Why would tapering hurt Indonesia?

Tyler Cowen has a new post discussing the financial strains in developing Asia. At the end he suggests that some of their problems are due to expectations that the Fed will taper QE. I doubt that plays much of a role, but would acknowledge that the alternative explanations are not very appealing either. When the picture is this muddled, it almost always suggests that more than one factor is involved.

So what’s wrong with the tapering explanation of Indonesia’s problems? Tyler even suggests that it fits the market monetarist methodology—market indicators suggest tapering is the problem.

Maybe they do, but it’s also the case that market indicators fit another explanation just as well—Indonesia is being hurt by expectations of stronger growth in the US, in much the same way that America’s 1929 boom caused problems for the rest of the world (via higher interest rates.) The question is not why is the Indonesian stock market down 21 percent. The real mystery is why are US stocks higher than when the taper talk began? Perhaps they should also be down 21 percent. Long term real interest rates have risen sharply in recent months. That should cause a stock market crash, unless the higher rates are caused by something that would also raise equity prices. And what might that be? Obviously stronger real growth in America is one possibility (although there are others as well.)

However Evan Soltas showed that although US stocks have done well in recent months, they’ve tended to fall on days where taper talk raised long term yields. OK, but that implies that the mysterious X-factor driving up US stock prices is even stronger than we thought, as it’s also had to overcome the negative effect of taper talk. And I admit that I just don’t see the signs of stronger economic growth. But then what’s going on with US equity markets?

I’d encourage everyone to take a deep breath and let’s wait 12 to 18 months, by which time it may be easier to see what’s going on right now. Here are some other issues to consider:

1. The article Tyler links to implies that Indonesia’s being hit by an adverse supply shock (lower RGDP growth and higher inflation.) But the numbers provided suggest the shock is mild, at least so far. Could this be the China slowdown hitting Indonesian commodity exports? Australia has recently been hit by this shock. Or are higher real interest rates reducing investment in Indonesia, and hence forcing “re-allocation?” This is where QE tapering could hurt Indonesia.

2. Why blame QE? If the mechanism is higher real interest rates caused by changing conditions in US credit markets, then it’s the exact same mechanism as in the late 1990s, when the US high tech boom made things difficult for many developing countries.

In other words, some countries may be more sensitive to volatility in global real interest rates than other countries. And again, if QE were causing that volatility then US equity prices should be reflecting that fact. But with a few exceptions they are not.

Here’s another way of making the same point. Write down on a piece of paper a monetary rule that makes real interest rates less volatile than NGDPLT. Can’t do so? Neither can I. That means that monetary policy actions by the Fed that are aimed at stabilizing NGDP, do not obviously make US real interest rates more volatile, and hence can’t be blamed for hurting fragile economies that are sensitive to real rate shocks. In that case tapering may be a problem, but only because it destabilizes NGDP. In that case the Fed is erring not because rates are rising, but because NGDP growth would be slowing.

Just to be clear, I’m not saying that higher global real interest rates that are caused by changing conditions in US credit markets cannot hurt Indonesia. They can, just as higher global oil prices caused by Chinese factors hurt the US in mid-2008. But if someone said that the higher Chinese oil prices were caused by less Chinese oil supply, and not more Chinese demand for oil, a skeptic would ask why Chinese consumption of oil had increased. And if someone claims that higher global real interest rates are caused by tighter money in the US, and not stronger RGDP growth expectations in the US, a skeptic will ask why US equity prices are much higher than a few months back.

I am skeptical of my own analysis here, as I just don’t see the faster growth that stock investors seem to see. But I’m also skeptical of alternative explanations. We need to let the dust settle to figure out what’s going on here.

PS. Did the Indonesian central bank take advantage of QE by allowing faster NGDP growth? If so, then they arguably contributed to the current instability.

HT: CA


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58 Responses to “Why would tapering hurt Indonesia?”

  1. Gravatar of mbka mbka
    26. August 2013 at 19:09

    Just FWIW and without proffering a solution: here in Singapore, the consensus of semi official and private chatter on investment matters, newspaper analysis etc., has long been that QE has fuelled Singapore’s real estate boom through unnatural capital influxes and that it caused all sorts of bubbles elsewhere in the region too. Further, consensus is that all this is going to come down now that QE is about to end. All this is practically presented as fact. (Counter-measures are being taken as well, for instance Singapore just introduced much tighter credit checks to limit the escalating debt service ratios of families to a maximum of 60% of income. That is because everyone expects interest rates to rise globally.)

    Come to think of it, this means that bankers and officials in the region have an Austrian model of the world (printing hot money in the US leads to bubbles elsewhere).

  2. Gravatar of Steve Steve
    26. August 2013 at 19:23

    http://www.thejakartaglobe.com/business/indonesia-announces-moves-to-reduce-imports-lift-investment/

    A slowdown in growth in China has squeezed demand and prices for Indonesia’s most lucrative exports — from coal to tin and palm oil, while foreign portfolio investment and foreign investment has slowed sharply on expectations the US Federal Reserve will taper its bond-buying program later this year.

    The slide in exports is coinciding with strong domestic demand for imports, stoking a trade deficit. In the second quarter, Indonesia’s current-account deficit was a worse-than-expected $9.8 billion, among the highest on record.

  3. Gravatar of Steve Steve
    26. August 2013 at 21:24

    This doesn’t help the CA balance, either:

    http://www.thejakartapost.com/news/2013/08/26/indonesia-may-miss-oil-output-target-year-operators-wary-after-graft-scandal.html

    Indonesia recently cut its oil output target from 900,000 barrels per day (bpd) to 840,000 bpd, or 6 percent lower, amid production decline in the past years due to aging oil fields, which prompted the country to leave OPEC in 2008.

    or this:
    http://www.businessweek.com/news/2013-08-02/freeport-s-grasberg-output-may-fall-20-percent-short-of-2013-target

    Freeport-McMoRan Copper & Gold Inc.’s (FCX:US) production at Grasberg in Indonesia, the world’s second-largest copper mine, may be 20 percent below this year’s target after a deadly tunnel accident in May suspended work.

