Stance, shock, cause
OK, the title’s not as dynamic as Camille Paglia’s Break, Blow, Burn, but I’m only an economist. Recently I’ve been trying to figure out several questions; including what do we mean by the stance of monetary policy, and what do we mean by a monetary shock? I suspect that at some deep level these are actually the same question, much as I suspect, “Does free will exist” and, “Is there such a thing as personal identity?” are the same question. This post is a reaction to some good comments I’ve received, and also an excellent new post by Nick Rowe. Don’t expect any final answers here, go to Nick’s post for specifics on VAR models.
Let’s work backwards from “cause.” Perhaps a monetary shock is a change in monetary policy that causes something or many things to happen. But that forces us to examine the thorny issue of what do we mean by “cause?” In a sense, monetary policy could be said to cause all nominal changes in the economy, and many real changes. After all, under a fiat money regime there is always some alternative monetary policy that would have prevented a nominal variable from changing. Thus if the price of zinc rises from $1.30 to $1.35 a pound, you could say the cause of the increase was the Fed’s refusal to use OMOs to peg the price of zinc at $1.30/oz. I think we can all agree that this is not a very useful view of causation. But this problem will creep in to some extent no matter how hard we try to pin down ’cause’.
Now let’s look at ‘stance’ and ‘shock’. By now you are sick of me telling you that interest rates don’t measure the stance of monetary policy. But why not? And why can’t I provide a definitive definition, if I’m so sure interest rates are wrong? Let’s consider three groups of possible indicators:
1. Interest rates and the monetary base
2. Exchange rates and the monetary aggregates
3. Inflation, NGDP growth and zinc prices
I’d like an indicator that always moves in one direction in response to a given change in the stance of monetary policy. That’s why I hate interest rates; tight money sometimes makes them rise, and sometimes makes them fall. So we can’t look at interest rates and identify the stance of policy. Ditto for the base, which might rise because we are monetizing the debt Zimbabwe style, or it might rise because we are accommodating a high demand for reserves at the zero bound, a la Japan since the late 1990s. That’s not to say that we can’t assume a given nudge in rates or the base leaves policy predictably tighter than a few minutes earlier. The problem is that we can’t look at rates or the base and tell whether policy is looser or tighter than 3 months ago, which makes it useless for projects like VAR studies. Nor does it help to look at rates relative to the natural rate, as the natural rate is highly unstable, and hard to estimate.
The second group is better. In general, tight money will appreciate the exchange rate and reduce M2. But I’m not 100% sure that’s always true. Is it possible that tight money could lead to expectations of depression, and that expectations of depression could lead to lower future expected exchange rates, and that this would reduce the current value of the currency? Is it possible that tight money could lead to such uncertainty that people want to hold more M2, relative to other assets?
The last group seems safest, and the first two items in group #3 are also the indicators chosen by Ben Bernanke back in 2003. I can’t imagine a case where tight money raises either inflation, NGDP, or zinc prices. So at least in terms of direction of change, they seem completely reliable. One can think of the CPI as measuring the (inverse of the) value of money. That’s a nice definition of easy or tight money—changes in its purchasing power. NGDP is slightly more ungainly, the (inverse of the) share of national income that can be bought with a dollar bill.
Unfortunately I’ve engaged in circular reasoning. I’ve defined easy and tight money in terms of inflation and NGDP growth, because I believe they are reliably related to the stance of monetary policy. But how do I know that the thing that causes NGDP to rise is easy money? Here I don’t think we can escape the necessity of relying on theory. Theory says that an unexpected injection of new money will have all the effects associated with easy money, such as temporarily lower interest rates, a depreciated currency, more inflation and NGDP growth.
If we define the stance of monetary policy in terms of inflation or NGDP growth, then it seems to me that it makes sense to think of “shocks” as policy actions that change the stance of monetary policy. Thus if Fed actions moved expected GDP growth from 4% to 6%, you could say that monetary policy eased and a positive monetary “shock” occurred. Vice versa if expected NGDP growth fell from 4% to 2%.
But lots of people aren’t going to like the implications of all this, or any of this, as there are deep cognitive illusions about distinctions between “errors of omission” and “errors of commission” that seem important (but in my view are not.) For instance, VAR studies could no longer disentangle monetary and demand-side fiscal shocks—-all changes in NGDP would be monetary shocks, by assumption. There would be no difference between a change in M and a change in V, both would be monetary shocks.
If you try to flee back to your comforting notions of causality, they will fall apart under close inspections. Suppose Russians hoard 5% of the US monetary base in 1991, and the Fed does not accommodate that increase, even though they easily could have done so. Interest rates soar, V falls, and the US goes into recession. What do the “concrete steppes” people say? Unfortunately they’d start arguing with each other. The monetary base concrete steppes people would insist the Fed did not cause the recession, it was caused by Russian currency hoarding. The base didn’t change. The interest rate concrete steppes people would insist the Fed did an error of commission; they increased interest rates sharply and caused the recession.
Nor is it possible to fall back on “unexpected changes in interest rates.” Suppose that prior to the Sept. 2008 FOMC meeting, markets had expected a huge negative monetary shock, which would occur because the Fed foolishly kept interest rates at 2%. But instead (suppose) the Fed surprised us and avoided a negative monetary shock by cutting rates to zero and switching to NGDP level targeting. There would be a huge negative surprise to interest rates, but no change in the stance of monetary policy, by the NGDP criterion.
Macroeconomics is riddled with unexamined assumptions about stances of policy, shocks, and causation. It’s ironic that we use the term ‘stance’ as there’s no stable ground here to stand upon. It’s like we’ve moved from a classical Newtonian world to a relativistic universe. What’s is the stance of policy? It depends where you are standing, how fast you are moving, what variables you are interested in, etc., etc.
