Pop Monetary Economics

Paul Krugman has an excellent post demolishing the following claim by William Cohan, in the NYT:

The case for raising rates is straightforward: Like any commodity, the price of borrowing money “” interest rates “” should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying.

BTW, Krugman’s post is the one to read (not mine) if you only look at one post on this topic.  He carefully walks through an explanation of what’s wrong with this paragraph, in a way that would be recognizable to any competent monetary economist. But in some ways it’s even worse than Krugman assumes.  Here’s Krugman:

The Fed sets interest rates, whether it wants to or not “” even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice.

That’s also my view, but I suppose one could argue that from a different perspective if you set the money supply you are letting markets determine interest rates, whereas if you actually target interest rates, then you are “interfering” in the market.  Not exactly my view, but let’s go with it.  Let’s put the best spin on Mr. Cohan’s essay.

Now here’s the big irony.  For the past seven years the Fed hasn’t been targeting interest rates, they’ve been using base control to influence the economy, increasing the monetary base through QE programs.  They switched from interest rate control before 2008 to monetary base control after.  And now Cohan is calling for the Fed to raise interest rates.  That means he wants the Fed to go back to manipulating interest rates.

So the great irony here is that in the paragraph I quoted from above Cohan says:

Like any commodity, the price of borrowing money “” interest rates “” should be determined by supply and demand, not by manipulation by a market behemoth.

And yet in the essay he’s actually calling for the exact opposite; he wants the market behemoth (the Fed) to start manipulating interest rates, something it hasn’t been doing for the past 7 years.

Unlike quantum mechanics, monetary economics doesn’t seem too hard.  As a result the media produces a non-stop stream of stories on monetary policy that are utter nonsense.  And by “utter nonsense” I don’t mean stories that disagree with my particular market monetarist views (Cohan might be correct that the Fed should raise rates), but rather stories that are simply incoherent, that are completely detached from the field of monetary economics.

We don’t hire plumbers to teach quantum mechanics at MIT.  We don’t put plumbers on the Supreme Court.  But we do put Hawaiian community bankers on the Board of Governors.  It’s not just that our media and Congress and President don’t understand monetary economics, they don’t understand quantum mechanics either.  The real problem is that they don’t even understand that they don’t understand it.  So they have unqualified people write op eds, and sit on the Board of Governors.  People ask me what Trump or Sanders think about monetary policy.  They don’t even know what it is!  What they think doesn’t matter, even if they were to get elected.  Just as it doesn’t matter what their view is on the best trajectory for NASA’s next Saturn bypass.

BWT, I have no problem with Hawaiian community bankers having important policymaker roles at the Fed, but put them on the committee for banking regulation, not monetary policy.

The title of the NYT piece said the Fed needed to “Show Some Spine”.  Over at the Financial Times they want the Fed to “Show Steel.”  (I guess that makes Paul and me wimps.)  Here’s the argument at the FT:

Yet monetary policy cannot confine itself to reacting to the latest inflation data if it is to promote the wider goals of financial stability and sustainable economic growth. An over-reliance on extremely accommodative monetary policy may be one of the reasons why the world has not escaped from the clutches of a financial crisis that began more than eight years ago.

I suppose that’s why the eurozone economy took off after 2011, while the US failed to grow.  The ECB avoided our foolish QE policies, and “showed steel” by raising interest rates twice in the spring of 2011.  If only we had done the same.

Of course I’m being sarcastic, but that points to another problem with the Cohan piece. Rates are not low because of QE (as Cohan implied), indeed Europe didn’t do QE during 2009-13, and that’s why its rates are now lower than in the US, and will probably remain lower.

If this stuff is published in the NYT and FT, just imagine what money analysis is like in the average media outlet, say USA Today or Fox News.

HT:  Tom Brown, Stephen Kirchner


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142 Responses to “Pop Monetary Economics”

  1. Gravatar of Becky Hargrove Becky Hargrove
    30. August 2015 at 06:10

    Of the Great Recession, Krugman says, “A lot of water has passed under the bridge since then, and I at least no longer feel the same sense of despair. Instead, I feel an even deeper sense of despair – because people are still rolling out those same fallacies…”

    I couldn’t agree more.

  2. Gravatar of marcus nunes marcus nunes
    30. August 2015 at 06:24

    Yet, when even highly qualified people like Fischer and Carney say that inflation (or lack thereof) is due to trade, FX, oil, commodities in general, China and whatnot, something must be very wrong in the realm of monetary policy making!

  3. Gravatar of Ray Lopez Ray Lopez
    30. August 2015 at 06:36

    This op-ed by Sumner is wrong in so many places I don’t even know where to begin. Perhaps this phrase: “Now here’s the big irony.” — and Sumner goes on about something unimportant. The biggest irony is that money is effectively neutral, so it really does not matter what the Fed does, within limits.

  4. Gravatar of Martin-2 Martin-2
    30. August 2015 at 06:44

    “those of us who remembered and understood Keynes/Hicks have been right about most things, and those lecturing us have been wrong about everything”

    Old news, but I wish Krugman would be mindful of the outgroup homogenization. Does Sumner understand Keynes/Hicks well enough to be right about most things, or does his frequent lecturing of Keynesians make him wrong about everything?

  5. Gravatar of Cliff Cliff
    30. August 2015 at 06:59

    Ray,

    If what the Fed does doesn’t matter, then why do the financial markets move so much when the Fed announces a change?

  6. Gravatar of ssumner ssumner
    30. August 2015 at 07:04

    Cliff, You don’t understand. Ray thinks the Fed is very unimportant, and very important too. He’s a deep thinker, far ahead of the rest of us.

    Ray says the Fed could do great harm, or not do great harm. But the Fed can’t do good by refraining from doing great harm. It’s all very deep–you and I could never possibly understand what’s going on in his mind.

  7. Gravatar of Ben Ben
    30. August 2015 at 07:17

    The definition of growth is flawed. You’ve said before the UK is doing well. Land prices are outstripping GDP “growth”. The young see the number of hours they need to devote to attain financial independence increase every day.

    How is this “growth”? It’s just can kicking.

  8. Gravatar of benjamin cole benjamin cole
    30. August 2015 at 07:53

    The barrage of new stories emanating from Jackson Hole is truly dispiriting. One participant after another is crying for the need for higher interest rates. I see the old standbys, about the need to show steel or resolve or nerve or something Teutonic, are back.

    Looks bad, friends.

    I have a friendly disagreement with Scott Sumner. I request Scott Sumner look at the Reuters article on Stanley Fischer today in which Fischer argues at length that all of these indicators which show inflation declining are really showing that inflation is going to rise.

    Maybe a community banker from Hawaii is not so bad. Actually, since a good plumber understands about flows and pressures…and has to hit a payroll….

  9. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    30. August 2015 at 08:40

    Actually, I disagree with Scott, this is not a good column by Krugman, because of; ‘The Fed sets interest rates, whether it wants to or not….’

    No it doesn’t. The Fed *influences* interest rates, around a narrow range, in the short-run. Once, many years ago, I proposed that to Milton Friedman. He told me (in a letter) that he agreed with that. Which is not surprising, since I learned it from his debate with Walter Heller at NYU in 1968.

    Heller made the mistake of saying, ‘the price of money (interest rates)’. To which famous Keynesian, Friedman responded;

    ——-quote——-
    The interest rate is not the price of money…. The price of money is how much goods and services you have to give up to get a dollar. You can get big changes in the quantity of money without any changes in credit.

    …. You must sharply distinguish between money in the sense of the money or credit market, and money in the sense of the quantity of money. And the price of money in that second sense is the inverse of the price level–not the interest rate. The interest rate is the price of credit.
    ———endquote———–

    And today Jon Hilsenrath strikes again. This time with India’s Central Bank head;

    http://www.wsj.com/articles/indias-rajan-says-reserve-bank-is-in-an-accommodative-policy-phase-1440886221

    ‘JACKSON HOLE, Wyo.””The Reserve Bank of India is in an accommodative phase of monetary policy, meaning it is looking to reduce interest rates, RBI Gov. Raghuram Rajan said.’

    Same error.

  10. Gravatar of TallDave TallDave
    30. August 2015 at 08:44

    Trump will put the nation back on the gold standard. Not because of Austrian business cycle theory, but because gold is classy. We’ll have the most luxurious monetary policy in the world!

  11. Gravatar of benjamin cole benjamin cole
    30. August 2015 at 09:03

    Add on: given the hysterical prissiness about inflation we see on display in Jackson Hole, I would guess that the year 2016 will again not be the one in which we see Full Tilt Boogie Boom Times in Fat City.

    A recession is very possible.

    Invest accordingly.

  12. Gravatar of E. Harding E. Harding
    30. August 2015 at 09:14

    “Rates are not low because of QE (as Cohan implied), indeed Europe didn’t do QE during 2009-13, and that’s why its rates are now lower than in the US, and will probably remain lower.”
    -Which is why U.S. TIPS yields collapsed during the 2013 taper tantrum. Oh, wait….

    German rates only truly collapsed after “whatever it takes”:
    https://research.stlouisfed.org/fred2/graph/?g=1IQW
    And German rates continued to collapse after the announcement of ECB QE in January 2015.

  13. Gravatar of Major.Freedom Major.Freedom
    30. August 2015 at 09:44

    The CIA must be getting really desperate/paranoid.

    Check out this hilarious psyops documentary allegedly from ISIS that elicits pro-gold, anti-Fed propaganda.

    Remember kids, the concepts of limited governments and free markets are now considered terrorist ideologies by the largest criminal gang in the country.

  14. Gravatar of Major.Freedom Major.Freedom
    30. August 2015 at 09:44

    Link:

    http://www.dailymotion.com/video/x33lcz2_the-rise-of-the-khilafah-and-the-return-of-the-gold-dinar_news

  15. Gravatar of E. Harding E. Harding
    30. August 2015 at 09:53

    The Islamic State has always styled itself as reactionary, so it’s no surprise that it would oppose fiat money and go back to gold. I don’t think it’s meant as an insult to gold standard supporters, I don’t think the IS cares about them. IS ideology is certainly not about limited governments and free markets.

    The bigger question remains: who is constructing the Islamic State’s ideological shell? Is it the U.S. executive branch, the Turks, or the Iraqi-born nominal rulers?

  16. Gravatar of Chuck Chuck
    30. August 2015 at 10:04

    I agree. Why does the Fed keep hiring yahoos who spout nonsense like this:

    “…the drop in oil prices over the past year, on the order of about 60 percent, has led directly to lower inflation…”

    http://www.federalreserve.gov/newsevents/speech/fischer20150829a.htm

  17. Gravatar of E. Harding E. Harding
    30. August 2015 at 10:08

    @Chuck, that’s not nonsense:
    https://research.stlouisfed.org/fred2/graph/?g=1IRN

  18. Gravatar of Bonnie Bonnie
    30. August 2015 at 10:14

    We need much more pop monetary economics of the MM flavor to balance out the public discussion. Roughly right in principle written by laypersons is much better than almost certainly wrong by the same.

    And I agree that bankers should be nowhere within reach of monetary policy formation. I would go farther than that, however, and put the responsibility for monetary policy with the Treasury so that we have someone to hold directly accountable for it.

  19. Gravatar of Major.Freedom Major.Freedom
    30. August 2015 at 10:33

    Sunner wrote:

    “Now here’s the big irony. For the past seven years the Fed hasn’t been targeting interest rates, they’ve been using base control to influence the economy, increasing the monetary base through QE programs. They switched from interest rate control before 2008 to monetary base control after. And now Cohan is calling for the Fed to raise interest rates. That means he wants the Fed to go back to manipulating interest rates.”

    Speaking of ironies, Sumner is eliciting one with that comment.

    For the past 7 years Sumner has been claiming that there has not been enough money printing, and that the near zero interest rates since is not evidence that there is enough money printing, but that there has not been enough money printing.

    He has also claimed that the zero bound is not a limitation on the Fed raising spending and prices. That the Fed can raise NGDP and prices by way of manipulating the monetary base to such a high degree that the “hot potato effect” does the rest.

    Importantly, this will have the effect of pushing interest rates back up due to the inflation premium effect.

    And now Sumner is calling for higher NGDP which will bring about just that, so sure enough, Sumner is calling for the Fed to manipulate interest rates in the same way that Cohan is!

  20. Gravatar of Vivian Darkbloom Vivian Darkbloom
    30. August 2015 at 10:51

    Not sure I understand the logic of:

    “The Fed sets interest rates, whether it wants to or not “” even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice.”

    Suppose the Fed were abolished tomorrow. Then, with this logic, the could not the claim be “The Federal Government sets interest rates, whether it wants to or not–even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice”.

    The Krugman quote strikes me as sophistry. Sure, we’ve got a Fed, but isn’t the degree of interference and influence over interest rates more the greater the Fed acts?

  21. Gravatar of Major.Freedom Major.Freedom
    30. August 2015 at 11:41

    Vivian,

    It is a half truth, as most Krugman quotes are.

    If you understand interest rates being determined in the short run by a myriad of factors, one of which is the change in the monetary base, then the Fed will always be influencing interest rates (since Krugman’s datum is the state, he uses terms like “set” in “set interest rates”) because the Fed will be changing the monetary base.

    That is the most charitable interpretation of what he wrote. Perhaps a more accurate interpretation is that Krugman’s logic holds the Fed as omnipotent, so even when the Fed doesn’t try, it still rules. Similar to Summer’s view.

  22. Gravatar of Major.Freedom Major.Freedom
    30. August 2015 at 11:44

    I should have included the words “over interest rates” after omnipotent.

  23. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    30. August 2015 at 12:04

    @Vivian Darkbloom
    If the fed were abolished tomorrow, it would at least have left the monetary base where it stands today, so initially, it would leave a monetary stance in place …

  24. Gravatar of A A
    30. August 2015 at 14:31

    @Vivian Darkbloom,

    Assuming that you have the option of doing something, then all exercises of that option, including not doing something, are a matter of choice. If your refrigerator broke down, and you are financially comfortable, then the decision to starve to death is better described as a consumption policy, rather than something forced upon you.

