How do New Keynesians define the stance of monetary policy?

When I started blogging I kept claiming that the steep recession of 2008-09 was caused by ultra-tight Fed policy.  I had the distinct impression that almost no one agreed with me.  Even some who favored NGDPLT preferred to call the mistakes “errors of omission,” not tight money causing a recession.

Then I found out that Bernanke agreed with me.  No, he didn’t say the Fed caused the recession under his leadership, but he did agree that it is NGDP growth and inflation that matter, not interest rates or the money supply:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman  . . . nominal interest rates are not good indicators of the stance of policy . . .  The real short-term interest rate . . . is also imperfect . . .  Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

At least he felt that way in 2003, maybe not today.  In any case, since mid-2008 the average growth in those two variables has been lower than at any time since Herbert Hoover was President.

Now there is an indication that Michael Woodford agrees with Bernanke.  Not the Bernanke of 2013, who obviously can’t admit that monetary policy has been really tight since 2008, but rather the Bernanke of 2003.  Unfortunately I cannot find a link, but highly reliable commenter “Integral” sent me this report about Woodford’s comments at the recent AEA meeting:

As for Woodford and Gertler, their comments were verbal. An audience member asked how they would gauge the stance of monetary policy, given that one shouldn’t use the money supply or level of the interest rate. Woodford replied with, loosely quoting, “one should look at outcome variables…inflation and nominal GDP.”

So I’m in a quandary.  Commenter “K” claims there is nothing new in my claim that money has been tight.  He says the New Keynesians agree with me.  OK, maybe he is right.  But then someone tell me why during the past 5 years I’ve read approximately zero articles written by New Keynesians talking about tight money causing a recession in 2008-09?  And a zillion articles that monetary policy is highly accommodative.

I suppose one could argue that NKs don’t think the Fed can do anything about the tight money, as we are in a liquidity trap.  But Bernanke doesn’t believe that.  And I recall Brad DeLong asking Bernanke why the Fed didn’t just raise the inflation target to 3%.  That would count as “doing something” in the NK model, wouldn’t it?  So DeLong must not believe the Fed can “do nothing.”

BTW, consider the following:

1.  In his writings on Japan, Bernanke often talked about the problems caused by a shortfall in NGDP.

2.  He seemed to refer to the concept of NGDP more than most elite macroeconomists (at the time.)

3.  People with views on monetary policy that are very close to those of Bernanke have recently converted to NGDPLT.

4.  The Fed explicitly set a 2% inflation target, right before the NGDP bandwagon gained momentum.

5.  The Fed obviously cannot switch targets right after explicitly adopting a 2% inflation target.

Suppose Bernanke were asked:  ”Off the record, would your job over the last 5 years have been easier with an inflation target or an NGDP target?”  What do you think he would say?


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41 Responses to “How do New Keynesians define the stance of monetary policy?”

  1. Gravatar of Morgan Warstler Morgan Warstler
    10. January 2013 at 19:49

    While we’re at at, lets ask Ben, ”Off the record, would your job over the last 5 years have been easier if the public sector suddenly delivered 4-5% YOY productivity gains?”

  2. Gravatar of Saturos Saturos
    10. January 2013 at 19:59

    Good old Morgan! Glad to see you’re back! Now where’s MF…

  3. Gravatar of Saturos Saturos
    10. January 2013 at 20:06

    Oh NOES: http://www.aljazeera.com/news/asia-pacific/2013/01/201311133759477326.html?utm_content=automate&utm_campaign=Trial6&utm_source=NewSocialFlow&utm_term=plustweets&utm_medium=MasterAccount

    The Japanese Cabinet has approved a fresh stimulus package of more than 20 trillion yen ($224 billion), aiming to lift the economy out of recession and create 600,000 new jobs.

    Prime Minister Shinzo Abe announced the decision on Friday at a news conference where he said the new measures were intended to add two percent to Japan’s real economic growth.

    Abe urged the central bank to move more aggressively to encourage lending and meet a clear inflation target to break out of the economic doldrums that have plagued Japan for two decades.

