More evidence that the real problem was nominal

Last year David Glasner produced one of the strongest pieces of evidence in favor of the view that the current recession was caused by an AD shortfall.  He found that beginning around 2008 stocks became highly correlated with TIPS spreads, suggesting the market was rooting for higher inflation, higher aggregate demand.  Even Paul Krugman gave him a high five.

Now Alexander David of the University of Calgary and Pietro Veronesi of the University of Chicago have a study that reached broadly similar conclusions:

At the onset of the financial crisis in 2008, the volatility of stock returns increased dramatically as the equity markets plunged. At the same time, U.S. Treasury bond prices shot up. The correlation of bonds and stock prices has been mainly negative ever since.

This makes sense: In times of trouble, we dump stocks and buy safe Treasury bonds, and their prices should move inversely. This also would mean that in better times, we buy stocks and sell bonds, implying that the correlation between Treasuries and stocks should always be negative.

It isn’t. The correlation between the aggregate stock market and long-term Treasury bonds has been mainly positive and rising from the 1960s to the end of last millennium. With the new millennium, the correlation between stocks and Treasuries turned negative, and strongly so, especially around the last two recessions.

Here they explain why the correlations have changed in recent years:

Before describing the implications of our model for the last decade, we should look at the late 1970s. Our estimates suggest that at that time investors faced large uncertainty about whether the U.S. would enter a persistent stagflation regime. Any consumer-price data that were above expectations were taken as an indication that the U.S. was transiting into such a regime, which brings about low growth and high inflation. The former makes stock prices decline, the latter makes long- term yields increase. Thus, data-driven fluctuations in investors’ beliefs about a stagflation regime pushed the prices of stocks and Treasuries to move together, and increased volatility for both.

In the recent Great Recession, the opposite occurred. The market now fears deflation, which is accompanied by low growth, as we know from the Great Depression. In this case, CPI data above expectations are great news for the economy, as investors interpret them as a signal that the bad deflation regime could be averted.

Deflationary Regime

Stock markets cheer higher-than-expected CPI, and Treasury yields increase in expectation of accelerating inflation. Thus, data-driven beliefs about entering a deflationary state push the prices of stocks and Treasuries in opposite directions. Large uncertainty about deflation also increases the volatility of stocks and bonds, as we observed in the data. In other words, the signaling role of inflation dramatically alters the joint behavior of stocks and bonds, with important implications for risk and returns of stock and Treasury investments.

In late 2008 the markets were telling us that the Fed was making a tragic mistake by allowing NGDP expectations to plunge.  But the economics profession didn’t listen, as they view stock investors as being irrational.  Economists were obsessed with the notion that the real problem was banking distress, and that fixing banking would fix the problem.  No, the real problem wasn’t banking, the real problem was nominal.


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42 Responses to “More evidence that the real problem was nominal”

  1. Gravatar of Greg Ransom Greg Ransom
    9. March 2012 at 09:24

    But _why_ was there a sudden and massive NGDP shortfall?

    _That_ is what needs explaining.

    Science produced non-magical explanation, and it needs to “mop up” any problem raising empirical pattern in our experience which is left hanging by an an incomplete explanation which fails to account for much of what is most significant in the patterns of the phenomena. (Compare

    Market monetarists, as far as I have been able to determine, is in that situation.

    And market monetarists are in this position in part I would suggest because they are more in the dentistry or plumbing business (i.e. policy business) rather than in the scientific explanation business.

    Market monetarists haven’t given us a broad enough underlying explanatory paradigm to account for much of the central empirical phenomena of problematic interest.

    Market monetarism leaves economic science in the same sort of position as the pre-Franklin “electricians” as described by Thomas Kuhn:

    “The history of electrical research in the first half of the eighteenth century provides an example of the way a science develops before it acquires its first universally received paradigm. During that period, there were almost as many views about the nature of electricity as there were important electrical experimenters. All their numerous concepts of electricity had something in common, they were partially derived from one or another version of the mechanical-corpuscular philosophy that guided all scientific research of the day. Yet though all the experiments were electrical and though most of the experimenters read each other’s works, their theories had no more than a family resemblance.