  25. Gravatar of Bob Murphy Bob Murphy
    30. August 2015 at 14:37

    Scott, are you just upset with the “setting interest rates” part of the quote, or (as I think Krugman is) are you also upset with the idea that low interest rates encourage excessive risk?

  26. Gravatar of John Hall John Hall
    30. August 2015 at 14:43

    Great post.

  27. Gravatar of Thanos Thanos
    30. August 2015 at 14:59

    Great post! But i cant understand this:

    “They switched from interest rate control before 2008 to monetary base control after. ”

    Yes but the Fed says it tries to lower long term interest rates. For them the base doesnt matter much. Credit easing is more important.

  28. Gravatar of Negation of Ideology Negation of Ideology
    30. August 2015 at 15:04

    “That’s also my view, but I suppose one could argue that from a different perspective if you set the money supply you are letting markets determine interest rates, whereas if you actually target interest rates, then you are “interfering” in the market.”

    It seems to me the Fed can only really guarantee a target of one thing and let everything else float around that. If the Fed targets the money supply, then interest rates are determined by the market based on that target. Just like if the Fed targets gold, the price of silver is determined by the market based on the price of gold. Targeting the money supply does “set” interest rates, just like targeting gold does “set” the price of silver. I don’t know if that’s very meaningful. The word “set” to me means either target or control.

    The Fed controls the monetary base, the minimum reserve ratio, and the rate it pays on excess reserves. It can use that to target any nominal price it wants including the price of Treasuries.

    Vivian –

    “Suppose the Fed were abolished tomorrow. ”

    And replaced by what? If it was replaced by the Bacon Standard, you’d get one set of interest rates. If it was replaced by increasing the monetary base by 3% per year you’d get another.

  29. Gravatar of Major.Freedom Major.Freedom
    30. August 2015 at 15:17

    How about no standard?

    For some magical reason people are able to produce and price software programs without a centralized force backed standard.

  30. Gravatar of TravisV TravisV
    30. August 2015 at 15:18

    Aside from identities, is David Glasner’s latest post the closest he’s come to a Scott Sumner takedown in years?

  31. Gravatar of Brian Donohue Brian Donohue
    30. August 2015 at 15:59

    Great post, Scott.

    Great quote from Friedman, Patrick Sullivan.

  32. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. August 2015 at 16:37

    E. Harding,
    “German rates only truly collapsed after “whatever it takes”:
    …And German rates continued to collapse after the announcement of ECB QE in January 2015.”

    Draghi’s “Whatever it Takes” speech was on July 26, 2012. German bond yields averaged a record low 1.24% that month, down from 3.34% in April 2011, the month the ECB did its first of two rate hikes that led to the 6-quarter double dip recession.

    http://appsso.eurostat.ec.europa.eu/nui/show.do?query=BOOKMARK_DS-055774_QID_704AE17C_UID_-3F171EB0&layout=TIME,C,X,0;GEO,L,Y,0;INTRT,L,Z,0;INDICATORS,C,Z,1;&zSelection=DS-055774INTRT,MCBY;DS-055774INDICATORS,OBS_FLAG;&rankName1=INTRT_1_2_-1_2&rankName2=INDICATORS_1_2_-1_2&rankName3=TIME_1_0_0_0&rankName4=GEO_1_0_0_1&sortR=ASC_-1_FIRST&sortC=ASC_-1_FIRST&rStp=&cStp=&rDCh=&cDCh=&rDM=true&cDM=true&footnes=false&empty=false&wai=false&time_mode=NONE&time_most_recent=false&lang=EN&cfo=%23%23%23%2C%23%23%23.%23%23%23

    Apart from April 2013, German bond yields never averaged less than 1.24% after Draghi’s “Whatever It Takes Speech” until July 2014.

    In other words you’ve got this totally backwards. German bond yields *stopped* collapsing after the speech.

    Also note that German bond yields reached a recent low of an average of 0.12% in April, the month after the ECB actually commenced its first QE. They rose to an average of 0.79% in June and closed at 0.74% on August 28.

    Your own graph shows the gap between US and German bond yields steadily widening from September 2012. And we all know what famous US monetary policy program started in September 2012, right?

    In fact, the only time there’s been a significant reduction in the gap between US bond yields and German bond yields since the US started QE3 has been since the ECB started its own QE program.

    Of course, none of this should come as a surprise since there’s abundant empirical evidence that QE raises bond yields.

    https://thefaintofheart.wordpress.com/2015/07/06/the-monetary-base-and-the-bond-yield-channel-of-monetary-transmission-in-the-age-of-zirp/

  33. Gravatar of Cliff Cliff
    30. August 2015 at 17:16

    E. Harding,

    Inflation is the change in the overall price level, not changes in the price of individual commodities.

  34. Gravatar of Ray Lopez Ray Lopez
    30. August 2015 at 17:30

    @Cliff – “If what the Fed does doesn’t matter, then why do the financial markets move so much when the Fed announces a change?” – because very short term, as Patrick R. Sullivan says, there’s a small effect, especially for financial intermediaries like banks, and for the commercial paper market. However, it’s also true the market over-reacts. Why does the market go down when a US president is shot? Same reason. It’s not that logical.

    @sumner – Patrick R. Sullivan said it best. And he has a letter from Friedman agreeing. Why do you insist your work is important when: (1) you don’t have an econometrics model, using history as a guide, that monetarism is important, nor can your apt pupil Mark Sadowski provide one (2), nor can you point to any countries that successfully used NGDPLT (or something close to it) except Israel and Australia in 2008, both very small countries and the latter dependent on China, so not good exemplars, (3) Ben S. Bernanke et al. (2003) said Fed policy shocks (where monetarism is most pronounced) has, with 95% confidence level, a 3.2% effect on the change in the US economy, (4) you don’t have any formal math model or computer simulation of NGDPLT, as Woodford and others have implied, (5) as the bearded Oxford economist blogger and his cohorts point out, your NGDPLT is a ‘faith based’ model, at least the Taylor Rule can point to some history of it working, and, (6) last but not least, you have no letter, unlike Patrick R. Sullivan, from Milt Friedman agreeing with this statement about monetarism: ‘The Fed *influences* interest rates, around a narrow range, in the short-run. Once, many years ago, I proposed that to Milton Friedman. He told me (in a letter) that he agreed with that. Which is not surprising, since I learned it from his debate with Walter Heller at NYU in 1968. ‘ M. Friedman. W. Heller. Giants in their field in the pre-internet age, when it was hard for just anybody and their dog to get 15 minutes of fame just by blogging nonsense on the web.

  35. Gravatar of E. Harding E. Harding
    30. August 2015 at 18:16

    “Inflation is the change in the overall price level, not changes in the price of individual commodities.”
    -Ah, but the overall price level is comprised of the prices of individual commodities.
    @Mark Sadowski
    -Are you saying U.S. 10-year Treasury bond rates are influenced by ECB monetary policy? And you still didn’t address my point about the 2013 taper tantrum: that shows pretty powerfully that threatened monetary tightening has a stronger immediate upward effect on real (and nominal) interest rates than an immediate downward effect on nominal interest rates via lower expected future inflation/NGDP, which may, though, manifest itself in the future:
    http://mises.ca/posts/blog/qe-reduces-long-term-rates-theory-and-history/
    “In other words you’ve got this totally backwards. German bond yields *stopped* collapsing after the speech.”
    -As you could see, I was comparing German with American rates, and, so far as I can see, there is no reason for my graph not to stand. How do you reconcile your claim that the announcement of QE3 raised U.S. nominal rates with the 2013 taper tantrum evidence? So far as I can see, U.S. nominal rates (not in comparison to any other country) were not significantly affected by the announcement of QE3, but were very strongly affected by the taper tantrum.
    “They rose to an average of 0.79% in June and closed at 0.74% on August 28.”
    -Maybe that was due to expected increases in German debt due to Greek troubles?

  36. Gravatar of ssumner ssumner
    30. August 2015 at 18:39

    E. Harding, I define easy and tight money in terms of NGDP growth. Areas with lower NGDP growth tend to have lower interest rates. I’m not arguing the correlation is perfect, but it’s pretty strong.

    If a central bank does something that looks like tight money, and NGDP growth increases, then you probably misjudged the stance of policy.

    Bob, I don’t know whether low rates encourage risk taking, or whether it would be good or bad if they did. I haven’t seen much risk taking since 2008 (compared to 2006.) But I do know that low rates are not caused by easy money, which is what Cohan is assuming.

    Thanos, Ok, but it’s not really targeting long term rates. So they have much greater “control” over short term rates.

    Mark, What would I do without you!

  37. Gravatar of Kevin Erdmann Kevin Erdmann
    30. August 2015 at 20:23

    I don’t understand how this idea that a loose monetary stance is related to low interest rates can be so widely assumed in the profession. One of the crazy moments to me on this topic was the June 19, 2013 FOMC press conference, where Bernanke announced that they were extending QE3, depending on future economic performance. He said that the Fed would continue to purchase securities. “These large and growing holdings will continue to put downward pressure on longer-term interest rates.” Literally, as those words were leaving his mouth, forward Eurodollar contracts were trading up by about 20 to 33 basis points.

    So, on the one hand, I don’t understand how so many economists can operate as if loose monetary posture causes low rates and that high risk taking is associated with low rates. But, on the other hand, the Fed apparently believes this, even as reality mocks the idea in real time.

  38. Gravatar of Ognian Davchev Ognian Davchev
    30. August 2015 at 22:52

    How is NGDP doing now? Is it on target?

    Maybe the Fed is actually doing NGDP targeting although they claim to do inflation targeting.

  39. Gravatar of benjamin cole benjamin cole
    30. August 2015 at 23:18

    I did a word count on Stanley Fischer’s recent presentation at Jackson Hole.

    Inflation is dead in the US, really dead in Europe and long dead in Japan.

    Yet Fischer mentions the word “inflation” 75 times in his presentation, and the expression “aggregate demand” but once.

    Looks bad, dudes.

    What has happened to central bankers? They have monomania.

  40. Gravatar of Major.Freedom Major.Freedom
    31. August 2015 at 03:28

    Kevin,

    When will you realize that “loose money” is but a definition that cannot be falsified or refuted by experience?

    Someone is not wrong by defining what the Fed has been doing is too tight, or too loose.

    If Bernanke defines what the Fed has been doing as loose, or accommodative, he’s not wrong, he is merely operating under a definition that differs from yours, in which you are not wrong either.

    The fact that you said Bernanke is wrong because “reality”, proves you don’t know how to distinguish your own opinion from an objective fact, which of course calls into question your entire set of posts here that purport to be accurate assessments of the facts.

    Your posts are shysterisms.

  41. Gravatar of Major.Freedom Major.Freedom
    31. August 2015 at 03:33

    Sumner wrote:

    “I define easy and tight money in terms of NGDP growth.”

    How can this be a useful definition when we have no ability to observe the counterfactual baseline NGDP from which to compare the actual NGDP?

    What’s that? We don’t actually need to observe the counterfactual baseline?

    OK, then I propose the definition of loose and tight money in terms of what otherwise would have existed in a free market.

    That is true market monetarist economics.

  42. Gravatar of ssumner ssumner
    31. August 2015 at 04:14

    Ognian, A variable not being targeted cannot be “on target.” If they are doing it secretly, we don’t know the target, and hence would have no way to judge.

    Ben, That doesn’t sound good.

  43. Gravatar of Dan W. Dan W.
    31. August 2015 at 05:06

    It’s too bad inflation is only mostly dead. For if it was truly dead then my property tax, my home and auto insurance, my medical costs and the cost of college education would not be rising. But they are and their increase more than makes up for stagnant pricing elsewhere.

    Also, inflation is not dead in the pricing of entertainment. Funny that. But I can choose not to subscribe to the cable sports package and choose not to go to DisneyWorld. Pricing of Disney tickets shows a nice, stable 5% rate of increase. Maybe we should just target Fed Policy to the cost of going to DisneyWorld!

    http://allears.net/tix/tixincrease.htm

  44. Gravatar of Benjamin Cole Benjamin Cole
    31. August 2015 at 05:22

    Scott–oh, it gets worse.

    Here is the agenda from the Jackson Hole meeting:

    Friday August 28

    8:00am Inflation Dynamics Through Firms’ Pricing Behavior
    9:00 am International Aspects of Inflation Dynamics
    10:25 am Central Bank Perspectives on Inflation Dynamics

    Saturday August 29

    8:00 am Reinflation Challenges and the Inflation: Targeting Paradigm
    9:00 am Inflation Dynamics During and After The Zero Lower Bound
    10:25 am Overview Panel: Global Inflation Dynamics

    Do you notice anything? Like the word “inflation” being in every panel title?

    There is no other topic, I mean, literally, there is no other topic headlined when central bankers get together.

  45. Gravatar of LK Beland LK Beland
    31. August 2015 at 05:42

    One note about quantum mechanics:

    We teach undergraduate students in physics all kinds of techniques to compute the quantum properties of several systems. At the end of a typical BSc, they leave with a limited ability to make predictive calculations.

    In the case of monetary policy, can the same thing be said about a typical economics undergraduate curriculum?

    (BTW, I think an explanatory factor is that QM is somewhat axiomatic, much more so than monetary economics)

  46. Gravatar of Njnnja Njnnja
    31. August 2015 at 06:04

    Whenever I start to despair about how the American political system seems to be ending up doing all the wrong things because of popular pressure, it reminds me of the Mencken quote:

    Democracy is the theory that the common people know what they want and deserve to get it good and hard.

    But then I think of Churchill:

    You can always count on Americans to do the right thing – after they’ve tried everything else.

    And I remember the late 80’s-early 90’s hysteria about how America’s best days were behind us, and Japan was going to be the greatest economy in the world. And look how that turned out.

    Yes it would be great if we just followed the policies that had the best outcome (setting aside the fact that you could hardly get 10 people to agree to “best outcome”, let alone 300 million) ex post, but we don’t have a crystal ball and even the best models are always wrong, sometimes useful, and even the worst models are like stopped clocks.

