Williamson on NeoFisherism (define “loosening”)
Stephen Williamson has a new post that interprets recent monetary history from a NeoFisherian perspective. It concludes as follows:
What are we to conclude? Central banks are not forced to adopt ZIRP, or NIRP (negative interest rate policy). ZIRP and NIRP are choices. And, after 20 years of Japanese experience with ZIRP, and/or familiarity with standard monetary models, we should not be surprised when ZIRP produces low inflation. We should also not be surprised that NIRP produces even lower inflation. Further, experience with QE should make us question whether large scale asset purchases, given ZIRP or NIRP, will produce higher inflation. The world’s central bankers may eventually try all other possible options and be left with only two: (i) Embrace ZIRP, but recognize that this means a decrease in the inflation target – zero might be about right; (ii) Come to terms with the possibility that the Phillips curve will never re-assert itself, and there is no way to achieve a 2% inflation target other than having a nominal interest rate target well above zero, on average. To get there from here may require “tightening” in the face of low inflation.
I partly agree, but disagree on some pretty important specifics. I thought it might be instructive to start out by rewriting this paragraph to express my own view, with as few changes as possible (in bold):
What are we to conclude? Central banks are not forced to adopt ZIRP, or NIRP (negative interest rate policy). ZIRP and NIRP are choices. And, after 20 years of Japanese experience with ZIRP, and/or familiarity with standard monetary models, we should not be surprised when ZIRP results from low inflation. We should also not be surprised that NIRP results from even lower inflation. Further, experience with QE and inflation forecasts embedded in TIPS should not make us question whether large scale asset purchases, given ZIRP or NIRP, will produce higher inflation. The world’s central bankers may eventually try all other possible options and be left with only two: (i) Embrace ZIRP, but recognize that this means a decrease in the inflation target – zero might be about right; (ii) Come to terms with the possibility that the Phillips curve will never re-assert itself, and there is no way to achieve a 2% inflation target other than eventually having a nominal interest rate target well above zero, on average. To get there from here may require “loosening” in the face of low inflation.
Why do we reach such differing conclusions? I think it’s because I have a different understanding of recent empirical data. For instance, Williamson’s skepticism about monetary stimulus in Japan is partly based on his assumption that the recent sales tax increase raised the Japanese price level by 3%. But there’s never a one for one pass through, as it doesn’t cover major parts of the cost of living, such as rents. So the Japanese price level (net of taxes) has risen by considerably more than Williamson assumes (albeit still less than 2%/year). Even more importantly, Japan had persistent deflation prior to Abenomics. And if Williamson is going to point to special factors such as the sales tax rise, it’s also worth mentioning that his recent data for Japan (and the other countries he considers) is distorted by a large one-time fall in oil prices. Almost all economic forecasters (and the TIPS markets) expect inflation to soon rise from the near zero levels over the past 12 months. Abenomics drove the yen from 80 to 120 to the dollar—-is that not inflationary?
In the Swiss case Williamson mentions low rates and asset purchases, but completely misses the elephant in the room, the huge upward revaluation of the franc earlier this year, which was widely condemned by economists (and even by many Swiss). This policy was unexpected, unneeded and undesirable. It immediately led forecasters to downgrade their forecasts for Swiss inflation, and those bearish forecasts have turned out to be correct. I hope that’s not the sort of “tightening” of monetary policy that Williamson believes will lead us to higher inflation rates.
Seriously, I’m confident that Williamson would agree with the conventional view that currency appreciation is deflationary. That should send out warning signals that terms like “loosening” are very tricky. Before we use those terms, we need to be very clear what we mean. You can achieve higher interest rates through either loosening (a crawling peg devaluation forex regime) or tightening (open market sale of bonds), it all depends how you do it. More specifically, it depends on the broader policy context, including changes in expectations of the future path of policy.
I think he also gets the Swedish case backwards. The Swedish Riksbank tried to raise interest rates in 2011. Instead of producing the expected NeoFisherian result, it led to what conventional Keynesians and New Keynesians and Market Monetarists would have expected—falling inflation. It led to exactly the type of bad outcome that Lars Svensson predicted. So Svensson was right. And contrary to Williamson, the Riksbank did not turn around and adopt Svensson’s preferred policy, which is actually the “target the forecast” approach; rather they continued to reject that approach. They continued to set rates at a high enough level so that their own internal forecasts were of failure. Once a tight money policy drives NGDP growth lower, the Wicksellian equilibrium rate falls and policy actually tightens unless the policy rate falls as fast or faster. That did not occur in Sweden.
Let me try to end on a positive note. I have a new post at Econlog that took a position roughly half way between the NeoFisherians and the Keynesians. Brad DeLong had noted that Friedman often claimed that low rates are a sign that money has been tight. I’d emphasize, “has been.” Krugman said this was wrong, at least over the time frame contemplated by Friedman. I disagreed, defending Friedman. I believe that Keynesians overestimate the importance and durability of the so-called “liquidity effect” and underestimate how quickly the income and Fisher effects kick in. At the same time, as far as I can see the NeoFisherians either ignore the liquidity effect, or misinterpret what it means. (My confusion here depends on how literally we are to take the “tightening” claim in the quote above.)