    It also includes plans a request to raise military spending by 100 billion yen ($1.1 billion) from the 4.6 trillion yen ($52.3 billion) budget last year, the first such increase in a decade.

    The increase is partly aimed at beefing up monitoring and defenses around islands in the East China Sea, known as the Senkakus in Japan and the Diaoyu islands in China.

    Also interesting is:

    Japan’s benchmark Nikkei 225 stock index jumped 1.4 percent Friday morning following Abe’s announcement. The Japanese yen, whose strength has hamstrung many exporters, weakened against the U.S. dollar, meanwhile, to 89.06 yen per dollar.

    So this is a sign that the new inflation target wasn’t credible?

  4. Gravatar of Saturos Saturos
    10. January 2013 at 20:07

    Sorry, last bit was me.

  5. Gravatar of Saturos Saturos
    10. January 2013 at 20:10

    In slightly better news: http://www.reuters.com/article/2013/01/11/us-usa-california-marijuana-idUSBRE90A03W20130111

  6. Gravatar of Saturos Saturos
    10. January 2013 at 20:16

    And finally there is this golden post by Matt Yglesias: “Fox News Doesn’t Understand How Coins Work” http://www.slate.com/blogs/moneybox/2013/01/10/fox_news_coin_ignorance.html

  7. Gravatar of Saturos Saturos
    10. January 2013 at 20:32

    Is “Beowulf” the most influential blog-commenter in the world? http://www.wired.com/business/2013/01/trillion-dollar-coin-inventor?cid=5284794

  8. Gravatar of Benjamin Cole Benjamin Cole
    10. January 2013 at 20:36

    Ah, the mystery that is Bernanke.

    What a great book there is to be written: the biography of Bernanke’s Fed years.

    Was it Vincent Reinhart who pulled Bernanke off course?

    Did Bernanke believe he had to govern by consensus–and he had nutballs like Richard Fisher to accommodate?

    Did Bernanke fear Tex Governor Perry’s promise to execute him, if Perry became the US President?

    Did Bernanke become steeped in Fed self-glorification, and buy into its self-exalted if ossified role as a brave and stalwart champion against the forces of weakness, depravity and inflation?

    Or, will any independent central bank define its role as “keeping inflation low”— obviously, a very doable goal—so that the central bank can fend off any criticism, and remain independent, and provide safe sinecure for its inhabitants?

    Why do we expect people in the economy to be “rational actors” but then never ask what would central bank staffers on fixed salaries recommend as a monetary policy?

    Wouldn’t central bank staffers–in safe sinecures—love deflation? Why do they not act in their self-interest?

    Interesting questions….

  9. Gravatar of Al Al
    10. January 2013 at 21:43

    This argument is little more than a language problem. The “errors of omission” argument is the same as overly tight monetary policy is the same as the refusal to employ “non-conventional” monetary policy is the same as the liquidity trap ineffectualness of “conventional” monetary policy.

  10. Gravatar of K K
    10. January 2013 at 21:57

    “I suppose one could argue that NKs don’t think the Fed can do anything about the tight money, as we are in a liquidity trap.”

    For the most part, that’s the answer. Forward guidance is of speculative efficacy due to questionable Fed commitment but also due to liquidity constrained agents for whom discount rates are very high.

    “But Bernanke doesn’t believe that. ”

    You truly can’t know that. Can you imagine the effect of Bernanke coming out and saying “we are out of tools”??? They would take him out back and shoot him. And rightfully so. He clearly has to proclaim confidence in the Fed’s measures.

    “That would count as “doing something” in the NK model, wouldn’t it?”

    It would change the *rule* for setting the policy rate. This modifies future short rate policy (what NKs call forward guidance) which can raise current inflation expectations, thereby lowering the current real rate thereby stimulating demand. But the caveats about the uncertain efficacy of forward guidance still apply.

    “tell me why during the past 5 years I’ve read approximately zero articles written by New Keynesians talking about tight money causing a recession in 2008-09?”

