Archive for the Category Monetary Policy

 
 

The ECB finally acts

So it looks like it will be one trillion euros in QE, somewhat more than the markets expected.  A few comments:

1.  The policy would have been far more effective if done a year or two ago.  It will still be somewhat effective, but not a game changer.  Think “less bad times” in the eurozone, not good times.  Greece might still blow up.

2.  The euro fell by 1.2% on the news.  Of course QE was widely expected and presumably some of the recent decline in the euro was due to expectations of QE.  Even so, it doesn’t seem like a very strong reaction to a bigger than expected number, so I’d expect only a weak impact on eurozone inflation (or deflation.)  Still, better than nothing.

3.  The US stock market rose on the news, another example of “never reason from a price change.” If the dollar had strengthened because of tight money in the US, stocks would have fallen.  If the dollar strengthens because of easy money in Europe, stocks rise.  The 147th example of the fallacy of the “beggar-thy-neighbor” theory.  (However this theory does apply to national fiscal policy in the eurozone.  Thus if Germany does fiscal stimulus in 2011, then the ECB must tighten even more to keep inflation on target, and the PIIGS see their GDP fall.)

4.  This is further evidence that the recent Swiss move was unwise.  Some of Switzerland’s defenders (at least in my comment sections) claimed they had to cut their tie with the euro, as the value of the euro would collapse after QE was announced.  It’s down only 1.2% today.  Contrast that with the capital losses suffered by the SNB due to a 21% appreciation of the SF.

5.  Tyler Cowen has a new post on deflation.  I’m going to quibble with a couple aspects of the post. First the title; “Why is deflation continuing in Europe and Japan?”  I don’t like the idea of using that title in a post where the very first paragraph points out that the BOJ has succeeded in moving Japan from deflation to inflation:

Consumer prices will rise an average 1.4 percent the fiscal year through March 2017, after failing to reach 2 percent — stripped of fresh food and a sales-tax boost — in any of the years since the goal was set, the median of 16 estimates shows. Governor Haruhiko Kuroda wanted to get there in about two years when he unleashed his record stimulus plan in April 2013.

I also don’t like this:

We are no longer at the point where two percent inflation is easy to achieve in Europe or Japan.  Central banks are doubted.  To achieve two, they would have to shoot for four, and thus announce a target of four.

That’s also Paul Krugman’s claim, but it’s false.  They could target TIPS spreads at 2%, for instance. Better yet, they could follow Bernanke’s advice and switch to level targeting.  I think the mistake many observers make (including Cowen and Krugman) is to see central banks struggling to hit their targets with their actual policies, and then assuming that it is technically difficult to do, or involves a large risk of overshooting.  That is to give central banks too much credit. Central banks are still back in the Stone Age with their QE-type policies.  As Bernanke pointed out years ago, and Woodford has confirmed, you need level targeting at the zero bound.  This would make it far easier for the ECB and BOJ to hit their target.  Real world central banks are not using best practices.

One place I do agree with Tyler is that it might be very difficult in a political sense.  Thus even if Draghi and Kuroda privately favor level targeting, it’s quite possible that they would be unable to convince a majority at their respective central banks.  So yes, in a narrow political sense it might be tough for a central bank head to do what is needed to succeed.

Politics in a broader political sense don’t matter, as everywhere in the world voters are clueless about central banking.  If the ECB switched from a 1.9% IT to a 1.9% PLT, the average European would respond “huh?”  Even most college students don’t know the difference between a change in inflation and a change in the cost of living.

Kevin Drum on market monetarism

Update:  Let me strongly recommend these two excellent posts on Switzerland, by Lars Christensen and Simon Cox.

Here is Kevin Drum:

Via James Pethokoukis, Scott Sumner claims that Market Monetarists got things right during the aftermath of the Great Recession when others didn’t:

It must be a major embarrassment to the profession that us lowly MMs turned out to be more correct during the crisis than any other major group (New Keynesians, New Classical, RBC-types, etc.) and indeed more accurate than other groups on the fringes (old Keynesians, old monetarists, Austrians, MMTers, etc.):

1. It’s now obvious that Fed, ECB, and BOJ policy was far too tight in late 2008 and early 2009, but MMs were just about the only people saying so at the time.

2. We correctly pointed out that fiscal austerity in 2013 would not slow growth in the US because of monetary offset, whereas in a poll of 50 elite economists by the University of Chicago, all but one gave answers implying it would slow growth.