    Go back to the 50’s and 60’s and look at all of the newly independent nations trying different ways of governance under autocratic rule. You were going to end up with a distribution of outcomes, and some were going to end up like Singapore and South Korea and some were going to end up like Zimbabwe and North Korea. In hindsight it’s easy to see who was right, and you can probably convince yourself that you would have been one of the smart ones who would have known the policy combination that those countries *should* have followed. But the older I get, the more humble I become in my ability to predict the future (although the irony is that in some ways, that is my day job), and I believe there is great wisdom in saying “I don’t know” and falling back on the wisdom of crowds. Democracy isn’t too bad after all. So although I end up pushing in favor of my preferred outcome, it doesn’t bother me too much if that preference isn’t followed.

    Plus, I hedge :)

  47. Gravatar of Mark A. Sadowski Mark A. Sadowski
    31. August 2015 at 06:17

    E. Harding,
    “Are you saying U.S. 10-year Treasury bond rates are influenced by ECB monetary policy?”

    No, I wasn’t, although there may be such influences.

    E. Harding:
    “And you still didn’t address my point about the 2013 taper tantrum:…How do you reconcile your claim that the announcement of QE3 raised U.S. nominal rates with the 2013 taper tantrum evidence? So far as I can see, U.S. nominal rates (not in comparison to any other country) were not significantly affected by the announcement of QE3, but were very strongly affected by the taper tantrum.”

    US bond yields (GS10) averaged 1.72% in September 2012 and apart from November 2012 were higher during every month of QE3. The only aberration I observe is the decline in yields from 1.98% in February 2013 to 1.76% in April 2013, *before* the “Taper Talk” speech on May 22, 2013. It wasn’t until June that yields exceeded the level they attained in February. And yields kept rising through December 2013 when they reached 2.90%.

    What happened in January 2014 to cause yields to start falling?

    The Fed actually began the process of tapering QE3.

    The monetary base peaked in August 2014. By then yields had fallen to 2.42%. The monetary base has been slowly falling since August 2014 (it is down 3.7% as of June) and monthly bond yields have been lower ever since.

    E. Harding,
    “Maybe that was due to expected increases in German debt due to Greek troubles?”

    The German share of Greek debt is only 2% of German NGDP, so that’s not very plausible. Moreover, now that the Greek situation is more or less (again temporarily?) resolved (Greek bond yields are the lowest in six months), why aren’t German bond yields “collapsing” due to the ECB’s QE?

  48. Gravatar of Charlie Jamieson Charlie Jamieson
    31. August 2015 at 06:24

    Whatever the Fed does, I doubt it will have anything but a very minor impact on inflation or employment or the standard of living.
    It just serves as a distraction from talking about other policies that would have a potential impact.
    As for monetary policy, I don’t think it’s worth discussing until we accept that money is created in the private sector. The Fed facilitates this — that is it’s primary function — but I’m not sure it know how to encourage more good lending or discourage bad lending.
    Those are legislative or regulatory functions.
    The Fed can’t do those, so it fiddles around with interest rates, which is one of the tools it has, but even then it really just responds to what rates the market wants.
    Even QE, which was supposed to be a game changer, wound up just being an asset swap — bonds for reserves — with very little impact on money in circulation.

  49. Gravatar of Brian Donohue Brian Donohue
    31. August 2015 at 06:46

    I’m with Sadowski. When I look at the data, QE and accommodative forward guidance in the US over the past five years have unambiguously led to increases in long-term rates (not just higher CPI expectations either, higher TIPS yields.) This is not an intuitive result, and not how almost everyone talks and thinks about it.

    The exception was Operation Twist, where the Fed explicitly tried to flatten the yield curve (increase the duration of its holdings) and, for a time, succeeded.

    Long-term rates dropped throughout 2014, as QE tapered.

  50. Gravatar of David de los Ángeles Buendía David de los Ángeles Buendía
    31. August 2015 at 07:23

    Dr. Sumner,

    Dr. Sumner,

    I do not disagree with your points. The Federal Reserve Bank (FRB) cannot both influence interest rates and the supply of money, if it targets an interest rate, it must allow the supply of money to fluctuate to support that rate. It is targets a supply of money, it must allow the interest rates to fluctuate to support that quantity. With the current Quantitative Easing Policy (QEP) the FRB is targeting a Quantity of money and so it is letting the price of money (interest rates) fluctuate.

    The FRB however does not make this point clear. They have a target Federal Funds Rate of 0 – 0.25% and a Zero Interest Rate Policy (ZIRP). Now it would no doubt be argued that ZIRP is simply the necessary by-product of targeting a very large quantity of money. It is making a virtue, or a policy at least, of necessity. it does however create the impression that the FRB is in fact targeting interest rates[1].

    [1] http://www.federalreserve.gov/faqs/money_12849.htm

  51. Gravatar of dtoh dtoh
    31. August 2015 at 07:34

    @scott
    Reposting…
    @scott,

    Monetary policy is not anything like quantum mechanics. It’s trivial but is misunderstood by the public (and policy makers) for three main reasons.

    1) For ideological reasons, some economists (e.g. PK) are loathe to reject fiscal policy (i.e. increased government spending) as an economic policy tool, and therefore disingenuously question the efficacy of monetary policy.

    2) The transmission mechanism for monetary policy is not properly understood by economists, and therefore, explanations of monetary economics come across as voodoo economics.

    3) There is a failure to distinguish between MB and MB-ER. People conclude that since there was a huge increase in MB which had little impact on economic growth that therefore monetary policy is ineffective. Economists need to strongly make the point that increases in reserves have no impact on the economy.

  52. Gravatar of o. nate o. nate
    31. August 2015 at 10:33

    Great post. I thought Cohan richly deserved the sarcasm. At least the Times relegates this kind of “logic” to the op-ed section. Some publications would insert it into news stories.

  53. Gravatar of Doug M Doug M
    31. August 2015 at 11:00

    Similar to Buckley’s, I would rather have be governed by the first 2000 people in the Boston phone book than the 2000 members of the Harvard faculty….

    Perhaps we were rather monetary policy be set by plumbers than PhD.s

  54. Gravatar of ssumner ssumner
    31. August 2015 at 11:10

    LK. Our models tell us that prediction is difficult, if not impossible in many areas of economics. If we could predict things like asset prices and business cycles, then our models would be wrong.

    Njnnja, Excellent comment.

    dtoh, I think it is difficult, like QM. Otherwise how can you explain why even many bright macroeconomists don’t get it.

  55. Gravatar of E. Harding E. Harding
    31. August 2015 at 11:16

    @Mark A. Sadowski
    -Don’t markets work by long and variable leads? Why would the implementation of an already announced action have any effect on anything? Once QE3 was announced in September, bond yields didn’t change much. This suggests QE3 didn’t have much of an effect on bond yields, upward or downward.
    “The only aberration I observe is the decline in yields from 1.98% in February 2013 to 1.76% in April 2013, *before* the “Taper Talk” speech on May 22, 2013.”
    -What are you trying to imply here? I claim that the spiking of both real and nominal rates in May-June of 2013 was due to the taper talk.

    You shouldn’t look at actions, you should look at the announcements which precede them. The taper talk announcement strongly raised rates, the September 18 postponement announcement rapidly lowered them.

    And, actually, you’re wrong; rates surpassed February’s and March’s heights by May 28.
    “and monthly bond yields have been lower ever since.”
    -That was due to the oil price fall. TIPS yields didn’t fall; they jogged in place. I’m not sure what caused both real and nominal rates to fall between January and August 2014, but the effect of the taper should have been fully reflected in the bond market by January 2014.
    “Moreover, now that the Greek situation is more or less (again temporarily?) resolved (Greek bond yields are the lowest in six months), why aren’t German bond yields “collapsing” due to the ECB’s QE?”
    -German rates are lower than they were at the height of the Greek crisis. They’ve been steadily declining, but not collapsing.

  56. Gravatar of Rod Everson Rod Everson
    31. August 2015 at 12:11

    Scott, and others,

    I’ve seen very little discussion of the exact mechanism the Fed will employ when it finally raises the fed funds rate.

    My assumption is that it will take the form of an announcement that the Fed is raising the interest rate being paid on bank reserves by, say, 1/4% followed later by some tinkering with the fed funds rate so that it starts to trade between 0.25% and 0.50%.

    Is this a general understanding, or are there other options that are more likely to be used instead?

  57. Gravatar of Rod Everson Rod Everson
    31. August 2015 at 12:34

    Scott, you wrote: “For the past seven years the Fed hasn’t been targeting interest rates, they’ve been using base control to influence the economy, increasing the monetary base through QE programs. They switched from interest rate control before 2008 to monetary base control after.”

    The Fed could have chosen to continue its longstanding policy of investing in short-term maturities when it expanded the reserve base. That would have also constituted what you refer to as “base control.” But they chose to invest instead in long maturities with the clear intent of driving the long end of the yield curve lower, and they were successful in doing so.

    Granted, they weren’t targeting a particular rate as was their past practice (unless you consider the continuation of ZIRP), but the manner in which they spent the money generated by their massive increase in bank reserves was certainly aimed at driving interest rates on the long end lower, so I would view it as an interest-rate-directed policy facilitated by base expansion.

    And paying 0.25% interest on all the newly-created excess reserves effectively neutralized any direct effect of the base manipulation. That left the QE’s main impact as artificially suppressing long-term rates. Just as the Fed in the past would step the fed fund rate down to get an expansion going, not knowing at the outset what the ultimate low rate would be, the Fed did the same with the QE’s, adding to them one after the other while looking for signs of economic recovery as long rates fell (or remained at lowered levels.)

    In my opinion, it’s not a stretch to assume that we’d see a QE4, and maybe 5, and 6, if we enter another recession over the near term. They’d argue that the strategy worked before and should be deployed again. Whether that would result in even lower long rates is an open question; it might not, depending upon the damage a recession would do to the federal budget and consequent financing needs.

  58. Gravatar of Jared Jared
    31. August 2015 at 12:39

    Several of you agree the Fed cannot target both the interest rate and the quantity of (base) money. But, oh, yes it can. And it does… by paying interest on reserves (IOR). Under its current procedures, the Fed can hit whatever supply target they wish through asset purchases (QE). Now, QE alone would push the fed funds rate (FFR) to 0 because most of that base money would be held, necessarily, as excess reserves. But once the central bank has the authority to pay IOR, it can also hit whatever rate target it wishes. The FFR and short term T-bills will arbitrage at the IOR rate (or slightly under because the GSEs hold and trade reserves but cannot, by law, receive the IOR). The Fed could raise rates by raising IOR while simultaneously increasing the base through QE if it so desired.

    See #3 http://www.newyorkfed.org/markets/ior_faq.html

  59. Gravatar of Rod Everson Rod Everson
    31. August 2015 at 12:55

    Jared,

    I agree with you but would add that any reserves they supply will have no effect on the economy or other money supply measures other than that driven by their choice of instruments to purchase with the expanded reserves. What I’m saying is the Fed’s direct influence on the economy and money via management of the monetary base has diminished to about zero. What matters instead is how they spend the money.

    I also agree that the level of the interest rate paid on reserves (the IOR rate) will effectively set the ceiling for the overnight rate on fed funds.

    So, yes, the Fed is directly managing both the fed funds rate and the monetary base level simultaneously. Ironically, neither is having much effect on the economy which is now left to grow or shrink without significant influence from the Federal Reserve.

    By that I mean that the level of bank reserves is no longer a constraint on the banking system. If the economy starts to expand, for whatever reason, banks will attempt to expand along with it and will easily be able to convert excess reserves to the newly-needed required reserves along the way. The Fed’s current operating procedures ensure that since the Fed exerts no constraint on such a conversion. This is why demand deposits have grown at a 20% annual rate over the past five years. Nothing the Fed has in place will keep that from happening, nor will it stop them from contracting at a similar rate should they try to raise the IOR rate.

  60. Gravatar of E. Harding E. Harding
    31. August 2015 at 13:00

    @Rod, that’s nonsense. The monetary base directly adds to the money supply and thus has a direct stimulative impact on the economy. You’re new here, so read Scott’s older posts. Banking is a sideshow when it comes to QE.

  61. Gravatar of Rod Everson Rod Everson
    31. August 2015 at 15:13

    E. Harding, I might be new here but I started following the Fed around 1974 and have a reasonable grasp on what the recent changes in operating procedures have done to the Fed’s capabilities.

    The Fed neutralizes every dollar of excess reserves by paying interest on it, thereby giving banks absolutely no reason to circulate it. That doesn’t mean the money supply won’t grow (it has) due to the presence of the excess, but it will do so, or not, regardless what the Fed does in terms of tweaking the short term rate by a quarter of a percent or so.

    Until the Fed re-establishes direct control over the reserve base that’s actually required to support the deposit base, it’s the Fed that’s become the sideshow, as you put it. The system can expand and contract at will, with the main limitation now being capital, rather than reserves required to be held against deposits. Those used to matter; they don’t in this environment the Fed has created.

  62. Gravatar of Ray Lopez Ray Lopez
    31. August 2015 at 16:43

    Sumner: ssumner 31. August 2015 at 04:14 Ognian, A variable not being targeted cannot be “on target.” If they are doing it secretly, we don’t know the target, and hence would have no way to judge.

    LOL! Coming right after Major Freedom’s trenchant observation about Sumner playing games with secret definitions, classic! Ironically, Sumner has no sense of irony (or maybe shame).

  63. Gravatar of Mark A. Sadowski Mark A. Sadowski
    31. August 2015 at 17:19

    E. Harding,
    “Don’t markets work by long and variable leads? Why would the implementation of an already announced action have any effect on anything?”

    I’ll let Scott answer that question if he so chooses.

    E. Harding:
    “Once QE3 was announced in September, bond yields didn’t change much. This suggests QE3 didn’t have much of an effect on bond yields, upward or downward.”

    It’s true that yields didn’t change much through December 2012, but then the initial amount of QE was only $40 billion a month. This was expanded to $85 billion a month in December. Yields went up significantly in January, February and March.

    E. Harding:
    “What are you trying to imply here? I claim that the spiking of both real and nominal rates in May-June of 2013 was due to the taper talk.”

