Archive for the Category Monetary Policy


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.

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Why are economists in denial about the eurozone?

[Before starting this post, I'd like to thank Timothy Lee for his nice 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. 

Our great, horrible, indifferent labor market

The Great:

The 4-week moving average of layoffs came out today at 287,750.  Total civilian employment in September was 146,600,000.  The ratio of the two, i.e. the chance of being laid [off---ouch that might have been my most embarrassing mistake ever] during a given week if you had a job, was below 2 in 1000.  That’s only happened once before in all of American history–April 2000.  (We don’t have data going all the way back, but the ratio was considerably higher in the booming 1960s, and I’m confident layoffs were much more common in earlier decades for which we don’t have data.  (“Gilded Age” bosses could lay off workers whenever they wanted.) And it seems very likely that we will soon break the April 2000 record, maybe this month.

Update: a bit higher than 2 in 1000 because not all layoffs put in unemployment claims.

The Horrible:

Total employment has barely budged in 7 years, while the employment population ratio has plunged much lower.  We are even seeing a lower employment/population ratio in the key 25-54 demographic, compared to seven years ago.  The U-6 unemployment rate is a very high 11.8%

The Indifferent:

The unemployment rate (U-3) is 5.9%, slightly above the Fed’s 5.6% estimate for the natural rate.

Thanks President Obama, you’ve given us a European labor market.  Workers with good jobs need not fear layoffs; the rest will have to be satisfied with part time work or unemployment.

Of course I’m half joking about Obama.  But just how good is his economic record?  The Washington Examiner has an article that quotes me.

The newest talking point of President Obama and his supporters, such as Paul Krugman, is that we are doing better at job creation than other developed countries.  I don’t think we are doing as well as Australia/New Zealand/Canada/Britain, but it’s surely true overall for one very obvious reason.  The eurozone.

Let’s examine that Obama/Krugman claim more closely.  Everyone seems to agree that since 2010 the US has done considerably more austerity than the eurozone.  No debate there.  And the huge divergence between the US and the eurozone has occurred since 2011.  The initial recession and initial recovery were quite similar in the US and eurozone.

The GOP Congress did exactly the opposite of what Obama wanted on austerity, and the result was that we grew dramatically faster than the eurozone.  That’s Obama’s success?  The big difference was of course monetary policy.  Obama’s comparing us to a region ruled by a central bank that is more incompetent that the central banks of the 1930s (Krugman has some graphs on that point.)

So yes, we are doing better than the eurozone.  Does Obama deserve credit for the fact that our monetary policy was less incompetent than the ECB?  That doesn’t even pass the laugh test.  Even Obama supporter Matt Yglesias says he’s been horrible on monetary policy.  He left multiple seats empty, when he had 60 votes in the Senate in 2009.  He’s doing the same today.  He never appointed a single person to the board who favored the sort of expansionary monetary policy that I favor, that Yglesias favors, that DeLong favors, that Krugman favors, that Christina Romer favors, and that any progressive with half of brain favors.  He almost picked bubblephobe Summers to head the Fed, and had to be stopped by a storm of protest that began here and then spread through the progressive blogosphere.  (Yes, some progressives always opposed him for other reasons; I’m talking about his monetary policy views.)

President Obama may or may not be a good President.  I think he’s been above average on foreign policy.  I’m willing to concede the Obamacare (which I opposed as a missed opportunity) did some good things like the Cadillac tax on health plans and helping the uninsured.  I think the financial reform was a missed chance, but others disagree. I’m disappointed with his record on drugs and civil liberties.

But there can’t be any serious question about the fact that he did NOTHING effective to help the economy.  The US recovery is less than the old trend rate of growth.  Has that ever happened before?  The Fed’s been less inept than the ECB—that’s all.

And the supply-side?  Even his supporters would admit he did nothing there.  They might disagree with the view that a heavy dose of extra regulation, higher MTRs, and no Keystone pipeline slowed the recovery.  But no one claims those actions sped up the recovery.  And the fracking boom (“drill baby drill”) fell on his lap.

