Krugman and Hamilton on the zero rate bound

Marcus Nunes sent me an interesting old post from Paul Krugman.  Here’s Krugman in November 2008:

Nearly every forecast now says that, in the absence of strong policy action, real GDP will fall far below potential output in the near future. In normal times, that would be a reason to cut interest rates. But interest rates can’t be cut in any meaningful sense. Fiscal policy is the only game in town.

Those were the posts that had me pulling my hair out in 2008.  Why wasn’t Krugman calling for monetary stimulus?  One answer is that rates were already at zero, and hence could not be cut any lower.  But there are lots of other ways to stimulate the economy.  And even worse, rates weren’t yet at zero, the fed funds targets was 1.0% in November 2008.   So I decided to follow the link in Krugman’s article, to see why he concluded that rates could be cut no further.  And it led to this James Hamilton post:

There was yet another announcement from the Fed this week that caused my jaw to drop, though you’d think I’d be getting used to such surprises by now. The Fed announced on Tuesday that it will raise the interest rate it pays on both required reserves and excess reserves to the level of the target itself, currently 1.0%.

My first reaction was, How in the world could that work? Why would any bank lend fed funds to another bank at a rate less than 1%, exposing itself to the associated overnight counterparty risk, when it could earn 1% on those same reserves risk free from the Fed just by holding on to them?  It would seem paying 1% interest on reserves should set a floor on the fed funds rate, so that any fed funds actually lent between banks would have to offer a higher rate than the official “target.”

But I’ve always been more persuaded by facts than by theories, and the effective fed funds rate reported for Thursday– the first day of the new regime– was 0.23%. So much for that theory. But what’s going on?

The answer begins with the observation that the GSEs and some international institutions also have accounts with the Fed. But unlike regular banks, these institutions earn no interest on those reserves, so they would in principle have an incentive to lend out any unused end-of-day balances as long as they earn a positive interest rate.

But that’s not a sufficient answer by itself, because there’s an incentive for any bank that is eligible to receive interest from the Fed on reserve balances to borrow those balances from the GSE at a rate less than 1%, get credited by the Fed with 1% for holding them, and profit from the difference. Why wouldn’t arbitrage by banks happy to get these overnight funds prevent the rate paid to the GSEs from falling below 1%?

Wrightson ICAP (subscription required) proposes that part of the answer is the requirement by the FDIC that banks pay a fee to the FDIC of 75 basis points on fed funds borrowed in exchange for a guarantee from the FDIC that those unsecured loans will be repaid. If you have to pay such a fee to borrow, it’s not worth it to you to pay the GSE any more than 0.25% in an effort to arbitrage between borrowed fed funds and the interest paid by the Fed on excess reserves. Subtract a few more basis points for transactions and broker’s costs, and you get a floor for the fed funds rate somewhere below 25 basis points under the new system.

Under this regime, the effective fed funds rate– a volume-weighted average of the rate associated with fed funds traded on a given day– would come in above the target if it is dominated by actual banks borrowing fed funds, and below target when dominated by GSE lending. In the latter case, the effective fed funds rate would seem to be a particularly meaningless statistic, reflecting nothing more than the institutional peculiarities just detailed.

That means a couple of things for Fed watchers. First, fed funds futures contracts, which are based on the average effective rate rather than the target over a given month, are primarily an indicator of how these institutional factors play out– how much the effective rate differs from the target– and signal little or nothing about future prospects for the target. Second, the target itself has become largely irrelevant as an instrument of monetary policy, and discussions of “will the Fed cut further” and the “zero interest rate lower bound” are off the mark.

That seems to support Krugman’s argument.  However in the remainder of the post Hamilton goes in a very different direction from Krugman:

There’s surely no benefit whatever to trying to achieve an even lower value for the effective fed funds rate. On the contrary, what we would really like to see at the moment is an increase in the short-term T-bill rate and traded fed funds rate, the current low rates being symptomatic of a greatly depressed economy, high risk premia, and prospect for deflation.

What we need is some near-term inflation, for which the relevant instrument is not the fed funds rate but instead quantitative expansion of the Fed’s balance sheet. I continue to have concerns about implementing the latter in the form of expansion of excess reserves, which ballooned by another quarter trillion dollars in the week ended November 5. Instead, I would urge the Fed to be buying outstanding long-term U.S. Treasuries and short-term foreign securities outright in unsterilized purchases, with the goal of achieving an expansion of currency held by the public, depreciation of the currency, and arresting the commodity price declines.

But the last thing we should expect to do us any good would be further cuts in the fed funds target.

I think this is exactly right.  Once you’ve started paying IOR, what you need is not so much a bigger monetary base, but rather a bigger currency stock.  Currency doesn’t earn interest.  Hamilton was writing before I published my paper advocating negative IOR, so I wouldn’t have expected him to mention that out-of-the-box idea.  Instead he points to the need for inflation, enacted by depreciating the currency and boosting commodity prices via QE.  Krugman would counter that the Fed can’t change the price of assets like stocks, commodities and foreign exchange, because we are stuck at the zero bound.  So let’s see who was right.

On December 16th, 2008, the Fed conducted a near perfect test of Krugman’s hypothesis.  They cut the fed funds target (and the IOR) from 1.0% to 0.25%.  Krugman would predict no effect, as the actual fed funds rate would stay around 0.25%.  Recall that the Keynesian model says that what matters is the actual short term interest rate, not the target rate.  In fact, the S&P500 rose by more than 5% on December 16th.  Now I do realize that very few people share my faith in the EMH.  And stocks did resume their downward trend over the next few months as new economic data showed the recession to be worse than expected.  So let me also provide a mechanism for why the IOR cut mattered.

Unlike Keynesians, monetarists don’t believe the short term rate is the key mechanism for the transmission of monetary policy.  Rather we look at things from a supply and demand for money perspective.  Increases in the supply of money are inflationary, and increases in the demand for money are deflationary.  The IOR program provides an excellent test of this hypothesis.  A change in the IOR can change the demand for ERs, without necessarily changing the effective fed funds rate at all.  We have four observations; the initial announcement of IOR on October 6, two subsequent increases in IOR in late October and early November 2008, and the big cut on December 16th, 2008.  In all four cases stock prices moved strongly in response to the IOR announcement.  The moves ranged from 3.85% to 6.1%, with an average change of over 5%.  Those are relatively big daily changes.   More importantly, all four changes were in the right direction; stocks fell sharply after the three increases in IOR, and rose sharply when IOR was cut.   This is certainly not conclusive proof (four observations isn’t enough, and other things were going on at the time) but it’s four data points in support of the monetarist transmission mechanism.

If you pay people to hold on to ERs, there’ll be a greater demand for ERs.  And when the demand for any good rises its value rises. But when the value of the medium of account rises, its nominal price cannot change, by assumption.  Instead, the only way for the medium of account to become more valuable is for all other prices to fall.  The Fed did a beautiful experiment in late 2008 by creating IOR—pity about the economy.

PS.  Of course a much more powerful refutation of the liquidity trap view came from market reactions to QE1 and QE2.


Tags:

 
 
 

91 Responses to “Krugman and Hamilton on the zero rate bound”

  1. Gravatar of Ram Ram
    30. May 2012 at 05:35

    It’s odd that as soon as the US approached the zero lower bound, Krugman started talking about fiscal policy. His reason, presumably, is that he saw what happened in Japan, and had little confidence in the potency of unconventional monetary stimulus. I agree with you that the BOJ’s decisions during the Lost Decade fly in the face of any “trap” theory, but even more ridiculous is to observe the supposed failure of Japanese unconventional monetary policy and not observe the unambiguous failure of Japanese fiscal policy. How many more bridges to nowhere did they need to build before Krugman would say, “hmmm…maybe I need to go back to pushing a higher inflation target”?

  2. Gravatar of ssumner ssumner
    30. May 2012 at 05:59

    Ram, Yes, and even if you assume Krugman thought monetary policy couldn’t work because the Fed was too conservative, why praise Bernanke for confirming Krugman’s prejudices about the Fed? Recall that Krugman recently indicated that he thought Bernanke did a good job in 2008 and early 2009?

  3. Gravatar of StatsGuy StatsGuy
    30. May 2012 at 06:07

    Speaking of higher inflation targets, did anyone notice this?

    http://www.clevelandfed.org/research/data/inflation_expectations/index.cfm?DCS.nav=Local

    News Release: May 15, 2012
    The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.38 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.

    That’s not short term… That’s over an extended time horizon! Over 10 years, that’s a 7.2% price gap. That means, right now, inflation expectations are such that the public believes actual price levels in 2022 will be 7.2% less than the Fed’s official target.

    I can only imagine that since May 15, it’s gotten worse – 10 year t-bill rates fell from 1.78% on May 15 to 1.64% as of a few minutes ago. Impressive.

  4. Gravatar of Matt Matt
    30. May 2012 at 06:08

    Lot else going on at the time. Beyond the cut to IOR, the 12/16/08 contained the following new passage, which I’m sure you’d agree was more important than the 75 bps reduction to IOR rate. The “all available tools” was seen as important, and it was the first official FOMC mention of a possible increase in agency purchases and extension of purchases to longer-term Treasuries:

    “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

    The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.”

  5. Gravatar of dwb dwb
    30. May 2012 at 06:18

    if history is any guide, like 2008, they’ll wait until its clear we went over the cliff.

  6. Gravatar of dwb dwb
    30. May 2012 at 06:25

    ” Ram, Yes, and even if you assume Krugman thought monetary policy couldn’t work because the Fed was too conservative, why praise Bernanke for confirming Krugman’s prejudices about the Fed? Recall that Krugman recently indicated that he thought Bernanke did a good job”

    maybe my recollection is wrong, but the ideas for QE came from Joe Gagon and othets. he said held little hope it would work.

  7. Gravatar of Steve Steve
    30. May 2012 at 06:50

    Interesting Krugman post. I guess you were right as usual. I consider myself corrected as to what Krugman believed then.

    For some reason I hadn’t realized that the Fed raise IOR from 0.25% to 1.00% briefly, before cutting again. What an epic policy error.

    I’m looking at the comment section on the Hamilton article; it’s an interesting time capsule with some chillingly prophetic comments. One points out that the FDIC fees were up to 75bp so a 100bp IOR allowed the Fed to pay the banks deposit insurance without requiring the FDIC to go hat in hand to congress. That certainly wasn’t the primary motivation, but the anti-bailout let ‘em fail sentiment was incredible in fall ’08.

  8. Gravatar of johnleemk johnleemk
    30. May 2012 at 06:55

    The fact that left liberals continue to defend Krugman’s ridiculous statements on the “liquidity trap” ruling out monetary policy as an option is IMO a very large part of the reason why the world’s economy is still in the crapper. Only when people get over their blind devotion to fiscal stimulus as the only solution will we have a chance for economic activity to return to normality. And the only foreseeable alternative to left liberal policymaking is worse: liquidationist, paleo-conservative “beatings will continue until morale improves” economic policy.

    Boggles the mind that the Cleveland Fed projects long-term inflation at the lowest levels in modern US history, and yet nobody in the political establishment is baying for central banks’ blood — unless they want to liquidate any form of monetary policy altogether.

  9. Gravatar of Cameron Cameron
    30. May 2012 at 07:06

    Do we have any idea what the Fed’s next move will be? It’s only a matter of time before they are forced to take another action.

  10. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 07:26

    ssumner:

    Why wasn’t Krugman calling for monetary stimulus? One answer is that rates were already at zero, and hence could not be cut any lower. But there are lots of other ways to stimulate the economy.

