A distant echo of the big bang
Before beginning, I’d like to announce that Gabe Newell (CEO of Valve) has generously funded the next year of Hypermind’s NGDP futures market, and I hope to announce some new contracts (including the exciting 2014:4 to 2015:4 contract) in the next week or so. I also plan to start posting daily NGDP futures prices, as soon as I can figure out how to get a link to that market. I hope to get iPredict’s NGDP futures market fully funded by January.
The recent news has been dominated by the sharp fall in TIPS spreads. In the US, 5-year inflation expectations are down to 1.25% and the 10-year TIPS spread is 1.68%. Does this mean money is way too tight? Not necessarily, but it does suggest that money was way too tight back in early 2010 and mid-2011.
Recall that I often say, “inflation doesn’t matter, only NGDP matters.” Back in early 2010 and mid-2011, CPI inflation briefly rose above 2%. Europe also experienced above target inflation at about this time. Many observers misinterpreted this data, believing it had implications for the proper stance of monetary policy, whereas in fact NGDP is the variable that matters.
So if NGDP was so low, why was inflation above target? If there is anything we know about Phillips curve models it is that they are consistently unreliable. In early 2010 and mid-2011 there was a big increase in global commodity prices, driven by fast growth in places like China. This had no bearing on US NGDP or monetary policy. The underlying demand conditions were quite weak in both the US and Europe. In recent months the commodity boom is unwinding, and lower headline inflation is showing up. But this does not necessarily mean money is too tight in the US (although it quite likely is a bit too tight to hit the Fed’s dual mandate over the next 5 or 10 years.) Instead, the recent deflation is a distinct echo of the actual NGDP “deflation” (and why is there still no word for falling NGDP!!) that occurred in the early part of this decade. That’s when money was much too tight, but supply disruptions in the Middle East and Chinese demand temporarily inflated oil prices, helping to disguise the deflationary pressures. Now it is showing up.
This all makes the hawks look ridiculous today. Indeed they have not one but two big problems:
1. The hawks fought against monetary stimulus in 2010 and 2011, arguing that we needed to focus like a laser on 2% inflation. OK, but 5-year inflation expectations are now 1.25%, even lower in Europe. What do the hawks say today?
2. The hawks are uncomfortable with low interest rates, and have developed dubious ad hoc “theories” that low rates will create asset market bubbles and financial instability. But how do we get higher rates? The hawks ignored the wisdom of Milton Friedman (that ultra-low interest rates mean money has been tight) and the Germans got the ECB to raise rates twice in 2011. The result is exactly as Friedman would have predicted. The US is about a year away from exiting the zero bound, whereas the eurozone is 5 or 10 years away, at best. The German plan backfired.
Hawkishness was the superior monetary model in the 1970s, but has since degenerated into an atavistic set of urges: No inflation! Higher interest rates! (As if those two goals are compatible.) It’s very sad, and perhaps a blessing in disguise that Friedman is not here to seen his ideas being abandoned by the right wing of the profession.
PS. Did I forget to mention that the misleading TIPS spreads are just one more reason why we need a Federal Reserve-funded NGDP futures market? If the government won’t fund this nearly perfect example of a “public good,” with a benefit/cost ratio of more than 100,000 to 1, who will? Not the Austrians. Not the Keynesians. Not the New Classicals. Not the RBC economists. Only the MMs are stepping up to the plate to make it happen.
PPS. Oh, and where are all the people who said in mid-2013 that Bernanke’s tapering comments caused much higher bond yields, proving that only QE was holding down yields? QE ended many months ago, and rates keep falling lower and lower. The market is financing our still large budget deficits at 2.74% on the 30-year bonds. Is that the “liquidity effect?” Is that “Cantillon effects?” Don’t be silly.
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13. December 2014 at 09:29
>>The hawks fought against monetary stimulus in 2010 and 2011, arguing that we needed to focus like a laser on 2% inflation. OK, but 5-year inflation expectations are now 1.25%, even lower in Europe. What do the hawks say today?>>
The same thing they said then. We must raise interest rates. They’re quite consistent. They certainly don’t admit error. (Today’s Krugman on the subject: http://krugman.blogs.nytimes.com/2014/12/13/is-our-economic-commentators-learning/ )
It seems to be one of the enduring features of being a hawk (or certainly those hawks) – all conditions demand raising interest rates.
13. December 2014 at 10:02
The former economist at Valve (now apparently a consultant for the company) had a very good interview on EconTalk last year with Russ Roberts. (http://www.econtalk.org/archives/2013/02/varoufakis_on_v.html)
Roberts described their workplace as “Hayekian.” I wonder if Newell is reading this stuff or if someone else at the company told him it would be a good idea.
