Recent monetary news

Vaidas Urba sent me a very nice speech by Mario Draghi.  Here he points out that monetary policy remains effective at the zero bound:

“Some argue that today the situation is different; that whereas Volcker could raise rates to 20% to tame inflation, central banks fighting disinflation are inhibited by the lower bound on interest rates. The Japanese experience after the bursting of the housing bubble in early 1990s is often presented as evidence.

But the Japanese case in fact only reinforces the importance of full commitment from policymakers. As long as the commitment of the Bank of Japan to a low positive inflation number was not clear, actual inflation and inflation expectations stayed in deflationary zone. Since the Bank of Japan has signaled its commitment to reach 2% inflation, however, core inflation has risen from less than -0.5% in 2012 to close to 1% today. This is still short of the 2% objective, to be sure, but downward price shocks are also hitting Japan like all other advanced economies.”

And here he discusses the mistakes made by “some central banks”:

In fact, when central banks have pursued the alternative course – i.e. an unduly tight monetary policy in a nascent recovery – the track record has not been encouraging. Famously, the Fed began raising reserve requirements in 1936-37, partially due to fear of a renewed stock bubble, but had to reverse course the next year as the economy fell back into recession. That has also been the experience of some central banks in recent years: raising rates to offset financial stability risks has undermined the primary mandate, and ultimately required rates to stay lower for longer.

It’s gratifying to read Draghi’s speech because it contains lots of talking points emphasized by market monetarists (and also by more enlightened Keynesians.) Notice how he realizes that raising rates actually causes them to be lower in the long run, something Milton Friedman recognized back in 1997.  Of course the ECB in 2011 was one of the central banks that tightened prematurely, and triggered a double dip recession.  Will the Fed’s 2015 tightening be added to the list?  It was certainly a mistake, but it’s too soon to suggest the next move will be down.  (The market predicts flat.)

Unfortunately, the outlook for the eurozone is increasingly bleak.  Wolfgang Münchau has a very good post:

Four signs another eurozone financial crisis is looming

The rout in European financial markets last week was a wat­ershed event. What we witnessed was not necessarily the beginnings of a bear market in equities or an uncertain harbinger of a future recession. What we saw — at least here in Europe — is the return of the financial crisis.

Version 2.0 of the eurozone crisis may look less frightening than the original in some respects but it is worse in others. The bond yields are not quite as high as they were then. The eurozone now has a rescue umbrella in place. The banks have lower levels of leverage.

But the banking system has not been cleaned up, there are plenty of zombie lenders around and in contrast to 2010 we are in a deflationary environment. The European Central Bank has missed its inflation target for four years and is very likely to miss it for years to come.

The markets are sending us four specific messages. The first and most imp­ortant is the return of the toxic twins: the interaction between banks and their sovereigns. Last week’s crash in bank share prices coincided with an increase in bond yields in the eurozone’s periphery. The pattern is similar to what happened during 2010-12. The sovereign bond yields have not quite reached the same dizzy heights, though Portugal’s 10-year yields are almost 4 per cent.

You might wonder why the eurozone debt situation is worsening even as the labor market gradually improves.  Perhaps the problem is that debt contracts are often quite long, whereas wage contracts tend to be much shorter.  Thus wage growth is now adjusting to slower NGDP growth, but long-term debt contracts have not fully adjusted.

The FT also has a piece that criticizes QE:

For years, central bankers have been reluctant to suggest that unconventional monetary policies even had costs. But while developed markets plunge ever deeper into uncharted financial territory as a result of central bank actions, the drawbacks and the limitations of such policies are finally becoming apparent.

The negative effects will become even more obvious over time. This will occur as asset price inflation — the main consequence of central bank policies — goes into reverse, robbing financial engineering of its efficacy and flattening the yield curve.

Suddenly, the success of central bankers in lifting financial asset prices through unconventional monetary policies seems to be coming to an end.

In other words, don’t do beneficial policies that help the economy and also raise asset prices as a side effect, because if at some point in the future you foolishly stop doing beneficial policies and NGDP growth plunges then asset prices may fall. Or something like that.

And this:

The Bank of Japan’s use of negative rates, dovish coos from New York Fed Chairman William Dudley, and carefully worded statements from Mr Bernanke’s successor, Janet Yellen, last week spooked markets rather than soothed them.

I suppose if you ignore the fact that the Japanese negative rate announcement triggered a big rise in global equity markets then this article might make some sense.  But I prefer not to ignore reality.

It’s hard not to see the current global situation in Manichaean terms.  On one side you have people like Draghi and Kuroda, desperately trying to nudge their institutions towards higher inflation.  On the other you have people who see up as down and left as right, and who offer no constructive suggestions as to how central banks can hit their targets.  In the middle is the Fed, just twiddling its thumbs.

PS. Discussion of market monetarism is now appearing in academic journals.  Here’s a new paper by Ryan Murphy and Jiawen Chen.  (Ungated preliminary version here.)

I also recommend the new post by Marcus Nunes, which discusses a post by Gavyn Davies in the FT.


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62 Responses to “Recent monetary news”

  1. Gravatar of Ray Lopez Ray Lopez
    15. February 2016 at 11:19

    “This is still short of the 2% objective” – why is that? Not ‘credible’ enough? What metaphysics! Perhaps not printing enough money? What is Sumner’s take?

