Fed policy options

The Fed has three primary ways to impact NGDP:

1.  Change the supply of base money–primarily through open market purchases (OMPs), or sales.

2.  Change the demand for base money through adjustments in interest on reserves (IOR)

3.  Change the demand for base money through adjustments in the Fed’s target (inflation, NGDP, etc.), or making it more credible though actions such as level targeting, or currency depreciation in the forex market.

Most pundits think and talk in terms of binaries, and thus underestimate the policy options available to the Fed.  Thus a pundit might say we need to ban currency and break the zero bound, because OMPs are ineffective at the zero bound—forgetting the option of impacting base money demand by adjusting the policy target.

For each of the three options, it’s useful to treat one as a given, and think about the other options in a two dimensional space.  Thus if we have a given policy target, say a 4% NGDP target path, then the Fed has two tools to get there, OMPs and adjustments in IOR.  Then you can think about how much weight the Fed should put on each tool, by considering other objectives, such as size of the balance sheet.  For any given NGDP target, the higher the IOR the larger the balance sheet, and vice versa.  If the Fed wants banks to hold lots of liquidity, they might opt for a higher IOR.  If they are worried that they’ll need to do a lot of QE to hit their target, and that this QE will be politically unpopular, they’ll go for negative IOR.  (That’s where the ECB is right now.)

But we don’t have to think of the policy target as a given.  Japan recently raised their inflation target from 0% to 1%, and then later to 2%.

Or we could assume that for some reason IOR is fixed at zero, as it was during the Fed’s first 95 years. Then the trade-off would be between steepness of target path and size of balance sheet.  The faster the desired rate of NGDP growth, the smaller the ratio of base money to GDP, and hence the smaller the central bank balance sheet.  Australia chose a high target path, and got a very small RBA balance sheet as a result.

And finally, the balance sheet itself might be a key objective.  For instance, the Swiss National Bank recently became concerned about their ballooning balance sheet.  Suppose central banks are averse to a large balance sheet.  In that case the target path and IOR become the two policy options.  The Swiss could opt for a higher rate of inflation, or they could opt for a lower rate of IOR.  In fact, they’ve opted for negative 0.75% IOR, an especially low rate.  In my view they should have changed the (effective) inflation target, by not revaluing last year.

Even within a category such as OMPs, there are several possible options.  Thus the central bank could buy Treasury bonds, or they could buy a riskier asset.  Generally speaking, the riskier the asset the more “bang for the buck”, but not as much more as you might imagine (in my view.)  Monetary policy primarily works by impacting the liability side of the Fed’s balance sheet; the asset purchases are not very important.  However when we are at the zero bound, or when the market rate equals the interest rate on reserves, it’s quite possible that the asset side becomes relatively more important.  It’s hard to say how much more, because policy at the zero bound is especially sensitive to expectations of future policy.  But if we hold the NGDP target path constant, then the specific type of assets being purchased might make some difference.

Here’s a question from Eliezer Yudkowsky:

Should market monetarists be pushing heavily to have the Fed be buying higher-priced bonds, foreign assets, or non-volatile shortable equities, instead of US Treasuries?

It seems to me intuitively that buying Treasuries with money might itself be a wobbly steering wheel, because as the Treasuries have lower yields and especially as you foolishly start to pay interest on reserves, you’re substituting two very similar assets. As the two assets get *very* similar you might be approaching a division-by-zero scenario where it takes unreasonably large amounts of money creation to change anything. And yes, there’s still an amount of money that’s enough. But maybe you would literally have to run out of short-term Treasuries to buy. Maybe you’d need to print far less money if you were buying a basket of low-volatility stocks or something. So maybe this is one of the things that market monetarists should push for, for the same reason we push for not using interest rate targeting because the meaning of the asset keeps changing? Like, if we try to create money and exchange it for Treasuries, does the meaning of that act change and diminish even as the Treasury yields get closer to zero.

If printing more of the unit of account or unit of exchange is supposed to have a mode of action that doesn’t interact with the similarity of that currency to the Treasuries that it’s replacing, then I confess that this is something I still don’t understand myself and definitely couldn’t explain to anyone else. It might need to be explained to me with some kind of concrete metaphor involving apples being traded for oranges in a village that prices everything by apples, or something. Right now, the only part I understand is the notion that people have a price/demand function for things-like-currency, which implies that if a Treasury has become a thing-like-currency, creating currency and removing Treasuries will be a wash in terms of the demand function.

I think this question needs to be broken down into pieces.  First, are we happy with the policy target?  In my view the ECB and BOJ should not be happy with their policy target, as it leads to such low NGDP growth expectations that they are forced into unpleasant decisions on IOR and/or QE.  They’d be better off with another target, say level targeting of prices, which would lead to faster expected NGDP growth and less need to do negative IOR or QE.

But let’s say the target is carved in stone, then what are the options?

I prefer starting with buying Treasuries, even if it is less effective than other assets. Recall that seignorage is basically just a form of tax revenue, which ultimately goes to the Treasury.  Unless you specifically want to build sovereign wealth fund, it’s not clear why you’d want the Fed to buy stocks.  And if you do want to build a sovereign wealth fund, it seems like it should be the Treasury’s decision.  In other words, the Treasury could borrow a trillion dollars and use it to buy index stock funds. Then the Fed would have lots more T-debt to buy.  This combined operation has the same ultimate effect as Eliezer’s proposal, but the lines of authority are clearer.

The next question is how much T-debt should the central bank buy?  I don’t really know.  I’d probably ask the Treasury how much they’d like to leave in circulation to give liquidity to the markets (which might be $5 trillion), and then stop at that red line.  At that point I’d have the Fed buy other assets, such as Treasury-backed GSE debt (i.e. MBSs), foreign bonds, AAA corporate debt, etc.  I suppose at some point you might end up buying stock, but I can’t really envision that happening.  On the other hand, a decade ago I couldn’t envision where we are right now—-6 1/2 years of nearly 4% NGDP growth and interest rates at 0.5%.  So who knows?

To summarize, I have several objections to the Fed buying stocks right now:

1.  I doubt it provides much more bang for the buck, as it’s the liability side of the Fed’s balance sheet that really matters.

2.  Even if they do need to buy more Treasury debt (relative to stocks), buying that debt is not costly, indeed the Fed usually makes a profit.

3.  Any decision to build a sovereign wealth fund should be made democratically, i.e. by the Treasury.

I could add other objections, such as that it’s “socialism”.  However I’m actually not all that worried about the Fed meddling in the management of companies.  But lots of other people would be.

Eliezer’s right that base money and T-debt are much closer substitutes at the zero bound, but I don’t see that as a problem.  So do more!

I prefer to work back from the target.  What percentage of GDP does the public want to hold in the form of base money, if the central bank is expected to hit its target?  Right now people are confusing two issues, a desire to hold base money because rates are low, and a desire to hold base money because the central bank is not expected to hit its target (as in Japan and the eurozone).  If credibility is the problem, then you need a mechanism to restore credibility.  I like my “whatever it takes” approach and/or level targeting, but other options are available.  Thus small countries like Switzerland can simply devalue their currency.

Until we get clear thinking from the central banks about the three policy levers discussed above, it’s hard to give good policy advice.  For instance, if the ECB actually has big problems hitting its inflation target at the zero bound, then the asymmetry built into their target is obviously exactly backward.  In a world where the zero bound is a big problem, the target should be “close to but not below 2%”. Right now, they have a policy target that conflicts with their operating procedure. The target reflects the assumption that it is high inflation that is difficult to control. And yet exactly the opposite seems to be true.

Then central banks need to think clearly about the inflation rate/size of balance sheet trade-off (at each IOR).  They don’t seem to know whether they are more averse to higher inflation or to a very big balance sheet, and hence end up in the worst of both worlds—missing the inflation target and thus getting an even bigger balance sheet.  Of course the lack of clear thinking might actually reflect very clear thinking by each member of the ECB, but no agreement on which of those clear paths is best.  But I think it’s worse than that, you have central bankers saying we need to raise rates so that we can cut them in the future, an EC101-type error.  So I’m not willing to give them the benefit of the doubt.