13. December 2014 at 10:23
Has FedBorg claimed another victim?
http://www.cnbc.com/id/102214004
13. December 2014 at 11:06
If there is anything we know about Phillips curve models it is that they are consistently unreliable.
Wasn’t the original Phillips curve concerned with WAGE inflation ?
If so, the original version seems like a pretty good idea to me.
13. December 2014 at 11:08
All good comments.
Daniel, Yes, and I agree that that version is better. I’d like to do some more empirical work on that when I get some time.
13. December 2014 at 11:51
Could you expand on this statement:
“In the US, 5-year inflation expectations are down to 1.25% and the 10-year TIPS spread is 1.68%. Does this mean money is way too tight? Not necessarily, but it does suggest that money was way too tight back in early 2010 and mid-2011.”
Why does it mean money was too tight then but not now?
13. December 2014 at 12:17
I think the commodity boom may itself be an echo/rebound from the financial crisis. This model works relatively well (graphs as link):
http://informationtransfereconomics.blogspot.com/2014/12/echos-of-financial-crisis.html
13. December 2014 at 12:18
We already have hordes of people(like Bloomberg and Stockman) claiming the oil crash was the result of malinvestment caused by low interest rates.
Meanwhile the TIPs breakevens are crashing because of lower oil prices.
So we have the claimed chain of causation:
low interest rate => crashing oil => deflation
Low interest rates cause deflation! QED!
13. December 2014 at 13:55
“The hawks fought against monetary stimulus in 2010 and 2011, arguing that we needed to focus like a laser on 2% inflation. OK, but 5-year inflation expectations are now 1.25%, even lower in Europe. What do the hawks say today?”
Our expectation that the hawks should be questioning their beliefs assumes that the hawks have a comprehensive view of monetary policy beyond “price stability”. In their view, the Fed’s only job is to keep inflation between 0-2%. They don’t seem to understand how or why monetary policy affects economic growth and unemployment (and frankly, neither to Keynesian “doves”) so as long as we haven’t had DEflation they think that any economic weakness in the interim had nothing to do with monetary policy. Thus they are left with vague/wild guesses as to why the economy has behaved the way it has.
13. December 2014 at 14:04
As for the Keynesians, without understanding the fundamental importance of the NGDP trajectory they’re just left with some vague notion that monetary policy is supposed to “provide stimulus”, and when Real GDP growth doesn’t materialize, they’re left baffled, assuming that there must be some problem on the fiscal end despite the fact that the government was already running nearly unprecedented deficits.
It’s kind of like watching two blind men accusing each other of not seeing clearly, and assuming that every step in the right direction was due to their own intuition while every step in the wrong direction was due to the other man’s misdirection.
13. December 2014 at 14:32
“””If the government won’t fund this nearly perfect example of a “public good,” with a benefit/cost ratio of more than 100,000 to 1, who will? “””
Governments often fail at funding public goods. They do a better job of taking over public goods that were established by the private sector and then government conservatism takes over and funding keeps going, but generally you need an interest group before government funds it.
13. December 2014 at 15:10
In the words of all my gamer friends, “Praise Gaben.” Seriously though that’s awesome he’s onboard with these ideas and I hope this catches on with the broader financial markets.
13. December 2014 at 15:30
The recent news has been dominated by the sharp fall in TIPS spreads. In the US, 5-year inflation expectations are down to 1.25% and the 10-year TIPS spread is 1.68%. Does this mean money is way too tight?
Positive oil supply shock? I suppose in the best of worlds, this means real growth is heading for 3-4% and the Fed is implicitly targeting 5% NGDP growth. In the worst of worlds, this means the markets see the Fed adopting a de facto 1.5% inflation target no matter what happens, even if that means strangling growth or exacerbating recession.
Too much of the right has given up empiricism on this issue, and descended into superstitious babbling about gold. Disappointing. But some are seeing the light.
13. December 2014 at 15:35
Looks like the departure of Narayana Kocherlakota is a loss for good CB policy. Well, depending who replaces him.
http://en.wikipedia.org/wiki/Narayana_Kocherlakota
I assume the last paragraph about “interest rates are too low” is a typo and they meant inflation, as otherwise it makes no sense in context.
13. December 2014 at 16:12
Good Guy GabeN runs a great company and contributes to getting NGDP futures off the ground? Awesome guy.
13. December 2014 at 16:43
“No inflation! Higher interest rates! (As if those two goals are compatible.)”
-How are these two goals not compatible? You’re confusing me here, Scott. I thought, all else being equal, higher interest rates would lead to lower inflation.
13. December 2014 at 16:58
E. Harding
https://en.wikipedia.org/wiki/Fisher_equation
Edumacate yourself.
