Archive for the Category Monetary Policy


Money illusion on steroids

Stephen Kirchner sent me the following from the Financial Times:

As economic growth returns again to Europe and Japan, the prospect of a synchronous global expansion is taking hold. Or, then again, maybe not. In a recent research piece published by Bank of America Merrill Lynch, global economic growth, as measured in nominal US dollars, is projected to decline in 2015 for the first time since 2009, the height of the financial crisis.

In fact, the prospect of improvement in economic growth is largely a monetary illusion.

I actually had to read this several times to make sure that my eyes were not deceiving me.  After all, this is the Financial Times, the world’s leading financial newspaper.  So we are to believe that even though real GDP is expected to rise, this isn’t actually “growth,” because output in Europe and Japan measured in US dollars is expected to decline.  OK, that’s pretty weird, and you wonder why he didn’t choose to measure Japanese output in terms of Brazilian reals or Indian rupees, but we’ll let that pass. What floored me was the next sentence, that measuring economic growth in real terms rather than nominal terms was an example of money illusion.

It seems like that since 2008 people can just say anything.  There are no rules anymore.  You can say that a good way to reduce inflation is cutting interest rates.  You can say that monetary policy is ultra-expansionary in countries suffering from deflation.  Say whatever you want, the lunatics have taken over the mental asylum.  It’s like the Chinese Cultural Revolution—all the old orthodoxies are discredited.  Anything goes.

One argument is that if central banks were not created to execute fiscal policy, then why require them to maintain any capital at all? Capital is that which is held in reserve to absorb losses. If losses are to be anticipated, then a reasonable inference is that a certain expectation of risk must exist. Therefore, central banks must be expected to take on some risk for policy purposes, which implies a function beyond the creation of a monetary base to maintain price stability.

Umm, how about bond price risk due to interest rate changes, not bond defaults?

In response to those who argue against the metamorphosis of monetary policy into fiscal policy, one need only point toward the impact of quantitative easing on interest rates. The depressed returns available on fixed income securities, largely as a result of QE, are acting as a tax on investors, including individual savers, pension funds and insurance companies.

Let’s see, the Fed did lots of QE over the past 6 years and is expected to raise rates later this year.  The ECB did none until a few weeks ago, and is expected to hold rates at zero for the next . . . well, basically forever.  Oh, and despite all the QE done by the Fed, the quantity of T-bonds held by the public has soared dramatically higher in recent decades.  But heh, whatever, go ahead and keep saying that QE is holding rates down.  Nobody cares about reality anymore; it’s all about throwing out catchy sounding observations.

Essentially, monetary authorities around the globe are levying a tax on investors and providing a subsidy to borrowers.

Yes, causing the biggest crash in NGDP growth since the 1930s sure helps borrowers.  They should all thank the Fed, and thank the ECB even more.

In the long run, however, classical economics would tell us that the pricing distortions created by the current global regimes of QE will lead to a suboptimal allocation of capital and investment, which will result in lower output and lower standards of living over time.

Which classical economists is he referring to?  I don’t recall that argument in any of the classical writers I read.  I do recall reading classical economists say that the sort of deflationary monetary policy that we see in Europe could reduce output and living standards. But QE? I must have missed that.

I sure wish America could go back to the boom year of 2009, when “living standards” soared much higher.  You remember, the year when America’s GDP soared higher at double digit rates (when measured in terms of euros.)

The WSJ wants to raise interest rates; now they just need to find a reason

I don’t comment on the Wall Street Journal very often, as they are behind a paywall. But I did read an editorial in a paper copy a few days ago, and as I recall the piece went on and on about how the Fed needed to be raising interest rates, without once discussing the Fed’s actual 2% inflation target.  But they did have lots to say about unemployment.

Things sure have changed.  When I used to subscribe to the paper version of the WSJ, they constantly lectured us on the fallacy of “Phillips Curve” thinking.  They told us that the Fed should control inflation, and not worry about unemployment. They obsessed about the value of the dollar.

And now inflation is running well below 2%, and is expected to continue doing so for many years, and King Dollar is back in the foreign exchange market.  But gosh darn it there must be some reason the Fed needs to raises interest rates, because . . . well, just because.