I don’t think Eliezer will be happy with this post–it’s too long to be an “elevator pitch”



65 Responses to “Fed policy options”

  1. Gravatar of Gary Anderson Gary Anderson
    30. March 2016 at 10:40

    Draghi, as I wrote about, is buying bunds when bunds are in massive demand. He is literally driving the 10 year toward a negative rate. And maybe that is the Kocherlakota-like plan, to create even more demand for bonds, than there is now, and drive rates negative. Then Germany and the US would have huge warchests of money from the sale of those bonds, as investors would pay to keep them. I think it is more like extortion and it is way worse than negative IOR: http://www.talkmarkets.com/content/bonds/draghi-and-germany-have-a-secret-plan-to-save-the-eurozone?post=90083&uid=4798

  2. Gravatar of Christian List Christian List
    30. March 2016 at 11:16

    Take Germany out of the equation. The Germans seem to be completely nuts when it comes down to monetary policy.

    Jens Weidmann, president of the Deutsche Bundesbank, is repeating over and over again, that money is way too lose. He repeats this since at least 2010. Nearly every week. This man seems to be completely bonkers.

    This week Volker Wieland and Isabel Schnabel joined in and said the same thing. These two are part of the five member group ” German Council of Economic Experts” that advises the German government. The media calls them “five wise men of the economy”. Another member, Peter Bofinger (the German Paul Krugman) joined them as well.

    Not to mention Wolfgang Schäuble – Weidmann and Schäuble are basically evil twins. Then there’s Otmar Issing, former Chief Economist and former Member of the Board of the ECB. Then there’s David Folkerts-Landau, chief economist of Deutsche Bank. Don’t even get me started on them.

    To make the list a bit shorter: There seems to be no German politician or economist that is not crazy.

    Maybe Scott Sumner knows one. But I don’t know any.

    And honestly I think this is the real problem here. Not Trump. Not Le Pen. Not the mini tiny AfD. But the mainstream German politicians and economists. They can really drive Europe over the edge.

    Everybody sees Trump coming. Everybody sees Le Pen coming. But who says and does something against those mad Germans? Nobody. You get hit by the things you don’t see coming.

  3. Gravatar of bill bill
    30. March 2016 at 11:17

    Question on a related topic.
    How differently would the US economy have performed if the Fed had never introduced IOR?
    Bernanke wrote that if the Fed hadn’t paid IOR, then the cash related to QE would have gone into the economy instead of just sitting in bank vaults. This seem perverse to me. I thought the point of QE was to stimulate the economy?

  4. Gravatar of Gary Anderson Gary Anderson
    30. March 2016 at 11:30

    Bill, you wrote: “I thought the point of QE was to stimulate the economy?”

    No, the point of QE was to save the rich and save the banks. The Fed cannot let a real boom happen, since banks all have bet on low interest rates on the swaps they force onto their customers. The Fed cannot raise interest rates much or they will literally cause the banking system to implode. They would like a little rise in rates, but nothing major. They can’t take the risk. Will Rogers spoke about this very thing:

    “The whole financial structure of Wall Street seems to have fallen on the mere fact that the Federal Reserve Bank raised the amount of interest from 5 to 6 per cent. Any business that can’t survive a 1 per cent raise must be skating on mighty thin ice… But let Wall Street have a nightmare and the whole country has to help get them back in bed again.” DT #950, Aug. 12, 1929

    Banks are betting on low rates, probably did back in the Great Depression as well.

  5. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    30. March 2016 at 11:33

    Shortening replies is a writing problem, and I’m happy to take that part on myself. 🙂 But I don’t feel like I understand the policy case. In fact, I’m not sure I understand what actually happens near the zero bound.

    Suppose we can’t talk the Fed out of IOR so that cash yields 0.25% and short-term Treasuries yield 0%. Suppose short-term Treasuries are yielding -0.01% and cash yields 0. Does buying Treasuries actually have a negative impact? Should we be, at the very least, yelling at that point to buy long-term Treasuries instead?

    I mean, I think if I saw an entity that was literally steering in the wrong direction, announcements it made about its future policy target wouldn’t impress me much.

  6. Gravatar of ssumner ssumner
    30. March 2016 at 11:51

    Bill, I’m not sure Bernanke said that, can you provide a link?

    Eliezer, Ok, now I see what you are getting at. My best guess is that OMPs are expansionary even if the yield on reserves is higher than the yield on T-bills. But that raises the issue of how could this ever occur? Why wouldn’t banks simply sell the T-bills in exchange for reserves? There may be hidden costs here that make reserves slightly less attractive than they seem.

    Another point worth considering is that markets consistently seem to treat QE as expansionary. The argument against this is that we don’t really know why–it may be the expectation channel, in which case the actual physical action of an OMP, but itself, may not be expansionary.

    In practice, the Fed mostly tends to buy securities with a higher yield than reserves, especially at the margin. So I’m not sure if this is a practical problem, but it’s certainly an interesting case to think about. You are asking if it is ever possible that producing more X, and exchanging that X for Y, makes X more valuable. (Because of the properties of Y)

    I don’t know of any cases like that, but in economics it’s almost always possible to construct counterintuitive hypotheses. Thus the argument that a higher price for potatoes (in 1850) would make the Irish buy more potatoes, because they already survived mostly on potatoes, and the higher price made them poorer, and hence even more reliant on potatoes. That’s the sort of hypothetical your suggestion reminds me of.

  7. Gravatar of Benjamin Cole Benjamin Cole
    30. March 2016 at 12:28

    Interesting post.

    I love the idea that the Swiss could have built a sovereign wealth fund by buying foreign bonds (through the Swiss National Bank) in order to level the price of their own currency.

    Or, they could have printed Swiss francs, and purchased foreign bonds, and used those bonds to pay domestic taxes, giving taxpayers a break.

    It seems that arcane accounting conventions, and central bank ossification, are preventing the Swiss public from benefiting from the strength of their own currency.

    The Swiss National Bank has devised a policy that does not control the value of their currency nor benefit the public.

    It looks to me like the US Fed could pay down another few trillion of the national debt, with only minor and positive consequences for inflation and real demand.

    I think we need to hire skilled sociopathologists to ponder what motivates central-bank policy making.

  8. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    30. March 2016 at 13:09

    By the financial markets response to Yellen’s speech yesterday, I’d say the QTM is alive and well;


    The Dow, which closed up nearly 100 points Tuesday after Yellen’s dovish speech, gained another 84 points, or 0.5%, to close at 17,717 Wednesday. The broader Standard & Poor’s 500 stock index was 0.4% higher and the Nasdaq composite gained 0.5%. Both the Dow and S&P 500 have closed at 2016 highs two consecutive days and have more than completely wiped out losses from the worst start to a year ever for stocks.

    With one trading day left in the first quarter, the Dow is up 1.7% for 2016 and the S&P 1.0%. Only the Nasdaq remains in the red for 2016, down 2.8%. This is a stark turn from the dark days of early February, when the three major U.S. indexes had 2016 losses ranging from 10% to 15% when the market hits its low for the year.

    Yellen, who said it is prudent for the Fed to “proceed cautiously” in its push to normalize interest rates, powered a global stock market rally. Aside from a drop in Japan, stocks rallied sharply in Hong Kong, mainlaind China, India, Australia, London, Germany and Paris.

  9. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    30. March 2016 at 13:27

    This does leave a bit of a gap in wanting the market monetarist argument to be as straightforward as falling off a cliff. Like, if I was writing a FAQ about this, I might want to insert a line saying “Well of course the Fed should be buying longer-term bonds then, just in case, and then everything is very straightforward” because otherwise everything would not be very straightforward.

    This is especially true if Treasury yields can move away from zero and then suddenly the demand for all the base currency you printed drops by a lot. In this case the control instrument ‘exchange base money for Treasuries’ is a super wobbly steering wheel and we’d be relying dangerously heavily on level paths and market expectations and prediction markets to make up for what was using basically a broken steering wheel. Like, interest rate targeting would be a bad idea, albeit a better idea, *even if* we had prediction markets an level targeting – interest rate targeting would add instability.

    So maybe a better policy would be “always exchange your new base currency for assets that bear at least 2% more nominal interest than your new base currency” (in case you pay IOR or have negative IOR). Otherwise, according to my possibly completely broken attempt to model all this intuitively, you’re carrying out a swap that becomes much more meaningful / impactful as the rates on Treasuries rise? Meaning that when money has become tight, your control instrument is less effective, and that when money has become loose, your control instrument is a lot more effective money, just like if you were targeting a fixed interest rate. Which could potentially be bad if there’s inertia in how fast you can buy things back and there was a division-by-zero problem that caused you to need to buy up huge amounts previously.

