Expectations fairies take asset markets on a wild ride, and economists pretend not to notice

In the physical sciences, researchers identify empirical facts, and try to model them.  In economics, we observe empirical facts, and then create models to explain why these facts cannot possibly actually occur.  Consider:

U.S. stock futures pointed to another strong session for Wall Street on Friday, as oil prices continued to climb and investors were encouraged by signals of potential central-bank stimulus, at the end of a tough week for global markets.

Dow Jones Industrial Average futures YMH6, +1.29% leapt 210 points, or 1.3%, to 15,997, while S&P 500 futures ESH6, +1.46% jumped 27.25 points, or 1.3%, to 1,888.75. Nasdaq-100 futures NQH6, +1.86% gained 72 points, or 1.8%, to 4,202.75.

Friday was looking like a repeat of Thursday, when oil led the market higher. Then, U.S. crude prices CLH6, +5.22% rose $1.58, or 5.3%, to $31.10 a barrel, while Brent crude LCOH6, +6.36% jumped $1.88, or 6.4%, to $31.10 a barrel.

Oil and global stocks got a boost after European Central Bank President Mario Dragi dropped heavy hints on Thursday that more stimulus could be in store when the ECB meets in March. The Stoxx Europe 600 index SXXP, +3.18% was up 2.6% on Friday, while Asian markets finished with solid gains, including a nearly 6% rise for the Nikkei 225 index NIK, +5.88%

The Nikkei got a boost after an aide to Prime Minister Shinzo Abe said Thursday that “conditions for additional easing have fallen into place,” according to The Wall Street Journal. The Bank of Japan will meet on Jan. 28-29, and some expect the central bank’s asset-purchasing program could be increased.

So the expectations fairies are causing wild stock and commodity price movements, even though both Japan and the eurozone are at the zero bound.  And yet in the comment section I’ll have people “proving” this cannot be so, because in highly unrealistic New Keynesian DSGE models, monetary policy is totally ineffective at the zero bound.

Or they’ll say it worked, but through the expectations channel, so that “doesn’t count.”  Oh really, don’t New Keynesians believe the highly expansionary monetary policy of the 1960s sharply raised NGDP growth?  Isn’t that the standard NK explanation?  But interest rates rose during the 1960s, so how can that be?  They respond, “yes but that’s because inflation expectations rose sharply, real interest rates actually fell.”  Oh, so you are saying the 1960s monetary stimulus worked by lowering real interest rates, and that only occurred because inflation expectations rose?  So even when not at the zero bound, it’s all about the expectations channel? Then what makes the zero bound special?

Meanwhile Narayana Kocherlakota has a new post entitled:

It’s Time to Make a Hard U-Turn

It’s very short, so rather than try to excerpt it, and not do it justice, I’ll just ask you to read the whole thing.  Can we all agree now that Kocherlakota was not crazy last fall, as so many people assumed?  “Hey, there’s one FOMC member who wants to cut rates”   “Ha ha ha”

Yeah, who got the last laugh?

Update:  Update, I also recommend this blog post by Lars Svensson, another central bank dissenter who turned out to be absolutely correct.

Just imagine if Kocherlakota and Svensson were made chair and vice chair of the Fed (in either order.)

HT:  Julius Probst,  Marcus Nunes


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35 Responses to “Expectations fairies take asset markets on a wild ride, and economists pretend not to notice”

  1. Gravatar of marcus nunes marcus nunes
    22. January 2016 at 06:27

    Related, Mervyn (King) & Marvin (Goodfriend) in reviewing Swedish mon policy for 2010-15, say the rate increases in 2010-11 were the OK thing to do! If only they looked at NGDP when doing the review…
    https://thefaintofheart.wordpress.com/2016/01/22/mervyn-marvin-botch-it/

  2. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 07:48

    “The Nikkei got a boost after an aide to Prime Minister Shinzo Abe said Thursday that “conditions for additional easing have fallen into place,” according to The Wall Street Journal. The Bank of Japan will meet on Jan. 28-29, and some expect the central bank’s asset-purchasing program could be increased.”

    It is legal for the BOJ to purchase non financial assets like REITS. It is an experiment worth looking at, however, it is illegal for the Fed to do the same. However, the Fed has decided to fund the highway bill, at the request of congress.

