Archive for the Category Monetary Policy


The Chicago School of Economics

Congratulations to Pace University, for winning the 2014 Fed Challenge.  The Bentley team (which was superb, as usual) represented the New England region in the competition.  After they returned I was told that the University of Chicago team presented a proposal that involved NGDP targeting.

As a Chicago alum, I’m happy to hear that the economics program is still do a good job of teaching its students.  I was also told that at one point the Chicago team mentioned NGDP futures targeting as an option.  That actually made me a bit sad, as I was never taught that cool idea when I attended the UC in the late 1970s. That’s not fair!

Then I remembered why; NGDP futures targeting had not yet been invented when I attend to UC. So there would be no way for me to have learned about the sort of monetary policies that make sense in a world of efficient markets.  At least I was fortunate to study at a university that had people like Lucas and Fama, and hence I learned the tools necessary to create those sorts of proposals. And that’s all you can ask for.

PS.  I was told that Evan Soltas was on the Princeton team, which came in second. Nice job.

PPS.  I have a post on the ECB over at Econlog.

Germans now favor a dual mandate for the eurozone; inflation and growth

Back in 2011, rising oil prices (and higher VATs) briefly pushed inflation above the ECB’s near 2% target.  Some pundits suggested it was unwise to tighten, because unemployment was so high, and the price increases were transitory, but the German’s insisted that the ECB must focus like a laser on inflation, and ignore all other factors.  So the ECB tightened repeatedly in 2011, driving the eurozone into a catastrophic double dip recession (depression?)

And now we face the opposite situation.  Eurozone inflation is down to 0.3%, and plunging oil prices seem likely to send it even lower.  So once again the Germans are suggesting that the central bank focus like a laser on . . . both inflation and growth:

German council member Jens Weidmann signaled how oil is now a focal point in the quantitative-easing debate when he said last week that the drop in energy costs is like a mini stimulus package, suggesting no need for the ECB to expand its current measures. The opposing view, previously argued by Draghi and ECB Chief Economist Peter Praet, is that temporary price shocks can deliver lasting harm to an economy as feeble as the euro area’s.

Seriously, it doesn’t matter what the data show, the Germans will always find a reason to favor ever tighter money, ever more deflationary policies.  Even if their own preferred policy (inflation targeting) calls for easier money.

PS.  Over at Econlog I have a related post on the IMF’s shameful record.

HT:  Michael Darda

Update:  For fans of Monty Python, Peter Tasker’s updating of the “What Have the Romans Ever Done for Us?” skit to Abenomics is wonderful.  I won’t quote the whole thing, but the punch line is:

Cleese – Alright, alright. Apart from full employment, higher asset prices, lower interest rates, record-high profit margins, better corporate governance, a tourism boom, more working women, exports and capex, what has Abenomics ever given us?

Twelfth voice – Nominal GDP growth?

Cleese – Growth! Oh, SHUT UP!

HT:  Nicolas Goetzmann

Update#2:  Lars Christensen has an excellent post on the fallacy of pointing to low eurozone bond yields as evidence that monetary stimulus is not needed.

Neo-Fisherism in a world of multiple policy tools

Nick Rowe has another post criticizing the Neo-Fisherian claim that pegging nominal interest rates at a high level would raise inflation to a higher level.  Nick points out that in a model where interest rates are the central bank’s policy tool, the equilibrium is extremely unstable.

In my view the best way to see the problem with Neo-Fisherism is to first consider the situations where it is correct, and then ask what’s wrong with the actual claims being made.

In an earlier post I discussed the situation where Japan had a long-term trend rate of inflation of zero percent, and the US trend rate was 2%.  The BOJ wanted to raise their trend rate to 2%, at least in the long run.  How would a Neo-Fisherite do this?

One easy way is to simply peg the yen to the dollar.  Because PPP tends to hold in the ultra-long run (many decades), Japanese inflation would be expected to rise to 2% on average, although year-to-year changes might be rather erratic.  And because interest parity holds very well, even in the short run, Japanese interest rates would immediately rise to US levels.  BTW, to do this thought experiment right, you’d want to assume it was done in 2016, by which time US short-term rates will be higher than Japanese short-term rates.  You’d like Japanese interest rates to rise immediately.

Of course an immediate rise in short-term Japanese interest rates resulting from a change in monetary policy might be contractionary.  But the BOJ has multiple policy tools, and any contractionary impact can be offset by a suitable one-time depreciation in the yen, before it is permanently pegged to the dollar.  And BTW, if Japan wants 5% inflation they simply need to have a crawling peg, with the yen falling 3%/year against the dollar.

