Tight money, easy credit

It’s getting difficult to even read the news without throwing a brick at the computer screen.  The world economy appears to be in the hands of people who don’t understand the difference between easy money and easy credit.  Here’s the Financial Times:

Opponents contend that the Fed’s third round of quantitative easing – nicknamed QE3 – has triggered volatile capital inflows into emerging markets, leading to an appreciation of their exchange rates, weighing on trade, and creating threats to financial stability.

Guido Mantega, Brazil’s finance minister and one of the Fed’s most vociferous critics, on Saturday labelled the Fed’s ultra-loose monetary policy as “selfish”.

Inflation has averaged 1.4% over the past 50 months, but apparently that’s still too high for Mr. Mantega.  America is “selfish” for not accepting even higher unemployment in order to drive inflation even lower.  We are being lectured to for running an excessive 1.4% inflation rate by the central banker of a country that not too long ago averaged 70 percent annual inflation for three decades.

At the other extreme is the Japanese:

Mr Shirakawa warned over the weekend of the “collateral damage” caused by an abundance of easy credit from developed markets to the rest of the world. “With the deepening of globalisation, no responsible policymaker could now dismiss the cross-border spillovers and feedbacks of their policies,” he said.

The BoJ chief called on officials in advanced economies to be more patient. He noted that despite “aggressive” and unconventional monetary policy, the growth trajectory of Europe and the US in the four years following the Lehman crisis had been lower than that of Japan following the bursting of its asset bubbles at the end of the 1980s.

“We have to accept that the growth rate may have to be lower” until excess debt is worked off, Mr Shirakawa said. “Unless we come to terms with this fact, recovery could be endangered by the adoption of inopportune and inappropriate policies, driven by discontent among the general public, that could erode efficiency and destabilise the global economy.”

Yes, we have a lot to learn from the central banker of a country that has presided over two decades of falling nominal GDP.  And notice the confusion between credit (which is not controlled by the central bank) and monetary policy, which is controlled by the central bank.

Right now the world has a saving glut or an investment drought (probably the latter) and hence real interest rates are low.  There’s not much the Fed can do about that other than adopt a higher NGDP target in the hopes that faster economic growth will raise real interest rates (but don’t expect miracles.)  But the Fed most certainly can increase American NGDP, which would help developing countries by increased global trade.

Christine Lagarde, managing director of the IMF, indicated that the IMF could relax its position against capital controls to take into account the impact of ultra-loose monetary policy in advanced economies, which she acknowledged was likely to spur large and volatile capital flows to emerging economies.

“We have been working on refining our institutional view on the liberalisation and management of capital flows from the perspective of countries that receive and those that generate capital flows,” she said on Sunday.

Now the confusion between easy money and easy credit is leading the IMF back to the bad old days of interventionist policies, such as capital controls.  There is no reason why easy money in the US should lead a developing country to adopt capital controls.  If their economy is overheating then they should tighten up on monetary policy.

Off Topic:  Matt Yglesias seems to agree that interest rate targeting won’t work in the future:

Interest rate targeting had a good run because everyone understood the convention, but the combination of low inflation and population aging means that negative demand shocks are now going to regularly put us at-or-near the zero bound. That means we’d be well-served to find some other monetary routine to appeal to.

As is often the case, I think he’s ahead of most economists in spotting this problem.  I don’t sense that most macroeconomists understand that rates will frequently fall to zero in future recessions, despite not having hit zero once in the half century before the current crisis.  We need a different monetary policy instrument/short term target.


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30 Responses to “Tight money, easy credit”

  1. Gravatar of Britmouse Britmouse
    18. October 2012 at 05:46

    I read that article another way: “Guido Mantega says Krugman et al are totally wrong about the ZLB”

  2. Gravatar of Morgan Warstler Morgan Warstler
    18. October 2012 at 06:03

    Scott,

    This is Greg Sargent of WaPo quoting Tim Noah of TNR:

    “The idea that government spending doesn’t help the economy contradicts a pretty sturdy consensus among economists (including, according to Paul Krugman, at least two of Romney’s own economic advisers, Greg Mankiw of Harvard and Glenn Hubbard of Columbia) that government spending does indeed stimulate the economy, just like John Maynard Keynes said.”

    http://www.washingtonpost.com/blogs/plum-line/post/the-morning-plum-mitt-romney-and-trickle-down-government/2012/10/18/ac183a04-190f-11e2-aa6f-3b636fecb829_blog.html

    —–

    I will CONTINUE to submit that you’d do MM great service if you’d take the Milton Friedman approach and rage once and while against the simpler idiots like those above.