Question for the NeoFisherians:
I often discuss the Fed announcements of January 2001, September 2007 and December 2007. That’s because all three were big shocks to the market. In all three cases long-term interest rates immediately reacted exactly as Irving Fisher or Milton Friedman might have expected. In the first two cases, easier than expected policy made long-term rates (and TIPS spreads) rise. And in the last case tighter than expected policy made long-term rates (and TIPS spreads) fall. Please explain.
To me, that’s the Fisher effect. But here’s the problem, the Fed produced those three results using the conventional manipulation of short-term rates. Thus in the first two cases the Fed funds rate was cut more than expected, and vice versa in the third case. From a Keynesian perspective this is really confusing—why did long-term rates move in the “wrong way”? From the NeoFisherian perspective this is also really confusing—why did moving short-term rates one way, cause TIPS spreads (and long term rates) to move the other direction? From a market monetarist perspective this all makes perfect sense. (It doesn’t always play out this way, but if you look at the really big monetary shocks the liquidity effect is often swamped by the long-term effects.)
HT: Marcus Nunes
Tags:
22. September 2015 at 07:20
From Scott’s Econlog post;
———quote———
Volcker did adopt a tight money policy in late 1979 and early 1980, but it wasn’t very credible. And for good reason, in mid-1980 the Fed suddenly switched to a highly expansionary monetary policy. As a result, by late 1980 and early 1981 NGDP growth was running at 19.2%. You read that right, 19.2%. And no, we are not talking about Venezuela or Zimbabwe; we are talking about the United States of America. I’m not sure what happened, but recall that the initial tight money policy drove the US into a steep recession in early 1980. Unemployment soared. Also recall that Volcker was a Democrat and the Democratic president that appointed him faced a difficult re-election battle in the fall. I don’t know whether this fact influenced the Fed, but for some reason the Fed slashed short term interest rates to single digits, even as CPI inflation averaged over 13% in 1980. That policy shift made no sense. The easing immediately ended the recession, which was (I think) the shortest on record. The economy began to recover in the second half of 1980.
As the explosive NGDP data for late 1980 and early 1981 came in, the Fed realized that its earlier anti-inflation policy had failed. Bond markets saw this failed effort, and became even more skeptical. Long-term yields soared to new peaks. So Volcker tightened again in the spring of 1981 (a policy supported by Reagan, but opposed by many of Reagan’s aides.) In mid-1981 the economy went into a steep recession, and interest rates fell sharply, just as in the spring of 1980. But this time the Fed persevered through high unemployment, and we had a long recession. This time they did squeeze inflation out of the economy. When the markets saw that this time the Fed was serious, there was another sharp drop in rates in late 1982.
———endquote———
I happened to be following developments with interest rates verrrrrry closely in 1980, as I had some real estate I was selling at that time. It was pretty clear that Volcker backed off his ‘monetarist experiment’ when he realized it imperiled Jimmy Carter’s re-election. By this time financial markets had had enough experience with inflation to be wise to his intention, and market rates began to rise. Which was the straw that broke the Carter’s back.
In his memoir, Volcker says he met with Reagan in January 1981 and told him what he intended for monetary policy, going forward. Reagan–who used to carry a copy of ‘Capitalism and Freedom’ around with him in his suitcoat pocket–understood that the first effect would be recession–told Volcker he would support him. I.e., Let’s end the inflation that has bedeviled the American economy for a decade and a half.
Volcker, in his book, then thanks Reagan for that. It would be pretty hard to ignore the implication that Carter did the opposite when he was President.
22. September 2015 at 07:39
Volcker, in his book, then thanks Reagan for that. It would be pretty hard to ignore the implication that Carter did the opposite when he was President.
It is hard to know these details as:
1) Volcker has never said anything against Carter and might have felt he did enough in Round 1.
2) It was Iran hostage that sank Carter. Also, Volcker in round 2 would have the benefit of the drop in oil prices with ending of Iran hostage and the breakdown of the oil embargo.
As a one & done Keynesian (basically the government makes big effect in 2009 but needs to pull back after the original stimulus), I think Central Banking rate changes are very similar. Japan can lower can get the benefit of low rates & stimulus in ~1998 – 1999, but needed to pull back after 2000. In terms of Japan, the stubborn deflation is caused by other economic realities.
22. September 2015 at 08:02
>>In the first two cases, easier than expected policy made long-term rates (and TIPS spreads) rise. And in the last case tighter than expected policy made long-term rates (and TIPS spreads) fall. Please explain.>>
From my perspective, easier policy would cause more growth and inflation (together, more NGDP), which in turn would lead to higher rates. For believers in the expectations hypothesis (long rates reflect expectations of future short rates), cutting now accelerates NGDP, which will require raising rates later.
I’m not sure which school this means I’m in.
22. September 2015 at 09:34
Economists like Sumner love to define their own terms, hence the “scare quotes” around ordinary words. Night = Day in Sumner’s lexicon.