I’m amused when people suggest that market monetarism is losing out among conservatives.  The only conservatives who seem to even have a coherent set of views on monetary policy are what Ross Douthat calls the “reform conservatives.” He mentions people like Ramesh Ponnuru, Jim Pethokoukis, Reihan Salam and Yuval Levin. Douthat suggests that reform conservatives favor:

e. A “market monetarist” monetary policy as an alternative both to further fiscal stimulus and to the tight money/fiscal austerity combination advanced by many Republicans today.

As far as the rest of the conservative movement – – – what are you waiting for? Moping around that interest rates are too low, just because, does not constitute a coherent monetary policy regime that will survive in the rough and tumble intellectual debate over public policy.  (I.e., it won’t survive Paul Krugman attacks, and for good reason.)

On March 30th, I’ll be speaking in favor of NGDP targeting at the Dirksen Senate Office Building.  I don’t feel at all lonely.

PS.  It’s worth noting that many of the best people in what might be called the free banking movement (Larry White, George Selgin, etc.) are also sympathetic to a monetary policy involving a nominal income target, or something closely related. And I’ve found lots of support for MM at free market think tanks in places like Britain and Australia.

PPS.  I have a new post on Stanley Fischer over at Econlog.


It’s good to be the Fed

Before the recession, the Fed typically earned a profit of about $30 billion per year. After the Great Recession, their profits rose to the $70 to $80 billion range, as their balance sheet expanded.

There was a time where the Fed actually was reluctant to engage in monetary stimulus out of fear that they would take on excessive risk.  I thought those fears were completely nuts, for several reasons.  They weren’t likely to absorb particularly large losses, and even if they did they didn’t really need enough bonds to back up the monetary base, only the share held as bank reserves.  And most importantly, the Fed is essentially part of the Federal government, so when the Fed sees its assets fall due to a decline in T-bond prices, the Treasury gains a precisely equal reduction in their liabilities.  It’s a wash.

Don’t believe me that the Fed is part of the Federal government?  Where do you think all those profits go?

Here’s the latest profit report, and it’s a blockbuster:

According to figures released Friday, the Fed reported net income of $101.3 billion. That’s an increase of nearly 30% from 2013.

But the Fed sends nearly all of its profits to the Treasury. Last year, that amounted to $96.9 billion. The Fed said this was a record.

Commenter “Negation of Ideology,” who sent me this article, added this information:

Also, out of a balance sheet of $4.5 Trillion, $800 Billion will be maturing in the next two years.  Sounds to me that those who are worried about the Fed being unable to unwind and being forced to sell bonds at a loss are worried about nothing.

And $1.35 trillion of the Fed’s “liabilities” are zero interest cash.  I can’t believe people were seriously worried about the Fed’s balance sheet, and that this might have even inhibited monetary stimulus.  The Fed had similar fears in the 1930s, which were far more justified, but even those fears are widely ridiculed by modern economic historians.  Imagine what future monetary historians will think when they pour over the FOMC minutes for 2010, 2011 and 2012.

Everyone should pray each night that interest rates soon soar up to levels that put the Fed balance sheet under stress.  That would imply we get back to the sort of healthy economy that we had in the 1990s.  Unfortunately, that’s just a pipe dream.

By the way, does anyone know why the Fed has decided to raise rates before unwinding the balance sheet.  Logically you’d expect last in, first out.  They cut rates, then did QE; so why not unwind the QE, then raise rates?

Tim Worstall is just as confused as I am.

The New Yorker on monetary policy

I recall the New Yorker used to advertise itself as “the best magazine in the world.”  I think it’s fair to say that this was not based on its economics reporting.  Gordon sent me the following:

At the end of last year, when jobs and output both appeared to be growing strongly, members of the F.O.M.C. were predicting that G.D.P. growth in 2015 would be somewhere between 2.6 and 3.0 per cent. Now they have cut their prediction for growth this year to somewhere between 2.3 and 2.7 per cent. That’s not a drastic revision, but it reflects a number of recent economic statistics, such as retail sales and exports, having come in weaker than expected. Yellen pointed to a subdued housing market and a stronger dollar as restraining factors.

While Yellen was at pains to point out that other recent indicators, notably jobs numbers, have remained strong, the big rise in the dollar over the past year clearly has Yellen’s attention. Indeed, I suspect that the rally in the currency has prompted a serious rethink inside the Fed—and for good reason. The rise in the dollar means, effectively, that monetary policy has already been tightened. From an economy-wide perspective, an appreciation of the currency acts just like an actual rise in rates: it reduces the over-all level of demand and causes a slowdown in G.D.P. growth. Now that this has happened, it’s no surprise that the Fed would reconsider its next move.