Just a few months ago Obama called for an “emergency” unemployment benefit of up to 73 weeks, much longer than during the President Clinton recovery, all because the labor market was doing so poorly nearly 6 years after he was elected.  And now a few months later they are touting their success in creating jobs—unbelievable.

It will be interesting to see how many liberals agree with him.

HT:  TravisV

Out of the Dark Ages: The first step

I’m finally ready to announce the first step in creating an NGDP future market.

[Update:  I won't say much now other than that some very generous offers have been received. Tomorrow I speak with an organization that helps fund innovative projects like this, so perhaps I'll be able to report more in the near future.  I plan to list the names of the people making offers, but will wait until tomorrow, as I'm checking to see who wants to remain anonymous.  The task is slightly more complicated than usual with two different funding targets, but I'll just say at this point that I am very pleased with how things have gone today.]

Future generations of economists will look back on our era with disbelief. Respected economists like Robin Hanson and Justin Wolfers clearly explained how prediction markets could generate all sorts of valuable information for policymakers, at an absurdly low cost.  And they were totally ignored by both policymakers and the economics profession.  The Fed continued to blunder into errors costing hundreds of billions of dollars (like their decision not to ease policy in the meeting 2 days after Lehman failed, on fear of inflation) partly because they weren’t willing to spend a few thousand dollars setting up and subsidizing prediction markets to gather real time investor forecasts.

The biggest problem by far was the lack of an NGDP futures market.  TIPS spreads are fine, but in a world of 2% inflation targeting much of the variation in inflation represents supply shocks, such as unstable commodity prices.  Interest rates are almost useless as a measure of the stance of monetary policy, and the money supply is only marginally better.  We need real time data on the single most important macroeconomic variable in the universe, expected US NGDP growth, which also happens to be the best indicator of the stance of US monetary policy. (Ben Bernanke once suggested that interest rates and the money supply are not reliable, and that only NGDP growth and inflation can reliably indicate the stance of policy.  But inflation is distorted by supply shocks, whereas NGDP is not.)

In recent weeks I have been working with Eric Crampton at the New Zealand Initiative and Robert Quigley-McBride at iPredict.  Robert put together the following proposal, with input from Eric and myself:

iPredict is a real-money prediction market run by Victoria University of Wellington. With over 8000 traders, iPredict is operated by students of the University with the purpose of forecasting social, economic and political events. iPredict has designed contracts for trading to allow forecasting of nominal GDP (NGDP). Traders will be able to buy and sell contracts paying $1 if NGDP falls within a particular range in a particular quarter.

An example contract would pay $1 if the US GDP for Q1 2014 were greater than or equal to $17,250 Billion and less than $17,500 Billion, based upon the [initial estimate for quarterly nominal GDP from] BEA Table in Section 1 – Domestic Product and Income, Table 1.1.5, Line 1. We would establish similar contracts spanning the intervals $250 Billion above and below the example contract, with two open ended intervals beyond those for outcomes above or below the ranges.

The set of contracts, for each quarter, will generate probability estimates for the different levels of NGDP, as well as providing a gauge of the traders’ uncertainty, or margin of error, on this estimate.

To support the accuracy of the forecasting, we wish to provide the market with an injection of liquidity. This will help by ensuring there is sufficient incentive for traders with beneficial information to bring it to the market. To support contracts for forecasting NGDP for the next 3 years, we will need to raise $1500. This will be used to provide a market maker on the contracts, which will ensure there is always a reasonable bid-ask spread, and that any trader wanting to bring information to the market can do so even if there is not necessarily another trader to take the other side in the trade.

An additional option to improve the accuracy of these contracts would be to pay interest on the value of the contracts to any traders holding shares over a long period of time. This would reduce trader reluctance to engage in the long term contracts because of the cost of the capital invested. This option would require substantial back-end system development to track the funds that traders have invested in the contracts, and so it would require funding in the region of $30,000.

iPredict is an authorised futures dealer in New Zealand under the Financial Markets Authority. However, they must strongly discourage Americans from trading on iPredict due to US laws. Anyone wishing to trade on iPredict should take note of the Terms of Service 1.5 “Nothing on this Website constitutes an offer or invitation to trade with any person who is under 18 years of age and/or outside New Zealand. In trading on iPredict, traders warrant that they are complying with all laws in the jurisdiction in which they are present. [bracketed portion added by me]

A few comments:

Obviously the proposal can be tweaked with further input from commenters.  They think a 5-contract setup is best, and I’d be inclined to go something like:

below 2.5% NGDP growth

2.5% to 3.5%

3.5% to 4.5%

4.5% to 5.5%

5.5% or more.