Also note how professional economists cannot see eye-to-eye: “Williamson …completely misses the elephant in the room”, “he also gets the Swedish case backwards”, “To me, that’s the Fisher effect” (so everybody can have an idiosyncratic view of anything it seems?), “From a Keynesian perspective this is really confusing” (I’m sure Keynesians would disagree, but Sumner doesn’t see it that way…) etc etc etc.
Pfft. A Bronx cheer is what “economists” need.
@Patrick R. Sullivan – since you appreciate the history of the Volcker Fed you’ll appreciate how Volcker proved money is neutral. See my reply to Brian Donohue from a while ago- “thanks for taking up the challenge. I respect you more, for what it’s worth, as unlike our host and his minions you don’t chiefly resort to name calling as your retort. But you are wrong about Volcker. Please go here: tradingeconomics.com/united-states/interest-rate Now note US Fed Funds Rate for 1979-82. Note the ups and downs. This is Volcker. Now go to the St. Louis Fed website and chart CPI. What you will see is this: from July 1979 to Feb 1980, the Fed Funds rate spiked from 10% to 20%-a huge jump that should have dampened inflation. Let’s leave aside that the Fed was following the market rather than leading it (my contention vs yours), let’s just observe what happened to CPI. CPI during this time was NOT affected (St. Louis Fed site, I cannot leave a link as it’s too long), in fact, it actually accelerated! The Fed had a tiger by the tail, and the tiger wanted to run. Now notice that the Fed *lowered* interest rates from 20% to 10% from Feb 1980 to July 1980, and again no effect on inflation EXCEPT at the END of the period, in July, the CPI rate of increase actually *declined*! The *opposite* of the idea of ‘raise Fed rates to lower inflation’! As our host would say, “never reason from a price level / change”. The Fed then again raised interest rates from 10% to 20% from July 1980 until July 1981 (not September as you say, but no big deal) but inflation continued during this time at roughly the same reduced pace as from July 1980. In other words, inflation broke on its own without much influence from the Fed, which yo-yo’d around with interest rates, following the market. Inflation gradually receded on its own, indeed a flareup occurred in April to July 1982 despite the high Fed funds rate. In short, you can read this data and conclude the Fed not only no effect, but arguably had a negative correlation in 1980 (i.e., when the Fed tightened, inflation was not affected, and when it loosened, inflation actually fell). The only way you can find cause-and-effect is if you introduce “lags” from the time the Fed did something and inflation responded. I’m sure a clever statistician could do this, but it’s just data mining. I firmly believe, looking at this data and other data, that money is neutral or super-neutral, and the Fed has little or no influence beyond a few days. And greater minds, like Fischer Black thought likewise.”
22. September 2015 at 10:34
I find it baffling that such esteemed economists like Williamson and Cochrane would so blatantly confuse cause and effect. Maybe it’s because I learned everything I know about monetary policy from Scott, but their errors seem so elementary. I guess there’s enough data out there with different Fed rate moves causing different directions in market interest rate/inflation movements that a multitude of theories can find support.
22. September 2015 at 10:43
‘Volcker has never said anything against Carter….’
No, but in his book, “Changing Fortunes”, he praised Reagan for standing firmly behind him, and compared him favorably to previous Presidents. One of whom, being Carter.
22. September 2015 at 10:44
Good examples, thanks for sharing.
22. September 2015 at 11:57
“It was Iran hostage that sank Carter.”
That’s likely true. By many accounts, based in part on his activities after his term ended, Jimmy Carter is said to have been one of the most decent humans ever elected to the Presidency. That may be true in many respects, but it is not sufficient qualification, in itself, for the job.
That said, I was amazed that *with the benefit of historical hindsight*, Carter recently mentioned the following as his “greatest regret”:
“I wish I had sent one more helicopter to get the hostages, and we would have rescued them, and I would have been reelected,” he said.
With hindsight, the hostages were released, peacefully and without casualties, a short time later (upon Reagan’s inauguration, about 9 months after the failed rescue attempt). What would have happened had Jimmy sent in that additional helicopter? Nobody, including Jimmy, knows. But, in addition to the possibility that the hostages would have been “rescued” and thereby released 9 months earlier, there are also the distinct possibilities that 1) that additional helicopter would also have been downed by a sandstorm, perhaps with the loss of American life (in addition to the 8 servicemen killed in the aborted attempt); and/or 2) the hostages would not have been rescued, but would have been killed, along with a number of US servicemen. in the attempt.
The fact that Carter’s greatest regret,* in hindsight of actual developments*, is that he didn’t further risk the lives of others to gain *at most* 9 additional months of “freedom” for the hostages, but also, presumably primarily, to bolster his own re-election chances, to me greatly diminishes the man and demonstrates why he was not a particularly profound thinker or effective President. It all sounds rather selfish, too.
22. September 2015 at 13:55
All that math and Williamson confuses cause and effect and utterly FAILS to account for the natural policy experiments (failures) we’ve had at the ZLB / near ZLB. Go figure.