  4. Gravatar of Benjamin Cole Benjamin Cole
    26. August 2013 at 21:39

    My reading on the DJIA is that is started retreating when the tapering talk seemed to get real.

    Why Indonesia? Well, it was a hot market for a while.

    And Beckworth has pointed out, that the Fed is the central bank to much of the world, since it is the global international reserve currency, and many currencies are essentially pegged to it (including the Thai baht). When the Fed expands, so does the Thai central bank…and maybe even the PBoC.

    What is all comes back to is that now is no time for central bankers to plant their wing-tipped shoes on the throat of the global economy to cut off the monetary air supply. More stimulus is needed—preferably, targeting healthy increases in NGDP.

    I am beginning to think that central banking is too important to be left in the hands of central bankers…their way of avoiding inflation and bubbles is perma-rcession and ZLB.

    And they seem to be getting their way….

  5. Gravatar of Doug M Doug M
    26. August 2013 at 21:55

    What if we got really fundamental? What is the real rate in Indonesia? Based off of the last years CPI it is negative. Either the exchange rate must fall or the rates must rise.

  6. Gravatar of Portfolio Careerist Portfolio Careerist
    26. August 2013 at 22:29

    My two cents on the US stock market: it seems possible for highly indebted companies that have recently lost money to make potentially significant upside moves. Of course these stocks and the overall market can turn down instantly and we won’t really know a year or so from today whether the rising market correctly saw steady/higher economic growth. Still, it’s fascinating to ponder how far the US stock market has come since the March-2009 bottom and how it’s plausible that it may yet go even higher.

  7. Gravatar of Prakash Prakash
    27. August 2013 at 00:54

    Hi Scott,

    Price level targeting is better than inflation (a derivative of price) targeting, giving a greater certainty for the future. Extending that logic one step, might Nominal Net Worth Level Targeting be better than Nominal GDP (a derivative of wealth) targeting?

  8. Gravatar of Singapore and southeast Asia and tapering Singapore and southeast Asia and tapering
    27. August 2013 at 02:11

    [...] is from a comment at Scott Sumner’s blog, I had exactly the same [...]

  9. Gravatar of Ben J Ben J
    27. August 2013 at 02:20

    Prakash, Scott supports a growth level target in NGDP.

    The distinction between Inflation Targeting and Price Level Targeting is equivalent to the distinction between a Nominal GDP growth target and a Nominal GDP Growth Level target, not a “nominal net worth level target”.

  10. Gravatar of TallDave TallDave
    27. August 2013 at 02:22

    OTOH, that 7.3% drop in durable goods suggests Tyler is probably right about this.

    http://online.wsj.com/article/SB10001424127887323407104579036592131161998.html

    The problem with QE is that the Fed is still lugging around an implicit promise to roll it all back. The long-term target is still too low (or, more accurately, targeting the wrong variable).

  11. Gravatar of TallDave TallDave
    27. August 2013 at 02:25

    the consensus of semi official and private chatter on investment matters, newspaper analysis etc., has long been that QE has fuelled Singapore’s real estate boom through unnatural capital influxes

    Quite distressingly, the right here in America has the same view of QE in relation to the stock market. It’s like they’ve forgotten money flows!

  12. Gravatar of Singapore and southeast Asia and tapering | Symposium Magazine Singapore and southeast Asia and tapering | Symposium Magazine
    27. August 2013 at 03:06

    [...] is from a comment by mbka at Scott Sumner’s blog, I had exactly the same [...]

  13. Gravatar of david david
    27. August 2013 at 04:03

    @mbka

    Or maybe they just target an exchange rate band and refuse to adjust it in the face of QE, and so suffer domestic inflation as well.

  14. Gravatar of Yichuan Wang Yichuan Wang
    27. August 2013 at 04:17

    The thing about stock prices is that they should represent the *discounted* value of all future cash flows. So if the expected path of real rates rises, of course you should see stock markets lose ground. Therefore the fact that equity markets have been growing reflects a very robust outlook for future growth prospects.

    However, if higher real growth in the U.S. draws capital away from Indonesia, then this could cause capital outflows that may adversely affect investments there. But so long as monetary policy can stay on track, there’s little reason why long run growth should be hurt.

  15. Gravatar of Ironman Ironman
    27. August 2013 at 05:32

    Scott Sumner wrote:

    However Evan Soltas showed that although US stocks have done well in recent months, they’ve tended to fall on days where taper talk raised long term yields. OK, but that implies that the mysterious X-factor driving up US stock prices is even stronger than we thought, as it’s also had to overcome the negative effect of taper talk. And I admit that I just don’t see the signs of stronger economic growth. But then what’s going on with US equity markets?

    Until recently, and specifically until 2:42 PM on 19 June 2013, what was going on in U.S. stock markets hasn’t been related to QE.

    Stock prices began rallying on 15 November 2013 in response to what we’ve described as the Great Dividend Raid of 2012. Here, influential investors responded to the potential risk of having the taxes that apply to dividends and capital gains triple following the re-election of Barack Obama, which guaranteed that substantially higher tax rates would take effect in 2013. That was the fiscal cliff crisis.

    Their response was to raid the funds being set aside to pay dividends in 2013 to instead pay out higher or special dividends before the end of 2012. That created a powerful incentive for investors to buy and hold stocks at the time.

    But, that was only the first phase of the so-called fiscal cliff crisis.

    The second phase came after the resolution of the fiscal cliff crisis, which defined how much income tax rates and the tax rates for dividends and capital gains would be going forward.

    For influential investors (the owners/managers/leaders of companies who have the ability to choose between salaries and dividends in how they are compensated), the new higher tax rates rates that applied against them created an incentive to favor taking their compensation in the form of dividends rather than as wages or salaries.

    The second part of the fiscal cliff rally then began as they began shifting money away from paying themselves large salaries, which shows up in the accounting on their companies books as reduced costs. That same accounting boosted the companies reported earnings – the same earnings from which a higher level of dividends are paid.

