Five year yields are 1.26% and falling almost every day

One need to look no further than the market for 5 year T-notes to see the increasing tightness of monetary policy.  NGDP growth expectations are now falling rapidly.  Indeed things are now so bad that even the New York Times has woken up to the fact that the Fed might have to act.

Even as Congress escapes from its brush with default, political divisions have all but immobilized the levers of fiscal policy, raising pressure on the Federal Reserve to address the nation’s economic lethargy.

And yet almost no one seems to understand the nature of the problem we face.  Here the Times describes Ben Bernanke’s perspective:

Ben S. Bernanke, the chairman of the Federal Reserve, said in the spring that it was time to see whether the economy could stand on its own. Last month he said the Fed would consider new steps if conditions deteriorated significantly. As the Fed’s policy-making committee prepares to meet Aug. 9, the drums are beating louder.

Right now the Fed is like a ball and chain, dragging the economy down.  Yet Bernanke still seems to see it as a pair of crutches.

The Fed already is engaged in a vast and unprecedented effort to bolster economic growth. It has held short-term interest rates near zero for almost three years, and amassed more than $2 trillion in Treasuries and mortgage bonds to hold down long-term rates. But since the end of June, when it completed its most recent round of asset purchases, the Fed has chosen to stand pat.

Yes, just like the Fed of the 1930s and the BOJ over the past 17 years have engaged in “vast and unprecedented efforts to boost economic growth.”

Its available options now are modest steps including replacing its promise to maintain low rates “for an extended period” with a more specific commitment, like a six-month minimum. More aggressive steps could include tilting the composition of its investment portfolio toward longer-term Treasury securities, to increase the downward pressure on long-term rates. The most drastic step, which analysts also consider least likely, would be a decision to increase the size of its portfolio.

This is just sad.  The markets are telling us that the Fed will hold rates at zero for far more than 6 months.  So that would hardly be a revelation.  Even worse, the Fed doesn’t seem to realize that near zero rates are a sign of tight money, not a sign of easy money.  (Queue up Friedman quotation here.)

For the moment, and for as long as possible, the central bank would like to do nothing. There is broad agreement that the unprecedented size of the Fed’s portfolio has complicated its ability to control the pace of inflation, and that additional purchases would exacerbate the difficulty.

No, the Fed is never doing nothing.  The fact that people think it is just demonstrates what we are up against.

Mr. Bernanke has said that growth must weaken and price increases abate. A vocal minority of Fed officials has gone further, arguing the central bank has reached the limit of its powers.

Maybe it’s a blessing that Milton Friedman is not around to read this stuff.  I can’t even imagine how frustrating it would have seemed to see one’s magnum opus on the Great Depression (which Bernanke said the Fed had accepted), thrown in the trash bin.

“It seems unlikely that the forces limiting the pace at which U.S. growth is recovering are amenable to monetary policy,” Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, said in a speech last week. “Additional monetary stimulus at this juncture seems likely to raise inflation to undesirably high levels and do little to spur real growth.”

That’s right; the extremely low level and growth rate of NGDP right now has nothing to do with the slow recovery.  Why would it?  There’s nothing in modern macro theory that would suggest NGDP falling 11% below trend would depress growth, is there?

The Fed is even less eager to renew its interventions into financial markets. The central bank has hovered on the edge of the debt ceiling debate like a homeowner riding out a hurricane, hoping for limited damage to the lethargic economy.

The operative word is ‘hoping.’  The Fed is hoping, not acting.

The Fed also could buy dollars in the event of a downgrade. Uncertainty already is driving investors to other currencies, and a sharper decline could undermine the dollar’s role as an international reserve currency “” a status that has significant benefits for the American economy.

That’s right; a stronger dollar will fix our AD shortfall.

Perhaps most important, intervening in exchange markets may not prevent the dollar’s fall. “If the dollar were just weak because people had lost confidence in the U.S. government, I don’t see why buying dollars is going to restore confidence,” said Mr. Kohn, now a senior fellow at the Brookings Institution. “The cure for that isn’t intervention. The cure is the government acting like adults.”

No, they are currently acting like adults.  The cure is to start acting like macroeconomists.  To start taking macro theory seriously.  To set policy at a level expected to produce the nominal spending they would like to see.  To set policy at a level where downside risks to nominal growth and upside risks are balanced.  To set policy at a level expected to succeed.

I am leaving in a few minutes for a vacation, and so I won’t have much time, if any, to respond to comments.


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87 Responses to “Five year yields are 1.26% and falling almost every day”

  1. Gravatar of John John
    2. August 2011 at 06:44

    Wow, am I reading Paul Krugman’s blog. The constant complaining about taking macroeconomics seriously is unbecoming. On a serious note, do macroeconomists ever consider the possibility that maybe fiscal and monetary stimuli are really sedatives or poison? Also, a serious program of dereguation would boost growth without having to resort to monetary or fiscal stimulus, which both ultimately rob the purchasing power of taxpayers and/or people using the U.S. dollar. Unfortunately, that would require an actual belief in capitalism (ie private property) to be politically viable. The quickest fix would be to legalize drugs which would boost income and employment that was previously uncounted. Again unlikely, but I honestly think drug legalization and deregulation are better tools than monetary and fiscal policy. The only benefit of monetary policy is for the politicians who can steal resources from the people without them knowing.

  2. Gravatar of Mike Sandifer Mike Sandifer
    2. August 2011 at 07:30

    John,

    Macroeconomists have been thinking about your questions for many decades at least, and your perspectives were rejected by most in the 30s and 40s and for good reason. There’ve been many, many, many papers written. You might want to actually do some research.

    If you actually read this blog and pay attention to the numbers Scott mentions, you may see that these last few years were all too predictable with conventional macro. The same is true of Krugman, but to a somewhat lesser degree, because he falls subject to economic fallacy at times, such as claiming China has a beggar thy neighbor policy. Also, sometimes he goes too far and demonizes people like Friedman or others who are actually on our side, having properly seen the problems with down economies like this to be demand-side, requiring government stimulus. Friedman just didn’t favor fiscal stimulus.

    Don’t think that the comments you see from economists in the media represents most economists in the country. I can tell you, I’ve spoken to many economists privately, and the actual consensus among them may be far different. It is generally recognized that wages and prices are sticky, Say’s Law doesn’t hold in monetary economies, and that monetary policy is the first best tool to boost demand, unless at the zero bound, in which case there’s some controversy. However, the evidence seems consistent with the idea that monetary policy can still work at the zero bound, given the results following QE1 and 2.

  3. Gravatar of Mike Sandifer Mike Sandifer
    2. August 2011 at 07:39

    John,

    If you haven’t already, you may want to begin with Scott’s first posts, which begin in early 2009, to understand his perspective in some detail.

  4. Gravatar of Kevin Donoghue Kevin Donoghue
    2. August 2011 at 08:03

    Scott,

    Enjoy the vacation.

    John,

    You might ask yourself why two people who differ as much in their politics as Krugman and Sumner end up sounding so similar. Could it be that empirical evidence played a part?

  5. Gravatar of effem effem
    2. August 2011 at 08:14

    Mike,

    You say: “Macroeconomists have been thinking about your questions for many decades at least, and your perspectives were rejected by most in the 30s and 40s and for good reason. There’ve been many, many, many papers written. You might want to actually do some research.”