    Of course, if you do buy long-term Treasuries, since Treasuries are supposed to be countercyclical, it’s possible the Fed would actually lose money that way. Though this would only happen in the first iteration of the cycle when people didn’t yet believe in the central bank’s will, it’s not like you could have predictable price changes *if* the central bank’s policy was actually going to work (which requires your control instrument be effective). But that would add more complexity to the argument. Similarly, buying procyclical equities, so as to make more of a profit on the first iteration, would add argument complexity.

    What I’m hoping for is to simplify the policy proposal to something that is in fact a slam-dunk relative to my own understanding, so that there’s a single clearly superior alternative to the present system with arguments that resolve very directly, even if it has yet better alternatives that could be implemented with some further complicated arguments somebody would have to figure out later. This is why we talk about prediction markets instead of existing financial markets, so as to avoid the complicated circularity issue and have a clearly superior policy alternative that doesn’t depend on resolving a complicated and presently unknown argument first.

    So in this case, it’s possible the slam-dunk would be that your control instrument is “Are there any outstanding government bonds that pay 2% higher nominal rates than your currency, whatever the current interest on reserves? Create currency and exchange it for those bonds.” Counterargument: “Might the central bank then lose money?” Reply: “That’s possible, although we shouldn’t overstate the probability because it hasn’t happened before. But it would happen only once, and all further losses would stop the moment the market realized you were serious about your level target.”

  10. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    30. March 2016 at 13:38

    Alternatively, the argument could be: “Create currency and exchange it for any kind of government bonds, which kind doesn’t matter – you can even use short-term bonds yielding near zero.” Counterargument: “But what if those are basically the same asset?” Reply: “Actually, people prefer not to hold onto that money the same way they’d hold a Treasury because (reason I don’t currently know), and we know this is true because of how the markets react to QE announcements.”

    It’s the presence of a fuzzy area where I don’t actually understand causal mechanisms or why certain things are true, that I want to avoid in describing the Clearly Superior Alternative Policy which establishes that central banks are definitely not doing the optimal thing right now. I have a fair amount of faith in my ability to understand and simplify complicated arguments, but only if there *is* a market monetarist answer to “But how does that work exactly?”

  11. Gravatar of BC BC
    30. March 2016 at 14:12

    What would happen if the Fed were to buy stocks but offset that position by shorting stock index futures like S&P 500 futures? Entering the futures position does not involve exchanging cash so the Fed would still be increasing money supply (to buy the stocks). Since a short futures position is equivalent to lending cash (buying a bond) and shorting stock, the overall position is equivalent to *synthetically* buying bonds. That would allow the Fed to increase money supply without buying up all the actual treasuries. On the other hand, if the Fed’s short futures position was really big, then it’s possible that such extra demand for short futures would attract counterparties that go long futures and try to hedge their positions by shorting stock and buying bonds. In that case, while the Fed wouldn’t be soaking up all the treasuries, it could conceivably inadavertently create more demand for treasuries. Hence, my question.

    In general, though, one purpose of derivatives is to separate the risk of owning securities (like stocks) from the capital required to buy those securities. That seems tailor made for the Fed. The Fed wants to buy lots of securities to inject money without actually taking the risk associated with the securities.

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    30. March 2016 at 14:24

    A thought experiment for you, Eliezer. What if the Fed does nothing, but the country’s counterfeiters make a technological breakthrough that allows them to produce $100 bills that are indistinguishable from the real thing. Literal money creation that doesn’t need T-bonds to execute. So, no worries about interest rates at all.

    What happens to NGDP when the counterfeiters start buying BMWs, houses, new threads at Brooks Bros, restaurant meals, week-ends at Donald Trump resorts….?

    Eventually…what happens to interest rates in the markets?

  13. Gravatar of Gary Anderson Gary Anderson
    30. March 2016 at 14:29

    ““Actually, people prefer not to hold onto that money the same way they’d hold a Treasury because (reason I don’t currently know), and we know this is true because of how the markets react to QE announcements.””

    I think treasuries are treated differently when used as collateral, then cash is. I read somewhere that cash disappears and treasuries still exist as collateral. I don’t know how true that is, maybe the economists know. But clearly, eliezer, everything you say about buying higher yield stuff on the part of the Fed is undone by Draghi on a daily basis. The lower he can go the better he likes it. He is the king of the Limbo. 🙂

    And Christian, you can’t take the Germans out of the equation because at least they have a plan. It is a very bad, extortionist plan, but they have a plan and Yellen clearly does not.

  14. Gravatar of Lewis Lewis
    30. March 2016 at 15:46

    kind of unrelated, but could you comment on this event?
    U.S. Bond Yields Hit One-Month Low on Yellen’s Remarks

    Am I right that you would have expected Yellen’s relatively dovish remarks to raise 10-year bonds, since they will raise expected NGDP? It makes sense that the 2-year did so, but the 10-year?

  15. Gravatar of Lewis Lewis
    30. March 2016 at 15:47

    *10-year bond yields, not 10-year bonds
    could it be that markets were expecting even more accommodation?

  16. Gravatar of bill bill
    30. March 2016 at 16:29

    Courage to Act. I took some notes when I had it out from the library. Here are some highlights. Some are direct quotes, others are just references:

    Page 325, middle paragraph
    We had initially asked to pay interest on reserves for technical reasons. But in 2008, we needed the authority to solve an increasingly serious problem: the risk that our emergency lending, which had the side effect of increasing bank reserves, would lead short-term interest rates to fall below our federal funds target and thereby cause us to lose control of monetary policy. When banks have lots of reserves, they have less need to borrow from each other, which pushes down the interest rate on that borrowing – the federal funds rate.

    And entire last paragraph on 325/326
    Until this point we had been selling Treasury securities we owned to offset the effect of our lending on reserves (the process called sterilization). But as our lending increased, that stopgap response would at some point no longer be possible because we would run out of Treasuries to sell. At that point, without legislative action, we would be forced to either limit the size of our interventions, which could lead to further loss of confidence in the financial system, or lose the ability to control the federal funds rate, the main instrument of monetary policy. The ability to pay interest on reserves (an authority that other major central banks already had), would help solve this problem. Banks would have no incentive to lend to each other at an interest rate much below the rate they could earn, risk-free, on their reserves at the Fed. So, by setting the interest rate we paid on reserves high enough, we could prevent the federal funds rate from falling too low, no matter how much lending we did.

    Pages 471-472: Used IOR at 0.25% to ensure that we didn’t hit the ZLB.

  17. Gravatar of bill bill
    30. March 2016 at 16:40

    Courage to Act. Start with the last paragraph on page 471.

    I’m not sure these various passages say exactly what I claimed. But I find each disturbing in its own way. I also found pages 544-545 disturbing too. Bernanke notes that Greenspan achieved the soft landing in the mid 90’s but he focuses on the market turbulence that accompanied that. Then on 545 he acknowledges his own success offsetting the fiscal cliff yet never connects the dots (i.e., that monetary policy can be effective at the ZLB).

  18. Gravatar of Derivs Derivs
    30. March 2016 at 16:46

    Not only entertaining, but you answered yourself at the end of paragraph 1. That is exactly what would happen. Essentially lots of work to get +paper and someone else now has to buy the very paper you apparently wished to avoid buying.

    “I’m actually not all that worried about the Fed meddling in the management of companies. But lots of other people would be.”

    For good reason. The operational design would be a mess. (When can they buy, sell (is it buy only?), % ownership, voting rights… and on and on….)

    Then there is the eventual headline (on a day the Fed is selling) “Fed selling exacerbates crash”

  19. Gravatar of Ray Lopez Ray Lopez
    30. March 2016 at 16:52

    Yawn, long post by Sumner, boring, as he admits. Let’s spice things up a bit.

    @Sumner- professor, do you agree with this ex-Fed governor? The Fed can just print money and give it to the Treasury, no need to get the public involved?:


    Narayana Kocherlakota – there’s no big difference between Helicopter Drop and traditional government financing, when the government is doing the spending, see:

    The Treasury can sell $100 billion in bonds to investors.
    The Treasury can issue $100 billion in bonds to the Fed, which pays for them by creating new money.