    Because the was a *financial crisis* which did huge damage. Here’s a NK consistent explanation:

    A severe shock to financial intermediaries drives down the natural rate from 2% to -5% (this is a structural problem). The Fed madly cuts the short rate, but Bam! hits the ZLB. Inflation drops to -2% so the real rate is now 2%, i.e. 7% above the natural rate. Recession. And you want to say the Fed did it?

    So yes monetary policy is “too tight”. But looking at that story I see a lot going on that is *not* monetary policy, and the amount that monetary policy (forward guidance) *might* be able to do is anything but certain. So to say that tight monetary policy caused the recession in this story is just plain weird.

  11. Gravatar of Mike Sax Mike Sax
    10. January 2013 at 22:36

    Ok, now it’s not printing my comments

  12. Gravatar of Mike Sax Mike Sax
    10. January 2013 at 22:54

    So my comment didn’t go through but my comment complaining that my comment did’t go through-did go through.

    Ok…

  13. Gravatar of Benjamin Cole Benjamin Cole
    11. January 2013 at 01:15

    Mike Sax-

    I once wrote a comment worthy of a Nobel Prize, but it got lost, and then I could not summon up that perfect pitch again.

    Life is tough and then you die.

  14. Gravatar of Merijn Knibbe Merijn Knibbe
    11. January 2013 at 03:08

    The zero lower bound squad, led by PK, would love to lower the interest rate to -5%, or something like that. Which of course implicates that they consider 0% to be ‘tight’. By the way – as inflation as well as the interest rate was a quite bit higher than in the EU/USA, Turkey did have the possibility to lower the interest rate in a dramatic fashion. And it did. With consequences consistent with the predictions of the zlb squad. Plus 3 million jobs, since 2008 (on a total of 21 million in 2008). Eurozonia: -3 million (on a total of 221 million)… Source: Eurostat.

  15. Gravatar of RebelEconomist RebelEconomist
    11. January 2013 at 03:43

    “The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it.”

    The indicator was widening TED spreads, as plenty of markets people were telling the Fed at the time. Where the Fed failed during the crisis – and I freely admit that I would have probably failed myself in their shoes – was in stepping in fast enough to act as the central moneymarket counterparty. Things like paying interest on excess reserves. Central banks needed to ditch their traditional disdain for private sector banks, clear what to do with government, and get on with it, because it was the whole system not one or two reckless banks that was at risk. They did not quite work it all out fast enough, hence Lehman, but it could have been a lot worse.

  16. Gravatar of ssumner ssumner
    11. January 2013 at 05:41

    Morgan, He’d scratch his head.

    Saturos–We think alike! I just posted on that story.

    Beowolf will be the most influential if they actually do the coin–but I’m still skeptical. It would actually help the GOP–so why would Obama want to?

    Al, Not entirely, Interest rates were positive during the entire NGDP collapse of 2008. There’s more to this than the zero bound. When the Fed refused to cut it’s target fed funds rate from 2.0% during the post-Lehman meeting in September 2008, there was almost no criticism from economists. What do you say about that?

    K, You said;

    “You truly can’t know that. Can you imagine the effect of Bernanke coming out and saying “we are out of tools”??? They would take him out back and shoot him. And rightfully so. He clearly has to proclaim confidence in the Fed’s measures.”

    Why would he have lied when he was an academic, back in late 1990s and early 2000s? He was not reluctant to criticize the BOJ.

    You said;

    “But the caveats about the uncertain efficacy of forward guidance still apply.”

    No fiat money central bank has ever tried to inflate and fail. Yes, there’s a first time for everything, but surely that shouldn’t be our baseline assumption.

    You said;

    “The Fed madly cuts the short rate”

    No it didn’t, see my response to Al. if they were actually concerned that NGDP would fall faster than they wanted, why not cut rates much faster? Why not target the forecast, as Svensson advocates?

    If you are right in your “weird” comment, why isn’t it equally weird to say tight money caused the Great Depression, a view now accepted by mainstream economists like Ben Bernanke? Didn’t the Fed do QE in the early 1930s? Didn’t they slash rates close to zero? Is Bernanke also a “weirdo?”

    Merijn, Yes, good point. The comparison between Turkey and Greece is especially interesting. They compete for the travel dollars for northern Europeans. I wonder why Turkey is more competitive?