People are constantly telling me that my “tight money” theory of the 2008 recession is loony. But I am never provided with any good reasons for this criticism. I have no doubt that there are hundreds of macroeconomists who are much smarter than I am, but I do occasionally wonder if my profession is somewhat lacking in imagination.
PS. Going back to the opening paragraph, the answers are no and no.
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1. May 2015 at 17:50
How aggressively the tools are employed is a better indicator of stance than a target. It may take a varying amount of effort to achieve a target under different circumstances.
NGDP is affected by the MB. Everything the fed does is through changes in the MB or expectations of changes.
Maybe we can just make definitions more specific. Monetary policy involves money. NGDP policy is about ngdp targeting.
1. May 2015 at 17:52
Scott, Here´s an attempt at understanding the problem:
https://thefaintofheart.wordpress.com/2015/05/01/forensic-evidence-that-bernanke-drove-the-car-off-the-road/
1. May 2015 at 18:23
“Is it possible that tight money could lead to expectations of depression, and that expectations of depression could lead to lower future expected exchange rates, and that this would reduce the current value of the currency? Is it possible that tight money could lead to such uncertainty that people want to hold more M2, relative to other assets?”
If we assume money is exogenous for a moment, even if they demand more m2 it won’t cause m2 to increase, it will cause a recession instead.
“Theory says that an unexpected injection of new money will have all the effects associated with easy money”
Yeah; honestly I don’t think you need to worry about the VAR stuff right now. Modern criticisms of monetarism aren’t really focused on whether more new money would increase NGDP, but rather, how much control the central bank really has over m2 (or m3 or m4).
1. May 2015 at 18:39
[…] Scott Sumner has just written a post that tries to understand the “stance” of monetary policy, and ends thus: […]
1. May 2015 at 19:02
Sumner: “In a sense, monetary policy could be said to cause all nominal changes in the economy, and many real changes.” – NON-sense. Money is neutral short term and long, prices and even wages are largely not sticky, and the Fed follows the market, numerous studies show.
Sumner: “Unfortunately I’ve engaged in circular reasoning” – indeed.
Truth is, Sumner confuses cause and effect. The cause of the Fed tightening or loosening is the real economy forcing their hand. These causes can be exogenous to the economy, or, just the result of internal dynamics like ‘irrational exuberance’. The Fed is impotent.
1. May 2015 at 19:15
“I suspect that at some deep level these are actually the same question, much as I suspect, “Does free will exist” and, “Is there such a thing as personal identity?”
“No and no.”
Prove it.
The funny thing is that in every critique of the Fed that Sumner makes, and in every recommendation Sumner makes for right action, he presupposes the individuals in the FOMC to have free will and personal identity. After all, he isn’t throwing his hands up in the air and thinking that whatever the FOMC does, was inevitable. For that would actually be what a lack of free will would entail.
Sumner also presupposes the individuals in the FOMC to have personal identities. After all, he isn’t staring at a rock or a tree and saying “You should print more money”. No, he specifically addresses the personal identities of the individuals in the FOMC. He says Yellen this, and Bernanke that.
It goes deeper. How many times has Sumner said “I think…” or “I believe…” or “I disagree…”?
Who is this “I” and why is it not my “I”?
Shouldn’t he be saying “We think…”?
You can tell when someone’s philosophy is flawed when they contradict themselves in advancing it.
Personal identity exists.
Free will exists.
I think, I act, I am. Period.
1. May 2015 at 19:44
Ray: “numerous studies show.”
The overwhelming majority of empirical studies I have seen strongly support that prices are sticky in the short term. I’ve never encountered a data centric person that doesn’t concede prices are mostly sticky in the short term, I’ve only seen people dismiss price stickiness when it happens to be very politically convenient for them to do so. You’re also ignoring debt deflation and debt erosion.
1. May 2015 at 19:53
The correct “stance” of money is that which is grounded on what a money IS. The law of identity. A is A.
What is money? Sumner can’t answer questions of causality because he has a flawed theory of what money is. No, it is not a medium of account. Money is a commodity. It is an object of economic action.
A commodity does not become money if it contains a certain chemical compound. It is the judgments of individuals that make a commodity a money. Some chemicals are judged by individuals as superior to other chemicals in serving as a money.
What is an object of economic action? It is an object that serves to increase the utility of an individual. But how does money increase the utility of an individual? It does so if the individual expects, and is correct, that they can sell that commodity for a good that they could not have bought if they sold what they themselves produced. Money is the most marketable commodity that serves as an indirect medium of exchange. A trades his labor not for food directly, but for money, and then they buy food with that money.
The most marketable commodity used as an indirect medium of exchange, that is what money is.
What is a market? A market is a process. It is a process of cooperation based on private property rights, which arise from homesteading and free trade.
Thus, money is that commodity which in a market process rises to become the most marketable, I.e. the most widely accepted.
Thus, if we consider what money IS, the question of the “stance” of money can ONLY be answered by way of observing what arises in a market process as the most marketable commodity.
Asking what is the “stance” of a state monopoly currency, cannot be answered by in terms injective, I.e. objective, factors. It is purely subjective, meaning it cannot be any one answer. One statist will say the stance of currency is too tight, another statist will say the stance of currency is too loose, and there is no way for these two individuals to settle their differences with each’s behavior and preferences being constrained by the other’s in a mutually respecting manner.