    “…there is absolutely no economic difference between the two forms of financing . In the first case (where investors buy the bonds), the Treasury pays interest on an added $100 billion in debt. In the second case (where the Fed creates money), the Fed pays exactly the same interest on an added $100 billion in bank deposits — which means that it can remit that much less money to the Treasury. (Fed liabilities grow only in the second case. That’s because, in the first case, the increase in liabilities generated by government spending is exactly offset by investor withdrawals to buy the Treasury debt issue.) ”

  20. Gravatar of ssumner ssumner
    30. March 2016 at 17:17

    Eliezer, There are no simple shortcuts here, unless one accepts prediction markets as a policy instrument. Any longer term bond that yields 2%, when T-bills yield 0%, is probably expected to yield 0% over the next three months, or else any extra yield above zero is due to the willingness of the buyer (the Fed) to take on more risk. That is, the coupon interest is offset by an expected fall in the price of the bond over the next 3 months, according to the expectations hypothesis for the term structure of interest rates. This isn’t just my argument, it’s also the way people like Krugman look at it. So Krugman would say if you buy something with a higher yield, it only works because the Fed is taking on risk, i.e. doing “fiscal policy”, not because they are increasing the money supply. So that won’t work as a slam dunk argument, they’ll accept the argument, but won’t consider it monetary policy. (As an aside, I don’t agree with the characterization of buying riskier assets as fiscal policy)

    Now things start to get murky. If you take a very extreme model, where all you have is money and T-bills, then at the zero bound the money supply discontinuously jumps up to include T-bills. T-bills are essentially cash. OMPs do nothing, it’s like swapping a $20 bill for two $10s. But QE does affect markets in the real world, and the question is why:

    1. Perhaps because base money and T-bonds are not truly perfect substitutes, even at zero rates. Either because of liquidity differences or risk differences.

    2. Or maybe they are almost perfect substitutes, but QE works as a signal of future policy intentions of the central bank.

    In theory, if you start from a suboptimal policy, like the current ECB or BOJ policy, it ought to be possible to become much more expansionary without a single dollar of QE. If you assume there is some policy that will credibly raise NGDP growth (a promise to buy the entire world, if needed), and if you assume the demand for base money as a share of NGDP falls as the expected growth rate rises, then simply promising to do that highly credible policy ought to be enough. So why don’t we see this more often? FDR did this in 1933, but you don’t see central banks doing the sort of dramatic move that would sharply raise NGDP growth expectations.

    You are much better at math than me; picture two stable equilibria, one high NGDP growth and low Base/GDP ratio equilibrium, like Australia. Then another stable equilibrium with zero NGDP growth and a high Base/GDP ratio, like Japan a few years ago. Then imagine an intermediate case like the US under Bernanke, where the equilibrium is not stable because locally an increase in the monetary base (and hence base/GDP ratio) is expansionary for NGDP growth—even though we know in the back of our minds that Australia and Japan are the logical endpoints of this game. That’s a very confusing situation, but seems to be true, which is one reason I’ve never had much success convincing others of my view.

    Just this past December, I could not convince Tyler that the Fed’s decision to raise rates would likely lower them in a year or two, and I even had trouble convincing myself, because the market response was not always consistent with this view. But now it looks like I might have been right. In any case, anything this counterintuitive is going to be tricky to explain to other people—I’ve been trying for 7 years. Thanks for your interest.

    (This summer I plan to write a book, starting at square one, and frankly acknowledging a few gaps that are not well understood.)

  21. Gravatar of ssumner ssumner
    30. March 2016 at 17:40

    BC, That’s a really interesting comment, and I’d like to hear what finance people think.

    Patrick, That’s actually a sort of (private) helicopter drop. I think Eliezer would agree that that works.’

    Lewis, That’s what I meant in my answer to Eliezer that there are certain questions here that are not well understood. Sometimes easy money makes 10 year yields go up, and sometimes it makes them go down.

    Elsewhere I’ve speculated that it has do do with level shifts vs. growth rate shifts. A level shift toward easy money reduces interest rates, and a growth rate shift raises them. The easiest way to picture this is in the forex market, look for the level shift in a change in the spot exchange rate, and a growth rate shift in a change in the expected appreciation or depreciation in the currency. But again, not well understood.

    Bill, Thanks, I do remember that, and of course I was very critical. We’ve known all along that the policy was an intentional contractionary policy. The New York Fed did an article in 2009 that admitted it was contractionary.

    The counterargument (made by commenter Vaidas Urba) is that without this authority the Fed would not have injected as much base money, so the IOR did not make things more contractionary. I’m not convinced on that point.

    Derivs, What if the Fed did this (BC’s idea) in addition to whatever T-securities it already was going to buy? Is it a way to inject more base money than otherwise, without the Fed taking on more risk. It sort of seems too good to be true, but I don’t quite see why. (I do understand that in a complete finance model this can’t really produce something for nothing–is the problem that the demand for base money would rise along with the supply?

    Ray, No difference for AD right now, a big difference for the government’s future tax liabilities (if you assume spending is different in the two cases).

  22. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    30. March 2016 at 17:45

    Do I have the right background story in my head for all this? Under normal conditions, people want medium of exchange so they can buy things, like a hot potato being passed around. To store value, suckers like me use bank accounts that pay trivial amounts but still non-zero amounts of interest, backed up by the US government. Big institutions that want safety use short-term Treasuries. Long-term treasuries are people who want guaranteed return of capital for sure, but are willing to take on some short-term volatility when inflation and equilibrium interest rates go up and down. Then there’s other risker bonds that pay more, and equities. Banks want to loan their currency so they can get risk-adjusted positive interest on it.

    Then monetary policy screws up. Inflation drops. People fly to safety and try to pile into Treasuries which increases the demand which increases the price which lowers the yield on those. As Treasury yields drop further, they also hold onto currency aka the medium of exchange, either because it just isn’t worth as much trouble to get a slightly higher yield by holding, or in the limiting case because currency and short-term Treasuries have become pretty much the same asset.

    Now people are holding onto currency and the velocity drops and bad things happen etcetera due to money’s function as a unit of account.

    Since in this environment the risk-free rate is nearly zero, you either have to charge massive negative IOR, or you have to exchange your currency for things that have some risk, like the extra yield that long-term Treasuries pay for the risk of changes in yields. Your currency has become part of a flight-to-safety demand pool that includes currencies and short-term Treasuries. If you add currency and retire short-term Treasuries, deleting the short-term Treasuries creates new demand for safe assets which absorbs your currency. So you either *have* to charge negative interest on reserves, or buy riskier assets like long-term Treasuries. If you do the latter, then you’re creating new safe assets to appease the flight for safety in a real sense, and the currency can hopefully start to flow into exchanges again.

    If this isn’t the background story then I’m missing some kind of factor to do with different functions baked into the system for currency versus Treasuries, or something.

  23. Gravatar of Ray Lopez Ray Lopez
    30. March 2016 at 18:12

    @Sumner – “Ray, No difference for AD right now [between the traditional way of changing the money supply versus the new proposed way of printing money by the Fed and handing it over to the Treasury, as the USA did during the US Civil War for a while], a big difference for the government’s future tax liabilities (if you assume spending is different in the two cases).”

    Please decode ‘if you assume spending is different’. If it’s in your new book, no spoilers necessary, just say it will be explained there, thanks. And what about the “inflation tax”? What’s wrong with that sort of tax? Are you implying the inflation tax leaves us worse off than today’s funk? Is that a prior?

    @Eliezer Yudkowsky – your problem is the same as Ptolemaic astronomers and the ‘epicycle’. Once you assume money is largely neutral, then all the difficulties disappear. Try it in your analysis and see. I too once believed in monetarism until I examined the evidence (start with Ben S. Bernanke’s FAVAR paper).

  24. Gravatar of Eliezer Yudkowsky Eliezer Yudkowsky
    30. March 2016 at 18:42

    > What would happen if the Fed were to buy stocks but offset that position by shorting stock index futures like S&P 500 futures?

    First reaction: I can’t imagine that a fundamentally neutral operation would be able to affect the market, so something must be wrong.