13. December 2014 at 17:40
Congratulations. Glad I could help create the market through my video-game-playing. I didn’t think playing Valve games would have anything to do with NGDP markets, but I was wrong.
I wish I could help create a widget showing TIPS spreads, treasury rates and NGDP market growth forecasts all on the same cuve, and then have that widget on the side of the blog. Is the drop in TIPS spreads purely a supply-factor from falling oil prices? Who can know without NGDP futures?
13. December 2014 at 17:54
“-How are these two goals not compatible? You’re confusing me here, Scott. I thought, all else being equal, higher interest rates would lead to lower inflation.”
The “all else being equal” is the tough thing that took me awhile to understand. High rates can mean higher or lower inflation. Low rates can mean lower or higher inflation. What the hell is going on here?
Well, let’s first say that the Fed has an inflation or NGDP target they rigorously stick to. The Fed then does NOT control interest rates. The market sets the interest rates based on the inflation or NGDP created. The market in general won’t have extremely high or low real interest rates. When savers part with their money, they expect to get enough money each year to compensate for inflation, i.e. interest.
So if the Fed has 0%, 5% or 10% de facto rigorous inflation targets, then interest rates will hover around those numbers. Japan has had super-low rates along with its 0% inflation for the last 20 years. After the ECB backstopped EU debt, their debt is also showing similarly low rates signalling a long-term zero inflation. The U.S. in the 70’s had 10% interest rates along with 10% inflation.
So if inflation was 10% and interest rates were 10%, does lowering interest rates (ie printing money) mean the Fed will reduce inflation. NO! The Fed can in fact keep 5% interest rates while inflation is 10%, but then they have to keep interest rates at that level as inflation goes to 15%, 20%, etc. Lowering interest rates in this case and keeping them low despite increasing inflation can only result in hyperinflation. Similarly, the ECB or the BOJ is free to increase rates despite zero inflation. Keeping the interest rates higher will result in deflation.
Make sense? Probably not, but start with the case of a rigid inflation or NGDP target. Then see that the Fed doesn’t control interest rates but the market does because the market dictates what interest rate is needed to create that level of inflation or NGDP. But the Fed CAN change their target, which means a new interest rate for the new target.
14. December 2014 at 02:36
The hawks fought against monetary stimulus in 2010 and 2011, arguing that we needed to focus like a laser on 2% inflation. OK, but 5-year inflation expectations are now 1.25%, even lower in Europe. What do the hawks say today?–Scoot Sumner
The hawks say today that 0% inflation is nirvana, and once we get close to that, even 2% deflation is the goal, met by 0% interest rates.
I am not making this up. Read John Cochrane, and Charles Plosser.
You can never be too rich, too thin or have a tight-enough monetary policy. Anorexic billionaires set the standard for the Fed!
In fact, it appears Fed has used the 2008 Great Recession as just another door to permanently lower rates of inflation, as it has every recession since 1980.
It would not be a surprise if an independent self-funded public agency (the Fed) ossified in its exalted mission statement or culture, would it?
The Fed may have been “right” to seize opportunities to lower inflation in the past, although as Sumner has pointed out, this tends to prolong cycles, especially downcycles.
But I think the record now shows that cutting measured inflation that last percent or two requires large increases in lost output and unemployment. Tim Duy has run charts showing a 5% movement in unemployment ties up to a 1% movement in inflation.
And for what? Inflation is a an official gauge, or nominal index of prices roughly on-target in the short-run (well, maybe not even, housing prices etc, but….), but with large subjective flaws over any longer period of time. The inflation-targeters are worshipping a gilded totem, but hollow.
The costs of moderate rates of inflation are probably offset by the benefits. And the certainly the cost of lost production in getting from 3% to 1% or 0% inflation is not worth it.
14. December 2014 at 08:39
In fact, it appears Fed has used the 2008 Great Recession as just another door to permanently lower rates of inflation, as it has every recession since 1980.
Yeah, I think that’s an underappreciated point — Volcker’s recession was intended to prove to markets that the Fed was no longer going to target employment, “breaking the back” of inflation and marking the end of TGI. Every time there’s a recession, the markets absorb another lesson in how serious the Fed is about the direction of monetary policy (for better or worse).
14. December 2014 at 09:32
Benny, You’re right, it doesn’t really prove money was too tight then, but that is in fact the case. The tight money a few years back slowed NGDP growth. For a time inflation remained about 2%, instead of falling as you would expect, but only due to temporary factors. Now that those temporary factors have gone away, we are seeing the lower inflation produced by tight money a few years back.
Steve, What will they think of next!