    Keep in mind that this action boosted profits (earnings), without a corresponding increase in revenues. Those have been largely stable throughout all this period.

    Stocks then continued their rally through the end of the first quarter. After that, investors began setting stock prices more in accordance with the expectations associated with a forward-looking focus on the first quarter of 2014, which was interrupted by Bernanke’s comments at 2:42 PM on 19 June 2013, which raised the prospects of an earlier end to QE, coming as early as by the end of the third quarter of 2013.

    Since that time, the forward-looking focus of investors has been split between the expectations that apply in 2013-Q3 and in 2014-Q1. Before the Syria noise event that began this morning, their forward-looking focus was almost equally split between these alternative futures.

    If you follow the links at the bottom of that last link above, you’ll find the whole history describing how the Fed’s comments related to the future of QE has affected stock prices since 19 June 2013 as we documented it in real time.

    Hope this helps!

  16. Gravatar of Brian Donohue Brian Donohue
    27. August 2013 at 05:56

    I’m with Yichuan and Benjamin Cole. Interest rates in this country are up be A LOT since the summer of 2012- something like 1.3%. Looking at TIPs, we see that all of this increase had been real- inflation expectations continue to tick along around 2%. And stocks have been money- the S&P 500 up about 25% since last summer, although all of this came by May, when the tapering talk began. Since then, stocks have ‘held up’ as rates increased. Bullish.

    It’s like we’ve traversed about half of the “short-term/long-term” trick we’ve been trying to pull off since 2009, and inflation remains in check. If I’m the Fed, I’m not rushing this taper thing.

  17. Gravatar of TravisV TravisV
    27. August 2013 at 08:45

    Prof. Sumner,

    You really should praise Ramesh Ponnuru for writing this:

    https://www.nationalreview.com/nrd/articles/354941/cause-depression

    http://www.aei-ideas.org/2013/08/did-the-housing-crash-cause-the-great-recession-no-it-was-the-fed

  18. Gravatar of Carl Carl
    27. August 2013 at 09:02

    Endless unverifiable speculation.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 09:41

    Off topic but I’ve caught John Quiggin saying some very silly things about Australia’s 1990 recession:

    http://johnquiggin.com/2013/08/26/a-note-on-the-ineffectiveness-of-monetary-stimulus/

    August 26th, 2013

    A note on the ineffectiveness of monetary stimulus – John Quiggin

    “A commenter on the previous post raised the idea, promoted by the “market monetarist” school, that monetary policy is so effective as to make fiscal policy entirely unnecessary, at least when interest rates are above the zero lower bound. My views on this issue were formed by the experience of the late 20th century, and in particular, the recession that began in 1990, following steep increases in interest rates. Having planned a “short, sharp, shock”, the RBA started cutting rates in January 1990.

    They didn’t go for 25 basis point moves in those days. Over the period to December 1992, rates were cut by more than 12 percentage points, from 17.5 per cent to 5.25 per cent. Over the same period, unemployment rose from 6 per cent to 10.9 per cent, a record for the period since the Depression. As I said in the previous post, tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.”

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 09:42

    1) Nominal interest rates are a terrible measure of monetary policy stance.

    The following is a graph of Australia’s nominal short term interest rates (blue), year on year CPI inflation rate (red) and real short term interest rates (green) from 1987 through 1996:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134407&category_id=0

    Year on year CPI inflation fell from 8.7% in 1990Q1 to 0.3% in 1992Q4. Since short term interest rates fell from 15.8% to 5.7% during this time period this means real short term interest rates only fell from 7.1% to 5.4%.

    The 1993 and 1999 versions of the Taylor Rule assumes that a real interest rate of 2% is the long run real neutral interest rate. Admittedly the Taylor Rule’s assumptions may not be applicable to Australia, but 5.4% is still a very high rate of real interest by any standards. The lowest that Australia’s real short term interest rates fell to in the early to mid-1990s was 2.3% in the second half of 1995.

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 09:44

    2) Even real interest rates are a very poor measure of monetary policy stance.

    One way of thinking about this is the Taylor Rule, which is simple rule for the appropriate level of the policy interest rate given the gap between inflation and the target inflation rate (say 2%) and the gap between unemployment and the natural rate of unemployment. The following is the 1999 version of a Taylor Rule for Australia (red) graphed along side the short term interest rates (blue) and the residual (green) from 1987 through 1996:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134410&category_id=0

    In constructing this Taylor Rule I’ve assumed the long run real neutral interest rate is 2% and that Australia’s natural rate of unemployment was 8% throughout this period. The OECD’s estimate of Australia’s NAIRU varies from 7.4% to 8.5% during this period, increasing from it’s low prior to the recession and peaking at its high when the unemployment rate peaked. Furthermore I’ve assumed an Okun’s Law coefficient of 1.8 based on Lawrence Ball’s recent estimates for Australia during 1980-1995 (“Okun’s Law: Fit at Fifty?”).

    Note that the residual increased from (-1.5%) in 1990Q1 to 9.8% in 1992Q4 and would not get close to 0% until mid-1995. Regardless of one’s opinion of the various parameters one thing is clear, by the standards of a simple rule monetary policy got much tighter, not easier from 1990Q1 to 1992Q4.

    And the policy rate never fell below 4.75% in the early to mid-1990s, so Australia didn’t have the excuse of the zero lower bound. Based on Ian Macfarlane’s recollections below, monetary policy was intentionally tight during this period as a means of reducing the inflation rate.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 09:45

    http://www.petermartin.com.au/2006/12/truths-about-australias-recession.html

    December 1, 2006

    Truths about Australia’s recession
    By Peter Martin

    “Australia’s Reserve Bank deliberately dragged its feet in moving to end the early 1990’s recession, according to its recently retired Governor Ian Macfarlane.

    In the latest of his Boyer Lectures, to be broadcast on Sunday, the former Governor says that the Bank decided to move slowly in ending the recession in order to grab a once-in-a-generation opportunity to turn Australia into a low-inflation economy.

    At the time Mr Macfarlane was an Assistant Governor under Governor Bernie Fraser.

