Archive for the Category Monetary Policy


The second step

A few weeks ago, I published a post discussing the minimum acceptable level of Fed accountability.  At a minimum, any institution needs to establish some procedure to evaluate how they are doing their job.  The Fed’s main job is to use its policy instruments to nudge AD up or down in a way that they think is most likely to hit their inflation and employment targets.  That’s monetary policy.

Because of policy lags it’s not always clear what current instrument setting is most likely to lead to an increase in AD that is compatible with on-target inflation and employment.  Thus the Fed needs to periodically evaluate past FOMC meetings, and tell the public whether, in retrospect, the policy stance set at the earlier meeting was too expansionary, too contractionary, or about right.  They can use any criteria they wish, it’s up to them.  Just tell us how well they are hitting they AD goals. Who could object to that?

It’s rather shocking the Fed doesn’t currently meet even that extremely minimal level of accountability.  Of course more would be better.  Ken Duda sent me some ideas that form a useful second step, still falling well short of NGDP targeting (an idea rapidly gaining popularity among the elite.)  Here’s Ken’s still extremely modest second set of steps:

1) publishing an NGDP forecast

2) publishing a forecast of how policy instrument settings would affect NGDP (“if we were to raise interest rates, we’d expect the NGDP level to be X% lower than if we hold interest rates at zero”).

3) forecasting what are desirable levels of NGDP, i.e., what NGDP level-path would be most consistent with the dual mandate, or what NGDP level-path would be consistent with what level of unemployment or inflation

4) operating a prediction market for any of the three above

I can’t even imagine how anyone could oppose any of those 4 steps, even if they were 100% opposed to NGDP targeting.  How would that information not be useful? Of course it would be useful, it would help markets to better understand what the Fed is doing.  Instead we see statements from Fed officials implying that the economy is currently skating on the edge of recession (my words not hers) and also that the Fed may well increase interest rates in the near future. No wonder markets are confused.

PS.  The first quarter was negative for both real and nominal GDP, and Cleveland Fed president Federal Reserve Governor Lael Brainard sees no bounce back in Q2.  Obviously I meant “recession”, not actual recession, which won’t happen even if we have 2 negative quarters.

PPS.  Over at Econlog I have an update on Summers’ NGDP targeting comments.

Marcus Nunes was right

More than three years ago Marcus Nunes did a post taking on two of my favorite macroeconomists, Robert Hall and Greg Mankiw.  It hardly seems like a fair fight, as Marcus is merely an amateur market monetarist down in Brazil.  And yet, I’ll show that Marcus was correct in both disputes.  In a January 2012 post, Marcus quotes from a Ryan Avent post.  Here’s Ryan:

This time around, Mr Hall addressed the point head on. He noted that in a liquidity trap, the real rate of interest was simply equal to the negative inflation rate. In other words, if the Fed’s nominal rate is at 0% and the inflation rate is 2%, then the real rate of interest is -2%. If a -3% real interest rate is necessary to clear the economy, then all that’s needed is a higher rate of inflation—3% rather than 2%. Mr Hall noted that this was an important point because potentially the Fed could have an enormously helpful impact on the economy simply by raising inflation just a little. And here’s where things got topsy-turvy. Mr Hall argued that (my bold):

  1. A little more inflation would have a hugely beneficial impact on labour markets,
  2. And a reasonable central bank would therefore generate more inflation,
  3. And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore
  4. The Federal Reserve must not be able to influence the inflation rate.

Both Ryan Avent and Marcus Nunes thought Hall was wrong.  So did I.  I could have given dozens of reasons.  Bernanke said the Fed could do more.  The Fed had not done the things Bernanke recommended the Japanese do.  The market response to QE rumors. The difference between central banks that did QE and those that didn’t.  Since this time we have lots more evidence, such as the Abe policy in Japan, which has pushed the yen from 80 to 125/dollar.  Despite the recent dip due to falling oil prices, Japanese inflation since 2013 is significantly higher than before.