Can this work in a closed economy model, or is it simply a beggar-thy neighbor policy?  Yes, it can work in a closed economy model.  Instead of pegging the yen to the dollar, do a policy of pegging it to gold (or a basket of commodities), and then depreciating the currency by 2% per year against gold (or that basket.)  Now that would be a policy deserving of the name “Neo-Fisherian!”

Ironically, the basic problem with Neo-Fisherism is that it’s way too Keynesian.  The entire discussion is done using Keynesian assumptions—that control of interest rates is what we mean by “monetary policy.”  So when they talk about raising the interest rate peg to a higher level, people naturally assume that this is to be done in the way that Keynesians would raise interest rates, via tighter money.  But tighter money won’t raise the rate of inflation—hence the ridicule.  In fact, Neo-Fisherism is perfectly fine if they’d spell out that they plan to raise interest rates via easier money, as with an exchange rate peg, or a crawling commodity price peg.  Interest rates are only one of many possible policy tools, and in some ways the worst tool because the short-term effect of changes in M on interest rates is often the exact opposite of the long-term effect.  That’s what leads to the instability (or “fragility”) problem identified by Nick.

PS.  Switzerland adopted the policy discussed above just a few years back (depreciate the franc and then peg it to the euro at 1.2.)

A time for nuance

Macroeconomics is really complicated.  I would consider myself a supply and demand-sider, a rational expectations and efficient markets guy, and a market monetarist.

So it’s not surprising that I am often misunderstood, just as more famous bloggers like Paul Krugman are often misunderstood.  When things are far out of whack, as in 2009, it’s much easier to be understood.  You simply need to pound the “monetary stimulus” theme with a sledgehammer.  No nuance required.  As the economy gets closer and closer to the natural rate of unemployment (and we are only about 6 months away), the issues get more and more complicated. Here are some things I find that I need to continually address in comment sections:

1.  Real shocks matter, even when demand is a problem.  If someone with cancer gets stabbed by a mugger on the way to the hospital, they have multiple problems.  Which problem is worse?  Well the stab wound is more acute, but the cancer is a bigger problem in the long run.  A demand shortfall may be more acute, but like a stab wound is more easily treated than structural problems. When an economy has severe structural flaws, a policy of monetary stimulus will not fix the country’s problems.  It will just fix one of them, leaving the more severe problems in place.

2.  Contrary to the recent claim of the New York Times, the definition of a recession is not 2 consecutive quarters of falling RGDP.  The US had a recession in 2001, but we did not have two consecutive quarters of falling RGDP, whereas Japan may have recently seen two consecutive quarters of falling RGDP, but is not in recession.  Economists look at many factors before determining whether a recession has occurred.  Recessions are periods where output falls well below trend.  It matters a lot whether the trend rate of RGDP growth is 7% (China) or zero percent (Japan.)

3.  Monetary offset works by adjusting the long run expected rate of growth in nominal aggregates (such as inflation or NGDP) to offset the effect of fiscal actions.  It is not capable of smoothing out high frequency fluctuations due to real shocks.  A sudden change in government spending, sales tax rates, or a natural disaster, will affect RGDP in the near term, even if monetary policy is offsetting any effects on NGDP 12 or 24 months out in the future.

4.  A failure to achieve RGDP growth and a failure to achieve NGDP growth are logically distinct events.  Don’t confuse them. Many economists use the wrong data when evaluating policy success. If you are making the Keynesian argument that monetary stimulus is incapable of boosting AD, you use NGDP data.  If you are making the Real Business Cycle (RBC) argument that monetary stimulus will not boost output you use RGDP data.  Many Keynesians seem to be oblivious to the distinction between a change in aggregate demand and a changed in the aggregate quantity demanded (caused by a supply shock.) For instance, the April 1 sales tax increase sharply depressed Japanese RGDP in Q2, leaving NGDP almost unchanged.  Keynesians don’t seem to realize that when they complain about slow RGDP growth in a country with high inflaiton (like Britain a few years back) they are making a RBC argument, which tends to discredit the Keynesian model.  There are lots of ways that policy can “fail.”  If you don’t know the right data to cite to make your point, no serious economist will pay attention to your arguments.

Furthermore, the EMH says the efficacy of policy is evaluated at the point it is announced (if a surprise) not after the fact.  There is no “wait and see to ascertain whether Abenomics worked.”  It was obvious from the get go that it would “work” in a limited sense, but fail to achieve the announced goals.  And it has.  If Japan wants to boost trend RGDP growth, then they need to adopt supply-side reforms.  Printing money doesn’t solve that problem, especially in a country with 3.6% unemployment.