3. We pointed out that massive QE would not lead to high inflation, while many other economists on the right said it would.

4. We correctly predicted that the BOJ and Swiss National Bank could depreciate their currency at the zero bound, while many on the left said monetary policy was pushing on a string at the zero bound.

5. We pointed out that the ECB’s tightening of policy in 2011 was a huge mistake, which now almost everyone recognizes.

I’m a little puzzled by this. Unless I’m misremembering badly, prominent lefty economists like Paul Krugman and Brad DeLong have been saying most of these things all along. And while I’m not really quite sure if these guys think of themselves as New Keynesians or Neo-Paleo Keynesians or modified Old Keynesians or what, they’re basically Keynesians.

The only one of Sumner’s five points where there’s disagreement, I think, is #2, and I’d argue that this is a very difficult point to prove one way or the other. My own read of the evidence is that the modest austerity of 2013 might very well have had a modest effect on growth, but frankly, a single year of data is all but impossible to draw any firm conclusions from. However, it’s certainly true that there were no huge changes in the trend growth rate.

Let’s take these one at a time.  There’s really only one reason why Kevin Drum and others even pay attention to market monetarists.  People like David Beckworth and I became well known in the blogging community for a very contrarian point of view in late 2008 and early 2009. We argued that monetary policy was way too tight and that this was making the recession much worse. Almost no one outside the market monetarist community was making that claim (with a handful of exceptions like Robert Hetzel at the Richmond Fed (in a much more polite fashion).)

In one of my early blog posts I wrote an open letter to Krugman asking him to support QE, NGDP targeting, etc., and he shot me down with a sarcastic reply, mocking the notion that monetary stimulus could help at the zero bound.  Yes, much later he supported QE, and even at that time he was not really opposed, but the Keynesian community was strongly pushing the “monetary policy is ineffective at the zero bound” viewpoint in late 2008 and early 2009.  Even more shockingly, so was almost everyone else.

If you don’t believe me, consider how Ryan Avent describes the impact of market monetarism in 2011:

Once upon a time, the Fed was viewed as having near-absolute power over the path of the economy. Then crisis struck and many argued that the Fed had run out of ammunition and fiscal policy was required. Eventually people began arguing that the Fed could do more and should do more, thanks largely to the efforts of Mr Sumner himself.

Or this from September 2012:

Yet even as this [QE] was taking place, the conventional wisdom across the economics wires was that monetary policy had largely done all it could do, or perhaps all it should do. The most straightforward argument on this score was that with interest rates at zero, the Fed was powerless to create more demand. QE could prop up banks, many suggested, but it could not influence the real economy. What was necessary instead was fiscal expansion, which could bypass a limping banking system and plow money directly into the economy.

A more sophisticated critique emerged from people like Paul Krugman, who diagnosed the economy has having sunk into a liquidity trap. With interest rates near zero, he argued, balance-sheet policy—swapping one zero-yield asset for another—was unlikely to prove effective. The only way the central bank could further stimulate the economy would be to slash the expected real return on bonds below zero by promising high inflation in the future. But this was hopeless; to do this, the Fed would have to credibly promise to “be irresponsible”: to tolerate inflation in some future in which the economy was no longer at the zero bound. Since no one would believe that the Fed would do such a thing, no one would expect high future inflation. The only solution to the problem is fiscal stimulus.

.  .  .

As these debates were playing out, a dissenting voice emerged in a tiny corner of the economics blogosphere. On February 2nd, 2009, Scott Sumner launched his blog with a flurry of posts assailing the conventional wisdom on monetary policy. But almost no one knew who Mr Sumner was, and so no one read those posts. Then on February 25th, Tyler Cowen linked to his blog, and readers and comments began trickling in. Mr Cowen’s status within the economics blogosphere signaled to the rest of us that these were ideas worth engaging.

The result was a long and detailed conversation on Mr Sumner’s key ideas, the heart of which was a call to refocus monetary policy on nominal GDP rather than inflation. As Mr Sumner is quick to admit, this is not an idea original to him. Rather, he argues (compellingly, in my view) it is one that follows directly from Milton Friedman’s monetarist revolution but which lost out to inflation targeting during the early years of the Great Moderation. The insight is that the central bank’s provenance isn’t the money supply or interest rates or inflation but simply demand, best captured in nominal output or income: the total amount of money spent each year. If one accepts, as most macroeconomists do, that nominal shocks can have real consequences, and if one then accepts, as is common, that central banks ought to try to smooth out nominal shocks, then it makes the most sense to just stabilise the biggest nominal aggregate. Alternatively, the best way to insure against a damaging fall in demand is to make sure that demand doesn’t fall, or at least to promise to quickly rectify any demand drop that does occur, by maintaining a stable path for nominal output growth.