The only way that one statist’s judgment of a commodity being too scarce, can be put into action, would be for that statist to use or threaten physical force to squash another individual’s judgment about how much money they are making available. And vice versa. The only way that a statist who thinks there is too much money, to be put into action, would be for them to use or threaten physical force against the other statist.
When Sumner says the state’s currency was too tight back in 2008, what he is actually saying is that those who use or threaten initiations of physical force against others, did not print enough currency. Those who were victimized by the use and threats of violence, their judgments about money were squashed. Those who were squashed of course include other statists who would have squashed the squashers if they had the opportunity, and it includes those like me who do not want to replace the initiation of violence with our own, but to eliminate it and allow market forces to determine what commodity ends up becoming most marketable.
Libertarians like me don’t want tight state currency nor loose state currency. We want an actual money to again exist. To be again produced and exchanged.
The current stance of MONEY is that there is very little of real money. Almost the entire supply of the circulating medium of exchange is a commodity that market forces are always “trying” to eradicate from society. That is why constant threats of force, and actual initiations of force, are required to prevent money from arising and are required to keep the state’s currency in circulation, where socialists of all stripes bicker constantly about how they can one up each other and have their ideal squash everyone else’s preferences for themselves.
I am supposed to believe that what Sumner wants for me, is best for me. I am supposed to ignore and reject what I want for myself out of some deceitful, disgusting, pathetically hollow and transparent plea to religious mantras and holy words. Sumner says “Pragmatism!” and like a lying priest he wants to lull his victims into obedience and domicility, and if they do not, then they will be viewed as “criminals” and his goons and thugs in the state are tasked with ensuring that Sumner’s preference squashes mine and everyone else who disagrees with what he wants for us.
Socialists asking questions about the ultimate foundation of economics is like pigeons playing chess.
1. May 2015 at 19:55
Darn auto correct.
Meant to write:
“Asking what is the “stance” of a state monopoly currency, cannot be answered by inter-subjective, I.e. objective, factors.
1. May 2015 at 19:57
I love the idea that zinc prices are a better indicator of the stance of monetary policy than interest rates. Is it true? I looked at http://www.infomine.com/investment/metal-prices/zinc/all/, and it’s hard for me to connect the price movement to my impression of monetary policy at the time. More discouraging, Aluminum (http://www.infomine.com/investment/metal-prices/aluminum/all/) looks pretty different from Zinc, but it’s hard to see why one of these should be a better indicator of monetary policy than the other.
But your point remains, as both Zinc and Aluminum look like less-bad indicators of monetary policy than the federal funds rate, which was high when money was too loose in the 70’s, and then low when money was too tight in 2008, etc. (Could it be that higher interest rates correlate with looser monetary policy? I wonder what the time lag is between too-tight money and low interest rates.)
-Ken
1. May 2015 at 20:34
Also thought I’d comment on interest rates.
I definitely agree the level of interest rates are a lousy indicator of the stance of monetary policy. This doesn’t mean /changes/ in interest rates are lousy: can you ever really say that a lowering of the interest rate, even if it’s as a result of previous tightness, is monetary tightening? No. Even if tight money can cause low interest rates, all you’re really saying is tight monetary policy can cause loose monetary policy as a response. The Fed being overly tight could lead to a recession, the fed panicking and reversing their decision, lowering rates to near zero but failing to boost the economy enough, is a good indicator that money was tight, and maybe still too tight (as if money was loose enough, the economy would recover, causing rates to rise). But that doesn’t mean you can say that the /change/ in interest rates was a tightening, it was still a loosening, it just didn’t loosen money enough to offset the previous tightness causing the recession.
1. May 2015 at 21:11
Britonomist,
Ray is just confused simpleton. Even the commenters at Marginal Revolution are fed up with him. He is useful in one way – the more certain he is about something, the more certain you can be that the opposite is true. I call this the Lopez Law. “Studies show” that “money is neutral” is a perfect and hilarious example.
1. May 2015 at 22:03
Haha, “Even” Marginal Revolution…
1. May 2015 at 22:20
One of the most ridiculous beliefs circulating the monetarist blogosphere is the incredulity concerning the US suffering from malinvestment and coordination problems.
Accepting it in principle is rare enough, but I notice that every time in practice this question is addressed, every excuse is made to convince others that if the US is suffering from widespread, general malinvestment and coordination problems, it somehow must have abnormally high price inflation, and if it does not, if price inflation is 1-2%, then we are supposed to blame insufficient money printing.
This belief is absurd because the Fed target prices to not rise by such high rates that would serve as alleged evidence that yes there are widespread coordination problems.
It would be like saying a man strapped to a torture rack can only be hurting if he yells out in pain, despite his mouth being gagged shut.
1. May 2015 at 22:36
@Ben J – projection noted. In fact I’ve been voted the #1 commentator at MarginalRevolution. Keep tryin’, you might be like me some day little man.
@Britonomist – cite please? “The overwhelming majority of empirical studies I have seen strongly support that prices are sticky in the short term” – actually, quite the opposite, as you implicitly acknowledge by saying “majority” instead of “all”. You probably mean to say that studies show *wages* are sticky in the short term, not prices. That’s why I qualified what I said originally by “even wages”, since I acknowledge, short term due to union and institutional factors, wages are often slightly sticky (not that it matters for the economy as a whole, unless you believe in the labor theory of value).
1. May 2015 at 23:59
“(not that it matters for the economy as a whole, unless you believe in the labor theory of value)”
Lopez Law in action. Ray thinks sticky price theories of the business cycle require the labour theory of value. You couldn’t make up this stupidity of you tried.