    I disagree. It is precisely because of this research that we are in the current crisis. Economics is not a science it is behavioral. The market knows what you know and economic actors adjust. As a result of mainstream macro which says to attack signs of slowing AD with monetary & fiscal stimulus the private sector massively increased leverage and financial assets achieved very high valuations. After all, if recessions are going to be short you can afford much higher leverage and risk-taking. Stability (macroeconomic policy) breeds instability (leverage, risk-taking, growth of finance industry, etc.).

    It may be the case that the result from studies done over the last 70 years are exactly the opposite as the nature of the economy has changed to incorporate that information (as well as the probable policy responses).

    Gold is telling us without question that money is not too tight. Of course, economists will simply explain that away.

  6. Gravatar of Kevin Donoghue Kevin Donoghue
    2. August 2011 at 08:24

    Gold is telling us without question that money is not too tight. Of course, economists will simply explain that away.

    They shouldn’t have much trouble. If the demand for gold is coming from Asia, how can that tell us that money is loose in America? A metal can’t “tell us” anything without a model.

  7. Gravatar of OneEyedMan OneEyedMan
    2. August 2011 at 08:33

    I was surprised by the market yawn in the face of the debt ceiling rise. Does that mean the stock market fall and yield changes over the last week weren’t about the ceiling?

    On the subject of tight versus loose monetary policy, my understanding is that ten year real returns have averaged about 1.7% (http://observationsandnotes.blogspot.com/2010/12/us-treasury-bond-real-return-history.html). The most recent 10 year TIPS had a real yield of about 0.625% and 1.125% (http://www.treasurydirect.gov/RI/OFNtebnd). That obviously tighter than average, but is the difference a lot or a little?

  8. Gravatar of effem effem
    2. August 2011 at 08:53

    “They shouldn’t have much trouble. If the demand for gold is coming from Asia, how can that tell us that money is loose in America? A metal can’t “tell us” anything without a model.”

    What makes you think demand is coming from Asia? Those who follow it most closely suggest demand is coming from all over the world. There is a very straightforward model for gold – it is the closest thing we to a currency that cannot be debased. Given that model, the implication is easy…the USD is being debased at record levels. Gold will sense that first everything else will follow. As far as I’m concerned that will destroy wealth, not create it.

  9. Gravatar of Benjamin Cole Benjamin Cole
    2. August 2011 at 08:56

    I just wish Bernanke-san would read Scott Sumner, and direct policy accordingly.

  10. Gravatar of Mike Sandifer Mike Sandifer
    2. August 2011 at 08:59

    effem,

    That’s laughable. Are you saying there’s no such thing as behavioral science? Both experimental and theoretical behavioral science have existed for well over a century. There’s a whole field of mathematical psychology.

    Besides, macro involves a broader brush and the conventional models seem good enough to offer policy prescriptions in most cases.

    And if you really think “the market knows”, then how can you disagree with Sumner or Krugman? The market’s telling their story right now. Inflation expectations are far too low, as are GDP expectations.

  11. Gravatar of Benjamin Cole Benjamin Cole
    2. August 2011 at 09:20

    News Flash:

    For the first time in history, the Daily Treasury Real Long-Term rate has fallen below one percent.

    See here: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=reallongtermrateYear&year=2011

    This is inflation?

  12. Gravatar of effem effem
    2. August 2011 at 09:26

    Ok Mike, so then tell me what are the macroeconomic implications of having high vs. low leverage in the system? How about high vs. low asset values (relative to underlying cash flows)? How about having an implied govt backstop for risky behavior vs not having a backstop? How about for economies with huge finance industries vs those with huge manufacturing industries? How about when the second largest economy pegs their currency to yours? Seems to me every policy recommendation I hear is meant to fit all situations.

    When Greenspan took the helm he made it abundantly clear that short recessions and bailouts of “systemic risks” were Fed policies. The market reacted exactly as it should – added leverage, took on more risk, and concentrated that risk within systemic insitutions. When the market adjusts for your policies they will no longer work – that’s my view anyway.

    Inflation expectations are low because the policy of trying to create inflation is counterproductive. It increases the costs of living more so than demand thereby destroying wealth. Gold is the strongest asset class in the world, oil remains stubbornly high despite weak growth, P/E multiples are compressing rapidly – to me, this paints the picture of horribly inefficient uses of capital lowering future expectations while keeping current demand propped up. I know that is tricky to model but that’s what the markets are telling me.

  13. Gravatar of Steve Roth Steve Roth
    2. August 2011 at 09:40

    Professor Sumner:

    I know you’ve discussed this many times in many ways, and I’ve read many chunks of it, but like many others who grapple earnestly with the likes of Sumner/Rowe/Waldman et. al., I still struggle mightily. Is the following characterization accurate (if simplified), and are the following questions cogent within that context?

    1. When you suggest the Fed should target nominal GDP, are you saying essentially that they should announce they’re going to ignore inflation, printing money regardless? So the hot-potato effect (spend it before it loses value) will increase velocity, driving NGDP growth? (Whether that spending is consumption or “investment” in/purchase of/creation of real assets. [Consumption and investment are on a continuum, of course, not perfectly distinct; lunch is an investment in the afternoon’s work.])

    2. Expectations of higher NGDP growth, hence expectations of higher demand, further drive real business investment, which further increases NGDP in a virtuous cycle?

    3. Meanwhile the increased money supply created to drive NGDP growth will reduce interest rates, further encouraging real investment through increased borrowing and also by a preference for real investment over low-yielding financial investment? (I think you’ve said that increased lending is *not* the transmission mechanism you believe in, but…?) [But, from this post: “near zero rates are a sign of tight money, not a sign of easy money. (Queue up Friedman quotation here.)” Tight money>low NGDP>low demand for loans>low interest rates?]

    But: to what extent are expectations of inflation and NGDP growth driven by the Fed’s promises? Don’t most people base their expectations largely on current realities? So if inflation is low/high and NGDP (growth) is low/high, their first-approximation exectation is that they’ll stay that way?

    IOW: Do they spend more because their money will/might lose value in the future, because demand will/might increase in the future, or because they’re doing so now? The latter seems more plausible; it certainly conforms with my own financial-investment thinking/decisions. (“If inflation starts to increase, I’ll deal with it/shift my asset allocation then.”)

    So: the only way the Fed can convince people they’re going to ignore inflation/drive NGDP is to ignore inflation/drive NGDP, and people won’t be convinced until the results start to show. ??

    Maybe once the Fed has established it’s inflation-ignoring cred, simple promises will have big (expectation) effects. But after decades of establishing inflation-*controlling* cred, it seems like that would take a while.

    Thanks for engaging with those of us who don’t have the monetary moxie of Nick Rowe et. al.

  14. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 09:42

    Sandifer, you sound as retarded as the MMT crowd.

    John makes CLEAR WINNING POINT.

    If we throw green regs over the side, if we get rid of land use rules, if we drop the minimum wage…

    NO ONE DOUBTS that economic activity will increase.

    You just don’t like the “externalities” so drop the shit, and stop pretending economists are all a bunch of environmentalists and labor champions.

  15. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 09:48

    Kevin,

    Sumner and DeKrugman are best explained by my analysis.