.  .  .

The notion that the central bank should focus on raising NGDP and that inflation is largely a sideshow has taken a while to catch on. But caught on it has. That is down partly to the effectiveness of the idea itself and the argument developed by Mr Sumner. And it is down partly to the fact that Mr Sumner’s framework has done a good job explaining the ups and downs of recovery. Blogs helped his idea find an audience. As the audience grew, Mr Sumner was able to find print outlets for his views. And through blogs, economists advancing the idea were able to communicate and deepen their arguments, eventually forming what has been called the first school of economics to emerge online: the market monetarists. This school now has a book out, edited by David Beckworth.

As the blogosphere cottoned on to the idea, it seemed to trickle up. This newspaper covered the idea in a column in August of last year. In October of 2011 Goldman Sachs’ Jan Hatzius endorsed the idea in a research note, and Christina Romer, a former head of Barack Obama’s Council of Economic Advisers, signed on in a column at the New York Times. In November of last year, Mr Bernanke was asked about NGDP targeting at a post-meeting press conference. And at this year’s Fed convocation in Jackson Hole, renowned monetary economist Michael Woodford presented a paper to an audience of central bankers which came down in support of the concept.

.  .  .

As the market monetarist community is now pointing out, the Fed’s new policy is a step in the right direction, but it is a long way from what they would actually recommend implementing. And they’re right. Fairly or not, however, the policy will be judged as a test of market monetarist ideas. Yesterday’s market moves suggest that nominal output growth should accelerate in coming quarters. How much acceleration is likely to occur will depend on how much room the Fed is willing to give the economy to run. If the rise in inflation expectations leads the Fed to begin walking back its new language a month from now, the gain will be small.

.  .  .

It is unfortunate for the school’s adherents that both the victory and the test are so incomplete. But they should be glad and proud all the same. And for the sake of the unemployed, let’s all hope they’re right.

In early 2013 Keynesians like Mike Konczal and Paul Krugman predicted that fiscal austerity would slow growth.  Indeed they were so confident that this would occur that they suggested 2013 would be a “test” of the market monetarist proposition that monetary stimulus would offset the effect of fiscal austerity.  If GDP in 2013 kept growing as fast as in 2012, the Keynesians would be proved wrong.  It didn’t grow as fast, it grew considerably faster.  Keynesians tend to cite real GDP growth, which accelerated from 1.60% in 2012 to 3.13% in 2013 (Q4 over Q4.)  Nominal GDP growth (the variable Keynesians should use to analyze austerity) rose from 3.47% to 4.57%.

Ryan Avent was right that what people really care about is jobs, and in the period since December 2012 the unemployment rate has fallen considerably faster than during the previous three years.  Of course after market monetarism passed Krugman’s “test” with flying colors, he denied that any test had taken place.  But you can be sure that if there had a been a recession in 2013, Keynesians would not now be saying that the increase in income taxes, payroll taxes and budget sequester of 2013 weren’t really all that important.  Here’s how Krugman characterized the austerity in April 2013:

as Mike Konczal points out, we are in effect getting a test of the market monetarist view right now, with the Fed having adopted more expansionary policies even as fiscal policy tightens.

And the results aren’t looking good for the monetarists: despite the Fed’s fairly dramatic changes in both policy and policy announcements, austerity seems to be taking its toll.

As far as point 4, if you want to see Keynesian skepticism about the ability of central banks to depreciate their currency at the zero bound, then check out this Krugman post.

Kevin Drum also mentions Brad DeLong.  Here’s DeLong in early 2009:

The fact that monetary policy has shot its bolt and has no more room for action is what has driven a lot of people like me who think that monetary policy is a much better stabilization policy tool to endorse the Obama fiscal boost plan.

The fact that Gary Becker does not know that monetary policy has shot its bolt makes me think that the state of economics at the University of Chicago is worse than I expected–but I already knew that, or rather I had thought I already knew that.

Just like Krugman, he mocks those who suggest that much more monetary stimulus is possible.  In fairness, both Krugman and DeLong have become more supportive of monetary stimulus in recent years, but I specifically mentioned late 2008 and early 2009.