2. May 2015 at 00:04
Dear Scott,
You might be interested in this new paper by Coibion, Gorodnichenko and Kumar, where they demonstrate the lack of attention by firms to inflation. Interestingly, firms don’t seem to understand inflation, whereas they very well understand growth and unemployment. Potentially, this has important implications in terms of the debate of (neo-)keynesians versus market monetarists. For instance, inflation targeting might not make any sense – in terms of communication – to the wider public, whereas NGDP targeting does.
http://www.nber.org/papers/w21092
2. May 2015 at 00:23
In a “Newtonian” world it is suggested the ’causes’ take place in 2008; in a relativistic universe might not the causes take place in 2007 ?
Didn’t the hording begin in 2007?
As an ordinary small business person 2007’s when I and a lot of my clients started ‘getting into cash’ (in the UK).
Why did we do so? A sense that we’d had a good run and good runs don’t last forever. Past experience that when oil prices rise it is not long before things cool off. (that doesn’t have to be true for it to have influence). Looking around and seeing ‘spivs’ at the Party. The speculator’s desire to be an early leaver from the party.
Leaving the party incrementally you can ‘feel’ whether it is the right thing to be doing. You can turn back or get more ‘out’. As 2007 went on and through 2008 there was a sense of disbelief that the music was still playing.
Forgive the crude metaphors, but perhaps that is how you have to describe things in a relativistic universe.
Anyway, nominal stability is to be prized. No parties, no hang overs.
2. May 2015 at 00:59
Nick Rowe’s piece, linked to by Scott, is superb.
2. May 2015 at 05:36
CMA, You said:
“How aggressively the tools are employed is a better indicator of stance”
So when the Fed cut the discount rate aggressively in the early 1930s, was money easy or tight?
Do you see the problem?
Marcus, Bernanke clearly understood the problem of determining the stance of policy back in 2003. What happened later? I don’t know.
Britonomist, You misunderstood my comment about M2. My point was that tight money could increase the demand for M2 (perhaps) making it a less reliable indicator of the stance of policy. The question of whether M2 is “exogenous” is irrelevant.
Ken, I’m pretty sure zinc prices are a better indicator that interest rates, at least if one is going to assume low rates mean easy money. You’d expect zinc prices to rise rapidly during hyperinflation, but you would not expect super low interest rates during hyperinflation.
Britonomist, You asked:
“This doesn’t mean /changes/ in interest rates are lousy: can you ever really say that a lowering of the interest rate, even if it’s as a result of previous tightness, is monetary tightening? No.”
Yes, in 1929-32 and in 2007-08 rapidly falling interest rates indicated tight money. The Fed drove NGDP much lower, and this reduced market interest rates. Don’t overemphasize the liquidity effect.
And again, I am looking for INDICATORS of the stance of money, not causal factors. I would never claim falling interest rates CAUSE tight money.
Simon, Thanks, that sounds interesting.
WleB, You asked:
“Didn’t the hording begin in 2007?”
Nope, just the opposite. Between August 2007 and May 2008 the base was roughly flat, and V actually rose a little bit. Because base growth slowed very sharply from earlier years, NGDP growth also slowed, triggering the onset of recession. But hoarding was not a factor at all, at least in an accounting sense.
James, I agree.
2. May 2015 at 05:40
Scott, monetary shock is a change in monetary reaction function, that’s why this is so difficult.
In 2011-2012 during Greek crisis lower expected Eurozone NGDP was sometimes associated with weaker EUR. And tight money has caused higher taxes in the Eurozone, pushing CPI up.
2. May 2015 at 05:56
@Ben J–pay attention: not sticky prices, but sticky wages. Sticky prices would indeed support Sumner’s version of NGDPLT. But sticky wages? Irrelevant, as I say, unless you are concerned with the working man aka “dual mandate” and/or are a Marxist and believe in the labor theory of value. But as robots take over real jobs, insofar as GDP goes, sticky wages are irrelevant. Sorry I can’t dumb it down any more for you.
@Simon- thanks. And if you think through what is written in the *Abstract of the paper you cite, it supports the theory of money neutrality in the short term not just long term. Folks open your mind: money illusion is an illusion, sticky prices hardly exist, and monetarism just does not matter. Free your mind from Sumner’s hypnotism and things will start making sense. *Abstract: “But few firms seem to think that inflation is important to their business decisions and therefore they tend to devote few resources to collecting and processing information about inflation.”
2. May 2015 at 06:10
Vaidas, You said:
“Scott, monetary shock is a change in monetary reaction function, that’s why this is so difficult.”
That won’t work either. Suppose policy tightens any time oil prices soar. Then if oil prices soar, policy will tighten even though the monetary reaction function did not change.
Good point about inflation, you’d want to use inflation net of VAT.
2. May 2015 at 06:13
“Britonomist, You misunderstood my comment about M2. My point was that tight money could increase the demand for M2 (perhaps) making it a less reliable indicator of the stance of policy. The question of whether M2 is “exogenous” is irrelevant.”
And my point is that just because the demand increases doesn’t mean the size of the monetary aggregate must increase as well (unless we assume m2 is not fully exogenous, which is reasonable). So to me this doesn’t make the size of the aggregate useless.
“And again, I am looking for INDICATORS of the stance of money, not causal factors. I would never claim falling interest rates CAUSE tight money.”
What this whole thing really sounds like is an aggregation problem. You need a microfounded concept of what ‘loose’ and ‘tight’ money actually is before a coherent conversation can be had.
What tight money SHOULD mean is a shortage of money, but what does this mean when there are different types of money? What does it mean if the central bank (allegedly) supplies reserves on demand?
2. May 2015 at 06:30
Ray “cite please?”
