Kelly Evans on NGDP futures markets
Jared Pincin and TravisV sent me an excellent discussion of NGDP futures by Kelly Evans on CNBC. It’s great to see the idea gaining momentum.
I like the way she describes the idea as a “prediction market.”
Just back from Seattle–will try to get caught up on comments.
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3. July 2013 at 04:53
Great news.
What’s needed is less Delphic interpretation the Fed’s intentions and the market’s expectations. If we take no other lesson from the last two months, it should be that.
3. July 2013 at 04:54
* less Delphic interpretation OF the Fed’s…
3. July 2013 at 07:53
I think we could do even better than settling for a “prediction” market.
I think NGDP futures could be traded on the back on an “underlying commodity” if we had capital securities whose payouts are linked to NGDP. An issuer of this could be sovereigns, who among other things, may want to achieve more equity-like financing. They could be the biggest sellers of NGDP risk — and so could some macro economy-driven private agents. Buyers of the risk would be almost anyone who already takes bets on the growth of the economy.
The NGDP “underlying” could be in the form of warrants attached to debt, or NGDP-linked payments making up or supplementing the payments on any security. Immediately upon issuance, the embedded instrument could be stripped, and NGDP could trade either as a separate commodity or at worst as “implied NGDP.” Eventually, to the extentent the Fed is unable maintain the realized volatility of NGDP at zero, an options market could also emerge, and that would be even more interesting.
I should say though, that one or two past EM debt restructurings may have involved the issuance of such warrants (Argentina comes to mind), and that this form of financing did not catch on..,But I think this was for reasons that could be addressable.
3. July 2013 at 10:01
GDP futures markets would exist if people wanted them. The CBoT tried to launch an inflation future. But there was not enough interest to sustain that market.
If you are going to create a liquid GDP futures market who will have a reason to take each side?
3. July 2013 at 10:16
Scott, I’d love to get your reaction to this:
http://idiosyncraticwhisk.blogspot.com/2013/06/a-just-so-story-about-recent-divergence.html
It’s my speculation about the recent market reactions after the Fed’s June meeting. I don’t think there was Fed tightening so much as Fed clarification, which reduced uncertainty about future monetary policy and inflation. The change in the forward yield curve suggests that this is what happened. It might be reasonable for this to decrease the implied inflation expectations in TIPS spread, increase nominal interest rates, and decrease equity prices, which is what happened.
3. July 2013 at 10:21
Doug,
The TIPs market provides most of the inflation betting/hedging/information on inflation the markets appears to need. If one wanted something more “stripped” out, they could pay/receive on OTC CPI swaps.
Almost anyone who benefits from a rise in NGDP (starting with governments) could be natural payers/selllers of NGDP risk. They could issue warrants that pay more as NGDP rises (essentially, sort of a covered sale) for consideration that reduces their all-in cost of borrowing. These warrants could be attached to bonds, or the bond payments could be NGDP linked. (In fact, governments should almost be “forced” to do this, as it is a great form of countercyclical financing…on both sides of an NGDP cycle.)
Anyone who seeks to make money investing in securities that are, essentially, leverage (operating or financial) bets on economic growth (stocks, corporate debt, etc), could be buyers.
3. July 2013 at 11:51
MG, That might work, but I think the forecast in a prediction market would be less biased, as “TIPS spreads” (or the NGDP equivalent) can be distorted by liquidity shifts.
Doug, That’s exactly my point. It’s why I want the Fed to create and subsidize a prediction market.
kebko, Interesting theory, but I have a hard time believing that inflation uncertainty had been increasing. It seems to me that in recent years markets have become ever more convinced that inflation will stay close to 2%.
3. July 2013 at 13:55
I’ll stop after this post, because I don’t want to annoy you by beating a dead horse.
1) Before the Fed announcement, the slope of the yield curve in Eurodollar futures increased by about 2bp between each quarter around late 2014. After the announcement, the slope now increases by about 3-4bp between each quarter. This increase in the convexity of the forward curve is highly suggestive of increased confidence about the date of the first rate increase. (If there was complete certainty about that date, for instance, the yield curve would be flat until late 2014, then kink up to some positive slope). Whether you think inflation uncertainty was high or low before, a decline in uncertainty about near future interest rates was undoubtedly the most important change in the last episode of interest rate movements.
2) I think that instead of being more convinced about inflation staying close to 2%, markets had actually lowered their inflation expectations to 1.5-2%, but with less certainty about outlier possible outcomes. I don’t know how to parse this out of the data – both of those expectations would lead to similar TIPS spreads. But, where we have the Fed pushing into novel policies that they don’t seem fully capable of managing well, using uncertainty as an explanation of the TIPS spread shouldn’t be controversial.
3. July 2013 at 15:58
Prof. Sumner,
This might not shock you but JOE STIGLITZ IS THE WORLD’S 2ND-MOST INFLUENTIAL BUSINESS THINKER!
I repeat: JOE STIGLITZ IS THE WORLD’S 2ND MOST INFLUENTIAL BUSINESS THINKER!!