    Rebeleconomist, Interesting that the Fed was created primarily to eliminate banking crises, and the worst two in US history occurred after they were created (1933 and 2008).

  17. Gravatar of K K
    11. January 2013 at 06:28

    Scott,

    “No fiat money central bank has ever tried to inflate and fail.”

    I think you know the response to this, because I’ve said it before: It’s the *liquidity trap*. How many fiat money central banks have tried to inflate their way out of a liquidity trap? See my point in the previous comment about how raising the inflation target is equivalent to changing forward rate guidance (the policy *rule*) but that such policy suffers from both credibility problems and, in the current environment, liquidity constraints on consumers due to balance sheet problems (see Eggertsson/Krugman 2010).

    “if they were actually concerned that NGDP would fall faster than they wanted, why not cut rates much faster?”

    I agree. They should have cut rates 6-12 months earlier. But hindsight is 20/20. “Experts” were certainly divided about how serious things were right up until the Lehman default. But once we were there it was way too late. Anc anyways, keeping NGDP on track for longer would only have allowed leverage to build up even more, amplifying the eventual bang. When the crash occurred, bank funding costs varied from 500 bps higher for the best banks to impossible for most. So forward guidance? Forget it. The liquidity trap was *way* too deep. The only ways out were: 1) rescue the banks or 2) let them default and let FDIC run them for awhile. Unfortunately, like Japan, they made the wrong choice.

    “why isn’t it equally weird to say tight money caused the Great Depression, a view now accepted by mainstream economists like Ben Bernanke? Didn’t the Fed do QE in the early 1930s? Didn’t they slash rates close to zero?”

    Because a gold standard really *is* super tight money. Maintaining the peg requires a *much* higher yield curve, ZIRP and QE be damned. A credible gold standard is the ultimate forward rate guidance commitment device. I’m not a depression expert and I don’t have data that far back but I’d bet that once they unpegged the dollar the yield curve collapsed, which is the NK definition of *looser* (note that I didn’t say “loose”).

  18. Gravatar of Britmouse Britmouse
    11. January 2013 at 06:43

    In answer to the title of this post, when NKs look at inflation forecast-targeting central banks shouldn’t they follow the Svensson methodology and use the deviation of expected inflation from target inflation as the “stance” (forward-looking) of monetary policy?

  19. Gravatar of Britmouse Britmouse
    11. January 2013 at 06:47

    K: if you don’t believe CBs can create inflation at the ZLB I’ve got some CPI data to sell you.

    Wouldn’t you say both the Riksbank and the Bank of Canada successfully inflated their way off the ZLB?

  20. Gravatar of K K
    11. January 2013 at 07:11

    Britmouse,

    “if you don’t believe CBs can create inflation at the ZLB”

    I definitely didn’t say that. I said that forward rate guidance (used by the Riksbank and to some extent, the BoC) is *less* effective than spot rate policy. How much less depends on institutional arrangements (some CBs are more credible than others: the Bank of Canada is a dictatorship which makes it way more credible than the Fed) and also *very* relevantly, the depth of the liquidity trap.

    “Wouldn’t you say both the Riksbank and the Bank of Canada successfully inflated their way off the ZLB?”

    Small countries with big international trade sectors and flexible exchange rates (e.g. Sweden) have big gains from “Svenssonian” devaluation. And credibility is surely helped by having the actual “Svensson” in the central bank. And Canada had nothing like the shock experienced by the US and barely touched the ZLB. Canada didn’t even *have* a downward inflation shock and they certainly didn’t inflate their way out of the crisis.

    I will say that if the liquidity trap is deep enough and consumers are liquidity constrained then there is not much the CB can do to create inflation (barring, possibly large purchases of real assets).

  21. Gravatar of Floccina Floccina
    11. January 2013 at 09:44

    Well Bernanke must be doing (or not doing) what he is doing for some reason, so is he afraid of a tipping point on inflation?

  22. Gravatar of Kevin Dick Kevin Dick
    11. January 2013 at 09:49

    @Floccina. Or the reason could be primate politics pure and simple.