There are so many articles. I only say “majority” because I’ve never seen an empirical article that dismisses the concept, but I haven’t read every single study ever so it’s possible it’s in one I’ve never read. Here are a selection:
http://www.degruyter.com/view/j/jafio.2005.3.1/jafio.2005.3.1.1089/jafio.2005.3.1.1089.xml
http://www.sciencedirect.com/science/article/pii/S109420250400016X
http://onlinelibrary.wiley.com/doi/10.1162/jeea.2006.4.2-3.575/abstract
http://www.sciencedirect.com/science/article/pii/0304407686900618
http://link.springer.com/article/10.1007/s00181-007-0160-3
http://www.sciencedirect.com/science/article/pii/S0304393201001118
2. May 2015 at 06:51
Re sticky prices (not wages): Noah Smith April 15, 2015 article: how-sticky-prices-might-be-the-cause-of-recessions “Steve Williamson of the Federal Reserve Bank of St. Louis dismisses sticky prices on his blog, saying that the Great Recession went on too long to have been caused by price stickiness, and that sticky-price models have conquered central banks mainly due to slick marketing. Elsewhere, University of California-Berkeley economist Brad DeLong grumbles that the success of the sticky-price models (called “New Keynesian” models even though they have relatively little to do with John Maynard Keynes) could be distracting from the search for deeper reasons for economic dysfunction” – note that there’s precious little empirical proof of sticky prices (not wages), and the sticky price to explain recessions research is ‘brittle or artificial’ in that a tiny bit of stickiness has huge repercussions, typical of back-fitting models that have little real world application. Note also DeLong, Williamson are not believers and are giants in their field.
2. May 2015 at 06:54
‘What tight money SHOULD mean is a shortage of money…’
If there is a shortage of something, ceteris paribus, its price will rise. In this case, people will have to bid more goods and services (including their labor) to buy it (a nominal quantity). For instance, a baker who had been in the habit of buying a dollar from his customers with a loaf of bread, will find himself having to offer his standard loaf PLUS a few slices. That, or bake larger loaves.
‘…but what does this mean when there are different types of money?’
That there will be different prices for the different prices of money
2. May 2015 at 06:56
Oops, should have been; ‘different prices for the different *types* of money.’
2. May 2015 at 06:59
Btw, we have historical examples of different types of money circulating alongside one another. Such as in immediate post-WWII Europe, when cigarettes and other goods were used as money.
2. May 2015 at 07:09
@Patrick Sullivan – you can educate yourself before trying to educate others by reading how money operated in the 19th century when different banks had different types of money (hint: they converged at $1, as a unit of account, for the same reason competitors will cluster in the middle of a street rather than seek opposite ends, hat tip to K. Arrow). Further, indeed in the USA due to a fallacy that attributed inflation to small bills, there was a chronic shortage of small bills and hence merchants had to do the tricks you suggest, bundling goods, or even issue their own script. Read any book on Free Banking such as by Richard H. Timberlake, K. Dowd, or G. Selgin among others.
2. May 2015 at 07:25
Well, Ray, thanks for taking the time to educate me, rather than waste your time educating yourself. Say, by reading what Alan Greenspan did in October 1987. He was on an airplane to Dallas on ‘Black Monday’ when the stock market began to plummet. On arrival he made a few phone calls, and early the next day the Fed issued a statement;
https://www.richmondfed.org/publications/research/region_focus/2006/fall/pdf/federal_reserve.pdf
‘The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.’
It followed up that statement with substantial open market purchases over the next days and weeks. I.e. it created more money. And Fed officials began a round of telephone calls to banks, reminding them they were in the business of lending that money.
2. May 2015 at 08:05
Scott, my response to Ray is awaiting moderation (probably because of all the hyperlinks)
Patrick:
“If there is a shortage of something, ceteris paribus, its price will rise…”
In other words, higher interest rates. Yes this is straightforward so far.
“That there will be different prices for the different prices of money”
So what is the price of bank money (demand deposits) compared to the monetary base? Is there a shortage of base, or of bank money?
2. May 2015 at 08:14
You mention NGDP as a possible indicator, but *expected NGDP* (a year or eighteen months in the future) would be much better. Then your example of the Fed lowering the Fed funds rate to zero in September, 2008, wouldn’t work: that would have been a shock to *expected NGDP*, though not to actual NGDP.
2. May 2015 at 08:20
Other commentators rightly ignore your foray into philosophy (you say “the answers are no and no” to the questions: “Does free will exist?” and, “Is there such a thing as personal identity?”), but let me take a shot. The answer to the question, “Did he do that of his own free will?” is sometimes “yes” (though sometimes “no”), and similarly for the answer to the question, “Did the same person do both those actions?” That means that the answers to *your* two questions are, in fact, *yes* and *yes* (though they are *not* *the same question*).
2. May 2015 at 09:26
——–Egregious Failure To Define Terms———–
“If there is a shortage of something, ceteris paribus, its price will rise…”
In other words, higher interest rates. Yes this is straightforward so far.
———endEFTDT——–
It is straightforward, but not as you think. I didn’t say anything about interest rates, because they are not ‘the price of money’.
2. May 2015 at 09:43
“It is straightforward, but not as you think. I didn’t say anything about interest rates, because they are not ‘the price of money’.”
In simple monetary models, it’s interest rates that adjust until the demand and supply of money is at equilibrium. What, in your opinion, is the ‘price’ of money? Are you referring to the price of a basket of goods? Price relative to foreign currencies?
2. May 2015 at 10:10
Great post, Scott. You still have your work cut out for you!
Empirically, the short term interest rate (price of money) is a function of the monetary base divided by NGDP. End of story.