    One early group of theories, following seventeenth-century practice, regarded electrical attraction and frictional generation as the fundamental electrical phenomena. This group tended to treat repulsion as a secondary effect due to some sort of mechanical rebounding and also to postpone for as long as possible both discussion and systematic research on the newly discovered effect of electrical conduction. Other “electricians” (the term is their own) took attraction and repulsion to be equally elementary manifestations of electricity and modified their theories and research accordingly. But they had as much difficulty as the first group in accounting for any but the simplest conduction effects. Those effects, however, provided the starting point for still a third group, one which tended to speak of electricity as a “fluid” that could run through conductors. This group in its turn, had difficulty reconciling its theory with a number of attractive and repulsive effects. Only through the work of Franklin and his immediate successors did a theory arise that could account for very nearly all these effects and that therefore, could and did provide a subsequent generation of “electricians” with a common paradigm for its research… It suggested which experiments would be worth trying and which would not and therefore guided research.”

  2. Gravatar of Greg Ransom Greg Ransom
    9. March 2012 at 09:31

    So Scott, if the EMH is true, why did any of this happen?

    Also, there were massive and widespread deflationary fears throughout the _early_ 2000s, fanned by none other than Greenspan, Bernanke and the Fed.

    And if the EMH is true, why were NGDP expectations plunging in 2008.

    Your story seems full of holes.

    Some mopping up is order — to plug at least some of the gushing holes.

    I’m not saying this can’t be done — I’m just waiting to _see_ it done.

  3. Gravatar of dwb dwb
    9. March 2012 at 10:08

    In late 2008 the markets were telling us that the Fed was making a tragic mistake by allowing NGDP expectations to plunge. But the economics profession didn’t listen, as they view stock investors as being irrational. Economists were obsessed with the notion that the real problem was banking distress, and that fixing banking would fix the problem. No, the real problem wasn’t banking, the real problem was nominal.</I.

    the only part i would quibble with is that those are not mutually exclusive. debt contracts are nominal, therefore any significant falloff in NGDP causes a banking crisis. the answer is both, but many economists got the order mixed up.

    If debt contracts were perfectly indexed to the price level P then only real fluctuations in Q (much smaller) would impact the banking system. But if things were different they would not be the same.

  4. Gravatar of marcus nunes marcus nunes
    9. March 2012 at 10:23

    But that´s Bernanke and his “Nonmonetary propagation mechanisms”. In other words, a “Credit freak”.

  5. Gravatar of John Thacker John Thacker
    9. March 2012 at 10:57

    Greg Ransom:

    “So Scott, if the EMH is true, why did any of this happen?”

    The Fed (and the government in general) isn’t a market.

    “And if the EMH is true, why were NGDP expectations plunging in 2008.”

    The EMH doesn’t rule out the possibility of unusual events. It just says that they can’t be predicted, and that the market reacts quickly in the face of them. Indeed, the market did, and reflected the new information. But if policymakers choose to ignore the market, that’s not the market’s fault.

  6. Gravatar of Becky Hargrove Becky Hargrove
    9. March 2012 at 11:54

    Like many others, I came to this blog with the idea that banking was a big part of the problem. It makes more sense to me now that – just like the Fed, the banks are primarily trying to deal with the fallout from the actual problem in the best way they can. So I am going to become like a broken record and try to explain why the supply side is the source of the problem.