    You have an easy argument about Fiscal, that cleanly slices in between DeKrugman wants more govt. spending and Mankiw being fine with tax cuts – Greg and Tim don’t understand those are both called Fiscal Stimulus by eggheaded economists.

    You argument is the eggheaded version… that Fiscal can’t help / wan’t help, the Fed moves last, gets what it wants.

    We both know, conservatives have more to gain from NGDPLT because it shrinks govt.

    At some point, you have to be that guy. Why not start today?

  3. Gravatar of ssumner ssumner
    18. October 2012 at 06:08

    Britmouse, Yes, that’s clearly his view, otherwise it could not create inflation and dollar depreciation.

    Morgan, I frequently argue against fiscal stimulus.

  4. Gravatar of Arthur Arthur
    18. October 2012 at 07:15

    Although personally I don’t like my finance minister, and I think he really thinks the US is running a easy monetary policy, I think what he’s actually complaining about is low interest rates, not easy monetary policy.

    I does not matter if the low interest rates in US are loose monetary policy or not, they appreciate our currency by interest rate parity.

  5. Gravatar of Doug M Doug M
    18. October 2012 at 07:28

    We know how the Fed can create easy money, but is there anything that they (or our elected representatives) could do to unclog the credit machine?

    It seems to me that Fed open market operations doesn’t accomplish much if money doesn’t turn into credit.

  6. Gravatar of TravisA TravisA
    18. October 2012 at 07:33

    I suppose that the definition of ‘easy money’ would be a monetary base that produced greater than 5% NGDPLT (or whatever the target growth rate is).

    But what is the definition of easy credit?

  7. Gravatar of Justin Justin
    18. October 2012 at 07:35

    Have you done any posts on the difference between easy money and easy credit? I’m not completely clear on the distinction either.

  8. Gravatar of marcus nunes marcus nunes
    18. October 2012 at 07:38

    Scott, you are being generous on Brazil´s inflation. Between 1980 and 1994, monthly inflation (CPI) averaged 16.7% with a maximum of 105.7%.
    Yearly inflation over the same period was on average 872% with a maximum of 7100%!
    And Mr Mantega adopts policies that increase wages and consumption and reduces industrial competitiveness, than says we don´t grow because of the exchange rate appreciation. And that´s the Fed´s fault!

  9. Gravatar of Morgan Warstler Morgan Warstler
    18. October 2012 at 07:44

    What I mean is in this example take Sarget and Noah to task, expand the people you go after to MORE COMMON widely read folks.

    Since you beat Krugman then go after the guys who throw his name around.

    Sargent and Noah can’t defend themselves. Matty won’t be able to defend them.

    And a WIDER swath of conservative bloggers will say hey this Sumner guy is ok.

    This is the modern version of Friedman.

  10. Gravatar of Andy Harless Andy Harless
    18. October 2012 at 08:09

    I wouldn’t dismiss the problem of volatile asset flows (or, more broadly, asset market instability); I just don’t think one should blame monetary policy. Low interest rates are a problem in that they make the value of an asset depend heavily on difficult-to-estimate returns from the distant future. (By contrast, high interest rates mean that most of the present value of an asset depends on relatively easy-to-estimate returns from the near future.) The savings glut or investment drought (depending on whether you think the subjective discount rate is too low or the risk/liquidity premium is too high) is a real problem, even aside from the disequilibrium it produces because of sticky wages and tight money. Brazil has a legitimate complaint against the over-savers of East Asia, Northern Europe, and the Arabian Peninsula.

  11. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    18. October 2012 at 08:22

    ‘And notice the confusion between credit (which is not controlled by the central bank) and monetary policy, which is controlled by the central bank.’

    Thus it has always been. Remember the Carter era credit controls, supposedly to stem inflation?

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    18. October 2012 at 08:24

    ‘But what is the definition of easy credit?’

    When anyone who can fog a mirror can get a loan. Which was official government policy in the USA from the early 1990s on (and still is, really).

  13. Gravatar of Tom Tom
    18. October 2012 at 09:41

    Fed most certainly can increase American NGDP

    Well, that’s part of the debate. I believe they should be trying, and have policies for NGDP of 6% and explicitly target it.

    But that’s a bit like saying banks build houses. Actually, bank loans allow builders to build houses. And Fed policies might allow banks to make more loans.