    OT–Krugman in his Econ 101 textbook (“Essentials of Economics”) does not even bother teaching IS-LM, but instead simply assumes money is non-neutral in the short-term and can raise output (he says it is “foolish” to think otherwise, tsk tsk). No evidence is given for this assertion, not even Blanchard’s weak argument of 60% correlation with actual data (note: not the usual 95% confidence figure, and 50% correlation would be a coin toss). So Krugman is as dishonest as Sumner. Both characters ‘pound the table’ that money is not neutral, yet they cite no evidence for this. The one paper –by Ben S. Bernanke (FAVAR 2002)–showing money is weakly non-neutral (3.2% to 13.2% effect out of 100% on a range of economic variables, i.e., nearly nothing), Sumner refuses to read, and Krugman is silent on.

    There is a crisis of credibility in economics. It’s not with central banks, but practitioners like Sumner and Krugman.

  2. Gravatar of marcus nunes marcus nunes
    15. February 2016 at 11:21

    There´s a preliminary downloadable version of the Murphy Chen papaer:
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2516554

  3. Gravatar of Kevin Erdmann Kevin Erdmann
    15. February 2016 at 11:33

    The mental illness that conflates rising asset prices with excessive monetary accommodation is the reason we are living through an extended depression. Depression is our explicit policy. Depression – whether in falling housing starts, falling stock prices, or declining credit – is met with sighs of relief and nods of appreciation. It infuriates me.

  4. Gravatar of Airman Spry Shark Airman Spry Shark
    15. February 2016 at 11:45

    PS. Discussion of market monetarism is not appearing in academic journals. Here’s a new paper by Ryan Murphy and Jiawen Chen.

    I think the ‘not’ should be a ‘now’.

  5. Gravatar of E. Harding E. Harding
    15. February 2016 at 11:48

    “Of course the ECB in 2011 was one of the central banks that tightened prematurely, and triggered a double dip recession.”

    -Why was there no double-dip recession in Canada? Interest rates are not an indicator of monetary policy. The ECB in 2011 raised rates when it was more than appropriate (by its target), but failed to loosen under Draghi to prevent extreme disinflation.

    As I pointed out in the thread http://www.themoneyillusion.com/?p=31477 , Draghi’s ECB was responsible for most of the EZ recession outside Greece (certainly for most of the slow recovery after Q2 2013).

    “The European Central Bank has missed its inflation target for four years and is very likely to miss it for years to come.”

    -All the years since Draghi has been in power as ECB President. Coincidence? I think not.

    Draghi talks the talk, but doesn’t get anywhere as close to the target as Trichet did. In fact, it seems to get farther and farther away from the target with each year.

  6. Gravatar of pmsap pmsap
    15. February 2016 at 11:52

    Unfortunately Draghi also asked for “help” is fiscal policy (expansionary fiscal policy). I guess this is a way to try to promote velocity.

    http://www.theguardian.com/business/live/2016/feb/15/market-turmoil-asian-stocks-soar-despite-japan-shrinking-14-live

  7. Gravatar of Major.Freedom Major.Freedom
    15. February 2016 at 12:01

    It’s gratifying to read Draghi’s speech because it contains lots of talking points emphasized by market monetarists (and also by more enlightened Keynesians.) Notice how he realizes that raising rates actually causes them to be lower in the long run.

    Notice now you and Draghi don’t realize the logical obverse that lowering rates actually causes them to be higher in the long run.

    Since the early 1970s prevailing rates have on average been lower than the market rates, which means today it takes more inflation to bring about any particular lower than market level of prevailing rates. This trend continues. The infrequent episodes of delimited increases in rates brought about by central banks over the decades have not been anywhere close to the levels required to reverse the long term trend.

    Enlightened economists are not socialists who propagandize for more central bank inflation.

  8. Gravatar of Brian Donohue Brian Donohue
    15. February 2016 at 12:54

    @Kevin Erdmann, through last Friday, the CAGR on the S&P 500 (including reinvested dividends) since 12/31/1999 is now 3.4%. The real CAGR is 1.3%.

    That’s over more than 16 years. Clearly, the Central Bank wheeze to prop up asset prices for the fat cats is proceeding according to plan.

  9. Gravatar of Britonomist Britonomist
    15. February 2016 at 13:13

    Ray Lopez you clearly have no idea what a confidence interval is, stop pretending you understand statistics.

  10. Gravatar of ssumner ssumner
    15. February 2016 at 13:14

    Ray, Bernanke thinks the Fed caused the Great Depression. That’s a pretty big “non-neutrality”

    Marcus, Thanks, I added a link.

    Kevin, I feel your pain.

    Airman, Thanks I fixed it.

    E. Harding, You asked:

    “Why was there no double-dip recession in Canada? Interest rates are not an indicator of monetary policy.”

    Probably because Canada did not raise rates relative to the Wicksellian equilibrium rate.

    Pmsap, No chance of much help on the fiscal side, the debt crisis may be returning.

    Brian, Interesting, so that’s 3.4% per year, right? As opposed to the roughly 8% over longer periods?

