Nothing to see here folks, move right along

While many of our famous macroeconomists, pundits and bloggers insist we need fiscal stimulus because the Fed and BoE and ECB are out of ammunition, Japan continues to prove them wrong:

Kuroda’s first policy meeting since taking office on March 20 was seen as a big test of his ability to steer the BOJ towards unorthodox measures to meet the inflation target it adopted in January, and markets liked what they saw.

Government bond futures soared and the benchmark 10-year bond yield hit 0.425 percent, its lowest ever. The yen, which had been creeping up in the run-up to the meeting, plunged, driving the dollar up by more than 2 percent to around 95.25 yen from around 92.90 before the decision.

The Nikkei stock index unwound losses of more than 2 percent to end up 2.2 percent, just shy of a 4-1/2 year closing high hit last month.

The BOJ will buy 7.5 trillion yen of long-term government bonds per month, roughly 70 percent of bonds sold in markets. It combined two bond-buying schemes, its asset-buying and lending program and the “rinban” market operation, to buy longer-dated government bonds, including those with duration of 40 years.

The stock market actually rose over 4% on the news, as it was down sharply right before the announcement.  And of course the decision was widely expected, so the market response merely reflects the extent to which the bond purchase was larger than expected.  It makes more sense to look at the stock market reaction since Abe first stunned the markets with a 2% inflation target proposal, while running for office in mid-November 2012.  The Japanese stock market is up 45% since that announcement.  The yen is down roughly 20%.

Some people will discuss whether the policy will “work.”  It’s already worked.  The yen plunged on the news.  That’s not supposed to happen when you are stuck in a liquidity trap.  More proof that fiat money central banks are never “trapped” by anything other than their timidity.  If the actual inflation rate doesn’t rise to 2%, then do it again, and again, and again, and again.  Suppose the yen went to 200, would there be no inflation?  How about 400?

Off topic, there is some evidence that sequestration is hitting the labor market. New unemployment claims are rising. Is that inconsistent with “monetary offset?” Of course not. Monetary offset can’t perform miracles. If the Fed did enough stimulus late last year to offset expected fiscal austerity in 2013, the high frequency data would still show variation from month to month, depending on exactly when the Federal layoffs actually occurred. Thus if the Fed was determined to keep RGDP rising at 2% despite austerity, you might see 3% RGDP growth in a quarter with no federal layoffs, and 1% RGDP growth in a quarter with layoffs. The Fed’s policy changes tend to occur about once per year, and hence cannot offset month-by-month real GDP growth rates. Monetary offset by the Fed will have failed (which is certainly possible) if RGDP growth for all of 2013 comes in under the 2% seen in recent years.

HT:  Cameron, Steve.


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38 Responses to “Nothing to see here folks, move right along”

  1. Gravatar of Justin Irving Justin Irving
    4. April 2013 at 06:00

    Scott, I think we have a bit of a problem. Japanese bond yields *fell* sharply on this news. Maybe there is some idiosyncrasy in the Japanese bond market wherein the liquidity effect dominates when big bond purchases are expected…I don’t know what to make of it though.

  2. Gravatar of Mikio Kumada Mikio Kumada
    4. April 2013 at 06:06

    Hello Scott, I thought you might be interested in this: It shows how important Governor Kuroda considers communicating the central bank’s goals to EVERYBODY, i.e. via the 2-2-2-2 chart: 2% inflation, in 2 years, 2x monetary base, 2x amount bonds purchased. Even my grandma will now understand what the central bank wants to achieve. A far cry from the old BOJ regime’s convoluted technical press releases with appendixes and exhibits that even economists got a headache reading sometimes (if they didn’t get bored).

    http://www.bloomberg.com/image/iaSDyG.kZLjU.jpg

  3. Gravatar of TallDave TallDave
    4. April 2013 at 06:18

    I am excited.

    This is the biggest test of monetary stimulus in recent memory. If it works in Japan, the “liquidity trap” model will crumble and the United States may finally adopt a pro-growth monetary policy — even as the support for fiscal stimulus collapses.

    Very, very interesting times!

  4. Gravatar of TallDave TallDave
    4. April 2013 at 06:20

    Justin Irving — I thought that was odd at first too, but all it really means is that the markets don’t expect much inflation (after all, the target is still only 2%).

