Does John Taylor want easier money or tighter money?

Here’s John Taylor in today’s Wall Street Journal:

As they meet this week, Federal Reserve Chairman Ben Bernanke and his colleagues will be looking at an economic recovery that has been far weaker than expected. Early in 2010 they predicted that growth in 2012 would be a robust 4%. It turned out to be a disappointing 2%. And as the recovery fell short of their expectations, they continued and then doubled down on the emergency interventions used in the panic in 2008.

The Fed ratcheted up purchases of mortgage-backed and U.S. Treasury securities, and now they say more large-scale purchases are coming. They kept extending the near-zero federal funds rate and now say that rate will remain in place for at least several more years. And yet—unlike its actions taken during the panic—the Fed’s policies have been accompanied by disappointing outcomes. While the Fed points to external causes, it ignores the possibility that its own policy has been a factor.

At the very least, the policy creates a great deal of uncertainty. People recognize that the Fed will eventually have to reverse course. When the economy begins to heat up, the Fed will have to sell the assets it has been purchasing to prevent inflation.

If its asset sales are too slow, the bank reserves used to finance the original asset purchases pour out of the banks and into the economy. But if the asset sales are too fast or abrupt, they will drive bond prices down and interest rates up too much, causing a recession. Those who say that there is no problem with the Fed’s interest rate and asset purchases because inflation has not increased so far ignore such downsides.

The Fed’s current zero interest-rate policy also creates incentives for otherwise risk-averse investors—retirees, pension funds—to take on questionable investments as they search for higher yields in an attempt to bolster their minuscule interest income.

Clearly John Taylor doesn’t like ultra-low interest rates right now.  But low interest rates are not a monetary policy.  Near-zero interest rates can occur during deflationary monetary policies (Japan), or during monetary stimulus.  Everyone from Milton Friedman to Frederic Mishkin to Ben Bernanke tell us that interest rates are not reliable indicators of the stance of monetary policy.  So that doesn’t tell us whether Taylor wants easier or tighter money.

Taylor seems to think that growth has been too slow, complaining about only 2% RGDP growth in 2012.  That suggests that easier money is needed. But he also complains about QE, claiming it didn’t help the recovery. However the stock market responded very positively to rumors of QE, not once but three times.  That suggests QE boosts growth.

Here’s Taylor again, suggesting money is currently easy:

There is yet another downside. Foreign central banks—whether they like it or not—tend to follow other central banks’ easy-money policies to prevent their currency from appreciating sharply, which would put their exporters at a disadvantage. The recent effort of the new Japanese government to force quantitative easing on the Bank of Japan and thus resist dollar depreciation against the yen vividly makes this point. This global increase in money risks commodity booms and busts as we saw in 2011 and 2012.

Obviously Japan desperately needs easier money, its NGDP is lower than 20 years ago.  I presume Taylor would agree that deflation isn’t a very wise policy.  So it’s a good thing if Fed actions force the BOJ to ease. And of course the world desperately needs an economic recovery, which would obviously boost commodity prices.  So I’m not sure why that’s a concern.

Like John Taylor, I’d like to see higher interest rates.  Unlike Taylor, I explicitly favor a more expansionary monetary policy.  I favor a higher NGDP target, which would raise long term Treasury bond yields.  He seems to favor higher interest rates via a tighter monetary policy boosting short rates (the liquidity effect.)  In my view that policy would depress long term bond yields to Japanese levels, as markets (correctly) expected a replay of the US in 1937, or Japan in 2000, or Japan in 2006, or the eurozone in 2011—4 attempts to raise short rates above zero—all premature, all 4 attempts failed.  They all drove aggregate demand and risk free long term interest rates even lower.

John Taylor says he wants higher interest rates for savers.  But only market monetarist policies can deliver higher interest rates to savers. There’s no short cut to recovery—we need faster NGDP growth.

NGDP has averaged just over 4% in recent years.  Suppose we had a tighter monetary policy and reduced NGDP growth to 2%.  What sort of RGDP growth would you expect?  I’d expect about 1%.

HT:  Michael Darda.


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126 Responses to “Does John Taylor want easier money or tighter money?”

  1. Gravatar of marcus nunes marcus nunes
    29. January 2013 at 08:06

    Scott
    Quite independently, it seems Taylor has the knack to “irritate” us:
    http://thefaintofheart.wordpress.com/2013/01/29/taylors-uncertainty-principle/

  2. Gravatar of Taylor´s “uncertainty principle” | Historinhas Taylor´s “uncertainty principle” | Historinhas
    29. January 2013 at 08:20

    [...] Scott Sumner has a post on Taylor Rate this:Share this:RedditEmailTwitterLike this:LikeBe the first to like this. This [...]

  3. Gravatar of Gregor Bush Gregor Bush
    29. January 2013 at 08:20

    “This global increase in money risks commodity booms and busts as we saw in 2011 and 2012.”

    This is a very common view on Wall St. It goes like this: QE (or “easy money” generally)results in “money going into” commodities and pushing thier prices higher. But because QE obviously (to Taylor) has no impact on “the real economy” prices eventually reverse lower when people realize that demand top take delivery of the physical commodities will disappoint.

    Apparently Taylor, and those who agree with him, thinks commodity markets are massively inefficient. I can only assume that Taylor has made a fortune trading commodities over the last couple of years.

  4. Gravatar of Geoff Geoff
    29. January 2013 at 08:21

    Seems John Taylor isn’t your run of the mill inflation dogmatist, and accepts at least the possibility that Fed attempts to help the economy may themselves have counter-productive effects and thus less than purely beneficial effects.

    Dr. Sumner:

    “Taylor seems to think that growth has been too slow, complaining about only 2% RGDP growth in 2012. That suggests that easier money is needed. But he also complains about QE, claiming it didn’t help the recovery. However the stock market responded very positively to rumors of QE, not once but three times. That suggests QE boosts growth.”

    Hmmm, I think that the “positive” stock market reactions to inflation announcements are not suggesting QE boosts growth, but rather that QE boosts nominal statistics such as prices, inflation, and spending. Stock prices are thus are not a reliable indicator of growth. The same argument for not reasoning from interest rates, also applies to stock prices. Zimbabwe stocks skyrocketing doesn’t mean growth or expected growth is skyrocketing. Investors just reprice stocks given the new monetary conditions.

    “Obviously Japan desperately needs easier money, its NGDP is lower than 20 years ago. I presume Taylor would agree that deflation isn’t a very wise policy. So it’s a good thing if Fed actions force the BOJ to ease. And of course the world desperately needs an economic recovery, which would obviously boost commodity prices. So I’m not sure why that’s a concern.”

    I think the concern is that even with stable NGDP, asset bubbles can be fueled by inflation if the rate of money growth substantially exceeds the rate of money growth that would have otherwise occurred in a for-profit competitive money market.

    One can’t see this possibility if one is dead set on NGDP as the sole indicator. It is a great error to reason from price level changes, and the associated concepts such as price inflation and NGDP, when considering asset bubbles. Asset bubbles aren’t fueled by excessive NGDP. They are fueled by excessive credit issuance that is greater than what is saved out of income and made available for investment, regardless of NGDP.

    The concept of asset bubbles is sector specific, and implies asset prices rising too fast relative to other prices, and so even with stable price levels and NGDP, they could arise. I think that’s what Taylor is getting at.

    “NGDP has averaged just over 4% in recent years. Suppose we had a tighter monetary policy and reduced NGDP growth to 2%. What sort of RGDP growth would you expect? I’d expect about 1%.”

    Me too. But unlike you, I wouldn’t conclude that ANY and ALL growth, as measured by aggregate output, is inherently good growth. For example, a farmer can increase his cow meat output, in the short run, by mistakenly allowing his cows to over-graze the field. His output really could go up, but I would not say it is “good” growth, because it is physically unsustainable and he’s going to experience losses in the future.

    Similarly, a logging company could very well increase its output by clear cutting a forest without replanting, instead of cutting only some trees and replanting like it usually does. If it mistakenly cuts down too many trees, then it would experience losses in the future. But in the short run, output really did go up.

    I am sure many more examples of this type can be imagined, where higher “output” in general may not be optimal, because it is coming at the expense of capital consumption, which lowers future real growth.

    You may not agree with this, but it is entirely possible that the US economy has become increasingly over-extended over the last few decades, as the gigantic world economy has been fundamentally altered in large part by the world’s central banks, which has encouraged capital consumption in the US and reduced real output in the future, which is now the present. Maybe we are experiencing low real growth not because of insufficient paper notes circulating, but because of farmers overgrazing the fields, and loggers cutting too many trees, and so on.

    We experienced a huge debt financed consumption binge, in which a large part of the “growth” was simply a result of US banks expanding large quantities of credit (which didn’t show up in “excessive NGDP”), which was used to purchase consumer goods from countries like China. Maybe there just isn’t sufficient real capital to generate the kind of 3%, 4% real growth that you believe can be brought about by a more rapid issuance of paper notes.

    Perhaps you are being somewhat misled about the efficacy of inflation, because of too little an emphasis on the structural side of things?

    It’s one thing to say that a 5% collapse in NGDP hurts growth, it’s another to say that 5% NGDPLT growth always ensures 3, 4, 5% real growth.

    How will more pieces of paper help a logging company that has no more trees to cut on their land? More money may very well just increase their costs of doing business, hurting them more.

    I think Taylor, rather than being targeted for criticisms because he dares question the efficacy of higher inflation, should be taken more seriously, and we should all have more open minds as to whether or not our current low growth really is only a function of insufficient inflation.

  5. Gravatar of marcus nunes marcus nunes
    29. January 2013 at 08:27

    Geoff
    900 word comment! You´re Major_Freedom incarnate!
    Since he has been conspicuously absent…

  6. Gravatar of Luis Luis
    29. January 2013 at 08:34

    But The problem IS that saving & hoarding liquidity have been quite high until now! -in spite of ultra low interest rates… John Taylor has a curious form of argumenting.

    See graphs about it in

    http://www.miguelnavascues.com/2013/01/deuda-ahorro-gasto.html?m=0

  7. Gravatar of Tom Brown Tom Brown
    29. January 2013 at 08:35

    Scott, I’m an infrequent visitor to your site, so I apologize if you’ve covered this before, but regarding this sentence:

    “Like John Taylor, I’d like to see higher interest rates. Unlike Taylor, I explicitly favor a more expansionary monetary policy. I favor a higher NGDP target, which would raise long term Treasury bond yields. ”

    Exactly how is a “more expansionary monetary policy” accomplished in your view? What are the specific steps and who takes them?

  8. Gravatar of Geoff Geoff
    29. January 2013 at 08:43

    Gregor Bush:

    “Apparently Taylor, and those who agree with him, thinks commodity markets are massively inefficient. I can only assume that Taylor has made a fortune trading commodities over the last couple of years.”

    Gregor, Taylor’s position does not require any assumption that the market is even the least bit “inefficient”. Market efficiency doesn’t mean that people can discern within prices that which is caused by changes in relative demand, and that which is caused by inflation. There is only one set of prices, and it is very misleading to call these prices “market” prices. True market prices would be a function of not only a competitive market in real goods, but a competitive market in money as well. One can’t possibly interpret an economy with a centralized monopoly in money, a “laissez faire market”.

    People who work in a division of labor require, obviously, market signals in order to “efficiently” allocate and price goods relative to each other. But these signals are subsumed, into the prevailing prices that are a function of both market forces and central bank activity.

    Market efficiency requires, obviously, a market. If there isn’t a market in X, then to the extent that X is related to everything else, then everything else that is affected by X would also be less of a market to that extent.

    I notice that those partial to inflation tend to be the most vocal in propounding “market efficiency” arguments, and my suspicion is that perfect market absorption of inflation is required in order to defend inflation against charges of counter-productive effects, which Taylor alluded to.

    Imagine a blood sucking vampire. It would make sense that this vampire would be the most vocal about insisting that the human body is a very efficient machine in being able to regenerate lost blood, don’t you think?

    Now, I am not of course comparing inflation to vampirism, I am simply using the vampire as an example to show how there can exist a very strong incentive to perhaps exaggerate the strength of that which the person depends on for sustenance, when its own activity MAY be counter-productive and MAY weaken it.

    Markets being unable to perfectly absorb inflation, and perfectly communicate through prices that part of prices which is market force generated, and that part of prices which is central bank generated, doesn’t mean that this provides opportunities for investors to exploit them. For these prices are, of course, in part a function of other investor expectations, and those other investors also cannot perfectly discern which part of prices is market generated and which part is central bank generated. Every investor is in the same boat of having to deal with the same set of prices, which may deviate significantly from the market force component when there are significant OMOs.

    Just ask yourself, do you know when looking at the price of say copper, which part of the price changes are the result of relative market force demands, and which part is due to current and future expectations of how inflation affects specifically copper? I know I can’t do it. I can make guesses, but it is entirely possible that inflation could make the price of copper rise quite substantially even while NGDP is stable, or falling somewhat.

    In short, there is not perfect communication of people’s real goods desires apart from inflation, from prevailing prices that are a function of both.

  9. Gravatar of Geoff Geoff
    29. January 2013 at 08:46

    marcus:

    “900 word comment! You´re Major_Freedom incarnate! Since he has been conspicuously absent…”

    Interestingly, you’re not the first person to say this. Sounds like he liked to talk too.

    Maybe long comment blog posters are becoming as increasingly popular as NGDP targeting!

  10. Gravatar of Geoff Geoff
    29. January 2013 at 08:47

    I think commenter Bill Woolsey can give me a run for my money when it comes to post lengths. That dude can type.

  11. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    29. January 2013 at 09:08

    This is only loosely related, but I can’t resist the opportunity to praise a recent book; ‘The Fateful History of Fannie Mae: New Deal Birth to Mortgage Crisis Fall’ (hey, interest rates play a big role!).

    http://www.amazon.com/dp/1609497694

    With the recent death of James Buchanan it’s a good validation of his theories; how the concentrated benefits of ‘housing policy’ were ruthlessly exploited by special interests to the detriment of taxpayer interests. Step by detailed step. It’s only a little over 200 pages, but packs an amazing amount of history into that space.