    We will only do Sumner’s approach when all efforts at government spending / fiscal end, and there is a great willingness to end all policies that cause sticky wages.

    Once we have that, THEN dong what Scott wants is fine, great even – because it basically puts the Fed on AUTOPILOT for the long term.

    Scott’s approach is really less government involvement in monetary policy.

    Meanwhile DeKrugman isn’t an economist – he champions anything that acts like a tax on people who own all the hard assets. And that is not economics, it is just social policy.

    Hope this explains why they sometime agree.

  16. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 10:01

    Steve,

    Scott says target a level NGDP which means pay no attention to inflation OR unemployment.

    So say we set it at 4% starting 2011…

    When RGDP come in at 1.5%, the Fed is now taking whatever action it needs to take to get inflation at 2.5%. If it comes in at 3%, the fed is after 1% inflation.

    But the accounting accrues.

    So NGDP for 2011 = 100, then for 2012 it is 104, and for 2013 it is 108.1

    So if in 2013, the Fed somehow owes 3 pts of NGDP, it is after a sizable amount of inflation to get there.

    For conservatives this means that if RGDP starts to run over 4%, then the Fed is committing to deflation.

    The effect of this commitment is that:

    1. everyone has clear expectations of Fed policy, which is good for business.
    2. so much so, that the fed is almost run by a computer.
    3. WHEN unemployment stays high, and it will stay high, we will KNOW it is bad government policy, and have the juice to throw out minimum wage and end UI as we know it.

  17. Gravatar of Kevin Donoghue Kevin Donoghue
    2. August 2011 at 10:02

    Steve Roth:

    Maybe once the Fed has established it’s inflation-ignoring cred, simple promises will have big (expectation) effects. But after decades of establishing inflation-*controlling* cred, it seems like that would take a while.

    That strikes me as a very concise statement of Krugman’s objection to Sumner’s viewpoint. How does Ben Bernanke convince us that he is the new Gideon Gono? By contrast, the great thing about fiscal policy is that you see it in action: the dams, bridges and battleships are being built before your eyes. When government is on a spending spree the reason why you shouldn’t keep your savings in barren money is blindingly obvious.

  18. Gravatar of Mattias Mattias
    2. August 2011 at 10:04

    Scott

    Do these low rates mean that QE has generated income/profits for the Fed or the Treasury? If so, maybe we should call it a Pyrrhic profit?

    🙂

  19. Gravatar of Skip Skip
    2. August 2011 at 10:13

    You should do a post on the growing trend (could be true) of economist stalking:

    http://www.youtube.com/watch?v=de7Rr3LdGWc

    Quite possibly the strangest video I have ever seen.

  20. Gravatar of John John
    2. August 2011 at 10:20

    Mike,

    Yes, I’ve read Scott’s early blog posts, done the research, read Keynes’ General Theory several times, and read the mainstream economists like Friedman and Krugman.

    Bottome line, you’re not gonna convince me that just because one set of views is shared by the majority of economists at the moment that it is the correct view. Two reasons, first off, economics is overwhelmingly political. There is no ability to do controlled experiments and all the most prestigious positions in the economics profession are in the government. It’s highly unlikely that government economists will have anti-government views. Second, find a time when the prevailing economic opinion wasn’t in lock step with prevailing political opinion. YOU CAN”T DO IT.

    One more point I wanna make: macroeconomics, invented by Keynes, is deeply flawed from an epistemological standpoint. Causal relationships are so dense in the fields of human action (econ, politics) that empirical analysis can’t prove or disprove theories. Economics should be based solely on theory, like geometry. It’s theory you have to attack to win a debate out here. Methodologically, macro is also flawed. Instead of tracing all economic effects from individual action, they study aggregate data that are often not even correct or measurable.

  21. Gravatar of John John
    2. August 2011 at 10:21

    Morgan,

    Thanks for the backup. It seems obvious to me that if the government were to start seriously attacking the 80,000+ page Federal Register, including legalizing drugs, gambling, market health care, and giving up on the green energy/environmental regulation garbage, the economy would recover so fast people’s heads would spin.

  22. Gravatar of John John
    2. August 2011 at 10:26

    Mike,

    I wanted to make one further point. Imagine a world in which monetary and fiscal stimulus actually where poison. Politicians and central bankers would react vigorously to crises and the economy would stagnate or go into depression for years. Read the rhetoric of Hoover, Roosevelt, Bush, Obama, or Bernanke. All of them thought they were gonna be able to stop the crisis cold with dramatic interventions that were unprecedented up to that point. They all prevailed over the worst economies. Coincidence?

  23. Gravatar of Bob Murphy Bob Murphy
    2. August 2011 at 10:37

    Scott wrote:

    One need to look no further than the market for 5 year T-notes to see the increasing tightness of monetary policy.

    But, but, but…don’t you keep telling us that interest rates don’t tell us about monetary policy??

    (I know, I know, you are like the all-star outfielder who doesn’t use both hands when catching a pop fly. He can do it but you don’t teach little kids to play that way.)

  24. Gravatar of Full Employment Hawk Full Employment Hawk
    2. August 2011 at 10:40

    “Also, a serious program of dereguation would boost growth”

    The current financial crisis was the result of lack of regulation. Both existing regulations not being enforced and needed regulation not existing. The economy performed much better during the post World War II years when the financial system was strictly regulated. It was only after the deregulation started that there began to be meltdowns in the financial system, like the savings and loan crisis.

  25. Gravatar of Full Employment Hawk Full Employment Hawk
    2. August 2011 at 10:51

    “Unfortunately, that would require an actual belief in capitalism (ie private property) to be politically viable.”

    You have an unwarrented faith in the infallibility of the invisible hand.

    In real world economic systems externalities, market power, asymmetric information, and missing markets are the rule, not the exception. Therefore real world economies only have an invisible paw, and not an invisible hand. The market system is very powerful and gets things reasonably right much of the time. If it did not economic systems beyond simple subsistence could never have developed. But it can get very badly off the rails some of the time. In those cases the visible hand is needed to put it back on the tracks.

    With the government playing this role when needed, a capitalist system based on private property is very viable.

  26. Gravatar of Full Employment Hawk Full Employment Hawk
    2. August 2011 at 10:55

    “There is a very straightforward model for gold – it is the closest thing we to a currency that cannot be debased.”

    YOU SHALL NOT PRESS UPON THE CROWN OF LABOR

    THIS CROWN OF THORNS!

    YOU SHALL NOT CRUCIFY MANKIND

    UPON A CROSS OF GOLD!

  27. Gravatar of StatsGuy StatsGuy
    2. August 2011 at 11:02

    1937

    http://www.huffingtonpost.com/2011/08/01/greece-far-right_n_915174.html

    Far right rising in Greece.

    Except, intriguingly, THIS TIME, Germany is France (Germany is the creditor that the rest of Europe owes) and China is Japan…

    Except Obama isn’t FDR, and…. oh well

  28. Gravatar of John John
    2. August 2011 at 11:03

    Full Employment Hawk,
    I’m not gonna get a whole long discussion with you, we obviously come from different ideological viewpoints that aren’t gonna change in one post. There’s little I’ve found in economic theory, including the original Keynes, Samuelson,Friedman, or Karl Marx blaming the boom-bust on regulation. You rea In fact many proponents of regulation concede that it will be costly in terms of growth but argue that it boosts fairness or stability.