    Like what? The fed deals almost exclusively with lenders. Monetary policy in our economy consists primarily of the Fed’s dependence on the banks to expand credit. That is where Fed policy is primarily channeled into aggregate spending. They don’t print money to purchase everything. They print primarily for the banks, and the banks are expected to expand credit as a result.

    Krugman is only half right. Yes, the Fed does become essentially powerless in a recession when general profitability is zero or negative, if banks refuse to lend into losing projects, and not because of any barrier of the lower bound in the fed funds rate. And you are only half right. Yes, the Fed can in principle give the banks as much money as they want, despite the fed funds rate being close to zero, but that doesn’t mean they can bring about any aggregate demand they want in this way. Not if the banks refuse to lend more.

    If after a financial collapse the economy has negative profitability, and banks refuse to lend more than they are already lending, for fear of incurring losses, then the Fed goosing bank reserves cannot possibly coax banks into lending more. The banks will hoard as much money as the Fed prints that cannot be profitability lent until costs fall below current aggregate demand.

    Only if the Fed starts buying things from non-lenders, such as consumer goods, or stocks, can the Fed have any direct influence in increasing aggregate demand. Depending on lenders is a no win situation if lending will incur losses at current prices.

    Unlike Keynesians, monetarists don’t believe the short term rate is the key mechanism for the transmission of monetary policy. Rather we look at things from a supply and demand for money perspective.

    A sustained, general increase in prices requires inflation of the money supply, but inflation of the money supply does not necessarily imply prices will rise. Not if the demand for money rises, as people await a sufficient fall in costs that will restore profitability, before expanding credit becomes attractive again. If NGDP falls during this process, then short of the Fed printing money to buy output, the Fed will have to accept a fall in NGDP because that’s what depending on banks can result in.

    Would you have the Fed buy cars and computers if that’s what it takes to increase NGDP, because banks are not lending enough to make NGDP rise via credit expansion? I’ve asked this before, but never got a satisfactory answer. Asked another way, how far will you go into “unconventionalism” when it comes to the Fed targeting NGDP? Suppose credit is insufficient. What should the Fed buy, and how does unearned money being printed and spent, constitute a gain for those who produce for the sake of those who spend without producing for that money? We’re talking trillions of dollars here.

  11. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 07:29

    ssumner:

    Increases in the supply of money are inflationary, and increases in the demand for money are deflationary. The IOR program provides an excellent test of this hypothesis. A change in the IOR can change the demand for ERs, without necessarily changing the effective fed funds rate at all. We have four observations; the initial announcement of IOR on October 6, two subsequent increases in IOR in late October and early November 2008, and the big cut on December 16th, 2008. In all four cases stock prices moved strongly in response to the IOR announcement. The moves ranged from 3.85% to 6.1%, with an average change of over 5%. Those are relatively big daily changes. More importantly, all four changes were in the right direction; stocks fell sharply after the three increases in IOR, and rose sharply when IOR was cut. This is certainly not conclusive proof (four observations isn’t enough, and other things were going on at the time) but it’s four data points in support of the monetarist transmission mechanism. The IOR program provides an excellent test of this hypothesis. A change in the IOR can change the demand for ERs, without necessarily changing the effective fed funds rate at all. We have four observations; the initial announcement of IOR on October 6, two subsequent increases in IOR in late October and early November 2008, and the big cut on December 16th, 2008. In all four cases stock prices moved strongly in response to the IOR announcement. The moves ranged from 3.85% to 6.1%, with an average change of over 5%. Those are relatively big daily changes. More importantly, all four changes were in the right direction; stocks fell sharply after the three increases in IOR, and rose sharply when IOR was cut. This is certainly not conclusive proof (four observations isn’t enough, and other things were going on at the time) but it’s four data points in support of the monetarist transmission mechanism.

    Not that I accept the following theory, but those same 4 data points also show support for a different, indeed opposite theory: The three declines in stock prices would have been even steeper if the IOR rate increase was less than what it was, and by the same token, the rise in stock prices that one day would have been even larger if the IOR rate decrease was less than what it was.

    This may sound counter-intuitive, but empiricism says my theory has been confirmed (as much as 4 data points can confirm a theory, so assume it’s 100 data points for the sake of argument).

    The directional correlation you are observing could very well support a counter-theory that makes a different, indeed OPPOSITE argument, and it would be completely supported by the data as well.

    You’re right, your theory is not conclusively proven by the data. And my imaginary counter-theory above is also not conclusively proven by the data either. But both our theories are supported by the data. But we can’t both be right. So what now? How will these two theories be settled? Please assume that I am “persuaded” of my theory for some reason, and not “persuaded” by your theory. Does this mean the world has accepted both theories as true? Because of our persuasiveness in our own theories? The world can contain contradictions? Or is my imaginary theory absolutely wrong?

    Either answer doesn’t bode well for a follower of Rorty.

  12. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 07:33

    johnleemk:

    Only when people get over their blind devotion to fiscal stimulus as the only solution will we have a chance for economic activity to return to normality.

    How else can the Fed increase aggregate demand, other than depending on lenders and/or investors, in an economy that has general absence of profitability in the current available projects, at current costs and revenues?

    Suppose you’re a money lender or investor in an economy with only two investment opportunities, one netting -5% and the other netting -10%.

    Is there a particular sum of money that I can print for your benefit that would eventually coax you into lending or investing in one or both of these two projects? Or will you hoard every dollar I print for you, until costs decline such that profitability is restored?

  13. Gravatar of Steve Steve
    30. May 2012 at 07:37

    Thomas Hoenig on CNBC: “Markets impress me, not by being smart, but because they are ruthless disciplinarians.”

    Hoenig has moved from the FOMC to the FDIC, but the liquidationist zeitgeist is still a b….

  14. Gravatar of StatsGuy StatsGuy
    30. May 2012 at 07:49

    Oil just tanked to below 88… well done. Brent approaching 100. The question is whether the Fed can get it to drop a bit lower before the Jun 19-20 meeting, or whether they’ll hold off till Aug 1 to take any action. There’s no question they’ll do something in one of the two meetings, the question is only whether they’ll be advanced enough by the 20th to commit. Since this year has largely progressed about a month or two ahead of last year, I’d say probably.

    Take a look at ticker GSG, the S&P global commodities index. It’s only 3-4% off of last year’s low (in October). I’m guessing they’re going to take it down below that slightly – and they have 3 weeks to do it. I’m going to guess they’re going to succeed, which means we’ll get easing, or strong language supporting easing, in June 19-20.

    Interestingly, the Fed members have been tight lipped for a few weeks, and I’ll guess this continues through June 19th to take down commodity prices a bit more – as long as commodities fall faster than equities, the Fed is pleased.

  15. Gravatar of Tom Tom
    30. May 2012 at 08:00

    Scott, Matt (at Nick Lowe’s site) has a great M. Friedman summary from 2000.
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/05/milton-friedman-on-monetary-policy-circa-2000.html#more

    Milton though the BOJ should be buying more bonds.

    I suggest the FED begin buying bonds issued by any company which has been profitable and paying net positive income taxes over each of the last 5 years; such bond buying to be in a maximum amount of the taxes paid.

    As Maj_F accurately points out, the FED runs monetary policy for the benefit of the banks; who, with little publicity, ARE the owners of the FED, aren’t they? Isn’t that why there’s no complete audit of the FED?

    (Perhaps Senate confirmation hearings about FED directors are just a facade, if not deliberate obfuscation, to induce voters to believe the FED is part of the democratic gov’t.)

    Finally, remember that TAX CUTS, as fiscal policy, did work for Bush, as well as Kennedy. Shouldn’t economists looking at data notice that and, if they call for fiscal policy, call more for tax cuts than gov’t waste, er, spending? increases?

  16. Gravatar of K K
    30. May 2012 at 08:06

    On Dec 16, 2008 the first fed funds future went from 22 to 17 bps so no big change, as you say. Also the SPX went from 868 to 913, a gain of 5.1% (which, BTW, was about average volatility during that month).

    So what happened? I don’t know what Krugman would say, but I assume he agrees that it’s the full term structure of expected short rates (i.e. the full yield curve) that matters. The 10 year yield went from 2.51% to 2.26%. I.e. while the cut to 25 bps was essentially fully priced in since early December, the Fed statement was more accomodative than expected. Expectations of the future short rate declined. IOR had nothing to do with it.

  17. Gravatar of dwb dwb
    30. May 2012 at 08:07

    ” Oil just tanked to below 88… well done. Brent approaching 100. The question is whether the Fed can get it to drop a bit lower before the Jun 19-20 meeting, or whether they’ll hold off till Aug 1 to take any action. There’s no question they’ll do something in one of the two meetings, the question is only whether they’ll be advanced enough by the 20th to commit. Since this year has largely progressed about a month or two ahead of last year, I’d say probably.”

    by june its probably too late unless they jawbone the market. 1 yr be tips are .7 and 3 yr are 1.3%. whats-his-face from the NY fed said last week no need for QE, kocherlakota said we are at full employment. the rumors are starting to fly on Spain, i think the Fed is so far behind the curve with their heads up their models that my advice would be to buckle up. i hope im wrong.

  18. Gravatar of John Thacker John Thacker
    30. May 2012 at 08:08

    Is there a particular sum of money that I can print for your benefit that would eventually coax you into lending or investing in one or both of these two projects?

    MF: Of course there is. Are you really proposing that there’s no level of inflation that would cause you to wish to engage in consumption or hold capital or a real asset instead of a depreciating currency?

    Of course a much more powerful refutation of the liquidity trap view came from market reactions to QE1 and QE2.

    I think that the refutation is especially powerful considering that most experts seem to disagree with you, Scott. After all, an initial response that fades away could be a sign of taking expert opinion seriously then the market having second thoughts. But here, the market agrees with you when the experts do not.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. May 2012 at 08:12

    Coincidentally I did some research on the early Fed history of IOER yesterday. Here’s what IOER and the effective FFR looked like 10/15-12/15 2008:

    http://research.stlouisfed.org/fred2/graph/?graph_id=76672&category_id=0

    IOER was set initially at 3/4 points below the FFR target or 0.75%. It was subsequently lowered to 0.65% and raised to 1.0% before being dropped to 0.25%. Note that the effective federal funds rate fell below IOER by 10/29 and fell as low as 0.11% on 12/10 at a time when IOER was 1.0%.

    Hamilton mentions the fact that the GSEs were not eligible for IOER. Apparently there are also foreign institutions that hold
    balances at the Fed that aren’t eligible either. Thus these institutions are the ones lending their surplus funds below IOER.

    There is a lot of disinformation about excess reserves and IOER out there. One new myth I’ve heard recently is that IOER establishes a floor for the effective federal funds rate. Well the graph above clearly demolishes that point of view.

    And this raises another larger issue concerning the supposed “decoupling principle.” Theoretically with IOER the Fed can now set the target rate at the level of their choice and simultaneously set the amount of reserves at the level of their choice. But based on what I’m seeing in the data and on what Hamilton is saying above this is absolutely false.

    How deep is the market for federal funds really in a world where banks are sitting on $1.5 trillion in excess reserves? It can’t be more than a relative trickle compared to how things were before. It appears to me that the only point to IOER is to set the amount of excess reserves. As Hamilton notes, under IOER the federal funds rate itself has become largely irrelevant as an instrument of monetary policy. It’s not so much a “decoupling principle” as an “irrelevancy principle.”

    And for those who are interesting in an interest rate measure of monetary policy stance this represents a huge quandary. It appears that there no longer is one, and this will become increasingly apparent when the Fed starts raising the rate paid on IOER.