But even if that was all wrong, we can still be 100% certain that Hall was completely incorrect.  Indeed it’s not even a debatable point anymore.  Why?  I hope it’s obvious to everyone by now.  Hall is wrong because the Fed plans to raise interest rates later this year, even though they expect inflation to continue running below 2%.  So the Fed does not want to raise its inflation target to 3%.  Period. End of debate.

[Isn’t it wonderful when economic debates get resolved with 100% certainty!  It happens so rarely.]

Now on to the next victim, Greg Mankiw.  Here he quotes Mankiw discussing the condition of the economy in early 2012, in light on Mankiw’s own version of the Taylor Rule:

Not surprisingly, the rule recommended a deeply negative federal funds rate during the recent severe recession.  Of course, that is impossible, which is why the Fed took various extraordinary steps to get the economy going.  But note that the rule is now moving back toward zero.  As Eddy points out, “At the current inflation rate, the unemployment rate needs to drop to 8.3% from the current 8.5% for the model to signal positive rates. We’re getting close.”

To be fair to Mankiw, he doesn’t explicitly say the Fed should raise rates when unemployment falls to the low 8% range, even if inflation stayed about the same. There’s some wiggle room.  So let me just say that I think the vast majority of readers would have assumed that Mankiw was stating that policy implication with approval.

In any case, we now know that tightening monetary policy in early 2012 would have been a big mistake.  Actual unemployment has fallen rapidly to 5.4%, and inflation remains well below the 2% target.  Furthermore, inflation is expected to remain below target for an extended period, while unemployment is expected to keep falling. Tightening policy in 2012 would have been a mistake, even if you were a hawkish Fed policymaker who would prefer to ignore unemployment and focus like a laser on their 2% inflation target.

In contrast, the ECB did raise rates a few months before the Nunes post, and we now know that the result was disastrous.

The bottom line here is that the Taylor Rule (in any form) is not a reliable instrument rule.  That’s not to say that the Taylor Principle is without value—I think it contributed to the successful Fed policy of the Great Moderation period.  But as a rigid instrument rule it simple doesn’t work.

PS.  In my tradition of “burying the lede”, let me point to a comment left by Julius Probst:

Yesterday, Larry Summers held a speech at DIW Berlin here in Germany, talking about secular stagnation.
He mentioned that bond markets expect low trend real growth rate in the years to come, low inflation rates and low interest rates – all of that is true in my opinion and I think that the FED is much too optimistic expecting long-term interest rates at 4% in a few years. It won’t happen.

I got to ask Larry Summers a question whether he favors more aggressive monetary stimulus – he does – and whether he favors a different monetary target.

He was against a 4% inflation target, but he favored a NDGP target !!!! I think that might have been the first time he did so in public ? At least the first time I know about it.

The same with me, I’d never heard that he favored NGDP targeting.  Maybe I backed the wrong horse in the Fed race last year.  Oh well.  I’d appreciate it if someone could send a link as soon as possible.  With endorsements by Woodford, Romer, McCallum, Frankel, DeLong, Krugman (sort of), Bullard, and now Summers, there is obviously strong momentum toward NGDP targeting among the macro elite.  So much for the silly view that MM ideas are becoming less popular.  (Of course I’m not claiming that our blog posts actually caused any of these conversions, just that our policy ideas are getting more popular.)

Recommended reading

1.  For a guy who has been right about everything, Paul Krugman sure is wrong about an awful lot of things.  Bob Murphy has an excellent new post which digs up lots of Krugman claims that turned out to be somewhat less then correct.

Krugman, armed with his Keynesian model, came into the Great Recession thinking that (a) nominal interest rates can’t go below 0 percent, (b) total government spending reductions in the United States amid a weak recovery would lead to a double dip, and (c) persistently high unemployment would go hand in hand with accelerating price deflation. Because of these macroeconomic views, Krugman recommended aggressive federal deficit spending.