    In the lecture he says that “in earlier recessions, all the policies and all the government rhetoric were pointed towards re-expanding the economy as quickly as possible and reassuring the public that all efforts were being made to cushion the blow”.

    But that in 1990, once it became apparent that Australia was going to have a recession “it was reasonably quickly realised that there was an opportunity to achieve something of lasting value out of the unfortunate events”…

    He says that while the bank did cut interest rates from 1990 it did it “in a measured fashion” in order to ensure that inflation did not rekindle.

    It was a new approach that the former Governor says had the support of the Government led by Prime Minister Bob Hawke and Treasurer Paul Keating.

    “It is significant that in March 1991, in the middle of the recession, the Government was prepared to announce a further phased reduction in tariffs, a move that would reduce inflation but do nothing to support the economy,” he said.

    In his lecture Mr Macfarlane is at pains to point out that the bank did not set out to create a recession in order to reduce the inflation rate. It merely took advantage of the opportunity that the recession presented it with.

    “The experience throughout the developed world… demonstrates an unfortunate but inescapable fact – no country with an entrenched inflation problem has significantly reduced inflation without it occurring in the context of a recession. While everyone would like to find a softer way of doing so, without incurring the unemployment costs of a recession, no-one has found such a way.”

    The former Governor says he finds it odd that in the United States the success of the Fed Chairman Paul Volcker in destroying inflation in early 1980’s is viewed positively while in Australia “the equivalent disinflation of the early 1990s tends to be viewed as a monetary policy mistake.”…”

  23. Gravatar of Milton Freeman Milton Freeman
    27. August 2013 at 09:49

    Just in-case anyone missed this. http://www.vice.com/en_uk/read/larry-summers-and-the-secret-end-game-memo

    Here’s the actual memo sent to then “DEPUTY SECRETARY SUMMERS” http://www.gregpalast.com//vulturespicnic/pages/filecabinet/chapter12/Geithner_Summers%20Memo.pdf

    If Summers really is chosen by Obama as Geithner was for the Treasury there may be more at play here than meets the eye.

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 09:54

    P.S. In the final analysis the only way to judge monetary policy stance is by the level of NGDP. And the rate of change in Australia’s NGDP plunged in the early 1990s:

    http://research.stlouisfed.org/fred2/graph/?chart_type=line&s1id=AUSGDPNADSMEI&s1transformation=pch

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 09:56

    Fixed link:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134422&category_id=0

  26. Gravatar of Morgan Warstler Morgan Warstler
    27. August 2013 at 11:07

    from Ramesh Ponnuru:

    “During these five years many economists and institutions have been ridiculed for having suggested, beforehand, that the economy could easily handle the decline of housing prices. Yet these forecasts weren’t wrong — or, if they were wrong, they erred only in implicitly relying on the Fed not to botch its job. The common wisdom that “financial crises lead to slow recoveries,” as applied to our economy, also understates the role of the Fed. Instead, very tight money led first to a financial crisis and then to a slow recovery.”

    I get that we see the causality going this way, but when I see it asserted, I feel like we’re being naive purists.

    Ultimately “financial crises lead to slow recoveries,” might be true PRECISELY because when they happen…

    The Fed can be expected to slow shit down while they make sure the bankers are ok first.

    My gut tells me that IF we stayed on 4.5% NGDPLT while “the economy could easily handle the decline of housing prices”

    that overall, the banks themselves would be a FAR WORSE position than they are today, relative to everyone else.

    As one bank after the next was forced to take the losses during the great home price unwind, even while the economy kept growing at 4.5%.

    And it would have been BRUTAL to banks.

    The way it has worked out there are still millions of homes in shadow inventory that often have someone who hasn’t made a mortgage payment in years.

    Home prices are appreciating, so banks have kept the non-performing assets out of the market.

    IF however the banks got no IOR, they got no bailouts, and instead they were just told to eat the losses and keep selling off the homes while the fed kept things at 4.5%.

    Well I’d be ecstatic!

    And that ought to give MM pause.

    It might be better to ask the question: If the Fed kept everything going at 4.5% perhaps the public would have been UNAFRAID of the fin crisis, and shrugged as the banks ate shit and died.

    And maybe thats why we don’t have 4.5% NGDPLT.

  27. Gravatar of TravisV TravisV
    27. August 2013 at 11:14

    Morgan,

    That is an awesome awesome AWESOME point!

  28. Gravatar of TravisV TravisV
    27. August 2013 at 11:21

    Morgan,

    Remember that Prof. Sumner’s theory is that the main obstacle to NGDPLT is the consensus of academic economists.

    Your alternative theory that the banks are the main obstacle is extremely cynical. One reason for doubting it is that the equity of the big banks collapsed to nearly zero. Surely their stock prices would have done much better with 4.5% NGDP growth.

    However, you are right that the big banks are substantially bigger than they were prior to the crisis. There’s been a lot of consolidation.

    So now, after the dust has settled, the executives of the biggest banks are probably more powerful than they used to be. Fair enough.

  29. Gravatar of Morgan Warstler Morgan Warstler
    27. August 2013 at 12:27

    TravisV,

    I don’t disagree the consensus economists need to move to MM.

    I have long argued that the Fed is first and always concerned with making sure the banking system is stable. Those economists somehow focus on bank stability not economic stability when the chips are down…. during a financial crisis.

    So I’m trying to think thru how Bankers would view a stable NGDPLT where somehow they got into a housing crisis, if Fed is running on auto-pilot / futures etc.

    Which brings up another point I have never been able to make the math work with here…

    If we start at 2000 and slope out 4.5% NGDPLT, even 5% NGDPLT, there’s a moment when early (like 2004) on the Fed simply stops buying debt, no?

    In fact they start selling shit to get back down to level.

    In such an environment, HOW do the banks and mortgage originators keeps offering no-look loans?

    BC, say in Jan 2005, we hit 5.1 LT%, and Fed starts selling, and in that month housing guys fight it, and they pump GDP up even more and it gets to 5.2%

    The fed is now pulling out a bazooka it’s dumping T-Bills on the market like CRAZY.