  20. Gravatar of Bill Woolsey Bill Woolsey
    30. May 2012 at 08:51

    “And the only foreseeable alternative to left liberal policymaking is worse: liquidationist, paleo-conservative

    “beatings will continue until morale improves” economic policy.”"

    exactly

  21. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 09:01

    John Thacker:

    “Is there a particular sum of money that I can print for your benefit that would eventually coax you into lending or investing in one or both of these two projects?”

    Of course there is. Are you really proposing that there’s no level of inflation that would cause you to wish to engage in consumption or hold capital or a real asset instead of a depreciating currency?

    John, you’re completely denying/ignoring the assumptions I made in my question. The charitable thing to do in debates like this is to accept the assumptions for argument’s sake.

    So I ask again. You John are a LENDER. You lend money. You create new loans out of nothing, using the money I print for your benefit as reserve, to facilitate transactions. Is there a particular sum of money that I have to give to you before you lend into either or both of the losing projects? This is the question I am asking.

    You talk about consumption, which I will go into later, and connect that with asking why aren’t the banks just consuming the $1.5 trillion they are hoarding, but for now, suppose the economy consists of only two (losing) projects.

  22. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 09:52

    Statsguy,

    The Cleveland numbers gave me the following idea: plot the CPI in the past and (expected) in the future and see how it does against a 2% level target. I took a 6-month average instead of the core CPI, mostly to not have to deal with the old “it doesn’t include gas and food” meme. I was really surprised by what I found though.

    http://i.imgur.com/hjbeP.jpg

    The blue line is CPI, the red is a 2% trend from the level beginning 2004 and the green is the actual 3-4% trend for 2004-07. I see two things from the graph:

    1. True CPI targeting at 2% would mean that the Fed should raise rates until we have enough deflation to hit that 2% trend. This should show why inflation targeting is not good enough.

    2. When you include commodities, the CPI shows that perhaps America has had more supply-side issues than we realize. I’m not sure what Scott wrote in the past on supply-side issues in America, but I’m not so sure now that gas prices didn’t have something to do with the recession. Not directly of course, but by perhaps having tighter monetary policy under inflation targeting vs. under NGDP targeting.

  23. Gravatar of 123 123
    30. May 2012 at 09:59

    Scott,

    Krugman’s blog was extremely useful after Lehman.
    Good example here:
    http://krugman.blogs.nytimes.com/2008/09/22/the-humbling-of-the-fed-wonkish/

  24. Gravatar of John Thacker John Thacker
    30. May 2012 at 10:04

    “So I ask again. You John are a LENDER.”

    Ah, MF, do you not remember your original post? You said “money lender or INVESTOR.” You said “lend or INVEST.”

    Seems to me that you’re the one denying/ignoring the assumptions in your own post. The charitable thing to do is to admit that you’ve conceded the argument as regards investors and investment, where the person investing obtains equity.

    As far as lending goes, if it becomes worth it for investors to invest, then they will seek loans and be willing to pay more for them, which will encourage lenders to lend.

    Why would LENDERS care about the investment return of the investment project, other than how it affects ability to repay (or if they get the project as collateral, which makes them partially investors– but then they should prefer obtaining collateral if inflation goes up, for the same reason)? (That’s why I discussed investment.) More dollars floating around means more dollars to repay outstanding loans, from the broader lending perspective.

    MF, you don’t even appear to understand your own argument.

  25. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 10:14

    John Thacker:

    “So I ask again. You John are a LENDER.”

    Ah, MF, do you not remember your original post? You said “money lender or INVESTOR.” You said “lend or INVEST.”

    Lending is a form of investing. You’re investing in a future cash flow.

    At any rate, it actually doesn’t matter whether you are a lender or an equity investor. The limiting factor is the existence of two projects that each are expected to incur a loss.

    Seems to me that you’re the one denying/ignoring the assumptions in your own post. The charitable thing to do is to admit that you’ve conceded the argument as regards investors and investment, where the person investing obtains equity.

    Equity also has to have a return. There are two losing projects. You have a sum of cash.

    As far as lending goes, if it becomes worth it for investors to invest, then they will seek loans and be willing to pay more for them, which will encourage lenders to lend.

    You’re again ignoring the assumptions of my argument. There are TWO available projects, one expected to net -5%, the other expected to net -10%. You can’t say the answer to my question is to invest or lend into some other opportunity, because my question is specifically regarding only the two investment/lending opportunities.

    Why would LENDERS care about the investment return of the investment project, other than how it affects ability to repay (or if they get the project as collateral, which makes them partially investors– but then they should prefer obtaining collateral if inflation goes up, for the same reason)?

    Debt investors can invest money through a loan, rather than equity. Two projects expected to incur losses on lending/investment.

    (That’s why I discussed investment.) More dollars floating around means more dollars to repay outstanding loans, from the broader lending perspective.

    But I am not talking about a broader perspective just yet. I am talking about you as a lender/investor, and two projects that are expected to earn negative returns at current prices.

    MF, you don’t even appear to understand your own argument.

    John, you are clearly evading the question, and I am starting to suspect why.

  26. Gravatar of John Thacker John Thacker
    30. May 2012 at 10:17

    MF:

    Suppose the economy consists of two economic opportunities, one of which is to buy land, and the other of which is to build a factory. Therefore there are three options; hold money, buy land, or build a factory.

    Now suppose that the quantity of money is expected to double. In such a case, you would definitely be more likely to want to invest in land or a factory now, rather than hold on to your depreciating money.

    The only purpose of money is to trade it for either consumption or investment in the future. If the quantity of money looks set to increase in the future, and thus the value of money decreases, then that will always make it make more sense to either consume more now or invest in other assets besides the more rapidly depreciating currency, including land, factories, or what have you durables.

    Now, there is an argument against stimulus (based on whether one things that AD is at potential and so forth.) But you claim to favor fiscal stimulus. Therefore you have to understand that monetary stimulus works the same in a situation where fiscal stimulus is possible.

    Monetary stimulus is also more efficient and less injurious to freedom.

  27. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 10:24

    John Thacker:

    Suppose the economy consists of two economic opportunities, one of which is to buy land, and the other of which is to build a factory. Therefore there are three options; hold money, buy land, or build a factory.

    Assume buying the land and building the factory, at current prices, will earn a negative return, or insufficient return.

    Now suppose that the quantity of money is expected to double. In such a case, you would definitely be more likely to want to invest in land or a factory now, rather than hold on to your depreciating money.

    Not if they are expected to lose money. You won’t invest in a loser just because you have more cash to burn.

    The only purpose of money is to trade it for either consumption or investment in the future. If the quantity of money looks set to increase in the future, and thus the value of money decreases, then that will always make it make more sense to either consume more now or invest in other assets besides the more rapidly depreciating currency, including land, factories, or what have you durables.

    Assume RETURNS are negative. You have cash. What do you do?

    Now, there is an argument against stimulus (based on whether one things that AD is at potential and so forth.) But you claim to favor fiscal stimulus. Therefore you have to understand that monetary stimulus works the same in a situation where fiscal stimulus is possible.

    I don’t claim to favor fiscal stimulus.

    No wonder you’re purposefully evading my question. You believe I am trying to play gotcha in getting you to admit that fiscal policy is somehow necessary because monetary policy has its limits. Please don’t misunderstand me. I am not here trying to trick you into accepting Keynesian dogma.

    Monetary stimulus is also more efficient and less injurious to freedom.

    It is less efficient than what I have in mind, which is not Keynesian fiscal stimulus at all, but that’s besides the point.

    Will you finally answer my question, now that you know I am not here trying to get you to admit Keynesianism is necessary?

    Two projects. One has a return of -5%, the other -10%. You as a lender/investor have a sum of cash. What do you do? It’s a simple question. Don’t worry, I’m not going to come back with “AHA! So fiscal spending IS necessary for prosperity after all!”

  28. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 11:16

    “Assume buying the land and building the factory, at current prices, will earn a negative return, or insufficient return.”

    I admit I stopped reading right there. Here’s a pretty safe assumption, according to classical economics/EMH, land should never, on average, earn a negative return. If land-buyers know everything except for news that hasn’t happened, then land prices would drop until homo economis land-buyers saw a positive return. Again, that’s on average. Clearly some land buyers have negative returns, but that’s usually due to news that hasn’t happened yet. The point is that “hold money” should never be the most rational option under classical economics.

    There may be “Zero Marginal Product Land,” if you will, such as super fund sites which are more trouble than their worth. Some ZMP employees are also cost more than their worth, even at minimum wage.

    But generally most workers would make money for money-holders at some lower wage. The fact that their wages do not drop is not to exonerate money-holders and deflation for not investing in people at a loss. They are being rational, but there’s no reason that the equilibrium level of wages has to go down. The Fed can print enough money to where demand goes up to where money-holders earn more than current interest rates by employeeing people.

  29. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 11:17

    Ugh, employing. That’s embarrassing.

  30. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 11:27

    Matt Waters:

    “Assume buying the land and building the factory, at current prices, will earn a negative return, or insufficient return.”

    I admit I stopped reading right there. Here’s a pretty safe assumption, according to classical economics/EMH, land should never, on average, earn a negative return.

    OK, but I’m not talking about on average. I am talking about a specific period of time. Like the specific period of time 2007-20010 where buying real estate earned negative returns.

    Instead of just looking for an excuse to play ignorant, maybe you should address the scenario AS IS, and stop trying to change it?

    The point is that “hold money” should never be the most rational option under classical economics.

    Who cares about classical economics. I’m talking about what can and does happen.

    Hold money can be, and sometimes is, the most rational option to take, given current prices, given current profitability.

    But generally most workers would make money for money-holders at some lower wage. The fact that their wages do not drop is not to exonerate money-holders and deflation for not investing in people at a loss. They are being rational, but there’s no reason that the equilibrium level of wages has to go down. The Fed can print enough money to where demand goes up to where money-holders earn more than current interest rates by employeeing people.

    But that requires banks to lend money first, because that’s how money primarily leaves the banking system.

    You’re just assuming that Fed inflation somehow raises spending on top of, around, over and above, if you will, lending, when it actually operates THROUGH lending. NGDP goes up when bank lending goes up. That’s primarily how the Fed’s money printing leaves the banking system. If banks won’t lend, because they expect losses, then it won’t matter if the fed promised the banks more reserves. More reserves in the bank’s coffers doesn’t instantly increase business profitability. No, the banks have to expand credit and bring about more aggregate spending before that occurs, but that requires a reason to lend in the first place.

  31. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 11:45

    By “on average,” I meant that the average of the distribution of the possible outcomes going forward.

    Look at the stock market in 2008. Clearly somebody who bought stocks at the beginning of the year saw negative returns. However, somebody wishing to sell stocks at the end of the year could still sell stocks. Stock prices went down to their market-clearing levels, where money-holders were finally enticed to buy stocks. So the scenario “AS IS,” has asset prices which go down a lot in value until people start buying them. And if markets are efficient, then the assets would not on average lose money going forward. All losses from 2008 news were imputed to the stock prices by 2009.

    The same thing should happen with people’s time. There are some distortions like the minimum wage, but very few workers actually have a work product that’s worth less than the minimum wage.

    Indeed, I don’t agree with classical economics either, not in the respect of wages. Indeed, “Who cares about classical economics. I’m talking about what can and does happen.”

    But it quite odd now that you’re arguing from evidence of what “can and does happen.” I thought we couldn’t look at human action at all and draw any sort of scientific conclusions? But if you’re now looking at the evidence and drawing positivist conclusions, then you should look at the evidence for lack of market-clearing in labor markets.