    Can’t buy it? Click on my name and read my four blog posts reviewing it (though I don’t come close to doing it credit).

    Warning, Housing Cause Denialists will hate it, because it’s going to be hard to deny the role Fannie and Freddie played in creating the housing bubble when you read just how big and dominant they were (and how they got that way–George Patton wasn’t as ruthless toward Nazis).

  12. Gravatar of Max Max
    29. January 2013 at 09:13

    There are some financial interests (money market funds, brokers, etc) who just want a slightly higher Fed Funds rate and they don’t care at all how it’s accomplished. If the Fed can set a floor of 0.25% (well above the “zero bound”), why not 0.5%?

    The cash management fee cuts (to maintain a 0% cash account yield after fees) amounts to billions of dollars a year, coming directly out of Wall Street profits. Keep this context in mind when reading WSJ editorials, no matter whether the author is the CEO of Schwab or some academic. You can’t be too cynical about these things.

  13. Gravatar of Steve Steve
    29. January 2013 at 09:20

    John Taylor: “If its asset sales are too slow, the bank reserves used to finance the original asset purchases pour out of the banks and into the economy. But if the asset sales are too fast or abrupt, they will drive bond prices down and interest rates up too much, causing a recession.”

    Obviously, the correct answer is to sell assets at a pace that acheives 5% NGDP growth. This could be reenforced with forward guidance. You should do a post pointing this out, short and snappy.

    Methinks Taylor should set up a firm along with Roubini, Hussman, Santelli, et al, selling Doom Every Direction.

  14. Gravatar of Bill Woolsey Bill Woolsey
    29. January 2013 at 09:22

    Scott:

    For you and I, many of Taylor’s arguments seem sound. They point to why interest rate targeting is a bad idea at the best of times, and further, why solving the lower bound problem with forward guidance is bad as well.

    But he isn’t giving up on interest rate targeting, is he?

  15. Gravatar of Greg Ransom Greg Ransom
    29. January 2013 at 09:26

    Creating malinvestment does not create ‘growth’ — that’s Economics 101.

    Never argue from temporary manipulations of stock prices to sustainable economic growth for the economy.

    Scott writes,

    “he stock market responded very positively to rumors of QE, not once but three times. That suggests QE boosts growth.”

  16. Gravatar of maynardGkeynes maynardGkeynes
    29. January 2013 at 09:27

    Get real: The stock market is not an indicator of anything. It’s a bunch of day traders working off of FED policy.

  17. Gravatar of TravisV TravisV
    29. January 2013 at 09:45

    Prof. Sumner,

    See below from Yglesias. I’m just curious whether you agree with him:

    http://www.slate.com/blogs/moneybox/2013/01/25/what_would_happen_if_we_let_all_the_immigrants_in.html

    the United States ran an open borders regime throughout the 19th century and we weren’t worse off for it. On the contrary, it laid the foundations for American greatness. Shifting back in that direction—with exceptions for dangerous criminals and other select problem types—over time seems perfectly feasible to me and would substantially increase overall human welfare.

  18. Gravatar of TravisV TravisV
    29. January 2013 at 10:28

    Prof. Sumner,

    Doesn’t most of the debt issued by the U.S. Treasury have a maturity of around two years? If so, does that mean that the Austrian argument that the Fed is pushing interest rates to “artificially low” levels has some validity?

    I can imagine an Austrian saying the following:

    “The government borrows most of its money for a two-year term, so the Fed is conspiring to keep interest rates for 2-year T-bills artificially low. They don’t care if that increases rates for 10-year T-bills because the government doesn’t issue many of them at all.”

  19. Gravatar of Suvy Suvy
    29. January 2013 at 10:43

    “900 word comment! You´re Major_Freedom incarnate!”

    Hahahahahaha. Where is Major_Freedom? I haven’t seen him on this blog in a while.

  20. Gravatar of Joe Joe
    29. January 2013 at 10:48

    I always find it interesting when people (especially educated one like John Taylor) demand more higher interest for savers by quoting the current nominal rates while ignoring what the real rates are. If we get higher rates for savers, there will most likely be higher rates, greater growth and some more inflation across the board. Just sayin…

  21. Gravatar of Tony Lima Tony Lima
    29. January 2013 at 10:56

    You need to be on Twitter. Please. We need you over there. I’m @GonzoEcon. Great piece on Taylor, who remains an embarassment to us Stanford alums.

  22. Gravatar of RPLong RPLong
    29. January 2013 at 11:13

    “But low interest rates are not a monetary policy.”

    I understand that this is technically accurate, but does anyone else get the sense that when Prof. Sumner says stuff like this, he’s trolling the internet?

  23. Gravatar of ssumner ssumner
    29. January 2013 at 11:19

    Marcus, I’m not surprised!

    Gregor, I’m confused too–does he believe markets are efficient?.

    Geoff, You are confusing levels and rates of change. Higher expected inflation reduces real stock prices, as we saw in the 1970s.

    Tom, The Fed should set a specific NGDP growth path target, and engage in level targeting.

    Patrick, Thanks for the link. I agree that the GSEs were a huge problem.

    TravisV, Yes, it would very likely boost global welfare.

    No, the Austrian view you cite has no validity. If rates were low because of easy money then long term rates would be soaring. But they are also falling to unbelievably low levels. And TIPS spreads are low.

    It’s tight money–no question about it.

    Tony, I’d like to but have no extra time–I’m always running way behind.

  24. Gravatar of ssumner ssumner
    29. January 2013 at 11:21

    Geoff, I should clarify that higher inflation reduces real stock prices, holding other things equal. When it is correlated with faster growth expectations (as it has been since 2008) it will raise real stock prices—but only because of the expectations of faster real growth.

  25. Gravatar of ssumner ssumner
    29. January 2013 at 11:23

    RPLong, Tell me why you think Taylor thinks tighter money will lead to faster RGDP growth, then we’ll see who the “troll” is.

    Is Taylor’s view any less contrarian than mine?

  26. Gravatar of RPLong RPLong
    29. January 2013 at 11:37

    Prof. Sumner, I looked at the Federal Reserve’s website before I commented on your blog. I also looked at the educational website the Federal Reserve created to provide materials to primary/secondary school teachers and students. Both websites indicate that controlling interest rates are one way the Federal Reserve conducts monetary policy.

    Whatever you think about about John Taylor is beside the point. When you say that “low interest rates are not a monetary policy,” you are being a bit trollish.

  27. Gravatar of Mark Mark
    29. January 2013 at 12:46

    RPLong,

    “Both websites indicate that controlling interest rates are one way the Federal Reserve conducts monetary policy.”

    Yep, it is ONE way. There are other ways too. Taken together they constitute monetary policy.

  28. Gravatar of Rodrigo Escalante Rodrigo Escalante
    29. January 2013 at 12:50

    Prof. Sumner,

    Great Post, I am really looking forward to your seminar on QE3 and inflation. Hopefully we will get a lecture on NGDPLT as well.

  29. Gravatar of Tom Brown Tom Brown
    29. January 2013 at 13:12

    Hi Scott, thanks for your response. You wrote what I was afraid you were going to write:

    “Tom, The Fed should set a specific NGDP growth path target, and engage in level targeting.”

    I understand your idea that just broadcasting the NGDP growth path target the to public will help to achieve that target, but what specific threats of activity (if not the activity itself) does the Fed yield to make that happen? I.e. what can they threaten with regard to OMOs or QE or near term overnight rate targeting, etc to back up this “NGDP growth path target?” For example, say the target was 5%: What specifically could the Fed threaten to do to move to us to that growth rate right now? I realize they wouldn’t necessarily HAVE to do anything (other than announce the target). If you’ve covered this before (which I’m sure you must have!), perhaps there’s a reference or a link you can provide. Thanks much!

  30. Gravatar of TravisV TravisV
    29. January 2013 at 14:20

    Prof. Sumner,

    I mostly agree with you. However, it is simply not true that long-term rates are falling to unbelievably low levels.

    Yesterday, the yield on 10-year Treasuries rose to 2.0% for the first time since April 2012:

    http://www.businessinsider.com/yield-on-10-year-treasuries-rises-to-2-for-the-first-time-since-last-april-2013-1

  31. Gravatar of Geoff Geoff
    29. January 2013 at 14:34

    Dr. Sumner:

    “Geoff, You are confusing levels and rates of change. Higher expected inflation reduces real stock prices, as we saw in the 1970s.”

    I understand the difference between levels and rates of change.

    I am a befuddled as to what I said that would lead to you saying I am confusing the two.

    I am just emphasizing that I think there is a difference between nominal growth and real growth. You say here that higher expected inflation reduces real stock prices. OK, I agree, but you said before that inflation that leads to higher stock prices (which is a nominal statistic) and that these higher prices suggest higher economic growth.

    I would think that is conflating the real with the nominal, since the higher stock prices caused by higher expected inflation doesn’t necessarily suggest higher real economic growth. In other words, just because stock prices go up, it doesn’t by itself suggest higher real growth is afoot. It could simply be stock prices adjusting to higher expected future prices of no greater real output, or even lower real output.

    “Geoff, I should clarify that higher inflation reduces real stock prices, holding other things equal. When it is correlated with faster growth expectations (as it has been since 2008) it will raise real stock prices—but only because of the expectations of faster real growth.”

    This statement is confusing. Are you saying higher inflation raises real stock prices, or are you saying higher real expected growth raises real stock prices?

    I am confused because when you say “it” in the quote above, you seem to be referring to higher inflation. So if you say “it will raise real stock prices”, I read that as “higher inflation will raise stock prices.” But then in the very last part, you say “but only because of the expectations of [higher] real growth”, which would seem to suggest that it is higher real growth which raises real stock prices, not higher inflation.

    Can you clarify for someone who is not super duper quick?

    One could interpret what you said in your clarification as saying higher inflation is merely “tagging along for the ride” as real stock prices are caused by higher real growth expectations. I don’t see how saying “higher inflation has been correlated with higher real expected growth since 2008″ entitles one to say that inflation is what is causing the real growth, because it is also possible that the real growth is itself encouraging more spending and shorter cash holding times, which means the correlation could be going the other way in addition to the [more inflation -> more real growth] direction.

    And, even if it were the case that higher inflation is causing higher real growth, I think it is wrong, as I mentioned above, to identify all growth as desirable growth. I gave a couple examples of what I mean.

  32. Gravatar of Geoff Geoff
    29. January 2013 at 14:43

    Tom Brown:

    The argument is that merely by virtue of communicating higher NGDP in the future, the Fed can bring about an increase in spending and decrease in cash holding times now, in the present, without any significant increase in OMOs.

  33. Gravatar of Geoff Geoff
    29. January 2013 at 15:26

    Dr. Sumner:

    “No, the Austrian view you cite has no validity. If rates were low because of easy money then long term rates would be soaring. But they are also falling to unbelievably low levels. And TIPS spreads are low.”

    I’m not an expert on the Austrian view or anything, but as far as I know, the Austrian view of “loose money” doesn’t imply or predict “soaring” long term interest rates. In fact, they often say that low interest rates can, not necessarily, but can, mean easy money.

    I believe they distinguish between stages of production, and how most of the inflation goes from stage to stage, ultimately to consumer goods.

    They claim that interest rates are temporarily lowered because of easy money, but once the easy money spreads throughout the economy from stage to stage, there will be a time where money is loose but it hasn’t yet shown up in consumer prices. Then, once the easy money finally manifests in higher consumer prices, that is when there will be an additional inflationary component added to interest rates, thus increasing them.

    At that time, or somewhat before that time (and this particular part I think I agree with) the Fed has a choice. It can either not tighten, and continue the inflation (1970s), which then leads to the Friedman-esque “Higher interest rates means money HAS BEEN loose”, or, the Fed can tighten and discontinue the inflation (2008), which pushes up interest rates on its own, and, in combination with the consumer price inflation from past inflation, it then leads to the Austrian-esque “Higher interest rates means money IS tight.”

    In short, the claim, as far as I know, is that easy money does not necessarily raise interest rates right away, if the inflation hasn’t yet reached consumer goods to a significant extent, which means there is no reason why investors would demand a higher inflation premium on lending just yet.

    Imagine the Fed bought my house for $100 trillion. Sure, interest rates can rise somewhat in expectation of my spending, but not until that money has spread throughout the economy to a great enough degree such that consumer prices rise, will there be an additional “here and now” consumer price inflation component added to interest rates, as more and more people come to learn that prices are rising. Not everyone knows what is happening with monetary policy, but interest rates depend on such people’s knowledge. Actual money spending has its own communication mechanism.

    Price expectations are no match for price reality, when we live in a world full of the types of people who don’t even know who the President is.

  34. Gravatar of Geoff Geoff
    29. January 2013 at 15:37

    TravisV:

    “I mostly agree with you. However, it is simply not true that long-term rates are falling to unbelievably low levels.

    “Yesterday, the yield on 10-year Treasuries rose to 2.0% for the first time since April 2012:”

    I think the argument is more over the long term, Travis. 2% is a historically minuscule rate, even if it is “the highest it’s been…in less than a year.”

  35. Gravatar of Michael Michael
    29. January 2013 at 15:38

    “I understand your idea that just broadcasting the NGDP growth path target the to public will help to achieve that target, but what specific threats of activity (if not the activity itself) does the Fed yield to make that happen? I.e. what can they threaten with regard to OMOs or QE or near term overnight rate targeting, etc to back up this “NGDP growth path target?” For example, say the target was 5%: What specifically could the Fed threaten to do to move to us to that growth rate right now?”

    I don’t think they can move us to a chosen NGDP growth path “right now”. But I think they absolutely can do it over time. Banks are holding massive quantities of excess reserves. That means banks have the capacity to lend a lot more money then they are currently lending. When increased bank lending starts the Fed is going to respond. They may unwind QE by selling bonds for excess reserves, they may raise the rate of interest on reserves (increasing banks’ incentives not to make loans), in all likelihood, they will do some of both.

    If they sat on their hands and did absolutely nothing, there would eventually be a massive increase in NGDP (due largely to inflation). I don’t think there is anyone, on any side of this debate, who disagrees that, given the current state of affairs, the Fed could allow massive inflation to occur if they for some reason wanted to do so.