    As I read the proposal, the Fed is creating currency and buying stocks. Separately, the Fed is taking a short position – borrowing stocks and selling those stocks for currency.

    At the end of the beginning of this operation, the Fed has as much currency as it started with; the stock market has as many equities for delivery as it started with; the Fed has a bunch of equities on deposit; a bank has fewer equities than it started with; and the bank owns a loan which must be paid back in those equities at a later date.

    Unless the operation of the Fed borrowing a bank or exchange’s stocks and promising to give them back later is somehow effectual as monetary policy, I don’t see this having an effect. Or possibly I’ve misunderstood the proposal.

  25. Gravatar of JP Koning JP Koning
    30. March 2016 at 19:21

    Scott, when you say that central banks have three levers, do you mean policy instruments? If so, isn’t it more conventional to say that the inflation target is the goal variable and IOR/OMO are the two instrument?

    For instance, see table 1 here:


    Perhaps you’ve dealt with this in another post?

  26. Gravatar of dlr dlr
    30. March 2016 at 19:39

    Since in this environment the risk-free rate is nearly zero, you either have to charge massive negative IOR, or you have to exchange your currency for things that have some risk, like the extra yield that long-term Treasuries pay for the risk of changes in yields. Your currency has become part of a flight-to-safety demand pool that includes currencies and short-term Treasuries. If you add currency and retire short-term Treasuries, deleting the short-term Treasuries creates new demand for safe assets which absorbs your currency. So you either *have* to charge negative interest on reserves, or buy riskier assets like long-term Treasuries. If you do the latter, then you’re creating new safe assets to appease the flight for safety in a real sense, and the currency can hopefully start to flow into exchanges again.

    I think this conversation is missing a Sargent-Wallace neutrality foundation and a clear separation between the expectations channel and the MM irrelevance violation you need to overcome Wallace neutrality. Issuing reserves to buy risky assets like stock does not appease the flight to safety without some intervening friction, like a portfolio balance channel or some (almost always overstated) intermediation bottleneck. Okay, if we initially assume that the cause of the increased demand for the medium account is some kind of safe asset “shortage” then this can solve the problem by definition. But that story can be a tautology.

    A different story is not a friction-generated safe asset shortage, but a flight to actual safety based on some fear about the world. So the required return on the medium of account drops and the Fed runs out of current convenience yield to offset it, and then the price level wants to drop. Issuing more reserves to buy stocks doesn’t change the riskiness of the world in any way in this case. The only hydraulic effect comes from the raw increase in government liabilities, which only trivially increases the riskiness of (and thus required return on) the medium of account, since you need to issue a massive amount of reserves to change the riskiness of the PV of future surplus of a healthy government with room on the Laffer curve. But from that perspective buying stock is no different than buying AAA bonds, so it isn’t a riskiness-of-the-asset-bought question. See Woodford (2012) for the basic MM irrelevance logic before considering all the popular fictions… err, frictions.

    On the other hand, if the Fed still has an expected future convenience yield to verbally manipulate, then buying risky assets is just another commitment signal that works through expectations (in what other game would we call expectations a mere “channel”) of its conventional reaction function over its monopoly on base money. And it’s probably a fairly potent one, but the optimal mechanics are then about which version provides the cleanest credibility signal as opposed to anything inherent in the riskiness of the assets purchased.

  27. Gravatar of Derivs Derivs
    30. March 2016 at 19:48

    “Derivs, What if the Fed did this (BC’s idea) in addition to whatever T-securities it already was going to buy? Is it a way to inject more base money than otherwise, without the Fed taking on more risk.”

    I’ve made comment before how prevalent the risk free rate is in calculating value of forward assets. All BC did was strip out the r function embedded in a future contract (Eliezer is missing this point in his 18:42 post – he is getting confused on the short position and not recognizing it as a future – which has no cash layout beyond initial margin).

    So basically BC could have come up with a trade in almost anything and extracted the interest rate component of valuation to strip out. It could as easily be Fed buying the IBM 140-150 call spread and buying the IBM 150- 140 put spread for less (10 – discount rate). In effect you are “synthetically” replicating paper at the term of those options, or futures in the case BC gave. As he was writing, I think he realized that he would be forcing someone into large opposite positions where they were exposed to int rates and they would be forced to buy the bonds.

    As for the Fed… they get no free cheese, no free risk, markets don’t give you something for nothing, they prefer to take.

  28. Gravatar of Cory Hoffman Cory Hoffman
    30. March 2016 at 21:28

    Professor Sumner,

    What I have gathered from your blog and other market monetarists is that the markets treat QE as expansionary for reasons such as this: they treat Fed policy statements, forward guidance and reserves as referential to the value of the dollar as a unit of account (while they don’t for treasuries – meaning treasuries are not perfect substitutes). This induces the hot potato effect via the expectations channel and results in more sales, etc. via dollar denominated monetary instruments.

    Is that in the ball park?

    Anyway, I read this article about the $1 billion wedding and thought it to be exhibit A for a Progressive Consumption Tax.


  29. Gravatar of Ray Lopez Ray Lopez
    30. March 2016 at 21:37

    @Cory Hoffman – thanks for that link to the NY Post story on the $1B wedding. I think the figure is inflated, since the family is only worth $6B, so unless they are crazy they would not waste 15% of their net worth on a wedding. At best $100M.

    This was interesting, seems very Muslim and/or southeast Asian: “Gutseriev is worth an estimated $6.2 billion, according to Forbes. The 58-year-old businessman owns two oil companies — Russneft and Neftisa — as well as a Russian radio station. There has been a four-year hunt for the perfect match for his son, according to Russian media. Ukhakhovs was chosen because she fit the mold the family was looking for, which included “to be beautiful, a virgin, shy and not public,” according to the Russian Tatler magazine.”

  30. Gravatar of BC BC
    30. March 2016 at 23:39

    Derivs: “As he was writing, I think he realized that he would be forcing someone into large opposite positions”

    No, I was asking the question at the outset. (“What would happen if…”) It’s not obvious to me that the counterparty that is long equity futures would automatically hedge with the underlying equities. Maybe, they want the levered long position in stocks? I would think it would depend on size of Fed’s equity position relative to either futures open interest or total equity market capitalization so that the strategy gives the Fed at least incrementally more “capacity” for QE then just buying treasuries alone.

    When the Fed buys treasuries, they are essentially printing money and loaning it to the government, which wants to borrow to spend on government services. QE capacity is limited by how much the government wants to borrow (supply of treasuries). When the Fed buys stocks and shorts equity futures, aren’t they essentially printing money and loaning it to people that want to borrow to buy stocks? Capacity is limited by how much people want to borrow to buy stocks.

    Again, the point of derivatives is that they allow separation between those that have capital from those that are willing to bear risk (such as equity risk). When the Fed prints money, it has plenty of capital but not willingness to bear risk. It’s not clear to me that there are no people that are willing to bear risk but lack capital with whom the Fed can trade. The Fed would just be providing capital like any other (investment) bank.

  31. Gravatar of derivs derivs
    31. March 2016 at 03:01

    “It’s not obvious to me that the counterparty that is long equity futures would automatically hedge with the underlying equities. Maybe, they want the levered long position in stocks?”

    My apologies then. I took it as a given that we are talking serious size here, based on the fact we are talking about an organization that now likes doing things in 50 billion dollar monthly clips. I also can’t comprehend these trades not resulting in massively increasing open interest and in not assuming they would not be mostly (90%+) executed as part of computerized spread trades that maintained delta neutrality for the counterparties taking the other side of the fed. Since the Fed would be taking no net delta sensitivity to equities I really have to believe that net-net the market ends up taking no delta sensitivity to these trades as well.

    Personally, I like to think the most acceptable reason for trading in derivatives is allowing one the ability to modify/reshape ones risk/reward surface.
    And just for the record, I don’t consider things like swaps as derivatives.

  32. Gravatar of Saturos Saturos
    31. March 2016 at 03:02

    I think a simpler way to answer Eliezer is just to note that a) even as yields converge there is a sense in which currency and T-bills do *not* become increasingly alike, namely that one is the medium of account and the other is not, and b) in the long run this fact is what really matters, as over the long run money and bonds cannot have the same yield whilst maintaining separate functions (i.e. there’s always some foreseeable horizon at which money is no longer expected to substitute for bonds). E.g. in a nominal recession the fundamental bottleneck causing the screwup is sticky wages, which won’t be stuck forever. And it is the long run expected path that determines how monetary policy works now.