    Finally, NGDP is not increased just through extra lending. For example, right now the Fed is paying banks 0.25% interest to not lend out their reserves. If they made that 0% or -0.25%, then that wouldn’t just get them to lend out money. People with money would also no longer have free bank deposits and banks would charge fees to pass along the cost of holding money. That would get money-holders to consume more.

    NGDP can be increased either through lending or consumption. An increase in C is as good as an increase in I. In practice, lending and consumption go up and down in lockstep since lending only makes sense if it is followed later by consumption to pay it off. But either one would do and broad monetary policy does not play favorites between either one. It just disincentivizes money-holding to then increase equilibrium wages above the full employment level.

  32. Gravatar of Mike Sax Mike Sax
    30. May 2012 at 11:50

    MF when you say this:

    “Would you have the Fed buy cars and computers if that’s what it takes to increase NGDP, because banks are not lending enough to make NGDP rise via credit expansion? I’ve asked this before, but never got a satisfactory answer. Asked another way, how far will you go into “unconventionalism” when it comes to the Fed targeting NGDP? Suppose credit is insufficient. What should the Fed buy, and how does unearned money being printed and spent, constitute a gain for those who produce for the sake of those who spend without producing for that money? We’re talking trillions of dollars here”

    I feel like the crowd in Nietzsche’s Zarathustra: “Yes give us that last man!”

    I agree with you here-there comes a point where it’s pointless to call it monetary policy when it’s clearly fiscal policy. The one area of disagreement-it’s a doozy-is that my answer is not to wait aroudn no matter how many years it takes for the market to come back on its own self but rather simply do fiscal policy.

    So I would say buy computers, etc. if nothing else works though I agree that’s not monetary policy anymore but fiscal-as Krugman would too.

  33. Gravatar of StatsGuy StatsGuy
    30. May 2012 at 12:04

    Matt, I think you are correct that prior to 2007, inflation was heading up briefly – many here have noted that, myself included. And it’s my opinion that 2008 was the Fed’s decision to pop (definitively) the commodity bubble.

    The cleveland Fed’s inflation expectations haven’t been too far off – note they did update their methodology in 2011. Projecting out the 2004-2007 inflation rate is not really reasonable – the entirety of 1980-present has been one big story of declining inflation. Up until now, one could always argue that the Fed was trying to get the country to a stable, anchored 2% trend.

    I think the question now is this – do we even believe the Fed’s claim that it wants 2%, because expectations are now WELL below that. If the Fed does not ease in June, then their real target isn’t even 2% inflation. It’s clearly something else, and I have no idea what.

    Scott doesn’t buy the commodities story – I think it’s a huge part of the story. It also is a major connecting link between expanding productive capacity (and middle class wealth/demand) in developing nations and reduced growth in the US. Under a 2% inflation target, if labor productivity (and demand) increase in brazil while commodity production is temporarily fixed, then prices of commodities go up, this drives prices up, which forces the Fed to restrict money and drives down aggregate demand in the US. If commodity supply is elastic, however, then my neighbor’s growth is good for me.

    So you gotta ask yourself, do you believe in scarcity? Well, do ya, ???

    Scott often claims that we should be glad for developing country advances, since this increases demand for our products (and supply of cheap imports). In truth, the impact on us depends on the elasticities for demand/supply of primary inputs vs. labor production (and other things). Under a sharply inelastic supply curve for commodities, an increase in Brazilian (or chinese, etc.) productivity (and hence demand for commodities for their own consumption) can substantially harm US growth.

    Remember the sumner conjecture (under a 2% inflation target, fiscal policy is nearly impotent)… Extend this to international terms of trade, and we find a lot weird things happen.

  34. Gravatar of Steve Steve
    30. May 2012 at 12:25

    @StatsGuy,

    I sent Scott a chart a while back showing that the post-WWII low for US Domestic oil production was… drum roll please… SEPTEMBER 2008!!! Of 800 possible months, it was the month the Fed twiddled it’s thumbs and watched as the financial system imploded. Sure they did some soon IOER sterilized liquidity programs, but no ease.

    So I find myself squarely between StatsGuy and SSumner. I agree that the fed was targeting headline inflation, and therefore commodity prices indirectly. I also think the Fed was targeting the dollar, which was getting hit by a mini-current account crisis due to commodities. But I don’t believe the Fed had any grand plan to target commodities specificly, but their narrow-minded view of inflation targeting did produce an implicit oil price target.

  35. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 12:27

    Mike Sax:

    “Would you have the Fed buy cars and computers if that’s what it takes to increase NGDP, because banks are not lending enough to make NGDP rise via credit expansion? I’ve asked this before, but never got a satisfactory answer. Asked another way, how far will you go into “unconventionalism” when it comes to the Fed targeting NGDP? Suppose credit is insufficient. What should the Fed buy, and how does unearned money being printed and spent, constitute a gain for those who produce for the sake of those who spend without producing for that money? We’re talking trillions of dollars here”

    I feel like the crowd in Nietzsche’s Zarathustra: “Yes give us that last man!”

    It’s not surprising that you would quote a passage from a philosopher who lifted his philosophy from Stirner. You know, the whole lack of originality thing.

    I agree with you here-there comes a point where it’s pointless to call it monetary policy when it’s clearly fiscal policy. The one area of disagreement-it’s a doozy-is that my answer is not to wait aroudn no matter how many years it takes for the market to come back on its own self but rather simply do fiscal policy.

    Again, there is no “waiting around” in the market. It is millions of individuals getting up each day, many of whom go to work, produce, and sell.

    Maybe YOU are waiting around, because you’re not being proactive, but that’s not the market process’ fault. It’s not freedom’s fault. It’s your fault.

    So I would say buy computers, etc. if nothing else works though I agree that’s not monetary policy anymore but fiscal-as Krugman would too.

    You can’t buy what hasn’t first been produced through saving and investment. You have economic science backwards.

  36. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 12:52

    StatGuy,

    I mostly agree with you, but I had a similar issue with trying different starting points for the trend. The 2% trend line had to start somewhere and whether it was 1990, 1999, 2003, etc., it was always around 3-4%, not 2%. It wasn’t a blip just because of the bull market in commodities in the mid-2000′s.

    I’m certainly not an inflationista and I’m whole-heartedly for much looser monetary policy to get NGDP back to trend which would cause much higher inflation. But I was honestly surprised by what I saw in the non-core CPI figures.

    1. Inflation in terms of what people pay for stuff was on a pretty high trend level in the 00′s before 2008. The trend may be even higher for the typical basket of goods for lower- and middle-class families, since I think the CPI has a basket more typical of upper-middle class families.

    2. Wage/core inflation, however, was lower in the 00′s. The Fed used this as proof that monetary policy wasn’t that tight. And they were right, monetary policy probably was too tight for much of this time. The lack of core/wage inflation was an indicator that the labor market was probably too loose for much of the Bush years.

    Whether these supply-side issues had mostly to do with developing country development is an interesting question. In other words, if China stayed like North Korea, would the US have had higher real wages?

    I’ll leave that question there, since supply-side and actual economic productivity are much more complicated than regular demand/NGDP. The tracking of the CPI curve for the last 10 years however does show both the issue with inflation targeting vs. NGDP targeting and why the Fed may have had tighter-than-optimal policy throughout just about all of the 00′s.

  37. Gravatar of ssumner ssumner
    30. May 2012 at 13:17

    statsguy, Yes, but I’ve never understood their methodology.

    Matt, I agree that was important, but Krugman wouldn’t have. Back then he claimed monetary policy was powerless and hence we needed fiscal stimulus.

    dwb, You are probably right.

    Steve, I have to admit that I wasn’t paying much attention to the FDIC issue at the time. Not many people know it, but this allows the Fed to set a negative IOR if they wish.

    Johnleemk, Even Yglesias agrees the left blew it by not paying more attention to monetary policy.

    Cameron, I’m not sure.

    MF, Touche, now you are clueless about both monetary economics and Rortian epistemology.

    Statsguy, I sure hope the Fed isn’t trying to drive oil prices down, if so then all is lost.

    Tom, The Fed doesn’t need new ideas, they need resolve. They know what to do, they just don’t want to do it.

    K, No, Krugman claimed the central bank can do no more when rates hit zero, hence we needed fiscal stimulus. Later he changed his mind.

    You also need to explain the other three data points. And also explain why an increase in the demand for the medium of account would not increase the value of the medium of account.

    Mark, I’m no expert, but if Hamilton is right then an 5.75% IOER puts a floor of roughly 5% on the fed funds rate. If it went lower than banks would borrow ERs to collect interest.

    123, Thanks for that post–it would certainly be among the top ten of the worst posts Krugman ever wrote.

    The worst of it is that he doesn’t seem to have even read the Fed announcement. They didn’t cut rates because they didn’t see the US having an AD shortfall. Krugman acts like the Fed was desperately trying to boost AD, and fell short, when they weren’t even trying!! Meanwhile no call for a more expansionary monetary policy, because there’s nothing more (according to Krugman) the Fed can do.

  38. Gravatar of Britmouse Britmouse
    30. May 2012 at 13:34

    Krugman interview, he’s asked about NGDP targeting:

    http://blogs.independent.co.uk/2012/05/30/krugman-the-full-transcript/

  39. Gravatar of K K
    30. May 2012 at 13:41

    Scott: “Later he changed his mind.”

    His publishing record from well before then, suggests that that is not what he believes, but who really cares what Krugman thought at that moment. Krugman is basically a neoclassical, old Keynesian type, in the same static equilibrium tradition as the market monetarists. The point is, that that is not what current standard theory suggests. It says the whole curve matters.

    “You also need to explain the other three data points.”

    Which three? You mentioned QE1 and QE2. Operation Twist? I’d be happy to, but can we first agree that I’m right about this one?

  40. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 13:46

    Britmouse:

    FTA:

    “What about Nominal GDP targeting? Would you support a change in the Bank’s mandate?”

    “I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target. Do you really want to do that? So it’s not clear that that’s a good long run framework. The argument that people are using for it now is that it’s a way of creating that credible commitment to future inflation without actually saying so in so many words. I guess my thought would be that if you think that’s going to fool anybody – if you think you can slide that past [hard money/libertarian US Senator] Ron Paul – you’re kidding yourself. I don’t have a strong feeling about NGDP one way or the other – I think the idea that it’s a magic bullet is wrong, but if that helps sell more aggressive monetary policy, sure.”

    You see that folks? Krugman is starting to learn to respect his intellectual superiors.

    Krugman knows Austrians aren’t easily fooled. Imagine if the entire population understood Austrianism. Bye-bye central bank. Morgan, that one was for you.

    Krugman should have said:

    “What if you have an acceleration of the rate of money supply growth, that’s automatically risking currency collapse. Do you really want to do that?”

    Just like inflation target advocates said “No! A bust is impossible!”, so too do NGDP advocates say “No! Accelerating rate of inflation of money is impossible!”

    Neither grasp economic calculation. It’s like it doesn’t even exist. As long as a money printer keeps total spending stable, everyone is expected to be able to coordinate their actions as if no intervention is taking place.

  41. Gravatar of Steve Steve
    30. May 2012 at 13:53

    Spanish diplomat quoted in Reuters: “But Germany has to choose. With Greece it did not have to choose. It could allow Greece to fail. But if Spain fails, Europe fails. So in the end we have to believe that Merkel and the Taliban of the Bundesbank will change their minds and do what they need to do to save Europe.”