    Second, Hawk, the economy was in the crapper in the late 1970s at the height of regulation when deregualtion started out of bear necessity. If regulation was so great, how come the draconian Sarbanes-Oxley or Patriot Act failed to prevent the crisis. How come the Dodd-Frank bill won’t prevent the next one? How do you possibly expect regulation to work when it always happens after the fact. It may be possible to bring order to the markets through regulation, but it’s the order of the graveyard.

    To piss everyone else off, economics isn’t the only science that’s highly politicized. Ecology/Biology has become that way as well. For example, history has proven Paul Ehrlich (writer of the Population Bomb) wrong every single chance that it has gotten, including a famous bet with economist Julian Simon. Yet, Ehrlich is one of the most decorated members of that field. Why? Because he tells people what they want to hear: that human beings are harmful, nasty creatures that are destroying the world around them with their unchecked greed and power.

  29. Gravatar of Full Employment Hawk Full Employment Hawk
    2. August 2011 at 11:06

    ” and there is a great willingness to end all policies that cause sticky wages.”

    In markets that are not strictly perfectly competitive and where wage changes and price changes are made sequentially instead of simultaniously, by all firms and workers simultaneously agreeing on wages and prices, wages and prices are inherently sticky as a result of the workings of the market process.

    Theoretical sticky wage and price models developed by New Keynesian economist derive their results without relying on minimum wage laws or unions, or similar impediments. And wages were sticky before labor unions had any significant power or there were minimum wage laws.

    They are sticky because real world economies only have an invisible paw, and not an invisible hand.

  30. Gravatar of John John
    2. August 2011 at 11:07

    Hawk,

    You’re venturing into the realm of the ridiculous here. If the markets, made up of individual people, are incompetent to run their own lives, why should we have more faith in the government? Do people magically become all-knowing angels once their appointed or elected? Free markets aren’t perfect because they are made up of imperfect people but the profit and loss test guides people to serve others better than the compulsion and coercion of government which lacks any sort of feedback mechanism.

  31. Gravatar of Full Employment Hawk Full Employment Hawk
    2. August 2011 at 11:17

    “Read the rhetoric of Hoover, Roosevelt, Bush, Obama, or Bernanke. All of them thought they were gonna be able to stop the crisis cold with dramatic interventions”

    The only one of them who actually engaged in dramatic interventions was Roosevelt. And the economy improved shaply during the first 4 years of his Presidency. It only went into a second dip after he returned to conventional economic policy and reduced the deficit in 1937.

    Obama clearly did not engage in dramatic intervention. He failed to fill the vacancies on the Board of Governors promptly with people who take the Fed’s mandate to achieve maximum employment seriously. As Keynesians pointed out before the stimulus was passed, it was too small to do the job. His adminstration failed to engage in agressive forecloture mitigation. And Obama quicly shifted from stimulus to deficit reduction.

  32. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 11:17

    Inflation Hawk, this is basically BS:

    “The current financial crisis was the result of lack of regulation. Both existing regulations not being enforced and needed regulation not existing.”

    The problem is you START OUT by assuming FDIC is acceptable.

    Let’s pretend there is no FDIC.

    Now, you have to choose what bank to put your money in… suddenly banks are selling themselves this way:

    “We keep 30% cash reserves!”

    “We NEVER resell loans!”

    “You can see ALL OUR LOANS performing in real time online.”

    NOW YES SURE, there would be banks that said “we keep 10% reserves” and they would argue “pays better rates!” but everyone would KNOW they take greater risks, and if they got hog stuck, you might lose your cash.

    WOULD YOU PUT YOUR MONEY IN AN UNSAFE BANK?

    ——

    These are the assumptions of the less regulations crowd. if you want to argue with us, AT LEAST have intellectual decency to work from our assumptions. Stop trying to put a screwed up STATUS QUO brought on by government on our backs and making us dance.

  33. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 11:21

    Inflation Hawk, it strikes me that I have never given you the benefit of the doubt…

    So please go through this exercise with me in good faith, and I’ll try to do the same for you under your assumptions next.

    You can be you in the discussions, meaning state your concerns with my assumptions as you personally would experience my paradigm.

    When we do your model, you can have be pretend to be anyone you want… put me in anyone’s shoes.

  34. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 11:23

    If you don’t feel like it, let me know because I do want to answer this:

    “In markets that are not strictly perfectly competitive and where wage changes and price changes are made sequentially instead of simultaniously, by all firms and workers simultaneously agreeing on wages and prices, wages and prices are inherently sticky as a result of the workings of the market process.”

  35. Gravatar of Things Are Getting Worse, Fast « Uneasy Money Things Are Getting Worse, Fast « Uneasy Money
    2. August 2011 at 11:31

    […] isn’t the first time, and I doubt the last, that I have used a post by Scott Sumner as the basis for one of my own.  But a blogger’s gotta do what a blogger’s […]

  36. Gravatar of John Turner John Turner
    2. August 2011 at 11:31

    When I pull the data from FRED2 (updated 7/29) the difference between 5 year constant maturity securities and 5 year inflation indexed securities is 2.07.

    So as far as I can tell the market expects inflation to average 2% over the next five years, and this expectation hasn’t changed much over the last few months. The last time the spread was bellow 1 was May 2009. Over the last 6 months the spread has averaged 2.11.

    5 Year Constant Maturity & Inflation Indexed Securities

  37. Gravatar of John Turner John Turner
    2. August 2011 at 11:37

    Oops, my link didn’t include both securities:

    http://research.stlouisfed.org/fred2/graph/?g=1nla

  38. Gravatar of Polemos Polemos
    2. August 2011 at 11:42

    Morgan Warstler,

    I think you are wrong when you try to draw a fine line between economics and social policy. Please tell me. What is the market price for human life? You incessantly complain about hungry governments and tax absorbing bureaucratic ticks. But, tell me, if there were markets for national security, who would protect the poor? who will die for you when a belligerent neighbouring community invades your state? are american soldiers getting the “market wages” given the nature of risk and personal sacrifices? i thought the us was a country where inquisitive and extrovert people inhabit. but sadly that is not to be the case. everyone, i discovered, is a slave of ideaology.

  39. Gravatar of Lee Kelly Lee Kelly
    2. August 2011 at 11:45

    The issue is not just about how much regulation, but what kind of regulation. Clearly, for example, if the government is going to keep bailing out creditors, then regulators need to provide the discipline that creditors would provide in a free market. This primarily means regulating bank capital. Unfortunately, regulation in this area was just bad leading up to the crisis; not too much nor too little, just bad — one might call it “mal-regulation.”

  40. Gravatar of JimP JimP
    2. August 2011 at 12:30

    Rogoff calling, again, for looser money. If only Bernanke were willing and able to do so.

    http://www.project-syndicate.org/commentary/rogoff83/English

  41. Gravatar of Liberal Roman Liberal Roman
    2. August 2011 at 12:42

    What about Trichet? At least here in America, we criticize our overly tight monetary authority. Over there, not a whimper about the TIGHTENING central bank.

  42. Gravatar of CA CA
    2. August 2011 at 13:10

    I just peaked at MarketWatch, Dow down 266 today.

    Hasn’t Mankiw, Rogoff, and Feldstein all called for looser money in the last week? I’m beginning to think the tide is turning, and the Fed is going to start getting more active.