  11. Gravatar of J Mann J Mann
    15. February 2016 at 13:21

    Scott,

    Completely off topic, my daughter has you to thank for “never reason from a price change.” This summer, in high school AP econ, she was asked to explain what would happen to the supply of regular apple cider if the price for hard apple cider increased.

    I’m pretty sure that the expected answer was that the increased price in the hard apple cider price would increase demand for apples, and that the resulting unit cost increase would shift the soft apple supply curve left, but after we talked about it, she answered:

    “The determinant is prices of other goods change. In order to determine the effect on regular apple cider supply, you would need to know the reason why the price of hard apple cider increased. Assuming that the price of hard apple cider increased because of an increase in hard apple cider demand, hard apple cider manufacturers will produce more hard cider, increasing the demand for cider apples, and therefore the cost of apples will go up, shifting the regular apple cider supply curve inward.

    However, it’s also possible that the price change in hard apple cider represents a change in hard apple cider supply rather than demand and therefore in the “quantity supplied.” In that case, you would need to know the reason why the hard apple supply curve shifted to determine its effect on the demand for apples. For example, an increase in a liquor tax could result in an increase in the hard cider market price but a decrease in the amount sold as a result of a shift in supply. In that case, the decrease in the apple demand by hard cider producers would result in a reduction in the cost of apples and therefore an increase in regular apple cider supply. On the other hand, if the hard apple supply shifted because of a drought that reduced the overall supply of apples, then the supply of regular apple cider would shift left, for the same reason as that of hard apple cider.”

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    15. February 2016 at 13:27

    @Brian. Insanity, isn’t it? And the consensus across the political spectrum is how to solve the problem of keeping Wall Street from having it so good. Insanity.

  13. Gravatar of ssumner ssumner
    15. February 2016 at 13:32

    J Mann, Great stuff, I’ll bet that surprised her teacher. (Most textbooks don’t explain that very well.)

  14. Gravatar of Brian Donohue Brian Donohue
    15. February 2016 at 13:44

    @Scott, yeah, that’s an annualized number. For comparison, the annualized S&P 500 return since 1/1/1950 is 11.1% (nominal) and 7.3% (real), but I’d take 8%.

    @Kevin, yes, insanity.

  15. Gravatar of E. Harding E. Harding
    15. February 2016 at 14:11

    “Probably because Canada did not raise rates relative to the Wicksellian equilibrium rate.”

    -Yes; I knew that (barring technicalities about, with IoR, more than one Wicksellian equilibrium rate being able to produce the same level of NGDP). But how can a central bank tell whether it raises rates relative to the WeR? Stock prices always fall on rate hikes above expectation, and I don’t think there are EZ-wide inflation-protected securities. In other words, how would the ECB have known in 2011 its rate hike wouldn’t have been like Canada’s?

  16. Gravatar of Britonomist Britonomist
    15. February 2016 at 14:12

    “In order to determine the effect on regular apple cider supply, you would need to know the reason why the price of hard apple cider increased…

    … However, it’s also possible that the price change in hard apple cider represents a change in hard apple cider supply ”

    This is an infinite turtle problem. You can always ask why something happened, and then ask why the thing that caused that to happened – and you can keep going forever. This misses the point entirely of ceteris paribus analysis, the whole point of which is to avoid this problem and assume a variable’s value changed for absolutely no reason at all (i.e. without anything else changing) – that way we can isolate the effect of a price change and a price change only. The effect of a supply or demand change is a different question.

  17. Gravatar of Mark Mark
    15. February 2016 at 16:15

    OT–Krugman in his Econ 101 textbook (“Essentials of Economics”) does not even bother teaching IS-LM, but instead simply assumes money is non-neutral in the short-term and can raise output (he says it is “foolish” to think otherwise, tsk tsk). No evidence is given for this assertion, not even Blanchard’s weak argument of 60% correlation with actual data (note: not the usual 95% confidence figure, and 50% correlation would be a coin toss).”
    I’m not sure what you’re talking about. If two variables are not correlated at all, their coefficient should be 0, not .5. And you don’t mention what the 95% confidence interval on the “50%” (I’m assuming you mean .5 correlation coefficient) is. Do you know that correlation coefficients and confidence intervals aren’t the same thing? Your post seems rather confused, and I’m not one to defend Krugman.

  18. Gravatar of bill bill
    15. February 2016 at 16:15

    I think the CAGR for stocks has been even lower than 3.4% since 2007 (a time which most pundits don’t think we were in a “bubble”).
    Like Kevin and Brian said, Insanity!

  19. Gravatar of Benjamin Cole Benjamin Cole
    15. February 2016 at 16:53

    Okay this is PR not macro: Michael Woodford has signed off on tax cuts married to QE..

    Ergo, we try to sell market monetarism as tax cuts for business and stimulus. The side effect of rising asset prices should be minimized in public discussion. The fact that people who sell bonds to the Fed then spend their money should be highlighted. The idea that the national debt is reduced might be spoken about.

    In terms of PR, the idea that QE primarily raises asset prices was a tremendous PR mistake.

  20. Gravatar of Ray Lopez Ray Lopez
    15. February 2016 at 17:53

    @Britonomist – it’s clear in your answer to J Mann you don’t understand ‘never reason from a price change’. Mann’s daughter answered correctly, though I would argue she answered things outside the scope of the question, which was directed to the first part of her answer.