  42. Gravatar of Steve Steve
    30. May 2012 at 13:53

    http://www.reuters.com/article/2012/05/30/us-eurozone-spain-idUSBRE84T1FJ20120530

  43. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 14:15

    “What if you have an acceleration of the rate of money supply growth, that’s automatically risking currency collapse.”

    No, it doesn’t, because the Fed can destroy money as quickly as they print it. If the Fed makes a public commitment to some low inflation or NGDP target, or says a 2% target but acts with a 2% ceiling, then no matter how much money they print, markets will rationally expect low inflation and make the Fed’s announcements a self-fulfilling prophecy.

    Where we have in fact seen hyperinflation, such as Zimbabwe or Argentina, it was fiscally driven. The central banks were not politically independent and, even if they had assets to sell to destroy their currency, they didn’t.

    When a central bank would not let hyperinflation happen, like the BOJ has not and the Fed and the BOE won’t, then hyperinflation won’t happen. Saying otherwise has been very, very wrong since Japan in the 90′s.

  44. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. May 2012 at 14:32

    Scott wrote:
    “Mark, I’m no expert, but if Hamilton is right then an 5.75% IOER puts a floor of roughly 5% on the fed funds rate. If it went lower than banks would borrow ERs to collect interest.”

    Well, there’s degrees of rightness.

    I did some more research and it turns out Hamilton was wrong about at least one important thing when he wrote that post. The new FDIC fee didn’t go into effect until November 13th. Here’s what Rebecca Wilder said the following day:

    “I do not agree with this assessment because the FDIC’s temporary debt guarantee program does not charge the 75 bps fee until November 13. And furthermore, the new formula used for reserve interest did not go into effect until November 6, and so Prof. Hamilton’s example would be valid only for one trading day (the two-week maintenance period ended on November 5, and the reserve interest paid during that period was 0.65%).

    As of November 6, the reason that the effective rate is trading below its target is simply the case of a huge supply of reserve funds (an added $1.2 trillion over the year) coupled with some participants in the federal funds market (the GSEs, for example) that do not earn interest on reserves held with the Fed.”

    http://www.newsneconomics.com/2008/11/fed-funds-market-is-not-new-and.html

    Thus the gap between the effective FFR and IOER, which was relatively large and persistent between 10/29 and 11/12 and peaked at 0.77% on November 6th, isn’t at all explained by Hamilton’s theory.

  45. Gravatar of Major_Freedom Major_Freedom
    30. May 2012 at 14:38

    Matt Waters:

    “What if you have an acceleration of the rate of money supply growth, that’s automatically risking currency collapse.”

    No, it doesn’t, because the Fed can destroy money as quickly as they print it.

    They can only destroy what they have in their possession. The money they don’t have in their possession, they can’t control.

    If the Fed makes a public commitment to some low inflation or NGDP target, or says a 2% target but acts with a 2% ceiling, then no matter how much money they print, markets will rationally expect low inflation and make the Fed’s announcements a self-fulfilling prophecy.

    Which is a perfect way of saying NGDP regularity will systematically collapse once pressure is placed on it for control purposes. See Goodhart.

    It’s the very fact that NGDP targeting would lose NGDP’s outward prophesizing, and become self-prophecizing, that will make the holding nature of money the counter-vailing force which results in the Fed losing control over the money supply.

    Where we have in fact seen hyperinflation, such as Zimbabwe or Argentina, it was fiscally driven. The central banks were not politically independent and, even if they had assets to sell to destroy their currency, they didn’t.

    No, fiscal spending is not inflationary. Only money printing is inflationary. Zimbabwe and Argentina experienced hyperinflation because their “independent” banks printed money.

    Our central bank is not politically independent either, by the way. Never has been.

    When a central bank would not let hyperinflation happen, like the BOJ has not and the Fed and the BOE won’t, then hyperinflation won’t happen. Saying otherwise has been very, very wrong since Japan in the 90’s.

    It’s not about not letting or letting hyperinflation happen. It’s about the inevitable consequence of depending on credit expansion to continually boost NGDP at 5% per year. This requires an exponentially increasing money supply, since credit expansion puts more and more pressure on the economy that always has a countervailing corrective force that deflation would accompany.

    The only way that NGDP targeting can avoid hyperinflation is if the Fed does not depend on credit expansion to increase NGDP, but rather sends checks to non-banking institutions, such as non-bank firms and households.

    Depending on asset purchases will just bring about an asset boom that will requires correction that deflation accompanies later on, which of course will require an acceleration in the rate of money supply growth to reverse. And so on.

    Depending on consumption will just stretch the economy away from being more capital intensive despite real consumer saving calling for more capital intensiveness. It will generate a consumption oriented business cycle, once the errors in consumption sector investment have been found to be in error. That will happen even with NGDP targeting, and because of the deflationary pressure, it will require accelerating money supply growth as well.

    No matter where the inflation goes, and it will go to some areas before other areas, correctional force is inevitable, and thus in order to maintain NDGP, accelerating inflation is inevitable.

  46. Gravatar of Steve Steve
    30. May 2012 at 14:40

    A Lonesome Dove

    Boston Fed’s Eric Rosengren predicts slow growth, calls for more action to help economy
    05/30/2012 4:54 PM

    Eric S. Rosengren, president of the Federal Reserve Bank of Boston, on Wednesday made gloomy predictions for a slow economic recovery through the year, calling on policy makers to do more to lower the US unemployment rate.

    “I am expecting growth of only 2.3 percent for the full year, I’m sorry to say; and unfortunately no improvement in the current US unemployment rate of 8.1 percent,” Rosengren said in a speech in Worcester. He added that he believes the Federal Reserve should take additional steps — though he did not specify what steps — to lower the unemployment rate.

    http://www.boston.com/businessupdates/2012/05/30/boston-fed-eric-rosengren-predicts-slow-growth-calls-for-more-action-help-economy/IOGN8nNwXURkxPF5IK04KN/story.html

  47. Gravatar of Matt Waters Matt Waters
    30. May 2012 at 15:19

    “They can only destroy what they have in their possession. The money they don’t have in their possession, they can’t control.”

    All currency is a Fed liability, which currently is backed by an asset. When they raise rates, for example, they sell an asset for currency and the currency is destroyed. It no longer exists until the Fed “prints money” again.

    Without getting pedantic on the rest of your post, you seem to also have a basic misunderstanding of what NGDP actually is. GDP = C + I + G + NX. For open market operations, they increase C and I by increasing the monetary base and signalling that the Fed will do everything possible until NGDP/prices are increased.

    If C increases, how exactly does that overextend the economy? Some private actor out there is spending money on something. That’s it. It may be a 100 foot yacht or giving to a charity or a dental procedure they were putting off. It doesn’t matter. Some private actor decided they wanted to buy something.

    Meanwhile, if I is increased, that just means some private actor is deciding to build something. I is not buying an asset like a stock. It is real, physical investment in capital stock. Some private actor decided to build a factory, build a hospital, etc. with their own money.

    At worse, there is no output gap between actual GDP and potential GDP. Then a 5% NGDP target causes 5% inflation. That’s a mathematical identity and not really open to interpretation or argument: (increase in NGDP) = (Change in real production)*(Change in prices). If real production is unchanged, then we have at most 5% inflation.

    Your argument seems to be that targeting NGDP WOULD cause consumption and investment to increase. That’s…somehow an issue. Private actors spending their own money on either consumption or fixed investment. If it’s true, for example, that we have overextended fixed capital stock, how is it a bad thing to then consume what that capital produces? I don’t get it.

    And that’s the core of where Austrian arguments go horribly, horribly wrong. They assume that through some unspecified “confusion caused by central bank action,” people do stupid stuff with their own money and create an adverse economic outcome. Therefore, we should have a pure libertarian state where only private actors determine everything, including the money supply.

    Or:

    1. Private actors do stupid stuff.
    2. ????
    3. Private actors should be given control over everything.

    I guess I don’t get it. It only makes sense as libertarian dogmatism carried to its absolute, most absurd, most illogical end.

  48. Gravatar of dwb dwb
    30. May 2012 at 15:43

    @britmouse,
    thanks for the krugman link

    I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target. Do you really want to do that?

    and??

    this is the guy who pokes fun at the inflationistas, while hes worried about some future productivity trend??

    lets cross that bridge when we come to it.

  49. Gravatar of dwb dwb
    30. May 2012 at 15:51

    the fed better do something quick: the ten year closed at 1.26%. Pretty soon we are going to have a bunch of Congress-people thinking up home district projects to help their re-election. we’ve had an earmark ban for a while now, there’s a lot of pent up demand.

  50. Gravatar of dwb dwb
    30. May 2012 at 16:11

    ^^ 1.62%. fat finger.

  51. Gravatar of Bill Ellis Bill Ellis
    30. May 2012 at 16:55

    Professor Sumner,

    By way of introduction I am big Krugman fan. ( I like you a lot too ) I have read every single post of his since he started “The Conscience of a Liberal”, even the ones with those giant gorgeous equations I have no hope of comprehending, but hope to glean something from. My degree is in Fine Arts, but I have loved all of the social sciences since…well, as long as I can remember. I considered myself a Keynesian as a kid, way before I ever heard of Paul Krugman. Yet, I do realize that I am too comfortably in a Kugmanite bubble. Still, when I searched for alternatives to expand my view I found little that had much value in the predominant economic philosophies.

    Then I found you…through Krugman.
    I have read every one of your posts, but still don’t understand you.
    ( I realized that I was primarily looking for an overt model, so my focus was off. Ugg. Now I have to get around to reading it all again…(Hey, how do you set a target with out a model ? )
    Maybe you can understand that I feel like “Ellis Through the Looking Glass” when I come here. But I am trying hard to get my bearings.

    Anyway, my gut tells me that Market Monetarism can be the most effective and hopefully widely accepted prescription for economic policy…IN NORMAL TIMES. ( Please excuse my shouting. I get exited by this stuff. ) …and Ya know what ? I don’t think P.K. would have a problem with that.

    I would love to see Market Monetarism and Keynesianism become the opposite political polls. But they ain’t. ( Wouldn’t that be a much better and rational national debate? )

    I wonder If you and P.K. would be so at odds if it were not for your political dispositions ? Your prescriptions are not nearly as at odds. ( Is there any reason Market Monetarism can’t work for liberals like me, who believe that some degree of equity in wealth is necessary for a well functioning society ? )

    I doubt I will ever abandon Keynesianism, I think we are all to some degree pre-constituted to see the world in certain ways.

    In conclusion, I consider it an incredible privilege to be able to post on your threads. And that you actually read and respond to some of the comments of folks like me is generous and intimidating. I will try not to waste your time. I will try my best to always be respectful. ( Sometimes I don’t realize when I am not. ) I won’t bother you again with anything like this comment…But I hope my occasional dumb question will not vex you too much.

    Thank you.

    I

  52. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. May 2012 at 17:33

    @dwb and Britmouse,
    Krugman said:
    “I have a possibly minor worry that in the longer run that if you do have an NGDP target, what if you have an acceleration of the rate of potential output growth, that’s automatically lowering your implicit inflation target. Do you really want to do that?”

    I can think of at least two things wrong with that statement.

    1) If one is following NGDPLT there isn’t an implicit inflation target
    2) If Krugman is worried about losing the option of negative real interest rates (the “liquidity trap”) then that’s moot since:
    a) presumably productivity growth has accelerated, and
    b) under NGDLT interest rates are not the policy instrument

    It doesn’t sound to me like Krugman has given this much serious attention.