  5. Gravatar of The Bank of Japan, Milton Friedman, and the death of Austrian austerity | AEIdeas The Bank of Japan, Milton Friedman, and the death of Austrian austerity | AEIdeas
    4. April 2013 at 06:28

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  6. Gravatar of John John
    4. April 2013 at 06:36

    I’ve never seen monetary policy linked to real GDP like this on the blog before. It seems like the reasoning among a lot of economists right now is that higher inflation will lead to higher short-term growth which will lead to higher long term growth by getting the economy out of a ditch. Once that happens, the Fed can back off on inflation in the future. This reminds me a lot of the Keynesian argument that we need more government spending now and we can work on reducing deficits later. Color me skeptical that there will be the political will at any point in the future to reduce deficits or inflation should that become necessary.

  7. Gravatar of Mikio Kumada Mikio Kumada
    4. April 2013 at 06:38

    To Justin: I don’t see the fall in bond yields as a problem, but as an intended consequence. Japan’s bonds have consistently offered positive real yields, and still do. Whereas all other advanced economies, since 2008/2009, have negative real yields. Even many emerging economies have (or have had long periods of) negative real yields. The only exceptions are the über-austerity-suffering euro periphery countries which don’t have their own central banks…

  8. Gravatar of The Bank Of Japan Has Finally Decided That The Japanese People Have Suffered Enough | CfpDir.com The Bank Of Japan Has Finally Decided That The Japanese People Have Suffered Enough | CfpDir.com
    4. April 2013 at 06:42

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  9. Gravatar of Steve Steve
    4. April 2013 at 07:17

    I am uneasy with the pronouncement that the one day market reaction (or financial market reaction of any term) is “proof” of success. Indication? Sure. I understand that the market reaction indicates a change in expectations – which is critical. But the true ultimate objective is higher inflation, and beyond that, higher growth/employment, etc. The unemployed couldn’t care less if expectations have changed (for a day).

  10. Gravatar of phil_20686 phil_20686
    4. April 2013 at 07:29

    An expansion of the monetary base should cause yields to fall in the first instance, since everyone tries to off-load their excess cash, some of it into JGB’s. Some of the rest of it will go into spending, and this will raise NGDP, which will then raise interest rates.

    This is just an example of time lags. If rates ares still depressed a year from now, then its a big problem for MM.

  11. Gravatar of Aidan Aidan
    4. April 2013 at 07:42

    Is sequestration hitting the labor market and causing unemployment claims to rise (if this isn’t just statistical noise) because “monetary offset can’t perform miracles” still evidence of a zero fiscal multiplier?

  12. Gravatar of Dan S Dan S
    4. April 2013 at 07:51

    Phil,

    Wouldn’t that present a pretty obvious profit opportunity, contra EMH? That would also seem to run counter to MM.

  13. Gravatar of Basil H Basil H
    4. April 2013 at 07:54

    Professor Sumner – Any thoughts on the fall in the JGB interest rates after the announcement? Is the huge increase in demand from the BoJ outweighing the drop in demand as investors substitute to riskier assets due to expectations of higher growth?

  14. Gravatar of TheMoneyIllusion » Baum and Horwitz on NGDP targeting TheMoneyIllusion » Baum and Horwitz on NGDP targeting
    4. April 2013 at 08:34

    [...] this new policy really work? Economist Scott Sumner says it already [...]

  15. Gravatar of Geoff Geoff
    4. April 2013 at 08:41

    Justin Irving:

    “Japanese bond yields *fell* sharply on this news. Maybe there is some idiosyncrasy in the Japanese bond market wherein the liquidity effect dominates when big bond purchases are expected…”

    You must be new here.

    Given OMOs X, if bond yields rise, then it is a confirmation of MM theory, and if bond yields fall, then it is a confirmation of MM theory.

    I’ve been saying for a long time on this blog that there are at least two forces acting on bond yields when central banks inflate, depending on what they buy. The upward pressure on prices from the “liquidity effect” that results from purchasing bonds instead of consumer goods, and the downward pressure on prices from the “inflation premium effect” that results from consumer price inflation itself which will happen anyway at some point regardless of what the Fed buys.

    I don’t know how many times I’ve seen blog posts pointing to falling bond yields right after an inflation announcement, in various countries around the world, as proof that inflation necessarily “hurts” bond holders, that inflation annoucements raise bond yields, and other ways of saying the same thing.

    Now in Japan bond yields fell and we’re still expected to believe theory confirmation.

    You won’t see anything like “OK, I admit it, OMOs can benefit bond holders if the liquidity effect dominates the inflation premium effect.”