    I’m claiming the spike in May and June only looks so big if you totally ignore the decline from 2.07% on March 11 to 1.66% on May 1. The sharp increase in yields in May and June simply brought yields back to the levels of the previously established upward trend. Consequently I wonder why market analysts waste so much time talking about May and June when it’s obvious that the real mystery is why there was a collapse in yields from mid-March through April.

    E. Harding:
    “You shouldn’t look at actions, you should look at the announcements which precede them.”

    I think you should look at both.

    E. Harding:
    “The taper talk announcement strongly raised rates, the September 18 postponement announcement rapidly lowered them.”

    There are at least 14 market days during QE3 where rates rose by more than they did on May 22, so it was large but hardly uniquely so. The decline on September 18 was indeed the largest during QE3. But I’m not sure that these one day gyrations mean what many claim they do. When I look at the monthly averages I don’t see any significant break in the trends.

    US bond yields rose from a low of 1.58% on November 15, 2012 to a high of 3.04% on December 31, 2013. The first was only two months after QE3 started, at a time when the monetary base had only risen by a total of about $50 billion. From February 2013 through November 2013 the monetary base rose a total of $945 billion or at an average rate of $94.5 billion a month. Consequently the later occurred shortly after a relatively long and rapid expansion in the monetary base and before the taper was officially announced.

    E. Harding:
    “And, actually, you’re wrong; rates surpassed February’s and March’s heights by May 28.”

    Given the context, I was obviously talking about monthly averages.

    E. Harding:
    “That was due to the oil price fall.”

    And what caused oil prices to fall (and the dollar and the renminbi to soar in value)? Or are oil prices totally exogenous?

    E. Harding:
    “I’m not sure what caused both real and nominal rates to fall between January and August 2014, but the effect of the taper should have been fully reflected in the bond market by January 2014.”

    The taper amounts were not decided in advance and were not unconditional.

    E. Harding:
    “German rates are lower than they were at the height of the Greek crisis. They’ve been steadily declining, but not collapsing.”

    Greek bond yields spiked to 19.23% on July 8th so I think it’s reasonable to claim that day was the “height” of the crisis. German bond yields closed at 0.67% on July 8th. They closed at 0.80% today. So it doesn’t sound at all like they are “steadily declining” to me.

  64. Gravatar of E. Harding E. Harding
    31. August 2015 at 17:22

    “The Fed neutralizes every dollar of excess reserves by paying interest on it,”
    -I have long held that this doesn’t matter. What is a quarter of a percentage point going to do, anyway? Nothing much, in the grand scheme of things. The idea a quarter of a percentage point of IOR gives banks “no reason to” lend money at 6% is such laughable nonsense that I cannot possibly imagine how you came to that conclusion. And QE mainly works outside the bank lending channel; it directly injects money into the economy -and, again, a quarter of a percentage point isn’t going to make a difference. When ECB short-term rates went negative:
    https://research.stlouisfed.org/fred2/series/EURONTD156N
    nothing important happened.
    I don’t get your second paragraph. Yeah, reserves become irrelevant as a bank lending constraint at a 0% Federal Funds Rate, I understand that. But that doesn’t mean the monetary base stops mattering. If the Fed did $400 trillion of QE overnight, you think there wouldn’t be hyperinflation? And the value of bank capital partly depends on inflation/NGDP expectations, too, anyway.

  65. Gravatar of E. Harding E. Harding
    31. August 2015 at 17:46

    The oil price fall was caused mainly by the expansion of oil production in the Western Hemisphere. Tight money probably had little (though not necessarily nothing) to do with it; the price of oil fell in terms of Yen and Euro as well. The dollar and renminbi soared in value because the U.S. and China are massive net importers of oil. The ruble fell because Russia is a massive net exporter of oil. Simple as that.

    You seem to be right that yields did increase around the time of the December 12, 2012 announcement. Wonder why that was. The movement was only medium-sized though, so it might have been influenced by other factors.

    “US bond yields rose from a low of 1.58% on November 15, 2012 to a high of 3.04% on December 31, 2013.”
    -I say this was mostly due to the May-June taper fears.

    German rates look like they’re steadily declining to me. Let’s check back in a Friedman unit.

    If you’re right, what do you think happened around March 2013, anyway, that caused yields to decline?

    BTW, from the looks of it, yields spiked most rapidly on June 19, 2013. And what do you think happened then?
    http://www.businessinsider.com/ben-bernanke-came-out-guns-blazing-today-2013-6
    Doesn’t look like easy money to me.

  66. Gravatar of Rod Everson Rod Everson
    31. August 2015 at 17:49

    E. Harding: I’ll agree that the $2.5 trillion of excess reserve creation was a direct stimulus to the economy over the period it was injected, and that it obviously added to the monetary base. What I was objecting to is the implication that those reserves did anything to the money supply, i.e., any of the M’s besides the base. That was really my point, that the IOR neutralizes any excess reserve provision and prevent it from generating money growth (growth in the M’s other than the monetary base itself.)

    As for the “laughable conclusion,” it’s what’s happening. If the IOR wasn’t being paid, funds would be at zero because every funds desk trader would hit a bid above zero with every dollar of excess he had. That measly 1/4% keeps them from doing so. It’s totally unrelated to the fact that banks can earn more on loans. Someone has to sit on the excess, because it’s in the system. Absent that 1/4%, they won’t do so unless the funds rate stays at zero.

    That’s why I asked in the first post how people think a tightening will proceed. I’m assuming they will first announce an increase in the rate paid on reserves, because that’s the only way they’ll move the funds rate upward, but maybe others think differently. If so, I’m curious what they expect.

    I’m not sure what you don’t get about the “second paragraph” but yes, $400 trillion of QE would of course generate a massive increase in asset prices at least, and probably in all prices. That said, if the Fed hadn’t allowed interest rates to drop to zero and then started paying interest on reserves, $2.5 trillion of excess reserves would also have resulted in a hyperinflation. The only reason it hasn’t done so is because of the combination of a near-zero short rate and the IOR of 1/4%. That’s sufficient to keep banks sitting on their own share of the excess reserve balance. And why not? It’s a $6.25 billion direct subsidy to the banking system.

  67. Gravatar of E. Harding E. Harding
    31. August 2015 at 19:31

    Rod, there’s still an excess reserve pileup in Europe, despite negative IOR. There’s still an excess reserve pileup in Japan, despite no IOR. There was an excess reserve pileup in the 1930s U.S., despite no IOR. Until I see hyperinflation (and not below-1% inflation) in Europe, I’m not buying the argument IOR does much of anything.

  68. Gravatar of Kevin Erdmann Kevin Erdmann
    31. August 2015 at 20:03

    Mark & E. Harding,
    Regarding QE3, don’t forget that in June 2013, the Fed announced that it wouldn’t taper indefinitely, pending economic data, and rates shot up immediately.

  69. Gravatar of dtoh dtoh
    31. August 2015 at 20:38

    @scott

    “I think it is difficult, like QM. Otherwise how can you explain why even many bright macroeconomists don’t get it.”

    Because many macroeconomists are not as bright as they think they are, and because PhD econ programs turn many of the bright ones into regression monkeys who lose the ability to actually think.

  70. Gravatar of dtoh dtoh
    31. August 2015 at 20:42

    @scott

    More seriously, I think a lot of the early economists developed their insights through actual experience and observation, whereas, a lot of economists today have no zero first hand experience of finance or business. The obvious eludes them.

  71. Gravatar of dtoh dtoh
    31. August 2015 at 20:53

    @Mark S
    You replied to E. Harding.

    “Once QE3 was announced in September, bond yields didn’t change much. This suggests QE3 didn’t have much of an effect on bond yields, upward or downward.”

    It’s true that yields didn’t change much through December 2012, but then the initial amount of QE was only $40 billion a month. This was expanded to $85 billion a month in December. Yields went up significantly in January, February and March.

    I think the better response is that bond yields in and of themselves don’t tell you anything about the efficacy of OMO. What matters is not the cost of borrowing but how much people/firms actually borrow (or to be more precise how much financial assets they exchange for real goods and services). There are two things that impact this: a) bond yields (financial asset prices) and b) NGDP expectations. If expected NGDP growth has increased, you can have more borrowing even if yields stay the same or go up. And in fact, the changed expectations may actually cause the yields to go up.

    This is really fundamental. If people don’t understand this, they won’t understand anything.

  72. Gravatar of E. Harding E. Harding
    31. August 2015 at 20:58

    @Kevin
    Here’s how the press spun it at the time:
    “Instead, Bernanke and the Fed did just the opposite. The FOMC revised up its economic forecasts – implying a quicker economic recovery, meaning tapering is closer than previously assumed – and even laid out a roadmap for tapering, saying bond buying could be completely finished by mid-2014.”

  73. Gravatar of E. Harding E. Harding
    31. August 2015 at 21:00

    @dtoh
    -TIPS yields went up on June 19, 2013, too.

  74. Gravatar of Kevin Erdmann Kevin Erdmann
    31. August 2015 at 21:42

    In the press conference Bernanke said the purpose of their policy shift at the meeting was to push down rates….

  75. Gravatar of dtoh dtoh
    1. September 2015 at 05:07

    @E Harding
    Same response. Financial asset prices (real or otherwise) don’t you tell you anything by themselves.

  76. Gravatar of Nick Nick
    1. September 2015 at 05:32

    Krugman drawing a line in the sand over the question of whether interest rates are artificial or not is laughable.

    His argument, which is stupefying, is that because interest rates are derived from supply & demand they are not “artificial”(his exact word).

    He does not deny that supply/demand are manipulated by various Fed policies/agencies…he simply ignores the fact.

    Manipulated supply/demand=manipulated interest rates(aka, “artificial”).

    In fact, most Fed appendages outright state they are trying to keep interest rates low.

    I’m sorry, but Krugman the Nobel Prize winner is a borderline moron on this topic. I have no qualms pointing this out either considering he likes name calling when trying to make points, so it’s “tit for tat” for this d-bag.

  77. Gravatar of Mark A. Sadowski Mark A. Sadowski
    1. September 2015 at 06:05

    E. Harding,
    “The oil price fall was caused mainly by the expansion of oil production in the Western Hemisphere.”

    That and the return of Iran as a major oil exporter.

    E. Harding:
    “Tight money probably had little (though not necessarily nothing) to do with it; the price of oil fell in terms of Yen and Euro as well.”

    The month the US monetary base peaked West Texas Intermediate still averaged $96.54, so almost all of the decline has occurred since. I’m not going to argue that US monetary policy is a major driver of oil prices because it isn’t (the monetary base does not Granger cause oil prices during ZIRP). But tighter US and Chinese monetary policy is a contributing factor.

    E. Harding:
    “The dollar and renminbi soared in value because the U.S. and China are massive net importers of oil. The ruble fell because Russia is a massive net exporter of oil. Simple as that.”

    I don’t subscribe to OBCT (oil business cycle theory). The dollar went up mostly because QE ended.

    https://thefaintofheart.wordpress.com/2015/07/13/the-monetary-base-and-the-exchange-rate-channel-of-monetary-transmission-in-the-age-of-zirp-part-1/

    The renminbi went up because it has a crawling peg to the US dollar (see Part 2). Only in the case of ruble is oil a plausible explanation of why the currency’s value went down.

    E. Harding:
    “You seem to be right that yields did increase around the time of the December 12, 2012 announcement. Wonder why that was. The movement was only medium-sized though, so it might have been influenced by other factors.”

    That in fact is the problem with analyzing all daily movements. There’s simply too much noise to know exactly what caused prices to move in a particular way on any single day. It’s essentially anecdotal evidence.

    E. Harding:
    “If you’re right, what do you think happened around March 2013, anyway, that caused yields to decline?”

    I honestly don’t know. I’m more curious why financial analysts aren’t curious about that.

    E. Harding:
    “BTW, from the looks of it, yields spiked most rapidly on June 19, 2013. And what do you think happened then?…Doesn’t look like easy money to me.”

    Actually it’s tied for third place with September 14, 2013. On those days the 10-year Treasury rose 13 basis points. The largest increases were actually on August 1, 2013 and November 8, 2013 when bonds rose 14 basis points.

    What happened on those days? I did a google search of the news and turned up nothing obvious. It’s like reading a bunch of Onion articles.

    http://www.theonion.com/article/something-about-tax-cuts-or-earnings-or-money-or-s-18169

    One hint would be to look at what stocks did on those days. Of the four days I just listed, the S&P 500 closed up on three out of four. In fact if you look at the entire sample of days during QE3 from September 13, 2012 through October 29, 2014, on days when bond yields rose, stock prices also went up, approximately three quarters of the time.

    That doesn’t sound like tight money to me.

    Looking at this more rigorously, during this sample period there is a positive correlation between bond yield and stock price index changes, and it is significant at the 1% level.

    It used to be common knowledge that bond yields and stock prices usually move together, but for some reason since 2008 people seem to know a lot of things that just ain’t so.

  78. Gravatar of ssumner ssumner
    1. September 2015 at 06:06

    Rod, No, they aren’t going to tinker with the fed funds rate, they’ll use IOR.

    You said:

    “That left the QE’s main impact as artificially suppressing long-term rates.”

    Yes, that was the theory a few years ago. And the proponents predicted that when QE ended long rates would rise. How’s that theory working out?

    Jared, You said:

    “Several of you agree the Fed cannot target both the interest rate and the quantity of (base) money. But, oh, yes it can. And it does… by paying interest on reserves (IOR).”

    That’s right. I’m so used to the pre-2008 situation that I sometimes forget.

    E. Harding, You said:

    “The idea a quarter of a percentage point of IOR gives banks “no reason to” lend money at 6% is such laughable nonsense that I cannot possibly imagine how you came to that conclusion.”

    Monetary policy doesn’t work by affecting bank’s willingness to lend, it works by changing the supply and demand for base money.

    Nick, I have some sympathy for Krugman’s position. To many people, “manipulation” sounds more like “price controls” than it does like “targeting a variable that is determined in the free market.”

  79. Gravatar of dtoh dtoh
    1. September 2015 at 06:44

    @mark

    “Monetary policy doesn’t work by affecting bank’s willingness to lend, it works by changing the supply and demand for base money.”

    And what increases the demand for base money?

  80. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 07:07

    @dtoh “And what increases the demand for base money?”

