I’m still catching up on a host of great posts. Let’s start with Yichuan Wang, who explains why rumors of tapering had such a big impact on various emerging markets. It was not the direct effect (which would obviously be tiny), but rather that it threw off their monetary policy because they foolishly focused on the exchange rate:
Here’s a link to my 3rd Quartz article on how much of the emerging market sell-off was about monetary policy failures in the emerging markets themselves. In particular, by trying to maintain exchange rate policies, central banks in these countries overexpose themselves to foreign economic conditions. The highly positive response to the recent delay of taper serves as further evidence that many of these emerging economies need better ways of insulating themselves from foreign monetary shocks. Much of the work, draws on blog posts from Lars Christensen. His examples comparing monetary policy in Australia and South Africa versus policy in Brazil and Indonesia were particularly helpful.
David Beckworth looks a a bunch of natural experiments on the efficacy of monetary policy at the zero bound:
The first quasi-natural experiment has been happening over the course of this year. It is based on the observation that monetary policy is being tried to varying degrees among the three largest economies in the world. Specifically, monetary policy in Japan has been more aggressive than in the United States which, in turn, has had more aggressive monetary policy than the Eurozone.1 These economies also have short-term interest rates near zero percent. This makes for a great experiment on the efficacy of monetary policy at the ZLB.
So what have these monetary policy differences yielded? The chart below answers the question in terms of real GDP growth through the first half of 2013:
The outcome seems very clear: when really tried, monetary policy can be very effective at the ZLB. Now fiscal policy is at work too, but for this period the main policy change in Japan has been monetary policy. And according to the IMF Fiscal Monitor, the tightening of fiscal policy over 2013 has been sharper in the United States than in the Eurozone. Yichang Wang illustrates this latter point nicely in this figure. So that leaves the variation in real GDP growth being closely tied to the variation in monetary policy. Chalk one up for the efficacy of monetary policy at the ZLB.
However I’d caution readers that the BOJ has still not done enough to hit a 2% inflation target. They have had limited success, but need to do more. They should also switch to a 3% NGDP growth target, as inflation is the wrong target.
Ryan Avent has an excellent post that is hard to excerpt.
I would be shocked if the public had any real sense of what QE is. QE is confusing. And any expectations-based strategy that relied on the public understanding precisely what QE is, or what nominal output is, or for that matter what the federal funds rate is, would be entirely doomed. But I don’t think that’s how this stuff works. I also don’t think inflation targeting works by getting everyone to expect 2% inflation and raise prices or demand pay-rises accordingly. Consumers basically never expect 2% inflation, and consumers and producers alike seem to ask for as much as they think they can get based on their observations about what other people can get. That’s one reason why I don’t think the argument that “no one knows what NGDP is” is not a strong criticism of NGDP targeting, though I also think that it would be daft for a central bank to say it was targeting NGDP rather than just, say, national income.
I think most people operate using pretty simply heuristics. They have a feeling for what it feels like to be in a boom or a bust or something between. They have a sense for when inflation—in the economics sense of the term—is eroding their real incomes. They also have in mind something called inflation which basically means energy costs. My general feeling is that over the past 20 years (and in contrast to the two decades before that) most people have not much distinguished between real and nominal, because there has been no point to doing so. Complaints about “inflation” in this period virtually always boil down to complaints about unpleasant shifts in relative prices: more expensive gas and housing, mostly.
My sense is that what the Fed should do is target the trend path for a nominal variable that minimises the consumer experience “weak job market”. I think a nominal GDP level target accomplishes that. And once the Fed adopts that target the system will work as it does around any target. The Fed message will be intermediated by financial markets. Consumers will to some extent take their cues directly from financial markets and will to some extent take their cues from the reaction by sophisticated businesses to the reaction in financial markets.
And in an even more recent post, there is this gem (in reply to a Krugman post):
In his initial post Mr Krugman writes:
“One answer could be a higher inflation target, so that the real interest rate can go more negative. I’m for it! But you do have to wonder how effective that low real interest rate can be if we’re simultaneously limiting leverage.”
But if you create higher inflation you don’t need low real interest rates to solve the demand problem; it’s already solved! Maybe this is the confusion that keeps the economy in its rut. Markets are looking to the Fed, saying “which equilibrium, boss?”. And the Fed is saying that it would prefer the adequate-demand equilibrium but priority one is keeping a lid on inflation. And markets are saying “well I guess we have our answer”.
However his final paragraph is slightly off course:
Or to be succinct about things, there is no a priori reason to think that generating adequate demand requires rising indebtedness. But when an inflation-averse central bank is trying to generate adequate demand when the zero lower bound is a binding or near-binding constraint (as it was in 2002-3 and is now) it just might.
The first sentence in that paragraph is where he should have ended the post. If the central bank is inflation averse, even more debt won’t help. I’d add that the Fed could produce a robust recovery with 2% inflation. The problem today is that inflation is below 2%, and is likely to stay there.
As far as Paul Krugman’s comment, I have no idea what he is talking about. He seems to be steadily regressing from new Keynesianism to a crude version of 1930s Keynesianism. Keynes also thought that higher inflation targets were not a solution to the zero rate trap. But Krugman should know better.
PS. Justin Wolfers also has a very good column, discussing the fall in the PCE deflator in Q2.
HT: Stan Greer, and lots of other commenters.