  53. Gravatar of dwb dwb
    30. May 2012 at 17:55


    It doesn’t sound to me like Krugman has given this much serious attention.


    nope, not to me. But then he does not think QE “does much” anyway. weird: i dont know why he thinks nominal expectations are more magical than inflation expectations.

  54. Gravatar of dwb dwb
    30. May 2012 at 18:09

    from the Krugman archive:

    http://krugman.blogs.nytimes.com/2010/07/24/monetary-and-fiscal-policy-a-clarification/

    The zero lower bound on short rates really does matter, even if longer-term rates are positive. The Fed can control short-term interest rates, it can influence long rates — there’s a world of difference between those two statements. So it’s not safe to assume that the Fed can, for example, hit any target for nominal GDP that it chooses.

  55. Gravatar of Bonnie Bonnie
    30. May 2012 at 18:26

    It’s guys like Bernanke and Dudley that matter when they are wrong.

    Here’s a gem from Bernanke and Mishken:

    http://web.uconn.edu/ahking/BernankeMishkin97.pdf

    Inflation Targeting: A New Framework for Monetary Policy?
    Author(s): Ben S. Bernanke and Frederic S. Mishkin
    Source: The Journal of Economic Perspectives, Vol. 11, No. 2 (Spring, 1997), pp. 97-116
    Published by: American Economic Association

    And here’s an excerpt of a recent speech by Dudley (full speech at link):

    http://www.newyorkfed.org/newsevents/speeches/2012/dud120524.html

    “In the current context, there is an additional complication that is extremely important. Simple policy rules implicitly assume that monetary policy is unconstrained and that the Fed can always achieve the federal funds rate policy setting the rule proposes—even if it is negative. By extension, they also assume that it is as easy to ease policy as it is to tighten policy if certain risks materialize. In practice this is not the case. Because our traditional tool, the federal funds rate, is already at its effective zero lower bound, we may want to react differently to a given economic outlook and set of risks than we would if policy were unconstrained. We are certainly not completely constrained: we have additional tools such as the balance sheet and forward policy guidance that we can use to provide additional monetary policy stimulus. But these tools have costs as well as benefits. Moreover, we can only imperfectly translate the impact of these policy instruments into interest rate equivalents for the purposes of evaluation using simple rules.

    “So for many reasons, I focus my attention primarily on how we are progressing and expect to progress relative to our dual mandate objectives. In this context, simple policy rules are an input, but my judgment also is informed by the economic environment and what we learn about the responsiveness of the economy to monetary policy.

    “Nevertheless, it is possible to translate my assessments into a language that would be more familiar to those who think in terms of a Taylor-type rule.

    “Recall that in a Taylor Rule framework, five major parameters can be adjusted:

    The inflation objective and the estimated output gap.
    Different weights can be placed on deviations of output relative to its potential and inflation relative to the Fed’s objective.
    The estimate for the neutral real short-term rate of interest.

    “Thus, while the Taylor Rule generally is viewed as a fixed formula, its underlying framework is sufficiently flexible that such a rule could be modified to reflect certain types of new information.
    What values should we use? In the United States, the inflation objective is well specified—a 2 percent annual rate for the personal consumption expenditures deflator.6 The FOMC has formally committed itself to this objective.

    “In contrast, there is disagreement among FOMC participants about how far the U.S. economy is operating from potential. Our staff forecast at the New York Federal Reserve estimates that the long-term unemployment rate is about 5 percent. The central tendency in the most recent Summary of Economic Projections is a bit higher at 5.2 percent to 6.0 percent, but the degree of dispersion is not particularly wide.

    “More difficult is the judgment about what weights to put on deviations of output from potential versus deviations in expected inflation from the Fed’s inflation target. This will differ among policymakers based on their views about the costs of deviations from the dual objectives and the structure of the economy. This debate can be summed up by looking at the two most well-known versions of the Taylor Rule—the original version put forward by Mr. Taylor, which is commonly referred to as Taylor 1993, and a later version updated by other economists that Mr. Taylor has discussed but does not endorse, which is referred to as Taylor 1999.7 Taylor 1999 puts more weight on deviations of output from potential than Taylor 1993. Thus, Taylor 1999 would lead to a later liftoff of the federal funds rate as the economy returns to full employment.

    “Which set of weights is better is a matter of judgment. John Taylor prefers Taylor 1993. My own thinking, when translated into Taylor Rule terms, favors the weights in the Taylor 1999 formulation. I believe that Taylor 1999 is likely to perform better in achieving the Federal Reserve’s dual mandate objectives. Compared with Taylor 1993 it can achieve significantly greater stability in employment without sacrificing the medium-term inflation objective or significantly increasing the variability of inflation outcomes.

    “Finally, the remaining parameter in the Taylor Rule is the neutral, real short-term interest rate. This is the interest rate adjusted for inflation that neither stimulates nor slows the economy. It is typically set at 2 percent. Although there is no reason why the neutral real rate cannot change over time, the 2 percent rate is typically plugged in without further attention. Whether this is appropriate is a critical question in today’s economic environment that I will return to a bit later.

    “Let me now discuss the economic outlook, and examine some of the implications for monetary policy. In doing so I will look at results obtained by applying some variants of the Taylor Rule, and explain some of my concerns about using simple policy rules in a mechanical way for setting monetary policy.

    “As I see it, the U.S. economy is continuing to slowly recover from the after-effects of the housing boom and bust and the financial crisis. But the recovery has been disappointing. Indeed, when we look back at economic forecasts made over the past three or four years it is notable that growth has systematically fallen short of both the Federal Reserve and private-sector forecasts.

    “Despite what has been an unusually accommodative monetary policy by historical standards, the economy has grown at only a 2.1 percent pace over the last four quarters and the Blue Chip consensus forecast only anticipates a modest acceleration to a 2.4 percent rate over the next four quarters….

    “More generally, there are several reasons to think that inflation will remain moderate and close to our objective. First, and most obviously, the economy continues to operate with significant slack. Second, measures of underlying inflation show little upward pressure. In fact, one—the Federal Reserve Bank of New York’s Underlying Inflation Gauge—is turning down. This measure uses a very wide set of variables to forecast the underlying inflation trend (Figure 6). Third, it is hard to be very concerned about inflation risks when the growth rate of nominal labor compensation is so low and stable. It is noteworthy to me that the employment cost index has risen only 2.1 percent over the past four quarters and has shown no acceleration (Figure 7). Fourth, inflation expectations remain well-anchored (Figure 8). This is critically important because inflation expectations are an important driver of actual inflation outcomes. Taking into account the current stance of monetary policy, I anticipate that inflation will decline to slightly below our 2 percent long-run objective over the next few years.”

  56. Gravatar of dwb dwb
    30. May 2012 at 19:16

    Bernanke and Dudley are just the tip of the iceberg. i just watched two igits, one from Knightley capital in a nice suit, talk about Icelands successful austerity. ummm there was this devaluation thing too, right?? AAARGH.

    as far as i am concerned whatever MBA school minted, er printed, his degree should be sued. retroactive failure.

  57. Gravatar of Woj Woj
    30. May 2012 at 19:35

    The recognition of how IOR changes monetary policy is really important IMO. Earlier today I wrote in a post (http://bubblesandbusts.blogspot.com/2012/05/permanent-zero-record-low-treasury.html):
    “Separately, when the Fed altered policy to begin paying interest-on-reserves (IOR) it also changed the direct measure by which monetary policy is adjusted. Given the enormous size of the Fed’s balance sheet (and outstanding Treasury debt), going forward it may be easier to effectively raise interest rates by hiking the IOR rate rather than actually altering the Fed’s target rate.”

    It seems that IOR was installed initially to limit the inflationary/expansionary impact of monetary policy. A negative IOR would certainly encourage greater lending by the banks, but may result in large misallocations of capital. Either way, I doubt IOR will go away anytime soon.

  58. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. May 2012 at 19:36

    “as far as i am concerned whatever MBA school minted, er printed, his degree should be sued. retroactive failure.”

    The failure lies in those who think that spending a couple of years studying how to run a firm makes one an expert on running a nation’s economy.

  59. Gravatar of Bonnie Bonnie
    30. May 2012 at 20:01

    dwb:

    It’s really too bad we have these guys with hyperinflated degrees with their hands on the monetary levers, Dudley in particular. I wanted to cut the excerpt of his speech down into some smaller quotation gems that would get the point across without taxing the time of those willing to read it, but it is so convoluted and meandering, missing the point that nearly everything that is “disappointing” about the economic recovery is right in his own words, that I left it that way to illustrate it. But even more to the point, the very fact that he talks about how uncertain they are about what to do, if anything, and takes 10 paragraphs of weasel verbiage to do it, is in large part responsible for the failure of their policy. It screams that they don’t know what to do and everyone else is on their own. He really should talk much less and think about how to solve the problem more.

    I think Bernanke is an incredibly intelligent individual, perhaps to the point of being sage-like, with limited ability to understand the concept of practical application that those like me with IQ scores that are inflated to a lesser degree find quite useful and satisfying. How useful is an explicit 2% PCE target policy with an incentive toward opportunistic disinflation when it causes an increase in market instability, reduces government revenue and adds to the load on social safety net spending, just for a few examples of the downside? It just doesn’t make sense to continue on with an obvious failure.

  60. Gravatar of Morgan Warstler Morgan Warstler
    30. May 2012 at 21:06

    Hey look! Stimulus!:

    http://www.politico.com/news/stories/0512/76849_Page2.html

  61. Gravatar of gofx gofx
    30. May 2012 at 21:34

    I would like to thank Major Freedom for his posts and urge many of the commenters not to be so flippant or dismissive. Economic calculation, the structure of production, and human action are like forces of nature. Eventually gravity wins. But even Hayek struggled with the “secondary deflation”. So I wonder if the best answer in context of MF’s question about the lending channel transmission mechanism for NGDP targeting being weak if there is no expected profit to lending (the only two projects have a loss of 5% and a loss of 10%) is that the expected profit/loss on those projects changes as a result of NGDP targeting (both the announcement effect and actual responses). And this is not necessarily through lowering of interest rates vis-à-vis an NPV or IRR calculation, since rates may very well go up. It is likely through increased comfort with the sales/demand side of the project. Exactly how this works, I assume will be in Scott’s book someday!
    It still may very well be that “preventing the secondary deflation” prevents or distorts economic calculation/re-calculation, or maybe we’re lucky and that the resulting structure of production (in some sense, loosely associated with Scott’s discussion of the SRAS curve) is not too far off from “optimal”. Or maybe we end up in a Misiean crack-up boom. I don’t know yet. If Hayek can struggle with it, so can I !

  62. Gravatar of dwb dwb
    31. May 2012 at 04:25

    true story: i texted a friend last night who runs a tech company “job creator” (he might be reading this, you know who you are). He said “qe3?” I said, no: Kochleratoka is walking around saying we are at full employment and Dudley says the economy is fine.

    he texted back: “were doomed”

    there is no liquidity trap only a policy trap, the only uncertainty is coming from the Fed.

    @Morgan,
    yeah i wondered if gold would decline as convervatives sold it to finance the campaign. seems so. But wait… isn’t all that campaign stimulus spending (mostly in swing states i assume) helping the economy and therefore Obama??? hmm.

  63. Gravatar of dwb dwb
    31. May 2012 at 04:29

    It just doesn’t make sense to continue on with an obvious failure.

    but how exactly does someone with an inflated degree change gears? you cannot just come out and say “wow that was a really stupid experiment, i am such a bonehead.” The FOMC is a like herding cats. It was Bernanke’s idea to push for inflation targeting, so how does he make a U-turn. I think we might be in this policy trap until hes no longer there.