  33. Gravatar of Derivs Derivs
    31. March 2016 at 04:19

    “a) even as yields converge there is a sense in which currency and T-bills do *not* become increasingly alike,”

    …and yet to me, even as yields widen they continue to look alike because I have never seen sizeable cash positions held that were not collecting overnight long rates. So holding cash for 90 days and adding in the overnight sweeps winds up looking a lot like the return one would have had if they just traded a 3mo bill 90 days prior. Reality is that all paper is literally just a cash(currency) for cash(currency) time spread, it’s daily price being subjected to the risk of interest rate moves away from the transacted rate during its term is really the only difference. (and 3mo paper is not very rate sensitive)

  34. Gravatar of TravisV TravisV
    31. March 2016 at 05:28

    Prof. Sumner,

    I wish you had touched on the idea of buying a basket of foreign currencies rather than bonds. Just my two cents.

  35. Gravatar of jonathan jonathan
    31. March 2016 at 05:46

    Honestly I’ve never quite understood why QE isn’t supposed to work in theory. I mean, treasuries of different maturities are not equivalent assets, so changing their relative supply should make a real difference, right?

    Scott, I also don’t understand your argument for why buying stocks wouldn’t be that effective. I mean, the equity premium is famously pretty big, so that suggests a big liquidity difference.

  36. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    31. March 2016 at 06:04

    ‘…there is a sense in which currency and T-bills do *not* become increasingly alike, namely that one is the medium of account and the other is not….’

    And one is the medium of exchange and the other is not.

  37. Gravatar of Derivs Derivs
    31. March 2016 at 07:49

    “I wish you had touched on the idea of buying a basket of foreign currencies rather than bonds. Just my two cents.”

    Travis… but whoever sells you their currency will be getting dollars in exchange and will probably buy what to hold those dollars?? 🙂

    The effect of i on fwd valuations of currencies, and therefore embedded i risk in currencies, is no small matter either.

    There is a reason that the bond market, boring as it is, is simply ginormous.

  38. Gravatar of Gary Anderson Gary Anderson
    31. March 2016 at 08:53

    “When the Fed buys treasuries, they are essentially printing money and loaning it to the government”

    Draghi buys them when they have negative interest. The ECB is pushing yield down on purpose, because there already is a shortage of bonds for flight to safety, for rich people and for use as collateral which all but Kocherlakota seem to ignore. He and Summers both fear a shortage of bonds, but Draghi doesn’t fear it which has me very confused. It should confuse market monetarists as well but market monetarists ignore the demand for bonds as colateral.

    We aren’t just talking negative IOR here, we are talking negative bond yields. By the way, in Euros, the US treasury 10 year is negative already.

    Market monetarists, who know GDP better than most, ignore the massive demand for bonds that exists in the world. Derivatives are skewing all measurements. Low yield could just mean massive demand for bonds, not recession or deflation.

  39. Gravatar of TravisV TravisV
    31. March 2016 at 09:08

    This sounds rather big-government to me…..


  40. Gravatar of ssumner ssumner
    31. March 2016 at 09:13

    Eliezer, That’s all pretty accurate, but not necessarily complete. Let’s take a swap of cash for zero interest T-bills. On one level it might seem to do nothing. On the other hand it might be very effective, if working through the expectations channel.

    I prefer not to think in terms of “will X work” but rather “if we do whatever it takes to work, how big is the demand for base money, and hence how big is the QE required”

    Thus a policy of $5 trillion in QE might not work if not accompanied by a “whatever it takes” promise, whereas a policy of only $50 billion in QE might work very well if accompanied by a whatever it takes promise.

    And this is why it’s also so difficult to talk about the effectiveness of buying stocks. That program might be very effective if viewed as permanent, but not effective at all if viewed as temporary. The concrete mechanistic aspects of monetary operations NEVER tell us enough to describe the outcome with any confidence, you always need to tack on expectations of future policy.

    Having said all that, I agree with the conventional view that buying stocks is more effective than buying T-bills at the zero bound, I just think the difference is small compared to differences relating to the expectations channel (of future policy).

    JP, The goal variable is also a policy instrument. And I’m not just talking about changes in the policy target, but also other changes that make the goal more credible, and hence increase inflation expectations. Thus FDR’s dollar depreciation program raised the expected rate of inflation in the US, without formally changing the administration’s official goal of reflating prices back to 1926 levels.

    dlr, See my answer to Eliezer. We may be on the same page about expectations, but I am not sure.

    Thanks derivs, Eliezer and BC, I’ll have to think about this one.

    Cory, Yes, I saw that too–excellent argument for a progressive consumption tax.

    Saturos, I agree, and that’s why I always try to allude to the expectations channel. See my reply to him today.

    Derivs, You said:

    “I have never seen sizeable cash positions held that were not collecting overnight long rates.”

    Cash does not earn interest.

    Travis, That’s a very tricky issue politically. Other countries would object.

    Jonathan, See my reply to Eliezer.

  41. Gravatar of Ray Lopez Ray Lopez
    31. March 2016 at 11:50

    Sumners answers everybody but me. They lob him easy underhand softballs and he hits them out of the park.

    Sumners: ” The concrete mechanistic aspects of monetary operations NEVER tell us enough to describe the outcome with any confidence, you always need to tack on expectations of future policy.”

    Thus monetary operations are completely not testable. E.g., if NGDPLT fails, the Fed was not credible enough. If it succeeds, Sumner saves the world (again). Since money is neutral, largely, likely NGDPLT will fail. Hence Sumner is reduced to yelling that the Fed should be even more irresponsible. It’s like trying to summon the fire department to get your cat out of the tree (something trivial, like monetarism, recall money is neutral) by yelling “fire!” in a crowded theatre. At some point, if the Fed is irresponsible enough, the public will panic and you might get a demand induced bout of hyperinflation (arguably, since usually hyperinflation is supply induced).

    Way to go Sumner. You saved the world, by destroying it, Apocalypse Now style (“We had to destroy the village in order to save it.”)

  42. Gravatar of Christian List Christian List
    31. March 2016 at 11:56

    Hyperinflation got a nice hot potato effect. This actually proves that ssumner is right, isn’t it?

  43. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    31. March 2016 at 12:36

    Travis, I noticed that too. When Brad is good, he is very, very good–and he is clearly right that NAFTA is not responsible for any of America’s economic problems, nor is China’s productivity. However, when he is bad…

    Remind me who has been President for the last seven years. A Republican?

    Whose idea was Cash for Clunkers? The $800 billion stimulus package? 99 weeks of unemployment benefits? Dodd-Frank? Obamacare? Raising the minimum wage?

    Then, if we want to go back even further, whose idea was it to interfere in the home loan industry’s underwriting standards in the 1990s? I can answer that; both parties. But surely the Clinton Administration’s Housing Initiative bears heavy responsibility for that (especially HUD’s 1994 Best Practices Initiative that forced the Community Reinvestment Act onto the country’s Mortgage Bankers’ Assn.)

    And back then the Clinton Administration’s Treasury employed, as a Deputy Asst. Sec’y, a brilliant young economist named Brad DeLong. Who had some interesting things to say about his encounters with Hillary Clinton:

    “My two cents’ worth–and I think it is the two cents’ worth of everybody who worked for the Clinton Administration health care reform effort of 1993-1994–is that Hillary Rodham Clinton needs to be kept very far away from the White House for the rest of her life.Heading up health-care reform was the only major administrative job she has ever tried to do. And she was a complete flop at it. She had neither the grasp of policy substance, the managerial skills, nor the political smarts to do the job she was then given. And she wasn’t smart enough to realize that she was in over her head and had to get out of the Health Care Czar role quickly.

