Archive for the Category Monetary Policy


George Selgin has a new blog

George Selgin appraises QE and Fed policy more generally over the past decade. I think it’s fair to say that he’s not a big fan. The way he frames the discussion might lead some readers to think he sharply disagrees with my views, but this is more a stylistic difference in emphasis.  On the core issues we agree:

1.  The Fed policy during the Great Recession should not be viewed as a great success.  Yes, we did better than Europe, but the recovery was still quite disappointing in an absolute sense.

2.  A policy of stable NGDP growth would have been far superior to actual Fed policy.

3.  With a better policy (such as NGDP targeting), it’s quite possible that little or no QE would have been needed, and there would have been less Fed intervention into credit markets.

Keep those three points in mind if it seems like he’s less in favor of QE than I am. George also favors a somewhat lower NGDP target than I favor, which leads him to put more weight on policy errors that occurred before 2008.  I like the way he ends the post:

Am I suggesting that the Fed could not possibly have done worse? Of course not. Only someone with a severely defective imagination could suppose so.  Whatever his shortcomings, Ben Bernanke was far from being an incompetent central banker.  In suggesting that we might have done better than Bernanke’s Fed did, I don’t mean that we could have used a better discretion-wielding central banker. I mean that we might have been better off avoiding seat-of-the-pants-style central banking altogether.

I struggle, moreover, to understand why more people don’t take the same view.   For if it takes a stunted imagination to suppose that things couldn’t have been worse, it takes a no-less defective one to suppose that we couldn’t possibly improve upon the presently-constituted Fed. Far [from] supplying grounds for celebration, or warranting complacency, the events of the last decade or so ought to make it more evident than ever that our monetary system is very far from being the best of all possible alternatives.

George links to a paper by Yi Wen with the following abstract:

We use a general equilibrium finance model that features explicit government purchases of private debts to shed light on some of the principal working mechanisms of the Federal Reserve’s large-scale asset purchases (LSAP) and their macroeconomic effects. Our model predicts that unless private asset purchases are highly persistent and extremely large (on the order of more than 50% of annual GDP), money injections through LSAP cannot effectively boost aggregate output and employment even if inflation is fully anchored and the real interest rate significantly reduced. Our framework also sheds light on some longstanding financial puzzles and monetary policy questions facing central banks around the world, such as (i) the flight to liquidity under a credit crunch and debt crisis, (ii) the liquidity trap, and (iii) the low inflation puzzle under quantitative easing.

Someone needs to explain to me the phrase “even if inflation is fully anchored.” Obviously if inflation is fully anchored then it’s almost logically impossible for expansionary monetary policy to boost RGDP.  (Unless the SRAS was 100% flat, which it isn’t.)  So why would an empirical result of this sort be at all interesting?

Obviously I’m missing something.  But what?

The NGDP futures market believes in the Great Stagnation

[Update:  Since Tyler linked to this I should clarify that I do understand that NGDP growth is a demand-side concept.  In earlier posts I’ve suggested that RGDP trend growth is now about 1.2% and trend inflation about 1.8%.  So the drop in NGDP growth from a 5% trend to 3% trend is mostly a RGDP (supply-side) story.]

For several years I’ve been arguing that we are in a Great Stagnation, and that trend NGDP growth is about 3%, not the 5% to 5.5% from before the crisis.  Just to be clear, I am referring to Tyler Cowen’s supply-side theory, not the Summers/Krugman demand-side secular stagnation, which I do not accept.

The NGDP futures price in the Hypermind prediction market has fallen from the 4.0% to 4.5% range earlier in the year, to its current value of 3.6%.  The 10 year bond yield has also been trending lower in recent weeks (although it’s quite erratic.) You might argue that 3.6% is still higher than 3.0%, but that’s the wrong way to think about it.  The 3.6% forecast is for an expansion year, a year when the unemployment rate is expected to decline.  The trend rate of growth includes both expansion years like 2015 and recession years like 2009, and the next recession. Thus if the nominal economy is expected to grow by 3.6% in an expansion year, the actual trend rate of growth is surely lower.  My 3.0% estimate is probably not far off from market forecasts.

