Archive for the Category Monetary Policy


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.


Draghi doesn’t understand what caused the eurozone double-dip

The ECB tightened monetary policy sharply in 2011.  This caused NGDP growth to plunge, and the eurozone fell into a double-dip recession.

Whenever you have a demand-side recession, some people will look at specific industries, and/or specific regions, to see what caused it.  This is mistake.  The US housing industry was hit hard in the recent recession, but didn’t cause it.  The PIIGs were hit especially hard after 2011, but did not cause the eurozone recession.  In any recession, there will be regional and industry variation in intensity, due to supply-side factors.  But those specific factors cannot explain a generalized decline in NGDP growth for an entire currency zone. Only monetary policy can explain that.

Here’s something from a Mario Draghi speech that Vaidas Urba sent me:

From 2011 onwards, however, developments in the two regions diverge. Unemployment in the US continues to fall at more or less the same rate.  In the euro area, on the other hand, it begins a second rise that does not peak until April 2013. This divergence reflects a second, euro area-specific shock emanating from the sovereign debt crisis, which resulted in a six quarter recession for the euro area economy. Unlike the post-Lehman shock, however, which affected all euro area economies, virtually all of the job losses observed in this second period were concentrated in countries that were adversely affected by government bond market tensions (Figure 2).

Is this true?  Consider these graphs, showing that it wasn’t just the PIIGS that experienced a double dip:

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Screen Shot 2014-08-24 at 1.24.02 PMSo the Netherlands, France, Belgium and Austria also had double-dips. The Dutch double-dip was worse than the first dip.  The ECB caused the double-dip recession—even new Keynesian models will tell you that.  (After all, the ECB raised rates twice in 2011, so this wasn’t one of those zero bound issues.)  Odd that Draghi doesn’t understand that the ECB caused the NGDP growth collapse, and that debt crises are the result of NGDP growth crashes.  That doesn’t make me very hopeful that the eurozone’s long nightmare will end anytime soon.