Here’s the full list:
http://krugman.blogs.nytimes.com/2013/07/03/nobody-pays-any-attention-to-what-i-say
2013:
Paul Krugman
Joseph Stiglitz
Bill Gates
Michael Porter
Thomas Friedman
Eric Schmidt
Richard Branson
Malcolm Gladwell
Robert Reich
Jack Welch
Muhammad Yunus
Niall Ferguson
Michael Dell
Howard Gardner
Jimmy Wales
2008:
Gary Hamel
Thomas Friedman
Bill Gates
Malcolm Gladwell
Howard Gardner
Philip Kotler
Robert Reich
Daniel Goleman
Henry Mintzberg
Stephen Covey
Jeffrey Pfeffer
Peter Senge
Richard Branson
Michael Porter
Michael Dell
3. July 2013 at 16:05
MG,
Theoretically, nearly everyone who has money has an interest in buying protecting against the devaluation of their money. They would be buyers of inflation protection. But who is the natural seller of inflation protection? There really isn’t anyone. Inflation contracts lack “two way flow.”
“Doug, That’s exactly my point. It’s why I want the Fed to create and subsidize a prediction market.”
How does the Fed subsidize the market? Again we need two way flow. Which side is the fed going to take? If we are talking about creating a prediction market, we are talking about getting a signal from a price change. (where did I hear “never reason from a price change?”) How does the fed subsidize the market without simultaneously distorting the price signal?
3. July 2013 at 17:20
Futures markets only work if the underlying is actually deliverable, and subjectively valued by individuals as an object of economic action.
NGDP does not qualify for this, thus there can be no NGDP futures market (which is why there is no market generated NGDP futures market now).
It is a silly idea grounded on a technocratic planner mentality divorced from an understanding of the market process.
3. July 2013 at 17:21
And note that I’ve read all the important literature on NGDP futures, so that last post is NOT in any way a product of ignorance.
3. July 2013 at 17:23
Dr. Sumner has mentioned many times that the incentive for investors to invest in NGDP futures is the interest the Fed pays on margin accounts.
Well, those would be nothing but fixed income instruments, valued in accordance with the rate the Fed arbitrarily sets. There would be no valuation of NGDP.
Oil futures, wheat futures, sugar futures, stock futures, etc, real world futures contracts are purchased because the underlying is actually deliverable and subjectively valued as objects of action. No individual can take delivery of “aggregate expenditures”.
The idea fails.
3. July 2013 at 17:25
Geoff,
Again the fool shows his face. Cash settlement is already the SOP for European options, so why can’t an ngdpfm be built that way?
4. July 2013 at 05:06
Goldman Sachs and Deutsche Bank had a short-lived project of Economic Derivatives that included variables like initial unemployment claims. It used existing infrastructure and studies showed it was weakly more accurate than conventional forecasting methods. Goldman came out for NGDP targetting. Why hasn’t someone lobbied them to restart the project with an NGDP derivative?
4. July 2013 at 05:17
kebko, Is it possible that confidence about when rates would rise increased, without any necessary increase in confidence about future inflation? In other words, the markets became more convinced that the Fed was set to act over a given time frame, but not necessarily dependent on the data?
MG, I don’t agree with your reply to MG. I would benefit from a “devaluation of money” as would many others. And I’m not even a debtor.
I’ve described the subsidies many times; the government would pay above market rates on the margin accounts of those who trade. Those who went long and short would share equally in the subsidies.
Geoff, I can’t tell when you are joking.
Sam, Good question.
4. July 2013 at 22:55
Scott,
It’s possible, but within the last couple of months, we’ve had people from the Fed both publicly pushing for an immediate tapering and publicly gnashing teeth about the dangers of unwinding the balance sheet incorrectly. The Fed announcement calmed both fears. A taming of these fears would have to be manifest through expectations about inflation uncertainty. I was looking for examples of investment banks worrying about this, when I found this, from June 21:
https://www.jpmorganfunds.com/blobcontent/409/22/1323362247509_MI-MB_TimetableForQE.pdf
I talk about it here:
http://idiosyncraticwhisk.blogspot.com/2013/07/a-just-so-story-about-recent-divergence.html
They basically have the same reading as me, but they think the S&P500 decline is an overreaction. In addition to my earlier thoughts, I also wonder if we are seeing deleveraging in the bond and equity markets because of the reversal out of a period where their returns have been negatively correlated. The recent uptick in interest rates from positive economic news plus the Fed reassurance that markets going forward might be less susceptible to wide discretionary monetary directions could have led to an unwinding in these positions. I have a chart in my post linked above on the correlation.
The conventional wisdom was to assume that rising rates were from tightening, and to read tightening into the Fed position that wasn’t there. There are plenty of reasons to explain the recent markets as a result of what I and JP Morgan agree the Fed actually said.
5. July 2013 at 05:58
kebko, That report may be right about market overreaction, but much of the report is utter nonsense, particularly the claim that QE was contractionary, or that more stimulus is not needed.
This is why we need a NGDP futures market, to address these sorts of questions.
5. July 2013 at 09:22
I agree with you about that…I might have been unclear above. I agree that most of the report is standard bunk about monetary policy. The part that I was agreeing with was that JP Morgan didn’t think the fed had tightened, but were still selling bonds anyway. And they were wrong about the overreaction in equities. My point is that there are reasonable causes for seeing equities fall.