  43. Gravatar of Silas Barta Silas Barta
    2. August 2011 at 13:17

    I have an alternate, crude theory about the current yield curve: bond purchasers are idiots. No sane human would look at the enormous financial obligations the US government has taken on (not just the debt but entitlements), its complete inability to make headway on them, and still see it as a good deal to get only 2.7% on a ten-year loan to that government.

    I’ve shorted treasuries (through an ETF, so limited downside). I’m just hoping the market doesn’t stay irrational longer than I can stay alive.

    How long until the Fed own all US government bonds?

  44. Gravatar of Lorenzo from Oz Lorenzo from Oz
    2. August 2011 at 13:51

    Full Employment Hawk: The current financial crisis was the result of lack of regulation. Both existing regulations not being enforced and needed regulation not existing. The economy performed much better during the post World War II years when the financial system was strictly regulated. It was only after the deregulation started that there began to be meltdowns in the financial system, like the savings and loan crisis.

    That is messing a whole lot of stuff together. The postwar period had lots of specific elements to it, notably high productivity growth. The boom came to an end when that productivity growth tanked. We then had the “stagflation decade” of 1973-1983. If was that experience which led to looking to new policy: particularly as the expansion in the welfare state put a premium on economic efficiency.

    One can also not lump “regulation” together in any analytically useful way. I will agree that prudential regulation was done poorly in the US. But the Australian experience is, provided one has good prudential regulation, you can mostly let the rest go.

    Lee Kelly’s point about regulators injecting moral hazard into the financial system is also very pertinent.

    Morgan: While I am sure changing the rules can affect economic activity, I am a touch sceptical that a generalised economic sluggishness across industries is solvable by specific changes in particular industries.

  45. Gravatar of Lorenzo from Oz Lorenzo from Oz
    2. August 2011 at 13:52

    Scott: have a great vacation!

  46. Gravatar of John John
    2. August 2011 at 14:17

    Hawk,

    Here’s a Hoover quote you might like: “We might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action.” (from his acceptance speech at the 1932 presidential nomination).

    It’s true he wasn’t quite as activist as Roosevelt. But then again, many revolutionaries get overtaken by people more extreme than them later on.

  47. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 16:04

    Lorenzo, I think there is no doubt that the entire housing debacle starts with FDIC.

    Without FDIC, banking is very boring business precisely because humans will store their money with whoever has the greatest reserves, and the least dangerous lending practices.

    So banks WOULD ADVERTISE how conservative they are – without any guarantees, it is the top concern on everyone’s mind.

    We shouldn’t concern ourselves with trying to reduce the cost of borrowing – it is antithetical to savings.

    It’s hard to get from there to “crisis” – because when people have to be concerned about the simple question “is my bank safe?” they are better prepared for the next questions “what the hell am I investing in?”

  48. Gravatar of Richard W Richard W
    2. August 2011 at 16:31

    I must say, I have to agree with Bob Murphy on this one. Why no strengthening of the USD, if you are going to reason that current low yields on treasuries signify tight money? The USD is weak across the board. Significantly in the USD/JPY and USD/CHF. The euro is getting killed in the EUR/JPY and EUR/JPY crosses. Is the decline in German bund yields and the blow out in Italian and Spanish yields signalling tight money in Germany, yet, loose money in Italy and Spain? Last week the pound sterling appreciated because the GDP figures were not as bad as some had forecast. This week the benchmark UK 10-yr gilt has fallen to its lowest yield since 1946. What has changed?

    I think the yields and the gold price are telling a story of risk aversion, fear and flight to safety. Moreover, I think you are guilty of reasoning from a price change without taking account of what is happening elsewhere with the USD, and Brent crude price which has only slightly weakened.

  49. Gravatar of r.r. r.r.
    2. August 2011 at 17:52

    Some questions.

    Why with inflation at somewhere around 3.5 percent would quantitative easing be a solution? Are the numbers distorted by oil and food, or is it just better to have higher inflation when real output slows down. How high would be too high for inflation? Why is NGDP the best way to manage inflation? Why shouldn’t we just always target say, 5 percent inflation. If inflation is good in a downturn, why wouldn’t it be good in an upturn too.

    Why, if the situation has been so dire the past few years, hasn’t the fed aimed at 5 percent inflation? Political resistance (Why are Republicans so anti- quantitative easing if inflation isn’t even high to begin with) ? Why does the fed rely on federal fund rates rather than quantitative easing? Why does “quantitative easing” require a special name if presumable that’s precisely what the federal fund rates tries to do as well through a separate mechanism?

  50. Gravatar of CA CA
    2. August 2011 at 17:54

    Brad Delong and Brink Lindsey briefly discuss Professor Sumner’s ideas in this recent bloggingheads post. Skip ahead to around 6:47 for the Sumner mention.

    http://bloggingheads.tv/diavlogs/37836

  51. Gravatar of Richard W Richard W
    2. August 2011 at 18:17

    *The euro is getting killed in the EUR/JPY and EUR/CHF crosses.*

  52. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 18:18

    DeKrugman’s dismissal of Sumner’s approach is exactly why I say you all better be rooting HARD for Rick Perry.

    Because if the economists that the Fed listens to are going to change their mind about “unconventional” monetary policy, it is going to require two things:

    1. Continued economic private sector suffering.
    2. A government that is racing to get out of the way of the private sector.

    Because no conservative economist worth his salt is going to do anything unconventional if he perceives that it aggressively glosses over the ill effects of socialism.

  53. Gravatar of RyGuy RyGuy
    2. August 2011 at 18:53

    Morgan,

    The shadow, unregulated banking system (with as assets at par with the regulated US banking system) was one of the key catalysts for the financial crisis. And your push is to deregulate further? It has already been said earlier but proper regulation realigns incentives with costs and acts against moral hazard.

    Secondly, without the FDIC, you assume “…humans will store their money with whoever has the greatest reserves.” Assuming this is true (which I doubt, since some people will still prefer a higher rate of interest as opposed to less risk) it does not imply that banks will act in a more risk averse manner.

    I believe that the competitive market is the best allocator of resources but it necessitates proper regulation to reduce moral hazard.

  54. Gravatar of Lorenzo from Oz Lorenzo from Oz
    3. August 2011 at 00:00

    Morgan: we in Oz have the equivalent of guaranteed bank deposits too plus land rationing. What we didn’t have is Fannie Mae and Freddie Mac. We also had stricter prudential regulation generally. So, no, the FDIC is not the problem.

    Meanwhile, back to Scott’s post, down here in Downunder, we are bothered because retail sales have fallen two months running and new home sales have had their biggest decline in five years. While unemployment is holding steady at 4.9% and the Reserve Bank has left the cash rate at 4.75% (an increase was thought likely). A different world.

  55. Gravatar of Lorenzo from Oz Lorenzo from Oz
    3. August 2011 at 00:09

    Oh, and our federal MPs give better value for money than members of Congress.

  56. Gravatar of Bill Woolsey Bill Woolsey
    3. August 2011 at 05:17

    High leverage and low asset prices should both increase the flow of saving, which lowers the natural interest rate. Under plausible assumptions, this will raise the demand for base money. Keeping the flow of money expenditures on output (consumer and capital goods) stable, requires lower market interest rates and a higher quantity of money.