To put it another way, the currency markets have already done a bit of the Fed’s work for it. By signalling to the market over the past few months that it was preparing to raise rates, the Fed prompted currency speculators to buy dollar-denominated assets, which bid up the price of the U.S. currency. Since this time last year, the value of the dollar against the euro has jumped by almost thirty per cent.

I can’t believe the Fed is downgrading its growth forecasts for 2015, who ever would have expected that to occur?  (Does anyone recall the last time they didn’t have to do that?)

More importantly, a rise in the dollar is most certainly not equivalent to a tightening of monetary policy.  If it was, then the dollar exchange rate would be the proper measure of the stance of monetary policy, not interest rates, real interest rates, the monetary base, M2, er, I mean NGDP growth expectations.

Perhaps the most incredible claim is that the dollar’s recent surge is due to the Fed signaling an intention to raise rates later this year, as if the market was not fully aware of that fact back when the euro traded at $1.35.  The new information in the last year has been monetary stimulus out of Europe (and probably some other things that I’m not aware of.)

In another New Yorker article John Cassidy suggests that, “the threat of bubbles, not inflation, should guide Fed policy.”  This despite the fact that the Fed’s last effort at bubble popping (in 1929) didn’t work out so well.  Not to mention that there is essentially no evidence as to what causes bubbles, which are not generally associated with easy money policies.  Michael Darda recently sent me a graph showing that “overvalued” markets are actually more likely to occur when money is tight:

Screen Shot 2015-03-20 at 5.13.20 PM

Hawks try to rewrite history

LK Beland pointed me to a new Lars Svensson post, which demolishes the Riksbank’s defense of its tight money policy:

In an interview in Bloomberg, Riksbank Deputy Governor Per Jansson again tries to defend the indefensible, the Riksbank’s sharp tightening of monetary policy in the summer of 2010. From the summer of 2010 to the summer of 2011, the Riksbank majority increased the policy rate from 0.25 percent to 2 percent.

The increases “from 0.25 percent in the summer of 2010 up to 2 percent in the middle of 2011 was really mostly about normal things that central banks look at,” given that growth at the time was about 6 percent, inflation was around 2 percent and household credit growth was about 9 percent, [Jansson] said. “There were really, in real time, no comments suggesting that it would be a stupid idea to increase the interest rate.”

But in real time, the Riksbank’s inflation forecast was below the inflation target and unemployment and the unemployment forecast were far above the Riksbank’s estimate of a long-run sustainable rate. In such a situation, easing, not tightening, is the right policy, since it shifts the inflation forecast up and closer to the target and the unemployment forecast down and closer the long-run sustainable rate. It thereby leads to better target achievement. Since tightening instead leads to worse target achievement, it is indefensible. My colleague in the Execeutive Board, Karolina Ekholm, and I indeed dissented from this tightening policy with very clear and logical arguments, namely that easier policy would in this situation lead to better target achievement.

Jansson’s claim of no opposition is extremely misleading, to put it mildly. It’s public knowledge that there was strong opposition to excessively tight money in Sweden by 2011.  The hawks were explicitly ignoring the Riksbank’s legal mandate, and several Riksbank members were pointing that out.  Here’s what was actually happening in 2011:

Ingves hire help to explain the rise in interest rates

Riksbank Governor Stefan Ingves interest rate increases has been questioned by everyone from finance minister to bank forecasters.

Express can today reveal that he hired a star consultant to defend the interest rate increases.

Cost: 140 000.

Riksbank Governor Stefan Ingves has been under fire recently.  Internally, the Bank, he has met with resistance by the so-called doves – Lars EO Svensson and Karolina Ekholm – who time and again expressed its reservations about interest rate hikes and sharp interest rate forecasts.

So the criticism of the hawks was so strong that by 2011 they were hiring a consultant to defend themselves against the dissents of several members of the Riksbank, including Lars Svensson.

For years the hawks have been telling me that monetary stimulus would lead to high inflation.  Now that they’ve been proved wrong, the new strategy is to say, “who could have known that we weren’t doing enough monetary stimulus?” Pathetic.

PS. Who could have known?  The market.