22. September 2015 at 13:55
Scott,
Talking of interest rates, what’s your view on the relationship between real interest rates and fiscal deficits in (a) a large economy like the US and (b) a relatively small economy like the UK? I was looking at some historical studies of the UK and they were saying that the relationship was very small, and cited the US in the 1980s as a case in point.
22. September 2015 at 14:39
All definitions of “loose” and “tight” that are not based on what would otherwise have occurred in a society that respects all individual rights, are necessarily definitions based on the whims of violent thugs and their banner waving yet very much cowardly stool pigeon intellectuals.
Oh sorry, excuse me, I meant based on what is “useful” and “pragmatic”…
…to the benefits of the violent thugs and their banner waving yet very much cowardly stool pigeon intellectuals.
22. September 2015 at 15:31
‘”I wish I had sent one more helicopter to get the hostages, and we would have rescued them, and I would have been reelected,” he said.’
He would have been re-elected whatever happened with the hostages, except for the economy. Carter had an 8 point lead in the polls as late as mid-October.
In hindsight, he should have avoided debating Reagan.
22. September 2015 at 16:08
Excellent blogging. I would like to see a post on the fact that Japan seems to be able to do a lot of QE without incurring much inflation and their unemployment rate is now very low.
22. September 2015 at 16:32
Thanks Patrick, That’s very interesting.
W. Peden, The studies I’ve seen suggest that deficits don’t have much impact on interest rates. But I’d guess that more government spending on things like infrastructure has more effect on interest rates than tax cuts.
22. September 2015 at 17:32
This is where Williamson jumped the shark:
“And it [QE] does not verify the much larger reach-for-yield, bubble-inducing, or other effects.”
It turns out he’s just a Very Serious Person after all.
22. September 2015 at 22:06
Patrick Sullivan: You may find this UPI story of interest:
President Reagan and Federal Reserve Chairman Paul Volcker, accused…
Feb. 17, 1982
WASHINGTON — President Reagan and Federal Reserve Chairman Paul Volcker, accused by some of pursuing competing paths to economic recovery, met privately Monday to discuss economic policy, the White House said Wednesday.
Deputy White House press secretary Larry Speakes confirmed the meeting took place, ending nearly two days of secrecy and statements of ‘no comment’ from the White House and the Federal Reserve.
Speakes, White House communications director David Gergen and Fed spokesman Joseph Coyne all refused to comment Tuesday on the meeting Tuesday.
Speakes said Reagan and Volcker discussed high interest rates, among other things.
Asked why the meeting was not disclosed until almost two days later, Speakes said, ‘We thought it was better that they carry on these discussions outside the glare of public attention.’
Gergen told reporters Tuesday, ‘We’ve had a fair amount of public press about our views toward the Fed and relations with Mr. Volcker and so forth.’
The meeting foreshadowed Wednesday’s session between Reagan and Belgian Prime Minister Wilfried Martens, president of the European Economic Community, who carried with him foreign concerns about high U.S. interest rates.
Much as members of Congress have voiced fears about Reagan’s projected 1983 budget deficit of $91.5 billion, the Europeans are showing a good deal of anxiety. Big deficits, they say, will mean continued high interest rates.
Reagan has asked that the Federal Reserve cooperate with the administration in attempting to get the economy back on the road to prosperity.
But that, in effect, is the extent of Reagan’s authority over the Fed, an independent agency that manages the nations’ money supply.
Earlier this month, Treasury Secretary Donald Regan said the president would meet with Volcker to discuss the linkage between the tight monetary followed by the Fed and the economic cures sought by the administration.
The administration has blamed high interest rates on the Fed’s ‘erratic’ management of the money supply. Volcker, however, has laid the blame on nervousness among lenders concerned about future budget deficits.
Reagan and Volcker had met three times prior to Monday’s session.
Some members of Congress have complained that the Fed and the administration appear to be at odds in their approaches to the economy.
Without a more coordinated attack on the problems of the economy, they say, recovery will be further postponed.
Last week, Rep. Jack Kemp, R-N.Y., said Volcker should be replaced if he cannot ‘do what he was required to do — give us a sound dollar, low interest rates and a stable bond market.’ Kemp also has criticized the administration of attempting to cure the economy purely through the budget, without addressing monetary policy.
But Volcker said Sunday the Fed will continue its ‘restraint on money and credit growth’ to fight inflation. He said cutting future budget deficits will result in lower interest rates and greater business investment.
—30—
After these meetings, Reagan Treasury Secretary Don Regan publicly proposed the Fed be moved into the Treasury Department (I think this is a good idea, as it would increase clarity, transparency and accountability in government. But it suggests the Reaganauts were out for blood).
Meanwhile….
Nearly forgotten today, a younger version of Allan Meltzer served as an Acting Member of President Ronald Reagan’s Council of Economic Advisers in 1988-9. Ten years after his stint on the CEA, Meltzer recounted the Reagan Days (1981-1989), in a piece entitled, “Economic policies and actions in the Reagan administration.”