    Exactly. Monetary policy changes the supply of the base, but when there’s a significant amount of excess reserves in the system, as today, the demand is influenced by other economic factors that affect the banking system’s demand for required reserves .

    Demand for base money is only impacted by monetary policy when it’s restrictive, i.e., when the level of excess reserves is at a frictional level. At a time like that (all of pre-2008), if the Fed reduced the reserves in the system to a level below that required by the banking system the entire economic system would contract in response, generating a recession and thereby ultimately lowering demand for required reserves.

    Today, with the massive level of excess reserves, demand for base money by the banking system consists of demand for required reserves and that demand will be whatever the economy dictates. The Fed has little to do with it. The 20% annual increase in demand deposits over the past five years set the demand for base money. The Fed set the supply with their QE’s. Clearly, supply has far outstripped demand.

  81. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 07:19

    @ ssumner:

    Rod: “That left the QE’s main impact as artificially suppressing long-term rates.”

    Scott: “Yes, that was the theory a few years ago. And the proponents predicted that when QE ended long rates would rise. How’s that theory working out?”

    Surely you’re not claiming a bad prediction as proof that the QE’s didn’t artificially suppress long-term rates?

    In my experience, expectations for long-term rates are very sticky. That leads to very long trends in long-term rates over time. There was a time not so many months ago when I actually thought the U.S. long-term market would just go to near-zero rates given what was happening in Europe at the time.

    I don’t think they belong there, nor do I think they belong anywhere near 2-3% given the fiscal condition of the U.S., but it takes a long time to reverse what is now a 30+ year trend of falling long-term interest rates, just as it took a long time to reverse the 30+ year rise in rates in the early 1980’s.

    Here’s a thought experiment for you: What would happen to long-term rates if the Fed announced that it was going to liquidate, in an orderly manner, but over the next year, it’s entire portfolio of long paper? Would long-rates be affected? If they aren’t artificially suppressed, any sell offs should be considered buying opportunities. How many market participants do you think would view it that way?

  82. Gravatar of dtoh dtoh
    1. September 2015 at 07:29

    @Rod
    Reserves have nothing to do it. The NY Fed exchanging deposits for Treasuries with Chase has no more impact than the NY Fed making the exchange with the St. Louis Fed. Ignore reserves they are not important.

  83. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 07:34

    @E. Harding

    I didn’t say that it was necessary for the Fed to pay interest on reserves to stop excess reserves from piling up. I said that IOR (or on the excess, specifically) is necessary to stop the excess from circulating.

    If the fed funds rate is zero, as it will most certainly be if the IOR is zero, then, yes, excess reserves can pile up without effect, as you indicated.

    The problem is that the interest rate on reserves sets a cap for the funds rate. That’s why I assume that an eventual rise in rates must be accompanied by a comparable rise in the rate being paid on reserves. Scott apparently agrees, per his recent response to my question on how they’ll proceed.

    This is more than a trivial issue. In my understanding of how Fed operations traditionally affect the money supply there should be no interest paid on reserves, and particularly on excess reserves, and the fed funds rate should never be allowed to reach an effective rate of zero percent. Both of these actions were serious mistakes on the Fed’s part, and have led to this unnecessary experimentation with the QE’s.

  84. Gravatar of Mark A. Sadowski Mark A. Sadowski
    1. September 2015 at 07:55

    dtoh,
    “And what increases the demand for base money?”

    You quoted Scott, not me. So perhaps your question is better directed at Scott. (However, to be clear, I entirely agree with Scott’s statement.)

  85. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 08:02

    @dtoh: “Reserves have nothing to do it.”

    Two part answer: In normal times, pre 2009 and the QE’s and ZIRP, reserves had everything to do with it.

    Today, not so much. More here: Title: Has the Fed Made Itself Irrelevant?

    http://ontrackeconomics.blogspot.com/2015/08/has-federal-reserve-made-itself.html

  86. Gravatar of dtoh dtoh
    1. September 2015 at 08:59

    Rod,
    No reserves never matter. The only thing that matters is MB-ER. The Fed has complete control over both MB and ER. Always.

  87. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 09:10

    dtoh,

    I’m assuming MB is Monetary Base, and ER is Excess Reserves (tentatively) and that MB-ER is the Monetary Base with Excess Reserves subtracted out. Correct, or not?

    After letting me know, please elaborate on the importance of MB-ER, if you would? Thanks.

  88. Gravatar of Nick Nick
    1. September 2015 at 09:54

    @ Sumner

    “targeting a variable that is determined in the free market.”

    With all due respect, not only is that manipulation as you note, it is one that can have an effect on price level, even if that effect is downstream or not evident at a given moment in time.

    An artificial interest rate does effect price level in a variety of ways, both immediate(like bubbles or popping bubbles) and long term(interest paid) and is a form of price control.

    That effect is not homogeneous, which is why the CPI should be controversial and is possibly politicized. (substitutions for steak with hamburger, etc.)

  89. Gravatar of TallDave TallDave
    1. September 2015 at 10:41

    It’s always a sad day when I’m forced to agree with Krugman.

  90. Gravatar of Philippe Philippe
    1. September 2015 at 10:44

    what do you mean by artificial?

  91. Gravatar of Philippe Philippe
    1. September 2015 at 10:45

    ^ Nick

  92. Gravatar of cthorm cthorm
    1. September 2015 at 11:11

    “We don’t hire plumbers to teach quantum mechanics at MIT.”

    Technically correct, but a poorly chosen example. Leonard Susskind, a contemporary of Richard Feynman, is a professor at Stanford teaching quantum mechanics and physics. Susskind is also a plumber.

    http://tedxcaltech.com/content/Leonard-Susskind

  93. Gravatar of E. Harding E. Harding
    1. September 2015 at 11:55

    @ssumner
    “Monetary policy doesn’t work by affecting bank’s willingness to lend, it works by changing the supply and demand for base money.”
    -Sure, I understand that, and a bank’s willingness to lend is part of the demand for base money.
    @Rod
    “The problem is that the interest rate on reserves sets a cap for the funds rate. That’s why I assume that an eventual rise in rates must be accompanied by a comparable rise in the rate being paid on reserves.”
    -Sure, that’s true, but isn’t that directly contrary to your point that the Fed has made itself irrelevant?

  94. Gravatar of Nick Nick
    1. September 2015 at 12:22

    @ Philipe

    That was explained already in my earlier post, to which it would seem that Mr. Sumner agrees.(I could be wrong)

  95. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 12:37

    @ E. Harding: “-Sure, that’s true, but isn’t that directly contrary to your point that the Fed has made itself irrelevant?”

    I mean irrelevant in the larger sense of effecting the usual goals of monetary policy which are 1) managing the supply of money to maintain stable prices, and 2) avoiding monetary actions that result in depressing the economy.

    Today, as the 20% annual growth in demand deposits over the past 5 years shows, the Fed no longer controls the supply of money circulating in the economy. M1, for example, will go wherever the economy leads it, without regard to the Fed.

    Furthermore, a paltry 1/4% increase in rates will neither create a recession, nor does the Fed have the room to avoid one should it occur.

    They no longer have the traditional tools available to either control the growth of demand deposits and M1, nor to counteract a recession. In that sense, they’ve made themselves irrelevant, and it’s by their own doing.

    As I said earlier, their mistakes were allowing the fed funds rate to get too close to zero and paying interest on reserves, especially excess reserves.

    Of course the Fed can mess with interest rates, but the effect is no longer what they intend, i.e., to affect money and/or economic activity. They can even mess with the economy and particularly the asset markets by doing another QE. Who knows? They might even get creative and give us negative interest rates on savings before they’re done experimenting with the largest economy in the world. Congress really needs to rein them in, and soon.

    Anyone who claims that the Fed is in command of the level of money actually circulating in the economy anymore is simply wrong, yet in a fractional reserve system, that is their primary responsibility. They’ve foolishly worked themselves into a position where they can no longer execute that responsibility.

  96. Gravatar of Philippe Philippe
    1. September 2015 at 15:35

    Nick

    Krugman’s point is: (1) whatever the Fed does is a monetary policy choice which is going to have an effect on interest rates. (2) the ‘natural’ interest rate is an equilibrium interest rate at which the economy is operating at potential and inflation is stable. Interest rates are ‘artificially low’ if they are below this ‘natural’ equilibrium rate.

    Krugman: “And how would you know if the Fed is setting rates too low? Here’s where Hicks meets Wicksell: rates are too low if the economy is overheating and inflation is accelerating.”

    Note that if interest rates are set by supply and demand they can still be above or below this equilibrium ‘natural’ rate, as supply and demand are not always in equilibrium. Krugman’s argument is that the ‘natural’ equilibrium interest rate is currently negative.

  97. Gravatar of Nick Nick
    1. September 2015 at 16:53

    @ Philippe

    “the ‘natural’ interest rate is an equilibrium interest rate at which the economy is operating at potential and inflation is stable. Interest rates are ‘artificially low’ if they are below this ‘natural’ equilibrium rate.”

    And because Krugman says it’s “so” then it is?

    No, I disagree. The natural interest rate would be one determined in a market free from manipulation. I think that is a fairly straightforward concept and for most(Krugman aside)that would not be controversial.

    “And how would you know if the Fed is setting rates too low? Here’s where Hicks meets Wicksell: rates are too low if the economy is overheating and inflation is accelerating.”

    This is opinion, nothing more. Not only is the notion of “inflation” a whole subject to be debated on its own, what metric would Krugman use to determine if an economy is “overheating”?

    The Austrian theory that bubbles form as a result of low interest rates seems to make most sense,and would seem be be at least implicitly acknowledged by many economists(see Volcker)without Austrian study even if the concept is not fully understood on an academic level.

    That’s how you know interest rates are “too low”, when you see dramatic & sudden price level changes. By the time it’s seen though, it’s usually too late.

  98. Gravatar of dtoh dtoh
    1. September 2015 at 18:09

    @mark
    Thought I was quoting your reply to Rod

    “Monetary policy doesn’t work by affecting bank’s willingness to lend, it works by changing the supply and demand for base money.”

    BTW – I mostly agree with Scott too, except I think monetary economics is trivial.

  99. Gravatar of dtoh dtoh
    1. September 2015 at 18:14

    @Rod
    Yes on MB and ER.

    Changes in MB-ER are important because they correlates with changes in marginal spending on goods and services by the non-banking sector (or changes in AD if you prefer that description) and they also signal Fed intentions which impacts expectations.

  100. Gravatar of Philippe Philippe
    1. September 2015 at 18:41

    “because Krugman says it’s “so” then it is?”

    No this is standard economics, it’s also a part of ‘austrian’ economics. The austrian business cycle theory is based on this concept. The natural rate of interest is also known as the Wicksellian rate of interest, after Knut Wicksell.

    In the ABCT, if the money rate of interest is lowered below the natural equilibrium rate of interest, there is an investment boom, the economy operates above potential and inflation rises. The natural equilibrium rate is the rate at which the economy operates at potential and prices are stable (or in other words inflation is stable).

    “The natural interest rate would be one determined in a market free from manipulation.”

    That’s meaningless as markets can be out of equilibrium. The ABCT actually involves market rates diverging from natural equilibrium rates as a result of over-expansion of lending by private banks.

    The austrian business cycle theory is also not about stock market bubbles.

  101. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 19:04

    @dtoh: “Changes in MB-ER are important because they correlates with changes in marginal spending on goods and services by the non-banking sector (or changes in AD if you prefer that description) and they also signal Fed intentions which impacts expectations.”

    I’m assuming AD is Aggregate Demand…it would be a lot easier if you’d just say so, however.

    So, MB-ER is just the Monetary Base (MB) as it used to be before the QE’s expanded Excess Reserves (ER) to ridiculous heights, right? Well, less the paltry few hundred million dollars that Excess Reserves used to run before the QE’s, I guess.

    I agree that the old base used to reflect changes in overall economic activity, to an extent anyway. I have some reservations about combining a measure of past inflation (currency in circulation) with a measure of future inflation (Effective Reserves) and making sense of the result, but that’s for another time.

    However, please tell me how changes in the MB-ER “also signal Fed intentions which impacts expectations.” I don’t think the Fed has a clue where that measure is going from month to month and they certainly don’t have any way of influencing it any longer. You claim that the Fed controls both MB and ER. If that’s true, then the Fed, by definition, also controls MB-ER. (If you control both elements of an equation, you must control the result, after all.) Since they really don’t control MB-ER, then they must not control one or the other of MB or ER, so which is it?

    Answer: ER. The demands of the banking system control the level of excess reserves in the system, not the Fed. The Fed provides total reserves, not excess reserves. If, for the sake of argument, the banking system expands dramatically over a few weeks, say by 5%, then required reserves will expand by 5% and those will be subtracted from Excess Reserves. The Fed will be able to restore the excess if they choose to do so, but then MB-ER will have expanded, but it will have been a non-Fed activity (economic expansion) that will have cause that measure to expand. Of course, if the Fed does nothing, ER will have shrunk, but again due to the economic expansion, not because of anything the Fed did.

  102. Gravatar of Rod Everson Rod Everson
    1. September 2015 at 19:29

    Philippe writes: “Krugman’s point is…..(2) the ‘natural’ interest rate is an equilibrium interest rate at which the economy is operating at potential and inflation is stable.”

    What a silly concept. Let’s assume the Fed’s job is to maintain a stable price level, as it should be. The economy will still have periods of expansion and recession and the equilibrium interest rate will change depending upon whether we are in a recession or an expansion, but if the Fed is doing its job, prices should fluctuate around a stable value. There will be no “natural” rate. Instead, interest rates will fluctuate to reflect increasing or decreasing demands for loans depending upon circumstances.

    Krugman seems to think there’s some magic (natural) rate that will prevent recessions and expansions. The whole idea is ludicrous. External events will always come along to generate recessions and expansions entirely outside the control of the Federal Reserve. And if the Fed attempts to counter them, it must first abandon its main responsibility, i.e., to maintain stable prices. It can’t be in State 1 (stable prices) and abandon it to address a recession, yet somehow remain in State 1. Either the recession is allowed to work its way through, or the Fed must abandon its pricing goal and attack the recession (or expansion.–And what is an unwanted expansion, by the way, assuming stable prices are achieved?)