PS.  I think Ryan Avent overstates my influence on others.  But the important point here is that people like Beckworth and I were getting so much attention because we were saying things that other people were ignoring.  If Kevin Drum wants to argue that we all believe those things today (“we” meaning both Keynesians and MMs), that’s great.  That means we were even more influential than I imagined.

HT:  Simon

Think in terms of policy regimes, not gestures

So the SNB got tired of pegging the Swiss franc, and shrugged.  A gesture.  They insist it was a successful policy, which was no longer needed.  But consider the following from Gavyn Davies:

The SNB balance sheet at the end of December was about 85 per cent of GDP, mostly in foreign currencies, and we do not know whether this has increased markedly during the bout of euro weakness in January. The SNB’s mark-to-market currency losses on Thursday were probably around 13 per cent of GDP (SFr75bn). Paul Meggyesi of JPMorgan says that “the SNB would have been bankrupted by this de-pegging had it not made such a large profit last year”. The SFr38bn profit in 2014 was announced only last week, which is surely not a coincidence.

Many economists believe that balance sheet losses are irrelevant for a central bank, so they should play no role in policy. But the SNB is 45 per cent owned by private shareholders, many of whom are individuals, who receive dividends from the SNB. The rest is owned by the cantons, which have been complaining recently about insufficient cash transfers from the SNB.

Losses of 13% of GDP are pretty significant.  And contrary to the claim of the SNB, Switzerland today is far worse off than in 2011, right before the currency was pegged.  The SF is far more overvalued, having risen an astounding 21% in just a few days.  And Switzerland was experiencing deflation at the previous exchange rate of 1.20!

Robert Lucas kept emphasizing that we need to think in terms of policy regimes, not discretionary decisions at a point in time.  And this is what defenders of the SNB miss.  They don’t have a cohesive regime in place.  It’s almost impossible to figure out what they are trying to accomplish. Even if we assume that political constraints put them in a difficult position (a hypothesis I am willing to entertain), the past 4 years of SNB policy are not defensible as making the best of a bad situation.  For instance, why wait until the peg is broken before lowering the interest rate to negative 0.75%?  (Insert horse/barn door analogy here.)

If the SNB was having trouble meeting its conflicting mandates, then it should have gone to the government long ago to discuss options.  Instead it blindsided the government with a panicky move.

A policy rule worked very well for 3 and 1/3 years, delivering good macroeconomic outcomes.   Then the SNB switched to a discretionary regime and promptly lost 75 billion SF.  Don’t blame the policy rule.

Yes, some bad things might have happened if the peg had been maintained, but nothing like the bad things that are about to happen.

There’s a reason markets didn’t expect this—it’s a really dumb move.

PS.  Of course I think NGDP targeting is far better than a fixed exchange rate regime, but there are things far worse than either.

HT:  Tyler Cowen

Reply to Tyler Cowen

Tyler has a new post where he makes this claim:

More concretely, I am not persuaded by the view that a kind of sheer internal commitment to good outcomes, however sincere, can sustain a peg or nominal target.  The outside world always impinges on the logic of commitment, and thus capital is required.  This is also why I do not agree with Scott Sumner’s claim that a truly credible Swiss target, eliminating the need to expand the SNB balance sheet to make it stick, is possible circa January 2015 or for that matter anytime soon.

Just to be clear, the post Tyler links to does not claim that a currency peg eliminates the need for a central bank to buy assets, and indeed the SNB had to buy assets to maintain its recent peg (which was “truly credible.”)  My claim is different, that the switch to tighter money in Switzerland will require an even bigger balance sheet; it will require the SNB to buy even more assets than the previous policy.

In this case, Tyler may be showing too much respect for the decision-making of central banks.  He should show the SNB exactly the same respect that the market showed their recent decision.  Yes, there are scenarios where you could imagine a central bank having capital problems.  That scenario does not fit Switzerland circa 2015, and even if it did the recent policy switch is not an effective solution. Indeed it makes the problem worse.

Update:  Over at Econlog I reply to a comment by Bill Woolsey.

If you do it they will believe

Paul Krugman has a post discussing the recent Swiss move to sharply appreciate their currency, despite deflation in Switzerland.  I agree with much of what he has to say, but not everything:

Two things to bear in mind. First, having in effect thrown away its credibility – in today’s world, the crucial credibility central banks need involves, not willingness to take away the punch bowl, but willingness to keep pushing liquor on an abstemious crowd – it’s hard to see how the SNB can get it back.