Meltzer’s chastising study reads in part””
“Uncertainty and lack of a coherent monetary policy were not limited to 1981-82. During the years 1984-87, the Reagan administration shifted from a freely fluctuating exchange rate to encouraging dollar devaluation first by talk and then, in 1986, by increasing money growth. These actions were followed by a decision at the Louvre in January 1987 to set a band for the exchange rate against principal currencies. Within a few months, the dollar was overvalued relative to the agreed-upon rates, so maintenance of the band required increased money growth in Germany and Japan and lower money growth in the United States. The band required higher interest rates. Between July and October 1987 interest rates on long-term U.S. government bonds increased approximately 25 percent (from 8 1/2% to about 10 1/2%). When anticipations of further increases in interest rates contributed to a rather dramatic decline of prices on the world’s stock exchanges, the administration shifted its position again. The dollar declined about 8 to 10 percent below the presumed bottom of the previous band.
It is difficult to find a consistent pattern, much less a coherent policy, in these shifts within less than one year from efforts to force devaluation by raising money growth and lowering market interest rates to a program of stabilizing exchange rates, lowering money growth, and raising interest rates and then to a program of lowering interest rates and allowing the dollar to fall. The shifts suggest an extremely short-term focus….” (boldface added.)
The Reagan Administration did not have a “coherent monetary policy,” says prominent rightie-tightie Meltzer, who served on Reagan’s CEA.
Suffice it to say hagiography can only go so far. The Reagan years were marked by large budget deficits and an incoherent monetary policy, says Meltzer.
I actually liked Reagan, and I think Trump is worth a look.
But facts are facts, Jack.
Reagan probably did not understand monetary policy, anymore than he knew what was going on in Iran-Contra (of which he said he had no recollection).
23. September 2015 at 00:57
Scott,
Thanks!
23. September 2015 at 06:12
Ben, Reagan’s aides opposed Volcker but Reagan himself was supportive.
And no, Trump is not “worth a look”, he’s a xenophobe and a nationalist and a fan of big government and a (self-described) militarist. Trump is wrong on almost every single issue, regardless of whether his views on that issue are liberal or conservative. It’s not easy to be wrong almost 100% of the time.
Don’t know his views on monetary policy, but Presidents don’t exert any influence over that issue (even though they theoretically could.)
23. September 2015 at 07:15
What Scott said; ‘Ben, Reagan’s aides opposed Volcker but Reagan himself was supportive.’
Most of Ben’s lengthy quote and commentary is irrelevant to the period in question, which is Volcker’s early tenure. The 1982 meeting was presumably about re-appointing Volcker for another term.
Remember that Republicans stood to lose seats in congress in the midterm elections (and did). Reagan fought with his ‘stay the course’ campaign. He didn’t blame Volcker for the recession (even though he’d caused it, as Reagan well knew). Which is why Volcker thanked Reagan for his support, in his book.
I’m mean Volcker was actually in that 1982 meeting, so who would better know what was discussed.
23. September 2015 at 07:34
Also, Martin Anderson, wrote about those meetings between Volcker and Reagan in his book ‘Revolution: The Reagan Legacy’;
———quote——–
President Reagan believed that a sound, stable, and predictable monetary policy was essential to restoring the economic health of the country. So did Volcker. Volcker was very concerned about the independence of the Federal Reserve and Reagan respected that concern. Others in the administration and in Congress often became impatient with Volcker and his fellow governors and urged Reagan to pressure the Fed, publicly and privately, to follow a different course. That would have been foolish and wrong, almost certainly having the opposite effect from what was intended.
The reason the monetary policy meetings between President Reagan and Volcker were an important economic policy chokepoint was not because of the good they accomplished, but rather because of the bad they avoided.
…. Reagan never asked him to either ease or tighten the money supply. I think Volcker very much appreciated the lack of direct pressure. Given that Volcker was a Democrat appointed by President Carter, a surprising amount of goodwill seemed to develop between them.
———endquote———-
Again, that’s eye witness testimony.
23. September 2015 at 07:39
Scott, what’s your reaction to Bill Gross telling the Fed to get off zero now:
http://www.cnbc.com/2015/09/23/bill-gross-to-the-fed-get-off-zero-now.html
23. September 2015 at 07:43
http://www.pbs.org/wgbh/commandingheights/shared/minitext/ufd_reaganomics_full.html
——-quote——-
GEORGE SHULTZ: Paul Volcker was undersecretary of the Treasury when I was secretary, and we worked together closely. He’s a fine person, and very knowledgeable. Toward the end of the Carter administration, with inflation out of control, Paul Volcker was made chairman of the Federal Reserve. He understood the problems well, but I think it’s fair to say he was under constraints as to what he could do about it.
When President Reagan took office, he had people like Milton Friedman. I was chairman of the economic policy group, Milton was a member, and there were others who said the essence of the inflation problem is monetary policy, and to deal with it effectively, you’ve got to discipline the money supply. Paul Volcker agreed with that, and President Reagan gave him a green light. Now, people worried about that, and many people warned President Reagan that if he did this, there’s likely to be a recession. And obviously who wants a recession? But I can remember President Reagan using those famous words, “If not now, when? If not us, who?”