    Monetarism needs to be tracking actual credit provided to the economy, not just “money”. Loan acceptance/ rejection rates. Quantities of loans by industry. I’d guess such statistics exist, but I don’t see bloggers or economists or Fed bank reports about them, yet continue to think they’re really where monetary policy turns into NGDP.
    Or not.

    So far, not.

  14. Gravatar of Major_Freedom Major_Freedom
    18. October 2012 at 10:17

    I rarely if ever have a desire to throw bricks at computer screens when I read bad arguments. I usually patiently go through the ideas and, where applicable, refute those bad arguments with superior economic theory.

    Case in point, this blog post. Rather then throw a brick at my screen, I’ll just patiently point out the flaws made, because I have answers to these particular issues and I don’t need to become emotional to make up for any lack of understanding and in the process make argumentative errors.

    Inflation has averaged 1.4% over the past 50 months, but apparently that’s still too high for Mr. Mantega. America is “selfish” for not accepting even higher unemployment in order to drive inflation even lower.

    This is fallacy of status quo.

    A 1.4% consumer price inflation rate can be associated with significant monetary inflation, if consumer price inflation would have been -1.4% had “conventional” monetary inflation rather than QE been in effect at this time.

    More importantly, a 1.4% consumer price inflation rate can also be associated with ASSET BUBBLES, since monetary inflation, as I pointed out yesterday, does not affect all industries equally.

    The deference to consumer prices displays a total misunderstanding of how inflation works. Inflation tends to enter the capital markets first before it enters other markets that directly raise consumer prices.

    There is no good reason why consumer prices should rise at the same rate as all other prices when there is monetary inflation. Empirically and theoretically, we should expect federal reserve easing to affect one industry at a time as money enters the economy at distinct points, rather than via helicopter drops.

    We are being lectured to for running an excessive 1.4% inflation rate by the central banker of a country that not too long ago averaged 70 percent annual inflation for three decades.

    .

    Ad hominem tu quoque. While it’s true that this banker’s “country” had high price inflation in the past, that has no bearing on the content of his own arguments concerning the US. But the fact that you are bringing nationalism into this only emphasizes my theory that market monetarism is more a nationalist mercantilist ideology, than a sound economics theory. We are supposed to feel patriotic and say screw you world, that the US has to see an increase in employment, and the rest of the world who owns dollars must pay the costs of the inflation that will artificially boost US employment in the present.

    Like I said before, market monetarism is a political strategy, not an economics theory.

    At the other extreme is the Japanese:

    Yes, we have a lot to learn from the central banker of a country that has presided over two decades of falling nominal GDP.

    More ad hominem tu quoque.

    And it’s not even factually correct.

    There was a very significant acceleration in nominal GDP starting around 1985, which peaked in 1995. If you consider the entire period from 1960 to the present, there has been a long term constant growth of NGDP.

    More importantly however, it is meaningless to only refer to Japan’s NGDP and claim that because it didn’t grow at a certain subjectively preferred rate, that Japanese people are worse off.

    For if we look at (another imperfect) statistic, “GDP per capita (PPP)”, then we can conclude that Japan has experienced economic growth for the last two decades.

    And notice the confusion between credit (which is not controlled by the central bank) and monetary policy, which is controlled by the central bank.

    This statement shows a confusion of how the monetary system works. The central bank indirectly controls commercial bank credit. The central bank can enable more or less credit expansion by changing bank reserves.

    If the Fed stopped inflating bank reserves tomorrow, then at some point, credit expansion will eventually come to an end, and the quantity of outstanding credit will peak. This is because banks cannot continually expand credit without a minimum quantity of reserves needed to satisfy interbank transfers and client withdrawals. Banks are operationally constrained by capital requirements, but they are nevertheless functionally constrained by reserves.

    More reserves means banks can increase credit expansion, ceteris paribus.

    Right now the world has a saving glut or an investment drought (probably the latter) and hence real interest rates are low.

    Oh dear. Savings glut? There is no such thing as a “savings glut.” It is a myth, designed by promoters of government spending.

    The economy has far more room for investment than any quantity of savings could ever exhaust. Just one city has enough profitable investment opportunities to absorb the entire world’s savings.

    There is definitely an investment drought, and that drought is caused in part by the banking cartel, which is keeping rates at low levels to benefit the member banks, at the expense of everyone else, including savers.

    There’s not much the Fed can do about that other than adopt a higher NGDP target in the hopes that faster economic growth will raise real interest rates (but don’t expect miracles.)

