Archive for the Category Monetary Policy


Silence is golden

My comment section has recently gone quiet, and I’m loving it.  Before explaining why, let’s consider this comment from Ryan Avent:

This misreading begins with its assessment of the stance of monetary policy; in the BIS’s view low interest rates are indicative of loose monetary policy. My colleague seconds this view, writing that central banks are determined to “keep monetary policy as loose as possible for as long as possible”. But this doesn’t add up. It suggests, for one thing, that monetary policy was remarkably loose during the Depression and extremely tight during the inflations of the 1970s, which we know is not true. It ignores, for another, that central banks have not remotely used all the tools at their disposal.

Remember the old Mad magazine “Spy vs. Spy?”  Reading Free Exchange sometimes makes me think “The Economist vs. The Economist.” Obviously I agree with Ryan the Economist, but what’s more interesting to me is that I can’t get the conventional wisdom to change its mind on this issue, even though I’ve won every argument.  On other issues I can force a debate.  Take monetary offset. I’ve had lots of debates on this issue, and people have presented me with very good arguments against my point of view.  Arguments that I find hard to refute.  It’s an open question.  In contrast, the conventional wisdom continues to plod ahead with the view that money has been easy over the past 6 years, despite the fact that when I challenge anyone on this issue their arguments collapse almost immediately.  No one has ever put even the slightest resistance to my demolition of the “low interest rates implies easy money” argument.  And I’ve debated dozens of economists.  But I can’t budge the conventional wisdom by one inch.  It’s rock solid.

One response is that it doesn’t matter what we call it, it’s just a question of semantics.  But it does matter, as the people who insisted that money was easy have been wrong about the effects of monetary policy.  Many of them argued we needed tighter money to help savers.  They applauded the fact that the sensible Germans stopped the ECB from going headlong into “easy money” like the British and Americans.  They applauded the eurozone interest rate increases of 2011, even though we explained that tight money leads to LOWER interest rates in the long run.  Well now the long run is here, and the German dominated ECB has just driven interest rates into negative territory. How’s that hawkish German policy working for those thrifty housewives in Stuttgart?

Of course being wrong about everything doesn’t stop them from making the same claims over and over again.  Here’s Ryan, sensibly directing his frustration against the BIS so that things can remain civil at The Economist:

Of course, it is grimly amusing to recall that the BIS wanted tighter policy in 2011 to fend off inflation. Had it pushed for more expansionary policy then in order to get a faster recovery despite—or even because of—the risk of inflationary pressures, then the case for higher rates now would be open and shut (assuming rates had not already begun rising). Though it wishes to cast itself as rising above short-termism in macroeconomic policy, it is strangely blind to the risk that excessively tight policy in the short run might lead to interest rates that are lower for longer than would otherwise be the case.

Now about that quiet comment section.  A few years ago I had near constant debates on two fronts. Exhausting debates.  On the left I faced one commenter after another ridiculing the idea that monetary policy could be stimulative at zero rates.  Ridiculing the notion that the “expectations fairy” could help the Japanese economy.  When the 2% inflation target fairy sent the yen sharply lower, and Japanese stocks sharply higher, and NGDP higher, and RGDP higher, and inflation higher, and unemployment to the lowest level in 16 years, it became a lot harder to ridicule my views.  Even fanatics don’t like to appear absurd, and making liquidity trap arguments in 2014 looks absurd. The monetary offset criticism has also died down, although it’s still a bit more of an open question than the liquidity trap nonsense.  But the failure of Krugman’s 2013 “test” certainly helped our cause.

On the right I was hammered by people who claimed my policies were hurting savers.  I tried to patiently explain that in the long run monetary stimulus was the best way to help savers, the best way to boost nominal and real interest rates.  I pointed out that tighter money would simply cause a double dip recession, as in the US in 1937 and Japan in 2001, and that it would lead to lower rates in the lower run.  The ECB ignored this advice in 2011, had their double dip recession, and German savers are now paying the price.

So there’s really nothing much left to debate.  My comment section has become a snoozefest. Maybe I should be like Krugman, and shift over to the inequality issue.  Like me, he was also proved right about everything, or at least that’s what we both claim.  :)

PS. Speaking of The Economist, this is a fascinating article.  If we must have governments, why can’t they all be like the Estonian government?  As my commenter Lorenzo says, small is beautiful.