Adam, But the hawks at the Fed have publicly endorsed 2% inflation, not 0% to 2% inflation.
Harding, Higher rates lead to lower inflation, and then lower interest rates. But the hawks don’t want lower rates. So why do they ask for higher rates, which will lead to lower rates, as in Europe?
14. December 2014 at 10:35
Scott, I think you’re giving the hawks too much credit.
1. If they don’t think there’s any problem with chronically undershooting the 2% target, and will never allow it to overshoot 2% in order to make up for that undershoot, then what you have is not a 2% target, it’s a 2% cap.
2. Since I assume that even the most hawkish Fed governors would admit that they don’t want DEflation, I assigned 0% as the lower limit.
Indeed, one of the hawks’ core misunderstandings is their obsession with the number 0. In their minds the goal is stable prices (0% change thus being an exaggeratedly important concept) rather than a stable price TRAJECTORY.
This is in addition to their inability to understand that it is the NGDP trajectory, not the inflation trajectory, that matters when it comes to market expectations, debt, and wages.
14. December 2014 at 10:58
(continued)… In other words, they view price stability as a static concept. It is actually human nature to view things statically, but that is not how the economy works. Interestingly, many doves seem to share that misconception. I watched a Brookings Institution forum recently that included Fed governors and economists on both the hawkish and dovish ends, and the common mistake they all made was to focus on where price levels are at this time relative to a year ago (the inflation rate itself), rather than relative to where they were EXPECTED to be at this time years ago when most business and household decisions on debt were made.
Basically Scott, you view things in dynamic terms (where are we relative to expectations and trajectory) whereas it is human nature, even for very smart and serious people, to view things in static terms (where are we relative to last year).
14. December 2014 at 15:56
To repeat what others have said, most of those on the right and the left have a very poor understanding of monetary policy.
And BTW Scott, I agree that NGDP is the best measure of the stance of monetary policy (interest rates tell you nothing), but you facilitate the confusion by talking about “QE ending.” Unless, you look at it in context of what MB minus ER is doing, you have no idea whether the ending QE is accomodative or contractionary.
14. December 2014 at 18:12
I think some hawks like Plosser would actually find some way to justify no extraordinary action in the event of deflation. One thing to look into was the FOMC minutes and transcripts for November 2009. All I see is a couple of terse press releases on QE1.
http://www.federalreserve.gov/newsevents/press/monetary/20081125b.htm
How was it approved exactly? I couldn’t find anything especially with a gap in official FOMC meetings from October to December. Was there a vote or was it somehow informal where the voting and discussion for QE1 wasn’t published, even after the FOMC transcripts for 2008 were published. Plosser WAS one of the governors on the FOMC in 2008.
14. December 2014 at 18:55
Yikes!
“Mario Draghi About to Quit ECB?”
http://www.zerohedge.com/news/2014-12-14/mario-draghi-goodbye-ecb-hello-italian-presidency
http://www.thefiscaltimes.com/Columns/2014/12/08/Why-Hell-Does-Mario-Draghi-Want-Leave-ECB-Now
14. December 2014 at 19:01
Does anybody know what the distribution of the Fed’s Treasury holdings were by maturity, as of October? And then, is the Fed reinvesting the maturing securities in order to maintain the same duration, or are they pushing it one way vs. the other? For example in September they seemed to be saying they would move the Fed’s balance sheet to longer-dated Treasuries, am I reading that right?
14. December 2014 at 19:03
Scott wrote:
“PPS. Oh, and where are all the people who said in mid-2013 that Bernanke’s tapering comments caused much higher bond yields, proving that only QE was holding down yields? QE ended many months ago, and rates keep falling lower and lower. The market is financing our still large budget deficits at 2.74% on the 30-year bonds. Is that the “liquidity effect?” Is that “Cantillon effects?” Don’t be silly.”
Scott, suppose for the sake of argument that an economist believed in the EMH and that the Fed’s impact (if any) on bond yields was a stock effect, not a flow effect.
In that worldview, what would we expect to push up bond yields? When the Fed announced information about when additional purchases would end, or when it actually followed through and stopped the purchases?
14. December 2014 at 19:09
“Instead, the recent deflation is a distinct echo of the actual NGDP “deflation” (and why is there still no word for falling NGDP!!) that occurred in the early part of this decade. That’s when money was much too tight, but supply disruptions in the Middle East and Chinese demand temporarily inflated oil prices, helping to disguise the deflationary pressures. Now it is showing up.”
Those magical, mystical, long and variable lags
14. December 2014 at 19:36
Bob,
Here you go. Table 2.
http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab2
The biggest component is 1.1 trillion of 1-5 years. Then 0.7 trillion for 5-10 years and. 0.65 trillion for 10+ years. The Agency MBS is 1.7 trillion as well, but the 10+ years maturity is probably misleading since much of that debt will be prepaid.