    What the Fed could do today (beyond asset purchases) is announce a target path for NGDP, and say that they will react to market expectations in such a way as to prevent nominal GDP from going above the target path. (What this means specifically is that tools they have at their disposal to slow NGDP growth – unwinding of QE, raising IOR, targteting a higher short term rate – will be used to prevent NGDP from going above the target path.) They can further annouce that, in the event that they miss the target in either direction, they will act to in such a way as to return to the path (whether that requires buying or selling of assets, raising or lowering IOR, targerting a higher or lower short term rate).

    All that matters is whether the Fed can hit the target path in the future, and whether they can tighten or loosen policy in order to stay on the path OR return to it in the event of any deviations. If one assumes that they can do it at some point in the future, then people and businesses need to take that into consideration in planning both present and future decisions.

  36. Gravatar of TravisV TravisV
    29. January 2013 at 16:27

    Geoff,

    If I were Prof. Sumner, I would ignore you. Your whole argument above depends on “long and variable lags.” In other words, you don’t believe that markets are forward-looking. Do yourself a favor and look up what Prof. Sumner has said about “long and variable lags.”

  37. Gravatar of Geoff Geoff
    29. January 2013 at 17:11

    TravisV:

    Congrats on completely misunderstanding what I said.

    I don’t in any way shape or form reject the argument that markets are forward looking. I even suggested markets are forward looking in the very post you’re criticizing.

    What I am saying is that forward looking estimates are no substitute for actual future events. That actual events affect prices apart from past expectations.

    If I were Prof. Sumner, I would perhaps send you a crib sheet on reading comprehension techniques.

    What a rude poster you are.

  38. Gravatar of Geoff Geoff
    29. January 2013 at 17:15

    And besides, it is absurd to suggest that mere disagreement over the issue of “long and variable lags” is sufficient to disengaging discussions. That would be a counter-productive “purity test” where anyone who doesn’t toe the line exactly, is outcast. We have words to describe such people, and they’re not exactly favorable.

  39. Gravatar of Lorenzo from Oz Lorenzo from Oz
    29. January 2013 at 17:15

    TravisV: Read Robert Fogel’s “Without Consent or Contract” for the effects on open borders on American politics and the standard of living of residents. (You might also ask Amerindians what they think about the outcomes of not-controlled-by-them immigration.)

    Part of the story of C19th labour flows was there were temperate zone flows and tropical zone flows and much of the politics of settler countries such as USA, Australia, Canada, New Zealand was about blocking tropical zone flows. While racist rhetoric was often involved, the concerns were far from irrational. Different sources of migrants pose different integration issues.

    I talk as a resident of country which has much higher proportion of foreign-born residents than the US and manages migration policy arguably rather better than the US. But we have geographical advantages (no land borders) and are the world’s most successfull cherry-pickers in migrant policy.

  40. Gravatar of Shaun Peterson Shaun Peterson
    29. January 2013 at 17:58

    Never underestimate the stamina of Austrians to make the same tired arguments over and over, even in the face of reality and it’s non Austrian economics bias. It really is amazing to watch.

  41. Gravatar of Geoff Geoff
    29. January 2013 at 18:23

    Shaun, care to elaborate? Is Taylor an Austrian?

  42. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    29. January 2013 at 18:37

    Is it known that higher inflation doesn’t increase stock prices even absent real growth expectations? Speaking from my relative ignorance, an obvious chain of causality would be that if interest rates go down or stay the same, and inflation expectations go up, then many financial players have an increased ability to borrow money that they can use to buy assets, and also increased expected nominal and real returns from borrowing to buy assets. I haven’t read much discussion of this one way or another, but I’d expect that inflation from increased lending wouldn’t hit the economy evenly; it would hit first where it was easiest to borrow money to purchase that asset, like houses or university educations. Since many financial actors are highly leveraged, shouldn’t we expect inflation to increase stock prices more than the price of items traditionally purchased using less leverage?

  43. Gravatar of Geoff Geoff
    29. January 2013 at 19:33

    Eliezer:

    “I haven’t read much discussion of this one way or another, but I’d expect that inflation from increased lending wouldn’t hit the economy evenly; it would hit first where it was easiest to borrow money to purchase that asset, like houses or university educations.”

    I am inclined to agree.

    It just seems weird to me to assume that inflation affects everything with a price equally, such that a stable rise in NGDP somehow prevents bubbles and other “within NGDP” fluctuations that hamper real sustainable growth.

    Imagine if NGDP rose at 5% per year, but the increase was entirely concentrated in one sector. Talk about a “real” side bottleneck!

    Reality of inflation, I think, is in between this one sector concentration extreme, and the all sector extreme. I think with higher rates of inflation, we move closer to the one sector extreme, and with lower inflation, we move closer to the all sector extreme.

  44. Gravatar of Benjamin Cole Benjamin Cole
    29. January 2013 at 20:29

    I read John Taylor’s editorial frontways, then backways, then sideways.

    It was like watching a really good boxer fight himself.

    Much already said here, I dont need to repeat.

    Incredibly, Taylor criticizes Japan for going to QE, even now as it suffers from deflation—this is the same Taylor who gushed about the success of Japan’s QE program from 2001-6, and has a paper to that effect on his website.

    Pow. Jab. Left hook.

    The Taylor says models don’t work when the Fed goes to QE. Does then the Taylor Rule work, when we are at zero bound, and deflation? (Yes, six of the last eight CPI readings have been negative).

    Uppercut. Right jab. Pow.

    I just don’t understand Taylor. Is he short bonds? Does he want a lousy economy so Obama is seen as a loser?

    Why does not Taylor mention that six of the last eight CPI readings have been down, and deflation is not only a threat but a reality?

  45. Gravatar of Don Geddis Don Geddis
    29. January 2013 at 20:40

    @Tom Brown: “what specific threats of activity … does the Fed yield to make that happen? I.e. what can they threaten with regard to OMOs or QE

    Yes, exactly. You’ve answered your own question. They threaten to buy stuff. There are plenty of Treasury bonds to buy (OMOs), and if more is still needed, plenty of mortgage-backed securities (QE). And eventually, just start buying non-financial assets, like real estate. But none of that would be needed, because the power of the threat is so obvious, that it would never be carried out. (C.f. Nick Rowe, concrete steppes.)

  46. Gravatar of Don Geddis Don Geddis
    29. January 2013 at 20:46

    @Michael: “If [the Fed] sat on their hands and did absolutely nothing, there would eventually be a massive increase in NGDP (due largely to inflation). I don’t think there is anyone, on any side of this debate, who disagrees that, given the current state of affairs, the Fed could allow massive inflation to occur if they for some reason wanted to do so.

    Wow. You seem to have this exactly backwards. You seem to think that the Fed is currently doing lots of actions to suppress inflation, and if only they would do nothing, then inflation would take off.

    In fact, I think pretty much everyone “on this side of the debate” would disagree with you. The current low-inflation (or even deflation) state, could easily continue for decades to come, just like we’ve seen in Japan.

    You seem to think that the only concern for the Fed is how to “prevent nominal GDP from going above the target path”. But in fact, the concern is the exact opposite. NGDP is too low, and the question being debated is what steps the Fed could take to RAISE it (and/or inflation), not to lower it.

  47. Gravatar of Niklas Blanchard is blogging again « The Market Monetarist Niklas Blanchard is blogging again « The Market Monetarist
    29. January 2013 at 21:46

    [...] Sumner also comments on John Taylor’s WSJ article – as do Marcus Nunes. Share this:Email Pin ItLike [...]

  48. Gravatar of Hugh Hugh
    29. January 2013 at 21:54

    There seems to be a consensus on this blog that QE raises NGDP. Where is the evidence for this? Short term bounces in stocks? Certainly the bang for buck ratio doesn’t look appetising.

    I agree that NGDP should be higher, but think that the wrong tools are being used: what about pushing the NGDP futures market idea? It seems a lower risk approach than QE.

  49. Gravatar of Phil Phil
    30. January 2013 at 02:58

    Hugh, no evidence is needed, the counter factual is so obviously false that it must be true. QE is mostly like printing money. The counter factual of QE raising ngdp, is that printing money cannot raise inflation. In that case the fed could buy 100% of the worlds assets with newly created money without changing the path of ngdp? That is so I obviously false that QE must raise ngdp, if you do enough of it.

  50. Gravatar of flow5 flow5
    30. January 2013 at 03:23

    Refocus. This doesn’t require knowledge. Wipe the slate clean.

    Monetary lags are not long & variable. The roc in short-term money flows is less than half that of the long-term proxy for inflation. Monetary policy used to respond immediately to an injection of legal reserves. I.e., given subpar economic growth, the roc for real-output would rebound quicker than the roc for inflation.

    But the Oct. 2008 IOeR policy emasculated the Fed’s “open market power”. Inflation burst out of the trough in 2009 inflation first. This is mathematically impossible. It also demonstrates that monetary policy was too tight & n-gDp growth too slow.

  51. Gravatar of Michael Michael
    30. January 2013 at 03:44

    “Wow. You seem to have this exactly backwards. You seem to think that the Fed is currently doing lots of actions to suppress inflation, and if only they would do nothing, then inflation would take off.”

    No, I don’t and didn’t say that. Inflation is being kept in check by the expectation that the Fed will, at some future date, act to suppress it by some mixture of targeting a higher Fed funds rate, selling assets bought during QE, and raising IOR. If it was somehow known (or even expected) that the Fed was NOT going to engage in any of these activities, there would be more inflation/higher NGDP today.

    “In fact, I think pretty much everyone “on this side of the debate” would disagree with you. The current low-inflation (or even deflation) state, could easily continue for decades to come, just like we’ve seen in Japan.”

    Yes it could. I agree.

    “You seem to think that the only concern for the Fed is how to “prevent nominal GDP from going above the target path”. But in fact, the concern is the exact opposite. NGDP is too low, and the question being debated is what steps the Fed could take to RAISE it (and/or inflation), not to lower it.”

    Various concerns that have been raise by various Fed critics include the following:

    1. The concern you mention above – that the Fed cannot raise NGDP to a particular target path.

    2. The concern that Fed policy since 2009 will eventually lead to runaway inflation. (Which would also mean runaway NGDP growth).

    These are not compatible concerns. If either one is impossible to address, then the other is a non-issue. Again, I don’t think anyone doubts that recent Fed action has created some potential for inflation in the future.

  52. Gravatar of flow5 flow5
    30. January 2013 at 04:07

    “Foreign central banks…tend to follow other central banks’ easy-money policies”

    The unregulated, prudential reserve, money creating, Euro-dollar banking system (evolving c. 1960′s) collapsed in July 2008 (not the ECB’s euro). The E-D market isn’t controlled by the IMF.

    Given that the relative size of the E-D banking system (is many times that of, for example, the Federal Reserve System of commercial banks), it’s not surprising [as CBs are permitted to buy their liquidity], we get hot money flows & currency wars.

  53. Gravatar of Shining Raven Shining Raven
    30. January 2013 at 05:15

    @Tom Brown:

    Scott Sumner thinks the Fed should threaten to buy up everything, not just Treasuries, MBS or other securities, but if necessary also stocks or real goods.

    This post really clarified things for me:

    http://www.themoneyillusion.com/?p=15964

    Very insightful comments by commenter K there as well.

    In other words: Scott Sumner wants the Fed to really engage in fiscal policy, but wants to call it “monetary policy”, since it is the Fed doing it, not Congress. In my view, this just completely confuses the issues, but what can you say.

    Hope this helps.

  54. Gravatar of Shining Raven Shining Raven
    30. January 2013 at 05:18

    @ Tom Brown: Comment by K on that post is here:

    http://www.themoneyillusion.com/?p=15964#comment-181285

    Comment by Scott Sumner: “I think that’s wrong, the purchase of high quality corporate debt at going market prices by central banks is just as much “monetary policy” as the purchase of Treasury debt”

    Reply by K:

    “Why would we want to confuse things by calling that “monetary policy?” Any kind of investment is monetary policy by your preferred definition. If a private agent issues bonds to dig holes in the ground and then the CB buys the bonds, that’s not “monetary policy.” It’s Keynes by the back door. Of course that kind of “monetary policy” can escape the liquidity trap. I think you are sabotaging the debate by obfuscating the commonly accepted meanings of words. If you want to hand some kinds of fiscal policy to the CB, that’s fine. But it’s not neutral in terms of wealth transfers, and calling it “monetary” doesn’t make it so.”

  55. Gravatar of Rien Huizer Rien Huizer
    30. January 2013 at 06:01

    Scott,

    Looks like we may see some empirical issues here. You may be right at the national level and wrong at the international (diplomatically speaking). The Japanese are clearly acting selfishly, which is not their proper role in world history, according to some.

  56. Gravatar of Max Max
    30. January 2013 at 06:29

    “In that case the fed could buy 100% of the worlds assets with newly created money without changing the path of ngdp? That is so I obviously false that QE must raise ngdp, if you do enough of it.”

    If the Fed destroys the government’s balance sheet, that is inflationary because it’s irreversible.

    So yeah, it would theoretically work, but it’s completely insane and no central bank would ever intentionally do it. Besides, it’s so easy for a CB to generate inflation. Just change the target.

  57. Gravatar of flow5 flow5
    30. January 2013 at 06:37

    You can have a tighter money policy with easier credit. The cost & availability of credit was controlled under Reg Q ceilings. The credit crunch in 1966 was the precedent.

    The IOeR policy not only emasculates the Fed’s “open market power”, it induces dis-intermediation (where the size of the non-banks shrink, but the size of the CB system remains the same). That’s how you encourage stagflation, not real income growth.

    Money flowing to the non-banks increases the supply of loan-funds, matches savings with investment, & increases the profits of the CBs.

    It bears reiteration that from a systems viewpoint, commercial banks (DFIs), as contrasted to financial intermediaries: never loan out, & can’t loan out, existing deposits (saved or otherwise) including existing transaction deposits, or time deposits, or the owner’s equity, or any liability item.