    @Mark – thanks for that confidence interval remark. You may wish to review this link before reading the rest of my answer: https://en.wikipedia.org/wiki/Confidence_interval#Meaning_and_interpretation (and the next section, ‘Misunderstandings’). And see this: http://stats.stackexchange.com/questions/6652/what-precisely-is-a-confidence-interval and the links therein.

    I misspoke when I said: “(note: not the usual 95% confidence figure, and 50% correlation would be a coin toss)”– I should have said ‘50% confidence interval’ not ‘correlation’, that was a typo. There is a bit of a fetish about what ‘confidence interval’ means, see the above links, but in any even I think it’s safe to say that 50% confidence interval is not conventional, nor is 60% as in Blanchard’s textbook on actual data that supports monetarism. The standard is 95%.

  21. Gravatar of Kgaard Kgaard
    15. February 2016 at 18:29

    I am wrestling with Japan’s recent experience:

    Japan bought enough assets to boost its balance sheet 175% and yet still didn’t come close to hitting the CPI target. This failure implies that the act of just buying assets isn’t really actually doing anything …In other words, buying the assets is just a sort of SIGNAL that the central bank REALLY would like commercial banks to lend more. Yet if the QE cash just sits on bank balance sheets, the whole exercise is pointless.

    One way to think about this would be to say that now commercial bankers will see that QE doesn’t inherently work — it still relies on commercial bankers issuing more loans. Or put differently it’s sort of a plea to bankers to issue more loans. In that sense QE is a paper tiger. Now that they see this, maybe bankers will be even more inclined to not make loans.

    I could be wrong in how I’m conceptualizing this but that’s how it is striking me. This is why the BoJ is moving to negative IOR, which is a “stick” to force banks to lend more. Intuitively that seems kind of weak. Why doesn’t the CB have something better than that to use?

  22. Gravatar of Ray Lopez Ray Lopez
    15. February 2016 at 18:29

    OT – on CI and probabilities, see http://stats.stackexchange.com/questions/26450/why-does-a-95-ci-not-imply-a-95-chance-of-containing-the-mean/81011#81011

    You cannot assume Confidence Interval (CI) x% is: (1) betting probability (I knew that), nor (2) that it captures the population parameter x% of the time (I did not know that, but it’s hardly an important distinction IMO). On this note, consider this thought experiment:

    You wish to show that the population parameter, the mean mu of flipping a fair coin and landing heads, is between 0.4999 to 0.5001, to 99.9% confidence. So you flip the coin N times, with N being very large. Eventually, at some N (I don’t know what that value might be but it’s big), you can say that mu is about 0.5 for heads coming up. But you can’t say the probability of heads is 50% (that’s wrong, and goes to the (1) above), nor, somewhat surprisingly, that flipping a coin will capture or show heads to be between 0.4999 to 0.5001 to 99.9% probability (that’s wrong, and goes to (2) above). On this last point, it’s because CI only goes to say your experiment to capture mu will show the true mu 99.9% of the time, not to the actual value of mu lies in this range. The later, actual ‘capture mu’ stat is not 99.9% but less. It’s less than 99.9% because perhaps the coin is not really fair, or the flipper is not really fair, or the seed used in your computer simulation is not really random, etc etc etc.

    Back to Blanchard and Krugman: the former in his textbook says the Fed changing interest rates affects the economy to 60% confidence, citing a paper. The latter does not even bother to cite a paper, but says it is “foolish” to think otherwise (that the Fed has no control, that money is neutral short term); 60% (not 95%) and ‘on faith, take it from me’. Would you buy a used car from these guys? I sure wouldn’t.

  23. Gravatar of Don Geddis Don Geddis
    15. February 2016 at 19:53

    @Britonomist: “assume a variable’s value changed for absolutely no reason at all (i.e. without anything else changing

    But that’s not possible, for prices. Prices, in equilibrium, result from the intersection of supply and demand curves. You cannot possibly have: (1) unchanging supply curve; (2) unchanging demand curve; (3) different price. So in your counterfactual world, at least one more thing must also change. (Perhaps that one additional thing is government-imposed price controls, but that breaks out of a free market enough that it would need to be stated explicitly.)

    The real problem is that there is no unique solution. You can achieve the new price with just a supply change; or you can achieve it with just a demand change; but those two imply opposite answers to the question of movement on all the other variables (such as what was requested in the original question).

    “Never reason from a price change” means that “ceteris paribus” is not uniquely determined for price changes. It’s like divide by zero: The final answer could be anything, and you really have no alternative but to back up a step and ask how exactly it was that you were approaching the zero. Depending on what led to the divide by zero, any resulting answer might be the correct one. The mistake is thinking that there’s only one possible way you could have gotten there, and thus falsely believing that there’s a unique “right” answer (in the absence of any clarifying information).

  24. Gravatar of ssumner ssumner
    15. February 2016 at 20:10

    E. Harding, Obviously they need better prediction markets, but I believe they do have German TIPS, don’t they?

    They could look at a wide range of indicators including NGDP growth, NGDP growth expectations, nominal interest rates, etc., etc., and I think most were signaling low inflation ahead. But again, if they are flying blind, why not create prediction markets?

    And why not shift to level targeting, which would make their job easier?