  16. Gravatar of davida davida
    4. April 2013 at 08:43

    @TallDave – there was another very similar test of monetary stimulus in recent times in a very similar country:

    “So, after 2000 the Bank of Japan engineered a huge increase in the monetary base; this was the original quantitative easing. And it didn’t even translate into a surge in the money supply! This is why I’m so skeptical of people who say that all the Fed has to do is target higher nominal GDP growth — in liquidity trap conditions, the Fed doesn’t even control money, so how can you blithely assume that it controls GDP?”

    http://krugman.blogs.nytimes.com/2010/10/29/more-on-friedmanjapan/
    http://krugman.blogs.nytimes.com/2010/10/28/friedman-on-japan/

  17. Gravatar of Justin Irving Justin Irving
    4. April 2013 at 09:10

    The bond market shouldn’t be concerned with statistical constructs like inflation.

    Bond yields in a deeply traded market should be a forecast for the minimum expected return on assets denominated in a country’s currency (plus a risk premium/penalty, depending on what’s happening in Europe). The Japanese plan clearly boosted expected NGDP growth, so why did yields fall? There could be subtle reasons which fit within MM, but I am uneasy. I don’t buy the delayed effects argument either because of EMH.

  18. Gravatar of ssumner ssumner
    4. April 2013 at 09:12

    Justin, I discuss that in my newest post.

    Mikio, Thanks for that info. But it is probably not enough to generate 2% inflation. I hope I’m wrong, but I think they’ll need to do more.

    TallDave, FDR refuted the liquidity trap model in 1933, Bernanke refuted it when the dollar fell 6 cents against the euro on the day QE1 was announced. but I guess we have to do it over and over again.

    Steve, All monetary policy can do is generate expectations that nominal aggregates will be on target.

    Japan is not there yet, but it is closer. The “success” is that they clearly moved a bit closer to where they want to be. Clearly this won’t be enough by itself to solve Japan’s problems, but it is expected to generate faster NGDP growth, and you really can’t ask for more than that.

    Market reactions are better than “outcome” tests, because who knows what the unemployment rate would have been in the absence of QE? This is why Japan needs to create and subsidize a NGDP futures market, so that there is a clear way to test the effectiveness of monetary policies. And of course level targeting, which they still refuse to do (and which Bernanke recommended the BOJ do.)

    John, No, that’s not my argument. I favor steady NGDP growth to avoid creating problems, not to “solve problems.” It’s the Keynesians who want to solve problems with fiscal stimulus.

    phil, If short term interest rates are expected to rise later, then there should be no time lag in the response in long term bonds.

    Aidan, Yes it is consistent, if you are considering whether fiscal austerity will affect 2013 growth. If NGDP growth for 2013 is below 4% or if RGDP growth is below 2% then I believe it’s fair to say that monetary offset failed and the multiplier was above zero. That may occur, as obviously the Fed is far from perfect. I’ve always argued that estimates of fiscal multipliers are nothing more than estimates of central bank incompetence.

    Basil, I discuss that in my new post.

    Everyone, As I’ve said dozens of times “OMOs can benefit bondholders if the liquidity effect dominates the inflation effect.”

  19. Gravatar of ssumner ssumner
    4. April 2013 at 09:15

    Justin, I don’t buy the delayed effect either. The bond markets are telling us that rates will stay low, even as inflation rises. Japan’s inflation is likely to rise to 1% or 1.5%, not 2%. America has zero interest rates despite 1% population growth and 2% inflation. Why shouldn’t Japan have zero rates if they have 1% inflation and falling population?

  20. Gravatar of Justin Irving Justin Irving
    4. April 2013 at 09:25

    Ok….that sounds pretty good Scott. The liquidity effect pushes down yields, and because this at most means 2.5% NGDP growth, there is still little prospect of BOJ going back to a short-rate driven policy framework. Demographic decline (falling investment demand) and (maybe?) a haven premium from the euro zone mess explain why yields are out of synch with expected NGDP growth. Damn this macro thing is slippery!

  21. Gravatar of The BoJ has it´s work ‘cut-out’ | Historinhas The BoJ has it´s work ‘cut-out’ | Historinhas
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  22. Gravatar of TallDave TallDave
    4. April 2013 at 10:41

    davida — notice the lack of numbers there. Clearly Krugman was wrong about them “not controlling money,” look what happened when BOJ changed the target (and quite modestly).

    Aidan — One month of $43B in annualized cuts to a $3.8T budget in a $15.6T economy are showing up in the labor market? Seems unlikely. Obamacare is having a MUCH larger effect.

  23. Gravatar of TallDave TallDave
    4. April 2013 at 12:20

    The bond market shouldn’t be concerned with statistical constructs like inflation.

