Archive for the Category Monetary Policy

 
 

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.  

The Fed finally says “enough”

It would be interesting to know what Fed people like Bernanke and Yellen privately think of the ECB.  Here’s an interesting story on Draghi (who is actually one of the more competent people over there):

Europe is leading a rout that has wiped more than $5.5 trillion from the value of equities worldwide. While data on everything from industrial production in Germany to manufacturing in the U.K. has contributed to the gloom, sentiment began souring on Oct. 2, when European Central Bank President Mario Draghi stopped short of spelling out how many assets the ECB might buy to head off deflation.

“The shock to markets has been so big in the past days, I have doubt that equities will recover from this very quickly,” Francois Savary, chief investment officer of management firm Reyl & Cie., said in a phone interview from Geneva. “Draghi’s latest communication to the market was a nightmare.”

A few years back I used to occasionally point out how much market wealth could be destroyed by the statement of a Fed official.  Of course real economists pay no attention to stock market reactions because everyone (wrongly) knows that stock traders are irrational.  I’m tempted to compare central bankers to children playing with matches, except that children rarely do $5.5 trillion in damage.

In one of the most bewildering statements I’ve ever seen Paul Krugman make, he seems to excuse the ECB’s ineptitude:

Europe has surprised many people, myself included, with its resilience. And I do think the Draghi-era ECB has become a major source of strength.

I suppose Krugman’s defenders will insist he meant “strength” being applied in evil ways.  If so, I’d have to agree.  But most normal people would assume he’s defending the ECB.  Unbelievable.

Meanwhile, in the US things are a bit more sane:

About an hour into the trading day Thursday, with the S&P 500 (^GSPC) at its lows and the smell of fear in the air Bullard took the mic and had his Battle of Agincourt “Once more into the breach…” moment.

“We have to make sure that inflation expectations remain near our target,” said Bullard in reference to the FOMC’s ongoing war against deflation. “And for that reason, I think a reasonable response by the Fed in this situation would be to…. pause the taper at this juncture.”

Just like that feverish selling broke. Bullard’s stirring cry to non-action ringing in their ears, traders began furiously bidding for shares. Yes, a non-voting Fed board member’s oblique reference to the possibility that the Fed may not completely eliminate its now $15 billion monthly QE program this month marked the lows for the correction thus far.

How big was Bullard’s bluster? Based on the World Bank’s estimate of the total market capitalization of US stocks the 2.5% gain in equities just in the States is worth about $420 to $450 billion.

HT:  TravisV,  J.V. Dubois

The real problem with Fed policy

Five year TIPS spreads are at 1.5%.  Because the Fed targets PCE inflation, and because 2.0% PCE inflation is roughly equivalent to 2.4% CPI inflation, the Fed’s target is roughly a TIPS spread of 2.4%.  So 2014-19 inflation expectations are 0.9% below target.  Here’s Ryan Avent:

American markets are once again hunkering down for a bout of disinflation. Expectations for inflation over the next five years have fallen half a percentage point since July, to around 1.5%: a level at which the Fed has previously moved to begin new asset purchases.

It’s important to recall that the Fed has a dual mandate, so this fact doesn’t necessarily imply that money is too tight.  Later we’ll see that it is too tight, but let’s first consider the counterargument.

The Fed’s dual mandate covers both inflation and employment.  Thus the Fed should push inflation above their target when unemployment is high, and they should push inflation below target when the unemployment rate is low.  It seem likely that unemployment will be below average over the next five years, if only because it’s been above average for the previous six.  So it’s possible that money is not too tight.  Possible, but extremely unlikely.  Here’s Ryan again:

THE monetary economics of a world in which interest rates are close to zero are not especially mysterious. Stimulating the economy at that point requires central banks to raise expected inflation. Disinflation, by contrast, results in passive tightening, since the central bank can’t lower its policy rate and since the real interest rate is the policy rate less expected inflation. In this world, the downside risks are much larger than those to the upside. There is infinite room to raise interest rates if inflation runs uncomfortably high (one might even welcome that opportunity to push rates up as that would reduce the probability that rates would fall to zero again in future). But there is no room to reduce interest rates if inflation is running to low. That, in turn, forces central banks to use unconventional policy or run psychological operations to try to boost expectations. Central banks are not very good at those sorts of things.

Suppose that the Fed runs inflation at 1.5% over the next 5 years, and then we hit another recession.  In theory, the Fed should then push inflation much higher.  But as Ryan’s comment suggests, exactly the opposite is likely to happen.  The Fed will let inflation fall even below 1.5% in the next recession, and we’ll be in exactly the same position we are today.

This means that the real problem is not that money is too tight today (although it is) but rather that the entire monetary regime is flawed.  Level targeting of prices would be better (and is the no-brainer solution to the euro-crisis, given their fixation with inflation targeting.  But the ECB is not a no-brain, it’s a negative brain.)  Another solution is NGDP targeting.  Even better would be NGDP level targeting.  These are ways of moving away from the Fed’s current procyclical monetary policy.

Ryan’s comment also points to the danger of passive tightening.  Many people still have trouble with the notion that monetary policy could be tightening even as central banks “do nothing.”  But clearly they can (and this isn’t just a MM view, it’s also a New Keynesian view, and an old monetarist view.)