  64. Gravatar of Morgan Warstler Morgan Warstler
    31. May 2012 at 05:04

    dwb,

    “Much of that decline came from Afscme Council 24, which represents Wisconsin state workers, whose membership plunged by two-thirds to 7,100 from 22,300 last year.

    A provision of the Walker law that eliminated automatic dues collection hurt union membership. When a public-sector contract expires the state now stops collecting dues from the affected workers’ paychecks unless they say they want the dues taken out, said Peter Davis, general counsel of the Wisconsin Employment Relations Commission.

    In many cases, Afscme dropped members from its rolls after it failed to get them to affirm they want dues collected, said a labor official familiar with Afscme’s figures. In a smaller number of cases, membership losses were due to worker layoffs.

    Tina Pocernich, a researcher at Wisconsin Indianhead Technical College, was a dues-paying union member for 15 years. But after the Walker law went into effect she told the American Federation of Teachers she wanted out.

    “It was a hard decision for me to make,” said Ms. Pocernich, a 44-year-old mother of five, who left the union in March. “But there’s nothing the union can do anymore.”

    But economic factors also played a role. Mr. Walker required public-sector employees to shoulder a greater share of pension and health-care costs, which ate up an added $300 of Ms. Pocernich’s monthly salary of less than $3,100. She and her husband, a floor supervisor at a machine shop, cut back on their satellite-TV package and stopped going to weekly dinners at Applebee’s.

    Meanwhile, she said, she paid the AFT $18.50 out of her biweekly paycheck and was now getting nothing in return. Her college eliminated one small-but-treasured perk, the ability to punch out an hour early during summer months—and the union was powerless to stop it.

    In the nearly 15 months since Mr. Walker signed the law, 6,000 of the AFT’s Wisconsin 17,000 members quit, the union said. It blamed the drop on the law.”

    This is what it is ALL about.

    As much as I want NGDPLT, I know that the real issue is structural.

    And that structural issue is PUBLIC EMPLOYEES.

    Since 1980, while the GOP was running up debt it failed to do the one thing it really NEEDED to do during the Bathtub Gambit, and that was make sure the total public employee overall compensation grew yearly at no greater inflation.

    Then two things happen:

    1. you don’t get Unions as a funding mechanism for Dems.
    2. progressives are forced to become truly “technical technocrats.”

    The NEXT BIG THING for technology is to replace $1T in public employee pay with $200B in technology spending.

    The keep $1 for every $5 saved model for tech, means $200B in annual revenues for the tech sector, that’s bigger than advertising in the US, and 5x what online advertising pays.

    Think that through. In return for $200B, Internet start ups have to make sure that my Guaranteed Income plan is in place, and that everything from driver’s licenses to SS cards, to fishing licenses are all mobile apps.

    With 50% less govt. buildings, video classrooms, and no US Postal Service, this country will BOOM! in ways make us truly a 21st century nation.

    —–

    dwb, Monetary Theory is nice, but the only really important thing is HOW FAST does the above happen.

    Had public employee been limited to inflation we’d already have the above. No ifs ands or buts.

    And that means the problem is structural

  65. Gravatar of Morgan Warstler Morgan Warstler
    31. May 2012 at 05:05

    http://online.wsj.com/article/SB10001424052702304821304577436462413999718.html

  66. Gravatar of Russ Anderson Russ Anderson
    31. May 2012 at 05:36

    Scott,

    While you’re talking about what can and should be done at the zero bound, this article, “Rosengren wants more Fed easing; Dudley, Fisher don’t” show that many of the Fed members see no reason for monetary easing.

    “I don’t hear any business people and job creators saying, ‘I need more liquidity, I need more money,’” Fisher told reporters after a speech. Even though inflation is not currently a threat, he said: “I don’t see what we would accomplish with further accommodation.”

    At the same time, some Fed policymakers, including Minneapolis Fed President Narayana Kocherlakota, want the Fed to begin raising rates again as early as this year.

    http://www.reuters.com/article/2012/05/31/us-usa-fed-idUSBRE84T1DE20120531

  67. Gravatar of W. Peden W. Peden
    31. May 2012 at 05:58

    Russ Anderson,

    Apparentely, Fisher lacks modern technologies like Google. First result for “US credit crunch” -

    http://www.reuters.com/article/2012/04/25/us-natgas-lending-idUSBRE83O10320120425

    Ah, but who needs more gas anyway?

  68. Gravatar of Negation of Ideology Negation of Ideology
    31. May 2012 at 06:33

    gofx -

    “Economic calculation, the structure of production, and human action are like forces of nature. Eventually gravity wins.”

    Ok, but what is it about NGDP targeting that prevents people from calculating, producing things, and taking action? People do those things in any monetary system.

    “It still may very well be that “preventing the secondary deflation” prevents or distorts economic calculation/re-calculation”

    Distorts it from what? I’ve asked this question many times of many people and never got an answer I understood. Is there some natural level of prices relative to an an arbitrary unit of account that we should compare it to? Why should we assume the arbitrary nominal price level should go down? If anything, shouldn’t we assume it should stay about the same? Or continue whatever trend it in on?

    Since one nominal price level is just as arbitrary as any other, how can we ask if preventing it from changing is a distortion? The only question left is what nominal price we should use for government purposes – seashells, tobacco, silver, gold, pork bellies, hourly labor, CPI, PCE, GDP or something else. I vote for the nominal price of GDP in the area the government covers because it is the broadest therefore the fairest and most stable.

  69. Gravatar of dwb dwb
    31. May 2012 at 08:07

    The NEXT BIG THING for technology is to replace $1T in public employee pay with $200B in technology spending.

    well, sounds nice, but i am ok with a certain level of inefficiency. the last thing i want is super efficient ways for the govt to monitor and spy, enforce (certain) laws, make wars and blow stuff up (700 Bn of defense spending, any idea where that goes?). The best way to cut the size of govt is to drastically reduce the number of things that are criminal activities (CA spends 50k annually on prisoners). A big giant border between TX and Mexico is a huge waste of $$. The biggest productivity enhancement would be to decriminalize lots of activities. I realize you have to worry about Iran and stuff, but geez, its gotta be cheaper to just pay them off. If its a choice between bribery and war, i choose bribery.

  70. Gravatar of ssumner ssumner
    31. May 2012 at 08:16

    Britmouse, That quotation from MF suggests that Krugman really doesn’t get it. He has trouble thinking of NGDP as a variable, he thinks it’s just a disguised form of inflation.

    K, You said;

    “His publishing record from well before then, suggests that that is not what he believes, but who really cares what Krugman thought at that moment. Krugman is basically a neoclassical, old Keynesian type, in the same static equilibrium tradition as the market monetarists. The point is, that that is not what current standard theory suggests. It says the whole curve matters.”

    Both Krugman and MMs assume ratex in their modelling, so I’m not really sure what you mean by this.

    You may be right about what Krugman really believes, I was talking about what his followers heard him saying in 2008. He was just interviewed in the UK and never once mentioned a higher inflation target for the BOE. His excuse in the US is that the Fed can’t be controlled by Obama, but Cameron determines the inflation target in the UK. So his call for fiscal stimulus makes no sense.

    I meant the three times IOR was increased.

    Steve, That Spanish quotation is interesting. And good to hear about the Boston Fed.

    Mark, But doesn’t your explanation suggest a risk-less arbitrage opportunity? Even if you are correct for that particular day, surely that would not persist over time? Or am I missing something?

    dwb, The answer to Krugman’s question is “yes.”

    Bill Ellis, My model is that NGDP fluctuations cause employment fluctuations due to sticky wages. Now tell me what other models have that mine lacks?

    Issues of income redistribution are completely unrelated to optimal stabilization policy. A Keynesian could just as well favor small or large government. Indeed Keynesians like Mankiw do favor small government.

    Bonnie, Thanks, that was interesting.

    Woj, You said;

    “It seems that IOR was installed initially to limit the inflationary/expansionary impact of monetary policy. A negative IOR would certainly encourage greater lending by the banks, but may result in large misallocations of capital. Either way, I doubt IOR will go away anytime soon.”

    Exactly, which is a long winded way of saying its effect was contractionary.

    As far as negative IOR, there are of course much better ways to do monetary stimulus, but it is an option.

    gofx, You must be new here, there’s a reason no one takes him seriously.

    Russ, He really is clueless.

    123, You said;

    “In this post Krugman says that AD will be too low. He also mentions negative t-bill rates, so presumably he thought that the natural FFR is or will be negative. Plus he observes that QE at previously unthinkable quantities does not work well. Only Krugman made these three points on 22 sept 2008.”

    Anyone with half a brain knew we were going into a recession (actually we’d been in one for 9 months), so it’s not a stretch to assume AD would be too low. There was no IOR at that time, so anything Krugman said about QE had no bearing on what came next. He was referring to the injection of massive amounts of non-interest bearing base money, something that was not tried.

    But you are missing the bigger picture—why wasn’t he demanding easier money?

    You said;

    “So basically Krugman’s conclusion was that any action fed is likely to take would be way too weak. And he was 100% right.”

    How is this a great insight? The markets were crashing, anyone who looked at TIPS spreads saw where we were headed. If we’d had NGDP futures at the time it would have been even more obvious, but alas, we still don’t.

  71. Gravatar of 123 123
    31. May 2012 at 09:18

    “123, Thanks for that post–it would certainly be among the top ten of the worst posts Krugman ever wrote.

    The worst of it is that he doesn’t seem to have even read the Fed announcement. They didn’t cut rates because they didn’t see the US having an AD shortfall. Krugman acts like the Fed was desperately trying to boost AD, and fell short, when they weren’t even trying!! Meanwhile no call for a more expansionary monetary policy, because there’s nothing more (according to Krugman) the Fed can do.”

    Scott,
    I disagree. This post by Krugman is in a top 10 blog posts ever written by anyone. Your blog did not exist at that time, but it is important to read it without hindsight bias, and it is not proper to compare it with what you would have written at that time.

    In this post Krugman says that AD will be too low. He also mentions negative t-bill rates, so presumably he thought that the natural FFR is or will be negative. Plus he observes that QE at previously unthinkable quantities does not work well. Only Krugman made these three points on 22 sept 2008.

    I see two problems with his post. First, he ignores the benefit of systematic policy rules, NGDPLT or PLT instead of IT, and LTRO or futures targeting instead of QE. Second, he writes about the risk of the Fed’s unconventional operations. However we know that Fed’s profits have increased during the crisis, so the Fed has it played too safe and it did not follow Bagehot’s recipe enough.

    I do not agree with your criticism about “The worst of it is that he doesn’t seem to have even read the Fed announcement”. Krugman thought that liquidity trap is unavoidable, And once you know that you are in a liquidity trap, interest rates are of a second order importance. Fed’s policy has sharply changed since the announcement younare refering to. And here Krugman says deflation is the danger, so presumably he supported FFR cuts:
    krugman.blogs.nytimes.com/2008/09/12/did-i-say-in-i-meant-de/

    So basically Krugman’s conclusion was that any action fed is likely to take would be way too weak. And he was 100% right.

  72. Gravatar of Jason Jason
    31. May 2012 at 11:40

    http://arxiv.org/abs/1002.2284

    I’ve been working on quantum computing lately, which made me remember this paper about the implications for P=NP when you mentioned the EMH.