    The BOJ buys long bonds which is a dead market. Wonder how banks make money lending if mortgages are tied to bond yields?

    Maybe central banks should just stop buying bonds and just by assets or just fund projects.

    Oh, by the way, the big banks did a form of NGDP targeting in rich neighborhoods. They permitted those that defaulted to live there free, so the prices would not crash in those neighborhoods. So, even in crash cities like Reno and Las Vegas, there were people living over 5 years in houses where the mortgage was not being paid.

    Of course, the average Joe was not afforded such a break. The banks didn’t care that the prices dropped in his neighborhood because they had big clients ready with credit lines to go in and pay cash at rock bottom prices on thousands of homes. So, they got the houses they wanted back through foreclosure and credit to their wealthy clients.

  3. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 08:13

    So, the question is, based on what the big banks did in the above statement, can NGDP targeting possibly be fair?

  4. Gravatar of Benjamin Cole Benjamin Cole
    22. January 2016 at 08:33

    Raghuram Rajan, the University of Chicago scholar who took over as governor of the Reserve Bank of India has been cutting rates aggressively in India, despite giving the usual central bankerly sermonettes about structural impediments when he took over in 2013.

    The RBI is also engaged in adhoc “liquidity injections,” which sounds a lot like QE.

    India is targeting greater than 7% growth in 2016.

    The Fed may be the dunce of the group, at this point.

  5. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 08:40

    Benjamin, can you answer my question about the fairness of NGDP targeting in the light of what the banks did with real estate? NGDP targeting is, after all, non financial asset buying as the approved course, it seems.

  6. Gravatar of John Thacker John Thacker
    22. January 2016 at 08:56

    Gary,

    Your example of what the banks did with real estate is exactly how fiscal policy (like the highway bill) works. It has nothing to do, however, with NGDP targeting.

  7. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 09:13

    John, thanks for the answer, but in NGDP targeting, the Fed would buy certain assets and not buy others. Is it fair.

    The banks did their own in house NGDP targeting for those particular neighborhoods. They didn’t fix up the houses or do fiscal stuff. They let the people stay so they could keep the prices up. They targeted the price. :)

  8. Gravatar of Marc Marc
    22. January 2016 at 09:37

    Why do daily changes in any market tell us anything about economic conditions or cause & effect? Aren’t you confusing noise for signal?

  9. Gravatar of ssumner ssumner
    22. January 2016 at 09:56

    Marcus, Thanks, I added an update.

    Marc, When asset prices change dramatically right after a major policy announcement, in much the same way that asset prices responded to similar policy announcements in the past, it’s far more likely that the policy announcement caused the asset price movement, than that the policymakers read the future in a crystal ball, and decided to move policy right before a major asset price movement.

  10. Gravatar of ssumner ssumner
    22. January 2016 at 09:57

    People, Let’s stop responding to Gary, perhaps he’ll go away.

  11. Gravatar of ChrisA ChrisA
    22. January 2016 at 10:12

    “Just imagine if Kocherlakota and Svensson were made chair and vice chair of the Fed” – Scott isn’t your proposal to define the role of Fed Chair such that you could make the manager of the local Dairy Queen Fed Chair and he would be successful?

  12. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 10:13

    Not a chance. You could ban me. That would be ok. I just want a simple question answered, is NGDP targeting fair? Who would it hurt?

    I would like to support NGDP targeting as opposed to the NK negative interest rate regime, but I need to know if it is fair.

  13. Gravatar of E. Harding E. Harding
    22. January 2016 at 11:05

    Gary, last response to you. It would hurt those with sticky wages who remain working during recessions. Its other negative consequences are unclear.

  14. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 13:10

    Yes, they will get laid off. But didn’t that happen anyway in Fall of 2008? How would it be different under NGDP? Just one more answer, Harding.

    Thanks for that LAST response, Harding. Feels like a funeral. Speaking of funerals, God already knows the ultimate termination point for all of us and what paths we take. He even determines the paths. Even for smart guys like Scott.

    It is comforting to know that there are quite a few MMers with blogs. Some are less active than Scott though.

  15. Gravatar of Cliff Cliff
    22. January 2016 at 13:13

    Wrong they will not get laid off. The fact that you think they will means you don’t understand the first thing about MM. What will happen is their real wages will rise less (or decrease). However others who would have lost their jobs will keep them.