———endquote———
and;
———–quote———-
INTERVIEWER: How important was President Reagan’s support for [Chairman of the Federal Reserve Paul] Volcker’s policies [directed at squeezing inflation out of the American economy]?
MILTON FRIEDMAN: Enormously important. There is no other president in the postwar period who would have stood by without trying to interfere, to intervene with the Federal Reserve. The situation was this: The only way you could get the inflation down was by having monetary contraction. There was no way you could do that without having a temporary recession. The great error in the earlier period had been that whenever there was a little contraction there was a tendency to expand the money supply rapidly in order to avoid unemployment. That stop-and-go policy was really what bedeviled the Fed during the ’60s and ’70s. That was the situation in 1980, in ’81 in particular. After Reagan came into office, the Fed did step on the money supply, did hold down its growth, and that did lead to a recession. At that point every other president would have immediately come in and tried to get the Federal Reserve to expand. Reagan knew what was happening. He understood very well that the only way he could get inflation down was by accepting a temporary recession, and he supported Volcker and did not try to intervene.
———-endquote———–
23. September 2015 at 08:23
Scott,
The chart of the effective funds rate (EFR) for the past 60 years shows two fundamental trends. From 1954 to 1981 the trend is upward. From 1981 to now the trend is downward. In both periods the EFR is volatile, especially so before 1990. Yet in both periods relatively large and frequent changes in the EFR did not alter the secular trend. It appears there is more going on than just the FED being “behind the curve”. If 1981/1982 was an inflection point what was it?
Perhaps simple supply & demand for money is the answer. During the baby boom period the demand for money was greater than what the economy could supply. This demand for money pushed interest rates higher. The deep 1981/1982 recession squashed demand and allowed the economy to begin supplying sufficient money to match demand. Since 1982 the economy has supplied more money than what is demanded and this excess supply has pushed interest rates down.
In a world flooded in money there is little economic demand for it. Sure, most people would want to have more money but the clear evidence is that the supply of money exceeds the economic demand for it. I believe your argument is this is because the real interest rate of money is too high. Perhaps it is. But is this a problem the central bank can solve? Is it a problem the central bank should solve? I understand the monetary theorist believes rates can and perhaps should go negative. But why go there? If the “market” is saying it does not want to expand debt then why should some arbitrary agency say the market is wrong? And if the central bank was to pursue this experiment how can the people have any confidence it will turn out well?
Perhaps, as John Cochrane writes, the FED should declare victory. It stabilized the economy! Why not shut off the lights and go home?
“The lesson is clear: In fact, our economy is stable. Small movements of inflation will melt away on their own. The Fed does not need constantly to adjust interest rates to avoid ‘spirals.'”
http://johnhcochrane.blogspot.com/2015/09/wsj-oped-directors-cut.html
23. September 2015 at 10:48
Scott, you write:
“Trump is not “worth a look”, he’s a xenophobe and a nationalist and a fan of big government and a (self-described) militarist. Trump is wrong on almost every single issue, regardless of whether his views on that issue are liberal or conservative. It’s not easy to be wrong almost 100% of the time.”
So you’re admitting his views rise to the level of being wrong then? It could be worse: they could be not even wrong. Or, as Nick Rowe once put it on another subject, “aren’t even not even wrong.”
Lol… I think that was the 1st Nick Rowe post I ever read and it’s stuck with me ever since.
If Trump were to be elected POTUS, I have a feeling it wouldn’t be long before he’d tire of it, call a hasty press conference and summarily fire America. … thus freeing up his valuable time for something more befitting of a man of his stature… perhaps another reality TV show, for example.
But I do suspect that Trump really does channel the rage and paranoia of a significant number of low-information self-pitying delusional voters out there: they’re convinced that massive (net) numbers of immigrants are flooding across the border, stealing their entitlements and jobs and raping and killing them, and as Trump-supporter Ann Coulter ever so delicately put it (as she’s known to do on so many subjects), contributing to the (for her) undesirable “browning” of America (and thus bringing on a tsunami of cultural catastrophes like out of control child rape… typical of Latin American culture, according to her).
Personally I’d take my chances and trade Ann and Donald, and all their supporters for twice their number in random “brown” immigrants from anywhere in Latin America. What are the chances they could possibly be any worse?
Actually, having lived in California all my life, and for the past 31 years in a city with a long history of heavy Spanish and Mexican cultural influence, I can truthfully say I don’t recall ever once seeing any Mexican immigrants standing at a traffic stop with a cardboard sign begging for money. I’ve seen a **LOT** of white people doing that. Nope, the many Mexican immigrants I see on a daily basis are all working for a living.
My anecdote is just an anecdote, and thus of limited value I realize… but it leads me to wonder just a bit what Trump loving nativist xenophobes are on about… Are they as dangerously delusional as the flat Earthers … er… I mean young Earth creationist science-haters (same difference, BTW) already swelling the ranks of their party?