    Well, yes and no, obviously in nominal terms you care about what inflation does to real yields. OTOH, what does inflation mean to you as a bond purchaser?

    This is something I’ve been thinking about lately, different players are going to have different views of “inflation” — obviously Joe Sixpack cares more about a rise in wheat prices than AAPL, so it’s probably fair to say they don’t experience “inflation” the same way. I think this is a major problem with inflation targeting — you really can’t boil down a multivariate, multidimensional highly subjective concept into one number that is equally meaningful to all players. And yet that’s the basis of our monetary policy.

  24. Gravatar of Geoff Geoff
    4. April 2013 at 13:32

    Everyone:

    Dr. Sumner’s comment

    “Everyone, As I’ve said dozens of times “OMOs can benefit bondholders if the liquidity effect dominates the inflation effect.”

    Contradicts this:

    “No, inflation hurts initial receivers.”

    and this:

    “Take that, Cantillon Effect fans”: Treasuries fell after the Federal Reserve said it will buy $45 billion a month of U.S. government debt, expanding its asset-purchase program while linking its main interest rate to unemployment and inflation.

    So we have inflation hurting the initial receivers, and we have inflation potentially capable of raising bond prices which of course benefits the initial receivers.

    In, out, up, down, heads I win, tails you lose.

    And **I** am losing credibility? Says what?

  25. Gravatar of John John
    4. April 2013 at 14:16

    Scott,

    I’m sure Keynesians would favor fiscal stimulus to avoid creating problems before they happen as well. I’m just sick of hearing constantly that the answer right now is to print more and spend more. It seems that Keynesians (almost) never favor less government spending and control while Monetarists, or Market Monetarists, never favor less power at the Federal Reserve. It goes back to Milton Friedman arguing against the gold standard in favor of floating exchange rates. When you combine the two philosophies you get where we are today with massive institutions trying to run the economy, something they both initially promised not to do.

  26. Gravatar of ssumner ssumner
    4. April 2013 at 17:06

    Justin, Yup, it’s too bad that Geoff will never be able to figure that out.

    Talldave, Bond investors care much more about NGDP growth than inflation.

    John, You said;

    I’m just sick of hearing constantly that the answer right now is to print more and spend more.”

    Me too, that’s not the answer. The answer is a rules based monetary regime, preferably NGDPLT. Let the market determine interest rates and the money supply. We are in a world of second best.

  27. Gravatar of Michael Doherty Michael Doherty
    4. April 2013 at 18:31

    Wait what? Came here to get some view on Japans grand experiment. But did you just say let the market determine interest rates and the money supply. How can you target NGDP with monetary policy and still have market driven interest rates?

  28. Gravatar of ACB ACB
    4. April 2013 at 19:39

    Michael, You let the market determine what interest rate (and maybe size of OMO’s) would be consistent with 5% NGDP growth.

    In general, I think my main problem with Austrian monetary theories is I don’t understand why markets would distort the structure of production while producing the same level of NGDP. Basically, the “interest rate” produces the markets “desired” level of NGDP at that interest rate. (Of course, expectations-based theories screw with everything, but that’s another story)

  29. Gravatar of "While many of our famous macroeconomists, pundits and bloggers insist we need fiscal stimulus because the Fed and BoE and ECB are out of ammunition, Japan continues to prove them wrong: The yen plunged on the news. That’s not supposed to happ "While many of our famous macroeconomists, pundits and bloggers insist we need fiscal stimulus because the Fed and BoE and ECB are out of ammunition, Japan continues to prove them wrong: The yen plunged on the news. That’s not supposed to happ
    4. April 2013 at 20:01

    [...] Source [...]

  30. Gravatar of My Parting Remarks on Scott Sumner and Interest Rates My Parting Remarks on Scott Sumner and Interest Rates
    4. April 2013 at 23:36

    [...] The BoJ announced a major monetary expansion, and Scott quoted a news article as if it confirmed his [...]

  31. Gravatar of Mikio Kumada Mikio Kumada
    5. April 2013 at 00:52

    Scott, yes, maybe the BoJ is not doing enough for 2%. I was more impressed by the SIMPLICITY and CLARITY of how Kuroda communicates. He really wants everybody to get the message. Besides, the BoJ said yesterday that they would do more if needed… The plan alreday shocked the George Soros’ and Bill Gross’ of this world, who warned against a run on the yen… maybe the BoJ did not want to go all guns blazing. Just half of them…

  32. Gravatar of dtoh dtoh
    5. April 2013 at 01:10

    Scott,

    You said; “Mikio, Thanks for that info. But it is probably not enough to generate 2% inflation. I hope I’m wrong, but I think they’ll need to do more.”