    And of course CHANGE THE MANDATE!! It’s the NGDP, stupid! (Not referring to you of course)

    Britonomist: You said:

    “This misses the point entirely of ceteris paribus analysis, the whole point of which is to avoid this problem and assume a variable’s value changed for absolutely no reason at all (i.e. without anything else changing) – that way we can isolate the effect of a price change and a price change only. The effect of a supply or demand change is a different question.”

    OK, how would you answer this exam question:

    Question: Suppose the price of oil rises by 30%, and suppose the elasticity of supply is 0.5 and the elasticity of demand is -0.3. What would happen to the equilibrium quantity of oil bought and sold in the marketplace? Show your work.

    Kgaard, You said:

    “Japan bought enough assets to boost its balance sheet 175% and yet still didn’t come close to hitting the CPI target. This failure implies that the act of just buying assets isn’t really actually doing anything”

    I sympathize with your frustration, but I can’t quite agree. As a matter of fact inflation has risen substantially since Abenomics started at the beginning of 2013. Indeed it’s actually averaged close to 2% by some measures, although if you take out the sales tax increase of 2014, then the underlying rate is closer to 1%. But even that is an improvement over the deflation under the previous several governments. So do more!

    On the other hand you are right that simply throwing money at the problem is probably not the most effective method. They need a smarter approach, such as switching to level targeting, preferably NGDP level targeting. That would provide much more bang for the buck. The BOJ could also consider currency depreciation as an option.

  25. Gravatar of Shmebulock, Crusher of Pussy Shmebulock, Crusher of Pussy
    15. February 2016 at 21:07

    So, uh, what exactly IS the Wicksellian equilibrium rate right now?

  26. Gravatar of ssumner ssumner
    15. February 2016 at 21:11

    Crusher, I have no idea, other than it must be pretty low, especially in Europe and Japan.

    In my view the Wicksellian equilibrium interest rate is a pretty useless concept.

  27. Gravatar of E. Harding E. Harding
    15. February 2016 at 21:28

    @ssumner

    “Obviously they need better prediction markets, but I believe they do have German TIPS, don’t they?”

    -They do, but German IPS would probably lead to an excessively tight monetary policy (which would still be looser than that today). Good points on all else.

    “And why not shift to level targeting, which would make their job easier?”

    -Good idea.

    BTW, even with NGDP, it seems the real mistake began after Trichet. The last three quarters of the Trichet ECB clearly had the seeds of a mistake, but an easily fixable one that would, had the post-Trichet ECB promptly acted, have resulted in a mild slowdown exclusively in 2011, at worst. The Trichet-era three-quarter-long slowdown did not have to last for another year+.

  28. Gravatar of E. Harding E. Harding
    15. February 2016 at 21:35

    “In my view the Wicksellian equilibrium interest rate is a pretty useless concept.”

    -I think it’d be a good idea to do a post on this.

  29. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    16. February 2016 at 03:58

    @Ben Cole
    Yes, thinking about QE as raising asset prices is the same mistake as saying it lowers long interest rates, when in fact, if effective, it should be the opposite. Ironically, if the Fed succeeds in QE (i.e. it increases spending and long rates go up) it will be criticized by the fiscal effect of QE (Fed bought assets that went down in price …)

  30. Gravatar of James Alexander James Alexander
    16. February 2016 at 04:00

    Scott
    Markets are good at forecasting but as you say, not always right. Things in the Euro Area aren’t so bad. NGDP growth is holding up at long-term averages and ECB QE is powerfully underpinning this growth, unlike the US. Of course, the inflation ceiling needs to be replaced by NGDPLT.
    https://thefaintofheart.wordpress.com/2016/02/15/european-ngdp-shaping-up-to-be-dull-but-not-down/

  31. Gravatar of Postkey Postkey
    16. February 2016 at 04:19

    @Kgaard

    ” . . . it still relies on commercial bankers issuing more loans.”

    “Proponents of the deposit view sometimes argue that it should not matter whether deposits or loans are being analysed, as both tend to be equal in the long run. Werner (1996c) shows that in the Japanese case, a broad credit measure and M2+CD, the traditional deposit measure, diverged greatly in the 1990s.
    While significant growth of M2+CD seemed to suggest an economic recovery in 1995, the credit aggregate suggested a contraction of nominal GDP growth – for the first time since 1931. The latter is what happened. Conversely, while M2+CD growth remained stable from mid-1995, the credit aggregate suggested a sudden economic recovery from the fourth quarter of 1995, which again materialised.”

    http://eprints.soton.ac.uk/339271/1/Werner_IRFA_QTC_2012.pdf

  32. Gravatar of J Mann J Mann
    16. February 2016 at 06:43

    @Britonomist & @Ray Lopez – I think you both have a point. We actually talked about that issue – at a certain point, we were in a rabbit hole of just what to hold constant for ceteris paribus, which is either a deep economics question, or a deep philosophy, or maybe philosophy of economics. :) Either way, we decided to just write down everything we talked about and risk over-analyzing.

    In hindsight, I *think* the right answer is that:

    – if the price of hard apple cider increased because demand shifted right, then ceteris paribus, you would expect the supply of soft apple cider to shift left, and

    – if the price of hard apple cider increased because hard apple cider supply shifted left, then cereris paribus, you would expect the supply of soft apple cider to shift right.