    Who can blame them? (I don’t blame them for the incentive, I blame them for the dishonesty and the shift of blame to others) They want to go for the greatest profit possible. But as a group, that means that most of them are primarily going for the middle to upper class marketplace. Because a lot of people do not exist in this imaginary marketplace, finance turns itself inside out trying to create instruments that match up buyer to seller, however possible. Also, because of this imaginary marketplace, unions try to force politicans and institutions of all kinds to keep pensions in place. Everyone in the process gets blamed at some point – except for the ones who caused the problem in the first place. The Fed feels powerless right now, as people in their own midst tell them to lay off the idea of growth. But people are starting to wake up to the fact that the marketplace is rigged, and the Fed already has all the research it needs to hold up the mirror to the supply side, to show them the places where growth is actually possible in the marketplace – right down to the nth degree in terms of actual income and purchasing potential. It only needs to gain courage from the public that they want the Fed to do this, to show how real growth is possible without undue inflation. Because the things people need the most do not have to have the price tag of yachts. If people gain the confidence that the Fed can target the potential consumers that matter most, they may also realize it was not the Fed that created inflation in the first place. It was the suppliers who created inflation by rigging the marketplace, and forcing the Fed to supply the money for that marketplace to keep it solvent. That the suppliers blamed that inflation on the Fed was wrong in the extreme.

  7. Gravatar of W. Peden W. Peden
    9. March 2012 at 12:19

    Becky Hargrove,

    I wouldn’t be quick to distribute dishonest. It’s very easy for anyone working in any institution to come to the conclusion that someone else is responsible.

    I was interested in the recent Eugene Fama interview by the interviewers’ observation that regulatory regimes created a large demand for AAA securities, which may have encouraged the deceptive selling of goods as better than they in fact were. As with the Great Depression, I’m sure we’ll still be finding twists and turns in the Great Recession well into the 2070s.

    (Apologies for the alliterative mania I have right now. I’ve been suppressing it while writing an essay.)

  8. Gravatar of Greg Ransom Greg Ransom
    9. March 2012 at 12:23

    John, it’s been 5 years.

    5 years for the EMh to do it’s stuff.

    Yet according to Scott, nothing so far, and as Scott tells it, nothing to be expected from EMH.

  9. Gravatar of Becky Hargrove Becky Hargrove
    9. March 2012 at 12:57

    W. Peden,
    Granted I need to remain calm in my approach! In highlighting the service sector I really do so not to create (yet more) blame, but to provide a central point of reference from which other disparate factors make a bit more sense.

  10. Gravatar of Becky Hargrove Becky Hargrove
    9. March 2012 at 13:00

    …addled brain, supply side sector.

  11. Gravatar of Mike Rulle Mike Rulle
    9. March 2012 at 13:22

    Greg,

    I do not understand what EMH has to do with any of this.

    The EMH is not a predictive model and is not meant to be. Unless you call “today’s” price a prediction. While it is correctly critiqued for assuming a normal distribution in returns, that is not central to its argument.

    The central practical point of EMH is that it is highly unlikely for investors to outperform (risk adjusted) the stock market (which EMH is centered on) in the long run. Obviously, given the low Sharpe ratio of the market it takes many years to test this point. It has been demonstrated to be substantially right. For some reason “efficient” has been converted to ex-post “correct price” in the minds of those who critque the EMH. Behavioral Finance is interesting, but I do not associate it with any over arching theory.

    The stock market began to drop in late 2007—–I believe investors thought the mortgage and housing market would begin seeing signs of life by 2008—but in fact, the opposite was occuring as liquidity gradually then rapidly began to fall. Then the Fall of 2008 arrived.

    ——————–

    Scott,

    For some reason, you left out the 1980-2000 period when discussing correlations of bonds and stocks. Also, the time frames for determining correlations matter. The correlations that began to go positive in the 1970s continued through out the 80s. T-Bills were 16% or so and prime was 20% or so circa 1981. The S&P was around its 14 year low with P/Es in the middle single digits. I-rates dropped and Stocks rose during that decade.

    In a constant “risk premium” world with no growth one would expect bonds and stocks to be correlated positively. In a changing risk premium world with positive or negative growth the correlations obviously can go either way. The risk premium for stocks is so high now relative to bonds, one might reasonably expect these to converge closer to each other. One might guess the next “big move” to be biased to negative correlation,—led this time by bonds dropping. Speculating of course.