    So, HOW DO WE GET A HOUSING BOOM?

    Whenever I ask Scott he says NGDPLT would stop the huge run up in housing prices.

    And it has never made sense to me.

    If the housing “boom” would ave been 20% smaller bc of NGDPLT, thats a massive savings ont he downside.

    How could it not be far more than that?

    How can the mortgage guys keep packaging homes in 200%, when the Fed is dumping everything it owns on the market to get back down to 5%?

    Anyone?

  30. Gravatar of Morgan Warstler Morgan Warstler
    27. August 2013 at 12:28

    “Whenever I ask Scott he says NGDPLT would NOT stop the huge run up in housing prices.”

    fixed

  31. Gravatar of François François
    27. August 2013 at 12:42

    @Scott Sumner

    Did you notice the recent change of trend of inflation expectations (Cleveland Fed)? Quite interesting IMHO. And would explain why US equities are up while bond yields are rising.

    Regards,

    Francois

  32. Gravatar of Scott Sumner Scott Sumner
    27. August 2013 at 13:27

    Mbka, Isn’t it more likely that low rates in the US, Europe and Japan caused by ultra weak NGDP growth led investors to seek higher returns in Asia? The ECB tried to raise rates in 2011, but they failed, and rates plunged even lower. So perhaps low rates did feed an investment boom in Asia, but not low rates caused by QE, rather low rates caused by weak growth.

    Everyone, I’m on a plane now, and will take the other comments when I return.

  33. Gravatar of Geoff Geoff
    27. August 2013 at 15:37

    “Maybe they do, but it’s also the case that market indicators fit another explanation just as well—Indonesia is being hurt by expectations of stronger growth in the US, in much the same way that America’s 1929 boom caused problems for the rest of the world (via higher interest rates.)”

    It’s comments like these that reinforce my existing conviction that Dr. Sumner has issues thinking like an economist. This analysis is of a political strategist who views the market in terms of a zero sum game, irreconciliable conflicts of interest manner. One nation’s gain ipso facto causes another nation’s loss.

    This idea that other nations are harmed “via higher interest rates” conflates “cheaper money” with economic health. It is not true that higher interest rates “harm” the general economy, nor is it true that lower interest rates “benefit” the general economy. Lower and higher interest rates are a reflection of existing economic health, specifically, the rate of time preference. If they are artificially manipulated by central banks, then both higher and lower interest rates can harm the general economy.

    In real terms: as both Smith and Ricardo showed, when one nation develops, in a context of world trade, all nations become better off, not just the developing nation. When the US developed quickly during the 1920s (which contained malinvestment as well due to the Federal Reserve System inflating money and credit unduly), it became a greater exporter of wealth to the rest of the world, including those nations whose interest rates changed.

  34. Gravatar of Geoff Geoff
    27. August 2013 at 18:45

    While inflationistas are fretting over future reduction in inflation, here is what actual inflation has done to the “median” worker in this country:

    http://i.imgur.com/SgGLhUG.gif

    This is economic stagnation. This is inflationism. This is what market monetarists want to exacerbate with their paper money fetishism.

  35. Gravatar of Geoff Geoff
    27. August 2013 at 18:45

    While inflationistas are fretting over future reduction in inflation, here is what actual inflation has done to the “median” worker in this country:

    http://i.imgur.com/SgGLhUG.gif

    This is economic stagnation. This is inflationism. This is what market monetarists want to exacerbate with their paper money fetishism.

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 19:05

    Scott,
    John Quiggin replied to my comment. Here’s part of his reply and my response.

    “A case of traps for young players, I’m afraid. In those days, the CPI included mortgage interest rates, so raising (lowering) interest rates produced an illusory increase in measured inflation. The actual reduction was more like 3.5 percentage points, from 6 to 2.5.”

    Fortunately FRED also has Australia’s household final consumption expenditure price index (HFCEPI) which has never included mortgage interest rates. Let’s repeat the analysis with it and see how much difference it makes.

    1) Nominal interest rates are a terrible measure of monetary policy stance.

    The following is a graph of Australia’s nominal short term interest rates (blue), year on year HFCEPI inflation rate (red) and real short term interest rates (green) from 1987 through 1996:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134407&category_id=0

    Year on year HCEPI inflation fell from 7.0% in 1990Q1 to 1.5% in 1992Q4. Since short term interest rates fell from 15.8% to 5.7% during this time period this means real short term interest rates only fell from 8.8% to 4.2%.

    The 1993 and 1999 versions of the Taylor Rule assumes that a real interest rate of 2% is the long run real neutral interest rate. Admittedly the Taylor Rule’s assumptions may not be applicable to Australia, but 4.2% is still a very high rate of real interest by any standards. The lowest that Australia’s real short term interest rates fell to in the early to mid-1990s was 2.5% in the second half of 1993.

  37. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 19:13

    Excuse me. Correct link.

    http://research.stlouisfed.org/fred2/graph/?graph_id=134494&category_id=0

  38. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. August 2013 at 20:13

    Scott,
    Here’s the remainder of John Quiggin’s reply and my response.

    “On the second point, it’s a semantic difference, not a real one. I’m using an absolute measure of the stance of policy, you’re measuring it relative to to the Taylor rule which (in my terminology) prescribes expansion when unemployment rises.”

    Let’s repeat the analysis with the HCEPI and then I’ll address this point.

    2) Even real interest rates are a very poor measure of monetary policy stance.

    The following is the 1999 version of a Taylor Rule for Australia (red) graphed along side the short term interest rates (blue) and the residual (green) from 1987 through 1996:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134496&category_id=0

    Note that the residual increased from 1.1% in 1990Q1 to 8.1% in 1992Q4 and the lowest it would get in the early to mid-1990s was 2.0% in 1995Q3. Regardless of one’s opinion of the various parameters one thing is clear, by the standards of a simple rule monetary policy got much tighter, not easier from 1990Q1 to 1992Q4.