23. September 2015 at 11:25
Scott,
1. It’s certainly true that we generally think of monetary policy in terms of a rule. Basically, everything is endogenous, so we wouldn’t want to talk about nominal interest rates “causing” inflation. That said, it’s now well understood that some standard Taylor rules take you to the zero lower bound, and as long as central bankers adhere to such a rule, they will never get off the ZLB. So, the rule causes low inflation. What’s the cure? Change the rule – but any rule that increases inflation has to have the property that the nominal interest rate will go up. This is obvious of course, as once you’re at zero, there is nowhere to go but up – barring relaxation of the ZLB of course, but relaxing the ZLB is not a solution.
2. We can quibble over the amount of pass-through from the consumption tax in Japan, but since the middle of last year, inflation has been roughly zero in Japan, in spite of massive QE.
3. Oil prices: This is just a relative price change – implications for inflation depend on monetary policy of course. Back in the day, people would talk about central banks “accommodating” the high inflation that would have otherwise been temporary given an oil price shock. You can accommodate on the downside too, I think. You should note as well that oil prices (like everything else) are endogenous on a world scale.
4. exchange rates: The exchange rate is endogenous too. The fact that the Swiss Franc appreciated presumably had something to do with Swiss monetary policy.
5. It’s hard to ignore when you see this happening in so many countries – low or negative nominal interest rates, low or negative inflation. Why wouldn’t you start thinking about how those go together?
23. September 2015 at 11:53
I don’t know why Keynesians would be confused. If the Fed eased more than expected then long term rates would rise expecting a hotter economy. If the Fed disappointed and didn’t ease enough as in December 2007 then long-term rates would decline as markets would expect a falling NGPD trend from a Fed not up to the job. How would DeLong or Krugman disagree?
23. September 2015 at 16:27
Pat Sullivan–
History often becomes hagiogaphy. And politics.
The fact remains that Allan Meltzer termed Reagan’s macro economic policies to be “incoherent.” The fact also remains that Secretary Treasury Donald Regan proposed placing the Fed into the Treasury Department. He was Reagan’s Treasury Secretary. Really, Reagan “supported” Volker but condoned a speech in which the Fed would be placed into the Treasury?
Reagan was a nice guy, good instincts, and avoided foreign entanglements. However he was either clueless regarding monetary policy, did not know what his Treasury Secretary was proposing, or he wanted to control the Fed.
I am no fan of Carter.
23. September 2015 at 16:39
If Trump is a militarist, he is less so than Fiorina or Rubio. If he is an xenophobe, he has a strange way of marrying foreigners. I favor larger amounts of legal immigration, but I can understand the law should be observed.
Trump’s trade policies might be dubious, on the other hand they might open up foreign markets.
As for religion and abortion, Trump is towards the middle of the pack, while Fiorina has made outrageous claims regarding organ-harvesting and Planned Parenthood.
I do not know if I could stand many years of being schoolmarmed by Fiorina or Clinton. Maybe Trump is not so bad.
23. September 2015 at 17:26
Christian Science Monitor 1986
“Dr. Meltzer says the greater threat to Volcker’s power comes from the Treasury, not from within the Fed. Last September Treasury Secretary James A. Baker III got the finance ministers and central bank chiefs of the five major industrial countries to agree that the dollar was overvalued.
Volcker, notes Professor Meltzer, “has the arms of Mr. Baker wrapped around him.” The Fed is dragged along when the Treasury tries to coordinate international economic and monetary policy.”
—-30—
Hmmm. Having Treasury Secy Baker with his arms “wrapped around” Volcker? To devalue to the dollar?
You mean the Reagan Administration wanted to devalue the dollar and was bear-hugging Volcker to go along? So says Allan Meltzer—and contemporaneously too. No rose-colored history glasses on.
Really, is this an example that “Reagan supported Volcker?”
It strikes me Reagan (a skilled pol) wanted to be seen as “fighting inflation” but actually ran big federal deficits and had long-knives out for Volcker and his tight-money policies.
So much so that monetary policy-making was shifted, in some regards, into the Treasury.
http://www.csmonitor.com/1986/0327/fmark27.html
23. September 2015 at 17:38
Patrick, Thanks, those are very interesting.
Dan, You just have no idea. Do you even know what phrases like “demand for money” mean? I guess not.
Steve, Thanks for the response. You said:
“It’s certainly true that we generally think of monetary policy in terms of a rule. Basically, everything is endogenous, so we wouldn’t want to talk about nominal interest rates “causing” inflation. That said, it’s now well understood that some standard Taylor rules take you to the zero lower bound, and as long as central bankers adhere to such a rule, they will never get off the ZLB. So, the rule causes low inflation. What’s the cure? Change the rule – but any rule that increases inflation has to have the property that the nominal interest rate will go up. This is obvious of course, as once you’re at zero, there is nowhere to go but up – barring relaxation of the ZLB of course, but relaxing the ZLB is not a solution.”