    This assumes we are gradually drifting out of massive danger. If we are, what does that say about NGDP and Fed “inputs”?

    I would love to believe your NGDP theory—-it seems so straight forward—the automatic liquidity stabilizer—-maybe so.

  12. Gravatar of Greg Ransom Greg Ransom
    9. March 2012 at 13:26

    If the EMH never works just whenever your theory needs it not to work in order to rescue your theory, and the EMH always works instantly and perfects just when it is needed to supply an objection to explanatory rivals, what you have is a convenient ad hoc theory saver invoked to protect your theory from anomaly.

  13. Gravatar of dirk dirk
    9. March 2012 at 14:29

    Today’s positive jobs report shows that avg weekly pay rose 2.5%, trailing inflation slightly. Indirect evidence that sticky-wages have been a problem?

  14. Gravatar of Neal Neal
    9. March 2012 at 15:52

    EMH says that as far as anybody can tell, all current information is reflected in prices. When expectations for nominal GDP lowered, that was immediately reflected in the stock market, and it crashed. This is consistent with EMH predictions.

    The bigger (and more interesting) problem is explaining why NGDP expectations fell in the first place. If I understand the market monetarist (MM) model, it doesn’t try to explain the animal spirits ultimately controlling NGDP expectations. It just says that they exist, and the monetary authority can exert strong influence over them.

    PS- “The real problem was nominal.” I see what you did there …

  15. Gravatar of Steve Steve
    9. March 2012 at 16:42

    “In late 2008 the markets were telling us that the Fed was making a tragic mistake by allowing NGDP expectations to plunge. But the economics profession didn’t listen, as they view stock investors as being irrational. ”

    Scott, since I’m not a macroeconomist, I should change my user name to “Irrational_Stock_Investor” instead of Steve.

    One interesting thing, if we had an NGDP futures market (or NGDP indexed treasury bonds), I’m certain people would stat arb them against stock prices, especially highly cyclical sectors like housing and autos that account for much of the swings in GDP.

    I’m sure the correlation we see between inflation expectations and stocks is just a weaker version of the correlation we would see between NGDP futures and stocks, if the former instrument existed.

    I’m not sure how well the NGDP arb would hold up in different times like the 1970s. Maybe traders then would arb RGDP against stocks.

    In the 1970s, inflation was always and everywhere a monetary phenomenon.

    From 2007-present, RGDP was always and everywhere a monetary phenomenon.

    In general, NGDP is always and everywhere a monetary phenomonon?

  16. Gravatar of Donald Pretari Donald Pretari
    9. March 2012 at 17:02

    I think that’s just what Fisher’s Debt-Deflation & the Chicago Plan of 1933 said should happen. I’ve certainly interpreted them that way, & the Economy picked up over the last 4 years precisely when Long Term Rates were Rising. At one point, I even said something about knowing things would get better when there’s fear in the eyes of the Bond Vigilantes.

  17. Gravatar of ssumner ssumner
    9. March 2012 at 17:38

    Greg, You said;

    “But _why_ was there a sudden and massive NGDP shortfall?

    _That_ is what needs explaining.”

    How many million times do I have to explain the same points over and over again.

    You said;

    “And if the EMH is true, why were NGDP expectations plunging in 2008.”

    Only you could take a great triumph of the EMH, and call it a failure. 2008 was one of the best market calls since 1929, when the stock market correctly predicted a depression.

    dwb, I agree.

    marcus, I agree.

    Becky, Banking can be a bad industry, causing lots of harm, without necessarily being to blame for a big fall in NGDP.

    Mike, Your criticism of Greg is exactly right.