    The notion that high leverage or low asset prices (and the consequent high saving) somehow require reduced money expenditures on output, reduced prices and wages, or worse of all, reduced output and employment, is nothing but Keynes’ paradox of thrift.

    Let me say it again–all of these pseudo-free market claims that the accumulation of too much debt or excessive asset prices during the boom make a recession inevitable come down to a claim that too much saving leads to recession. It is vulgar Keynesian economics at its worst.

  57. Gravatar of Morgan Warstler Morgan Warstler
    3. August 2011 at 05:28

    Lorenzo, I’m not getting your point. Dumping FDIC and ending lang regs makes perfect sense – whether here on in Oz.

  58. Gravatar of Five year yields are 1.26% and falling almost every day « Economics Info Five year yields are 1.26% and falling almost every day « Economics Info
    3. August 2011 at 06:01

    […] Source […]

  59. Gravatar of Zamba Zamba
    3. August 2011 at 06:20

    Scott, may I ask you a question that is bothering me as a student of economics:

    When there is a fall in government spending, thus an increase in savings, what’s the mecanism behind the adjustment of interest rates? I mean, in this case the Fed has to cut the rates by using the open market operations for the economy to get back to its potential,or the Fed just have to let the interest rate falls, without any open market operations?

    Thanks

  60. Gravatar of Jeff Jeff
    3. August 2011 at 06:49

    @Scott,

    It’s even worse than you think.

  61. Gravatar of Full Employment Hawk Full Employment Hawk
    3. August 2011 at 08:52

    From the Financial Times:

    “The drop in Britain’s gilt yields to a new low was hailed by the Treasury on Tuesday as proof that George Osborne’s austere policies had kept the country’s economy on track.”

    According to Milton Friedman these new lows are evidence that Britain has a tight monetary policy.

  62. Gravatar of Full Employment Hawk Full Employment Hawk
    3. August 2011 at 08:56

    “If you don’t feel like it, let me know because I do want to answer this:

    “In markets that are not strictly perfectly competitive and where wage changes and price changes are made sequentially instead of simultaniously, by all firms and workers simultaneously agreeing on wages and prices, wages and prices are inherently sticky as a result of the workings of the market process.”

    I would like to hear your answer.

  63. Gravatar of Dead man’s curve? « Blogging Through the Wreckage Dead man’s curve? « Blogging Through the Wreckage
    3. August 2011 at 10:58

    […] Sumner’s blog The Money Illusion has two provocative posts today that argue that Federal Reserve policy is currently too tight, despite the […]

  64. Gravatar of Morgan Warstler Morgan Warstler
    3. August 2011 at 10:58

    1. I don’t argue that in “some” circumstances wages are sticky. I argue that IF you want to make the argument there is nothing we can do about it, then you can only make it AFTER we have done everything possible to unstick wages.

    So out goes Davis-Bacon. Out goes minimum wage. Out goes public employee unions.

    Meaning if sticky wages are a construct you intentionally PUT IN PLACE, then they are not an economic fact that encourages money printing.

    It just means you KNEW there would be no money printing and doomed your side to be unemployed – which was a really shitty thing for you to do.

    2. This is very much similar to your FDIC thing – which you seem unwilling to answer for…

    You start with an assumption: FDIC is status quo and immovable, and therefore your opponents must also accept further bank regulations.

    RyGuy,

    I don’t disagree with the idea of some regulation, but to me it is ONLY justified if everyone KNOWS they can lose their money.

    So what what are the mini/max regulations RyGuy would create if the GOAL was:

    1. heighten the sense that banking is not backstopped by government.
    2. reduce theft, decrease moral hazard.

    There’d still have to be routine public floggings – both in hangings and idiots left penniless. I personally like no FDIC and I like Glass-Steagall.

    But generally, you are non-responsive on banks…

    I said that when people clamor for a safe bank, banks will INVENT new ways to proving how safe they are. Like exposing their entire loan book to customer scrutiny, etc.

  65. Gravatar of MTD MTD
    3. August 2011 at 14:25

    Bob – Scott has argued, as Friedman did, that low rates are more often a sign that monetary policy has been tight, while high rates are more often a symptom of policy having been loose. Since most economists associate high rates with tight money and low rates with loose money, this is counterintuitive. Plunging rates across the Treasury term structure are thus consistent with Scott’s view that the market is pessimistic about future NGDP and that these low rates not a symptom of easy money, but falling velocity. There’s no contradiction here.

  66. Gravatar of John John
    3. August 2011 at 19:17

    I’ll throw out a controversial view on banking regulation here. The optimal lending practices, reserve standards, and size of any banking firm are for entrepreneurs and customers to decide. Economists and politicians really don’t have much they could do to help. A regulation will either restrict customer service, if it is an effective regulation, if it is a superflous, or ineffective regulation, it will already be best practice at any bank. The very idea of regulation is mistaken.

  67. Gravatar of Dennis Dennis
    3. August 2011 at 19:59

    Hi Scott
    I just watched Brad Delong talking to Brink Lindsey talk about how your solution would look if the Fed acted on it. He said you plan basicaltalked the Fed buying $200 billion of Treasuries per month (3 x the QE2 rate) with newly created dollars until enough people have sold enough risky assets to the Fed that they start spending rather than lose it to inflation.

    Was his assessment in the ballpark of what you plan requires?
    Was his simplified description of your plan accurate?
    Seems there is little political cover for the Fed to act in this fashion.

    Thanks
    Dennis

  68. Gravatar of dwb dwb
    4. August 2011 at 04:46

    not only are yields 5 years and in low, but breakeven inflation is really low as well.

    0.25 -0.136 -0.148 0.012
    0.5 0.040 -0.206 0.246
    1 0.158 -0.900 1.058
    2 0.320 -1.279 1.599
    3 0.503 -1.203 1.706
    4 0.834 -0.981 1.815
    5 1.202 -0.721 1.923
    7 1.921 -0.294 2.215
    10 2.484 0.305 2.179

    Inside of 5 years market-expected breakeven inflation based on TIPS is well below 2%. Inside of 1 yr – a 1.1% breakeven rate (this is based on the Jul-12 TIPS with a yield of -.885% and the 1 yr TSY with a yield of .2%). That is roughly a 50% chance of 2% inflation and a 50% chance of 0% inflation, unacceptably high.

    Nope no hyperinflation here.

  69. Gravatar of johnleemk johnleemk
    4. August 2011 at 06:31

    Scott,

    Nate Silver has a chart of the predicted real output gap, comparing the current Great Recession to the Great Depression: http://fivethirtyeight.blogs.nytimes.com/2011/08/04/double-dip-or-not-economy-is-falling-farther-behind/

    For the first time, I think, I am really afraid that this recession will be the next Great Depression. I wasn’t scared of the financial crisis, but I am scared as hell of this. I can imagine a chart of NGDP along those lines is even more depressing. The Fed is dithering, and its inaction (or should I say, deflationary action) is frightening.

    I just don’t buy the supply-side case, insofar as it relies on blaming the minimum wage and drug war for the Great Recession. While those are terrible things, there is no plausible explanation except faith-based economics for them causing a recession of such scale. The PSST supply-side case makes more sense, but as its chief proponent, Arnold Kling says, inflationary action from the Fed would hardly harm anything — and might as we monetarists think, even help.