The actual contracts would have dollar amounts specified, however, as the percentages change with revision to NGDP at the starting point.

We would use initial estimates of NGDP, as the later revisions are unforecastable before the initial announcement, so we’ll get an unbiased forecast.  The advantage is that investors don’t have to wait as long for the payoff.

We have to exclude Americans because . . . well because America is no longer a free country.  More specifically there are two problems.  First, iPredict does much more than the Iowa Electronics Market, and hence doesn’t have their waver from the Feds.  And second, there are now incredibly burdensome “know thy customer” rules that America imposes on foreign financial firms dealing with US citizens.  A small entity like iPredict (run by the Victoria University of Wellington) obviously doesn’t have the funds to meet all these burdensome regulations.  Now when I travel around the world almost everyone I talk to in the financial area regards US citizens in roughly the same way they view the Ebola virus.  They see our government has being a sort of madhouse.

You will notice two sums mentioned.  The $1500 figure is the cost of setting up the market.  If that’s all we can raise the market will still go ahead.  However it would be nice if we could raise an additional $30,000, so that the market can be subsidized with interest-bearing margin accounts, which will help insure more trading, more liquidity.

The market may well fail.  There is currently no NGDP market in the private sector, presumably because there is little market demand.  That’s the whole point of prediction markets. Corporations setting up internal prediction markets to forecast next year’s sales don’t do so to meet “market demand;” they want information, the wisdom of crowds.

The market is only a first step.  The goal is to shame the economics profession and policymakers into to setting up a better funded market in the US, with government funds supporting the market.  I’m not normally a fan of big government, but consider:

1.  Market NGDP expectations are a pure public good.

2.  The cost of a superb market would be trivial, a few millions.

3.  The benefit would be in the hundreds of billions, if not trillions.

4.  The trivial cost could easily be more than recouped by cutting the Fed budget for economic forecasting.

It’s a no-brainer for libertarians, but also for thoughtful liberals who agree with people like Christy Romer and Michael Woodford on the importance of NGDP, and the need for wise policymaking.  I see no good arguments against creating an even better market than we will be able to establish.

My initial inclination was to try something like Kickstarter.  But I’m no good with computers, and very busy.  So first I’m going to try to raise all the funds from one or two rich people.  This really shouldn’t be hard.  It should appeal to everyone from liberals like George Soros, to moderates like Michael Bloomberg, to libertarians like the Koch brothers and Peter Thiel.  I recall a few years back that someone sent me a youtube of a west coast billionaire (Valve Corp?) giving a talk, and suddenly casually mentioning the need for a NGDP futures market.  The startup cost ($1500) is pocket change for a billionaire, and even the $30,000 is very affordable.  If that doesn’t work, we’ll try Kickstarter.

As a reward I’m willing to name the market after the big donor when I write about it in my blog. So if Mr. Jones donates $1500, I’ll call it the “Jones NGDP market,” unless they prefer anonymity. If Mr. Smith later kicks in $30,000, I’ll rename it the Smith/Jones NGDP market.  Extra typing for me.  And I still type with two fingers!

This could be a history making initiative.  I implore potential donors to think about what this might lead to, and to consider whether they want to be seen as the visionary who began the long process of modernizing economic policymaking.

Don’t send me money; contact me and I’ll set you up to talk directly to the people in New Zealand. If we do get the market set up, I hope my non-American readers will participate, at least in a small way. It would help to make the market a success.  But again, the real goal is to shame the people in power into stopping all this Nostradamus nonsense, and move economics and economic policymaking into the 21st century.  It’s long past due.

I can respond to comments, or you can email me directly at