Watch for the endgame

I just returned from the UK where I gave several talks and interviews.  The main purpose of my trip was to give the Adam Smith Lecture at the Adam Smith Institute.  I was very impressed with the people there, especially Ben Southwood and Sam Bowman.  Here is a link with a video of the lecture.  I also spoke at the Cambridge Union, and to some bankers and Treasury people.  I did a BBC radio interview, and an interview on BBC’s “Newsnight” TV show, which should be broadcast soon.

Almost from the beginning, I’ve been more popular in the UK than the US.  That’s probably because the US has a sharper left/right split.  Over here my views are too right wing for the left (which is rapidly moving ever further leftward), whereas the right sees me as a redistributive Keynesian inflationist.

I noticed that in the UK all the talk is of raising interest rates later this year, as their economy is growing fast and the employment population ratio is nearing the previous all time peaks of 1971 and 2006 (what a contrast with the US!)  You may recall that a few years ago I said that the exit from policies can be very revealing.  It can help us to understand the effects of policy (as when tapering had a market reaction in the US) and also the underlying dynamics of the monetary fiscal interaction.

First a bit of background information.  Since 2008, the UK has run extremely large budget deficits, bigger than the US as a share of GDP. Everyone agrees these are too large, and need to be reduced. But Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument (although I have doubts due to monetary offset), but the implication is that if the recovery ever becomes so strong that you need to raise rates, then clearly the first place to tighten is fiscal policy, and policymakers should only raise rates when the budget deficit has returned to the optimal level based on the classical principles of public finance.  Britain is obviously far from that point.

A few years back I was very skeptical of the notion that fiscal stimulus in the US was being done because of a lack of effectiveness of monetary stimulus.  I predicted that when the time came for tightening Keynesians would prefer monetary tightening to fiscal austerity, even though their own model says that fiscal austerity should be done first, as it reduces the (still too high) budget deficit.

In my admittedly unscientific survey of the UK press it seems to me that there is more enthusiasm for monetary tightening than accelerated fiscal austerity, just as I expected.  Here is an editorial in The Independent, which doesn’t even mention of the option of fiscal tightening.  (And here’s the Times.)

Just to be clear, I am not criticizing the BoE, which has done a good job under Mark Carney. NGDP is rising at a brisk rate.  Given the refusal of fiscal policymakers to speed up the austerity process, the BoE may need to raise rates in 6 months to a year.  That’s monetary offset, and it is quite appropriate.  The real problem in Britain is government spending, which is still too high.  (Or if you are a left-winger, the real problem is that taxes are too low.)

PS.  Obviously I’m pleased that there is a single-minded focus on the BoE as the institution that should and does steer the nominal economy.  It’s a pity that single-minded focus wasn’t there in 2008 and 2009.

HT:  Travis, W. Peden

Why we are in this mess

From the NYT:

President Obama has yet to announce nominations to the remaining vacancies on the Fed’s board, but the White House has signaled that at least one of the two vacancies will be filled by someone with community banking experience.

In other news, American Airlines plans to hire a Boeing 747 co-pilot with experience driving a school bus.

I sometimes wonder if we should drop macro from the intro economics sequence, and just do two  semesters of micro.  Macro’s as hard as quantum mechanics if done right, and if done wrong . . . .

People tell me “you can’t do that, it’s important that citizens be knowledgable about important public policy issues like monetary policy.”

OK, let’s say that’s true.  If so, can you explain to me why citizens need to be well informed about monetary policy, but monetary policy makers don’t need to be well informed about monetary policy?

Just asking.

Seriously, we need two Federal Reserve Boards.  One for monetary policy and one for banking regulation.  Yes, that will add a few million dollars to the Federal budget, but has anyone computed the cost of bad monetary policy and bad banking policy?  Are we such cheapskates that we insist on trying to hire 7 “jack of all trades” to do a crappy job in both areas?

I gave a talk at the Cambridge Union today, which was quite an honor.  Working off the iPad now, so blogging will be sporadic.  Later in the week I’ll have a couple posts at Econlog that were written earlier.




Why are market monetarists such extremists on fiscal policy?

Here’s Simon Wren-Lewis:

I’m interested in this asymmetry, and where it comes from. Why do MM hate fiscal expansion at the ZLB so much? It could be ideological (see Noah Smith here), but I suspect something else matters. I think it has something to do with monetarism, by which I mean a belief that money is at the heart of issues to do with stabilisation and inflation. MM is not about controlling the money supply as monetarism originally was, but I think many other aspects of monetarism survive. My own view is more Wicksellian (or perhaps Woodfordian), whence the failure to be able to lower interest rates below zero naturally appears central. To those not trained as macroeconomists (and perhaps some that are) these sentences will appear mysterious, so if this idea survives comments I may come back to it later.