    There is definitely a supply side part to this recession, but much of it no doubt is demand side — look at how weak inflation and NGDP are relative to trend! Much of the supply side, as you say, is endogenous to the demand shortfall — if NGDP were growing, we wouldn’t see a Congress hiking unemployment insurance. Whether you think the recession is 20% demand side or 80% demand side, there is absolutely no justification for the Fed’s stance on inflation and NGDP — none! It’s so depressing.

  70. Gravatar of Mark C Mark C
    4. August 2011 at 07:32

    Since we are talking about market here, FYI, 10yr UST just hit 2.50%, while 5yr UST now is 1.16%. If we go to the TIPS market and try to sell some TIPS, we won’t be able to get a bid, coz everyone is a seller of TIPS, even the ‘pricemakers’ wouldn’t dare to take the risk. Though 5yr BE still stays at around 1.8%, short term BE is tanking fast. I believe market has started pricing in a recession.

    If tomorrow’s NFP is less than 50K or even negative, things could get real ugly.

  71. Gravatar of Morgan Warstler Morgan Warstler
    4. August 2011 at 07:45

    johnlemeek,

    “I just don’t buy the supply-side case, insofar as it relies on blaming the minimum wage and drug war for the Great Recession. While those are terrible things, there is no plausible explanation except faith-based economics for them causing a recession of such scale.”

    This mis-states the very logical opposition.

    SINCE WE AGREE that these are very terrible things, then this moment is a tremendous time to fix them… they are luxuries we cannot afford.

    Now AFTER we fix Davis-Bacon, minimum wage, public employee unions, maybe even the drug war (altho I think that one is hard)… we will know what kind of drag this stuff really was.

    And that will give us STRONG DATA on who was right. And as I keep saying, IF Sumner is right, then there is time in the nearish future where the Fed will make the kind of unconventional policy action they aren’t ready to make.

    Until then, we are witnessing a virtuous cycle:

    1. Public employees are being fired, the states are getting rid of lefty technocratic regulations, discussions on taxes are going nowhere.

    2. And housing prices are falling, wages are falling, and productivity is increasing.

    Austerity might not solve, but IF Sumner has magic fairy dust, we sure as shit aren’t sprinkling it on socialism.

  72. Gravatar of MikeDC MikeDC
    4. August 2011 at 09:23

    Morgan,
    I’m not witnessing that. Government spending and involvement in pretty much all phases of the economy is still increasing. Further, I see no popular impetus for getting rid of that raft of bad policies.

    In fact, while I see people on the left squealing about how the irresponsible and crazy Tea Partiers were willing to default in order to cut spending, I see very little recognition that every game of chicken has to have two sides.

    That is, the left side of these negotiations appeared very willing to default rather than cut even a dollar of actual spending. The monumental cave in the left commentariat is freaking out about is a minimal reduction in the growth rate of planned expenditures well the future.

    “Yes, we know we’re very in debt, and to compensate for this, we plan to stay at the cheap hotel instead of the expensive one on our next 4 vacations. But not on the vacation we’re going on next week.”

  73. Gravatar of johnleemk johnleemk
    4. August 2011 at 09:27

    Morgan,

    The whole point is that demand-side policy — monetary policy — is much easier to make than supply-side policy. Your argument seems to be that it’s better for a terrible recession to ensue so you can get the supply-side reforms you want, and that the Fed will be completely and willingly complicit in this, so we should just sit back and let a terrible recession force supply-side reforms through. I’ll worry about getting people’s livelihoods back to them the easy way first. I still buy Scott’s warning about depressions turning people more towards statism than towards liberty.

  74. Gravatar of MikeDC MikeDC
    4. August 2011 at 11:05

    Johnleemk,
    Unfortunately, I think if it were that easy to do the demand side policies, they’d be done. Just because the number of people that need convincing to change the Fed policies are smaller doesn’t necessarily make the public choice problems of divergent interests solvable here.

    I also think in the longer term supply and demand can’t be separated so easily. Increasing AD through monetary policy, if I understand Scott’s view (not a sure thing) is that the Fed must create a credible expectation that it will force rising NGDP and then things will work themselves out. My fear is tha the supply side incentives at play in the US have been so battered and perverted over the last few years that it will fail to make enough gains no matter how much the Fed attempts to inject. At some point this itself will limit the Fed’s credibility.

    Anyway, I came here today to see if Scott was breaking from his vacation to launch a takeover of the Fed. Scotts notes on rates were obviously spot on, and today we’re seeing a full on rout that’s going into really dangerous territory. And I don’t see the Fed or the ECB doing a damn thing about it, which is even scarier. It’s a shame we haven’t turned over monetary policy to the Swiss who are promptly easing the he’ll out of their currency.

  75. Gravatar of johnleemk johnleemk
    4. August 2011 at 11:21

    Even the Japanese are on the ball, good grief: http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/08/04/bloomberg1376-LPDQBX0UQVI901-6PR3TVTOLDBP0U8N8R6252MA4D.DTL

    The Fed is broken, there’s no doubt about that.

  76. Gravatar of Easy Money | Market Notes of a Sort Easy Money | Market Notes of a Sort
    4. August 2011 at 11:27

    […] not much I can say that Scott Sumner hasn’t said.  The dollar and treasuries are rising, commodities and equities falling. Classic tight-money […]

  77. Gravatar of Morgan Warstler Morgan Warstler
    4. August 2011 at 13:39

    johnleemk,

    “Your argument seems to be that it’s better for a terrible recession to ensue so you can get the supply-side reforms you want, and that the Fed will be completely and willingly complicit in this, so we should just sit back and let a terrible recession force supply-side reforms through.”

    That is my argument. Altho MiksDC’s thinking is my own.

    There is nothing easy here. I’m making a VERY REALISTIC and rational argument:

    There is a reason the collective consciousness of the leading economists is that monetary won’t help.

    I think they THINK America has a deeply disturbed a broken structural economy – full of mal-incentives, political junk, rent seeking, intentional price stickiness, and anything else you want to lumo in there…

    And as such they look at doing more QE and think it is a bandaid.

    I’m saying that those who want to see QE for the right reasons (ie Sumner, not DeKrugman) should accept that WHO WINS IN 2012 MATTERS DEEPLY in changing the attitudes of leading economic thought.

    And I don’t care if you “like it” – I’m saying if you don’t want to accept the reality of that then I don’t think you are being honest.

    When the government is doing EVERYTHING it can to get out of the way of the private sector – the folks at the Fed will feel far more comfy with unconventional policy.

  78. Gravatar of Rien Huizer Rien Huizer
    5. August 2011 at 00:48

    RyGuy,

    The shadow banking system existed because there were insured/TBTF dealers and banks acting as their counterparty in last resort. It is highly unlikely that without a core of institutions that could print their own US gvt contingent liabilities, there would have been such a large shadow banking system. There are only two viable models of bank regulation:

    (1) making it comprehensive (i.e. making it onerous/illegal to do shadow banking (for instance by forbidding banks to deal in commercial paper and/or provide liquidity etc to CP programs other than formally underwriting or guaranteeing it, forbidding them to engage in any form of CDS business except with other banks) :or:

    (2) adopting a very narrow type of banking (essentially functioning as a FED wire payments franchisee licensed to take insured (and only insured) deposits and investing those deposits in eligible collateral. No lending, trading or underwriting. Maybe custodian business. The rest of the financial services industry should be entirely unregulated (and regulated foreign institutions should seek a US charter that would require them to be locally capitalized so as to not offer unfair competition to the uninsured US financial system.

