Archive for the Category Monetary Policy

 
 

The problem with procyclical inflation

Here’s Charles Evans in the WSJ:

“We’ve averaged well under that 2% mark for the past six-and-a-half years,” Mr. Evans said. “With a symmetric inflation target, one could imagine moderately above-target inflation for a limited time as simply the flip side of our recent inflation experience–and hardly an event that would impose great costs on the economy.”

There’s no doubt in my mind that a policy of letting inflation run a bit above target during the next boom will not cause great hardship during the next boom

But a policy of running inflation below target when unemployment is high and above target when it is low makes the business cycle much worse, and does impose great hardship.  Some conclusions:

1.  A procyclical inflation policy violates the dual mandate.

2.  NGDP targeting would lead to countercyclical inflation (a good thing).  As Nick Rowe likes to say, you want to make it so that the public’s stupid belief that inflation is bad . . . is true.  Good supply-side policies would become anti-inflation policies.

3.  Discussions of “what should the Fed do now?” are meaningless and incoherent, unless embedded in a clearly specified long run policy regime, as are discussions of whether QE “increases inequality.”

Charles Evans is actually one of the best people at the Fed.  Then there is the other Charles:

Federal Reserve Bank of Philadelphia President Charles Plosser said Friday that inflation levels that have fallen persistently short of where the central bank wants them to be are not a significant issue to him right now.

It’s true that inflation levels are “a little bit low” relative to the Fed’s desire to have price pressures hit 2%, Mr. Plosser said at an appearance in New York. But, “for the most part, I’m not too concerned about that,” he said.

What he doesn’t say is that the reason the Fed has failed is partly due to the fact that he’s consistently been pressuring them to be more contractionary, even as they were already far too contractionary to hit their dual mandate. So Plosser’s telling us that the Fed is not doing its job, partly due to his consistently bad advice, but he doesn’t much care.

Fortunately, market monetarist ideas are gradually seeping into the media.  A few days ago we saw this at the Financial Times, now it’s Bloomberg’s turn:

Based on the gap between yields of government notes and TIPS, traders have scaled back estimates for average inflation through 2019 by a half-percentage point since June to 1.52 percent, Fed data compiled by Bloomberg show.

.  .  .

With the Fed’s preferred measure averaging 0.34 percentage point less than CPI in that span, traders are signaling prices based on that gauge may rise as little as 1.18 percent. Through August, the personal consumption expenditures deflator has fallen short of the Fed’s 2 percent goal for 28 straight months.

Fed officials “need to be paying attention to that because there’s a collective wisdom element to the TIPS market,” Mitchell Stapley, the chief investment officer for Cincinnati-based ClearArc Capital, which manages $7 billion, said in an Oct. 8 telephone interview.

Did QE worsen inequality? That’s not even a question

When people ask whether QE worsened inequality they think they are asking a coherent question. But that merely shows how poorly most people understand monetary economics.

Let’s ask a different question:  Did Obama’s appointment of Ben Bernanke increase inequality? Any sensible listener would ask: “Compared to what?”  After all, most models are roughly linear, at least for very small changes (I’m rusty at math, so tell me if that is wrong.)  In other words, whatever impact monetary policy has on inequality, the impact of picking Bernanke over a more dovish alternative (Romer) would have been the opposite of Obama picking Bernanke over a more hawkish alternative (Summers.)   I can’t imagine anyone being able to make sense of the question “did Bernanke increase inequality” without knowing the counterfactual Fed chair.  And of course the same is true for Fed policies, is the counterfactual more or less contractionary than the actual policy?

Now some people will say; “the obvious implication is that the counterfactual was no QE, and that this was a more contractionary alternative.”  This is very likely how people think about it, but of course that assumption is wrong.  My preferred policy would have been far more expansionary, and hence would have involved far less QE.  Let’s break this down into 2 questions:

Does monetary stimulus increase inequality?

Does delivering monetary stimulus via QE affect inequality more than some other method?

I’ll take the second question first.  Suppose Bernanke did not do QE, but rather some equally effective stimulus method.  Perhaps slightly raising the inflation target, or going to level targeting. Would that make any difference for inequality?  I hope it’s obvious that it would not.  The mechanics of QE are totally uninteresting.  You are just swapping one Federal government interest bearing liability (reserves) for another federal government interest bearing liability (T-bonds.)  Any “Cantillon effects” are trivial.  I hope I don’t have to explain to people that this “money” did not “go into the stock market”:

a.  The money went into bank reserves, or currency.

b.  Money never goes into markets; there is no giant safe on Wall Street storing all the money invested in stocks.  Money goes through markets.  You buy, someone else sells.