    Conceptually the real neutral interest rate is associated with the real interest rate level which implies that monetary policy is neither expansionary nor contractionary. In the long-run, the real neutral interest rate is determined by economic fundamentals such as the long-term savings behaviour, productivity, population growth etc. But in the short run, the real neutral interest rate is affected by the disturbances to the economy that influence the prospect of closing the output gap in the medium term, in particular the size of the output gap itself.

    Thus when unemployment is above the natural rate, as it was from 1991 on, the short run real neutral interest rate is likely to be below the long run real neutral interest rate. It may not be as low as the rate given by a Taylor Rule, but nevertheless real short run interest rates were relatively high throughout the early to mid-1990s. Thus I find it difficult to believe that anyone could possibly think that Australia’s monetary policy was expansionary in the early to mid-1990s.

  39. Gravatar of Prakash Prakash
    27. August 2013 at 21:21

    Ben J,

    I can understand the question as I think I skipped a step there. I’m not saying that this is the correct way of thinking about these.

    But this is the sequence of derivatives I thought of.

    Nominal Net worth , Nominal Net Worth Growth ~ Nominal GDP , Nominal GDP Growth

    There are reasons why nominal net worth growth may be a slightly better measure than Nominal GDP because of the whole “goods” and “bads” debate. But there is no denying that it is a much more difficult thing to measure.

    If financial independence is the goal of economic agents, then why look at targeting Nominal Net worth Growth or Nominal GDP growth level, when we can go a step deeper and choose to target Nominal Net Worth?

    I hope it is clearer now.

  40. Gravatar of Ben J Ben J
    27. August 2013 at 23:21

    Scott,

    Great post from Yichuan Wang about how stocks are not “in a bubble” and that monetary policy does not (or at least has not) caused “bubbles” in stock prices.

    http://noahpinionblog.blogspot.com.au/2013/08/popping-bubble-bubble.html?m=1

  41. Gravatar of James in London James in London
    28. August 2013 at 02:17

    Of course, if you (or I) could regularly work out why equity markets are where they are and where they are going you would be Warren Buffett and not a humble Bentley Prof. We can all dream.

  42. Gravatar of TravisV TravisV
    28. August 2013 at 06:09

    Morgan,

    Check out this story!

    http://www.theatlantic.com/business/archive/2013/08/the-2-biggest-things-the-washington-post-got-wrong-about-the-budget/279058

    Two points:

    (1) I’m not sure that Obama is really all that “liberal” (i.e. push to grow the government as much as possible).

    (2) Quantitative Easing is conservatives’ best friend. The tool of QE makes it possible to push govt spending / GDP lower and lower and lower over time.

  43. Gravatar of Suvy Suvy
    28. August 2013 at 06:46

    It’s because of the capital flows. Every single financial crisis has to do with the international flows of capital that’s usually triggered by expansions/contractions in liquidity. The reason that these countries are facing current account deficits and losing control of their countries is because these markets that were flooded with liquidity are now seeing the liquidity rapidly withdrawn. The twin deficits(fiscal and current account) are putting major downward pressure on their currencies.

  44. Gravatar of Assorted Links | azmytheconomics Assorted Links | azmytheconomics
    28. August 2013 at 07:39

    [...] 5. Sumner on Asian volitility [...]

  45. Gravatar of AldreyM AldreyM
    28. August 2013 at 08:47

    Off-Topic,

    The last posts of Nick Rowe were very interesting.

  46. Gravatar of TravisV TravisV
    28. August 2013 at 09:48

    Pethokoukis on Twitter:

    “We continue to expect second-half 2013 real GDP to average 3.25%” – Deutsche Bank

    Wow! Too optimistic?

  47. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. August 2013 at 10:44

    Scott,

    John Quiggin responded to my reply and here it is with my response.

    John Quiggin:
    ““Tightening relative to a monetary rule” is another way of saying as “Not relaxing as much as the monetary rule prescribes”. It doesn’t matter which you use, as long as we are clear that we are using the world “expansionary” differently.”

    Obviously my last comment wasn’t clear enough. Expansionary monetary policy would be the equivalent of a real short term interest rate less than the real neutral rate of interest. All other things being equal, the short run neutral rate is lower than the long run neutral rate when the unemployment rate is above the natural rate. This is true completely independently of the Taylor Rule.

    There are simple econometric methods for estimating the short run neutral interest rate, but I take it that is beyond the scope of this conversation, and it should not be necessary in order for me to make my basic point. From 1969Q3 through 2013Q1 the real short run interest rate has averaged 2.20% in Australia, and I submit that is a reasonable proxy for the long run real neutral rate there. Thus when the unemployment rate is above the natural rate, any real short run interest rate above 2.20% should be contractionary.

    John Quiggin:
    “I could quibble more about the numbers, but even on your own numbers, we see the real interest rate falling from 8.8 per cent to 4.2 per cent, while unemployment went up like a rocket. You say that this was 8 per cent too high, which implies that we would have hit the zero nominal lower bound on your Taylor rule.”

    They are not “my” numbers. They come from the Federal Reserve who in turn got them from the OECD, who in turn got them from the Australian Bureau of Statistics: Australian National Accounts: National Income, Expenditure and Product – Table 5. Expenditure on Gross Domestic Product (GDP), Implicit price deflators, Households; Final consumption expenditure; Seasonally Adjusted ; Series ID A2303940R. If you go and check you will see the values are identical among all three institutions.

    The fact that the real short run interest rate fell is less important than the fact that it was too high throughout. Whether it fell from 8.8% to 4.2%, or from 88% to 42% it was above the long run real neutral interest rate of 2.2%. Unemployment had risen to 7.9% by 1990Q4, and the OECD’s estimated NAIRU for Australia is 7.5% in 1990, so it was already above the natural rate by then, implying that the short run real neutral rate was below 2.2% fairly early on. And yet, real short run interest rates averaged 7.7% in 1990, 6.2% in 1991, 4.3% in 1992, 2.9% in 1993, 4.2% in 1994 etc. So monetary policy was contractionary throughout. Of course unemployment went “up like a rocket”.