Yes, that’s all true (except I’d say “has to have the property that the nominal interest rate will EVENTUALLY go up”), but that’s not where NeoFisherians get into trouble. The problem is statements that imply that if the Fed were to raise interest rates last week the inflation rate going forward would be higher than if they didn’t, which is not the case. I’ve consistently argued that the main problem with NeoFisherism is that the public statements, at least in the blogosphere, are not clearly enough spelled out.
You said:
“5. It’s hard to ignore when you see this happening in so many countries – low or negative nominal interest rates, low or negative inflation. Why wouldn’t you start thinking about how those go together?”
Start thinking? I got into blogging in early 2009 insisting almost every week, until I was blue in the face, that low rates usually indicate money has been tight. So I’m very sympathetic to one aspect of NeoFisherism. I’ve probably done more blog posts arguing that low rates don’t mean easy money that anyone else in the history of mankind. So no, it’s not really something I need to start thinking about.
In my view, tight money causes weak NGDP growth, which causes low inflation and low interest rates. Hence the two go together, as you say. I’m not sure what more one can say.
It’s not clear to me what model says oil is not a special factor that should be stripped out of inflation, but sales taxes are. But I certainly agree that the BOJ has fallen short of their 2% target (as I predicted) and will continue to fall short. Nonetheless they have boosted the Japanese price level, relative to the pre-Abe policy (as I predicted).
Inflation has also been roughly 0% in the US over the past 12 months. And the US inflation rate is widely expected to rise back above 1% in the near future. The Fed’s so worried about inflation they plan to raise interest rates soon. So if Japan has failed, has the Fed also failed? How are the cases different?
The oil price shock has temporarily depressed inflation everywhere, given the actual monetary regimes of real world central banks, regardless of whether you want to call it a relative price change.
Yes, the Swiss franc appreciated 20% in one day, and it was clearly a central bank decision. They tightened monetary policy by ending the peg and allowing currency appreciation, and hence fell into deflation. If they had adopted a more expansionary monetary policy, say a 20% currency devaluation, they would now have inflation.
Peter, Krugman clearly disagrees, and said so in a recent post on the Volcker disinflation, where he claimed that tight money raised long term rates for several years. I did a rebuttal arguing that this isn’t true.
Ben, There’re all horrible.
23. September 2015 at 19:06
Side note to Scott Sumner:
You are the honest academic-libertarian type.
You lack the requisite cynicism, small-mindedness, mean-spiritedness to understand a pol.
The oldest gag in the world is to publicly “support” somebody, even to his face, and then have underlings take out the long knives.
Reagan “supported” Volcker, probably wanted Volcker to be a frontman for an expansionary monetary policy. Volcker variously resisted.
The recollections of partisans of Reagan’s support of Volcker are only that—partisan accounts. Revisionist histories.
The Dems are no better. Krugman can barely utter a hoot against Obama, who has overseen the tightest monetary policy since Hoover.
24. September 2015 at 05:28
Scott,
Are you saying the laws of supply and demand do not apply to money? The person buying a mortgage for a house in 1981 was willing to pay 18% interest on the loan. Why 18%? Because that is what the market said the going rate was. If few had been willing to pay 18% then the rate would have been lower. Please tell me you agree on this fundamental principle of supply & demand.
Now you may disagree with the phrase “demand for money”. You, as an ivory tower economist may have more refined language. However, the consumer perspective of credit and loans is to get access to money. Thus the name of one of the famous lending companies “The Money Store”.
So will you give the question another chance? What happened in 1981 that changed the trend line of interest rates from increasing to decreasing? What happened in the economy to allow interest rates to not only stop rising but to steadily decline? Something fundamental changed. What was it?
24. September 2015 at 06:52
‘The fact remains that Allan Meltzer termed Reagan’s macro economic policies to be “incoherent.”’
How does that trump–pardon the expression–the observations of people who actually were in the Reagan-Volcker meetings? Which includes Volcker himself.
24. September 2015 at 06:58
‘Are you saying the laws of supply and demand do not apply to money?’
No, Scott is saying that interest rates are NOT the price of money.
‘The person buying a mortgage for a house in 1981 was willing to pay 18% interest on the loan.’
That 18% was the rental on the money borrowed/used. Not the purchase price of money. In your example that’s the house the seller is giving up.
24. September 2015 at 12:42
Ben, Volcker said Reagan supported him. Why would Volcker lie? I think the simplest explanation is the most plausible.
Dan, You are so hopelessly confused it would take years to set you straight. But please, at least try not to confuse money with credit.
24. September 2015 at 12:57
Scott,
What happened in 1981/82 that so fundamentally changed the trajectory of interest rates? What role did monetary policy have in this change? Do you believe the central bank has the power to create either upward or downward trends in long-term interest rates or is the central bank simply following the market and giving the illusion of control, while standing by to “save the system” when TBTF events occur?
If the truth is the latter than the obvious conclusion is that most of the FED’s fiddling with interest rates is detrimental to the economy and a distraction. Can we at least agree on this?
25. September 2015 at 06:35
Dan, You don’t know what the Fed did to cause the downward trend in rates?
It’s called tight money.