  103. Gravatar of Philippe Philippe
    1. September 2015 at 19:59

    Janet Yellen:

    “The equilibrium real rate is typically viewed as the level of the short-term interest rate, less inflation, estimated to be consistent with maximum employment and stable inflation in the long run, assuming no future disturbances to the economy.”

    http://blogs.ft.com/gavyndavies/2015/04/02/yellen-shoots-for-equilibrium-interest-rates/

  104. Gravatar of E. Harding E. Harding
    1. September 2015 at 21:13

    @Mark
    Iran being a major driver of oil prices? Don’t see it.
    http://www.eia.gov/todayinenergy/detail.cfm?id=21792
    “I don’t subscribe to OBCT (oil business cycle theory). The dollar went up mostly because QE ended.”
    -Well, monetary base changes certainly explain why the dollar went up against the Euro. But I still suspect oil played a large role in the dollar rise. If there was no QE in Europe, the Euro would have risen, as well. I think oil plays a small (though real) role in business cycles, but a major role in currency exchange rates.
    @Rod
    “They no longer have the traditional tools available to either control the growth of demand deposits and M1, nor to counteract a recession.”
    -Ah, but they have a non-traditional tool: the size of the monetary base. If the monetary base is used properly and when the Fed is cognizant of market movements, the Fed can still counteract demand-side recessions effectively. I think this was well shown in the 2013 fiscal policy crunch and Japan’s return to inflation in the past few years.
    @Mark
    “What happened on those days? I did a google search of the news and turned up nothing obvious.”
    -Well, June 19, 2013 had clearer causes than “nothing obvious”.

  105. Gravatar of dtoh dtoh
    1. September 2015 at 21:42

    Rod,
    The Fed controls both MB and ER and therefore MB-ER as well.

  106. Gravatar of Nick Nick
    2. September 2015 at 06:34

    @ Philippe

    “No this is standard economics, it’s also a part of ‘austrian’ economics. ”

    Really? Ok, so show me just ONE ABCT scholar that references Wicksellian Differentials as a foundation for ABCT? Just one!

    In fact, Hayek DISMISSED the notion of “equilibrium interest rate” as Rod Everson above alluded to as “silly” when he wrote “Prices & Production”.(and Rod is right!)

    So I eagerly await this reference/claim you make that ABCT treats equilibrium interest rate in the manner you suggest.

  107. Gravatar of ssumner ssumner
    2. September 2015 at 07:24

    dtoh, You said:

    “And what increases the demand for base money?”

    It depends mostly on two factors, real GDP and nominal interest rates. My recent 4 part series on the QTM explains it all.

    Rod, You have everything exactly backwards. I think you are trying to say that the Fed does impact the demand for base money. If it doesn’t, then monetary policy would be very powerful at the zero bound.

    Philippe, That’s what I wondered too. What is an “artificial” interest rate. One made out of plastic, not natural wood?

    Nick, You said:

    “No, I disagree. The natural interest rate would be one determined in a market free from manipulation. I think that is a fairly straightforward concept and for most(Krugman aside)that would not be controversial.”

    I don’t know where you studied economics, but that’s a bizarre view. Krugman’s view is the standard view on the subject.

    And by the way, Austrian economics (along with Post Keynesian, MMT and Marxism, and yes, market monetarism) are fringe ideologies, not part of the mainstream. So Krugman is in the mainstream and you are not.

    Cthorm, Thanks I enjoyed that.

  108. Gravatar of Rod Everson Rod Everson
    2. September 2015 at 07:50

    @dtoh

    You wrote: “Rod, The Fed controls both MB and ER and therefore MB-ER as well.”

    No. The Fed cannot control the level of required reserves in the system any longer because they’ve allowed Excess Reserves (ER) to balloon. This should be clear.

    Say, for example, the Fed decides to set ER at exactly $2.500 trillion. They then lose control of the size of the Monetary Base (MB), for if the banking system then expands, then the level of required reserves will expand accordingly. That expansion will necessarily expand the total Monetary base because it will take up a portion of the ER balance which the Fed, under an operating rule of maintaining ER at exactly $2.500 trillion will be forced to add back to the system.

    Conversely if the Fed decides to maintain the Monetary Base at a set figure, say $3.500 trillion, then an expansion of required reserves in the banking system due to economic growth will necessarily reduce the Excess Reserve position. The Fed will do nothing since the Monetary Base was unaffected.

    I’m not sure what isn’t clear about this. It seems pretty straightforward to me. In either case, the Fed has to choose between maintaining MB or ER; it can’t do both simultaneously. And if that’s the case, they certainly have no control over the base less the excess (MB-ER).

  109. Gravatar of Rod Everson Rod Everson
    2. September 2015 at 07:55

    @ssumner

    You wrote: “Rod, You have everything exactly backwards. I think you are trying to say that the Fed does impact the demand for base money. If it doesn’t, then monetary policy would be very powerful at the zero bound.”

    First, I have things “backwards” without quoting what you’re referring to.

    Second, you tell me what you “think” I’m “trying to say” without again referring to what I actually said that makes you think that,

    Finally, you conclude from what you think I’m saying (that I probably am not, but can’t refute you since I don’t know what you’re referring to) that something ridiculous would result which makes at least one of us look like we don’t know what we’re talking about.

    See any problem with this process, Scott?

    Please quote me, then criticize it. Otherwise, it’s impossible to figure out a sensible reply.

  110. Gravatar of Rod Everson Rod Everson
    2. September 2015 at 08:06

    @E. Harding

    You wrote, in reference to the Fed lacking it’s traditional tools of monetary policy: “-Ah, but they have a non-traditional tool: the size of the monetary base. If the monetary base is used properly and when the Fed is cognizant of market movements, the Fed can still counteract demand-side recessions effectively. I think this was well shown in the 2013 fiscal policy crunch and Japan’s return to inflation in the past few years.”

    Just so I understand you, are you implying that the Fed has reduced its role in combatting recessions to implementing massive QE’s to expand Excess Reserves by an amount sufficient to counteract any future recession?

    That is, the $17 trillion of GDP threatens to come in at $16 trillion instead of growing to, say, $17.5 trillion, so the Fed should goose Excess Reserves by that missing $1.5 trillion via another QE?

    Or are you implying something else? But if the above is what you mean, Congress had better get to work, because the Fed would be out of control and would have completely abandoned its mandate to maintain a stable price level. (Actually, they’ve already done that with QE1-3.)

    As for the Japan “evidence,” the U.S. Fed claims to want a measly 2% inflation, yet has expanded excess reserves by $2.5 trillion and yet can’t even achieve that. Just how much will it take? Or is that the wrong question? Maybe “Does it even work?” is the one that should be asked first.

  111. Gravatar of Rod Everson Rod Everson
    2. September 2015 at 08:14

    @Nick

    In fact, Hayek DISMISSED the notion of “equilibrium interest rate” as Rod Everson above alluded to as “silly” when he (Hayek) wrote “Prices & Production”.(and Rod is right!)

    Thank you. “Silly” is probably not highfalutin enough for this forum, but it captured how I see it. I take some comfort in learning that Mr. Hayak apparently felt the same.

  112. Gravatar of Rod Everson Rod Everson
    2. September 2015 at 08:36

    From the article, Krugman stated: The Fed sets interest rates, whether it wants to or not “” even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice.

    Does this supposed rejoinder to Cohan make sense?

    Say the Fed sets the Monetary Base at a certain level, Krugman’s “monetary policy choice.” How on earth does this set interest rates in a dynamic economy? They would fluctuate continuously as the demand for loans fluctuated. And since reserves would remain constant, the fluctuating interest rate would directly impact the demand for loans.

    Absent a productivity factor in the banking system, a series of expansions will necessarily generate lower prices over time as both the currency and the reserve components of the monetary base are stretched thinner and thinner. With a constant base, prices would have to fall as real economic activity rose.

    But interest rates? They’d be all over the place depending upon whether a contraction, stability, or expansion were underway at the time. Higher interest rates would generate downward pressure on prices, and lower rates would generate upward pressure on prices (think housing, and expand that thinking to all other asset classes, including consumables.)

    Now, I’m not saying that such a policy would be best, but it certainly wouldn’t, as Krugman asserts, amount to the Fed setting interest rates. Quite the opposite. They’d go to the level dictated by the supply and demand for loans of all maturities at any particular point in time.

  113. Gravatar of dtoh dtoh
    2. September 2015 at 08:57

    Rod,
    The Fed absolutely controls both the base and excess reserves (and required reserves and total reserves.) They control the base through OMO – they can buy or sell any amount of assets. They control required reserves by setting the reserve requirement and they control ER by setting the rate on IOR. The Fed can cause any allocation of total reserves between required reserves and excess reserves simply by adjusting the reserve requirement and/or the rate on IOR.

  114. Gravatar of dtoh dtoh
    2. September 2015 at 09:03

    @scott

    “It depends mostly on two factors, real GDP and nominal interest rates.”

    And what causes changes in real GDP (other than trend growth)?

  115. Gravatar of Philippe Philippe
    2. September 2015 at 10:36

    Nick,

    “show me just ONE ABCT scholar that references Wicksellian Differentials as a foundation for ABCT?”

    How about Ludwig von Mises (‘The Causes of the Economic Crisis’, p.107-113):

    “3. INEVITABLE EFFECTS OF CREDIT EXPANSION ON INTEREST RATES

    In conformity with Wicksell’s terminology, we shall use “natural interest rate” to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money.

    “Money rate of interest” will be used for that interest rate asked on loans made in money or money substitutes. Through continued expansion of fiduciary media, it is possible for the banks to force the money rate down to the actual cost of the banking operations, practically speaking that is almost to zero. As a result, several authors have concluded that interest could be completely abolished in this way. Whole schools of reformers have wanted to use banking policy to make credit gratuitous and thus to solve the “social question.” No reasoning person today, however, believes that interest can ever be abolished, nor doubts but what, if the “money interest rate” is depressed by the expansion of fiduciary media, it must sooner or later revert once again to the “natural interest rate.” The question is only how this inevitable adjustment takes place. The answer to this will explain at the same time the fluctuations of the business cycle.

    […]

    5. MALINVESTMENT OF AVAILABLE CAPITAL GOODS

    The “natural interest rate” is established at that height which tends toward equilibrium on the market. The tendency is toward a condition where no capital goods are idle, no opportunities for starting profitable enterprises remain unexploited and the only projects not undertaken are those which no longer yield a profit at the prevailing “natural interest rate.” Assume, however, that the equilibrium, toward which the market is moving, is disturbed by the interference of the banks. Money may be obtained below the “natural interest rate.” As a result businesses may be started which weren’t profitable before, and which become profitable only through the lower than “natural interest rate” which appears with the expansion of circulation credit.

    Here again, we see the difference which exists between a drop in purchasing power, caused by the expansion of circulation credit, and a loss of purchasing power, brought about by an increase in the quantity of money. In the latter case [i.e., with an increase in the quantity of money in the narrower sense] the prices first affected are either (1) those of consumers’ goods only or (2) the prices of both consumers’ and producers’ goods. Which it will be depends on whether those first receiving the new quantities of money use this new wealth for consumption or production. However, if the decrease in purchasing power is caused by an increase in bank created fiduciary media, then it is the prices of producers’ goods which are first affected. The prices of consumers’ goods follow only to the extent that wages and profits rise.

    Since it always requires some time for the market to reach full “equilibrium,” the “static” or “natural” [footnote: In the language of Knut Wicksell and the classical economists] prices, wage rates and interest rates never actually appear. The process leading to their establishment is never completed before changes occur which once again indicate a new “equilibrium.” At times, even on the unhampered market, there are some unemployed workers, unsold consumers’ goods and quantities of unused factors of production, which would not exist under “static equilibrium.” With the revival of business and productive activity, these reserves are in demand right away. However, once they are gone, the increase in the supply of fiduciary media necessarily leads to disturbances of a special kind.

    In a given economic situation, the opportunities for production, which may actually be carried out, are limited by the supply of capital goods available. Roundabout methods of production can be adopted only so far as the means for subsistence exist to maintain the workers during the entire period of the expanded process. All those projects, for the completion of which means are not available, must be left uncompleted, even though they may appear technically feasible””that is, if one disregards the supply of capital. However, such businesses, because of the lower loan rate offered by the banks, appear for the moment to be profitable and are, therefore, initiated. However, the existing resources are insufficient. Sooner or later this must become evident. Then it will become apparent that production has gone astray, that plans were drawn up in excess of the economic means available, that speculation, i.e., activity aimed at the provision of future goods, was misdirected.

    6. “FORCED SAVINGS”

    In recent years, considerable significance has been attributed to the fact that “forced savings,” which may appear as a result of the drop in purchasing power that follows an increase of fiduciary media, leads to an increase in the supply of capital. The subsistence fund is made to go farther, due to the fact that (1) the workers consume less because wage rates tend to lag behind the rise in the prices of commodities, and (2) those who reap the advantage of this reduction in the workers’ incomes save at least a part of their gain. Whether “forced savings” actually appear depends, as noted above, on the circumstances in each case. There is no need to go into this any further.

    Nevertheless, establishing the existence of “forced savings” does not mean that bank expansion of circulation credit does not lead to the initiation of more roundabout production than available capabilities would warrant. To prove that, one must be able to show that the banks are only in a position to depress the “money interest rate” and expand the issue of fiduciary media to the extent that the “natural interest rate” declines as a result of “forced savings.” This assumption is simply absurd and there is no point in arguing it further. It is almost inconceivable that anyone should want to maintain it.

    What concerns us is the problem brought about by the banks, in reducing the “money rate of interest” below the “natural rate.” For our problem, it is immaterial how much the “natural interest rate” may also decline under certain circumstances and within narrow limits, as a result of this action by the banks. No one doubts that “forced savings” can reduce the “natural interest rate” only fractionally, as compared with the reduction in the “money interest rate” which produces the “forced savings.”