    If all you know is that the price changed, then either demand or supply has to have shifted (or both), so I don’t think you can hold both of those constant. But I guess once you grant that hard apple demand or supply has changed, you assume that the reason for that change doesn’t have any collateral effects, so the tax example was good, but the drought example probably wasn’t.

  33. Gravatar of TallDave TallDave
    16. February 2016 at 06:57

    Heh, it seems like only yesterday Japan had a de facto target of 1%. Monetary policy can’t solve all Japan’s ills, but they can do better than zero real growth.

    The FT excerpt is hilarious, like complaining that pumping water out of the boat will backfire if they start pumping water into the boat instead, plus it does nothing about the rain!

  34. Gravatar of Gabe Gabe
    16. February 2016 at 07:17

    so are the economoaist here all on board the train to get rid of $100 bills so we can tax peoples accounts with negative interests more effectively?

  35. Gravatar of Britonomist Britonomist
    16. February 2016 at 07:42

    “But that’s not possible, for prices. Prices, in equilibrium, result from the intersection of supply and demand curves. You cannot possibly have: (1) unchanging supply curve; (2) unchanging demand curve; (3) different price. So in your counterfactual world, at least one more thing must also change. (Perhaps that one additional thing is government-imposed price controls, but that breaks out of a free market enough that it would need to be stated explicitly.)”

    It doesn’t actually matter what’s possible for hypothetical thought experiments. Although what IS needed is context, it really depends on the model the student was using. Ceteris paribus takes a model as given, changes the value of some variable *as a first move* (if it doesn’t do this, it’s not ceteris paribus by definition), and sees what happens. So I should have clarified, other things can change but *only things exogenous to the model* in question. I think my problem was I was assuming a specific model in my head that I thought this student was definitely being taught – in this model the price of a substitute or related good is exogenously determined, and is simply an input variable for the supply and demand equations for regular cider. In this case we really can, for the purposes of thought experimentation, shock the prices of this exogenous variable and see what happens – it doesn’t matter why the price changed because the model doesn’t include an equation for the price of hard cider that we have to consider.

    So my mistake was assuming a specific model in her case, but in reality she may have been taught a totally different model or no model at all, making her question a bad example for the point I was trying to make.

    My overall point is that you can always say that “in reality, the supply and demand for x partly determines the price of y, so we should first consider if either of these changed to decide what effect a change in y has on x”. This is why when we make models we explicitly decide which variables are endogenous and which are exogenous, or we’ll never get anywhere (infinite turtles). My criticism is the idea that only ‘price’ is a factor that is typically endogenous and must not be ‘reasoned’ from, when in reality practically EVERYTHING is endogenous, so it can be just as fallacious to ‘reason from a quantity change’ as it is to ‘reason from a price change. I don’t think price is anything special in this regard.

  36. Gravatar of Anthony McNease Anthony McNease
    16. February 2016 at 08:04

    Scott, Lars has a very good and relevant post up referencing your 2009 article explaining that the nominal shock was exacerbated by the Fed because they misdiagnosed the problem. This seems exactly what Yellen and the FOMC seem to be doing again chasing after asset bubbles and worrying over a Phillips Curve that hasn’t been relevant in a decade (or more).

    http://marketmonetarist.com/2016/02/11/the-real-problem-is-a-nominal-problem-also-in-2016/

    “In this 2009-article Scott Sumner argued that a key contributing factor the mistakes of the Fed in 2009 was the that Fed simply misdiagnosed the crisis. Hence, while Scott clearly showed that the crisis was caused by an excessive tightening of monetary conditions, which in turn led to a banking crisis the Fed on the other was convinced that the banking crisis was the cause rather than the consequence of the crisis.

    Furthermore, all through 2008 the Fed continued to argued that monetary conditions were highly accommodative, while in fact if you where tracking market indicators then it was clear that monetary policy had become insanely tight.

    I fear that the Fed today is making the same mistake once again.”

  37. Gravatar of J Mann J Mann
    16. February 2016 at 09:49

    Britonomist, thanks for your response. Can I ask you a follow up question?

    Can you clarify how your model would resolve the problem and why?

    In particular, does your model assume that price changes in hard apple cider are the result of demand shifts, or are re you saying that ceteris paribus requires us to assume that the price of hard apple cider shifted but both the demand and supply curves remained unchanged. (I.e., that a price floor was imposed above the previous equilibrium price).

    I guess the latter case works – if we assume that *neither* demand nor supply has shifted and that the price change is endogenous, then the price change would result in a lower quantity sold of hard apple cider – while it’s true that suppliers would be happy to supply more at the new price than at the prior price, consumers are less willing to buy then then were, so fewer hard apple cider sales will occur as a result of the price floor, resulting in lower demand for apples and increasing the supply of soft apple cider.

    I don’t think that’s what the textbook authors were going for, but I see how that’s getting closer to ceteris paribus than our answer was. Thanks!