If this ratio increases, the price of money goes down. When it decreases, rates go up. We can isolate which factor is driving rates at any point in time (and hopefully move the discussion forward).
2. May 2015 at 10:18
If Superman sees a man tied to the railroad tracks and chooses not to save him, then who killed the man, the villain, Superman, or the train?
What if Superman didn’t save the man only so that he could stop an incoming nuclear warhead? What if the only reason Superman was flying around that day was to save the man on the tracks. Then did the villain who tied him there save the city by causing Superman to fly and stop the nuclear warhead?
The only true exogenous variable is the current position and momentum of every particle in the universe. And that’s not even knowable due to the uncertainty principle. Whoa dude.
2. May 2015 at 12:07
I’ve read this blog for over a year, yet I still can’t explain why the position of steady inflation is better for the economy than steady no-inflation. Could somebody please explain to me why NGDPLT works better than, say, what the author of this piece regularly promotes?
http://www.realclearpolitics.com/articles/2015/05/02/zero_inflation_is_holding_the_economy_together_126471.html
2. May 2015 at 12:41
Britonomist, You said:
“And my point is that just because the demand increases doesn’t mean the size of the monetary aggregate must increase as well (unless we assume m2 is not fully exogenous, which is reasonable). So to me this doesn’t make the size of the aggregate useless.”
I agree that just because the demand for money increases doesn’t mean the stock of M2 money increases. I don’t understand your point.
You said:
“What tight money SHOULD mean is a shortage of money”
I strongly disagree. Money was very tight in 2009, but there was not shortage of money. I could get cash from the ATM whenever I wanted it.
Philo, Yes, expected NGDP is better.
Regarding personal identity. There was a recent article about head transplants. We’ve already heard of bionic arms and legs. Kidney transplants. Heart transplants. So if “you” can get a new head, arm, leg, heart, etc, what precisely is the “you” that gets all these things? It your personal identity in your spleen?
You don’t have free will, because there is no “you”, just a bundle of thoughts that hover around the brain of the organism that other people regard as Philo. Can you control those thoughts? What is the “you” that would control them? A little man inside your brain? The thoughts just happen, one after another.
Britonomist, Interest rates are the price of credit, or the rental cost of money. The price of money can be defined as 1/P, or 1/forex rates, or 1/NGDP.
Jknarr, Thanks but see my reply to Britonomist on the price of money.
Andrew, I find it most USEFUL to think of causation in terms of policy counterfactuals.
Stephen, We both think that if NGDP growth is 4%, the lower the inflation the better. We both oppose inflation targeting. Larry may disagree with me, but I see no evidence there.
2. May 2015 at 12:52
“I strongly disagree. Money was very tight in 2009, but there was not shortage of money. I could get cash from the ATM whenever I wanted it.”
In which case maybe ‘tight’ and ‘loose’ are not good words to use, the definition is very unclear.
2. May 2015 at 14:09
Scott, your ATM example doesn’t seem right to me. You were moving your own money from the banks vault to your wallet. If you had gone to the loan officer instead of the ATM, and asked for a marginally new amount of money, say by showing them the deed to a property which you would normally expect to be useful as collateral for gathering some money that you hadn’t previously been warehousing, I suspect you would have had a different feeling about if there was a shortage of money.
2. May 2015 at 23:10
@Britonomist- your cites don’t support the general proposition of sticky prices, but rather some stickiness over limited time periods for certain countries (Germany, Israel, France). Further there’s this from the third paper you cite: “2) downward price rigidity is only slightly more marked than upward price rigidity;” Ergo, if prices are sticky going up and down, then it really does not matter long term does it? It’s a wash. And 2015 – 2008 = 7 years is decidedly “long term”.
As for true evidence of price stickiness, the evidence is equivocal (from my notes): “Mark Bils and Peter Klenow looked at how businesses changed prices, and found that the changes were too frequent to be consistent with the sticky-price story. But in 2014, they reversed their stance, looking at evidence on the adjustment of markets in recessions” Note two esteemed researchers flip-flopped on this issue, showing it is not a ‘close call’.
3. May 2015 at 05:30
Britonomist, Yes, tight and loose are misleading words, that seem to apply more to credit than money.
Kevin, I would call that a decline in the supply of credit, not tight money. But obviously others see it differently. I don’t think anything important is at stake here, just word choice. I’d prefer saying something like money is increasingly scarce. In economics, there’s a big difference between “decline in supply” and “shortage.”
3. May 2015 at 06:02
Britonomist wrote:
> can you ever really say that a lowering of the
> interest rate, even if it’s as a result of previous tightness,
> is monetary tightening? No.
See Nick Rowe’s excellent post:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/04/var-vs-wtf.html
For example, suppose the Central Bank was holding their policy rate target at 3%, with a 2% inflation target. Then, they announced that they had seen the light, and were changing to a 0% inflation target. Because the real Wicksellian rate has not changed, they are lowering their policy rate target to 1%. There you have it, a rate cut that corresponds to monetary tightening.
I don’t see any sensible definitions other than:
tightening: changing policy to reduce NGDP growth
loosening: changing policy to increase NGDP growth
tight: a policy that leads to a lower-than-desirable level of NGDP
loose: a policy that leads to a higher-than-desirable level of NGDP
“Tight” and “loose” are meaningless without a NGDP level target, but “tightening” and “loosening” can be used even without having a specific NGDP level target in mind, because “tightening” will cause actual NGDP to fall relative to any target.
-Ken
Kenneth Duda
Menlo Park, CA
-Ken
3. May 2015 at 07:16
Be careful with the zinc prices stuff. It’s only a short step from there to gold prices, and we don’t want to get people started on that one.