    It’s a good thing mad scientists who use human beings as lab rats aren’t in charge of the printing press…oh wait.

    But the Fed most certainly can increase American NGDP, which would help developing countries by increased global trade.

    Inflation doesn’t increase global trade. It distorts global trade. Developing countries whose citizens are forced into the fiat world banking cartel regime, where US dollars are imposed as the reserve currency, such that local countries inflate slower or faster in accordance with US dollar inflation, are actually harming the people of those developing countries. “Inflation” and “spending” doesn’t generate healthy economic growth. It misleads people.

    Now the confusion between easy money and easy credit is leading the IMF back to the bad old days of interventionist policies, such as capital controls. There is no reason why easy money in the US should lead a developing country to adopt capital controls.

    There is no good reason no, but there is a reason. That reason is increased capital markets volatility in developing economies on account of easier money in developed countries.

    If you want to avoid capital controls, then eliminate the banking cartel that is causing so much of the instability.

    If their economy is overheating then they should tighten up on monetary policy.

    On Monday. But then their NGDPs will fall, and on Tuesday you will be complaining that their NGDPs are falling.

    Market monetarists are way behind the curve in correctly diagnosing economic problems.

  15. Gravatar of Adam Adam
    18. October 2012 at 10:21

    How can a central banker not understand that low growth makes it harder to work through those debts??

  16. Gravatar of Major_Freedom Major_Freedom
    18. October 2012 at 10:29

    Adam:

    How can a central banker not understand that low growth makes it harder to work through those debts??

    Inflation doesn’t increase real growth.

    Inflation in our monetary system is primarily composed of credit expansion. Asking for more inflation to help alleviate debt overhang is like asking for another credit card to pay off the first one.

  17. Gravatar of B. H. Soetoro B. H. Soetoro
    18. October 2012 at 11:11

    “Right now the world has a saving glut or an investment drought (probably the latter)”

    YES! Because SO MUCH of the worlds capital is tied up in Govt Debt which is delivering garbage economic returns.

  18. Gravatar of ssumner ssumner
    18. October 2012 at 11:17

    Andy, Let’s suppose asset values are more difficult to determine at low rates. Is that really what the Brazilians are objecting to? It’s not obvious to me that this sort of difficulty would have major welfare implications, especially the implications that policymakers in the developing world seem to think it has.

  19. Gravatar of Adam Adam
    18. October 2012 at 12:18

    M-F – I’ll break my habit of not reading or responding to you to note that neither I nor Mr Shirakawa said anything about inflation.

  20. Gravatar of PeterP PeterP
    18. October 2012 at 12:42

    I see that you make up definitions as you go.

    “And notice the confusion between credit (which is not controlled by the central bank) and monetary policy, which is controlled by the central bank.”

    So what is “monetary policy” which makes it distinct from impacting credit?

    The CB monetary policy acts by acting on credit. It is very weak because the only tool they have is to change rates, cool that you noticed that finally.

    Monetary base has no causal impact on credit or anything else. MB follows loans/deposits, doesn’t lead them.
    http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

  21. Gravatar of Major_Freedom Major_Freedom
    18. October 2012 at 13:36

    Adam:

    M-F – I’ll break my habit of not reading or responding to you

    Just to be sure, don’t you mean Sumner’s habit, which you and other followers have adopted in order to gain acceptance into the MoneyIllusion clan?

    Maybe it takes an outsider’s perspective to see it, but the level of credulity among many of the posters here is rather remarkable.

    to note that neither I nor Mr Shirakawa said anything about inflation.

    Neither of you need to say anything about inflation in this instance. The person being addressed is a central banker…from Japan…who is allegedly not inflating enough.

    If you jump on the bandwagon and go from criticism of lack of inflation to criticism of lack of growth, then inflation is implied in your position.

  22. Gravatar of Major_Freedom Major_Freedom
    18. October 2012 at 13:48

    PeterP:

    Your response is rather strange. You seem to criticize the view that monetary policy is separate from credit, and yet you go on to assert that Fed action (monetary base) has no causal impact on credit or anything else. Those two seeming positions of yours don’t jive with one another.

    Your statement that the monetary base has no causal impact on credit or anything else is just wrong.

    While in practise, MB increases typically follow credit expansion, it doesn’t mean MB is not the causal force. For banks extend credit expecting that they can borrow in the overnight market whose rate is kept lower than market by…the Fed inflating bank reserves. If the Fed stopped inflating bank reserves, then at some point, credit expansion would come to an end. It cannot go on forever without the Fed backstopping the banks by ensuring sufficient liquidity is available.

