Archive for the Category Monetary Policy


Don’t show this St. Louis Fed article to Nick Rowe

A commenter sent me a paper from the St. Louis Fed:

This view can also be represented by the so-called “quantity theory of money,” which relates the general price level, the total goods and services produced in a given period, the total money supply and the speed (velocity) at which money circulates in the economy in facilitating transactions in the following equation:


In this equation:

  • M stands for money.

  • V stands for the velocity of money (or the rate at which people spend money).

  • P stands for the general price level.

  • Q stands for the quantity of goods and services produced.

Oh, so that’s the quantity theory of money.  In fairness, they do mention stable velocity later on. But stable velocity is the QTM, it’s where you start the explanation.  They continue:

And why then would people suddenly decide to hoard money instead of spend it? A possible answer lies in the combination of two issues:

  • A glooming economy after the financial crisis
  • The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds

In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sector’s money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).

If only the Fed had joined the ECB in raising interest rates back in 2011.  Then we would have had a much faster recovery.

What do the Germans really think?

Nicolas Goetzmann sent me the following:

The European Central Bank is doing what it can to help the flagging euro zone economy but it has basically run out of tools, German Finance Minister Wolfgang Schaeuble said on Tuesday.

“It’s no good to hold the central bank responsible for growth and jobs – it’s doing what it can but it has basically exhausted its tools, as you can see from current developments,” he told Germany’s Bundestag lower house of parliament.

“Cheap money can’t force growth either – otherwise we’d have no problems now,” he said.

I have no idea what any of this means, but I can think of at least two possible interpretations:

1.  The Germans think the ECB is stuck in a liquidity trap, and that further stimulus will not boost inflation.  Of course in that case the Germans would not object to further stimulus at the ECB.

2.  The Germans believe that further stimulus would boost inflation, but that higher inflation would not boost RGDP growth.  But in that case the “exhausted its tools” phrase is a completely misleading metaphor, as it [Update: by "it" I meant the metaphor] hints at a liquidity trap, not a vertical SRAS curve.

Anyone else have any idea as to what he means?  And shouldn’t a German finance minister be able to communicate with the public in a way that is understandable to someone with PhD in monetary economics from the University of Chicago?

Maybe it was better when they ignored us

Nicolas Goetzmann sent me the following article in the FT, by Wolfgang Munchau:

The third theory is monetarist. Some will be surprised to find that monetarists still exist, but they do under new guises, such as “market monetarists”. Milton Friedman, the godfather of monetarism, said inflation is always and everywhere a monetary phenomenon. And so, of course, would be a lack of inflation. The market monetarists argue that the central bank should target a certain measure of broad money in circulation to achieve price stability.

Yikes.  I’m still counting the number of mistakes in that paragraph.  How many can you find?

At least he didn’t call us Austrians, which is how Allan Meltzer referred to me (twice!) at the recent Mont Pelerin Society meetings.  :)

PS.  I wonder if famous pundits think this way:  ”I vaguely recall hearing something about market monetarists.  I suppose they must believe X.  I could look it up, but eh, I’m an important pundit and MMs are a bunch of nobodies, so they’ll just have to make do with my characterization. After all, I’m pretty busy right now.”

To QE, or not to QE, that is NOT the question (Reply to Simon Wren-Lewis)

We really ought to consider adopting a whole new monetary regime, NGDPLT.  But what if the Fed refuses. What then?  Then we are in the world of second best—QE and negative IOR.  These are not good policies, but they are less bad than deep depressions or wasteful government spending. Here’s Simon Wren-Lewis:

Perhaps these distortions are quite small. However this discussion illustrates a more serious problem with QE, which is that we still have no clear idea of its effectiveness, or indeed whether effects are linear, and what the best markets to operate in are. Announcements about QE clearly influence the market, but that could be because it is acting as a signalling device, as Michael Woodford has argued. Jim Hamilton is also sceptical. This strongly suggests that the uncertainty associated with the impact of QE is far greater than any uncertainty associated with either conventional monetary policy or fiscal policy.

Thinking about it this way, I cannot see why some people insist that unconventional monetary policy is always preferable to fiscal policy. In a comment on a recent Nick Rowe post, Scott Sumner writes “My views is that once the central bank owns the entire stock of global assets, come back to me and we can talk about fiscal stimulus.” What this effectively means is that it is better for one arm of the state (the central bank) to create huge amounts of money to buy up large quantities of assets than to let another arm of the state (the Treasury) advance consumers rather less money to spend or save as they like. This preference just seems rather strange, but maybe Lenin would have approved!

Of course I was joking, but I do seriously believe that Britain would be better off if it were able to acquire the entire stock of global wealth, at zero cost. That would be even more impressive than the “pink bits” on the map acquired under Queen Victoria.  However if I had my way the Fed would have adopted a policy closer to that of the Reserve Bank of Australia (a monetary base of 4% of GDP), rather than the BOJ (a monetary base of more than 20% of GDP.) QE is both a sign of a failed policy, and at the same time (paradoxically) is better than not QE, combined with the same failed policy.

Debates over monetary policy should not be debates over QE.  The discussion should focus on what policy regime is optimal.  An optimal policy regime would probably not involve any QE at all. And even if it did, it would still be less inefficient than fiscal stimulus. That was my point.  (Remember that the “advance to consumers” must eventually be clawed back via distortionary taxes.)

One way of stimulating demand when interest rates are stuck at zero is to promise a combination of higher than ideal inflation and higher than ideal output in the future. (This can be done either explicitly or implicitly by using some form of target in the nominal level of something like nominal GDP. For those not familiar with how this works, see here.) The cost of this policy is clear: higher than ideal future inflation and output. Once again, these costs can be worth it because of the severity of the current recession, which is why nominal rates are stuck at zero. Whether these costs are greater or less than the cost of changing government spending is debatable: a paper by Werning that I discussed here suggests optimal policy may involve both.

Given that inflation doesn’t matter at all, it is hardly possible for it to be above or below “ideal” levels.  People who talk about the welfare costs of inflation are confusing inflation with NGDP growth.  There are welfare costs of excessive long run NGDP growth, primarily excess taxation of nominal returns on capital. But inflation by itself does not have important welfare costs.  The only possible inflation cost is the “menu costs” of price changes, but even that is unclear, given that nominal wage changes also involve menu costs.  Thus a NGDPLT policy minimizes both the “welfare cost of inflation” and the problem of suboptimal output fluctuations.  There is no trade-off. NGDPLT also reduces financial sector instability, relative to inflation targeting.  It’s a win-win-win policy.

HT: Marcus Nunes, who also has a post.

The Keynesian model continues to unravel

After everything that has happened since the beginning of 2013, it feels kind of pointless to continue beating the dead horse of Keynesian economics.  But it’s also kind of hard to resist given the arrogance ”confidence” of some of its most famous proponents.

Today two more things happened that the Keynesian model says are impossible:

1.  The ECB cut rates from negative 0.1% to 0.2%.

2.  The euro fell on the news.

So much for the zero bound, and the theory of monetary policy ineffectiveness.

Oh, and US stock futures rose on the news.  So much for “beggar-thy-neighbor” theories, which have already been shot down 100 times.

Update: Vaidas Urba sent me an interesting observation from Gavyn Davies:

Unlike the example of Japan under Mr Kuroda, or QE3 in the US under Ben Bernanke, there is no suggestion that this is “open ended” action from the ECB, and no attempt to influence the foreign exchange market or inflation expectations by aggressive use of language. If the programme works, it will be because monetary conditions have genuinely been eased by the measures, not because of fanfares or smoke and mirrors.