  38. Gravatar of TravisV TravisV
    16. February 2016 at 10:09

    “Earlier on Tuesday, Chinese stocks closed with their biggest daily percentage gain in more than three months. Remarks by Premier Li Keqiang were interpreted as hinting at more stimulus for the world’s second-biggest economy.”

    http://uk.reuters.com/article/usa-stocks-idUKL3N15V42M

  39. Gravatar of Britonomist Britonomist
    16. February 2016 at 10:29

    “In particular, does your model assume that price changes in hard apple cider are the result of demand shifts, or are re you saying that ceteris paribus requires us to assume that the price of hard apple cider shifted but both the demand and supply curves remained unchanged. (I.e., that a price floor was imposed above the previous equilibrium price). ”

    My model simply doesn’t have supply and demand curves for Hard Apple Cider, only regular apple cider. The price of Hard Apple Cider is an entirely exogenous variable to the model. Exogenous variables aren’t unusual in economics by the way.

  40. Gravatar of J Mann J Mann
    16. February 2016 at 11:12

    So what effect does your model predict and why?

  41. Gravatar of Britonomist Britonomist
    16. February 2016 at 11:34

    J Mann: ambiguous, I haven’t specified the model other than the price of Hard Apple Cider being exogenous. It depends on the extent Hard Apple Cider is a substitute or complementary good for the demand equation, and/or the extent it’s a related good for the supply equation etc… I cannot say without giving you a more specific model. The thing is, these questions are normally always asked *after* specifying a model, if no model has been given then I’d say it’s not a question suitable for a high school exam.

    If I had to guess, I’d assume that your daughter was simply being asked in the context of an equation for a supply curve for ‘related goods’, in this context an increase in the price of one related good causes the supply of the other good to fall, and vice versa. That is usually the context that these questions are asked, demand isn’t even considered yet.

  42. Gravatar of Alessandro Alessandro
    16. February 2016 at 12:38

    Scott, you posed the following question to Britonomist:

    “OK, how would you answer this exam question:
    Question: Suppose the price of oil rises by 30%, and suppose the elasticity of supply is 0.5 and the elasticity of demand is -0.3. What would happen to the equilibrium quantity of oil bought and sold in the marketplace? Show your work”

    For my own understanding, here is my attempt at an answer:

    We know a rise in oil price can be the result of one of two possible scenarios:

    Scenario 1: Supply curve shift to the left, causing a increase in the price of oil, but a reduction in the quantity supplied. Furthermore, we know that,
    Price elasticity of supply = % change in quantity/%change in price.
    Substituting in a 30% price increase and an elasticity of 0.5, therefore implies a 15% drop in the quantity of oil supplied in this scenario.

    Scenario 2: Demand curve shift to the right, causing an increase in the price of oil, but also an increase in the quantity demanded. Again substituting a 30% price increase and an elasticity of -0.3, therefore implies a 9% increase in the quantity of oil demanded in this scenario.

    Do i pass the exam or am i retaking Econ101 next semester?

    Thanks Scott

  43. Gravatar of Britonomist Britonomist
    16. February 2016 at 13:44

    Scott, I counter your question with this question. Suppose equilibrium quantity of oil bought and sold is reduced by 30%, and assume those same elasticities – what is the equilibrium price at this quantity?

    Never reason from a quantity change.

  44. Gravatar of J Mann J Mann
    16. February 2016 at 14:42

    Alessandro, here’s my take:

    “Question: Suppose the price of oil rises by 30%, and suppose the elasticity of supply is 0.5 and the elasticity of demand is -0.3. What would happen to the equilibrium quantity of oil bought and sold in the marketplace? Show your work”

    eS = 0.5 = (dQ/Q)/((dP/P)=0.3)
    0.3*0.5=dQ/Q
    The desired quantity supplied increases by 15%

    eD = -0.3 = (dQ/Q)/((dP/P)=0.3)
    -0.3*0.3 = dQ/Q
    The desired quantity demanded decreases by 9%

    Scott asks for the “equilibrium quantity”, which is a definitional issue. It seems to me that (1) either the before or after price wasn’t an equilibrium price (i.e., a below-equilibrium price ceiling was removed or an above-equilibrium price floor was imposed), or that at least one of the curves shifted.

  45. Gravatar of TravisV TravisV
    16. February 2016 at 14:58

    “Deutsche Bank Flip Flops, Now Begs For Central Bank Intervention And Ideally More QE”

    http://www.zerohedge.com/news/2016-02-16/deutsche-bank-flip-flops-now-begs-central-bank-intervention-and-ideally-more-qe

  46. Gravatar of TravisV TravisV
    16. February 2016 at 15:21

    Good stuff from Pethokoukis:

    http://theweek.com/articles/605033/when-financial-markets-start-freaking-about-donald-trump

    https://www.aei.org/publication/and-the-price-tag-for-bernie-sanders-free-stuff-30-trillion

  47. Gravatar of TravisV TravisV
    16. February 2016 at 15:26

    Dear Commenters,

    Has Prof. Sumner written a historical account of what happened as inflation targeting became more and more popular among a variety of countries during the 1980’s and 1990’s? It would be nice to see a visual illustration of the stabilization of inflation occurring throughout the world all at about the same time.

    I just left a comment re: this topic on Marcus Nuns’s blog:

    https://thefaintofheart.wordpress.com/2016/02/16/market-monetarism-divine-coincidence/#comment-19400

  48. Gravatar of Kgaard Kgaard
    16. February 2016 at 15:43

    Scott … If the transmission mechanism by which QE leads to higher CPI remains fuzzy, how does declaring an NGDP LEVEL actually advance the ball? If the core of the problem is that QE is a really flaky way get more CPI, how, conceptually, does a level help? I mean … I imagine it would … but the question still stands.