  23. Gravatar of Federico Federico
    11. January 2013 at 09:51

    Hi Scott, I was actually that audience member. My question was roughly how one should go about thinking whether MP is too tight or easy given current conditions and the wide variety of policy tools, and whether one could even take about the stance of monetary policy as a whole since there were all these different tools or if one can still look at macro variables like nominal spending and inflation. Unfortunately only Woodford responded (and it was pretty clear what his views were). He basically said that one should think about the stance of monetary policy in terms of outcomes and not in terms of interest rates, and that he thought NGDP would be a great candidate for an outcome variable. He also stressed that the Fed should clearly communicate the economic outcome target for the outcome to the public, and then use whatever policy tool they see fit until they hit that outcome. Note that at no moment did he specifically mention targeting expectations, but he did stress the need for clear communication. At some point (I think as part of another question) he talked about the difficulties of the CB credibly committing to any policy.

  24. Gravatar of TallDave TallDave
    11. January 2013 at 10:38

    Suppose Bernanke were asked: ”Off the record, would your job over the last 5 years have been easier with an inflation target or an NGDP target?” What do you think he would say?

    I tried this, the answer was “Get out of my bedroom! I’m calling the police!”

    Seriously, great question. I hope he asks himself that one more often.

  25. Gravatar of Steve Roth Steve Roth
    11. January 2013 at 11:17

    @K: “How many fiat money central banks have tried to inflate their way out of a liquidity trap?”

    I’d really like to hear an answer to that!

    Has BOJ not “tried”?

  26. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. January 2013 at 11:47

    You’re new here, Steve?

  27. Gravatar of Steve Roth Steve Roth
    11. January 2013 at 11:54

    @Patrick: No, I visit now and then but don’t have all the arguments internalized.

    The [Delong channeled by Sumner] “why doesn’t the Fed announce a 3% inflation target?” challenge strikes me as a strong argument, and also a damn good recommendation. (Given the absence of NGDP[L]T.) Demand Inflation Now! But I’m not fully convinced it would work, that people would be convinced that Bernanke’s successor would our could (practically or politically) carry it out.

    So, truly curious: looking for K to answer his own question.

  28. Gravatar of K K
    11. January 2013 at 12:18

    Steve,

    “looking for K to answer his own question.”

    Alright. First let me channel Scott: “They never tried because they didn’t *want* inflation. *If* they had wanted it, they would have gotten it because no fiat money central bank ever…”

    Whether they failed to try may or may not be true. Either way, it can’t support Scott’s case that you can always inflate. Personally I suspect that to the extent they appear not to have appeared very committal on generating inflation it is because 1) credibility means everything to central bankers (it’s job security for VSPs) and 2) they strongly suspected that they couldn’t inflate and therefore never made any commitment to try since failure is bad for credibility. Which always reminds me of the King in the Little Prince “commanding” the sun and the moon to rise and set at the usual hours.

  29. Gravatar of flow5 flow5
    11. January 2013 at 12:27

    “The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it”

    Nothing has an r2 to compare with roc’s in bank debits relative to gDp. Money X velocity (money actually exchanging hands) serves as a proxy for roc’s in all transactions, i.e., correlates to roc’s in nominal-gDp.

    Economic prognostications are for all practical purposes – infallible.

    SEE: Member Bank Reserve Requirements — Analysis of Committee Proposal, February 27, 1938 – declassified March 23, 1983 — “the committee proposed that reserve requirements be based upon the turnover of deposits”

    Bank debits reflect both new & existing residential & commercial real-estate sales/purchases. As such the housing boom/bust would have stuck out like a sore thumb (more so than the metric I used in Dec 2007).

    POSTED: Dec 13 2007 06:55 PM |

    10/1/2008,,,,,,, -0.20* possible recession
    11/1/2008,,,,,,, -0.10 * possible recession
    12/1/2008,,,,,,, 0.10 * possible recession

    The recession/depression was the direct result of Bernanke pursuing a contractionary monetary policy.