14. December 2014 at 20:04
Trading NGDP futures is long overdue, kudos to Sumner! Now read this: The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison – Ben Bernanke and Harold James (“If the argument as it has been made so far has a weak link, however, it is probably the explanation of how the deflation induced by the malfunctioning gold standard caused depression”)
Why did some countries not suffer much from the Great Depression? Niall Ferguson has a chart of real national product indices from 1919-1939 by country. Though such historical data are always suspect, it shows: (also see: en.wikipedia.org/wiki/Great_Depression) and this excellent graphic showing countries leaving the gold standard and per capita income: http://en.wikipedia.org/wiki/Gold_standard#mediaviewer/File:Graph_charting_income_per_capita_throughout_the_Great_Depression.svg that:
UK did not suffer much, though apparently the North UK suffered more than the South UK; Japan did not suffer much (militarization perhaps offset drops in other spending); Sweden did not suffer hardly at all, and btw despite not suffering they elected in the long running Social Democrats; Switzerland, on a gold standard (“From 1936 until 2000 the Swiss Franc was based on a 40% gold-reserve”) did not suffer much, but, the Netherlands, which stayed on a gold standard until 1937, suffered a lot. But France, Italy do not seem to have been affected much by staying on the gold standard, though, as B. Eichengreen would agree, based on the USA and the UK as data, leaving the gold standard seems to have helped to increase GDP. Belgium was not much affected by the Great Depression, and leaving gold in 1935 did not seem to help. Possibly Belgium was still devastated by WWI and coming off a low base. Denmark not only survived but apparently thrived during the Great Depression, and did not seem affected at all.
14. December 2014 at 20:21
Matt, thanks, duh! I knew about that release and didn’t think to use it for what I wanted.
14. December 2014 at 20:41
@Major Freedom – lol, good spot, spot on of an earlier Sumner article that implies the opposite of today’s ‘echo’ viewpoint! “Those magical, mystical, long and variable lags” indeed. Dr. Sumner, a giant in his field, seems to have a selective memory. Very common, not deliberate, but he filters information that fits his theory. PS–I don’t care that Weeks did not anticipate targeting NGDP and others like Sumner did; good for them. PS2– I am still not aware of any major difference between targeting a basket of commodities (aka ‘price targeting’) and targeting NGDP, except perhaps the labor market is a big component of NGDP, unlike with commodity pricing. But there’s a clear correlation between the two. Essentially Sumner’s targeting NGDP proposal is, as Major Freedom, I, and other hard money advocates can plainly see, a disguised Keynesian / Krugman appeal to print money and repress savers. Same as it ever was.
14. December 2014 at 21:19
Ray, if you still can’t understand the difference between targeting commodity prices and targeting nominal GDP, I’m not sure there’s any point in pursuing the matter further until you study any introductory Macroeconomics textbook.
15. December 2014 at 02:00
Ray,
Does stuff like “sticky wages” and “negative supply shock” mean anything to you ?
In other words – if wages are sticky (and they are, no matter what some morons insist), and you respond to a negative supply shock by tightening monetary policy (because that’s what the logic of commodity pricing would ask you to do), what impact do you think it will have on employment and economic output ?
a disguised Keynesian / Krugman appeal to print money and repress savers
How exactly does moderate inflation harm savers ?
And economics is not a morality play, so try harder and/or smarter.
15. December 2014 at 04:26
Ray Lopez:
“I am still not aware of any major difference between targeting a basket of commodities (aka ‘price targeting’) and targeting NGDP, except perhaps the labor market is a big component of NGDP, unlike with commodity pricing. But there’s a clear correlation between the two. Essentially Sumner’s targeting NGDP proposal is, as Major Freedom, I, and other hard money advocates can plainly see, a disguised Keynesian / Krugman appeal to print money and repress savers. Same as it ever was.”
The major difference between price targeting and NGDP targeting is that they are targets of different nominal variables. A spending variable is not the same as a price variable. A price is a function of supply and demand, while spending is a function of only demand. If they are correlated, it would only be to the extent that prices and output are correlated. But output and prices can and have diverged, and that is when targeting spending would diverge from targeting prices, and that is by design. Sumner’s view is that NGDP is correlated with spending on wages, and given wage prices are sticky, targeting spending instead of prices will ensure spending on wages does not significantly fall if there is a decline in output and hence a decline in the price level given price stickiness. This is incidentally why Sumner regards targeting spending on wages to be even better, because it avoids relying on historical correlations between spending on wages and NGDP. That correlation has broken down.