That’s not quite right.  It’s very easy to see how they could get it back—simply re-peg the SF at 1.20/euro. The second peg would be much stronger than the first, because the markets would think the following:

“Wow, what a humiliating reversal from the SNB! The result of letting the SF float must truly have been catastrophic for them to do such an embarrassing about face after 3 days.  Obviously they won’t ever make that mistake again.  The new peg will be solid as a rock!”

It’s easy to see how they “can” get it back.  Rather what Krugman should have said is “it’s hard to see them getting it back.”  And he would have been right.  I can’t imagine the SNB re-pegging at 1.2, and hence future SNB promises will be less likely to be believed.  Ditto for promises from other central banks.

Update:  Andy Harless beat me to it.  And several commenters pointed out the SNB is already thinking about depreciating the SF.  But you know they won’t go all the way back to 1.20, which means they’ll have to try much harder.

But the real problem is not lack of credibility; it is that central banks have the wrong target.  If they would actually target inflation at 2%, or NGDP growth at 5%, the markets would believe them. Why wouldn’t they be believed?  The markets aren’t stupid.  Yes, they’ll get blind-sided occasionally as we all were by the Swiss, but (on average) markets will forecast central banks to do exactly what they will do.  Do it and markets will believe.

Back to Krugman:

These days it’s fairly widely accepted that it’s very hard for central banks to get traction at the zero lower bound unless they can convince investors that there has been a regime change – that is, changing expectations about future policy is more important than what you do now. That’s what I was getting at way back in 1998, when I argued that the Bank of Japan needed to “credibly promise to be irresponsible,” something it has only managed recently.

Krugman thinks the problem is the zero bound, but that claim is simply no longer plausible.  The Fed is itching to raise rates around mid-year, despite 10-year inflation forecasts that are far below 2%, and even worse the Fed is officially targeting PCE inflation, which run 0.3% to 0.4% below the CPI inflation embedded in TIPS spreads.  There’s a reason markets don’t expect 2% inflation; the Fed is behaving as if it is targeting inflation at slightly below 2%.  When we were at the zero bound you could have made a semi-plausible claim that it was all due to monetary policy impotence (even though that claim was false) but that view no longer has any plausibility in a world where the Fed is about to raise rates.

(In my monetary offset posts I used to get hammered by the argument, “but surely you agree the Fed would prefer inflation to be higher?”  OK, where are you guys now that the Fed is about to raise rates?)

I wish I could recall the post I did around 2009 or 2010 where I said the validity of market monetarist arguments would be much more obvious when we finally exited from the zero bound. (I based that on the fact that the causes of the Great Depression became much easier to see during the long recovery period.)

The “promise to be irresponsible” argument is also false.  Central banks need to promise to be responsible.  They need to set a price or NGDP level target, and promise to do whatever it takes to hit that target.  Krugman is wrong when he claims the BOJ has recently been irresponsible (meaning that it has generated high inflation.)  It has not done so.  Apart from the one-time boost from higher sales taxes, Japanese inflation has been running around 1%.  That’s better than the deflation they used to suffer, but it falls short of their 2% target.  Being irresponsible has nothing to do with it.  BTW, the Swiss move makes me more inclined to believe the Japanese will quietly give up on their 2% inflation target.

In my comment sections I see continued confusion about central bank balance sheets.  People seem to think that the Swiss needed to let their currency float to avoid a big balance sheet.  Over at Econlog I explain why letting the currency float will lead to a bigger balance sheet than the previous peg (especially if you hold IOR constant—recall they could have lowered the IOR to negative 0.75% without breaking the exchange rate peg.)

Maybe the following analogy will help.  Imagine a teenage girl that is depressed about her looks, and spends all day lying on the couch eating Ben and Jerry’s ice cream, and watching TV.  She doesn’t want to change her behavior, but wants to look slim and pretty.  What do you tell her?

Now imagine a central bank that wants to run a deflationary monetary policy, but insists it doesn’t want a big balance sheet.  What do you tell it?  The SNB reminds me of that teenage girl.

PS.  Tyler Cowen has a good post on the ECB’s anticipated QE program.  I am equally skeptical. It will probably help a little, but the good that will result is probably already priced into the euro/dollar exchange rate.  That’s not nothing, but it’s far short of what’s needed in the eurozone.

PPS.  Some commenters have criticized my support of fixed exchange rates.  I oppose fixed exchange rates.  It’s just that the Swiss 1.20 peg was less bad that what came before or after.  There are degrees of badness.