    I don’t claim to know all the reasons why the correlation between stocks and bonds varies over time. Quite frankly, I’m more interested in the question Glasner examined, the correlation between stocks and TIPS spreads. That abstracts somewhat from risk (assuming T-bonds and TIPS are both risk-free) and focuses on the macro issue of whether higher inflation expectations are good or bad news. In the Great Depression stocks were strongly and positive correlated with inflation shocks.

    dirk, For sticky wages you need to look at hourly pay, not weekly pay.

    Neal, NGDP expectations fell because of tight money. The Fed didn’t even cut interest rates in the meeting after Lehman failed. Since the Wicksellian equilibrium rate was obviously falling fast, money was effectively getting much tighter. People need to ignore interest rates, and look at NGDP growth expectations. Bernanke and I see that as the proper indicator of whether money is easy or tight.

    Steve, Investors actually have little interest in NGDP futures, that’s why there is no market. So if a market existed, I doubt whether it would be used much for hedging. My hunch is that it would be almost a pure prediction market.

    Your last line is best.

    Donald, Good point.

  18. Gravatar of Neal Neal
    9. March 2012 at 17:48

    Then what caused the Wicksellian equilibrium rate to fall? Was it supply or demand movement? What was the shock? etc. Does MM ultimately address these questions?

    It just seemed to me that Greg is arguing that MM can’t explain everything. All I meant was that it doesn’t need to.

  19. Gravatar of Steve Steve
    9. March 2012 at 18:30

    “Steve, Investors actually have little interest in NGDP futures, that’s why there is no market. So if a market existed, I doubt whether it would be used much for hedging. My hunch is that it would be almost a pure prediction market.”

    Investors are interested in anything that has a market. If we had NGDP indexed debt, it would go into portfolios and get traded against cyclical stocks. People would talk about NGDP breakevens on CNBC and fret whenever they fell below 4%. And people would create NGDP derivative markets to trade and hedge their exposures to NGDP debt.

    Would people be interested in inflation futures if TIPS hadn’t been created? Probably not. I believe CME does have inflation futures but I can’t even find a tradable contract easily.

    Here’s a good quote “Since the introduction of government-issued bonds linked to inflation indices in many major currencies, a liquid market in inflation-linked swaps and other derivatives has grown”
    http://www.quarchome.org/inflation/InflationLinkedDerivatives20060908.pdf

  20. Gravatar of Steve Steve
    9. March 2012 at 18:58

    ssumner wrote: “The Fed didn’t even cut interest rates in the meeting after Lehman failed.”

    Scott, this is the most important forgotten headline story from the same day that Lehman failed:

    http://blogs.wsj.com/environmentalcapital/2008/09/15/ike-watch-hurricane-didnt-slam-refining-but-gas-prices-will-rise/

    “September 15, 2008, 10:34 AM
    Ike Watch: Hurricane Didn’t Slam Refining, But Gas Prices Will Rise”

    “So even if Ike’s wrath was less than many feared, the storm will still leave some scars on the U.S. economy at a vulnerable time.”

  21. Gravatar of Steve Steve
    9. March 2012 at 19:05

    Here’s what the USA today had to say on the day of the infamous post-Lehman Fed meeting:

    http://www.usatoday.com/news/nation/2008-09-14-ike_N.htm

    Texas coast faces long recovery after Ike
    Updated 9/16/2008 12:57 AM

    Gas prices jumped in Ike’s aftermath. Fifteen Gulf Coast refineries were shut down Sunday, including ExxonMobil’s Baytown, Texas, facility, the nation’s largest refinery.

    On Monday tensions were rising in Houston from people waiting in line for gas — only to be turned away — to those who took shelter in the city’s convention center who complained they couldn’t get information about how to get food and clean clothes.

    It could be more than a month before full power is restored in Houston, said Floyd LeBlanc, spokesman for the city’s main power supplier, CenterPoint Energy. He said CenterPoint expected Ike to knock out less than half of its 2.26 million customers. But the storm’s enormous girth and punishing winds hit harder than many expected.