If there were no QE, but equally fast NGDP growth produced by a higher inflation target, stocks would have done equally well.  Indeed stocks responded more strongly to forward guidance than QE3 in late 2012.

So now we can rephrase the QE question: “Did Bernanke’s monetary policy since 2009 worsen inequality?”  Now it’s much easier to see that we need a counterfactual.  You might prefer to describe that policy as 1.5% inflation, or perhaps 4% NGDP growth (my choice.)  Either way it’s a fairly contractionary policy.  And it’s no longer “obvious” what the counterfactual is, would it be 3% or 5% NGDP growth?  In my view 5% growth would have helped the unemployed and the rich more than the middle class with stable jobs (say teachers.)  So that has mixed effects on inequality, indeed so ambiguous that it’s probably not worth even thinking about, as the effect would be trivial compared to the net gain to America from a stronger economy.

If you think the alternative to QE was a more contractionary policy, say 3% NGDP growth, then it would hurt the rich and poor more than the middle class.  In order to favor that policy you’d have to hate the rich so much that you be willing to impoverish millions of poor people to screw the rich. But even someone who hates the rich as much as Paul Krugman favors QE.

Sorry, but “does QE increase inequality?” is a really, truly moronic question.  I apologize for wasting your time.

PS.  Here’s Buttonwood at the Economist:

This is at the heart of the matter. Even if the Fed does not increase rates next year, it will surely take a big economic shock to make it resume QE. The markets have relied on the central banks for so long, like a small child holding his dad’s hand when learning to ride the bike. It is time to let go of the hand now, but there will be a few bumps and bruises along the way.

This is truly a horrible metaphor, and helps explain how the developed world got so far off course. Taken literally, the counterfactual to “using monetary policy” is barter. Obviously that’s not what people mean when they say it’s time to stop using monetary policy.  Buttonwood probably means that we are propping up the economy with an excessively expansionary monetary policy.  But of course that’s confusing the tools (fed funds targets, the monetary base, etc.) with the actual policy itself (1.5% inflation, 4% NGDP growth, etc.)

By 2007 almost no serious economist in America believed that money was “easy” in the early 1930s, despite ultra-low interest rates and massive QE.  And now almost all serious economists believe monetary policy has been “easy” in recent years precisely because of ultra-low rates and massive QE.  This fact is appalling.  The intellectual decline in mainstream macroeconomics since 2007 is stunning–nothing like this regression has happened since the early 1970s, or perhaps the late 1930s.  And this time the worst mistakes are being made by those on the right.

By the way, the right metaphor is not training wheels, but rather which way do you want to steer the bicycle?  No serious pundit is advocating walking.

Ben Southwood finds lots of evidence for (market) monetarism

Ben Southwood of the Adam Smith Institute has several recent blog posts that are well worth reading.

When the Bank moves its key policy rate, commentators talk about it hiking or cutting interest rates; on top of this, we’ve seen extremely low effective interest rates in the marketplace; together this makes it reasonable to believe that the central bank is the cause of these low effective rates.

There are lots of reasons to doubt this claim. In a previous post I pointed out that the spreads between Bank Rate and market rates seem to be narrow and fairly consistent—until they’re not. I made the case that markets set rates in an open economy. And I arguedthat lowering Bank Rate or buying up assets with quantitative easing (QE) may well boost market rates because they raise the expected path of demand, the expected amount of profit opportunities in the future, and thus investment.

Since then I came across an elegant and compelling explanation of exactly why this is. In a 1998 paper, Tore Ellingsen and Ulf Söderström show that this is because some monetary policy changes are purely expected and ‘endogenous’ responses to economic events, whereas some monetary policy changes are unexpected ‘exogenous’ changes to the central bank’s overall policy framework (like raising or lowering the inflation rate that markets believe they really want).

When changes are expected, market rates keep a tight spread around policy rates; when changes are a surprise, cutting Bank Rate actually results in higher interest rates in the marketplace.

The post has some nice graphs showing this distinction.  He has another post citing no less that 4 papers with monetarist-friendly findings.  Here’s one example:

In “QE and the bank lending channel in the United Kingdom”, BoE economists Nick Butt, Rohan Churm, Michael McMahon, Arpad Morotz and Jochen Schanz tackle the popular creditist view that movements in lending drive overall activity, and that quantitative easing works by stimulating lending, and find “no evidence to suggest that quantitative easing (QE) operated via a traditional bank lending channel”. Instead, their evidence is consistent with the monetarist view, that “QE boosted aggregate demand and inflation via portfolio rebalancing channels.”