    “So when senior members of the economic team said that key senators like Daniel Patrick Moynihan would have this-and-that objection, she told them they were disloyal. When junior members of the economic team told her that the Congressional Budget Office would say such-and-such, she told them (wrongly) that her conversations with CBO head Robert Reischauer had already fixed that. When long-time senior hill staffers told her that she was making a dreadful mistake by fighting with rather than reaching out to John Breaux and Jim Cooper, she told them that they did not understand the wave of popular political support the bill would generate. And when substantive objections were raised to the plan by analysts calculating the moral hazard and adverse selection pressures it would put on the nation’s health-care system… [ellipses in original]

    “Hillary Rodham Clinton has already flopped as a senior administrative official in the executive branch–the equivalent of an Undersecretary. Perhaps she will make a good senator. But there is no reason to think that she would be anything but an abysmal president”

  44. Gravatar of Christian List Christian List
    31. March 2016 at 15:26

    @Patrick R. Sullivan

    “Brad …..is clearly right that …..”

    I find Brad really fun in this post. At first he gives the impression that he will totally debunk the story of the populists.

    Only to admit during the whole piece more and more that they are right to a surprisingly big extent. He does not admit this openly of course but his phrasing speaks for itself.

    His first real point is “Yeah but it helped China”. How nice but this was never the point of the populists. Hardly anyone denies that it helped China.

    Then he says “It was not globalization that caused incomes to stagnate.” Only to write the after next (!) sentence: “The reason that incomes have stagnated is that American politicians have failed to implement policies to manage globalization’s effects.”

    In other words (and he makes this very clear later): Globalization did in fact cause incomes to stagnate but the US should have implement policies that redistribute incomes on a very large scale to offset these exact effects of globalization.

    And he goes on like this. There are many examples.

    Really funny.

  45. Gravatar of Gary Anderson Gary Anderson
    31. March 2016 at 18:19

    You libertarians crack me up. It is ok to raise the cost of commodities, by targeting NGDP (I know there are other ways to target NGDP), but let government raise the minimum wage, and you all have a fit.

    So, let me get this right. It is ok for banksters to raise commodity prices through QE, so the worker has to pay more for the commodity but not ok to raise his wage so he can afford to do it?

    What is this, some kind of evil circus? Clowns to the left of me, Jokers to the right. (Bob Dylan)

  46. Gravatar of Gary Anderson Gary Anderson
    31. March 2016 at 18:23

    “Community Reinvestment Act onto the country’s Mortgage Bankers’ Assn.”

    Patrick, are you serious? You need to look at this chart that proves the CRA did little to influence the bubble. Also, keep in mind that the CRA did not operate in the bubble states. The chart proves that private mortgage pools really pumped the housing bubble, not public mortgage pools. You really are brainwashed, Patrick. Please consider the chart: http://www.examplesofglobalization.com/p/housing-bubbles-most-important-chart.html

  47. Gravatar of Oderus Urungus Oderus Urungus
    31. March 2016 at 18:38

    Money is non-neutral in either the short or the long runs.

  48. Gravatar of Major.Freedom Major.Freedom
    1. April 2016 at 03:50

    Since there is nothing in NGDPLT theory that distinguishes between government spending and private sector spending, the government (Treasury plus Fed) could engineer high levels of inflation financed deficit spending, and claim to be running “optimal monetary policy” with any given NGDP target.

    And Sumner would have no way to dispute or disagree with it. He couldn’t even say “monetary policy is fine but fiscal policy is not, so there should be a reduction in the deficit offset by the Fed”, because there is no rational grounds in Summer’s theory that leads to any conclusion about any limit to any deficit. It is all arbitrary. And why? Because he’s left wing. Government spending is not fundamentally critiqued. It is at best tolerated with softball criticisms not really criticisms.

  49. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. April 2016 at 07:36

    Very interesting piece on Israel’s inflation rates by Alex Cukierman;


    ‘During the first 45 years of the [Israeli Central] Bank’s existence, both the average level and the variability of inflation went through dramatic changes in both upward and downward directions. For the entire period the average 12-month inflation rate (measured each month as the 12-month rate of inflation since the same month in the previous year) was 31%. It fluctuated between a maximum of 486% just prior to the 1985 cold turkey stabilisation and a minimum of almost minus 3%. However, those summary statistics hide very different inflation environments.

    ‘Figure 1 provides a bird’s eye view of inflation in Israel from the creation of the Bank until April 2015. The blue line shows actual inflation each month at yearly rates. The Figure divides the 61 years between the creation of the Bank of Israel and April 2015 into six sub-periods, in line with the nature of the inflationary process. Within each sub-period the rate of inflation fluctuates around a sub-period mean marked by a horizontal red line. Eyeballing of the figure suggests that those means differ substantially across sub-periods. Three of those are prior to the July 1985 inflation stabilisation and the remaining three after it.1 It appears that the 1985 stabilisation constitutes a watershed in the sense that prior to it sub-periods’ inflation means are increasing over time while, after it, they are decreasing.’

  50. Gravatar of Don Geddis Don Geddis
    1. April 2016 at 08:29

    Oh, Major.Freedom … all these years of reading this blog, and you still don’t really understand what people are talking about here, do you?

    Macro economics has both a supply side and a demand side. NGDPLT and monetary policy are only about the demand side. But for the overall economy, of course the supply side matters too. That’s just a different topic.

  51. Gravatar of TravisV TravisV
    1. April 2016 at 09:03

    Tim Duy praises Janet Yellen in a new post:


  52. Gravatar of Scott Sumner Scott Sumner
    1. April 2016 at 17:34

    Ray, You said:

    “Sumners answers everybody but me. They lob him easy underhand softballs and he hits them out of the park.
    Sumners: ” The concrete mechanistic aspects of monetary operations NEVER tell us enough to describe the outcome with any confidence, you always need to tack on expectations of future policy.””

    I only answer people who know how to spell my name.

    Seriously, this post is so far over your head that your comments aren’t even funny. So why answer them, if I can’t tease you?

    Gary, I generally try to ignore your silly comments, but when you suggest that Bob Dylan could ever, in 1000 years, write lyrics that inane, I have to take issue. Misquote Dylan one more time and I’ll make you the second person banned from my blog.

    Thanks Patrick, Israel is an interesting case.

    Thanks Travis.

  53. Gravatar of Major-Freedom Major-Freedom
    1. April 2016 at 17:54

    Don Geddis:

    As I’ve showed many times over the years on this blog, the dichotomy between “the demand side” and “the supply side” are not pragmatically distinct when it comes to inflation, i.e. “monetary policy” and “fiscal policy”. Yes for certain limited uses we can separate the two to understand various other concepts such as prices, but it is absurd to claim that there are no fiscal policy implications with monetary policy, and vice versa. Remember, my argument was about monetary policy and fiscal policy, not demand side and supply side. You are again trying to steer the argument away to where you feel comfortable, instead of where the logic and evidence goes.

    Fiscal policy is not solely a supply side concept. This should be obvious given that fiscal policy encompasses dollars.

    Monetary policy, all monetary policy, implicates “a” fiscal policy of some kind. It is ridiculous to believe that government debt monetization, which is what monetary policy is most often, has “nothing to do with government fiscal policy.” It would be as equally ridiculous to believe that should the Fed be monetizing the debt of say Apple, that the activity would have “nothing to do with Apple fiscal policy”. If the latter is ridiculous, then so is the former.

    The choice to monetize government debt is a fiscal decision of government. The money the Fed “earns” as the interest on government bonds, is remitted to the Treasury, not Apple. The principal of the bonds is remitted to the Treasury (save except the guaranteed 6% dividends paid by the Fed to itself and its “made” mafia member banks, not Apple.

    But my argument is actually different from even that. Since NGDPLT encapsulates government spending, then IF fiscal policy is such that NGDP consists of 10% government spending, or 25% government spending, or 40%, or 50%, or 60%, or any percent, there is nothing in NGDPLT theory to distinguish them.

    Now as you alluded to, in order to actually explain one NGDP to the next, different or equal, we would have to step outside NGDPLT. Of course this is not a bug, but a feature, so it goes, but I am saying that is a weakness not a strength. We are supposed to completely abstract from the Fed once NGDP is 5% annual growth, regardless of what the Fed is monetizing. This is I argue a flaw. Not all “equal” NGDPs are in fact equal, as the relative distributions matter. The fact that NGDPLT cannot answer for or explain or even address one 5% NGDPLT from any other 5% NGDPLT, that lacking is amusingly communicated as some sort of ideal focus and targeting of what is “really” important. We are the same thing in Marxism with its absence of any serious inter-firm trade analysis, and focus on a single form only as if it were all that went on.