  30. Gravatar of flow5 flow5
    11. January 2013 at 12:30

    Using interest rates as the monetary transmission mechanism is impossible. That what the Treas. – Fed. Res. Accord of Mar. 1951 was all about (the assumption that the money supply can be managed through interest rates).

    Net changes in Reserve Bank credit (since the Accord) are determined by the policy actions of the Federal Reserve. But William McChesney Martin, Jr. changed from using a “net free” or borrowed reserve approach to the Fed Funds “Bracket Racket” c. 1965.

    As of Oct 9, 2008 the payment of interest on excess reserve balances has forced the Fed to abdicate its “open market power”.

    As we’ve already witnessed, the effect of these operations on interest rates (now via the remuneration or deposit rate), is indirect, varies widely over time, & in magnitude. What the net expansion of money will be, as a consequence of a given injection of additional reserves, nobody knows until long after the fact. The consequence is a delayed, remote, & approximate control over the lending & money-creating capacity of the banking system.

    Yellen says: the “Fed will vary interest on reserves (deposit rate) when tightening policy. But LSAPs & Operation Twists flattened & artificially depressed the back-end of the yield curve. Yields on longer-dated securities are spring loaded if loan demand picks up & inflation expectations rise. The FOMC will have to raise the remuneration rate (i.e., invert the short-end segment of the yield curve), faster than the CB’s net interest margins expand.

    Countervailing tightening will constrain short-term wholesale borrowing & lending vis a vis the deposit rate. And that spells stagflation (business stagnation accompanied by inflation). As Tyler Durden noted: “the collapse in shadow banking has been somewhat offset by increasing liabilities at traditional banks”. Or, it will continue to take increasing infusions of Reserve Bank credit to generate the same inflation-adjusted dollar amounts of n-gDp.

  31. Gravatar of Chuck E Chuck E
    11. January 2013 at 13:08

    Flow 5,

    Where does risk play a part in these Fed/Banking system waltzes? It seems to me that member banks take their IOR payments and then lend only to the top 20% of their customers, and make a decent return. This has the effect of throttling liquidity for the other %80 of their customers.

  32. Gravatar of flow5 flow5
    11. January 2013 at 13:31

    They issue different cards for the high rollers? I don’t know, but given a higher ROE (from higher n-gDp/higher & firmer rates), &/or inflation expecations, they will expand credit. Money creation is not self-regulatory – it feeds upon itself.

  33. Gravatar of Mike Sax Mike Sax
    11. January 2013 at 13:40

    benjamin same to you. I wasn’t saying it was a nobel prize just don’t get why I kept trying to post an innocent comment and getting squahsed. Isn’t this what everyone claims happens at Delong’s?

  34. Gravatar of Mike Sax Mike Sax
    11. January 2013 at 13:41

    I’ll try one more time-third on same comment. I find that the more Bob Murphy warns about you Scott, the more positively disposed towards you I feel.

    http://diaryofarepublicanhater.blogspot.com/2013/01/bob-murphy-gives-me-4-reasons-to-like.html

  35. Gravatar of Mike Sax Mike Sax
    11. January 2013 at 13:42

    Eureka!

  36. Gravatar of ssumner ssumner
    12. January 2013 at 08:19

    K, You said;

    ““Experts” were certainly divided about how serious things were right up until the Lehman default. But once we were there it was way too late.”

    Then why didn’t then cut rates in the meeting after Lehman failed? Rates weren’t cut to zero until mid-december 2008, by which time the great NGDP crash was mostly over (using monthly estiamtes of NGDP from “Macroeconomic Advisers”

    You said;

    “Anc anyways, keeping NGDP on track for longer would only have allowed leverage to build up even more, amplifying the eventual bang.”

    Now you are talking like an Austrian. I favor 5% NGDP growth forever. level targeting. No “eventual bang.” In any case the great housing construction crash was mostly over by April 2008, when unemployment was 4.9%. So sectors can easily adjust to excesses without NGDP having to crash.

    You said;

    “I’m not a depression expert and I don’t have data that far back but I’d bet that once they unpegged the dollar the yield curve collapsed, which is the NK definition of *looser* (note that I didn’t say “loose”).”