As things turned out, Krugman was wrong on each of the above points: we learned (and this surprised me, too) that nominal rates could go persistently negative, that the US budget “austerity” from 2011 onward coincided with a strengthening recovery, and that consumer prices rose modestly even as unemployment remained high. Krugman was wrong on all of these points, and yet his policy recommendations didn’t budge an iota over the years.

Far from changing his policy conclusions in light of his model’s botched predictions, Krugman kept running victory laps, claiming his model had been “right about everything.” He further speculated that the only explanation for his opponents’ unwillingness to concede defeat was that they were evil or stupid.

Read the whole thing.

2.  Caroline Baum has a very nice post on “never reason from a price change.”  She’s one of the relatively small number of journalists that seem to really get this idea.

The Fed is equally confused when it comes to long-term rates. If you were to ask policy makers if interest rates move pro-cyclically, they would all answer yes. But when rising market rates become a reality, the cries go out that higher rates will damage the economic growth. At the same time, a decline in long rates is automatically assumed to provide economic stimulus. Alas, the expectation that the 100-basis-point decline in 10-year Treasury yields last year would boost investment was mugged by reality.

Getting back to oil prices, economists are still waiting (hoping?) for the oil-price-tax-cut to materialize. Bad weather is getting old as an excuse.

Read the whole thing.  Moving from the sublime to the ridiculous:

3.  John Tamny has a post entitled:

Baltimore’s Plight Reveals the Comical Absurdity of ‘Market Monetarism’

In case you are wondering who John Tamny is, in an earlier post he explained that Bernanke’s inflation targeting idea was unwise, as it would imply that each and every price was stable, not just the overall price level.  Flat panel TV prices could no longer decline.

I’m too busy to do a post mocking all of Tamny’s more recent claims, but he was polite enough to write it in such a way that all I really need to do is quote him.  It’s self-mocking:

‘Market monetarists’ believe that economic growth can be managed by the Federal Reserve.  .  .  .

Market monetarists’ believe the Fed can achieve the alleged nirvana that is planned GDP growth and national income through money supply targets set for the central bank by members of the right who’ve caught the central planning bug.  .  .  .

In fairness to the neo-monetarists, they would all agree that Baltimore has problems that extend well beyond money supply. Still, if money supply planning is the alleged fix for the broad U.S. economy, presumably it would have a positive impact locally.  .  .  .

Specifically, ‘market monetarists’ seek consistent money supply growth, and then when the economy is weak, a bigger increase in the supply of money to boost GDP. . . .

It’s kind of simple. Money supply once again can’t be forced. . . .

It can’t be repeated enough that production is money demand, and is thus the driver of money supply. Money supply shrank in the 1930s not because the Fed decreased it (if it had, alternative sources of money would have quickly revealed themselves), but because the federal government erected massive tax, regulatory, and trade barriers to production. All that, plus FDR’s devaluation of the dollar from 1/20th of an ounce of gold to 1/35th of an ounce in 1933 further put a damper on the very investment that powers new production. It’s forgotten by economists today, but when investors invest they’re tautologically buying future dollar income streams.

If you are looking for a few laughs, the Tamny piece is highly recommended. Indeed I’d call it “tautologically funny.”

PS.  Over at Econlog I have a new post that indirectly addresses some of the confusion in the Tamny post.

HT:  David Beckworth

Update:  Well I may not have gotten the ECB to adopt NGDPLT, but consider this comment from yesterday’s post:

Must be nice to be the sort of rich hedge fund manager that gets this “critical” information before the rest of us.

And from today’s WSJ:

The ECB will post speeches of its board members on its website when they are scheduled to begin, without making them available to journalists ahead of time under embargo as the ECB had done for many years.

The decision, which takes effect immediately, came one day after the public release of comments by executive board member Benoit Coeuré caused a stir in financial markets. Mr. Coeuré  said the ECB would front load bond purchases under its €1.1 trillion ($1.2 trillion) quantitative easing program in May and June to account for a summer lull in bond markets.