Some implications:

1.  Very low nominal rates are the new normal, as I’ve been saying for many years.

2.  The Fed policy regime is bankrupt, as it is based on interest rate targeting and growth rate targeting, a combination which simply doesn’t work at the zero bound. They need to do NGDPLT.

3.  The Fed needs to raise wage inflation to 3% to hit its 2% PCE inflation target. Although wage growth has accelerated a tiny bit in recent months, it is still at only 2.136% over 12 months, far below the wage growth required to hit their inflation target. (Of course I oppose inflation targeting, but if they are doing it then they should do it.)

4.  While the Fed says they target 2% inflation and unemployment near the natural rate, their actions are not consistent with that target.  They run low inflation during period of high unemployment, whereas their mandate calls for the exact opposite.

Money illusion on steroids

Stephen Kirchner sent me the following from the Financial Times:

As economic growth returns again to Europe and Japan, the prospect of a synchronous global expansion is taking hold. Or, then again, maybe not. In a recent research piece published by Bank of America Merrill Lynch, global economic growth, as measured in nominal US dollars, is projected to decline in 2015 for the first time since 2009, the height of the financial crisis.

In fact, the prospect of improvement in economic growth is largely a monetary illusion.

I actually had to read this several times to make sure that my eyes were not deceiving me.  After all, this is the Financial Times, the world’s leading financial newspaper.  So we are to believe that even though real GDP is expected to rise, this isn’t actually “growth,” because output in Europe and Japan measured in US dollars is expected to decline.  OK, that’s pretty weird, and you wonder why he didn’t choose to measure Japanese output in terms of Brazilian reals or Indian rupees, but we’ll let that pass. What floored me was the next sentence, that measuring economic growth in real terms rather than nominal terms was an example of money illusion.

It seems like that since 2008 people can just say anything.  There are no rules anymore.  You can say that a good way to reduce inflation is cutting interest rates.  You can say that monetary policy is ultra-expansionary in countries suffering from deflation.  Say whatever you want, the lunatics have taken over the mental asylum.  It’s like the Chinese Cultural Revolution—all the old orthodoxies are discredited.  Anything goes.

One argument is that if central banks were not created to execute fiscal policy, then why require them to maintain any capital at all? Capital is that which is held in reserve to absorb losses. If losses are to be anticipated, then a reasonable inference is that a certain expectation of risk must exist. Therefore, central banks must be expected to take on some risk for policy purposes, which implies a function beyond the creation of a monetary base to maintain price stability.

Umm, how about bond price risk due to interest rate changes, not bond defaults?

In response to those who argue against the metamorphosis of monetary policy into fiscal policy, one need only point toward the impact of quantitative easing on interest rates. The depressed returns available on fixed income securities, largely as a result of QE, are acting as a tax on investors, including individual savers, pension funds and insurance companies.

Let’s see, the Fed did lots of QE over the past 6 years and is expected to raise rates later this year.  The ECB did none until a few weeks ago, and is expected to hold rates at zero for the next . . . well, basically forever.  Oh, and despite all the QE done by the Fed, the quantity of T-bonds held by the public has soared dramatically higher in recent decades.  But heh, whatever, go ahead and keep saying that QE is holding rates down.  Nobody cares about reality anymore; it’s all about throwing out catchy sounding observations.

Essentially, monetary authorities around the globe are levying a tax on investors and providing a subsidy to borrowers.

Yes, causing the biggest crash in NGDP growth since the 1930s sure helps borrowers.  They should all thank the Fed, and thank the ECB even more.

In the long run, however, classical economics would tell us that the pricing distortions created by the current global regimes of QE will lead to a suboptimal allocation of capital and investment, which will result in lower output and lower standards of living over time.

Which classical economists is he referring to?  I don’t recall that argument in any of the classical writers I read.  I do recall reading classical economists say that the sort of deflationary monetary policy that we see in Europe could reduce output and living standards. But QE? I must have missed that.

I sure wish America could go back to the boom year of 2009, when “living standards” soared much higher.  You remember, the year when America’s GDP soared higher at double digit rates (when measured in terms of euros.)