    On the company’s computer, red dots began identifying the outages at 11 a.m. Friday, long before the storm came ashore. First, it was Galveston, the island Ike hit directly. Then, it was everywhere else. Outages hit 1 million at 1:15 a.m. Saturday with Ike still outside the city.

    “It got uncomfortable,” LeBlanc said. “The storm wasn’t even over our area.” By 5 a.m., the outage map looked like it had been hit by “an exploding red tomato. It was jaw dropping,” he said.

    When the wind stopped blowing at 11 a.m. Saturday morning, CenterPoint had “nearly lost every customer,” LeBlanc said. “This is unprecedented.”

    Overall, the Federal Emergency Management Agency reported that 2.5 million people had lost power throughout the disaster zone in Texas, Louisiana and Arkansas. An estimated 7,000 repair crews were scheduled to arrive in Houston on Sunday, but LeBlanc said some residents there may be without electricity for more than four weeks.

    As much of the Gulf remained in darkness, gasoline prices jumped nationwide. Ninety-eight percent of the Gulf’s natural gas and crude production was halted.

    Energy Department spokeswoman Healy Baumgardner said Sunday the government is “doing everything possible to minimize impacts to American families,” including releasing emergency oil stockpiles and monitoring allegations of price gouging.

    Restoring electricity remained the chief energy priority. “We have a lot of work ahead of us,” LeBlanc said. “A parallel challenge is expectation” because everyone wants to see their power on first.

    “To see almost our entire system out is very frightening,” says Cindi Salas, who manages the computer maps and models CenterPoint uses to track outages and repairs. “It was unprecedented.”

  22. Gravatar of Philo Philo
    9. March 2012 at 21:01

    “But the economics profession didn’t listen, as they view stock investors as being irrational.” Stock investors lack status. Few of them have advanced degrees, and many of them aren’t even very rich. Indeed, many individual investors are outright boobs; it is then easy to conclude, by a fallacy of composition, that the whole group of investors is boobish. Journalists constantly describe investor psychology in simplistic terms. The expectations enshrined in market prices often fail to be borne out by events, so hindsight bias makes the markets look bad. The EMH is counter-intuitive, though the economics profession ought to know better than to reject it.

  23. Gravatar of Doc Merlin Doc Merlin
    9. March 2012 at 21:15

    “He found that beginning around 2008 stocks became highly correlated with TIPS spreads, suggesting the market was rooting for higher inflation, higher aggregate demand. Even Paul Krugman gave him a high five.”

    This is the worst line I have ever heard you say Scott. You are /NOT/ known for dumb lines, but this is a doozy. What high correlation means is that money-side macro effects are driving the markets, not micro-fundamentals. This doesn’t mean that the market participants are voting for anything.

    Furthermore it wasn’t just tips spreads they were correlated with. Over the last four years the correlations in everything financial have been at record levels This just means that the majority of volatility in the market is driven by the Fed and the Government. That is all.

  24. Gravatar of Doc Merlin Doc Merlin
    9. March 2012 at 21:17

    @Philo:
    Thats brilliant.

  25. Gravatar of Steve Steve
    9. March 2012 at 21:24

    Philo is right. Most academics don’t respect practitioners and most practitioners don’t respect academics. I read this blog not because I am an academic but because genius is like pornography; I know it when I see it.

  26. Gravatar of Steve Steve
    9. March 2012 at 21:33

    I’m not trying to spam this blog but I have fire in my belly this Friday eve.

    My rationale for posting Hurricane Ike stories is that few people appreciate the magnitude of the short-term supply side shock that struck at the same time Lehman failed. Shutting down Refinery Row was huge, and it definitely affected the Fed.

    Then there’s the ECB in April 2011. Krugman demonstrated in an event study that the GIPSI sovereign spreads began to blow out on exactly the same day the ECB raised rates in April 2011. What happened between April 2011 and the prior ECB meeting? Well, a civil war in Libya and a tsunami in Japan. Basically Ghadafi did to Europe what Napoleon wasn’t capable of.