    When CBs grant loans to, or purchase securities from, the non-bank public, they acquire title to earning assets by initially, the creation of an equal volume of new money- (demand deposits -TRs) — somewhere in the banking system. I.e., commercial bank deposits are the result of lending, not the other way around.

    We have not only sinister bankers but stupid economists.

  58. Gravatar of ssumner ssumner
    30. January 2013 at 07:13

    RPLong, You said;

    “Prof. Sumner, I looked at the Federal Reserve’s website before I commented on your blog. I also looked at the educational website the Federal Reserve created to provide materials to primary/secondary school teachers and students. Both websites indicate that controlling interest rates are one way the Federal Reserve conducts monetary policy.”

    That doesn’t conflict with my claim that interest rates are not a monetary policy. Otherwise you’d need to answer the following question: Does the Fed think high interest rates (say 20%) are easy money or tight money? And what do you think? And why? Something can be a tool for implementing a policy, w/o being a policy.

    Rodrigo, Thanks.

    Tom, You said;

    “I understand your idea that just broadcasting the NGDP growth path target the to the public will help to achieve that target, but what specific threats of activity”

    It’s a mistake to think in terms of threats. It’s a mistake to think of the economy as sluggish and the Fed as being like a farmer trying to prod a stubborn mule. The Fed currently has a very tight monetary policy. That is the problem. The Fed doesn’t want 3% inflation, they’ve said so.

    Once you set the target path, the money supply becomes endogenous. You supply as much base money as the public wants to hold at that NGDP growth rate. If you don’t know how much that is (I think they do know) then you create an NGDP futures market.

    TravisV, I view 2% rates as ultra low, nearly the lowest in US history.

    Goeff, A monetary policy that produces higher expected inflation will raise real stock prices, but the higher expected inflation itself will reduce real stock prices.

    Eliezer, My reading of the evidence is that higher trend inflation will, ceteris paribus, reduce real stock prices by raising the effective real tax rate on capital. There is some support for that proposition from the 1970s.

    A one time increase in the price level could raise real stock prices in the short run, as stock prices are more flexible than goods prices. In the long run its neutral.

    When AD is depressed, and only when AD is depressed, easy money will tend to boost both inflation expectations, real growth expectations, and stock prices. This has been true since about 2008. In my view the real growth expectations increase is what causes the higher stock prices, and not the higher inflation expectations.

    Admittedly in the real world it’s often hard to differentiate between changes in the price level and changes in the expected rate of inflation. And there may also be some non-neutrality at very low rates of inflation, for sticky wage/money illusion reasons.

    Hugh, You said;

    “Certainly the bang for buck ratio doesn’t look appetising.”

    QE is costless, so the bang for the buck is infinite. But I agree that NGDP futures targeting is better, and I’ll have a paper on that coming out in a couple months.

    Shining Path, You said;

    In other words: Scott Sumner wants the Fed to really engage in fiscal policy, but wants to call it “monetary policy”, since it is the Fed doing it, not Congress.”

    No, I oppose having the Fed buy up non-Treasury assets, unless needed, and it will never be needed, hence I oppose it.

    And I do know the difference between fiscal and monetary stimulus, but apparently you don’t. One boosts the deficit and the other doesn’t.

    Suppose I argued that if an asteroid was going to strike Earth then humans should all get into deep caves. You’d claim “Sumner thinks all humans should get into deep caves” without any qualifier about asteroids. An asteroid strike is more likely that the Fed needing to buy non-Treasuries.

    Rien, They most certainly are not acting selfishly, why would you makes such a strange argument? If Japanese growth increases, they’ll import more goods. It will help the US, just as US devaluation of 1933 helped the rest of the world.

  59. Gravatar of RPLong RPLong
    30. January 2013 at 07:45

    Okay, Prof. Sumner, I’ll try this one last time, on the off-chance that I’m not being clear.

    I FULLY UNDERSTAND that your statement is TECHNICALLY CORRECT. I have no qualms with that.

    The problem is that in the WSJ article, Taylor comes right out and says:

    “Consider the “forward guidance” policy of saying that the short-term rate will be near zero for several years into the future. The purpose of this guidance is to keep longer-term interest rates down and thus encourage more borrowing. A lower future short-term interest rate reduces long-term rates today because portfolio managers can, in a form of arbitrage, easily adjust their portfolio mix between long-term bonds and a sequence of short-term bonds.”

    THEREFORE, it is CLEAR that when Taylor refers to low interest rates being a monetary policy, he is using the common language that you, and I, and the people at the Fed, and pretty much the whole entire world uses when they say stuff like, “The Fed sets interest rates at X%” or “The Fed is targeting X% interest rates” or etc. etc. etc.

    You are going off on a technicality that only serves to obfuscate what you and Taylor are both saying. Taylor IS NOT making a universal declaration that low interest rates **ARE** monetary policy. He is using popular, well-understood language as shorthand for what he sees as an easy money policy.

    Get it? Now, you can dispute him on Fed policy, fine. You might be right. I sure don’t know, I’m just a layman.

    But to state that Taylor is wrong because he is using universally accepted language is to troll the internet. I don’t see the usefulness of it any more than I see the usefulness of calling smart people “lunatics” or saying as commenter “Tony Lima” did above, that a famous, intelligent, well-respected, and by all accounts CIVIL economist like John Taylor is “an embarrassment” to Stanford alumni.

  60. Gravatar of ja ja
    30. January 2013 at 07:57

    This has probably been answered before, but I’ve been wondering for a while: what would happen if the Fed increased money supply by a huge amount but only by buying long term bonds (Treasuries or otherwise). Would long-term interest rates fall? Would we call that contractionary if they did?

  61. Gravatar of Shining Raven Shining Raven
    30. January 2013 at 08:07

    Hi Scott,

    I very much remain not a Peruvian Maoist terrorist organization, thank you.

    “No, I oppose having the Fed buy up non-Treasury assets, unless needed, and it will never be needed, hence I oppose it.”

    This really does not cut it. Seriously. There is a serious argument that monetary policy (in the classical sense of swapping Treasuries for bank reserves) does not get traction at the zero lower bound. You hand-wave that away by saying that the central bank

    And I do know the difference between fiscal and monetary stimulus, but apparently you don’t. One boosts the deficit and the other doesn’t.

    Aha. Funny, that. And I thought that the point was that monetary policy simply exchanges one asset for another, whereas fiscal policy actually increases the net financial assets held by the public. I.e. if the central bank buys a car, it is fiscal policy (somebody who held a real good now holds a financial asset, a bunch of dollars); if the central bank buys a treasury, it is monetary policy (somebody who already had a financial asset of one type now has another financial asset, and both are liabilities of the government).

    In any case, whether it is the Fed or the Federal government buying a car, in both cases the amount of liabilities of the government increases, so it is fiscal.

    “Suppose I argued that if an asteroid was going to strike Earth then humans should all get into deep caves. You’d claim “Sumner thinks all humans should get into deep caves” without any qualifier about asteroids. An asteroid strike is more likely that the Fed needing to buy non-Treasuries.”

    Unfair. The context of my remarks is quite clear: We are talking about a situation in which monetary policy does not get traction – the asteroid is pretty much upon us. I quoted from an linked to a discussion thread on a post titled “Do OMOs “work” at the zero bound? That’s the wrong question.” You cannot possibly say that I am taking you out of context, only because I do not re-state the qualifications every possible time.
    I understand that you believe that the Fed is keeping monetary policy “tight” (because they pay interest on reserves, or do not announce an NGDP target or whatever), and that that is the problem.

    However, other people are of the opinion that the problem is the zero lower bound and a resulting impotence of monetary policy. You cannot on the one hand dismiss this objection by saying that the central bank can get around the problem by engaging in purchases of assets other than treasuries, and then turn around and say that you never advocated for this, since the people making the objection are wrong, wrong, wrong, and it’ll never com to this.

    Then it is incumbent on you to show how *else* monetary policy can get traction.

  62. Gravatar of Shining Raven Shining Raven
    30. January 2013 at 08:12

    You hand-wave that away by saying that the central bank…

    …can increase inflation at will by purchasing any asset, but then distance yourself from that argument again at convenience.

  63. Gravatar of Geoff Geoff
    30. January 2013 at 08:13

    Dr. Sumner:

    “Goeff, A monetary policy that produces higher expected inflation will raise real stock prices, but the higher expected inflation itself will reduce real stock prices.”

    Will real stock prices rise or fall? It looks like you’re saying inflation will increase real stock prices in one respect, but decrease real stock prices in another respect, which leaves the net effect of inflation unaccounted for.

  64. Gravatar of Geoff Geoff
    30. January 2013 at 08:27

    Shining Raven:

    “However, other people are of the opinion that the problem is the zero lower bound and a resulting impotence of monetary policy. You cannot on the one hand dismiss this objection by saying that the central bank can get around the problem by engaging in purchases of assets other than treasuries, and then turn around and say that you never advocated for this, since the people making the objection are wrong, wrong, wrong, and it’ll never com to this.”

    I think that is accurate. I am inclined to agree. I too have seen arguments in blog posts on this website to the effect that the Fed can get around the ZLB by “unconventional” monetary policy (which would seem to suggest purchases of things OTHER than treasuries, wouldn’t it?). Then when asked about what types of “unconventional” monetary policy proposals could do it, Dr. Sumner gets all huffy and says he is against unconventional monetary policy and that the Fed doesn’t need to use “unconventional” monetary policy after all.

    This needs an explanation.

  65. Gravatar of Shining Raven Shining Raven
    30. January 2013 at 08:28

    “And I do know the difference between fiscal and monetary stimulus, but apparently you don’t. One boosts the deficit and the other doesn’t.”

    I realize that I actually agree with you, provided you include all other outstanding liabilities of the government in the deficit, such as currency and bank reserves.

    In that case you are correct: fiscal policy increases the deficit (additional outstanding liabilities, such as dollars or treasuries), and monetary policy does not affect the total amount of government liabilities, since it only switches between different kinds of them (treasuries vs. dollars).

    In any case, if the Fed buys anything other than a government liability with currency or reserves, it is fiscal, since it increases the total amount of government liabilities outstanding.

  66. Gravatar of Geoff Geoff
    30. January 2013 at 08:36

    I found this post wherein Dr. Sumner states the following:

    “In that case here’s the right way to think about monetary policy ineffectiveness: Assume that the Fed always stands ready to buy enough assets to keep expected NGDP growing at say 4.5% per year, level targeting. They agree to start with the safest assets (say T-bills) then move on to slightly riskier assets, such as T-notes and bonds, and then move on to agency debt, municipal bonds, high quality corporate debt, etc. In that case monetary policy is “ineffective” if the public’s demand for base money when expected NGDP growth is on target is greater than the amount of Treasury debt held by the public. That’s it. It’s that simple.”

    and then

    “And I really don’t see any problem with relying exclusively on monetary policy for demand stabilization in the US, even if the demand for base money exceeded 70% of GDP. For God’s sake the US government already does insane things like bail out auto companies and banks. Why in the world would we be squeamish about having the Fed buy high quality private debt at fair market value?”

    and

    “Here’s the right approach: The Fed says; “We are going to do whatever it takes to succeed, so that our internal forecasts are on target.””

    “And here’s the right question: “How much stuff do we have to buy?””

    So it would appear at first glance that Dr. Sumner both supports and does not support “unconventional” monetary policies. Maybe if the Treasury starts purchasing more equity from more failing companies, will it be more politically palatable for the Fed to do the same thing FOR GOD’S SAKE.

  67. Gravatar of Becky Hargrove Becky Hargrove
    30. January 2013 at 09:05

    Shining Raven,
    I’m trying understand where you’re coming from and will continue to do so. However I am but a layperson and, like others, need for the discussion to (also) take place in terms that laypeople can contribute to. Laypeople especially need to be able to contribute in terms of the larger goals you seek with your own method, even if they don’t always understand the finer points of the arguments.

  68. Gravatar of Shining Raven Shining Raven
    30. January 2013 at 09:19

    Hi Becky,

    I am a layperson myself, and I am trying to make sense, I am not trying to be obscure. Sorry if that is the case.

    For me, the question is one of the mechanics with which Scott wants to implement his ideas. My understanding is that he does not see the same constraints on the Fed in implementing monetary policy that many other people see. In particular, he does not see the interest rate targeting that the Fed does in practice as anything that is really necessary for the operation of the Fed.

    I think he is wrong in this, and that he has to rely on a complete change in the operation of the Fed in order to get the results that he wants. Well, he does actually want to change the Fed and the banking system, but he does not see the same problems that I see. So I try to convince him (or rather, perhaps innocent bystanders) that there is a real problem that he seems to overlook. (Namely, setting interest rates is what the central bank does, and there really is a limit to this, and it is not easy to get around without a profound change in the operations of the central bank – and what he proposes to do is really fiscal policy, better suited to be controlled by Congress).

  69. Gravatar of Becky Hargrove Becky Hargrove
    30. January 2013 at 10:32

    Shining Raven,
    I’ll try to address some of your concerns and also provide a bit of my perspective:

    What Scott seeks is not so much a change in operations as a change in focus, and I want to elaborate why I believe that change in focus could make a difference. Interest rate targeting would remain a vital tool, however it works more efficiently when viewed through the lens of total output, so that the ability of every income to contribute to economic possibility at any given moment is better understood.

    Expectations are especially hampered in the present because of the uncertainty on what really needs to be measured. As a long term unemployed, even if clarity were to somehow emerge at the Fed and optimism returned, by no means does that mean I would now get a job without leaving someone else jobless. Some would say “Congress needs to take care of that and provide you minimal income.” And even Market Monetarists tend to be sympathetic to a degree. Let me explain why I hesitate at such guaranteed floors – for someone like myself they act like ceilings which prevent the economic access people continue to need: such as being able to live where one can walk to a doctor when they can’t afford a car for instance. Measuring the whole makes it more likely we find solutions for those left out instead of just adding them to the ones already standing at the back of the line.