    You’d lose that bet. Indeed when monetary stimulus was at its most aggressive (a brief period in November 1933) long rates on Treasuries were actually rising (as market monetarists predict.) I would add that there are plenty of modern examples of tighter than expected policy annoucements lowering long rates and vice versa. God help the NKs if they really believe what you claim they believe.

    Britmouse, Yes they should.

    Steve Roth, Pay no attention to K, he doesn’t know what he’s talking about, and is in way over his head.

    K, Next time you try to “Channel” me you might actually first check and find out what I believe. The BOJ has tightened policy on several occasions when there was no inflation. That’s consistent with a central bank that doesn’t want inflation. Krugman once tried to explain away my observation and Ryan Avent at the Economist basically mocked his explanation, it was so pathetic. Avent said his explanation basically proved my point. No one who understands Japan can seriously argue that the BOJ has been trying to inflate and failing. It’s absurd.

  37. Gravatar of K K
    12. January 2013 at 09:58

    Scott,

    “Then why didn’t then cut rates in the meeting after Lehman failed?”

    It was the day after. They cut by 50 bps three weeks later and by another 50 three weeks after that. As I said, they could definitely have cut faster but if the natural rate was -5% or -10% I don’t see how it could have made a difference if they had made the transition from 2% to 0% a couple of months earlier. The required intervention was an order of magnitude bigger.

    “In any case the great housing construction crash was mostly over by April 2008, when unemployment was 4.9%. So sectors can easily adjust to excesses without NGDP having to crash.”

    Housing had nothing to do with the immediate problem which was a financial intermediary balance sheet problem. Lending was for all intents and purposes finished, no capital available. Primary bond and equity markets were completely closed. *That* is a monster problem, vastly greater than a few percent in the policy rate. Essentially borrowing rates were infinite for a broad range of borrowers including a lot of banks.

    “You’d lose that bet.”

    Alright. I’ll have a look, report back later.

    “I would add that there are plenty of modern examples of tighter than expected policy annoucements lowering long rates and vice versa.”

    Yes. Tighening tends to raise the front end and lower the back end. It’s a necessary consequence of long term inflation stability. When I refer to collapse of the yield curve it would be out to a certain point (e.g. 5 or 10 years) and then a perhaps a rise later (unless the asymptotic expected inflation rate changes). The front end is economically *way* more important than the back because consumers and businesses almost all borrow shorter than five years.

    “God help the NKs if they really believe what you claim they believe.”

    “Pay no attention to K, he doesn’t know what he’s talking about, and is in way over his head.”

    OK. I apologize for “channeling” you. It was impolite. But *that* is ridiculous.

    “No one who understands Japan can seriously argue that the BOJ has been trying to inflate and failing. It’s absurd.”

    Well it’s a good thing I didn’t say that, then! If you read what I wrote, I said it was entirely likely that they *didn’t* try to create inflation, the reason (possibly among others) being that they were afraid of failing in a public manner. But whether they tried or not that doesn’t changed the fact that the evidence on fiat money central banks generating inflation in a liquidity trap is *very thin*. And the non-liquidity trap data is not relevant because it’s not a topic of dispute. That was my point all along. That doesn’t prove you are wrong, but it certainly doesn’t prove that you are right.

  38. Gravatar of K K
    12. January 2013 at 10:46

    Ok, not “ridiculous”. It seems harsh, though. But I do apologize.

  39. Gravatar of flow5 flow5
    12. January 2013 at 14:15

    Rates aren’t too low (policy too easy). Economists “can’t see the forest thru the trees”. If eliminating Reg. Q ceilings caused stagflation (& it did), then the payment of interest on excess reserve balances will inevitably bring on a depression. Go easy.

    E.g., in the early sixties, the bankers at Citibank invented the negotiable CD. It proved highly successful – at least from the standpoint of Citibank. The cost of acquiring funds was less than the net returns on the additional earnings assets Citibank was able to acquire. But Citibank’s profits were at the expense of other banks, since all the funds that Citibank acquired by this method came from other commercial banks within the same Federal Reserve System. As so held, unused savings are lost to investment (e.g., denied to the non-banks), or as unspent savings (are lost to consumption).