    The point is that SUPPLY SHOCKS ARE ABSOLUTELY ***FATAL*** TO AN INFLATION TARGETING REGIME!!! It’s painfully obvious, Hurricane Ike swamped the entire US economy and Libya conquered the entire European continent all thanks to inflation targeting.

  27. Gravatar of Doc Merlin Doc Merlin
    9. March 2012 at 21:43

    @Steve:
    “The point is that SUPPLY SHOCKS ARE ABSOLUTELY ***FATAL*** TO AN INFLATION TARGETING REGIME!!!”

    I’ve been trying to make this point on this blog for years!
    Price inflation targeting is a absolutely horrible idea.

  28. Gravatar of Max Max
    9. March 2012 at 21:46

    “Only you could take a great triumph of the EMH, and call it a failure. 2008 was one of the best market calls since 1929, when the stock market correctly predicted a depression.”

    “Financial markets have a very safe way of predicting the future. They cause it.” – George Soros

  29. Gravatar of ssumner ssumner
    10. March 2012 at 07:15

    Neal, You asked:

    “Then what caused the Wicksellian equilibrium rate to fall? Was it supply or demand movement? What was the shock? etc. Does MM ultimately address these questions?

    It just seemed to me that Greg is arguing that MM can’t explain everything. All I meant was that it doesn’t need to.”

    I’ve done posts on this as well. One cause was tight money. Between mid-2007 and mid-2008 the growth in the monetary base slowed sharply. That’s what most people regard as tight money, not just me. So because the growth in MB slowed sharply, the economy slowed. And when the economy slowed, the Wicksellian rate falls.

    I’ve also pointed to high gas prices (which hit auto, truck and RV sales) as well as the housing slump, as factors lowering the Wicksellian rate.

    Steve, I agree there would be some gamblers. My point is that if NGDP futures were widely needed for hedging risk, we’d already have a market. Profit-maximizing financial markets would have created such a market. So I think it would be used purely for fun–gambling.

    Thanks for those stories. TIPS spreads were plunging at that time, meanwhile the Fed was relying on inflation forecasts from USA Today, not market forecasts.

    Philo, Nicely put.

    Doc Merlin. I think it’s reasonable to talk of a market “rooting for X” when prices move higher on news that X is less likely. I think readers will understand what I meant, I know that markets don’t literally have a mind.

    Steve, Very good observations. I might do a post.

    Max, Soros obviously never heard of the 1987 stock market crash. :)

  30. Gravatar of Major_Freedom Major_Freedom
    10. March 2012 at 07:47

    Just because major market participants expect or even demand higher inflation, it doesn’t mean they should get it.

  31. Gravatar of TheMoneyIllusion » You want concrete? I’ll show you concrete! TheMoneyIllusion » You want concrete? I’ll show you concrete!
    10. March 2012 at 08:27

    [...] Steve provided some very interesting links, which shed further light on the mistakes of 2008.  In earlier posts I pointed out that after the [...]

  32. Gravatar of Greg Ransom Greg Ransom
    10. March 2012 at 22:51

    Well, what is the answer?

    Can you say it in a sentence? In a paragraph?

    What you’ve said isn’t definite enough to have something to have at hand to examine.

    You’ve actually been all over the place, dodging what look to me to be central questions.

    One sentence.

    What is it.

    Or one paragraph.

    Something tangible that shows the steps of the direct casual pathway.

    Greg,

    “But _why_ was there a sudden and massive NGDP shortfall?

    Scott,

    How many million times do I have to explain the same points over and over again.

  33. Gravatar of Bill Woolsey Bill Woolsey
    11. March 2012 at 05:40

    Scott:

    Why 1990?

    The Great Moderation is usually dated from 84 till….

    Was there a new regime in 1990?

    When I look at the gaps from trend, I see almost no from 1999 to 2001. Using both methods, we are well below trend in 2003. Using the 1990 starting point it is -2.4% and with a 1985 start point it is -2.7%.