    The resources which are claimed for the newly initiated longer time consuming methods of production are unavailable for those processes where they would otherwise have been put to use. The reduction in the loan rate benefits all producers, so that all producers are now in a position to pay higher wage rates and higher prices for the material factors of production. Their competition drives up wage rates and the prices of the other factors of production. Still, except for the possibilities already discussed, this does not increase the size of the labor force or the supply of available goods of the higher order. The means of subsistence are not sufficient to provide for the workers during the extended period of production. It becomes apparent that the proposal for the new, longer, roundabout production was not adjusted with a view to the actual capital situation. For one thing, the enterprises realize that the resources available to them are not sufficient to continue their operations. They find that “money” is scarce.

    That is precisely what has happened. The general increase in prices means that all businesses need more funds than had been anticipated at their “launching.” More resources are required to complete them. However, the increased quantity of fiduciary media loaned out by the banks is already exhausted. The banks can no longer make additional loans at the same interest rates. As a result, they must raise the loan rate once more for two reasons. In the first place, the appearance of the positive price premium forces them to pay higher interest for outside funds which they borrow. Then also, they must discriminate among the many applicants for credit. Not all enterprises can afford this increased interest rate. Those which cannot run into difficulties.”

    https://mises.org/sites/default/files/The%20Causes%20of%20the%20Economic%20Crisis,%20and%20Other%20Essays%20Before%20and%20After%20the%20Great%20Depression_2.pdf

  116. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    2. September 2015 at 10:40

    @Philippe and others
    Earlier formulations of ABCT did enphasize malinvestments caused by “too low” rates of interest. But notice that this formulation focus on interest rates just like the keynesians and new-keynesians focus on rates (not a very good thermometer). But I believe that this idea is not a cornerstone principle of ABCT. ABCT goes along very well with the “hot potatoes” effect defended here by Prof. Sumner (and perceived higher demand for consumer goods leading to malinvestments in the upstream capital goods and commodities sectors), and the correct “measure” of an overheating economy is not inflation (since positive supply shocks can blur the picture) but a positive change on the growth rate of NGDP.

  117. Gravatar of Rod Everson Rod Everson
    2. September 2015 at 10:55

    @dtoh

    You wrote, in part: “…and they control ER by setting the rate on IOR.”

    Okay, I’ll bite. Please explain how the Fed, should it desire to do so, would reduce the level of Excess Reserves to exactly $2.0 trillion by fiddling with the Interest Rate on Reserves? (the IROR, in dtoh-speak, I suppose.)

    You imply that there’s a precise way to do that in your reply. I’m skeptical.

  118. Gravatar of Nick Nick
    2. September 2015 at 12:03

    @ Philippe

    You have completely missed why Mises put “natural interest rate” in quotes on each reference, BUT, MORE IMPORTANTLY, you have NOT shown one Austrian economist using “Wicksellian Differentials” as I asked in establishing a supposed cornerstone of ABCT as you claim:

    “In the hands of the Austrian economists, the natural rate became the rate that reflects the time preferences of market participants and allocates resources among the temporally defined stages of production. The output of one stage serves as input to the next in this logical and broadly descriptive representation of the economy’s production process. The temporal dimension of the economy’s capital structure is a key macroeconomic variable in Austrian theory.”

    https://mises.org/library/natural-and-neutral-rates-interest-theory-and-policy-formulation

    and it is this “temporal dimension” that Hayek clarified & wrote about in Prices & Production in response to Wicksellian Differentials, by pointing out that equillibrium is dynamic(hence impossible to “target”, a Keynesian folly per se)

    Even further, the summary in “natural interest rates” is the following passage by Garrison:

    “In summary terms, the natural rate is seen as an equilibrating rate. It is the rate that tells the truth about the availability of resources for meeting present and future consumer demands, allowing production plans to be kept in line with the preferred pattern of consumption. By implication, an unnatural, or artificial, rate of interest is a rate that reflects some extra-market influence and that creates a disconnection between intertemporal consumption preferences and intertemporal production plans.”

    You’ve mistaken Mises’s discussions as a cornerstone of theory when it has NOTHING to do with Wiksellian Differentials(which technically is “Natural Rate of Interest” less Money Rate of Interest; you tried to equivocate).

    More importantly however, you’ve helped to highlight Krugman using and outdated and long discredited notion(Wiksellian Differentials) in an attempt to conflate them with “natural interest rates” which Hayek(and many, many others) pointed out were impossible to “know”(that is a specific target, aka Keynesian folly) and were “dynamic”.

    The “natural interest rate” is a joke. It’s a guess. Does it “exist”? Yes, in a sterile numbers environment that doesn’t reflect reality.(a pad of paper with static #’s) That’s why so many economists piled onto Hayek’s bandwagon over it in the 30’s and Wiksell’s theory was shown as flawed….which makes Krugman’s reference to Wiksellian Differentials laughable.

    While the idea that the “natural interest rate” exists(as a term) is not in debate, Mises put it in quotes because Austrians consider it unknowable and its there for academic purposes. But again, Wicksellian Differential are not “natural interest rates”, which are just a theoretical component of such.

    Wicksellian Differentials were discredited by Hayek a long time ago(and others) and Krugman digging up its corpse doesn’t help his cause.

    Maybe you misunderstood my request to “”show me just ONE ABCT scholar that references Wicksellian Differentials as a foundation for ABCT?”

    I’m open to any links you can provide to my earlier request.

  119. Gravatar of Nick Nick
    2. September 2015 at 12:47

    @ Sumner

    “Philippe, That’s what I wondered too. What is an “artificial” interest rate. One made out of plastic, not natural wood?

    “No, I disagree. The natural interest rate would be one determined in a market free from manipulation. I think that is a fairly straightforward concept and for most(Krugman aside)that would not be controversial.”

    “I don’t know where you studied economics, but that’s a bizarre view. Krugman’s view is the standard view on the subject.”

    So I suppose when you “wondered”, you really didn’t?

    Here’s a nice discussion on “artificial interest rates”:

    “By implication, an unnatural, or artificial, rate of interest is a rate that reflects some extra-market influence and that creates a disconnection between intertemporal consumption preferences and intertemporal production plans.”

    http://mises.org/library/natural-and-neutral-rates-interest-theory-and-policy-formulation

    As for “bizarre”, I find it bizarre that a straight forward explanation of what a “natural interest rate” would compose would be labeled as “bizarre” without at least further discussion on the topic- to each their own I guess.

    The idea that you would define a “natural interest rate” to include manipulated components of supply & demand seems inaccurate in the least, but possibly disingenuous regardless of labeling a person or definition “fringe” in its discussion.

    Does “fringe” now include definitions that makes sense in plain English?

    At least I provided a link to said use and discussion, one that’s pretty well ordered/thought out too.

    Certainly more so than “Krugman’s view is the standard view.”

  120. Gravatar of Philippe Philippe
    2. September 2015 at 13:09

    Nick,

    “In fact, Hayek DISMISSED the notion of “equilibrium interest rate” as Rod Everson above alluded to as “silly” when he wrote “Prices & Production”.”

    Robert P. Murphy, (‘Multiple Interest Rates and Austrian Business Cycle Theory’):

    In its canonical form (e.g. Mises 1998 and Rothbard 2004), Austrian business cycle theory (ABCT) has focused on the distortions in the structure of production introduced by lowering “the” market rate of interest below “the” natural rate. To be sure, Mises and his followers are aware that in the real world, there are a multiplicity of interest rates, depending on the length of the loan and the perceived risk of default. Even so, it remains that the standard exposition of ABCT (e.g. Garrison 2001) still relies on the contrast between “the” market rate vs. “the” natural rate of interest. […]

    “Friedrich Hayek’s Prices and Production (1931) was an elaboration and extension of the Misesian theory of the trade cycle, of which Piero Sraffa published a scathing review (1932a) in the Economic Journal. Hayek responded (1932), and then Sraffa offered a final rejoinder (1932b). The Sraffa-Hayek debate involved several points of fundamental disagreement, but for our purposes we need to concentrate only on one: the possibility of multiple “natural rates” of interest on different commodities.

    Following Mises, Hayek had argued in Prices and Production that the unsustainable boom period is caused when the banks charge a money rate of interest lower than the “natural rate” of interest. Against this explanation, Sraffa made the simple observation that there is no such thing as “the” natural rate of interest in any economy outside of (what we would now call) a steady-state equilibrium. Consequently, Hayek’s proposal that banks set the money rate of interest equal to “the” natural rate of interest was apparently nonsensical.

    To set the context, we should first review two quotations from Sraffa’s initial review:

    ‘Dr. Hayek’s theory of the relation of money to the rate of interest is mainly given by way of criticism and development of the theory of Wicksell. He [Hayek] states his own position as far as it agrees with Wicksell’s as follows:”””In a money economy, the actual or money rate of interest may differ from the equilibrium or natural rate, because the demand for and the supply of capital do not meet in their natural form but in the form of money, the quantity of which available for capital purposes may be arbitrarily changed by the banks.”

    […]

    “when Hayek laments that the banks cause a divergence of the money from the equilibrium rate of interest, he is referring to the fact that the false interest rate disrupts the intertemporal coordination between producers and consumers.”

    http://consultingbyrpm.com/uploads/Multiple%20Interest%20Rates%20and%20ABCT.pdf

  121. Gravatar of Nick Nick
    2. September 2015 at 13:41

    @ Philippe

    I’m in a bit of a time crunch, so I wanted to do a quick post and I’ll check back tomorrow.

    First, I’ve noticed you’ve not answered my challenge to cite an Austrian scholar using Wicksell’s as foundational to ABCT.

    It is important for us to discuss why I brought this up in the context of your quote of mine:

    “In fact, Hayek DISMISSED the notion of “equilibrium interest rate” as Rod Everson above alluded to as “silly” when he wrote “Prices & Production”

    and THAT SPECIFIC context was under the notion that you could use STATIC VARIABLES(Wicksell’s flaw) in determining “equilibrium interest rate”.

    That was Hayek’s point of attack, and my purpose in asking you to find an Austrian scholar using Wicksell Differentials.
    (I know you can’t.)

    It highlights the Austrians main argument, that you can’t “target” something that is unknowable. “Data driven” as one organization puts it, which means your always chasing, management by fire per se…that’s not a “theory”.

    Bob Murphy(who I love!), is not claiming any ability to deduce “natural interest rates” in your link.

    Even further, right at the end his reference “false interest rate”…maybe some find that more palatable than “artificial”.

  122. Gravatar of Philippe Philippe
    2. September 2015 at 14:03

    Nick,

    you have NOT shown one Austrian economist using “Wicksellian Differentials” as I asked

    Wicksellian Differential = Natural Rate of Interest – Money Rate of Interest

    Ludwig von Mieses, as I quoted him above:

    “In conformity with Wicksell’s terminology, we shall use “natural interest rate” to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money.

    “Money rate of interest” will be used for that interest rate asked on loans made in money or money substitutes. […]

    “if the “money interest rate” is depressed by the expansion of fiduciary media, it must sooner or later revert once again to the “natural interest rate.” The question is only how this inevitable adjustment takes place. The answer to this will explain at the same time the fluctuations of the business cycle. […]

    “the equilibrium, toward which the market is moving, is disturbed by the interference of the banks. Money may be obtained below the “natural interest rate.” […]

    “What concerns us is the problem brought about by the banks, in reducing the “money rate of interest” below the “natural rate.””

    Natural rate of interest – Money Rate of Interest = Wicksellian Differential

  123. Gravatar of Philippe Philippe
    2. September 2015 at 14:49

    Ludwig von Mises, ‘The Theory of Money and Credit’, p.355-365:

    “Wicksell distinguishes between the Natural Rate of Interest (naturliche Kapitalzins), or the rate of interest that would be determined by supply and demand if actual capital goods were lent without the mediation of money, and the Money Rate of Interest (Geldzins), or the rate of interest that is demanded and paid for loans in money or money-substitutes. The money rate of interest and the natural rate of interest need not necessarily coincide, since it is possible for the banks to extend the amount of their issues of fiduciary media as they wish and thus to exert a pressure on the money rate of interest that might bring it down to the minimum set by their costs. Nevertheless, it is certain that the money rate of interest must sooner or later come to the level of the natural rate of interest, and the problem is to say in what way this ultimate coincidence is brought about. […]

    “If it is possible for the credit-issuing banks to reduce the rate of interest on loans below the rate determined at the time by the whole economic situation (Wicksell’s natiirlicher Kapitalzins or natural rate of interest), then the question arises of the particular consequences of a situation of this kind. Does the matter rest there, or is some force automatically set in motion which eliminates this divergence between the two rates of interest? It is a striking thing that this problem, which even at a first glance cannot fail to appear extremely interesting, and which moreover under more detailed examination proves to be one of the greatest importance for comprehension of many of the processes of modern economic life, has until now hardly been dealt with seriously at all.

    We shall not say anything further here of the effects of an increased issue of fiduciary media on the determination of the objective exchange-value of money; they have already been dealt with exhaustively. Our task now is merely to discover the general economic consequences of any conceivable divergence between the natural and money rates of interest, given uniform procedure on the part of the credit-issuing banks. We obviously need only consider the case in which the banks reduce the rate of interest below the natural rate. The opposite case, in which the rate of interest charged by the banks is raised above the natural rate, need not be considered; if the banks acted in this way, they would simply withdraw from the competition of the loan market, without occasioning any other noteworthy consequences. […]

    “The increased productive activity that sets in when the banks start the policy of granting loans at less than the natural rate of interest at first causes the prices of production goods to rise while the prices of consumption goods, although they rise also, do so only in a moderate degree, viz., only in so far as they are raised by the rise in wages. Thus the tendency towards a fall in the rate of interest on loans that originates in the policy of the banks is at first strengthened. But soon a counter-movement sets in: the prices of consumption goods rise, those of production goods fall. That is, the rate of interest on loans rises again, it again approaches the natural rate.”

  124. Gravatar of Major.Freedom Major.Freedom
    2. September 2015 at 15:37

    If central banks cause unsustainable real capital booms through lowering interest rates below market rates, which they do, and we were to model that using the Wicksellian singular concepts for both prevailing and market interest rates, instead of plural rates, we would not be saying anything contrary to the fact that central banks cause unsustainable real capital booms.