    My hope is that through targeting the sum total of actual output, people can eventually observe how vital aspects of economic activity inadvertantly get crowded out, by existing portions of the marketplace. For example, building reforms allowing technologically assisted housing and commercial construction could go a long way to restore the idea of middle class life, and also allow much needed infrastructure reforms that would revitalize communities. However, before we can gain a better perspective of economic balance, it really helps to have a better understanding of the economic whole, which is why I support NGDPLT.

  70. Gravatar of Don Geddis Don Geddis
    30. January 2013 at 11:07

    @Shining Raven: “We are talking about a situation in which monetary policy does not get traction

    No, we’re talking about where interest rates are near zero, and so monetary policy cannot increase demand by using its preferred instrument of lowering rates. But OMOs and QE of MBS still work just fine.

    other people are of the opinion that the problem is the zero lower bound and a resulting impotence of monetary policy

    Yes, Sumner has spent YEARS arguing that these other people are fools, and their erroneous beliefs have CAUSED the untold suffering of the years of recession that we’re in the middle of.

    You cannot on the one hand dismiss this objection by saying that the central bank can get around the problem by engaging in purchases of assets other than treasuries … Then it is incumbent on you to show how *else* monetary policy can get traction.

    You’ve missed a critical step. Sumner never said that the key to escaping the zero lower bound, is to purchase assets other than treasuries. That’s where you’ve made your mistake in understanding.

    The “assets other than Treasuries” is only a reductio ad absurdum, for the objection “but what would the Fed do, if it bought up all the T-bills there are, and still that wasn’t enough?” It’s merely to demonstrate that the Fed will never run out of power.

    But as to what to ACTUALLY do, Sumner advocates: (1) set clear expectations of future NGDP (this does 99% of the work to raise current NGDP); and (2) buy as many Treasuries as necessary (OMOs), to demonstrate credibility. Sumner has high confidence that NGDP expectations will rise very quickly, long long before the Fed runs out of T-bills to buy. So the non-Treasury assets, while an interesting theoretical idea, never enter into the expected Fed actions.

    Does that help clarify it for you?

  71. Gravatar of Tom Brown Tom Brown
    30. January 2013 at 11:10

    Scott, thanks for your reply. That helps. Unfortunately I don’t know what you mean by this sentence: “If you don’t know how much that is (I think they do know) then you create an NGDP futures market.” First question: What is an NGDP futures market, and is that something the Fed can do within it’s current mandate/charter/legal authority?

    Geoff, thank for the link and quotes from Dr. Sumner! I found that very illuminating. I especially like this one for it’s specificity:

    “They agree to start with the safest assets (say T-bills) then move on to slightly riskier assets, such as T-notes and bonds, and then move on to agency debt, municipal bonds, high quality corporate debt, etc.” – Scott Sumner

    Did that article precede the “NGDP futures market” idea? Where would that market fit into the sequence that Dr. Sumner outlines in your quote?

    That quote goes a LONG way to filling in the gaps for me in terms of this quote from Scott: “You supply as much base money as the public wants to hold at that NGDP growth rate.” — it tells me HOW that is accomplished, which is what I really wanted to know. Thanks!

  72. Gravatar of Tom Brown Tom Brown
    30. January 2013 at 11:36

    Shining Raven,

    I’m ABSOLUTELY no expert on this, but this is how I see government deficit spending funded by treasury auctions vs QE by the Fed:

    Deficit spending takes from Peter to pay Paul (Peter and Paul both private sector entities) and issues a net financial asset (the bond, issued to Peter) in the process. Equity on the private sector consolidated balance sheets increases in the process, though reserves don’t.

    QE is simply a swap of assets with the Fed: reserves for Treasury bonds. No new net financial assets are issued to the private sector (however, new reserves are), thus no private sector equity growth on the consolidated balance sheet (aside from profits on the transactions — but I’m ignoring that for simplicity).

    Those two are illustrated here:

    http://econviz.org/macroeconomic-balance-sheet-visualizer/

    under the operations (lower left corner)

    1. “Government Spends (Consolidated)”

    2. QE (either kind they list: household or bank)

    Now taken together, deficit spending AND QE could be viewed as government self-financing, except that it requires the participation of the private sector to accomplish.

    If you perform both you can see that in terms of the consolidated balance sheets, the results are exactly equivalent to the hypothetical government self-financing operation they provide: the poorly named:

    3. “Government Spends (Without Borrowing)”

    However, I don’t view the Fed and the government as the same thing. The Fed is officially an “independent” hybrid public/private entity, and it’s supposed to help to support the banks, clear payments, and implement monetary policy.

  73. Gravatar of Tom Brown Tom Brown
    30. January 2013 at 12:04

    Don, thanks for your clarifying comment as well! Where does the NGDP futures market Scott mentions fit into the scheme you’ve outlined.

  74. Gravatar of Don Geddis Don Geddis
    30. January 2013 at 13:37

    @Tom Brown: NGDP Futures are an alternative that could (as I understand it) completely replace OMOs and interest rate targeting and QE. The Fed would create the market, and commit to keeping it liquid. They would buy or sell NGDP futures on their own market, whenever the public (as shown by current NGDP futures prices) believes that the US economy is off target. New money would enter the economy through this futures market.

    Without the futures market, the Fed needs an internal private forecast of future NGDP, and then chooses the amount of OMOs (buying T-bills) so that their internal forecast corresponds to their desired target. It would probably be good enough, but a futures market is likely to offer better predictions, and also to offer a new financial instrument as a tool for updating the money supply.

    (This is just my understanding, as a non-economist who reads Sumner’s blog. He’s the one who is proposing the idea, not me, so take what I’ve said here with a grain of salt.)

  75. Gravatar of John Taylor, Post-Modern Monetary Theorist « Uneasy Money John Taylor, Post-Modern Monetary Theorist « Uneasy Money
    30. January 2013 at 14:07

    [...] you may be asking yourself, is Post-Modern Monetary Theory all about? Great question!  In a recent post, Scott Sumner tried to deconstruct Taylor’s position, and found himself unable to determine [...]

  76. Gravatar of Tom Brown Tom Brown
    30. January 2013 at 15:50

    Don Geddis, thanks for your thoughts on the futures market.

  77. Gravatar of Geoff Geoff
    30. January 2013 at 16:29

    Don Geddis:

    Your explanation here was very clear, and well written. Some of my confusions were cleared up. Thank you.

    But I have one remaining one: What if the “confidence” you speak of is undue? What if the Fed bought up as many treasuries as is practically possible, and the NGDP target still can’t be achieved? For the sake of completeness, I think there has to be clear and concrete steps for what the Fed should do in that circumstance.

    For if the goal is NGDP targeting, and not “avoid purchasing non-treasuries”, then I think it should be an important part of the theory, even if you believe the likelihood is slim.

    No offense, but I don’t trust anyone, let alone you or Dr. Sumner, or myself, when it comes to “confidence” of a central bank monetary plan. For every past generation of economist was “confident” that their own plan, from stabilizing the price level to whatever else, would prevent excessive unemployment and falling output, so forgive me if I don’t consider you or Dr. Sumner as the second coming, and don’t blindly take you on your “confidence.”

    I much rather prefer detailed and well researched/reasoned explanations. Granted, you weren’t intending to do that, just clarify what Dr. Sumner is actually saying, so please don’t take this as meaning you’re making a mistake in some way.

  78. Gravatar of Don Geddis Don Geddis
    30. January 2013 at 18:24

    @Geoff: I’m glad you found my previous comment helpful.

    What if the Fed bought up as many treasuries as is practically possible, and the NGDP target still can’t be achieved?

    You are right that the Fed would indeed need a plan for that case, even if the chances of it happening are vanishingly small. But it seems that you already quoted Sumner’s answer, in an earlier comment of yours:

    “start with the safest assets (say T-bills) then move on to slightly riskier assets, such as T-notes and bonds, and then move on to agency debt, municipal bonds, high quality corporate debt, etc.”

    And, to be honest, if the Fed somehow bought all financial assets and NGDP still wasn’t enough, it could start on non-financial assets (real estate, etc.). In the limit, it would buy up all of planet Earth. Surely inflation would begin to rise a bit, before the Fed owns all human assets.

  79. Gravatar of Major_Freedom Major_Freedom
    30. January 2013 at 18:56

    Don Geddis:

    Yes, I know Dr. Sumner has made some rough outline comments for what the Fed “could do”, but I think for the sake of certainty and expectations, investors should know what the Fed is specifically going to do. I don’t think it’s enough to have a one sentence ordered list of possible things they can do.

    I know you’re purposefully being a little facetious in your last paragraph there, to make a point, but doesn’t it unsettle you that your theory is leading you to so cavalierly say the Fed can buy up huge swaths of the economy if it has to? I mean, what good is a stable NGDP if the citizenry doesn’t own any means of production, and are hence all employees of the state?

    The reason why I bring this up is that it is my view that without clear policy constraints to what the Fed can buy, if we leave the extent of the Fed’s “unconventional” OMOs an open ended question, to be decided in the future, then that “small possibility” of having to buy the kitchen sink becomes a small possibility with a great enough shift in outcomes that I would say makes it something that cannot be left to the hopes and dreams of economists who are “confident” that they can get what they want without a radical change to our way of life.

    The Fed owning the US economy is not something to smirk at for rhetorical effect. You can be a comic now, but that’s only because we aren’t living in that kind of a world.

  80. Gravatar of Don Geddis Don Geddis
    30. January 2013 at 20:27

    @MF: So … nice … to see you here again.

    Let’s say that the chance of the Fed needing to buy anything other than safe financial assets, is less than the chance of an asteroid wiping out the whole US. Is it really worth spending the time and effort to come up with the exact detailed plan, so much ahead of the need?

    The only point of the thought experiment, is to relieve worries that the Fed might “run out” of possible assets to buy, even though it still needed to increase NGDP. If that were feasible, then it would be an important part of the plan to understand what the Fed could possibly do then, once there was nothing left to buy. But the thought experiment shows that this, too, is a needless worry, because there will always be more than enough possible things to buy. The whole point is that we don’t need to come up with yet a different way for the Fed to get money into the economy, other than the very simple “buy stuff”. That will always be sufficient for our monetary policy needs.

  81. Gravatar of Saturos Saturos
    31. January 2013 at 01:29

    Hi MF! But you realize that Scott has done posts with detailed lists of what assets the Fed should buy, in what order, in order to hit its target? And then saying that if they had to go far down that list they would already have failed.

  82. Gravatar of Shining Raven Shining Raven
    31. January 2013 at 02:32

    @Don Geddis: Thanks for engaging. I get the point that Scott thinks it will NOT be necessary to really engage in unconventional monetary policy.

    If QE is working, why hasn’t inflation taken off? My point is: I don’t think it is working as Scott predicted, so it does not get around the ZLB, and you need a credible policy for increasing NGDP/inflation/employment/whatever under these circumstances. *Especially* when you want to rely on signaling, expectations, there has to be a credible course of action to make the proposed target come true!

    Then you say again in a comment above, replying to Geoff:

    ““What if the Fed bought up as many treasuries as is practically possible, and the NGDP target still can’t be achieved?”

    You are right that the Fed would indeed need a plan for that case, even if the chances of it happening are vanishingly small. But it seems that you already quoted Sumner’s answer, in an earlier comment of yours:

    “start with the safest assets (say T-bills) then move on to slightly riskier assets, such as T-notes and bonds, and then move on to agency debt, municipal bonds, high quality corporate debt, etc.”

    And, to be honest, if the Fed somehow bought all financial assets and NGDP still wasn’t enough, it could start on non-financial assets (real estate, etc.). In the limit, it would buy up all of planet Earth. Surely inflation would begin to rise a bit, before the Fed owns all human assets.”

    Sorry, but you really don’t get to make this argument – you just told me that Scott is NOT advocating this. So we now need a plan along these lines after all, don’t we?

    That is what I am saying, and again, if the Fed buys something that is not a government security, this is not conventional monetary policy, and if it buys “planet earth”, that is certainly not monetary policy any more, but fiscal policy, and better left to other bodies with a bit more oversight.

  83. Gravatar of Scott Sumner Scott Sumner
    31. January 2013 at 06:28

    RPLong, I hardly think your view is “universally accepted.” I am quite sure that Nick Rowe doesn’t regard an interest rate as a monetary policy. It’s a tool that may or may not be useful in terms of achieving monetary policies like inflation targeting. But let’s say you are right. Please tell me what sort of monetary policy it would be if the Fed set rates at 20%. Would that be easy money or tight money?

    Shining Raven, If Congress borrows a billion and pays the money out in transfers then the consolidarted government balance sheet is an extra billion dollars in debt. If the Fed spends a billion on MBSs, then an extra billion in Treasuries will go out in circulation. I agree with you there. But the consolidated balance sheet of the government looks essentially the same. The extra billion in T-bonds held by the public is offset by the extra billlion in MBSs held by the Fed, which is part of the government. So its a wash. Now you can define fiscal policy any way you wish, and perhaps there are definitions that would make your argument correct. I’m interested in USEFUL definitions. It’s clear that monetary stimulus does not create future fiscal problems in the form of future tax liabilities, and fiscal stimulus does. That’s the only difference that matters, and its why we should use monetary stimulus instead of fiscal stimulus. Of course there is no need to buy MBSs at all, the Fed should just buy Treasuries.

  84. Gravatar of RPLong RPLong
    31. January 2013 at 07:28

    Prof. Sumner:

    So your reply is to just pretend I’m saying something I’m not?

    Okay, have fun with that.

  85. Gravatar of Don Geddis Don Geddis
    31. January 2013 at 09:56

    @Shining Raven: “If QE is working, why hasn’t inflation taken off?

    Because the Fed mismanages the expectations. 99% of the effectiveness, is about what the public believes about future Fed action. It is not about the direct effect of the direct economic action, which is always minimal.

    It used to be, the Fed just said “we will buy $xB in T-bills next month”. That accomplishes almost nothing. Recently, they’ve started saying “we will continue to buy $yB every month, until unemployment [...] or inflation [...]“. This is better, but still very weak.

    Sumner wants them to say: “we will immediately begin buying T-bills as fast as we can, every day, and not stop until forecasts of future NGDP rise to our target.” Sumner believes that this threat is (or could be) so credible, that very few actual purchases would need to be made, before NGDP immediately rose to target.