3. May 2015 at 07:44
“Ergo, if prices are sticky going up and down, then it really does not matter long term does it?”
Actually, it does matter in the short term still in any macro model, but nobody said prices were sticky in the long term.
3. May 2015 at 07:52
Scott: ” I’d prefer saying something like money is increasingly scarce.”
So in 2008, what measure of money was scarce? Base money? What caused that?
Ken: “tightening: changing policy to reduce NGDP growth
loosening: changing policy to increase NGDP growth
tight: a policy that leads to a lower-than-desirable level of NGDP
loose: a policy that leads to a higher-than-desirable level of NGDP”
They may be sensible definitions for normal times. But in the context of trying to evaluate what effects central bank policies have on NGDP (which is what many VAR studies on monetary policy are trying to do), those are useless definitions for the circular reasons Scott mentioned.
3. May 2015 at 09:21
All of these higher-level “Ms” are just various forms of liabilities, i.e. debt. They serve as money, but are only a note promising the delivery of money.
All these derivative forms of money reference base money. You can have immense amounts of debt referring to a scarce amount of base money as a deliverable. It’s just leverage.
As in the futures market, where a massive amount of open interest can ride on a slender number of registered deliverables, this is normal. For every derivative future, there is a winner and a loser based on the price of the reference asset. Most contracts never take delivery, everybody clears their longs and shorts at the reference price.
Occasionally, though, there is a deliverable crunch. Call 2008 a “commercial signal failure” in base money. Banks were way, way, over their skis with unbacked zero-maturity liabilities; while the Fed was clearly starving the system of deliverables (reserves).
http://research.stlouisfed.org/fred2/graph/?g=1a1Q
Not enough base money, you’ll invariably have overleverage and a run on the bank. If you lack base money to transact, you create money reference debt obligations until the point of over-leverage and a clear lack of deliverables.
Debt always ultimately clears and nets out with base money demands. With the banks now recapitalized with excess reserves, the only question before us now is whether the real US economy is overleveraged. Will the real economy demand huge amounts of base money, and what will this do to NGDP?
3. May 2015 at 11:30
The state has made wage rates stickier than they otherwise would have been, and the stickiness that otherwise would have been would not cause recessions that last months and into years.
Wage rates would fall as quickly as unemployment fell after the recent extraordinarily high welfare was removed.
3. May 2015 at 12:58
@Scott
A possible indicator of monetary police stance could be the issuance of private debt…
4. May 2015 at 06:23
Ken, I agree with everything you say, except I might use expected NGDP growth rather than actual.
I don’t understand Britonomist. If the Fed suddenly and dramatically reduces the money supply, and this causes deflation and falling interest rates, how can that not be tight money?
Britonomist, In late 2007 and early 2008 base money was scarce because the supply suddenly stopped growing. In late 2008 it was because the demand for base money increased sharply.
I think it is the VAR studies themselves that are useless. I’m not surprised the Fed has not been able to use them successfully.
Jose, Why is that?
4. May 2015 at 07:41
There are easy questions about personal identity (“Is your personal identity in your spleen?” — Ans.: no; “Am I the very man who married X [insert name of my wife] six years ago?” — Ans.: yes), as well as hard ones (“Exactly which sequences of transplants of organs in your body would be compatible with the continuing existence of *the same person*?”). The existence of the hard ones shows that we should not expect soon to come up with an *obviously correct theory* of personal identity; it does not show that there is no such thing as personal identity.
As for free will, you seem to have some theory (quite a vague one, I’ll bet!) about what free will must be, and you note that there is, in actuality, nothing that corresponds to your theory. Let me suggest that your theory is wrong. In practice (by the way, I thought you were a pragmatist rather than some sort of *a priori* theorist!) we easily distinguish between voluntary actions and other events (admittedly, there are there a few hard cases, as there are with all our distinctions). Voluntary actions = free will.
4. May 2015 at 07:56
Britonomist writes:
> But in the context of trying to evaluate what effects
> central bank policies have on NGDP (which is what
> many VAR studies on monetary policy are trying to
> do), those are useless definitions for the circular
> reasons Scott mentioned.
You’re saying my definitions aren’t useful if the purpose is to do something totally silly, namely VAR studies on the effects of central bank policies.
If the central bank wants to know what policies would enable it to hit a given NGDP target, it doesn’t need VAR studies, it needs a prediction market.
If someone is wondering what the effect would be of a 1% cut in the CB’s policy rate, they don’t need VAR studies, they need to read Nick Rowe’s post (http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/04/var-vs-wtf.html), and hopefully they will come away understanding that their question doesn’t make sense because the effect will depend entirely on the market perception of the reason for the 1% cut.
There is no point in these studies and therefore there is no reason the desire to do them should lead us away from a sensible definition of “tight” and “loose” monetary policy.
-Ken
4. May 2015 at 07:59
It’s like, “your definition of ‘walk’ is no good because it would exclude many of the walks the Ministry of Silly Walks wishes to fund.” 🙂
4. May 2015 at 12:22
@Scott
“I don’t understand Britonomist. If the Fed suddenly and dramatically reduces the money supply, and this causes deflation and falling interest rates, how can that not be tight money?”
Which post is this addressing here? That doesn’t sound like something I’d say, maybe you misinterpreted me?
For the record, this is what I think:
“Tight money” is when it’s too expensive for banks to get reserves to cover their liabilities (e.g. it’s expensive because of a harsh discount window penalty, high federal funds rate, or a major discount to par when they sell bonds), meaning the banking sector is forced to contract credit or not grow it so quickly. In the worst cases, this can cause a credit crunch.