They find this result by looking at the difference between banks that dealt directly with the Bank of England when it was buying gilts (UK government bonds) with new money in its QE programme. If the creditist view held, these banks would be more able to expand their lending with the extra deposits created when the BoE hands over new money for gilts.

And a post exposing the silliness of internet Austrian commenters, who seem to think that anyone who is not an Austrian is a Keynesian.

Ben’s colleague Sam Bowman (also at the ASI) has a good post explaining NGDP targeting.

Meanwhile, the only head of a major central bank ever to say good things about NGDP targeting now presides over an economy that is creating jobs at a rate no one could have imagined 18 months ago.

Tyler Cowen on exports

Tyler Cowen has a wonderful new post pointing out that all countries can increase their exports at the same time, and this may boost global output.  I’m going to try to make it even wonderfuler (is that a German word?)

[Update: When I say "exports" I mean "exports", not "exports minus imports" (a category no one should pay any attention to.)]

Let’s avoid reasoning from an export change, and ask why exports might increase:

1.  Supply-side reforms that boost the efficiency of the export sector, perhaps by removing tax/regulatory barriers.

2.  Monetary stimulus aimed at currency depreciation.

3.  More government saving, which depreciates the real exchange rate.

My claim is that if these things are done on a global scale, the first two are expansionary in net terms, and the third is neutral.

Supply-side reforms boost output under either an inflation target, or a dual mandate.  If you want to use the Keynesian model, these reforms boost the Wicksellian equilibrium interest rate, which makes NGDP grow faster, even at the zero bound.

For years I’ve been pointing out that a (mild) international currency war would be great.  All currencies can depreciate at the same time, against goods and services. We know that monetary stimulus in the US makes European stocks go up, and vice versa.  But it isn’t just market monetarists; Keynesians like Barry Eichengreen have also noted that a currency war would be expansionary, as it was in the 1930s. These first two points are probably what Tyler had in his mind when he criticized the mercantilist mindset.

As far as government saving (fiscal austerity), I’d say it’s a net wash, for monetary offset reasons.

PS.  Roughly 100% of the time when people blame virtue in one country (Germany, China, Japan, etc.) for problems in the global economy, they are working with a flawed model.  Classical economics (Hume’s Of the Jealousy of Trade) was supposed to be about overcoming that xenophobia.  We still have work to do.

PPS,  I once published a paper claiming that IS-LM was essentially a gold standard model.  Here’s Tyler:

It sometimes feels like the IS-LM users have a mercantilist gold standard model, where the commodity base money can only be shuffled around in zero-sum fashion and not much more can happen in a positive direction.

Yup.

 

 

A nod toward market monetarism at the FT?

I suppose I sometimes read too much into things, but I couldn’t help thinking that the conclusion of a recent Financial Times editorial had a sort of market monetarist flavor.  See what you think:

The other positive is the quick reaction from central bankers to the market alarm. James Bullard and Andrew Haldane, who vote on interest rate in the US and UK respectively, have spoken of their concern about increasing downside risks to growth. Their hints that interest rate rises have been pushed into the future met with a bullish reaction. For all the controversy about how quantitative easing works, markets clearly understand that monetary policy still matters.

On this subject it would be unwise to question the market view. This week has been about macroeconomic concerns. The big worry is that aggregate demand may fail to keep up with potential supply, thereby generating a perilous deflationary dynamic. Fighting deflation is a job central bankers can do – so long as they remain alert.

This week the gloomsters harked back to the economic collapse that started in the summer of 2008. Such talk is premature, but lessons from that disaster are still relevant. Six years ago, the markets’ warnings of an impending global recession were met with hawkish noises from many central banks, and even a rate rise from the European Central Bank. This time so far has been different. For that, if nothing else, there are reasons to be modestly cheerful. [emphasis added]

I really do believe there is more understanding of the need for aggressive monetary actions this time around.  Some have mocked James Bullard for doing a 180 in a single week, and I see their point. But I prefer to applaud people who understand it’s not the job of central banks to change their AD forecasts, it’s the job of central banks to move aggressively enough that they don’t need to change their forecast.  Give Bullard points for open-mindedness, humility, and honesty.  All good qualities in a central banker.

PS.  I have a heavy grading load for the next two weeks, and as if that isn’t enough I’m simultaneously involved in putting together several big proposals that may have a huge payoff later.  I’m discouraged that the predictions markets are taking longer than I’d hoped (perhaps I was naive about the complexities of these things) but at the same time I am increasingly optimistic that we can aim even higher next year.  This will happen.