  16. Gravatar of Ray Lopez Ray Lopez
    22. January 2016 at 13:23

    Sumner makes numerous errors (sigh):

    1) He erroneously assumes that random noise and one-day panic selling and a relief rally are significant and can be ‘modeled’ by equilibrium type economic models like DSGE

    2) He erroneously believes that some hated ex-MN Fed dude with an Indian surname and some Sumner supporter named Lars, both calling for a rate cut, somehow ‘got it right’ and the rest of us are dupes. Simple probability theory will tell you in any large sample of forecasters somebody will ‘get it right’ just by chance

    3) He hopes that commentator “Gary” will go away. That’s not worked for “Ray”. If Sumner wants no dissent, why not moderate his blog like DeLong, like Skeptical Economist, like Krugman’s staff do?

    4) He erroneously believes the “expectations fairy” (EF) cannot ‘turn on a dime’ and must be consistent. In fact, the EF is a fudge factor so indeed it can change day-to-day. It’s nothing more than a tacit acknowledgement that economics is non-linear and cannot be modeled.

    5) Most fundamentally, Sumner feels money is non-neutral and monetarism matters, when in fact it’s largely not.

  17. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 13:34

    “Wrong they will not get laid off.” You are right Cliff. Sorry. If NGDP slowed the recession, that is correct. Sorry.

    Some businesses would like to break contracts, though, like auto companies.

  18. Gravatar of Njnnja Njnnja
    22. January 2016 at 13:47

    Gary’s whole premise doesn’t make sense. First, long foreclosure lags had much more to do with # of foreclosures and judicial/non-judicial (and Nevada was basically judicial after the crash) than “NGDP targeting in rich neighborhoods.”

    Second, if a borrower can sell property for at least the value of the mortgage, they usually do that instead of getting foreclosed on. So if a servicer is foreclosing, then the bank is probably going to take a loss, even at market value. If the lender somehow engineers the sale in a non-arm’s length transaction at even less than market value, then the bank will take an even bigger loss.

    If a bank really wants to give the bank’s money to a “wealthy client” they would just write them a check instead of this stupid scheme.

    God forgive me for even replying.
    :(

  19. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 13:56

    So, Njnnja, I know the banks did not really do NGDP targeting. But they faked price stability by keeping deadbeat people in their homes on the high end. That is fact. They created an illusion of illusion. People thought the pricey homes held their value through constricting supply.

  20. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 14:03

    And people living in their homes for free is still happening, or at least was happening in 2015: http://www.zerohedge.com/news/2015-03-30/broke-you-may-now-be-entitled-free-home

    If all those high end homes prices tanked, the recession would have been far worse.

  21. Gravatar of Thomas Aubrey Thomas Aubrey
    22. January 2016 at 14:23

    Scott, I must have missed something but what has happened to the NGDP futures market you used to have on your webpage?

  22. Gravatar of Njnnja Njnnja
    22. January 2016 at 15:44

    @ Gary:

    To the extent that you want to use your link as an illustrative case it supports my position, not yours.

    many of them clustered in states like Florida, New Jersey and New York, where lenders must get judges to sign off on foreclosures.
    So the problem is judicial states.

    her roughly $1,300 monthly mortgage payment
    And low-to-moderately priced homes.

    As I said, long foreclosure lags had much more to do with # of foreclosures and judicial/non-judicial (and Nevada was basically judicial after the crash) than “NGDP targeting in rich neighborhoods.”

    However, the singular of data is not anecdote, so a single foreclosure case doesn’t prove anything. But if one does look at the data in detail, you are going to see that “banks giving money to wealthy clients” isn’t even a blip on the foreclosure timeline.

  23. Gravatar of LK Beland LK Beland
    22. January 2016 at 16:09

    “Just imagine if Kocherlakota and Svensson were made chair and vice chair of the Fed (in either order.)”

    I’ll one-up: they could add Paul Krugman and Robert Hetzel to that mix (plus, putting Krugman in a position like that would probably limit his ability to trash talk).

    (In an ideal world, they would also nominate you, Prof. Sumner, although it would probably be criticized by many since your CV is not quite as impressive as theirs).