TravisV sent me an article indicating that the Fed is beginning to understand the situation:

St. Louis Fed President James Bullard told Bloomberg TV that the Fed should consider delaying the end of quantitative easing in response to tumbling inflation expectations.

His concern was tumbling inflation expectations. . . .

Bullard was basically echoing the concerns of San Francisco Fed President John Williams, who suggested the Fed may have to increase its asset purchase program.

I don’t always agree with Bullard, but to his credit his views are always data driven. He’s an important swing vote at the Fed, as he’s one of the moderates.

PS.  Once again, we’d have a much better idea of whether money is too tight if we had a NGDP futures market.  But the Fed isn’t willing to spend $2 million dollars to set up a subsidized prediction market that would provide useful forecasts, even as trillions of dollars of wealth (and lots of potential jobs) are being wiped out each week.  And the economics profession is equally apathetic. Over at Econlog I have a related post.

Update:  Mark sent me an excellent and somewhat related post from a few days back by Tim Duy.  He’d make these points even more forcefully today.  And take a look at the dovish shift in the FOMC next year.  I’d wouldn’t be at all surprised if there were no fed fund rate increases in 2015. Where are 4 votes for higher rates?  The real problem is the eurozone.

Screen Shot 2014-10-16 at 1.50.22 PM

Why are economists in denial about the eurozone?

[Before starting this post, I'd like to thank Timothy Lee for his nice Vox.com post on the NGDP futures market project.]

I do sort of understand why people resist my claim that the Fed caused the Great Recession in the US.  After all, I’m asking people to believe several highly implausible claims:

1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.

2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

3.  Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero.

Although I must say it’s odd that these points are so implausible, after all, they are taken word for word from Frederic Mishkin’s textbook, which was the number one monetary textbook in the US back in 2008.

But here’s what really confuses me.  You don’t even need to make these sorts of “implausible” claims to blame the ECB for the Great Recession (“Depression?) in the eurozone.  I was thinking of this when I heard David Wessel explain the eurozone’s possible triple dip recession on NPR this morning.  Basically he said (as far as I recall):

1.  The 2008-09 eurozone recession was caused by the ripple effects of the US housing crisis.

2.  The 2011-12 double-dip was caused by sovereign debt problems.

3.  The current slowdown and possible triple dip is caused by Russia/Ukraine.

Wessel’s a fine reporter, and it’s his job to express the conventional wisdom.  I have no doubt that he has done so.  But this view seems preposterous to me, on all sorts of levels.

It is possible for real shocks to get transmitted via trade and/or financial channels, even with sound monetary policies.  But even if the linkages are very close (as with the US and Canada), the secondary effects will be milder.  And they were milder for Canada (and would have been still less pronounced if the BOC had targeted Canadian NGDP.) The eurozone is far less closely linked to the US than is Canada (which sends 70% of its exports to the US.)  So the ripple effects should be much milder in the eurozone than Canada.

And even if you don’t buy anything I just said, there is a much bigger problem with the standard view.  It completely ignores the fact that the 2008-09 NGDP plunge in Europe began earlier than in the US and was actually deeper (a bit over 4% vs. a bit over 3% in the US.)

But it’s even worse; the eurozone was already in recession in July 2008, and eurozone interest rates were relative high, and then the ECB raised them further.  How is tight money not the cause of the subsequent NGDP collapse?  Is there any mainstream AS/AD or IS/LM model that would exonerate the ECB?  I get that people are skeptical of my argument when the US was at the zero bound.  But the ECB wasn’t even close to the zero bound in 2008.  I get that people don’t like NGDP growth as an indicator of monetary policy, and want “concrete steppes.”  Well the ECB raised rates in 2008.  The ECB is standing over the body with a revolver in its hand.  The body has a bullet wound.  The revolver is still smoking.  And still most economists don’t believe it.  ”My goodness, a central bank would never cause a recession, that only happened in the bad old days, the 1930s.”

For God’s sake, what more evidence do people need?

And then three years later they do it again.  Rates were already above the zero bound in early 2011, and then the ECB raised them again.  Twice.  The ECB is now a serial killer.  They had marched down the hall to another office, and shot another worker.  Again they are again caught with a gun in their hand.  Still smoking.

Meanwhile the economics profession is like Inspector Clouseau, looking for ways a sovereign debt crisis could have cause the second dip, even though the US did much more austerity after 2011 than the eurozone.  Real GDP in the eurozone is now lower than in 2007, and we are to believe this is due to a housing bubble in the US, and turmoil in the Ukraine?  If the situation in Europe were not so tragic this would be comical.

And now we have a third possible murder, although at least this time the revolver is not smoking (they didn’t raise rates–it was errors of omission.)  Like the Pink Panther series of films, this story is beginning to move from classic comedy to utter farce.

(Whenever I do these posts I can’t get anyone to refute what I am saying.  How could they? But they don’t accept it either.)

PS.  Some commenters will always say; “if it’s monetary, how can Germany be booming?”  As if supply-side factors can’t explain regional variation in a demand slump.  In any case, German real GDP has risen by a grand total of 3% since the first quarter of 2008, vs. 7.5% in the US.  If Germany is booming, how would you describe the US?  And BTW, the recent monthly numbers look pretty good for the US, and horrible for Germany—they are the leading edge of the triple dip.

PPS.  Is there any more confusing database than Eurostat?  I’d expect more of the Iraqi central bank.