5.  Rational expectations theory says that monetary policy cannot be evaluated in isolation, but rather must be considered in the context of a clearly spelled out policy regime.  Admittedly, when things are clearly far off course, (as in 2009) you can assume monetary policy is too tight under any plausible policy regime.  But not today.  For instance, I could easily construct plausible arguments for money being either too easy or too tight:

a.  Too tight:  Because we are likely to hit the zero bound in the next recession, policy should be more expansionary, to promote a trend rate of NGDP growth high enough to keep us away form the zero bound.

b.  Too easy.  NGDP growth is likely to average a bit over 3% over the next few decades, given the Fed’s inflation target.  In recent years it has run a bit over 4% per year.  If it keeps that up it will later have to be offset with sub-3% NGDP growth, perhaps leading to recession.  Inflation should be low during booms and high during recessions.  Yet Janet Yellen seems to be determined to raise inflation up to 2%, probably getting there near the peak of the business cycle.

Which do I believe?  Neither.  I don’t know what’s optimal until I’m told what sort of objective the Fed has in the long run.  Tell me their long run NGDP target, and I’ll tell you whether money is too easy or too tight today.

It’s much better to live in a place like Switzerland where the problems are complex and the solutions are unclear, rather than North Korea where the problems are simple and the solutions are straightforward.

Were market monetarists wrong about Japan?

If there has been any blogger more accurate than me in their claims about Japan in recent years, please send me all his/her relevant posts, so I can can give him/her some praise.

Just to review:

1.  I predicted the BOJ would be able to depreciate the yen, if it choose to do so.  I’ve been proved right again and again.  Paul Krugman had doubts.

2.  I predicted monetary stimulus would boost inflation, but that they’d fail to hit their 2% target (excluding taxes).  I was right.  Krugman’s been all over the map, hostile to fiscal stimulus in the late 1990s, then too pessimistic about the possibilities for monetary policy before Abe, then (perhaps) too optimistic.  And now?  I can’t tell.

3.  I predicted the monetary stimulus would boost growth, but that growth would remain low as the working age population is falling fast.  I was proved right. (Krugman agrees it boosted growth.)

4.  I predicted a growth surge before the April 1 tax increase and a growth slump afterwards.  I was right.  BTW, this has nothing to do with “monetary offset.”  And Japan is not in a “recession.”

I mention this in response to a recent post by Paul Krugman, who has totally forgotten about the outcome of his earlier 2013 “test” of market monetarism, and started claiming that monetary offset doesn’t hold:

The bad growth news shows, pretty clearly, that the consumption tax hike was a big mistake. It also shows, by the way, how weak the market monetarist argument — which is that fiscal policy doesn’t matter, because central banks can always achieve the nominal GDP they want — really is; do you seriously want to contend that Kuroda likes what he sees, that he isn’t trying as hard as he can to boost Japan out of deflation?”

This is Krugman being Krugman—making it seem like his opponents are making idiotic claims.

BTW, Kuroda is engaged in monetary offset (the yen has recently fallen from 109 to 118), just as market monetarists would expect, and no, he is not doing all he can.  For instance, he could do MORE, and in all likelihood will do MORE when he discovers that he needs to do MORE to hit his target.

Perhaps some day Krugman can explain to us how events that we predicted accurately somehow disprove the market monetarist view.  Does he believe that market monetarists claimed that Japanese consumers would be indifferent between buying a car on March 31 and April 1st, after the tax rise?   It sounds like an April Fools Day joke.

The real problem with the sales tax increase is that the money is being used to finance additional government spending.  A few years back the Keynesians told us that taxes didn’t matter very much, it was all about spending.  Well Japan is ramping up its government spending.  Now Keynesians seem to have suddenly discovered that it’s taxes that matter, not spending.

PS.  Just three weeks ago Krugman did a post showing that inflation expectations in Japan have risen to almost 2%.  I doubt that, but let’s say Krugman’s right.  If inflation expectations have risen to close to 2%, then how could the tax increase have had a major impact on the prospects for growth going forward?  Is Krugman making an Art Laffer-style supply-side argument that tax increases reduce growth without reducing inflation? Is he now an inflation optimist and a growth pessimist for Japan?  Where’s the model?  When conservatives used to make that argument he would ridicule it.  BTW, I’m a moderate on this question—call me a supply and demand-sider.

HT:  Michael Darda