Wages are not a component of NGDP. NGDP components consist of expenditures on (final) products, and labor is not a product, but a means to produce products.
I am not a hard money advocate. I am a free money advocate. Let the market decide how hard or soft is the money.
I agree that Sumner’s proposal is Keynesian. In fact, Sumner has said that his proposal is the true “heir” to orthodox Keynesianism, because Keynes, according to Sumner, whether Keynes realized it or not, his theory of “aggregate demand” being the ultimate driver of employment and growth, the problems Keynes envisioned occurring with AD is solved by NGDPLT.
I don’t agree with his views, but that is how I understand it.
15. December 2014 at 06:27
Adam, I think you misunderstood me. I think the hawks at the Fed are just as inconsistent as you claim. My point was different. They are “officially” on board with the Fed’s announced 2% inflation target. They claim to support it. But they talk and act like they don’t, as you say.
I agree about the dynamic vs. static issue.
dtoh, I agree that ending QE is not necessarily accommodative or contractionary.
Bob, It would be the announcement. But if the policy later ended, and rates were still very low, it could no longer be argued that the policy was the reason for low rates, even though the policy may have lowered rates, ceteris paribus.
In other words, QE did not cause 10 year yields to be 2% rather than 4%. But perhaps with QE still going they’d now be 2.0% rather than the current 2.1%. Which is quite a different claim. My critics were saying rates would not be very low without the “artificial” QE. But they are really low! And the Fed is not financing the deficit.
Ray, You have a lot of work to do to get the knowledge base necessary to understand this blog. This post has nothing to do with policy lags, which as you rightly say, I claim are very short. The recent fall in oil prices is not a lagged effect of the earlier tight money policy. That policy reduced non-oil prices years ago, but the effect was partly hidden by rising oil prices. Now oil has fallen for reasons unrelated to monetary policy (perhaps) and we see the headline CPI showing data that in many ways reflect what was going on in 2010. In previous business cycles you did not usually see rising oil demand during recessionary periods. China is what made this global cycle different.
Almost every country started recovering from the Great Depression at the time it left the gold standard. That’s a stylized fact that virtually all economists agree upon. Of course the severity of the depression differed in different places, due to supply-side factors, currency over/undervaluation before the Depression, industry mix (farming/manufacturing), etc.
But I do love how you provide a graph of interwar GDP, after telling me earlier that the concept of GDP didn’t exist until invented by Kuznets in 1934.
And why no response on Mints? I’m still waiting for you to tell me why we should be interested in the claim that Mints was one of the 100s of economists in the interwar period who favored price level stabilization.
15. December 2014 at 07:46
@Major Freedom- thank you, that clarified things; I will cut and paste your reply for future reference. I think Sumner needs to put up a FAQ to explain his views more clearly, unless, as is typical in this field, he wishes to hedge his bets by being obscure. To me, targeting prices works as follows (apparently this is NOT the way most of you reading this blog understand things): I. prices fall due to a demand shortfall. Fed prints money until such time prices rise again. Why is this not the same as: II. NGDP falls due to demand shortfall, and wages being sticky, NGDP falls less than prices. Fed prints money–a bit less than it would under scenario I–until such time NGDP rises back to the former level and/or trajectory. Both schemes IMO are harmful and Keynesian.
@ S. Sumner–thanks for that clarification on the first part of your reply, it does now make sense, sorry for any confusion on my part. You: “Almost every country started recovering from the Great Depression at the time it left the gold standard. That’s a stylized fact that virtually all economists agree upon.” No. It’s only true for the US, UK, the Netherlands, and thus arguably true for a ‘weighted average’ world GDP since those first two countries were the leading economies. But it’s not true for France, Hungary, Italy, Japan or Belgium from the chart link I provided, nor for the Nordic countries and Switzerland, from Chap. 12, Fig. 42 of Ferguson’s Cash Nexus. It is true for the Netherlands (Ferguson). So I would qualify your statement as follows: ‘the UK, US, and Netherlands all recovered from the Great Depression–coincidentally perhaps?–when they left the gold standard. For other countries the gold standard did not matter’. You: “But I do love how you provide a graph of interwar GDP, after telling me earlier that the concept of GDP didn’t exist until invented by Kuznets in 1934.” ??? I’m glad I amuse you, rather than getting banned as Mankiw did when I started posting in his Comments (he closed his blog to comments shortly thereafter–I like to think it was because of me but I’m egotistical; B. DeLong also censored my posts). The concept of GDP was indeed invented perhaps later, but historians like the late, great Angus Maddison routinely constructed GDP going back to pre-Industrial Revolution eras. You: “And why no response on Mints?” Because I conceded the point. By your own admission you did not originate the idea of targeting NGDP so you have to ask yourself why would policymakers adopt this logic now, if they did not back then? Momentum? You need arguably to get some conservative think tank behind this idea, so it does not reek of Keynesianism. Optimistically for you, recently some grey haired guy at the Hoover Institute of all places–where I once saw Milt Friedman walking out of at Stanford (while I was reading his book Free To Choose by coincidence)–did endorse targeting NGDP, much to my surprise. There’s Reds everywhere these days it seems!