    The “effect” of a Fed purchase of T-bills, depends critically on the context in which the Fed explains why they are doing the purchase, and what they intend to do in the future.

  86. Gravatar of Tom Brown Tom Brown
    31. January 2013 at 10:36

    @Shining Raven: Thanks for you responses… I just now noticed them!

    @Scott/Raven: I’m confused by Scott’s response:

    http://www.themoneyillusion.com/?p=19091#comment-224225

    “If the Fed spends a billion on MBSs, then an extra billion in Treasuries will go out in circulation.”

    Scott, did you mean to write “out OF circulation?” because “out in” doesn’t make sense to me in that context. Why would the Fed buying MBS put Treasuries out IN circulation? It seems to me that congress borrowing a billion is what puts the Treasuries “out in circulation.” Are you assuming the Fed first SELLS Treasuries and then buys the MBSs? Why would it do that?

    This part also confuses me: “But the consolidated balance sheet of the government looks essentially the same.” You mean the gov (including Fed) consolidated balance sheet after either 1) Congress borrows and spends 2) Fed buys MBS?

    Also this: “The extra billion in T-bonds held by the public is offset by the extra billlion in MBSs held by the Fed” … does this assume that congress borrowed and spent and then the Fed bought MBSs? Or is this a case of the Fed selling Treasuries before buying MBSs? Something else?

    Help, anyone?

  87. Gravatar of Tom Brown Tom Brown
    31. January 2013 at 10:55

    … sorry, my assumption that you meant

    “…Treasuries will go out OF circulation.”

    doesn’t work either. It must be that you mean the Fed is essentially swapping Treasuries for MBSs. True?

  88. Gravatar of Shining Raven Shining Raven
    1. February 2013 at 02:50

    @Tom Brown and @Scott:

    I have the same problem Tom has, how do treasuries come in here?

    The way I see it, the Fed buying anything other than government liabilities is a fiscal operation, because it increases the amount of government liabilities outstanding (on a consolidated government balance sheet).

    So buying MBS is already “unconventional monetary policy” (essentially really fiscal), since MBS are of course not government liabilities. And I agree with Scott that this has essentially the same effect on the consolidated balance sheet of the government as deficit spending by the treasury. Only in the case of MBS purchases, the newly issued government liabilities are reserves held by the banks, and in the case of debt financed deficit spending, it is treasuries.

    So I also don’t really see where the treasuries come in for the MBS purchase?

    Of course, the extra reserve balances could the be converted back into treasuries, which is purely a monetary operation that does not affect the totla amount of government liabilities. So in that sense it does not matter if you use “treasuries” instead of “bank reserves” for the MBS purchases.

    From my point of view, this is (under current conditions) equivalent. But that *is* my point, so I am not sure where we disagree?

  89. Gravatar of Shining Raven Shining Raven
    1. February 2013 at 03:02

    @Don Geddis:

    I understand that there is an “expectations channel”, but I believe that there needs to be an actual threat to back up the announcements. ]

    For interest rate targeting, there is a threat. The Fed absolutely controls reserves, and thus can shift the Fed funds rate to its target, because if it does not move there, the Fed can do OMOs and put it there. It is a choke point that it controls absolutely.

    But for other, less direct expectations, there is no equivalent mechanism.

    This seems to me to be overlooked here. Sure, I see that this *can* work, since a lot of economic activity is influenced by our expectations.

    It seems to me to be the same as a bluff in a poker game. Nobody would deny that this can work, but it is certainly not guaranteed, and if the bluff is called, then that’s it.

    So the question here is: What does the Fed do if its bluff is called? Since a bluff it is, the Fed simply does not control NGDP in the same direct way as it controls the Fed funds rate, and people know this. There are lots of doubts that such a policy can work (for example, the ones I voice here), so the FEd needs to do something to convince people such as me that it can make NGDP take off.

    And it is not an answer to say that it can just buy up all kinds of stuff other than treasuries (“planet earth”), because right now legally it is *not allowed* to do this. So I guess my question is, do we need to change the legal framework to make this work?

  90. Gravatar of Shining Raven Shining Raven
    1. February 2013 at 03:06

    To make this perfectly clear, I do not deny that the Fed can increase NGDP if it starts to buy cars, toothpaste and airline tickets. It most certainly can.

    I only say that this is not an argument, since currently it is not allowed to do this. So please explain how it works in the existing legal framework.

    As a secondary point, I also do not think it would be a good idea to give this authority to the Fed. I believe this should rest with Congress.

  91. Gravatar of J J
    1. February 2013 at 05:18

    Presumably if the Fed bought all the treasury debt in the world, which is within its power, then NGDP would rise significantly.

  92. Gravatar of Shining Raven Shining Raven
    1. February 2013 at 05:46

    Why would it?

    Treasuries are a source of income for people who hold them, as long as they are interest-bearing. If the Fed buys all treasuries in the world, everybody who held interest-bearing treasuries now has non-interest bearing money. So *everybody is loosing income* through these Fed actions.

    Say I am holding treasuries as part of my retirement portfolio. And now they are replaced by cash. Does this make it more likely to now *spend* more money? On the contrary, I need to save more, in order to achieve the same wealth when retirement time comes around, since my income just went down.

    Under current conditions, where (short-term) treasuries are essentially non-interest bearing, it makes no difference for me. But if all treasury debt is bought up, then of course long-term treasuries are also bought, and presumably they will always be interest-bearing and not be perfectly substitutable by cash.

    Anyway, it is not at all clear that this action increases aggregate demand.

  93. Gravatar of Shining Raven Shining Raven
    1. February 2013 at 05:53

    Backing up, I now see this might work if the price of treasuries would increase significantly as a consequence of the massive Fed purchase program.

    If the price rises high enough such that it replaces my lost expected interest income exactly, then I would not have to save more out of current income. In that case the AD effect would be a wash.

    If the price rises even higher, then there would be a stimulating effect because of additional income realized, above expectations.

    So it very much depends on how the treasuries are valued or the price is set in the purchase program by the Fed. Don’t tell me it’s a market price – in this scenario the Fed is obviously cornering the market….

  94. Gravatar of Don Geddis Don Geddis
    1. February 2013 at 09:35

    @Shining Raven: Maybe we need to back up. Do you accept the Quantity Theory of Money, modulo small changes in velocity (and of course talking about the long run)? In the US, a gallon of milk costs about 4 US-units of currency (dollars). In Tokyo, it costs more like 800 Japanese-units of currency (yen). Do you have any explanation for why the answer is “four” in the US, and “eight hundred” in Japan, other than the outstanding size of the currency base?

    If you’re on board with that, then the answer is: all the Fed needs to do is to increase the size of the currency base, and the price level will naturally adjust. (I.e., the long run Neutrality of Money.) And of course, if the price level rises, then NGDP will rise along with it.

    Now, if you want to disagree with the Quantity Theory, or with Neutrality, then that’s a different discussion. But that’s no longer about the Fed.

    Oh, and also: the Fed is obviously not legally restricted to only buying Treasuries. They are currently purchasing MBSes, for example. So your concern about their legal authority is overblown.

  95. Gravatar of Tom Brown Tom Brown
    1. February 2013 at 10:47

    @Don Geddis: when you write “currency base” what do you mean exactly? Here are the definitions of M0, MB, M1, etc:

    http://en.wikipedia.org/wiki/Money_supply

    One of those? Or do you mean reserves (electronic bank Fed reserve deposits plus physical vault cash held at banks)? This latter definition of course excludes the Treasury’s Fed reserve deposit and physical cash held outside of banks.

    Or do you mean something else?

  96. Gravatar of Max Max
    1. February 2013 at 10:55

    Don, if there’s no opportunity cost to holding base money, then adding base money is ineffective. It just moves bonds from the financial sector to the Fed, and the real economy doesn’t even notice that anything happened.

  97. Gravatar of Tom Brown Tom Brown
    1. February 2013 at 11:04

    @Shining Raven

    So Shining Raven, You still have a problem with Scott’s statement:

    “If the Fed spends a billion on MBSs, then an extra billion in Treasuries will go out in circulation.”

    Correct? Or do you now think he meant that the Fed would exchange Treasuries for MBSs?

    Also, I have a question about this that you wrote:

    “Of course, the extra reserve balances could the be converted back into treasuries”

    What “extra reserve balances” are you referring to? The extra balances resulting from Fed MBS purchases?

  98. Gravatar of Don Geddis Don Geddis
    1. February 2013 at 14:40

    @Max: “if there’s no opportunity cost to holding base money, then adding base money is ineffective.

    You’re making a prediction about the real world, based on a particular theory. And there are important caveats, like whether the currency injection is expected to be temporary, or permanent. You’re trying to argue that monetary policy is impotent at the zero lower bound. But not everyone agrees with that. In the real world, if the Fed bought all Treasuries available on the market, would the price level rise? That’s an empirical question, not one that can be settled definitively by theory. Sumner has strong arguments that it indeed would rise (“hot potato” effect, “no central bank in history has tried to inflate, and failed”, etc.).

  99. Gravatar of Max Max
    1. February 2013 at 15:33

    “You’re trying to argue that monetary policy is impotent at the zero lower bound.”

    No, I’m just saying that increasing the quantity of money *now* doesn’t do anything.

    At some future date, it might. But whatever quantity of money the Fed sets *now* has no bearing on that, assuming it’s costlessly reversible.

    At this point somebody usually says, but surely if the Fed bought “everything” it would be inflationary? Yes it would, because it would not be reversible. But there is no need to do that. The bank can simply change its target. That’s what everyone cares about, not the quantity of money.

  100. Gravatar of Shining Raven Shining Raven
    2. February 2013 at 05:13

    @Tom Brown:

    So Shining Raven, You still have a problem with Scott’s statement:

    “If the Fed spends a billion on MBSs, then an extra billion in Treasuries will go out in circulation.”

    Correct? Or do you now think he meant that the Fed would exchange Treasuries for MBSs?

    Yes, I still don’t quite understand what he meant. And yes, the only way that I can make sense of it is to assume that he meant that the Fed exchanges Treasuries for MBS.

    Also, I have a question about this that you wrote:

    “Of course, the extra reserve balances could the be converted back into treasuries”

    What “extra reserve balances” are you referring to? The extra balances resulting from Fed MBS purchases?

    Yes. I was trying to come up with a scenario in which the Fed effectively exchanges Treasuries for MBS (see above). This would be a roundabout way of achieving this result.

  101. Gravatar of Shining Raven Shining Raven
    2. February 2013 at 05:50

    @Don Geddis:

    @Shining Raven: Maybe we need to back up. Do you accept the Quantity Theory of Money, modulo small changes in velocity (and of course talking about the long run)?

    The honest answer is that I only accept it partially. Yes, the price level must have something to do with the amount of “money” outstanding. The devil is of course in the details, i.e. what exactly the right “measure” of money is, and I understand that this is very much an open discussion, with all kinds of different monetary aggregates.

    My view is that the relevant quantity cannot possibly be only currency (M0) or only the monetary base (MB), but needs to include the money actually used in transactions, i.e. demand deposits etc, so I think M2 is much closer to being useful here.

    If you’re on board with that, then the answer is: all the Fed needs to do is to increase the size of the currency base, and the price level will naturally adjust. (I.e., the long run Neutrality of Money.) And of course, if the price level rises, then NGDP will rise along with it.

    But increasing the currency base (I assume you mean MB, which includes reserves) obviously does not achieve this! Otherwise we would have needed to see a tenfold increase in the price level in 2008 with quantitative easing.

    And I *understand* that Scott thinks that interest on reserves is the reason this has not happened. I find this however completely unconvincing, because also under normal conditions there *is* interest on reserves (in the Fed funds market) for all practical purposes, which the Fed essentially sets, and the only difference now is that the mechanism for setting it has changed.

    My point: I don’t think identifying M=MB in the QTM formula is valid, and it is not enough for the CB to increase currency (how?) or monetary base to start to inflate.

    Now, if you want to disagree with the Quantity Theory, or with Neutrality, then that’s a different discussion. But that’s no longer about the Fed.

    Well, I disagree partially with both. I am far from convinced that the really coarse QTM with “base money” has any validity in the real world. As I said, the basic idea about the price level seems sound to me, but I am far from convinced that the “M” in the QTM can be equated to currency.

    If the Fed starts to buy up stuff other than treasuries, this is a fiscal operation, I believe that there are wealth effects, and it is not neutral.

    Oh, and also: the Fed is obviously not legally restricted to only buying Treasuries. They are currently purchasing MBSes, for example. So your concern about their legal authority is overblown.

    I don’t think so. I am not sure exactly where the legal authority comes from to buy MBS, which are of course not government liabilities, but I am sure this had to be specifically authorized. I *am* sure that the Fed is still very much restricted in what it can buy, and that e.g. stocks are right out.

    Sumner has strong arguments that it indeed would rise (“hot potato” effect, “no central bank in history has tried to inflate, and failed”, etc.).

    See, this is what drives me crazy in these discussions: Yes indeed, *if* a central bank is allowed to buy whatever it wants, then it can indeed inflate. But you guys keep telling me that this is not what you advocate, we do not need to enable the Fed to do this, no, Scott does not want this etc. etc.

    Now, we have a situation in which the Fed increased bank reserves in QE in 2008 by a factor of what? 100? Obviously this has not led to a 100fold increase in the price level. So the simple view of the QTM seems to be wrong.

    If I understand Scott, his position is that the Fed has mismanaged expectations (okay), and that the problem this is not working and has not let to inflation has to do with interest on the reserves. Which is 0.25%. (For essentially technical reasons my understanding is that it is difficult to lower it further, since it would get money market funds in trouble, although I don’t really understand how this would work.)

    I find it completely implausible that lowering the interest rate on reserves from 0.25% to 0% would lead to a 100fold increase in the price level, i.e. massive inflation. If I take a QTM seriously in which an increase in the monetary base leads to a change in the price level and the CB can inflate at will by increasing MB, then this would be the consequence. Does not track for me. In my opinion, this shows clearly that things don’t work that way.