HT:  lysseas

What happened to the QE skeptics?

I don’t hear much anymore from people denying that printing money boosts NGDP. Perhaps this story from yesterday morning explains why:

The comments from Benoit Coeure, initially made in private on Monday at a conference attended by one of Britain’s richest hedge fund managers Alan Howard, some of his peers and academics, sent markets into a flurry when they were published on Tuesday.

Anticipating a flood of yet more euros onto the market, the single currency tumbled when the ECB released its Executive Board member’s remarks, sending European shares rising to near multi-year highs.

Coeure said the speed of the recent spike in bond yields, was worrisome and that the ECB could “moderately” increase its buying in May and June so that it did not fall below its monthly buying target. He said, however, that the two were not linked.

Other central bankers chimed in with support for the ECB’s fledgling scheme to buy 60 billion euros a month of chiefly government bonds, a programme known as quantitative easing.

“The Eurosystem is ready to go further if necessary …,” Christian Noyer, who as governor of the Bank of France also sits on the ECB’s decision-making Governing Council, said in Paris.

The excitable market reaction, pulling the euro down below $1.12 and paring back the returns or yields on government bonds, illustrates how critical money printing is to confidence.  (emphasis added)

Two comments:

1.  Yes, the markets are right that money printing is critical.

2.  Must be nice to be the sort of rich hedge fund manager that gets this “critical” information before the rest of us.

Then there are those who are agnostic on the real economy, but insist that QE is blowing up bubbles:

Academics will no doubt be discussing the effectiveness of QE in lifting the real economy for a couple of generations at least, and probably not reaching any definitive conclusions. Perhaps it pulls countries out of a recession, or perhaps they would have eventually started to grow again anyway? One thing we can say for sure, however, is that it boosts asset prices.

In fact, it is already happening. A series of Mario Draghi bubbles are already inflating across the eurozone. Where exactly? Well, Spanish construction is booming, Dublin house prices are soaring, German wages are accelerating, Malta is riding a wave of hot money, and Portuguese equities are among the best performers in the world. For a lucky few investors, QE is already working its magic.

In the 21st century, pundits will be unable to see anything other than recessions and “bubbles.”  There will no longer be periods of stable growth without “bubbles,” like the 1960s.  Of course bubbles don’t actually exist, but low interest rates as far as the eye can see means that asset prices will look bubble-like unless artificially depressed by a tight monetary policy that drives the economy into recession.

By the way, the rest of the article has data that supposedly supports the claims in the quote above, but they aren’t even close to being adequate.  Spanish construction is booming”?  How would we know?  They support that claim by pointing to a recent 12% rise in construction.  They don’t tell you whether that’s from a highly depressed level. Didn’t Spanish construction fall something like 60% or 80% during the Great Eurozone Depression? German wages accelerating?  We are told one German union got a 3.4% wage increase. That’s it. Malta’s property prices are up 10%.  Portuguese stocks are up 25%.  Snippets of information that provide essentially no support for the bubble claims being made.  But when you are sure that QE is blowing up “bubbles”, I guess that’s all you need.  After all, there could not possibly be any rational explanation for Malta’s property prices rising 10%, could there?

Surprise, the Fed again overestimates growth

The first quarter NGDP growth numbers are in, and they show about 0.1% annualized growth.  The Hypermind full year forecast fell from 3.8% to 3.6% on the news.  I doubt if we’ll even hit 3.6%, which would require nearly 4.8% annual growth for the final three quarters of the year.

The Fed seems anxious to raise interest rates this year, but I’m having trouble understanding what “problem” this is supposed to solve.

Overheating?  Expected future overheating?

Or is this urge a sort of atavistic gesture, like an arm or leg that suddenly jerks after being still for too long?  Are they planning to raise rates because . . . well because it’s the job of central banks to move interest rates to and fro?

The new and improved modern Fed says they will be “data driven.”  OK, what do they learn from the fact that the economy is once again underperforming their expectations?