    Savings are impounded (bottled up) within the CB system. From the standpoint of the system, CBs don’t loan out savings, they create new money when they lend & invest. CB held savings are a leakage in Keynesian National Income Accounting & the IS=LM equation doesn’t balance.

    Savings flowing “thru” the non-banks never leaves the commercial banking system in the first place. CBs are credit creators (where lending is inflationary). Non-banks are credit transmitters (where lending is non-inflationary, in fact, deflationary if unused).

    CB lending expands the volume of money & directly affects its velocity, whereas non-bank lending directly affects only the velocity of deposits.

    The lending capacity of the CBs is determined by monetary policy, not the savings practices of the public.

    The lending capacity of non-banks (financial intermediaries) is almost exclusively dependent on the volume of voluntary savings placed at their disposal. The CBs, on the other hand, could continue to lend if the public should ceased to save altogether.

    Non-banks lend existing money which has been saved, & all of these savings originate outside the non-banks; whereas the CBs lend no existing deposits or savings: they always, create new money in the lending & investing process.

    Savings held within & used by the non-banks (but subsequently transferred back to the CBs balance sheets by their owners), induces dis-intermediation (where the size of the non-banks shrink, but the size of the CB system remains the same). Such has been the case during our Great-Recession (see BOG’s Z.1 flow of funds statistical release). However, the last period of dis-intermediation for the CBs occurred during the Great Depression (the CBs have been backstopped since 1933).

    The non-banks (e.g., shadow banks), are intermediaries (between savers & borrowers) – where savings equals investment (constructively in real-investment & not with financial-investment).

    The welfare of the CBs (& the U.S. economy), is dependent upon savings flowing thru the non-banks (the CB’s customers). The greater the proportion of non-bank earning assets to CB earning assets – the healthier our economic future will be.

    Financing real-investment or government deficits by the Reserve banks (debt monetization), & commercial banks (money creation), doesn’t constitute a utilization of savings.

  40. Gravatar of ssumner ssumner
    13. January 2013 at 08:44

    K, Yes, they cut rates three weeks later. But people need to think about what this means. The Fed wasn’t out of ammo when NGDP collapsed. They were doing what they regarded as “optimal monetary policy,” which they seem to think included the biggest crash in NGDP since the 1930s. Some alternative policies would not have been effective, I agree. Others (such as NGDPLT) would have been highly effective. The markets crashed because they correctly understood there’d be no level targeting, the Fed wasn’t going to aggressive try to get back to the old trend line. RGDP soared in the period after March 1933, when much of the US banking system was completely shutdown.

    You said;

    “Housing had nothing to do with the immediate problem which was a financial intermediary balance sheet problem.”

    If you keep moving the goalposts everytime I swat down your arguments, we won’t get anywhere. Are you making the Austrian argument, or not?

    As far as money announcements, I’ve seen cases where the “back end” was as short as 3 months.

    Here’s my take on the liquidity trap:

    1. No real world cases of central banks trying to inflate and failing.

    2. Markets responding to even very modest initiatives at the zero bound as if they are somewhat effective. So why not do much more? Why not adopt NGDPLT?

    3. Lots of theoretical papers by elite macroeconomists showing how to stimuluate at the zero bound.

    Theory, evidence, and markets all support, and the other side has? It seems they have a sloppy and false reading of what happened in Japan, and nothing more.

    I’d add that it’s even worse. My critics will say the Japanese yen depreciation option doesn’t count, because it would be at the expense of the rest of the world. That’s false, but let’s say it was true. The very same critics later use Japan as an example of a liquidity trap, even though they’ve just conceded it wasn’t–small countries can always debase their currencies. So where is the evidence?

  41. Gravatar of flow5 flow5
    13. January 2013 at 12:23

    “was caused by ultra-tight Fed policy”

    You shouldn’t “sugar coat it”. Monetary policy was by definition contractionary. I.e., it was un-intentionally crafted to force an absolute reduction or decline in both nominal & real gDp. You should have made time to look at the numbers.

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