    The distinction between “monetary policy” and “fiscal policy” is at root a deceitful method of window dressing the central bank as “independent” from the dirty fiscal and political matters that are subject to the sways and passions of politicians and citizens. To portray the central bank as if it were some pure and ivory encrusted institution of social stability and intellectual superiority. The truth of course is that the Fed IS a political institution. Created by an act of Congress. A tool of government to finance its spending in excess of the taxation tolerated. The perpetual increase in borrowing and spending would not be possible without governments printing their own money.

  54. Gravatar of derivs derivs
    2. April 2016 at 02:41

    “Cash does not earn interest.”

    Scott, I’m not talking about the $6,000 siting in someones drawer.

    Do you really think I spent my days breaking things down to the tiniest little components at the 4th decimal just to let my positive cash balances receive 0 while the place holding that cash was sweeping overnight lending rates for the benefit of themselves???????
    Banks + Clearing member firms use what they call long/short rates that they give/charge clients with positive/negative balances in their accounts.
    Even in my own parent bank(s), the parent had to pay us daily for our cash balances or all hell would have broken loose. If you trade with a private clearing house, they credit/debit you once a month for those cash balances.

  55. Gravatar of derivs derivs
    2. April 2016 at 02:51

    One of the sweet little benefits of being a clearing firm with a few thousand clients is that each client is either borrowing or lending every night, often the net position for the clearing firm is 0, but the firm charges all the debits 1% while paying all the credits at .8% and scalps each side although they have no net exposure. Adds up to nice free money very very quickly.

    Firms that have lots of small proprietary traders do this as well. The firms traders can be net 0 at the end of the year, and the owner can make millions just from doing this to his traders as small traders can pay a considerable spread…

    Obviously bigger accounts will demand very narrow spreads on long/short rates…

  56. Gravatar of Don Geddis Don Geddis
    2. April 2016 at 08:54

    Major(.-)Freedom: You want to try to think of everything at once, but all you’re doing is managing to confuse yourself, and make no theoretical progress at all. “Divide and conquer” is the successful approach to actually understanding complex topics.

    Economics, as a whole, can be divided into micro and macro. Macro itself, can be divided into supply-side and demand-side. Monetary policy is ONLY about demand-side macro. That does NOT mean that, merely because we are only discussing 1/4 of economics, that the other 3/4 of economics is not also very important to the economy.

    Fiscal policy is confusing, because it has significant effects on both the supply and demand side. Monetary policy is much clearer: it is essentially omnipotent on managing demand-side macro, while at the same time essentially irrelevant or impotent on affecting supply-side macro.

    You attempt to deny it, but a monetary policy like NGDPLT accommodates a huge variety of possible supply-side policies. This is why it is so productive to separate the analysis, and to consider only the demand-side macro effects of NGDPLT.

    We ALL agree that it ALSO matters what happens to the supply side. Whether government is 10% of GDP of 60% of GDP matters a huge deal to the economy, and we can have that conversation. And, yes, NGDPLT says nothing at all about what fraction of GDP government “should” be.

    All that means is that NGDPLT is not a complete theory of all of economics. It’s only 1/4 of it. But it’s a darn good 1/4. You seem to be complaining that there are important things in economics that NGDPLT doesn’t address. Everybody agrees with that. That’s not a criticism. What you seem to miss, is that this is how one makes actual progress in science. Break off an important problem that is solvable, and solve it.

    NGDPLT is an incredibly good (although not optimal) solution to the 1/4 of economics that is demand-side macro.

  57. Gravatar of ssumner ssumner
    2. April 2016 at 10:14

    derivs, You need to use language more precisely. “Cash” does not mean “bank deposits” at least in economics. It means paper money, like in your wallet. That’s all that counts as cash, nothing else. The Fed produces cash and bank reserves, nothing else. When finance types talk about “cash” they are actually talking about debt.

    You are talking about a completely unrelated concept.

  58. Gravatar of Christian List Christian List
    2. April 2016 at 19:10

    Ignoring Gary is a good strategy that I try to follow in the future. At least I hope so.

  59. Gravatar of Derivs Derivs
    3. April 2016 at 11:52

    “Cash” does not mean “bank deposits” at least in economics. It means paper money, like in your wallet…When finance types talk about “cash” they are actually talking about debt. You are talking about a completely unrelated concept.”

    Yep, 2 very different things. By that definition, even at zero rates, of course base money and T-bonds are not perfect substitutes.
    Cash has a fixed value and therefore no volatility. T-Bonds will continue to have a volatility and therefore change value.

  60. Gravatar of flow5 flow5
    3. April 2016 at 12:28

    You either admit your mistake (N-gDp targeting), or I will permanently discredit you.

    – Michel de Nostradame

  61. Gravatar of Dimitri Klimenko Dimitri Klimenko
    11. April 2016 at 14:05

    OK, so here’s an alternative to QTM; you can see it as a synthesis of the MMT and market monetarist views of money. Basically, my proposal is to consider a hybrid quantity/composition theory of “net financial assets”, as per the MMT idea.

    In short, the fundamental idea is that both the *quantity* of private sector net financial assets and the *composition* of those private sector net financial assets are relevant to inflation. So, for example, if the private sector has $10 of money and $10 of interest-paying T-bonds, then in the short term this is more inflationary than the private sector having only $10 of net money and no T-bonds, but less inflationary than having $20 of money.

    I can see the potential benefit of NGDP targeting, but I think it’s important to consider the long-term impact of this. For example, if we take QTM seriously, then a long-term target of 3% GDP growth + 2% inflation would mean the monetary base must grow by 5% every year. Now, let’s assume that while the central bank is doing this, the government somehow manages to actually get a long-term balanced budget.

    The *only* way this can happen is if the government sector accumulates financial assets from the private sector (i.e. a sovereign wealth fund), but this doesn’t seem like a sensible approach to me. After all, why should the government be forced to interfere with (and distort) private markets in order to sustain monetary policy?

    To me, it makes much more sense for the government to sustain the long-term growth in the monetary base by having a long-term structural budget deficit (of 5%).

    The policy proposal here is rather a simple one: hold fiscal policy responsible for the *amount* of net financial assets, and hold monetary policy responsible for the *composition* of those assets.

    (1) Have the government finance its deficits by “printing money” directly, with a long-term structural deficit target of, say, 5%. Obviously it should be a long-term target; after all, sometimes the government will be rather unlucky and end up with budget surpluses for reasons beyond its control.

    (2) Hand over the task of issuing bonds completely over to the central bank, so that it gets to decide the composition of “net financial assets”, i.e. how much is made up by money vs short-term vs long-term bonds. The central bank will use these monetary policy tools in support of, say, a 5% NGDP target.

  62. Gravatar of Dimitri Klimenko Dimitri Klimenko
    11. April 2016 at 14:51

    Also, I think having deficits financed by printing money directly, and then holding the central bank responsible for “unmonetizing” the deficit by issuing bonds is a much more reasonable default, for two reasons.

    (1) Having bonds in the system adds extra economic distortion compared to having money alone.

    (2) The current system has an anti-inflationary bias, in which the central bank is hesitant to “monetize” sufficiently due to fears of inflation. Reversing the setup so that the government prints money and the central bank “unmonetizes” removes that bias.

  63. Gravatar of Dimitri Klimenko Dimitri Klimenko
    11. April 2016 at 17:04

    The three possible outcomes of a 5% NGDP target + 0% long-term structural deficit:

    (1) Long-term government accumulation of private assets.
    (2) Abandonment of the NGDP target and long-term deflation.
    (3) 5% NGDP growth is supplied endogenously by the private sector, forming a bubble which eventually bursts and causes either (1) or (2).

  64. Gravatar of Dimitri Klimenko Dimitri Klimenko
    11. April 2016 at 17:44

    So, in other words, if the Federal Reserve had followed your policy recommendation of NGDP targeting, the 2008 crisis would probably have been averted, but eventually an even bigger crisis would have happened; unless the government switched over to a long-term budget deficit, or took over an ever-increasing share of the private sector.

    Long-term NGDP targeting is unsustainable without a corresponding structural budget deficit (or “helicopter money”).

  65. Gravatar of bbrophy bbrophy
    3. May 2017 at 07:35


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