    PS: I must admit that Stephen Poloz is doing a decent job in Canada. Speaking of which, here is anecdote #302 in regards to monetary offset: http://www.theglobeandmail.com/news/politics/impact-of-liberal-stimulus-weighed-on-bank-of-canada-rate-decision/article28284958/

  24. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 16:14

    NJNNJA, yes, now it is all in the courts. I agree with you. Nevada is a judicial state and a law was passed that they must link the mortgage with the note. They have to prove ownership prior to foreclosing. Of course that slowed the process of foreclosure down, which stabilized prices, as people were allowed to carry on.

    However, there were neighborhoods in which notices of default were sent out and no defaults took place at all. In Arrowcreek, and upscale development in Reno, there were 65 percent of the homes in pre foreclosure but they never were foreclosed on. Real estate agents said that they held off to keep the price up. No one knows how extensive that was.

  25. Gravatar of ssumner ssumner
    22. January 2016 at 17:16

    ChrisA, Yes, ideally.

    Chris, No, it’s not fair–now go away.

    Thomas, It was causing problems with the blog, so I moved it to Sites I Visit.

    LK, “Not quite as impressive” is an understatement.

  26. Gravatar of E. Harding E. Harding
    22. January 2016 at 18:23

    ssumner, don’t you mean Gary instead of Chris?

  27. Gravatar of gofx gofx
    22. January 2016 at 18:41

    Scott, on a related matter, you are getting famous,–or infamous….

    http://www.forbes.com/sites/nathanlewis/2016/01/21/nominal-gdp-targeting-is-just-another-red-herring-to-divide-conservative-monetary-consensus/#735951691c3e

  28. Gravatar of E. Harding E. Harding
    22. January 2016 at 18:54

    Links to shadowstats. Not instantly discredited, but halfway there.

  29. Gravatar of TallDave TallDave
    22. January 2016 at 19:30

    Poetic that markets are most sensitive to monetary intervention at precisely the time at which liquidity trap theories say such effects cannot exist — the point at which the Fed must intervene to support the NGDP trend.

  30. Gravatar of Gary Anderson Gary Anderson
    22. January 2016 at 22:32

    Harding said: “ssumner, don’t you mean Gary instead of Chris?”

    Tattle tail. I would put the smiley face but it always ends up in the wrong place, like in the middle of a sentence.

    Harding, I have a question for MMers. Can the futures contracts for NGDP be gamed, or the market in that paper cornered, distorting price. One guy cornered the cocoa market. The investment banks corner the oil market from time to time.

    So what about NGDP futures market?

  31. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    23. January 2016 at 07:01

    @LK
    I support Krugman for the Fed, so that we at least are spared his trash talk. Never thought about that, it is a great idea.

  32. Gravatar of Willy2 Willy2
    24. January 2016 at 00:18

    – “Expectation Fairies” ??? I also have A LOT OF “Expectations” but they almost never turn into anything solid, something I can benefit from.
    – Newspapers & Websites Always have the need to fill space in their papers and on their blogs. So, they write on what happened in the markets and what government leaders said. And then they try to connect the two things to find an explanation for what happened (e.g. in the markets). Just let them, it will keep them busy and make sure they won’t commit (serious) crimes.
    – The moment I hear the word “Zero Bound”, I know the person who speaks such words is a nutcase.
    – Same story for the words “Targeting NGDP”. It’s a total waste of words/digital ink. Central Banks can do ONE thing only and that’s increase or the amount of money in the financial system. Nothing more & nothing less.

  33. Gravatar of ssumner ssumner
    24. January 2016 at 14:20

    E. Harding, Yes, that was a typo, I meant Gary.

    gofx. Life’s too short to respond to that sort of nonsense. A gold standard? Like in 1929-33?

    Gary, You got your simple question answered, now go away.

  34. Gravatar of Benny Lava Benny Lava
    25. January 2016 at 12:55

    http://finance.yahoo.com/news/massive-layoffs-manufacturing-texas-164435388.html

    I just wanted to say I told you so.

  35. Gravatar of ssumner ssumner
    25. January 2016 at 13:13

    National unemployment rate = 5.0%

    Texas unemployment rate = 4.6%

    Benny, What’s that you told me?

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