The WSJ wants to raise interest rates; now they just need to find a reason

I don’t comment on the Wall Street Journal very often, as they are behind a paywall. But I did read an editorial in a paper copy a few days ago, and as I recall the piece went on and on about how the Fed needed to be raising interest rates, without once discussing the Fed’s actual 2% inflation target.  But they did have lots to say about unemployment.

Things sure have changed.  When I used to subscribe to the paper version of the WSJ, they constantly lectured us on the fallacy of “Phillips Curve” thinking.  They told us that the Fed should control inflation, and not worry about unemployment. They obsessed about the value of the dollar.

And now inflation is running well below 2%, and is expected to continue doing so for many years, and King Dollar is back in the foreign exchange market.  But gosh darn it there must be some reason the Fed needs to raises interest rates, because . . . well, just because.

I’m amused when people suggest that market monetarism is losing out among conservatives.  The only conservatives who seem to even have a coherent set of views on monetary policy are what Ross Douthat calls the “reform conservatives.” He mentions people like Ramesh Ponnuru, Jim Pethokoukis, Reihan Salam and Yuval Levin. Douthat suggests that reform conservatives favor:

e. A “market monetarist” monetary policy as an alternative both to further fiscal stimulus and to the tight money/fiscal austerity combination advanced by many Republicans today.

As far as the rest of the conservative movement – – – what are you waiting for? Moping around that interest rates are too low, just because, does not constitute a coherent monetary policy regime that will survive in the rough and tumble intellectual debate over public policy.  (I.e., it won’t survive Paul Krugman attacks, and for good reason.)

On March 30th, I’ll be speaking in favor of NGDP targeting at the Dirksen Senate Office Building.  I don’t feel at all lonely.

PS.  It’s worth noting that many of the best people in what might be called the free banking movement (Larry White, George Selgin, etc.) are also sympathetic to a monetary policy involving a nominal income target, or something closely related. And I’ve found lots of support for MM at free market think tanks in places like Britain and Australia.

PPS.  I have a new post on Stanley Fischer over at Econlog.


It’s good to be the Fed

Before the recession, the Fed typically earned a profit of about $30 billion per year. After the Great Recession, their profits rose to the $70 to $80 billion range, as their balance sheet expanded.

There was a time where the Fed actually was reluctant to engage in monetary stimulus out of fear that they would take on excessive risk.  I thought those fears were completely nuts, for several reasons.  They weren’t likely to absorb particularly large losses, and even if they did they didn’t really need enough bonds to back up the monetary base, only the share held as bank reserves.  And most importantly, the Fed is essentially part of the Federal government, so when the Fed sees its assets fall due to a decline in T-bond prices, the Treasury gains a precisely equal reduction in their liabilities.  It’s a wash.

Don’t believe me that the Fed is part of the Federal government?  Where do you think all those profits go?

Here’s the latest profit report, and it’s a blockbuster:

According to figures released Friday, the Fed reported net income of $101.3 billion. That’s an increase of nearly 30% from 2013.

But the Fed sends nearly all of its profits to the Treasury. Last year, that amounted to $96.9 billion. The Fed said this was a record.

Commenter “Negation of Ideology,” who sent me this article, added this information:

Also, out of a balance sheet of $4.5 Trillion, $800 Billion will be maturing in the next two years.  Sounds to me that those who are worried about the Fed being unable to unwind and being forced to sell bonds at a loss are worried about nothing.

And $1.35 trillion of the Fed’s “liabilities” are zero interest cash.  I can’t believe people were seriously worried about the Fed’s balance sheet, and that this might have even inhibited monetary stimulus.  The Fed had similar fears in the 1930s, which were far more justified, but even those fears are widely ridiculed by modern economic historians.  Imagine what future monetary historians will think when they pour over the FOMC minutes for 2010, 2011 and 2012.

Everyone should pray each night that interest rates soon soar up to levels that put the Fed balance sheet under stress.  That would imply we get back to the sort of healthy economy that we had in the 1990s.  Unfortunately, that’s just a pipe dream.

By the way, does anyone know why the Fed has decided to raise rates before unwinding the balance sheet.  Logically you’d expect last in, first out.  They cut rates, then did QE; so why not unwind the QE, then raise rates?

Tim Worstall is just as confused as I am.