    More in terms of monetary policy or more in terms of structural reform.

    Mikio,

    You said: “The plan alreday shocked the George Soros’ and Bill Gross’ of this world, who warned against a run on the yen… maybe the BoJ did not want to go all guns blazing.”

    I think it only shocked them because they guessed wrong and had long yen positions.

  33. Gravatar of Mikio Kumada Mikio Kumada
    5. April 2013 at 05:01

    Well, as far as the “run on the yen” is concerned (the scenario mentioned by Soros and Gross – it is theoretically possible that the Japanese lose faith in the yen and dump it for foreign assets.

    However, right now, the exact opposite is happening.

    1) Abe’s popularity ratings are at a record for any post-war leader, at 70-75%. Consumer and business sentiment indicators are looking up since Abe’s re-election. It would be schizophrenic for the Japanese to support their government’s economic polices and at the same time lose confidence in their currency.

    2) I checked the net investment flows today – they show that the Japanese are actually doing the exact opposite of what Soros and Gross fear – i.e. they are selling foreign bonds at an unusually high rate, and dumping foreign stocks at RECORD pace. Also, foreigners are buying Japanese stocks at near record rates. Foreigners are, however, net sellers of Japanese bonds – but not at an extreme rate, and that’s not so significant anyway because foreigners hold only about 5% to 10% of Japan’s government bonds (and much of those foreigners are actually foreign central banks who hold the yen for non-investment reasons such as domestic reserve management, and exchange rate policy).

    I would say, Abe, Kuroda and his team, have made a good start. The BoJ did leave the door open to do more, by the way.

    Structural reforms -> there is talk about liberalizing the energy sector and of course there is the TPP talks. More should be forthcoming. I am not sure how important that is, though…

  34. Gravatar of Aidan Aidan
    5. April 2013 at 06:55

    TallDave – I was referring to what Scott wrote in this post: “Off topic, there is some evidence that sequestration is hitting the labor market. New unemployment claims are rising.”

    While I certainly think it’s possibly that sequestration could have contributed to some of the March slow down, I never said that’s the main factor. I do think it’s possible that the payroll tax hike that market monetarists all said was a big nothingburger hurt the economy – see the retail numbers, for example.

    But I’m not going to freak out about one month’s report, or one week’s unemployment claims. I’ll wait to see the revisions and the trend line. Just something to consider.

  35. Gravatar of ssumner ssumner
    5. April 2013 at 10:43

    Michael, You let the market determine what money supply and interest rate is most likely to lead to 5% NGDP growth over the next 12 months.

    Mikio, Thanks, you certainly know more about it than I do.

    dtoh, Structural reform will boost RGDP growth, and is needed. Not sure it will boost inflation.

    Aidan. Retail sales in January and February were strong, that’s why I said it wasn’t a big factor. But I’m sure it had a SOME effect. Hours worked per worker are rising–could that be a way to hold down the cost from fringe benefits?

  36. Gravatar of Aidan Aidan
    5. April 2013 at 11:44

    I definitely agree that it’s much to early to tell. You may be right about the hours per worker, I’m not smart enough to evaluate everything at play here. I’d be more worried if January and February hadn’t been revised upward, I’m not ready to declare “recovery over” yet.

    I think the U.S. could offer as interesting a monetary policy experiment as Japan this year. I hope that you’re ultimately proven right.

  37. Gravatar of Mikio Kumada Mikio Kumada
    6. April 2013 at 06:39

    Scott, thanks for the comment. Regarding structural reform – could it be actually counterproductive at this stage (in which Japan has hardly any nominal growth), to introduce deregulation?

    Employment levels in Japan are probably high (due to a demographically induced shortage), which is a good moment for reflationary policies, but deregulation could suppress wages growth.

    Opening the agriculture sector to US goods, for example, as part of a future TPP entry, could depress food prices.

    Should these things not be timed for a later moment, once Japan has some stable nominal GDP growth?

  38. Gravatar of ssumner ssumner
    6. April 2013 at 08:08

    Aidan, I hope I’m right as well. Of course I use a target-the forecast approach, so I’m already satisfied that the fiscal effect is expected to be very small. But most people look at outcomes, not forecasts, and for that it’s anyone’s guess. I may well be wrong.

    Mikio, I actually think suppressed wage growth might be good–it might boost employment. I think it’a always a good time for supply-side reforms, even in a depression. Supply-side reforms will make it possible to raise NGDP (popular) without much increase in inflation (which is unpopular.)

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