A few quick reactions:

1.  I seem to recall that some market monetarists think fiscal stimulus is worth a shot.

2.  I’ve argued that some types of fiscal stimulus can survive monetary offset.  For instance, if the central bank is targeting inflation then an employer-side payroll tax cut can work, by boosting aggregate supply.  Christina Romer has made the same argument, although I’m not sure uses the aggregate supply shift framework.  A cut in VAT rates can also help, if the central bank is targeting prices inclusive of indirect taxes.

I don’t think my views on these issues can in any way be described as ideological.  I actually think VATs and payroll taxes are our most efficient taxes, and instead tend to oppose high personal income tax rates.  And recall that fiscal stimulus can involve either lower taxes or higher spending, so it doesn’t fit neatly into a left/right debate over the size of government.

I think Wren-Lewis has a better argument when he points to the fact that MMs often oppose fiscal stimulus at zero rates.  I could write a whole dissertation on this issue (and arguably have in this blog) but here are a few points that come to mind:

1.  Monetary offset is highly counterintuitive.  It’s like the face/vase picture, where something can be easily seen from one perspective, and yet look invisible from another.  Here are a few examples:

a.  In this post I discuss a few comments by Tim Duy, a respected centrist Keynesian, which perfectly describe monetary offset.  Yet I am almost certain that Tim Duy doesn’t agree with my views on monetary offset (i.e. I doubt he agrees that fiscal multipliers are still zero at the zero bound.)  He sees what I see, but (presumably) interprets what he sees very differently.

b.  Paul Krugman said 2013 was going to be a “test” of the MM claim of monetary offset.  When we passed that test with flying colors (as growth accelerated), he ridiculed the idea that there had ever been a test.  Perhaps that’s because he’s so sure the idea is wrong that he assumed any test that seemed to show otherwise must be wrong.  Indeed in the case of the UK he complained about austerity, and then when GDP started accelerating unexpectedly, said something to the effect that on second thought there hadn’t been much austerity in 2012.  Then why not tell us that in 2012?  And suppose MM had failed the 2013 Krugman test?  Does anyone think he would have said “in fairness to the MMs, it wasn’t a fair test, because other things might have changed?”

c.  Many Keynesians accept that monetary offset applies at positive interest rates, but insist it doesn’t apply at zero rates.  But these same Keynesians often insist that fiscal austerity in the eurozone caused the recession of 2011-13, even though their own model says that interpretation makes no sense when rates are not at zero, and rates were not at zero when the eurozone went into the double dip recession.  The only response I’ve ever heard is that the liquidity trap model also applies to very low but positive interest rates.  Even if that were true, it would not be relevant for a case where the monetary authority is actually “pulling on the string” by raising its target rates, as in 2011.  That showed clear intent to restrain AD growth.  And yet I’ve never once heard a Keynesian refute this point.  So how can we take seriously the austerity claims that were being made in 2011?  If there is a model where austerity reduces NGDP growth during a period where the central bank is raising rates to restrain inflation, I’d love to see the model.  But as far as I know no Keynesian has even produced a defense of this claim.  Just silence.

2.  I also have an ulterior motive.  I think stabilization policy would be much more effective if everyone agreed with Ben Bernanke that the Fed never runs out of ammunition, that they can always do “more.”  Obviously this perception was not widely held, and hence the public put very little pressure on the Fed to boost AD in 2008-09.  I would go even further, I believe Bernanke would have welcomed more pressure on the Fed to stimulate the economy in 2008-09.  Insiders insist that the Fed was frustrated because 90% of what they heard was criticism from “inflation nutters.”  Krugman defenders will (correctly) point to the fact that Krugman asked the Fed to do more.  But I’ve spoken with highly intelligent economists around 2008-09, who read Krugman’s column frequently and very much like Krugman, who were shocked when I told them Krugman thought the Fed could do more.  They said the impression they got was that Krugman thought we were in a liquidity trap, and could do no more. That we needed fiscal stimulus.  His actual (nuanced) message got lost. Maybe the “pro-stimulus” side of the inflation debate needed more single-minded fanatics like me that sent a clear message–the Fed and BoE are steering the nominal economy, and if you don’t think there is enough AD then blame them for not doing more.  Instead the central banks were mostly blamed for doing too much.