This can also, in the medium run, result in low interest rates for two reasons, 1) because the central bank panics and attempts to loosen again when the economy is in a deep recession – and 2) because the low expectations of future growth & inflation fails to restore interest rates to a sensible level, this is why low interest rates are often an indicator that money was tight.
I don’t define it as low NGDP growth, I just think of that as a possible and common symptom of tight money – or alternatively, a symptom of initially tight money, leading to a recession, leading to a liquidity trap.
Loose money is when banks can expand credit very cheaply, leading to a positive output gap, loosening is when the central bank makes the cost of expanding credit cheaper, a liquidity trap is when banks have no desire to expand credit and it can’t get any cheaper.
Note: my definitions of “loose” and “tight” don’t encapsulate all of monetary policy, for instance it doesn’t encapsulate helicopter-drops.
4. May 2015 at 12:25
@Kenneth Duda
“namely VAR studies on the effects of central bank policies.”
Sure, I just brought that up because that is what the topic of Rowe’s original post is. It’s not just VAR studies, any attempt to evaluate the effect central bank policies have on NGDP logically, or in a model, will be useless if you define changes in NGDP as changes in central bank policy. You can use prediction markets, but that just tells you what the market thinks is effective at boosting NGDP, not why it boosts NGDP.
4. May 2015 at 19:25
@ Kenneth Duda:
Your framing of the objection to the proposed definition was: “It would exclude many of the *walks* that [etc., etc.] . . . .” But a definition of ‘walk’ should not exclude any *walks*, so the objection is (trivially) correct.
5. May 2015 at 06:14
Philo, I don’t agree with your definition of free will (voluntary actions.) If I did, I’d agree free will exists.
I think even voluntary actions are pre-determined by genetics plus environment.
5. May 2015 at 06:21
Britonomist, I was reacting to this:
“I definitely agree the level of interest rates are a lousy indicator of the stance of monetary policy. This doesn’t mean /changes/ in interest rates are lousy: can you ever really say that a lowering of the interest rate, even if it’s as a result of previous tightness, is monetary tightening? No. Even if tight money can cause low interest rates, all you’re really saying is tight monetary policy can cause loose monetary policy as a response.”
Which I strong object to. Tight money doesn’t cause easy money, if it causes falling interest rates, but falling interest rates don’t describe the stance of policy.
5. May 2015 at 10:22
Scott, first of all I think the problem boils down to the fact that when I think of tight vs loose, I think of a counter-factual where, /all else equal/, interest rates remain unchanged – and compare the drop in interest rates to the counter-factual. Suppose instead, after 2008 Bernanke just decided not to drop interest rates at all (again, really stressing ceteris paribus here, so absolutely nothing has changed market wise that might put upwards pressure on interest rates, the only thing that has changed is Bernanke’s preferences/discretion/subjective beliefs not related to data) – one can easily conclude that, compared to /this counter-factual/, the dropping of interest rates was in fact a policy loosening, /despite the fact that it’s still a signal of overall past tightness/, or overall /insufficient looseness/ thus meaning money is still tight on an /absolute scale/ but not relative to my counter-factual.
6. May 2015 at 06:46
Britonomist, Again, I don’t think you’ve thought through the implications of what you are saying. It’s a free country and you can say what you wish, but people won’t take you seriously unless you are consistent. And if you are consistent with that definition it will lead to crazy claims such as that money was tight in the 1970s because the Fed raised interest rates. Or during the German hyperinflation because they raised rates.
It’s better to just ignore interest rates; they tell us nothing useful about the stance of monetary policy
6. May 2015 at 09:16
Scott, I honestly not sure that you’re making a good faith attempt to actually understand what I’m saying in this case, you keep dismissing what I’m saying into a simplistic strawman, especially when I’ve gone to unbelievable, extra special bending-over-backward lengths to really strongly clarify how high interest rates could still signal loose money and vice versa: if you’re still saying – ” if you are consistent with that definition it will lead to crazy claims such as that money was tight in the 1970s because the Fed raised interest rates” – then you’re clearly not understanding my point at all, even after I’ve repeated myself multiple times that low interest rates can easily reflect tight money and vice versa.
So here’s another point, you seem to be interested in a binary description description of the stance of monetary policy, ‘tight’ vs ‘loose’ – where as I view it as a spectrum of a scale, where there is varying degrees of looseness or tightness, and that just because the central bank enacts a policy towards the ‘loose’ direction of the scale, doesn’t mean money is overall ‘loose’.
6. May 2015 at 09:21
s/I honestly/I’m honestly*
s/spectrum of a scale/spectrum or a scale*
7. May 2015 at 05:33
Britonomist, You said:
“then you’re clearly not understanding my point at all, even after I’ve repeated myself multiple times that low interest rates can easily reflect tight money and vice versa.”
Yes, I must have misunderstood your view, because I agree with that. I thought you were saying that interest rates can be used to identify the stance of policy, or a change in the stance. They cannot, for exactly the reason you cite here–low rates can reflect easy or tight money. If you start with normal rates, and go to low rates, policy may have gotten easier or tighter.
20. May 2015 at 07:14
It would appear that our disagreement about “free will” is purely verbal. The question, then, is: which of us has the better definition? I rest my case on the fact that almost always in ordinary (non-philosophical) discourse the phrase ‘free will’ is used in the context “he did it of his own free will,” or something similar, where the intended contrast is with action that is somehow non-voluntary. Therefore my equation of *free will* with *the capacity to act voluntarily* has the support of ordinary linguistic usage, and it would be unnecessarily confusing to employ an entirely different definition, such as *not pre-determined*. (But, to repeat, my point is *merely* verbal.)