    The tool the Fed has is not only changing rates, but changing the quantity of money available to banks to facilitate their inter-bank transfers and withdrawal requests. The more banks expand credit, the higher these requests become. If the Fed doesn’t increase bank reserves, then the banks will go bankrupt through continuous credit expansion (which is what happened in the 19th century).

  23. Gravatar of Doug M Doug M
    18. October 2012 at 14:05

    “Asking for more inflation to help alleviate debt overhang is like asking for another credit card to pay off the first one.”

    As long as new credit card offers come in the mail, I can get 2 or 3 new credit cards every year, and revolve the ballances from the old cards to the new cards. I can put of reckoning for years.

    People don’t go bankrupt because they run out of money, they go bankrupt because they run out of credit.

  24. Gravatar of Benny Lava Benny Lava
    18. October 2012 at 15:07

    Whoa, did MF just argue that Japan is better off today than 20 years ago? With 20 years of deficits and Keynesian stimulus? With one of the biggest debt to GDP ratios on earth? Man Scott these comments are getting weirder every day.

  25. Gravatar of Major_Freedom Major_Freedom
    18. October 2012 at 18:56

    Doug M:

    “Asking for more inflation to help alleviate debt overhang is like asking for another credit card to pay off the first one.”

    As long as new credit card offers come in the mail, I can get 2 or 3 new credit cards every year, and revolve the ballances from the old cards to the new cards. I can put of reckoning for years.

    People don’t go bankrupt because they run out of money, they go bankrupt because they run out of credit.

    Well, at least you admit such a policy has a finite life, and is not indefinitely sustainable.

    ————————————

    Benny Lava:

    Whoa, did MF just argue that Japan is better off today than 20 years ago? With 20 years of deficits and Keynesian stimulus? With one of the biggest debt to GDP ratios on earth? Man Scott these comments are getting weirder every day.

    Actually, all I argued is that despite low NGDP growth, living standards, as measured by the imperfect statistic of GDP per capita (PPP), living standards have not decreased.

    If you want me to address stimulus and deficits, then I would say that living standards would have been even higher without them.

    But nice try putting words into my mouth. I guess it provided for a good laugh.

  26. Gravatar of Saturos Saturos
    18. October 2012 at 19:28

    “The world economy appears to be in the hands of people who don’t understand the difference between easy money and easy credit.”

    It always has been, but you’ve only realized this since 2008, hence this blog.

    I don’t think Mantega was ever a central banker.

    How can you say that the central bank doesn’t control credit?

  27. Gravatar of ssumner ssumner
    19. October 2012 at 05:36

    Saturos, The central bank influences nominal credit, just as they influence all nominal variables. But not real credit.

  28. Gravatar of Andy Harless Andy Harless
    19. October 2012 at 06:30

    Scott,

    I think that is ultimately what the Brazilians are objecting to. The substance of their complaint is “volatile capital inflows…creating threats to financial stability.” If the world were saving less, capital inflows wouldn’t be so volatile: most of the projects in Brazil that attract volatile capital would simply not be funded at all, and the projects that were funded would be ones that are clearly worth doing and therefore would be seen through to completion. Now the Brazilians also complain about the exchange rate, and that complaint is partly nonsense: they have to realize can’t have both stable prices and booming exports, and the choice is theirs. But to the extent that the complaint is about the volatility of the exchange rate, it’s not nonsense: they can’t make the choice between stable prices and booming exports if they can’t forecast the exchange rate. And the volatility of the exchange rate is largely a function of the difficulty in valuing their capital, which in turn results from the low level of world interest rates.

  29. Gravatar of John Thacker John Thacker
    19. October 2012 at 07:01

    MF once again demonstrates that he doesn’t understand what ad hominem is, though that’s typical of Internet trolls. Surely criticizing a central banker’s performance of monetary policy is germane when disregarding that central banker’s monetary policy recommendations and pronouncements?

    Every comment MF posts only seems to increase the probability that he’s a troll designed to convert people to market monetarism, by making the trolls look bad. Still slim, though, because these beliefs are out there.

    Interesting that in Brazil it’s an elected official saying so. In Japan, the central bank is considerably tighter than what the politicians want.

  30. Gravatar of ssumner ssumner
    19. October 2012 at 14:13

    Andy, That may well be their view, as you say. Of course that would confirm my argument that they confuse money and credit, which is why they complain about low saving America and not high saving Germany.

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