should have.  On the other hand I’m not at all certain that even this weaker claim is true (I doubt it), but it’s not obviously far-fetched.

Aggregate demand–it’s not what you think

Most people have some understanding of “demand,” at the level of individual products.  Most people think aggregate demand is somehow related to that concept of demand.  It isn’t.

Here’s an interesting exchange between Matt Yglesias and Michael Mandel:

I find the “slow rate of innovation” hypothesis much more convincing than weak demand …

@MichaelMandel For any given level of innovation, a level of demand that produces high unemployment and low inflation is inadequate.

@mattyglesias Innovation–the creation of new goods and services that people want to buy– is what produces higher level of demand

(Yglesias had the middle comment, Mandel the other two.)

At first I thought Mandel was making some sort of “Say’s Law” argument.  Supply creates it’s own demand. If so, they would have been talking past each other, as Matt Yglesias actually is talking about aggregate demand, whereas Say was talking about what we’d now call “quantity demanded.”  Say was saying that if the LRAS curve shifts to the right, there will be a new equilibrium at a higher level of quantity demanded, even if the AD curve does not shift at all.  And that’s true.  But of course it doesn’t address the claim of people like Matt and myself, which is that AD is too low, that the AD curve is too far to the left.   That is a problem, at least in the short run (Say’s Law fixes it in the long run.)

On second reading I wonder if I misread Mandel.  Perhaps he meant that companies needed to produce more nifty products, to whip up enthusiasm among consumers.  In other words, he’s saying there are too many products out there like BlackBerry, which are not innovative, and hence consumers are sitting on their wallets.

If so, that would also be wrong, but in an interesting way.  AD has nothing to do with “demand” in the microeconomic sense.  Matt’s right that in the 1930s there were plenty of nifty products; the problem was that consumers had too little money to buy the goods.  What would it look like if lack of nifty products really were the problem?  Imagine next Tuesday every store in American announced a sale; every product was priced at one cent.  Even Tiffany diamonds, Ferraris, Hollywood homes, etc.  Also assume that shopping did not pick up on that day.  Then we’d be living in a Mandel world, were a lack of nifty products was holding back AD. Of course we clearly do not live in that world.

At the micro level “demand” is a sort of real concept, the amount of BlackBerries that consumers want to buy at various prices.  Aggregate demand is nothing like that.  AD went up more than a trillion-fold in Zimbabwe a few years back, and yet “demand” as most people visualize the term remained anemic.  (I.e. demand in terms of relative prices.)  AD is a nominal concept, a concept related to money, not consumer goods.  Only the central bank can solve our AD problem, no one else has the proper tools.

If consumers have the money, I assure you there will definitely be things they want to buy.  I’m already preparing my shopping list just in case all stores announce a one cent sale next Tuesday.

PS.  Or maybe Mandel had a third meaning that I missed, in which case—never mind.

PPS.  Counterarguments based on income inequality won’t help either.  That’s simply a one-time velocity shift; monetary policy still drives AD.

It’s all about the Benjamins

A few years back I did a post entitled:

Helicopter drops would work, but “helicopter drops” might well fail

A “helicopter drop” is economist lingo for a combined fiscal/monetary stimulus.  Trillion dollar deficits combined with trillion dollar QE.  We’ve done that (as has Japan), and although it “worked” in the very limited sense of slightly boosting NGDP, it did not “work” in the sense of sharply boosting inflation, as the naive quantity theory would predict.  The reason is obvious; the injections are not expected to be permanent.

A helicopter drop without the scare quotes refers to an actual drop of green pieces of paper out of black helicopters.  Lots of them—trillions of dollars worth.  This would work in a Krugmanesque “promise to be irresponsible” sense; the public would correctly see them as a desperate move to debase the currency.

That’s also the distinction between increasing reserves and currency.  At the margin the distinction is not very important, and several people pointed out in comments on yesterday’s post that most models treat cash and reserves as being equivalent.  But that misses the symbolic value of wheelbarrows full of currency. A zero IOR would be seen as business as usual.  But a significantly negative IOR would be seen (correctly) as a desperate move to debase the currency.  A “WTF?” moment in Fed history.   As trillions of ERs got converted into pictures of Ben Franklin, the public would see visual symbols of Germany/Zimbabwe.  Thus it would “work” in the sense of producing the sort of inflation predicted by the QTM.  Especially if there were no Fed promises to prevent inflation.  Of course hyperinflation is a bad policy, which is why the Fed won’t do it.  Thus we’ll probably never know whether I was right or not.

PS.  I cheated a bit at the beginning, as a “helicopter drop” should be zero interest reserves.  So the US did not (quite) do that.  But Japan did, so my point stands.