    Don Geddis, you are entirely correct that we have several competing theories, and that ultimately these are empirical questions that need to be settled by looking at the real world.

    Looking at the empirical results from QE (no massive inflation), it seems clear to me that a simple QTM in which the CB can inflate by increasing MB does not look so good, and Scotts arguments in favor seem less than strong.

  102. Gravatar of dtoh dtoh
    2. February 2013 at 05:53

    There is only conventional monetary policy. It consists of the Fed exchanging money for financial assets.

    It doesn’t matter what financial assets the Fed buys.

    The Fed can target whatever rate goal they want: inflation, interest, RGDP growth, NGDP growth. They can’t target more than one.

    OMP works because its ultimate counter-party (not the financial intermediary) is an economic entity who is exchanging a financial assets for money because they want to spend the money on real stuff (AD).

    The counter-party enters into this exchange with the Fed because an increase in the real price of financial assets (1/ expected real risk adjusted return) has induced them to exchange financial assets for real goods and services. This is the most elementary of economic principles. A rise in the price of one good (financial assets) relative to another good (real goods and services) induces an exchange. (Indifference curves are negatively sloped and convex).

    The ZLB is irrelevant. Economic entities care about real rates. (An increase in expected inflation raises the real price of financial assets just as effectively as a decrease in nominal interest rates).

    Fed action also lowers the real price (1/ expected real return) of investments/purchases of real good and services because there is an expectation that higher NGDP will increase the return on these investments/purchases.

    The effectiveness of OMP is reduced if the net effect is just an exchange by financial institutions of financial assets for Fed reserves. The Fed can easily prevent this with zero or negative IOR rates. Higher expected inflation will have the same effect.

    Inflation is only indirectly impacted by changes in the money supply and only to the extent that OMP have an impact on AD and cause an expected imbalance between the short run supply and demand for goods and services.

    There is obviously a bunch of other stuff going on, but it’s just footnotes.

  103. Gravatar of dtoh dtoh
    2. February 2013 at 07:20

    There is only conventional monetary policy. It consists of the Fed exchanging money for financial assets.

    It doesn’t matter what financial assets the Fed buys.

    The Fed can target whatever rate goal they want: inflation, interest, RGDP growth, NGDP growth. They can’t target more than one.

    OMP works because its ultimate counter-party (not the financial intermediary) is an economic entity who is exchanging a financial assets for money because they want to spend the money on real stuff (AD).

    The counter-party enters into this exchange with the Fed because an increase in the real price of financial assets (1/ expected real risk adjusted return) has induced them to exchange financial assets for real goods and services. This is the most elementary of economic principles. A rise in the price of one good (financial assets) relative to another good (real goods and services) induces an exchange. (Indifference curves are negatively sloped and convex).

    The ZLB is irrelevant. Economic entities care about real rates. (An increase in expected inflation raises the real price of financial assets just as effectively as a decrease in nominal interest rates).

    Fed action also lowers the real price (1/ expected real return) of investments/purchases of real good and services because there is an expectation that higher NGDP will increase the return on these investments/purchases.

    The effectiveness of OMP is reduced if the net effect is just an exchange by financial institutions of financial assets for Fed reserves. The Fed can easily prevent this with zero or negative IOR rates. Higher expected inflation will have the same effect.

    Inflation is only indirectly impacted by changes in the money supply and only to the extent that OMP have an impact on AD and cause an expected imbalance between the short run supply and demand for goods and services.

    There is obviously a bunch of other stuff going on, but it’s just footnotes.

  104. Gravatar of ssumner ssumner
    2. February 2013 at 09:07

    RPLong, I don’t “pretend,” and I have no idea what you are talking about.

    Tom and Shining Raven, If the Fed buys MBSs instead of Treasury debt, then more Treasury debt is sold to the public. Since the Fed is basically part of the government, it’s a wash.

    One can call things whatever one wishes, but what matters is that fiscal stimulus means higher future tax liabilities, and monetary stimulus does not.

    Shining Raven, You said;

    “Why would it?”

    Suppose the Bank of Denmark bought the entire stock of global government debt and paid in cash. Denmark is at the zero bound. Now Denmark would immediately become far and away the richest country in world history—if you are correct. I suspect you are not correct.

    Max, You said;

    “But there is no need to do that. The bank can simply change its target. That’s what everyone cares about, not the quantity of money.”

    Exactly.

  105. Gravatar of Tom Brown Tom Brown
    2. February 2013 at 10:19

    @Scott: Sorry, but that’s still not 100% clear. You write:

    “Tom and Shining Raven, If the Fed buys MBSs instead of Treasury debt, then more Treasury debt is sold to the public.”

    OK, you clearly state here that the “Fed buys MBSs instead of Treasury debt.” Why? Why wouldn’t they buy both?

    Also you do not mention who sells “more Treasury debt… to the public.”

    1. The Treasury?

    2. The Fed?

    And do you really mean:

    A. “more Treasury debt is sold to the public” [more than what is normally sold to them at the regular Treasury bond auctions]

    or do you mean:

    B. “more Treasury debt is HELD by the public?” [because the Fed is no longer buying it up from the public... and thus the public continues its normal purchases of Treasury debt at Treasury auctions and ends up holding on to more of it... but no greater amount is actually SOLD to the public]

    So we have four possibilities here:

    1A, 1B, 2A, 2B

    Are any of those four what you meant?

  106. Gravatar of Shining Raven Shining Raven
    2. February 2013 at 13:41

    @Scott:

    Suppose the Bank of Denmark bought the entire stock of global government debt and paid in cash. Denmark is at the zero bound. Now Denmark would immediately become far and away the richest country in world history—if you are correct. I suspect you are not correct.

    ??? What does this have to do with the scenario we were talking about? Now you are introducing exchange rates that are possibly variable and you are talking about something that Denmark’s central bank can not in fact do without the willingness of other countries to hold kroner in arbitrary quantities. How could the central bank actually effect this? At some point no foreigner would be willing to exchange anything for kroner.

    What do you want to tell me here? That a central bank can engineer inflation by buying foreign assets that are not actually denominated in its own currency? Sure, I agree, it can certainly do that. But this is not what we are talking about! Obviously, a central bank can intervene in the foreign exchange market, and by devaluing its own currency, can increase the price of imports and thereby generate inflation via rising import prices.

    Are you proposing that the Fed should do this? If not, why do you bring it up?

    Back to the scenario I was actually discussing: A central bank buying up liabilities of its own government in its own currency. I mean, when J said “all treasury debt in the world”, I understood this to mean all US treasury debt in the world. The Fed does not conduct open market operations by buying and selling foreign government debt.

    In this case, everybody now holds cash instead of treasuries. Currently both are essentially non-interest bearing. Why exactly would I now start *spending* money? I wouldn’t! So no increased pressure on prices, no higher inflation, no additional economic activity, no increased AD. Nothing happens. Which is exactly what we see.

  107. Gravatar of Shining Raven Shining Raven
    2. February 2013 at 13:52

    I cannot find this anymore, but somebody on Nick Rowe’s blog made this comment:

    Suppose you have some representative agent in the private sector. Because of the current state of the economy, he cannot get full-time work any more, but is only employed half of the time that he worked before the recession and that he would still like to work. As a consequence, his income from dependent work has dropped by half, and he has correspondingly cut his expenditures. His wealth so far is unaffected.

    Now you magically replace all his (perhaps long-term and still interest-bearing) treasuries in his portfolio by cash. Would he now spend this? No, of course not, because his income is unchanged! This has absolutely no effect in this regard, and since the interest income from the treasuries is now absent, his income is in fact further reduced, and he would have to cut further into his expenditures in order to not reduce his wealth.

    The only way in which you can get people to spend more is by offering them additional windfalls. If the Fed starts to bid up asset prices in such a way that people can realize unexpected gains from this and obtain additional income, yes, certainly, this could lead to additional spending and economic activity.

    However, this is not any longer conventional monetary policy!

  108. Gravatar of dtoh dtoh
    2. February 2013 at 14:23

    Raven, You said;

    “In this case, everybody now holds cash instead of treasuries. Currently both are essentially non-interest bearing. Why exactly would I now start *spending* money? “

    What you need to understand is that economic entities (not financial intermediaries) only do the marginal exchange of financial assets into money in the first place for the purpose of spending the money on real goods and services. The reason they are induced to do this marginal exchange is that Fed action has caused the real price (1/expected real return) of financial assets to rise relative to the price of real goods and services so effectively they are exchanging financial assets for real goods and services.

    Economic entities do not spend money because they have it, but they do acquire money if they intend to purchase real goods and services.

  109. Gravatar of Shining Raven Shining Raven
    2. February 2013 at 15:13

    Yes, but what does that have to do with monetary policy?

    I see two points in what you say.

    Sure, usually somebody who sells a treasury only does this because he wants money to buy something else. However, for this you do not need a central bank and open market operations (in which you can only participate anyway if you are a primary dealer, and these are essentially all “financial intermediaries” that you exclude). There is always a market in treasuries if you want to convert them to cash. So this has nothing to do with monetary policy.

    So if the Fed does an OMO with a primary dealer, how does this encourage an “economic entity” to sell a treasury? It doesn’t! Either the economic entity already wants to spend money anyway and exchanges the treasury for cash on its own initiative, or it doesn’t, and the fact that the Fed bought a treasury from a primary dealer does not change this at all.

    Now we come to the second point: If the Fed action causes an increase in the asset price, then of course the “economic entity” can realize a gain, and at the margin realizes additional income, which can lead to additional spending. So yes, this can increase NGDP, no question there, because of a wealth or price effect.

    But this is an effect *at the margin*, as you say, so the additional income to spend only comes from the marginal gain.

    Whereas I understand Scott to say that *all* of the money now held in stead of the treasury becomes a “hot potato” and is being spent into the economy. And this I don’t see.

    I guess my overall point is the following one: I understand Scott to say that there is a way that the Fed can force people to hold more cash than they want to hold, and that they then start spending (“hot potato effect”). And that this can somehow be achieved through monetary policy, on the initiative of the central bank.

    And I simply don’t see how this can work.

    Your argument does not support this either, since you also say that people only exchange treasuries for cash when they want to spend the money anyway. Thus this is *not* an effect of OMOs by the central bank, it is not forced by the central bank, and entirely due to their own initiative. They only acquire the money because *they* want it to spend.

    So this fails already on the first count.

    (For completeness let me say that the Fed can force primary dealers to participate in OMOs, so they can be forced to hold more “money” than they want, but not “economic entities (not financial intermediaries)”.)

    And my point is now that *even if you assume* that somebody in the public can be magically forced to have to exchange his treasuries for cash, this does not make him likely to spend this money (per the “hot potato effect”).

    So for me the question remains open how monetary policy is supposed to achieve such a “hot potato effect” that leads to higher inflation etc. etc.

  110. Gravatar of Tom Brown Tom Brown
    2. February 2013 at 16:26

    @Shining Raven, I like your argument, however I might add one thing to what you said regarding primary dealers. I inquired with Cullen Roche at pragcap.com about the most common buyers in Treasury auctions, and he provided me with the quote of an unnamed “NY Fed official” who told him this:

    “The primary way dealers finance their bond purchases is in the repo market. So here is one scenario. Funds are wired from the dealer’s account at its clearing bank to Treasury on issuance day. During the day, the clearing bank provides intraday credit to the dealer, so the dealer is borrowing from the bank. That same day, the dealer enters into a repo, pledging the newly acquired Treasury as collateral. The other side of the repo is likely to be a money market mutual fund or other money market investor. Therefore, by the end of the day, and for the overnight period, the money market investor is effectively funding the dealer’s position. Of course, there are a variety of ways in which positions can be funded, but the repo market is the key one.”

    By “dealer” I don’t think he means “primary dealer” but instead means the party wishing to buy a Treasury.

    So what I got from this is that the most common buyer of Treasuries at Treasury auctions is actually non primary dealers, though they use the primary dealers to obtain the Treasury through this repo mechanism. When the dust settles, the effect (I believe) is most similar to the Treasury Direct program where non-PD’s buy debt directly from the Treasury. These two purchasing mechanisms are illustrated on econviz.org under the operations

    1. “Government Issues Debt” [The Treas Direct like method]

    2. The consolidated operation consisting of
    A. Government Issues Debt (Banks buy via TT&L)
    B. Government transfers TT&L account to Fed

    But again, according to Cullen 1. is more common than 2. because of the repo mechanism outlined above.

  111. Gravatar of Tom Brown Tom Brown
    2. February 2013 at 16:34

    @Shining Raven, so regarding my question to Scott above:

    http://www.themoneyillusion.com/?p=19091&cpage=3#comment-224740

    Which do you think he probably means? 1A, 1B, 2A, or 2B? or something else? I’m still confused about this.

  112. Gravatar of dtoh dtoh
    2. February 2013 at 17:46

    Raven,
    If the real price of financial assets rise relative to the price of real goods and services, then at the margin there will be an increased exchange of financial assets for real goods and services. That can be the sale of financial assets already being held for liquidity purposes, new bank borrowing, etc. You need to think of all financial assets being fungible for this purpose.

    A marginal increase in the purchase of real goods and service is an increase in AD.

    The Fed induces this increased exchange by raising the real price of financial assets through OMP, which works in two ways. 1) The increased demand for financial assets caused by the Fed purchases raises the nominal price, or 2) increased inflation expectations because of Fed action causes a decrease in the real expected return (i.e. an increase in the real price).

    To the extent that the new money issued in exchange for financial assets through FED OMP is not just held by financial intermediaries as vault cash or ER, then it all used by non-financial economic entities for the purchase of real goods and services (otherwise there would be no reason for the entities to acquire the additional money). So at the margin all of the new money is used for incremental spending on real goods and services (i.e. increased AD). On top of that you get a multiplier effect because the money initially spent for real goods and services becomes income for other economic entities and so forth and so on.

    Again, it’s important to realize that we’re talking about a marginal increase in spending on real goods and services caused by the Fed action…not what economic entities would do anyway absent any Fed action.

    Hope this makes it clearer.