    Sure, it is a lazy way to go about it. Sure, it would not be an exact description of the real world. Sure, the theory has opportunities for improvement.

    But what is definitely not implied is to completely throw away the theory, since even the orthodox form of the theory is the best theory we have for how central banks cause unsustainable booms. Helping to make the best theory even better is what I will thank Sraffa for doing. And that’s really all he did do.

  125. Gravatar of Nick Nick
    2. September 2015 at 16:09

    @ Philippe

    “Natural rate of interest – Money Rate of Interest = Wicksellian Differential”

    Ok, fair enough. I think see your point now. I was thinking in concrete terms and was unable to assimilate that you are referring to the use of the Wicksellian Differential in concept, not in practice. (because “natural interest” is impossible “to know” as Hayek points out-in my opinion that is)

    Is that your argument?

    If so, do you argue then that “natural interest” can be known and/or successfully applied using Wicksellian Differentials to monetary policy?(or anything else)

  126. Gravatar of ssumner ssumner
    2. September 2015 at 16:44

    Rod, You said:

    “Exactly. Monetary policy changes the supply of the base, but when there’s a significant amount of excess reserves in the system, as today, the demand is influenced by other economic factors that affect the banking system’s demand for required reserves .

    Demand for base money is only impacted by monetary policy when it’s restrictive, i.e., when the level of excess reserves is at a frictional level. At a time like that (all of pre-2008), if the Fed reduced the reserves in the system to a level below that required by the banking system the entire economic system would contract in response, generating a recession and thereby ultimately lowering demand for required reserves.

    Today, with the massive level of excess reserves, demand for base money by the banking system consists of demand for required reserves and that demand will be whatever the economy dictates. The Fed has little to do with it. The 20% annual increase in demand deposits over the past five years set the demand for base money. The Fed set the supply with their QE’s. Clearly, supply has far outstripped demand.”

    That’s what I’m talking about.

    You said:

    “the U.S. Fed claims to want a measly 2% inflation, yet has expanded excess reserves by $2.5 trillion and yet can’t even achieve that.”

    The Fed thinks they’ve achieved their inflation goal, which is why they plan to raise rates. What you think doesn’t matter to the Fed, or to the markets. I actually agree with you that the Fed has fallen short, but unlike you I believe they’ve done it because they didn’t want a more expansionary policy. If I were wrong then the Fed would obviously not be planning on raising rates.

    Nick, Mises.org is now considered mainstream economics?

  127. Gravatar of dtoh dtoh
    2. September 2015 at 17:30

    @Scott,

    “Demand for base money is only impacted by monetary policy when it’s restrictive, i.e., when the level of excess reserves is at a frictional level.”

    I think you are referring to demand for base money by the banking sector? Isn’t what we are interested in the demand for base money by the NON-banking sector. If demand by the non-banking sector does not change that generally correlates with no change in AD. If we are interested in the impact of monetary policy on AD, then we need to look base money less reserves.

  128. Gravatar of dtoh dtoh
    2. September 2015 at 17:39

    @Rod
    ” Please explain how the Fed, should it desire to do so, would reduce the level of Excess Reserves to exactly $2.0 trillion by fiddling with the Interest Rate on Reserves?”

    Lower the rate until ER reaches $2.0. Am I missing something?

  129. Gravatar of Nick Nick
    2. September 2015 at 17:42

    @ Sumner

    “Nick, Mises.org is now considered mainstream economics?”

    I never claimed it was, I’m whining because the insinuation is(in my mind)is that we should adhere to the “standard view”(definition)of a plainly worded statement, “natural interest rate”, in this case.

    The discussion should center around why the “standard view” of the plainly worded statement should be retained or not- not whether a particular branch of economics is “fringe” or not.

    It’s like discussing “inflation”; when we converse about it should we talk about it as price increases or expanded money base? What is “fringe” is not relevant in regard to what the definition SHOULD mean.

    The word “artificial” connotes & means very specifically:

    “made or produced by human beings rather than occurring naturally, typically as a copy of something natural.”

    It would seem to apply without controversy(and is used by some economists) to a situation in which the interest rate is being derived by manipulated supply/demand, in strict attention to the use of English.

    Naturally(ahem, pun intended), it would make sense to do the same for the phrase “natural interest rates”.

    Why should someone ignore simple phraseology for the sake of being part of mainstream thinking if the words obscure or inhibit correct thinking? Just because it’s “the norm”?

  130. Gravatar of eric eric
    2. September 2015 at 18:00

    Sorry, but large scale QE is the ultimate in interest rate manipulation–across the yield curve. It took the market out
    of interest rate determination.

  131. Gravatar of Philippe Philippe
    3. September 2015 at 05:40

    Nick,

    this paper might interest you. It gives a good account of how Hayek’s views on monetary issues changed over time.

    http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.202.1035&rep=rep1&type=pdf

  132. Gravatar of ssumner ssumner
    3. September 2015 at 07:41

    dtoh, I never said that, you misquoted me.

    Nick, You were the one that said no one agreed with Krugman, it turns out he’s right in the mainstream.

    I don’t follow the rest of your comment at all–have no idea how you are using terms like artificial and manipulation. Aren’t interest rates “made by human beings”?

  133. Gravatar of Rod Everson Rod Everson
    3. September 2015 at 07:55

    @dtoh

    I wrote:
    “ Please explain how the Fed, should it desire to do so, would reduce the level of Excess Reserves to exactly $2.0 trillion by fiddling with the Interest Rate on Reserves?”

    You replied: “Lower the rate until ER reaches $2.0. Am I missing something?”

    Yes, I’d say you’re missing something. By implication then, they could drive Excess Reserves upward to exactly $3.0 trillion by raising the rate? How much will they have to raise the interest rate on reserves? How soon will Excess Reserves hit $3.0? Why will Excess Reserves rise at all, for that matter? They could fall if the economy is expanding despite the rising interest rate on reserves. This is your definition of “complete control over ER?”

    Interesting.

  134. Gravatar of Rod Everson Rod Everson
    3. September 2015 at 08:14

    @ssumner

    Scott, I wrote, in part: “Today, with the massive level of excess reserves, demand for base money by the banking system consists of demand for required reserves and that demand will be whatever the economy dictates. The Fed has little to do with it. The 20% annual increase in demand deposits over the past five years set the demand for base money. The Fed set the supply with their QE’s. Clearly, supply has far outstripped demand.”

    You replied: “I think you are trying to say that the Fed does impact the demand for base money. If it doesn’t, then monetary policy would be very powerful at the zero bound.”

    You see why I asked you to quote me before commenting?

    I try to explain why the Fed no longer has any direct influence over the demand for base money, or demand for required reserves actually, and you reply that I’m trying to say the opposite, then draw a conclusion from your assumption that I really mean exactly the opposite of what I actually said.

    I’m forced to draw the conclusion that you are missing what I’m saying in the original post since you addressed none of the substance.

  135. Gravatar of dtoh dtoh
    3. September 2015 at 08:24

    @Scott,
    You’re right. Sorry about that. Misparsed (is that a word) the quotation marks.

  136. Gravatar of dtoh dtoh
    3. September 2015 at 08:37

    @Rod

    Responses in the order of your questions.

    Yes but the economy would take a hit if they didn’t increase the base. By whatever amount is needed to hit the target. Depends on how high they raise the rate. If the economy is expanding raise the rate higher so risk adjusted returns on ER are higher than on other assets. Yes.

  137. Gravatar of Nick Nick
    3. September 2015 at 11:45

    @sumner

    “I don’t follow the rest of your comment at all-have no idea how you are using terms like artificial and manipulation. Aren’t interest rates “made by human beings”?”

    Yes, human beings “make” the interest rates. But if there are gov’t manipulations in supply/demand(also by humans), then the question is what is the impact of those changes on the interest rates decided by those subject to it/outside of said manipulations.

    Why is it that if activity short of a forced interest rates directly impacts interest rates by humans/markets, that would be considered “natural” by mainstream economists?

    Conversely, if we assume there was no manipulation of supply/demand that interest rates would be different, is that not enough to suggest they are artificial? Do you feel that “made by humans” is enough to remove the notion of “artificiality” from the definition?

    If so, what about Bob Murphy’s term “false interest rate”? One definition being “appearing to be the thing denoted; deliberately made or meant to deceive.” in that the interest rates determined by those outside of the market manipulations are based on a subjective value that is not accounting for said manipulation?

    Do you really see no need to clarify/distinguish an interest rate derived partially by a supply/demand/medium manipulation vs. that of a market left to its own?

    It would seem to me to have value to distinguish the two, even if the terminology is in question.

    “Nick, You were the one that said no one agreed with Krugman, it turns out he’s right in the mainstream.”

    Well, first I didn’t say “no one agreed with Krugman”, I said it was “a fairly straightforward concept and for most(Krugman aside)that would not be controversial”.

    So back tracking for a moment to that comment, please let me qualify
    it and say I never my statement to be targeted to specifically “mainstream economists”, I meant it to be in a general sense.

    Someone that would look at the statement/definition based on what the words mean, not how the mainstream economists might define it. (which is why I brought up the definition of inflation as an example; which is defined differently by the “public”, and even among economists of different schools)

  138. Gravatar of ssumner ssumner
    4. September 2015 at 08:02

    Rod, I don’t think you understand the concept of money demand. The evidence you cite suggests the Fed does influence money demand. Bank holdings of base money has surged under QE, as you point out. That means more money demand. You seem to think that the existence of lots of ERs shows that banks aren’t demanding money, but it shows just the opposite.

    If supply was actually outstripping demand then banks wouldn’t hold all those ERs. We’d have hyperinflation.

    Nick, Economists have a well thought out set of terms for different concepts. The concept you seem to be getting at is analogous to price or rent controls, or minimum wage laws, where government regulation moves a price away from the equilibrium point of S & D. But that’s not what’s going on in the fed funds market. I have not idea what Bob means by false interest rates. Again, if people would use standard language then we could avoid all these word games.

    We see the same problem with Rod’s comment above, I have no idea how he is using the phrase “money demand”

  139. Gravatar of Rod Everson Rod Everson
    4. September 2015 at 08:46

    @ssumner

    Okay, I’ll repeat exactly what I specified earlier:

    Scott, I wrote, in part: “Today, with the massive level of excess reserves, demand for base money by the banking system consists of demand for required reserves and that demand will be whatever the economy dictates. The Fed has little to do with it. The 20% annual increase in demand deposits over the past five years set the demand for base money. The Fed set the supply with their QE’s. Clearly, supply has far outstripped demand.”

    You will note, if you read what I actually said instead of assuming I’m saying something else instead, that I defined “demand for base money by the banking system” to “consist of demand for required reserves.”

    Some things are obvious, Scott. It should be obvious that I’m discussing the demand for required reserves. Granted, the Fed wanted to embark on its QE voyages, so it dramatically increased the supply of base money and did find a way to get the banks to hold onto it, i.e., by paying Interest on Reserves (IOR).

    But instead of addressing my point, which is precisely that the Fed no longer directly controls the level of required reserves, you prefer to get into a definition of terms discussion, while also (intentionally?) completely ignoring my point. And then telling me I’ve got it all “backwards” in the bargain.

    So, to satisfy your need for precise language, I assert the following:

    Unlike the pre-2008 experience, the Fed, today, no longer exerts direct control over the level of required reserves in the system, i.e., the level of reserves demanded by the banking system as required reserves. Instead, the level of required reserves demanded by the banking system now responds entirely to “whatever the economy dictates.”

    I see in your arguments a tendency to avoid a discussion of what the Fed has forsaken in its Quantitative Easing ventures, perhaps because you realize it’s forsaken a great deal, or more likely because you didn’t think much of those tools to begin with.

    A very good argument can be made that the Fed no longer has the tools available to manage the overall level of prices, i.e. the inflation rate. This argument is reinforced by the fact that central banks that have embarked on QE ventures no longer seem able to attain even the modest 2% inflation rate they claim to desire, at least by the measures they choose to use.

    And now we are left with the situation that, should the economy go into recession (as it might now be doing), the only obvious tool remaining to the Fed is to initiate QE4 in response, an action that will make it ever more difficult to return to traditional monetary policy tools. But then, that might have been the goal all along?

    Seniors didn’t take to the barricades when near-zero interest rates were forced upon them by the Fed, but I wouldn’t bank on their continuing acquiescence when the Fed decides that achieving negative rates by fiat is the next step in this pathetic display of mismanagement of monetary policy.

  140. Gravatar of Nick Nick
    7. September 2015 at 08:45

    “Nick, Economists have a well thought out set of terms for different concepts.”

    You mean “mainstream” economists?

    My argument is in the same vein of the definition of “inflation”.

    Do you acknowledge that the definition of that word in terms of its use in economics means different things to different schools?

    If so, I think it’s valid to debate which English words seem to apply better to the economics of any given situation.

    So in your comment “Again, if people would use standard language then we could avoid all these word games” I would like to point out that you written subsequent articles referencing “natural interest rates”- so let me ask you a question along those lines.

    What would YOU like to call interest rates that aren’t natural? Or even better, if you don’t mind using mainstream economic definitions using words that might obscure meaning, maybe you can tell me what “they” might refer to interest rates that are “natural” as.

    Why is this important? Because it seems like a “word game” to me as well, especially when Krugman argues that the current interest rates aren’t “artificial”. If they aren’t artificial, & they aren’t “natural” as you use the term in your subsequent writings, what are they?

    Seriously, I’m open to whatever you or mainstream economists want to call them as long as they are distinguished.

  141. Gravatar of Nick Nick
    7. September 2015 at 08:48

    edit: “interest rates that AREN’T “natural” as.”

  142. Gravatar of ssumner ssumner
    8. September 2015 at 05:30

    Inflation and natural interest rates are similar in that in both cases there are slight differences in how they are defined. (CPI vs. PCE, or natural rate that leads to 2% inflation vs natural rate that leads to 4% NGDP growth.)
    An interest rates below the natural rate is generally called easy money, and vice versa.

    I think you have to also look at Krugman’s comment in context, he was criticizing people who thought that if the Fed would go back to targeting interest rates, they would no longer be artificial. Or if they stopped doing QE they would no longer be artificial.

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