    The key point I think that people agree on is that markets are only more efficient than other methods that have been devised for setting prices (which is a linear programming problem and [sort of] order N^3 [hence P, so we don't need to even get into P=NP], mentioned recently on crookedtimber.org in their discussion of Red Plenty). So I think the best you can do using the stock market and the EMH is to say that cutting IOR was a non-trivial exploration of the solution space. In the next few months the “IOR shock” dissipated. Note: that is exactly the Keynesian claim of the efficacy of fiscal policy — a shock that dissipates.

    That paper on P=NP was mentioned before in a comment on a previous post by someone else:
    http://www.themoneyillusion.com/?p=10437
    And somewhat dismissively mentioned by Tyler Cowen
    http://marginalrevolution.com/marginalrevolution/2010/03/just-dont-claim-i-said-this-was-true.html

    Again, the point I am making is not so much about the EMH and P=NP, but the actual meaning of market efficiency that is fairly universally accepted: markets are a more efficient approximate (and possibly good enough for all practical purposes) calculation of a solution than an exact linear programming model (Hayek’s price discovery).

    Markets cannot magically solve things that are potentially unknowable (e.g. optimal monetary policy) except as an approximate or heuristic solution.

  73. Gravatar of 123 123
    31. May 2012 at 14:49

    Scott, Krugman predicted the Japanese scenario in his sept 22 ’08 post. He was more pessimistic than markets were at the time.

  74. Gravatar of Mark A. Sadowski Mark A. Sadowski
    31. May 2012 at 18:12

    Scott,
    You wrote:
    “Mark, But doesn’t your explanation suggest a risk-less arbitrage opportunity? Even if you are correct for that particular day, surely that would not persist over time? Or am I missing something?”

    That is absolutely correct. Moreover it was not just for one day. For a period of *15 days* the gap between the effective FFR and IOER ranged between *0.29% and 0.77%*. According to Wilder the 0.75% FDIC fee on borrowed federal funds was not imposed until November 13th and speculates that the huge persistent gap was due to the dramatic increase in the supply of reserve funds at the time. Here’s the graph one more time showing the gap. Remember, the fee was not introduced until 11/13/2008:

    http://research.stlouisfed.org/fred2/graph/?graph_id=76672&category_id=0

  75. Gravatar of Larry Larry
    31. May 2012 at 18:16

    I’ve long regarded EMH as being at least the best approximation we have of how people respond to changing circumstances. I thought that the alternative was that behavior was random. However, my confidence is beginning to crack. Three popular books are responsible:

    The Blank Slate (Pinker)
    Thinking Fast and Slow (Kahnemann)
    The Righteous Mind (Haidt)

    have pretty much convinced me that research is beginning to unpack the obvious fact that we don’t behave that rationally. Shouldn’t this understanding have impacts through economics. Tax policy? Development? Banking?

  76. Gravatar of gofx gofx
    31. May 2012 at 21:37

    @Negation of Ideology-
    “Ok, but what is it about NGDP targeting that prevents people from calculating, producing things, and taking action? People do those things in any monetary system.. . .Distorts it from what?”

    Thanks for your response. It’s not that people won’t be calculating, it’s that the information upon which they make those calculations (prices and quantities) is different from what it would have been under alternate policies. And its not “arbitrary nominal price levels” that are what’s most critical, it’s the impact on relative prices. That’s why (at least in my opinion, and I am paraphrasing) Bill Woolsey talks of NGDP targeting as the “least bad” method of intervention that still allows for microeconomic adjustment. And that’s probably why you see different targets (level targets, but summarized in growth rates) expressed by Scott (5%), Morgan (4-4.5%), and Bill (3%). There’s some tradeoffs going on there!
    The baseline from which to measure distortion is typically going to be, what a “free banking”, competitive money institutional arrangement might produce, or given, our existing institutions, any other “less accommodative” Fed policy that implicitly puts more pressure on wages and prices to adjust.
    To be clear, NGDP targeting seems to me to be superior to inflation targeting, Taylor Rules, and certainly Krugman-type fiscal policy. And its likely that combined with an NGDP futures market we can get the current central bank/ fiat money system as close to a “free market based” solution (which of course, per Hayek we could never know a priori what that is) until such time as the institutional situation can be changed, i.e. free banking etc. Unless, of course even though it’s the “least bad” method, its still too bad, and Mises and gravity prevail.

  77. Gravatar of Major_Freedom Major_Freedom
    31. May 2012 at 21:43

    gofx:

    You’re a voice of reason in the stink of monetarism.

  78. Gravatar of Peter N Peter N
    1. June 2012 at 02:41

    Scott,

    The Swiss situation is rather interesting, since they can maintain a peg on the euro or the dollar, but not both.

    Maintaining the euro peg requires severe financial repression in Switzerland to make franc assets unattractive, which the Swiss have said they will engage in as needed. The more expensive dollar will make non-eurozone imports more expensive and the added value of exports (exports – import inputs) more attractive.

    Releasing the peg would push the franc up against both the euro and the dollar (though more so the euro) and probably cause asset price inflation. The cheaper imports and less competitive exports would erode national industry (think China and the US), and Switzerland has no compensating natural resources.

    Neither of these prospects is very attractive. The best policy is probably to let the peg crawl just enough to counter the worst of the peg side effects, but since the peg and non-peg side effects work to some extent on different parts of the economy, some distortion seems inevitable.

    There’s a fascinating paper in this for some lucky economist.

  79. Gravatar of Negation of Ideology Negation of Ideology
    1. June 2012 at 08:19

    gofx -

    I’m glad you specified your baseline. And I’m glad you specified which version of “free banking” you mean, because it seems like each person who uses that term means something different. Hayek’s version is spelled out in “The Denationalization of Money”. So it’s not a gold standard you are comparing it to, it’s a system where every bank issues its own notes and anyone is free to accept or reject them, and any contract can be written in any bank’s notes. Some may issue notes based on gold, some on silver, some on NGDP, etc. Then they can keep as small a reserve as they want. (As opposed to some people who call themselves “free banking” advocates, but want to ban fractional reserve banking.)

    That’s fine I suppose, but it should be pointed out that private companies already can issue these kinds of securities and people can trade them and write contracts in them. That still doesn’t answer the question of what the government should use to collect taxes, royalties, fines, damages in civil lawsuits, pay government employees, etc. If the government exists, it will have to make some kind of decision as to what it will use for money. And if you believe the government shouldn’t exist, than it’s kind of a moot point.

    I submit that the government issuing its own currency for public purposes and basing its value on the entire economy is far more neutral and free market than the government picking and choosing among various private securities and commodities and determining what exchange rate each of them will have.

  80. Gravatar of gofx gofx
    1. June 2012 at 18:32

    @Negation of Ideaology
    Yes, you accurately summarized my free banking description, but whoa there! We’re getting a bit away from evaluating monetary regimes. Free banking doesn’t imply there should be no government. But let’s discuss your point about needing government-issued money.

    You may be right, that after considering transactions costs, standardization of the unit of account , and a whole host of issues, government-issued money may have a role. But we should at least consider the possibility that private money could have a role too. In fact they could exist simultaneously. We’ve seen countries “dollarize” their economies before (at least for commercial transactions) and I believe Iceland has recently considered just flat out adopting the Canadian Loonie as its currency—not even having their own Icelandic currency. And at the risk of the wrath of the MMT folks, even the U.S. government under some circumstances will take payment of taxes in something other than dollars:
    §6316. Payment by foreign currency
    The Secretary is authorized in his discretion to allow payment of taxes in the currency of a foreign country under such circumstances and subject to such conditions as the Secretary may by regulations prescribe.
    (Aug. 16, 1954, ch. 736, 68A Stat. 778; Pub. L. 94–455, title XIX, §1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1834.)

    Maybe the federal deficit would be less if some folks had been allowed to pay their taxes with Google stock!

    The U.S. Government has a monopoly on postal services (technically it’s a private company [Just like the Fed!] or quasi- private, now, but for most of our history it was a government agency). Everybody uses envelopes to “exchange” mail. But the government doesn’t supply the envelopes. You can use “privately issued” envelopes, even when dealing with the government. There are some standards on envelope sizes etc., and the government even sells some envelopes too. Who controls the supply of envelopes?

  81. Gravatar of gofx gofx
    1. June 2012 at 18:44

    Thanks MF. And thanks, Scott. Both of you as well as Morgan, Bill and many other contributors on this blog provide valuable ideas an analysis on this critical area that affects all our lives.

  82. Gravatar of ssumner ssumner
    1. June 2012 at 19:15

    Jason, I agree that markets are only approximately efficient.

    123, I recently gave him credit for that. But if you are going to disagree with markets you have a 50% chance of being right.

    Mark, I think we’ll need more information to resolve that question.

    Larry, When those three authors (or people using their ideas) start beating the stock market I’ll take it seriously. For now I’ll stick with the EMH.

  83. Gravatar of dtoh dtoh
    2. June 2012 at 08:15

    [i] But when the value of the medium of account rises, its nominal price cannot change, by assumption. Instead, the only way for the medium of account to become more valuable is for all other prices to fall. [/i]

    Yes, but if you have changed it value by exchanging oranges for the MOA, then fall in the value of oranges will be larger than the fall in other prices. Similarly if you exchang financial assets for the MOA, the change in the value of financial assets will be greater than the change in the value of real goods and services.

  84. Gravatar of ssumner ssumner
    3. June 2012 at 06:57

    dtoh, But the financial assets you buy are a drop in the bucket, hence the effect on asset prices from the purchase is tiny (except when nominal rates are zero.)

  85. Gravatar of dtoh dtoh
    3. June 2012 at 18:47

    Scott,
    You said, “But the financial assets you buy are a drop in the bucket, hence the effect on asset prices from the purchase is tiny (except when nominal rates are zero.)”

    Yes, but a) the same thing can be said about the amount of MOA that is being “sold” into the system, b) it’s not just the amount of the exchange but as you often state, expectations have a major impact.

  86. Gravatar of ssumner ssumner
    4. June 2012 at 08:35

    dtoh, That mixes apples and oranges. The change in the MOA (in percentage terms) is much bigger right now than the change in total assets from OMOs. And if you use future expected changes, the same is true.

  87. Gravatar of dtoh dtoh
    5. June 2012 at 00:54

    Scott,
    Well I think you will agree that if the price of financial assets rise relative to real goods and services, then that will lead to an increase in spending on real goods and services. The bigger the asset base, the bigger the impact on AD.

  88. Gravatar of Saturos Saturos
    5. June 2012 at 02:07

    Stocks, yes. Bonds, no.

  89. Gravatar of ssumner ssumner
    5. June 2012 at 13:28

    dtoh, No I don’t agree, I think monetary policy determines spending. The huge rise and fall in stock prices in 1987 had no impact on spending.

  90. Gravatar of dtoh dtoh
    5. June 2012 at 13:43

    Scott,
    I agree but the transmission mechanism is through the price of financial assets relative to real goods and services or more precisely expectations of future financial asset prices relative to expected prices for real goods and services.

    1987 had no impact because it was short term. After the initial shock, long expectations quickly reverted to what they had been before.

  91. Gravatar of dtoh dtoh
    5. June 2012 at 13:59

    Think about it in terms or real world behaviour. Suppose your broker decides to close your account, sells off $100k worth of Treasuries, and drops off a briefcase with $100k in cash on your doorstop. Are you suddenly going to decide that your previous decision about how much to keep in financial assets and how much to spend on real good and services is going to change. No it’s not; if you’re rational you’ll just go somewhere else and buy another $100k in Treasuries. Unless…..

    the price of Treasuries has risen in which case you’ll shift your allocation to hold fewer Treasuries and to spend more.

Leave a Reply