  113. Gravatar of dtoh dtoh
    2. February 2013 at 19:19

    Raven,
    BTW – When I started reading the blog and thinking about this issue my thinking was very similar to yours. The problem for me was the hot potato effect (HPE) model/mechanism that Scott adheres to. It did not IMO reflect behaviour in the real world (as you have also pointed out).

    I think the problem with the HPE is that it is predicatively accurate, and that Scott and others like it because of that predicative accuracy (it makes it easy for them to think about the effects of monetary policy) and because the development of monetary theory involved an ideological rejection of Keynesian models of nominal interest rate effects and by sub-conscious extension real interest rate (i.e. real price of financial asset) effects on AD.

  114. Gravatar of Negation of Ideology Negation of Ideology
    2. February 2013 at 19:51

    Shining Raven -

    The dictionary defines fiscal and monetary policy differently than you do:

    http://dictionary.reference.com/browse/fiscal+policy
    http://dictionary.reference.com/browse/monetary%20policy

    Remember, the Fed wasn’t even allowed to buy Treasury bonds until 1932. Are you claiming that we had no monetary policy before then? The ECB doesn’t buy any EU bonds(they don’t exist) and didn’t buy any government bonds until the crisis. Are you claiming the ECB didn’t have a monetary policy under a few years ago?

    You say:
    “Namely, setting interest rates is what the central bank does, and there really is a limit to this, and it is not easy to get around without a profound change in the operations of the central bank – and what he proposes to do is really fiscal policy, better suited to be controlled by Congress”

    And how do they “set interest rates”? By buying Tresuries or lending to banks. Maybe you include lending to member banks as monetary policy. So lending money to banks is monetary policy but lending to Fannie and Freddie isn’t? If the Fed gave them a bank charter would those MBS purchases suddenly become monetary policy?

    And what about countries on the gold or silver standard? When the bought gold or silver were they engaging in fiscal policy?

  115. Gravatar of Shining Raven Shining Raven
    3. February 2013 at 03:01

    @Negation:

    The dictionary defines fiscal and monetary policy differently than you do

    You don’t seriously want to discuss technical terms according to a general, non-technical dictionary definition?

    What a central bank does is sometimes almost “neutral”, and sometimes not neutral at all, when it changes relative prices in the economy and does not only change the overall price level. I do not think that it is useful to say that whatever a central bank does is monetary policy, in particular not in a discussion that contemplates to widen the powers of the Fed.

    Remember, the Fed wasn’t even allowed to buy Treasury bonds until 1932.
    Yes, and when did the US leave the gold standard?

    Are you claiming that we had no monetary policy before then? The ECB doesn’t buy any EU bonds (they don’t exist) and didn’t buy any government bonds until the crisis. Are you claiming the ECB didn’t have a monetary policy under a few years ago?

    You *do* know that the ECB lends against European government bonds as collateral, do you?

    And how do they “set interest rates”? By buying Tresuries or lending to banks. Maybe you include lending to member banks as monetary policy. So lending money to banks is monetary policy but lending to Fannie and Freddie isn’t? If the Fed gave them a bank charter would those MBS purchases suddenly become monetary policy?

    Yes, of course, and no.

    Of course lending to banks is monetary policy. What else? In lending money to the banks, the central bank creates additional money. Just as any bank creates money when it extends credit. This is clearly monetary policy.

    And no, even with a bank license for Fannie and Freddy MBS purchases are not monetary policy (most MBS did not originate with Fannie and Freddie anyway, or did they? I do not think so). This would be buying *private debt* by the central bank, which is fundamentally different from buying essentially risk-less government debt, or lending against such as safe collateral.

    Buying private debt or bank shares is clearly not “neutral”, but distorts the price level of the private debt that the Fed buys – with essentially unlimited purchasing power – relative to private debt that it does not buy. Clearly not neutral on the overall price structure, and thus not really monetary policy: There are obviously significant direct effects beyond a simple expansion of the money supply.

    And you do know that the Fed has an overdraft facility and lends at the discount window? These are obviously not the only tools it has, but this is certainly part of conducting monetary policy.

    And what about countries on the gold or silver standard? When the bought gold or silver were they engaging in fiscal policy?

    In my opinion, this is a totally different question. But no, almost by definition it is not fiscal policy if the central bank buys and sells gold under a gold standard system.

    Sure, it does distort the price of a unit of gold relative to all other prices in the economy, but since the unit of gold is the unit of account for all prices, this changes the overall price level, and not relative prices between goods that are not gold. Clearly monetary policy, by definition. A stupid system, in my opinion, but that was not the question.

  116. Gravatar of Shining Raven Shining Raven
    3. February 2013 at 03:11

    @Tom Brown:

    I think he means 2B, or really only B, and no more treasury debt is sold, but more is held by the public, since the Fed buys MBS instead of treasuries, and the Treasury issues the same amount as before.

    I am sure you and Cullen are correct about the technical points, and I believe you that primary dealers sell on a lot of treasuries to the public. But I don’t think it has much bearing on my argument that the Fed cannot force any non-primary dealers to buy or sell treasuries. Mind, I might be overlooking something in what you are telling me. I understand that the technical details are often important to understand what really is and isn’t possible in these transactions, a point that I am frequently making myself here…

  117. Gravatar of Negation of Ideology Negation of Ideology
    3. February 2013 at 06:13

    Shining Raven -

    Ok, so your argument is that the Fed buying private debt is not neutral, and I agree with that. Of course, lending to banks is also buying private debt, and not neutral. I think you’re confusing two unrealated issues. But you were correct here:

    “Of course lending to banks is monetary policy. What else? In lending money to the banks, the central bank creates additional money. Just as any bank creates money when it extends credit. This is clearly monetary policy.”

    Exactly. It is the creating (or destroying) of additional money that determines whether or not it is monetary policy, not where it goes. If the Fed gave every citizen a $1000 loan that would also be monetary policy. If Congress issued $1000 of the old US Notes (which are still legal tender) to every citizen it would also be monetary policy. However, if the government taxes or borrows to do these things, it is fiscal policy.

    And if you don’t like non-technical dictionaries, I’m happy to look at any legitimate source that has definitions. But words have meanings, and if you use them however you feel like then the ability to communicate is lost. You’ve chosen to add the criteria of neutrality to the definition of monetary policy – I don’t know where that comes from. I agree that neutrality is a good goal for monetary policy, but I disagree with you that if some action isn’t neutral it cannot by definiton be monetary policy.

  118. Gravatar of Negation of Ideology Negation of Ideology
    3. February 2013 at 06:15

    Shining Raven -

    “A stupid system, in my opinion, but that was not the question.”

    I agree with you. The gold standard is an incredibly stupid system.

  119. Gravatar of Shining Raven Shining Raven
    3. February 2013 at 07:26

    @dtoh:

    Thanks for your patience, I appreciate it.

    I actually think that I agree with you, I can get on board with a lot of things that you say. I agree that a change in prices of financial assets (your mechanism 1) can lead to people realizing the gains and spending the additional income on goods and services. I just think that this is more an income or wealth effect, not really due to the increase in the money supply as such.

    About your point 2) I still have to think a bit, but of course it is true that the rising of the price lowers the real return on these financial assets. How this translates into inflation expectations, I am really not sure. It’s less clear to me how this would work.

    To the extent that the new money issued in exchange for financial assets through FED OMP is not just held by financial intermediaries as vault cash or ER, then it all used by non-financial economic entities for the purchase of real goods and services (otherwise there would be no reason for the entities to acquire the additional money).

    And… this is the rub for me. This is all correct, as far as I can see. The problem is your qualification “To the extent that the new money issued in exchange for financial assets through FED OMP is not just held by financial intermediaries as vault cash or ER, …” which seems quite crucial to me.

    The point is: (Almost) Only financial intermediaries deal directly with the Fed. Only they can be forced by Fed action to acquire reserves without having any direct plans to spend the money. So they might well hold the money without spending it, and without any HPE. This seems what is happening now.

    So I don’t disagree with you on the existence of these marginal effects, and that they can be caused by the Fed. I believe they are quite real. It is just that I do not think this is what Scott or the other market monetarists have in mind as effects of monetary policy. They seem to say that it is not an effect at the margin, but in the bulk, and that *all* the money exchanged for an asset will lead to additional spending.

    As far as multipliers are concerned after the money has been spent by a first actor and becomes additional income for somebody else, of course I am completely on board with that as well. So I don’t think I am too far from your position (which seems to differ from Scott’s).

  120. Gravatar of Shining Raven Shining Raven
    3. February 2013 at 08:20

    @Negation: Thanks for your answer. I am sorry if I was unclear and I really don’t want to be slippery here.

    I agree that one should stick to the accepted meaning of words, and I don’t want to play tricks. It just seems to me that the boundary between exactly what is a monetary and a fiscal operation is still pretty much debated.

    I believe you can argue about the exact boundary between monetary and fiscal operations ’till the cows come home (see references below).

    I guess I am coming at this from the neo-Chartalist view or however you want to define it, and I am sorry if I am sowing confusion in not making this clear.

    Here is Scott Fulwiler on Nick Rowe’s blog on this:

    Fiscal policy is about the changes in the qty of net financial assets held by the non-govt sector. …

    Monetary policy is about managing the payments system and setting an interest rate … CB operations to manage the payments system and achieve the interest rate target do not alter the qty of net financial assets held by the non-govt sector. For instance, open market operations are asset swaps that change the relative qty of reserve balances and Tsy’s in order to achieve the overnight target. CB loans … likewise add both an asset (the reserve balances) and a liability (the loan or overdraft) to the non-govt sector’s balance sheet.

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/a-monetarist-theory-of-neochartalism.html?cid=6a00d83451688169e20120a660806f970b#comment-6a00d83451688169e20120a660806f970b

    I append another exchange from Nick Rowe’s blog on the topic. Even though Nick Rowe does not quite agree with RSJ’s position, he agrees at least that “helicopter drops” by the central bank do have a fiscal aspect and are not purely monetary policy.

    RSJ:

    That is called fiscal policy. Helicopter drops are fiscal policy. When you give someone money for free, that is a transfer. I would prefer not to give transfers to those who bought bad debt per se, but again, that is a matter for politicians to decide, not the central bank.

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/06/why-its-a-really-good-thing-that-the-ecb-has-overpaid-for-greek-junk-bonds.html?cid=6a00d83451688169e20133efa0be18970b#comment-6a00d83451688169e20133efa0be18970b

    Nick Rowe in reply:

    If the bonds are government bonds, then by your definition, *all* monetary policy is fiscal policy. …

    “Helicopter drops are fiscal policy.” They are both monetary and fiscal. A money-financed transfer payment to whoever picks up the cash off the ground.

    So again, sorry, I did not want to confuse you on purpose and muddy matters.

    But it seems pretty clear to me that ordinary monetary operations do not change the net financial positions of private actors – since either government liabilities (treasuries) held as assets by the banks are exchanged for reserves, or banks can borrow against eligible collateral (government bonds) [even here, where the cb "buys" private debt, it does not take on risk, because the loan has to be collateralized by a risk-free asset!]. Both of these operations do not change the net financial position of the banks.

    This is different in non-conventional monetary operations, where the central bank takes on private credit risk (MBS) instead of risk-free assets. This clearly has a price-distortion effect and is in some sense a subsidy, so it has a “fiscal” aspect, in the sense that it is re-dsitributionist.

    I think we actually agree on the facts, and only differ in our evaluation. And I admit it is partially my fault, for not making clear how I am thinking about this.

  121. Gravatar of Tom Brown Tom Brown
    3. February 2013 at 08:23

    @Shining Raven, Thanks. I too thought it might just be “B” but he makes the point of writing “more Treasury debt is sold” … which is what threw me.

    Regarding on-selling: I don’t have a bigger point other than to point out the difference between the two methods (on-sell vs TT&L) regarding the consolidated balance sheets. I don’t see how it affects your argument… just wanted to point that out in case you saw a reason why it should.

  122. Gravatar of Shining Raven Shining Raven
    3. February 2013 at 08:23

    I think I’ll bow out here, my posts get increasingly longer, and I don’t want to end up looking like M_F (whom I believe to be quite sharp, although I don’t share his point of view, and who nonetheless writes posts that are too long – so I guess I’ll take him as a warning).

  123. Gravatar of Shining Raven Shining Raven
    3. February 2013 at 08:24

    @ Tom Brown: Thanks!

  124. Gravatar of Tom Brown Tom Brown
    3. February 2013 at 09:34

    @Anybody? It seems to me that excess reserves remain excess reserves on the consolidated bank balance sheet until:

    1. Gov issues debt… in which case they become excess reserves again as soon as the gov spends the proceeds.

    2. Fed exchanges Treasuries for them in OMOs

    3. Private non-banks withdraw their deposits in the form of paper bills and coins.

    4. Banks make enough loans to private non-banks such that what was once excess reserves becomes required reserves.

    Am I missing a mechanism here?

    1. Is a wash since the Gov will surely spend the proceeds. 2. Is not likely to happen in our current circumstances (in fact the opposite is happening with QE)
    3. I can’t believe this is a significant mechanism to reducing excess reserves, especially since paper bills and coins will most likely be redeposited in private non-bank deposit accounts again, at which point they become excess reserves again.
    4. The only means I see for excess reserves to decline in our current circumstances.

  125. Gravatar of Nobody Nobody
    3. February 2013 at 14:04

    So..

    All I want to know is:

    Should we finally get into the Stock Market at all time new highs on Monday or not? (out since 2008)

    How high can the DJIA go if the Fed continuously purchases the current 85B every month for the next 2 years?

    Will we see DJIA 25,000 / 35,000 in a couple years? Is this still a risk free trade as it has been the last 4 years?

    If we get in the market at all time highs can we count on the Federal Reserve to prop up the market if it starts to go against us so not to wipe out the little savings we have left for retirement?

    Any insight would be great!!

  126. Gravatar of John Taylor Espouses The Republican Line on…Everything | Political Algebra John Taylor Espouses The Republican Line on…Everything | Political Algebra
    21. August 2013 at 10:27

    [...] Wall Street Journal op-ed. In response, Money Monetarist (and Republican) Scott Sumner showed the inconsistency of Taylor’s [...]

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