15. December 2014 at 08:44
Scott,
One last thing just to clarify, because I don’t think you’re getting my (modest) point. I’m not trying to get you to say, “I stand corrected, QE significantly pushed down Treasury yields.” Rather, I want you to say, “If someone erroneously thought QE significantly pushed down Treasury yields, then it’s true that such a person can easily handle the fact that yields have stayed low since QE ended.”
The reason is the stock/flow distinction. The Fed is still holding all the Treasuries it amassed during QE. If we’re good believers in the EMH, then when the Fed made the announcements and investors got confirmation that the Fed was sticking to the plan, yields would’ve adjusted at that time. Then, once the program officially ends but the Fed still holds all those securities and reinvests the maturing principal, the Fed’s thumb would still be holding down yields.
Look, if the Fed announced it was going to buy half of the shares of Microsoft over the next 12 months, people might understandably think that would push up Microsoft’s share price, right? And then once the flow of purchases stopped, but the Fed still held half of the total shares of Microsoft, it would be reasonable for people to say the Fed was artificially propping up the share price, wouldn’t it?
15. December 2014 at 10:09
@Bob Murphy:
That would not be reasonable.
The effective price of stock is the upper bound of ineffective ask prices (such that going above this limit would induce a current holder of the stock to sell) and the lower bound of ineffective offer prices (such that going below would induce a marginal buyer to purchase).
This does not depend on the stock of stocks, only on the order book.
Provided the Fed’s holding of stocks is unconditional, such that it does not respond to price incentives, and provided also that it does not hold so much of the stock that trading is illiquid, then merely holding onto the shares has no effect on its price.
The act of purchase or sale themselves affect prices, but whether that change is temporary or permanent depends on your assumptions about the rest of the market. Generally, in a highly liquid financial market we would probably assume that any price change is mostly temporary, with any permanent part being incorporated into the general price level of all things. (That is, the Fed’s purchase of Microsoft shares on a permanent basis would not be expected to affect the ratio of the Microsoft and Ford share prices.)
15. December 2014 at 11:15
Majromax I’m pretty sure you just argued that if we assume the Fed doesn’t drive up the share price of Microsoft when it buys half the shares, then the Fed has no effect on the share price of Microsoft.
15. December 2014 at 12:45
Ray Lopez,
And what happens if, for example, rebels blow up some refineries in Nigeria, which results in higher oil prices ?
Can you even understand the question or are you too busy condemning anything you don’t understand as being “harmful and keynesian” ?
15. December 2014 at 17:17
Sumner in this blogpost:
“Instead, the recent deflation is a distinct echo of the actual NGDP “deflation” (and why is there still no word for falling NGDP!!) that occurred in the early part of this decade. That’s when money was much too tight, but supply disruptions in the Middle East and Chinese demand temporarily inflated oil prices, helping to disguise the deflationary pressures. Now it is showing up.”
Sumner in the comments after being shown the above comments contradicts an earlier blog post:
“The recent fall in oil prices is not a lagged effect of the earlier tight money policy.”
Maybe in a future post lagged effects of monetary will again magically and mystically appear.
15. December 2014 at 17:25
Majromax:
“Provided the Fed’s holding of stocks is unconditional, such that it does not respond to price incentives, and provided also that it does not hold so much of the stock that trading is illiquid, then merely holding onto the shares has no effect on its price.”
But it had to have affected demand by buying them, and thus affected the price through the law of demand, and it had to have affected expected future demand now that the Fed has shown itself as a historical buyer, which also affects demand and hence prices.
You can’t abstract too much from normal market conditions if you want to explain prices. Psychology is very important.
15. December 2014 at 17:46
The reason why the two passages contradict is that the NGDP change in the early part of the decade SHOULD, if your anti-lag story is right, should have been fully priced in the oil (an asset) market, and thus any subsequent change in supply conditions should not be in any way connected to today’s price changes. There should be no causal connection between today’s oil price changes and past monetary policy changes.
If you are going to argue that oil supply disruptions had a temporary price inflationary effect, subsequent to which the supply conditions that caused the upward pressure are no longer there, which has since resulted in oil prices falling to where they would have been had the supply disruptions not taken place (it is not important just how much further the price falls), then what you are invariably claiming is that today’s oil prices, today in Dec 2014, are a function of monetary policy that took place in the early part of the decade.