    As for my Taylor Rule, it doesn’t prescribe a rate below zero until 1992Q2. That’s over two years of tight monetary policy before the zero lower bound was reached.

    John Quiggin:
    “Having been there at the time, I’m confident that a cut to zero wouldn’t have made a lot of difference. Do you think it would?”

    Guess.

  48. Gravatar of ssumner ssumner
    28. August 2013 at 12:32

    Thanks Steve, That makes sense.

    Ben, I agree, but that just goes to show that the tapering talk is not the dominant market influence. Something else is dominating equities.

    Prakesh, NGDPLT is to NGDP growth rate targeting as price level targeting is to inflation targeting. So you have the wrong analogy. You do not want to target wealth because the goal is to stabilize the labor market.

    TallDave, What does that have to do with Tyler’s argument? I think everyone agrees that tapering is contractionary.

    Yichuan and Brian, I agree.

    Ironman, I’m not sure I follow the argument. Taxes on dividends rose sharply. How does that make it more profitable to take dividends?

    Mark, That’s right, criticize a MM argument by referring to interest rates as an indicator of the stance of monetary policy. When will the Keynesians learn?

    Morgan, Yes, the Fed rescued banks rather than Main Street, whereas they should have done the reverse. NGDPLT make sit easier to do the reverse.

    Francois, Thanks, is there a link?

    James, And even Buffett has never been able to predict the direction of equity MARKETS.

    Suvy, Never reason from a capital flow. Ask what’s causing the capital flow.

    Thanks Aldrey,

    Travis, I just don’t see the growth that others see. I think 2% is closer to the truth.

    Mark, Regarding Quiggin’s last point, a cut to zero would have indicated that monetary policy had failed. The correct policy would have been NGDPLT. Having said that, your other post implies the policy succeeded, as the RBA was trying to copy Volcker. So why does he regard policy as a failure?

    Keynesians play lip service to the notion that interest rates reflect the condition of the economy, but then keep reverting to the idea that they somehow reflect the stance of monetary policy.

  49. Gravatar of François François
    28. August 2013 at 12:54

    @ Scott Sumner

    Here is the link. I would have thought that you would be familiar with that page … :-)
    http://www.clevelandfed.org/research/data/inflation_expectations/

  50. Gravatar of ssumner ssumner
    28. August 2013 at 13:08

    Thanks Francois.

  51. Gravatar of TallDave TallDave
    28. August 2013 at 13:37

    Scott — Well, it seems like evidence of lower growth, at least.

    Mark, Regarding Quiggin’s last point, a cut to zero would have indicated that monetary policy had failed. The correct policy would have been NGDPLT.

    Agree. I still feel strongly that CBs have not really tried to inflate until they at least raise the inflation target, like BOJ has started doing. I’m not sure how much others agree, but I think it helps amplify the point that conventional policy isn’t exhausted at ZLB (even if NGDPLT is clearly better than conventional policy).

  52. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. August 2013 at 14:05

    Scott,
    “Regarding Quiggin’s last point, a cut to zero would have indicated that monetary policy had failed. The correct policy would have been NGDPLT. Having said that, your other post implies the policy succeeded, as the RBA was trying to copy Volcker. So why does he regard policy as a failure?”

    Quiggin’s original post indicates he thinks that because the RBA made large cuts to nominal interest rates over a period of 2.5 years that they tried to stimulate the economy and failed. When I pointed out that the decrease in real interest rates was not that great, and that by a Taylor Rule they made policy tighter, not looser, he criticized my measure of inflation and pointed out that a Taylor Rule is designed to produce expansionary policy when unemployment is high.

    So I changed the measure of inflation, which barely changed my results, and I pointed out that when unemployment is high that the short run neutral rate should be below the long run neutral rate so anything above say about 2% when unemployment is above its natural rate is contractionary.

    In his response he continued to quibble over the data and merely reiterated what he said previously about the Taylor Rule apparently because he didn’t understand what I was trying to say. This time he seemed to be claiming that *any* decrease in real rates is expansionary. My last response points out the data comes from the Australian Bureau of Statistics, and I tried to convey the absurdity of his arguing that any reduction in real interest rates is expansionary.

    I’ve been intentionally avoiding talking about other indicators of monetary policy stance because I don’t think it is necessary. Frankly his argument that any reduction in interest rates is expansionary is sufficiently stupid enough on its face that I’ve allowed him to dig himself in deeper and deeper.

    His argument also seems to be:
    1) This is how I remember events, so it must be true.
    2) I’m older than you, so there.

    Isn’t he supposed to be a top ranked economist? Instead of admitting his argument is weak he seems to be resorting to proof by intimidation.

  53. Gravatar of TallDave TallDave
    28. August 2013 at 14:38

    Thanks for sharing Mark, I have to agree. Keep up the good fight!

    More and more it seems like the debates tend to boil down to “what is expansionary monetary policy for a given place and time?” That seems to be the main barrier to understanding why NGDPLT is a better policy — at least, it really clicked for me after thinking about that more.

  54. Gravatar of Morgan Warstler Morgan Warstler
    29. August 2013 at 02:46

    “Yes, the Fed rescued banks rather than Main Street, whereas they should have done the reverse. NGDPLT make sit easier to do the reverse.”

    - Scott Sumner

    Note to MM all out there blogging: put the meat in the window.

    Write headline posts like the above quote, then explain to people. Mechanize NGDPLT (imagine running at level and see when since 2000, the punch bowl would have been taken away.

    Then, once people see things would be different starting 2004-2005, run thru a hypothetical fin crisis where the Fed doesn’t let NGDPLT fall. Extraordinary asset purchases for sure. If people insist on seeing it handle a sudden shock, even tho they don’t build up as much under NGDPLT, tell them how much extra-ordinary and what does that mean / would be required in late 2008.

    Travis, QE makes sequester cuts go down. Now as we taper, the Fed is going to let the Govt. pay more for their debt, while the Fed keeps the mortgage train going.

    Tho, the continued buying of MBS is really about the banks, and not about Main Street.