    Both are unfeasible politically (and internationally as well), but maybe (1) is a little easier than (2) . Allowing insured institutions to more or less shepherd a shadow banking system (as counterparty, dealer, primary broker etc) is just plain stupid on the regulator’s part.

  79. Gravatar of Rien Huizer Rien Huizer
    5. August 2011 at 00:52

    MikeDC

    You said

    “I also think in the longer term supply and demand can’t be separated so easily. Increasing AD through monetary policy, if I understand Scott’s view (not a sure thing) is that the Fed must create a credible expectation that it will force rising NGDP and then things will work themselves out. My fear is tha the supply side incentives at play in the US have been so battered and perverted over the last few years that it will fail to make enough gains no matter how much the Fed attempts to inject. At some point this itself will limit the Fed’s credibility.”

    Amen.

  80. Gravatar of anon anon
    5. August 2011 at 10:38

    Morgan, supply-side reforms are helpful whether or not QE3 occurs, because they are disinflationary and enable the Fed to provide more liquidity in the short run. So, in that sense, QE is no “band-aid”.

    Indeed, one can argue that _as long as monetary policy is dysfunctional_, supply-side reform is useless because DeKrugman’s weird “depression econ” will actually apply (paradox of thrift and whatnot). This is not really true because the Fed does care about avoiding deflation, and investors know this, so AD can still be improved. But the argument is not altogether implausible.

  81. Gravatar of Morgan Warstler Morgan Warstler
    5. August 2011 at 11:06

    anon, supply-side reforms:

    1. are more important than monetary to the overall health of the system, because the folks with hard assets SAY SO. They call the tune, the country dance the jig.

    2. are deflationary, but that can be eased by QE.

    So you have it back-asswards. DeKrugman is a tard who is AGAINST supply-side reforms. He HATES supply side reforms, that’s why his support of Sumner is so tepid.

    Dekrugman does not want those with hard assets to call the tune.

    The logic is super clear:

    There is magic fairy dust called QE, it promotes stock prices, and prices in general.

    So IF we are going to use it, we are going to use IF and ONLY IF the government is making hard fiscal supply-side reforms.

    You might not like this fact, but it doesn’t keep you from answering this question:

    IF THE ONLY WAY you are going to get QE is to make deep structural changes that undermine price supports in wages, pushing more people out of the wagon, and making government dance to private interests – weakening regulatory bodies.

    Do you champion those changes, or do you keep asking for QE, while you go vote Democrat?

    It is easier to pass a camel thru the eye of a needle than it is to get you guys to stop theorizing and start forming policy based on what is politically tractable.

    With a divided government, and the strength of the Tea Party, the Fed will be miserly, and QE will be a dribble and we will be in this nightmare for a long, long time.

    OR

    Under a Perry regime and GOP Congress, the Fed will cheer “Cut, cut, cut!” and sprinkle so much damn fairy dust on the economy, progressives are never heard from again.

    We can have a jaw dropping turn around in 24 months time, we just have to render unto the Tea Party their due.

  82. Gravatar of MikeDC MikeDC
    5. August 2011 at 15:31

    Just to clarify, I think both monetary and supply side policy improvements are necessary but not individually sufficient to get us to where we need to (and should) be.

  83. Gravatar of MR MR
    5. August 2011 at 19:33

    Wait, wait, wait.

    Abolishing the minimum wage and cutting public employees will be our salvation? Are you serious?

    So our response to a massive shortfall in AD, with NGDP off trend, inflation subdued (contrary to the wild-eyed predictions of the libertarian right going all the way back to 2008,) inflation expectations low, huge amounts of excess capacity, and millions of unemployed workers, is to…suck as much demand out of the economy as we can?

    Yes, an Irving Fisher debt-deflation spiral is just what we need right now.

  84. Gravatar of Morgan Warstler Morgan Warstler
    6. August 2011 at 12:59

    MR, there can be no deflation with magic pixie dust.

    Repeat that: there can be no deflation with magic pixie dust.

    What this means is that we can go tit for tat, cut the support structure out from under wages, and print money to make sure the economy stays positive.

    QE means we get to cut public employees and minimum wage without negative consequence.

  85. Gravatar of John Papola John Papola
    9. August 2011 at 05:08

    Scott,

    Isn’t it possible, as George Selgin makes explicit regularly, that the theoretical ideal of NGDP (or MV) stability (or low and stable growth) is only applicable to a decentralized monetary system and unhelpfully inapplicable to the impossible task of central banking?

    Put another way: a system of free banking (via George) theoretically stabilizes nominal spending. Hayek believed this to be true as well. I think you do as well. So George believes that a combination of a frozen base of Federal Reserve Notes combined with a real banking market including private note issue would be the right move. You’re advocacy for a NGDP futures market seems in line with this kind of market-knowledge reform. George tells me that you and he are pretty close to one another on your understanding of macro.

    But there seems to me to be a giant leap from these reforms to actively advocating the the Fed in its current form should actively try to stabilize NGDP growth. Pointing out that they got it wrong ex-post is not the same things as believing they can get it right ex-ante.

    I don’t believe they can. And neither did Hayek. So rather than advocate for central monetary planners to target a free banking ideal, just stick to criticizing their ex-post failure and advocate the ideal. Asking the Fed to aim for NGDP stability seems like asking a man trying to speak a foreign langue phonetically to translate. He just doesn’t have the knowledge to do it.

    “…The one thing of which we must be painfully aware at the present time … is how little we really know of the forces which we are trying to infuence by deliberate management; so little indeed that it must remain an open question whether we would try if we knew more.” F. A. Hayek

  86. Gravatar of W. Peden W. Peden
    9. August 2011 at 05:37

    John Papola,

    I can’t speak for Prof. Sumner, but I would prefer free banking to NGDP targeting. Then again, I also differ from Prof. Sumner on the mechanism of NGDP targeting: I would prefer a money supply range rule to a government-subsidised quasi-market.

  87. Gravatar of Scott Sumner Scott Sumner
    12. August 2011 at 09:23

    Everyone, No time to answer all these old comments, but I read them all. I’ll answer a few, and bring it up again in a new post if you wish.

    Kevin, Great comment on Krugman and me relying on empirical evidence. Regarding credibility, I see markets often responding strongly to the merest hints of easier money, like stocks late in the day Tuesday, or rumors of the (fairly weak) QE2. Remember that Bernanke has never tried anything bold. It’s too soon to say he wouldn’t be believed if he did.

    Steve and rr, If you Google themoneyillusion and Selgin, you’ll find a couple posts with Selgin in the title. They may discuss the advantages of NGDP over inflation.

    Bob Murphy, You caught me, that was a bad call on my part. You’re right that I was also looking at other evidence beyond interest rates, like falling stock prices.

    John Papola, I don’t see why the Fed can’t get the job done. Level targeting would make it’s job much easier, as the market would help move things back on track when NGDP fell below the target path for a short period.

    Zamba, Without any OMOs the market rate would fall by itself, as it did before we had a Fed.

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