You didn’t say today’s oil prices are a function of present monetary policy, or expected future monetary policy. If you did then you would have avoided the contradiction. But because you are saying today’s oil prices are in part a function of monetary policy in the early part of the decade, what you are saying is that that monetary policy event has had an effect on not only past oil prices, but all oil prices since.
Here’s a helpful hint: It is clear by the history of this blog that the obligation on the reader is not assuming the blog posts are consistent and then for better or for worse, form a judgment of agree or disagree. No, what (some) of your readers have found themselves having to do is sift through what are often inconsistent points, and pray and hope that one has not been in some way inadvertantly brainwashed or misled into accepting an argument that was presented seemingly reasonably but built upon inconsistent premises.
15. December 2014 at 20:09
@Daniel–thanks for that thought experiment. I think the answer is that for every commodity the somehow, due to a freak accident, raises in price, many more commodities, during a business downturn, would fall in price. So on net balance there would be a fall in prices (and by correlation a fall in NGDP). In your example, keep in mind that oil today is something like 3% of US GDP, not that big a deal anymore.
@Major– You are right, the Sumner passage is ambiguous (see the word ‘perhaps’ below), but I gave Sumner the benefit of the doubt, as he is no doubt trying to make his theory work. We critics have the luxury of nitpicking, truth be told, but that’s our job! 🙂 Sumner’s passage: “This post has nothing to do with policy lags, which as you rightly say, I claim are very short. The recent fall in oil prices is not a lagged effect of the earlier tight money policy. That policy reduced non-oil prices years ago, but the effect was partly hidden by rising oil prices. Now oil has fallen for reasons unrelated to monetary policy (perhaps) and we see the headline CPI showing data that in many ways reflect what was going on in 2010. In previous business cycles you did not usually see rising oil demand during recessionary periods. China is what made this global cycle different.”
15. December 2014 at 20:33
The stock distinction on the Fed’s balance sheet Bob Murphy is making doesn’t seem to gel with what we know about the Fed’s ownership of the outstanding stock of Treasury bonds. The proportion of outstanding Treasury bonds the Fed owns is of the same order as it was before the crisis. It’s been buying lots in the last few years, but there have been many created as well.
Is there another hypothetical stock effect? And what is the mechanism for this stock effect?
15. December 2014 at 22:15
Ray Lopez,
So on net balance there would be a fall in prices (and by correlation a fall in NGDP)
So you think it’s perfectly normal for a drought (leading to higher food prices) to result in an increase in unemployment ?
What exactly is wrong with you ?
16. December 2014 at 07:23
Scott, its a little worse then you suggest. Using the TIPS curve and the oil curve we can see in the past month 1yr CORE inflation expectations have fallen 60bps to 0.92%, 2yr CORE inflation expectations have fallen 60bps to 1.01% and 4yr CORE inflation expectations have fallen 70bps to 1.2%
All these numbers take into account both the recent sell off in gasoline and the changes in the shapes of the curves over the past month.
16. December 2014 at 13:10
Ray, You said:
“Major Freedom- thank you, that clarified things; I will cut and paste your reply for future reference. I think Sumner needs to put up a FAQ to explain his views more clearly, unless, as is typical in this field, he wishes to hedge his bets by being obscure.”
If you are going to participate in this blog, the first thing you need to understand is that everything Major Freeman says is wrong. If he says I believe X, then I probably believe not X. Ignore him. I’ve had FAQ in the right column from the beginning of my blog, so I can’t be accused of “being obscure.”
You said:
“Because I conceded the point.”
I must have missed that concession.
NGDP targeting has always been supported by numerous people in the right. It’s not a “Keynesian” idea.
And you are wrong about the Great Depression, countries began recovering when they left gold. If your data doesn’t show that, it’s wrong. And why no mention of Germany?
Bob, Rates haven’t just stayed low since QE ended, they have fallen further. Obviously that’s not due to QE. So we can all agree that rates move around for reasons having nothing to do with QE. So where is the evidence that QE depressed rates? There’s also no model, as the amount of debt sold to the public soared under QE. And there’s no empirical support. So there’s basically nothing.
But yes, I agree that the current low rates don’t prove that QE did not result in lower rates than otherwise, indeed I think it might well have slightly reduced yields.
BTW, Lots of the conservative foes of QE were making a “flow ” argument, which is of course inconsistent with the EMH, as you correctly point out. I was aiming this jab at them.
JD, That core data seems a bit low to me, but I agree with your broader point that core expectations are below 2%, and falling.