This anonymous comment at the end of the Wren-Lewis post is a perfect example of how many Keynesians fail to grasp the implication of the ECB’s 2011 policy.  He/she confuses a situation where rates are low and even lower rates wouldn’t help (a good argument), and the very different case where rates are actually being raised (a bad argument).  If they are being raised then there is a presumption of 100% monetary offset.  I’m not sure why this idea is so hard to grasp.

W. Peden and Nick Rowe have some good comments after the Wren-Lewis post.

Mark Sadowski also replies to Wren-Lewis.

So much for the zero bound

When the ECB raised rates from 1.0% to 1.25% in April 2011, the Keynesians told us that Europe was at the zero bound and thus needed fiscal stimulus. When the ECB raised rates from 1.25% to 1.5% in July 2011, driving the eurozone into double-dip recession, they told us that Europe was at the zero bound and thus needed fiscal stimulus.  When the ECB later cut rates from 1.5% to 1.25% we were told they were at the zero bound.  Ditto for the rate cut to 1.0%, and the rate cut to 0.75%, and the rate cute to 0.5%, and the rate cut to 0.25%, and the rate cut to 0.0%.

And today the ECB has cut rates to negative 0.10%.  I guess they are still at the zero bound?

A few observations:

1.  The market reaction in both the US and Europe seemed to be mildly positive, although I’d caution you that this move was widely expected, so we don’t really know how much impact it had. My sense is that eurozone policy is still relatively tight in absolute terms, and that the ECB is likely to undershoot its 1.9% inflation target for the next few years.

2.  I do feel more confident in predicting that eurozone rates will stay lower for far longer than US rates.  There’s an old saying, “if you want peace, prepare for war.” I don’t know about that, but for 5 years I’ve been saying that if you want higher interest rates then you need to cut interest rates.  And now the mainstream media seems to finally be catching up.  Here’s the FT:

When the governing council of the European Central Bank meets in Frankfurt on Thursday, it is widely expected to announce a loosening in policy – most likely a cut in both the refinancing and deposit rates. Two weeks later, the US Federal Reserve will probably respond to strengthening economic data by moving in the opposite direction, tapering the pace of quantitative easing for the fifth consecutive meeting. This is another sign of how monetary policy is diverging in the two largest economies, a trend that is set to shape funding markets for years to come.

When I advocated easier money in 2011 I was hammered by commenters worried about the interest income of old folks.  Well the ECB tried their approach—they raised rates.  And as a result the eurozone went back into recession and now faces a Japanese-style situation, near-zero rates as far as the eye can see.  Meanwhile the US is planning to start raising rates next year.  Just one more example of where us MMs turned out to be right and the conventional wisdom (especially conservative conventional wisdom) was wrong.

2.  People used to say the Fed can’t cut rates below 0.25%, for various reasons.  I think we now know those were excuses, not reasons.

3.  Some people argued that negative rates would be contractionary.  The markets don’t seem to think so.

4.  My first blog post (after the intro) mentioned negative IOR.  I also published articles in January and March 2009 suggesting that negative IOR is an option.  At a personal level, I’ve always wondered if I was the first to publish this idea in an economics journal.  A New York Fed article from 2009 that explained negative IOR did cite one of my articles.  Anyone know of any negative IOR articles before 2009?

Having said that, negative IOR is far from my first best choice.  Like Lars Christensen, I prefer NGDPLT, with price level targeting as a second best option. I prefer QE to negative IOR.  But I do think it’s better than nothing.  There are rumors the ECB plans to do more.  Let’s hope so.

PS.  Yes, I understand that the zero bound still holds for cash.  It would be interesting to see whether the ECB would allow reserve conversion into vault cash as a way of evading the zero bound.  My guess is that they’d apply the negative rate to vault cash if the holdings soared beyond a reasonable threshold.

Update:  Like Tyler Cowen and David Beckworth, I’m skeptical of proposals to eliminate currency.  In order of preference:

1.  A NGDPLT policy at a rate high enough to avoid the zero bound (say 5%.)

2.  A big central bank balance sheet, with NGDPLT at a lower growth rate.

3.  Negative IOR.



100.  Eliminating paper money.

I also agree with Tyler’s claim that the new ECB policy is “not enough.”