  55. Gravatar of ChrisA ChrisA
    29. August 2013 at 04:03

    Sorry, a bit late for this thread. But can someone explain to me why printing more fiat currency than would be the case otherwise (i.e. QE) lowers interest rates rather than raises them (all things being equal). It seems like QE would raise inflation expectations, thus raising natural interest rates. So tapering off QE should lower interest rates (all things being equal). So what is disturbing the South East Asian markets is not QE being tapered, but increasing expectations of growth in the West, which is raising natural interest rates. QE being tapered is more of a coincidence, since obviously the FED is also watching the economy and seeing growth.

    I know there is this theory that QE has lowered long term interest rates by buying up secure assets, so lowering their price by supply/demand. But I don’t understand how that works overall. I mean anyone selling their assets must have an alternative investment in mind (otherwise why sell their asset) which yields better than the current asset. So again QE should cause a shift into higher yields not lower.

    What am I missing?

  56. Gravatar of ssumner ssumner
    29. August 2013 at 10:20

    TallDave, Yes, but I don’t think “slower growth” was Tyler’s argument. Perhaps you mean it makes it less likely that the rise in rates were due to higher growth. As I said, I also fail to see signs of higher growth.

    Mark, Yes, interest rates are a silly way to talk about monetary policy.

    Chris, That’s a very good question.

  57. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. August 2013 at 10:23

    Scott,
    The debate with John Quiggin continues. Here is Quiggin’s latest reply with my response:

    John Quiggin:
    “OK then, I’ll make some points on the data. First, the starting point for the cash rate was 17.5 per cent, as I said in my post, not 15.8 per cent. So, to restate, the cut was about 12 percentage points. If you can call this a contraction, I think you are in

    http://thediacritics.com/2011/08/23/humpty-dumpty-meaning-of-words/

    Humpty Dumpty territory.”

    The value of 15.8% represents a quarterly average of nominal short term interest rates. And, to be technical, the cash rate target was in a range from 17.0% to 17.5% from January 23, 1990 through February 14, 1990.

    To reiterate, nominal interest rates are a terrible measure of monetary policy stance, real interest rates are somewhat better. Furthermore even changes in real interest rates are a terrible measure of monetary policy stance. To be clear, it is the level of real interest rates that matters, not the change. And if the rate to which it is changed is still higher than the real neutral interest rate, then monetary policy is still contractionary in the sense that it is conducive to a reduction in real output.

    John Quiggin:
    “Also, the most relevant inflation variable is expected inflation, which was about 4 per cent as measured by the difference between nominal and inflation-adjusted bond rates, or 5 per cent, as measured by consumer surveys. Expectations adjusted more slowly than actual inflation rates, because most people expected a bigger resurgence of inflation than actually took place.”

    This is may be a good point but it presents some problems. The main consumer survey of inflation expectations is the Westpac/Melbourne Institute survey, and it does not appear that I have access to such historical data. As for inflation adjusted bond rates, the RBA records seem to indicate that none were issued from 1988Q2 through 1992Q4. However we know that the indexed bond yield was 4.74% in 1988Q1 and 4.62% in 1993Q1. Since 10-year bond yields averaged 12.20% in 1988Q1 and 8.13% in 1993Q1 this means inflation expectations were 7.46% in 1988Q1 and 3.51% in 1993Q1.

    Note that real rates barely changed, so almost all of the reduction in 10-year bond rates reflected a change in inflation expectations. Thus it is possible to approximate inflation expectations from April 1988 through December 1992 by subtracting 4.68 (the average of 4.74 and 4.62) from the 10-year bond yield. This proxy has the additional advantage that FRED has Australian 10-year bond yields in monthly frequency.

    Ten year bond yields averaged 12.2% in January 1990 and 8.94% in December 1992. Thus this estimate of inflation expectations declines from 7.52% in January 1990 to 4.26% in December 1992. The real call rate target thus declined from 9.48%-9.98% in late January 1990 to 1.49% in December 1992 by this measure. However, assuming Australia’s long run real neutral rate is 2.2%, then the real call rate target did not fall low enough to be economically expansionary until January 1992 by which point unemployment had already risen to 10.1%. I’ll link to a graph of relevant data in a subsequent comment since it will be held for moderation.

    Inflation expectations calculated from indexed bond yields indicate that real call rates by this measure never dropped below 1.5% except in May through August 1994. Interestingly, it was in fact the summer of 1994 when unemployment first started to rapidly drop. But by 1994Q4 the real call rate target was again above the long run real neutral rate of 2.2%. So even by this measure monetary policy was only expansionary in 1992Q1 through 1994Q3, and only significantly expansionary in the summer of 1994.

    As a bonus, I’m including a revised Taylor Rule for 1988Q2 through 1992Q4. I’ve made the following changes; I’ve raised the real neutral rate to 2.2%; I replaced inflation with the aforementioned proxy for inflation expectations; I replaced the Okun’s Law coefficient with a more precise value of 1.81; I replaced the natural unemployment rate with a value of 7.73%, which happens to be the weighted average of the OECD’s NAIRU estimates for 1988Q2 through 1992Q4. I’ll include the link to the graph in the subsequent comment.

    The Taylor Rule residual rises from (-0.3) points in January 1990 to 4.5 points in December 1992. Almost all of the increase occurs between April 1990 and April 1991 when it rises from (-2.7) to 4.3 points. The Taylor Rule residual is positive from November 1990 on forward during this period. The only time the Taylor Rule prescribes a rate below 1.3% is in July 1992 when it falls to 0.5%.

    Extending the Taylor Rule calculations forward using indexed bond yields to estimate inflation expectations, and the OECD’s annual NAIRU estimates, reveals that the only month that the Taylor Rule residual drops below zero is August 1994. So this largely confirms what the real call rates already revealed.

  58. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. August 2013 at 10:23

    Here are the links to the updated graphs:

    http://research.stlouisfed.org/fred2/graph/?graph_id=134839&category_id=0

    http://research.stlouisfed.org/fred2/graph/?graph_id=134860&category_id=0

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