    Also, both show above trend in 2000. Both are 2.7% above trend in the third quarter of 2000.

    Are you generating trends from the data or are you going with the 5% target?

  34. Gravatar of ssumner ssumner
    11. March 2012 at 07:45

    Major, Yup.

    Greg, The Fed increased the monetary base at a rate slower than the decline in the Cambridge k.

    Bill, Wasn’t trend NGDP a bit higher in the 1980s, when inflation was 4%?

  35. Gravatar of Greg Ransom Greg Ransom
    11. March 2012 at 11:06

    So the monetary base increases at a slower rate than the percentage of currency and demand deposits relative to some GDP measure.

    So what.

    If the Efficient Market Hypothesis is true, why should this matter for anything.

    What is the causal mechanism.

    You don’t provide _any_ causal mechanism.

    Its all _magic_ between a) the rate of base money increase; and b) the decline in the ratio of currency and demand deposits to GDP.

    You’ve given me a correlation. That’s statistics.

    Science provides underlying causal mechanism. There is _no_ science here.

    None.

  36. Gravatar of Greg Ransom Greg Ransom
    11. March 2012 at 11:13

    Scott,

    Why should the relation between: a) the rate of base money increase; and b) the decline in the ratio of currency and demand deposits to GDP matter _5_ years after the event.

    EMH is true. And these events took place at _least_ 5 years ago.

    What’s the causal mechanism that make this still a causal source of economic discoordination _five_ years after the even.

    That’s some EMH you invoke.

  37. Gravatar of Major_Freedom Major_Freedom
    11. March 2012 at 13:37

    ssumner:

    Greg: “But _why_ was there a sudden and massive NGDP shortfall? _That_ is what needs explaining.”

    How many million times do I have to explain the same points over and over again.

    The answer that the Fed didn’t print enough is not an answer, because it doesn’t explain why people suddenly REDUCED their spending even though the Fed wasn’t taking money out of the economy up to late 2008. Why should spending in late 2008 all of a sudden plummet despite the fact that money printing was maintained? That’s the question you aren’t answering.

  38. Gravatar of John Butters John Butters
    12. March 2012 at 07:39

    As someone who watches the markets every day, I think this is right. I keep pointing out that QE raised both equity markets and bond yields, by the processes you talk about. Economists seem to have missed this obvious fact and keep producing models to show that QE reduced bond yields.

  39. Gravatar of ssumner ssumner
    12. March 2012 at 18:11

    Greg, I’d cite the hot potato effect as a causal mechanism, but I’m sure you won’t like that either.

    John Butters, You are right.

  40. Gravatar of Greg Ransom Greg Ransom
    13. March 2012 at 06:39

    OK, you’ve got a mechanism. How does it do the job you’ve assigned it?

    Scott writes,

    “Greg, I’d cite the hot potato effect as a causal mechanism, but I’m sure you won’t like that either.”

    And, actually, there is no grounds for your saying this. I object to things which are objectionable, are pure punts, or fail to have the cognitive content folks which to bluff others into believing they have, etc. I like underlying causal mechanisms, especially ones that don’t invoke magic or “then a miracle occurs”.

  41. Gravatar of Greg Ransom Greg Ransom
    13. March 2012 at 07:42

    !) The Fed increased the monetary base at a rate slower than the decline in the Cambridge k.

    plus

    2) The “hot potato” effect is a causal mechanism of some sort.

    What’s missing:

    Connecting this stuff together to explain anything, esp. the major empirical patterns seen over the last 10 years or so.

  42. Gravatar of Classical Values » Market Monetarism Classical Values » Market Monetarism
    28. April 2013 at 20:16

    [...] theory also explains something else that is odd — since 2008, the stock markets have become strongly correlated to monetary stimulus.  They seem to be saying “Right now looser money means we expect growth.”  This is [...]

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