    The more I dig into this, the more it seems to me that QE becomes less effective as the assets bought in become more cash-like. When the ECB was buying garbage loans that nobody else wanted, that was obviously helpful. When the BoJ is buying 5-year JGBs yielding 0.13%, there’s not much difference between the bonds they get and the cash they lay out.

    That, I think, is why they NIRP-ed it.

  49. Gravatar of ssumner ssumner
    16. February 2016 at 17:02

    E. Harding, I must have done something on that question, but I’ll keep it in mind.

    James, I agree.

    Gabe, Not me, I’m a fan of currency. I like its anonymity.

    Thanks Anthony, I think I quoted from that post somewhere, perhaps at Econlog.

    Alessandro, You forgot the third option, both curves shift. But otherwise you are correct.

    Britonomist, You said:

    “Never reason from a quantity change.”

    Yes, and that’s exactly my point. These questions are essentially meaningless, and you see them in EC101 courses.

    Kgaard, Elsewhere I’ve discussed these questions in more detail. There are two issues:

    1. How fast should NGDP grow in the long run? That determines the monetary base/GDP ratio. Although IOR also affects the ratio.

    2. The second question is what instrument should you use. People overrate the second question’s importance. First you must figure out where you are going, and then decide how to get there. You buy assets until expected NGDP growth is on-target. If the base is too big for your liking, then you set a faster NGDP growth target.

    You might check out this post:

    http://www.themoneyillusion.com/?p=13454

  50. Gravatar of Shmebulock, Crusher of Pussy Shmebulock, Crusher of Pussy
    16. February 2016 at 18:26

    @scott

    Wait, aren’t you always saying 1/2% interest rates aren’t really low because they’re still above the Wicksellian natural rate? And now you’re saying that’s a useless concept? Are you just making shit up as you go along?

  51. Gravatar of ssumner ssumner
    16. February 2016 at 18:31

    Crusher, You missed the point. Interest rates in general are not a useful way of looking at things. I prefer to focus on other variables. But if someone insists on asking me how 1/2% interest rates cannot be an easy money policy, I point out that it’s tight money if it’s set above the Wickselllian equilibrium rate. But how would we know that? We’d know that by looking at inflation or NGDP growth, which would be below target. But in that case just skip the middleman and focus on inflation or NGDP growth, not interest rates.

  52. Gravatar of Shmebulock, Crusher of Pussy Shmebulock, Crusher of Pussy
    16. February 2016 at 19:48

    Yeah, but then your theory is completely circular. CB actions didn’t raise inflation or NGDP growth? Well, clearly the CB didn’t intervene enough. We “know” this because of the lack of the desired outcome. Totally unfalsifiable.

  53. Gravatar of ssumner ssumner
    16. February 2016 at 19:57

    Crusher, Gee if they didn’t hit their target they need to do more? Alert the media!! Seriously you need to do a lot of work to get up to speed on this subject–try reading some older posts.

    like this one:

    http://www.themoneyillusion.com/?p=13330

  54. Gravatar of Shmebulock, Crusher of Pussy Shmebulock, Crusher of Pussy
    16. February 2016 at 20:28

    Ah yes, your usual “read the 100’s of posts I’ve made on this subject” response. Look, you insulate your theory by claiming the authorities didn’t do enough of what you said they should do, as evidenced by the lack of NGDP growth. You then try to weasel out of this non-falsifiability by saying their actions were tight relative to the Wicksellian rate. But you then admit this rate is just a proxy for the very thing you base your criteria of success on. Yeah, I agree that if the CB doesn’t do enough to raise inflation, inflation won’t rise. Why I should take MM seriously is a different matter.

  55. Gravatar of TravisV TravisV
    16. February 2016 at 21:25

    Great comment on David Henderson’s oil analysis:

    http://econlog.econlib.org/archives/2016/02/post_14.html#353589

    As David Glasner has said, expectations are fundamental!

  56. Gravatar of Kevin Erdmann Kevin Erdmann
    16. February 2016 at 21:28

    Shmebulock’s dietician must have a fun job.

    “So you say that if I eat more, I’ll get fatter, but when I asked you exactly how much I should eat, you said you couldn’t tell me that. You said, if I am gaining weight, then that probably means I’m eating too much. This is circular!”

  57. Gravatar of Prakash Prakash
    17. February 2016 at 00:48

    Prof. Sumner,

    There is a very interesting titbit hidden in here which might have very interesting implications (or might not).

    If debt contracts are even stickier than wages, does it make sense to target the income from capital (dividends + interest) for macroeconomic stability in the future?

  58. Gravatar of Scott Sumner Scott Sumner
    17. February 2016 at 08:24

    Crusher, Why do my stupid commenters always have to be so arrogant?

    I’ve said 100 times exactly what central banks need to do. They set a NGDP level target, and then adjust the monetary base until expected NGDP growth is on target. If they are too stupid to figure that out, create an NGDP futures market to tell them where the base should be. How hard is that to understand?

    Kevin, Good analogy.

    Prakesh, I don’t think so, because labor market instability is the much bigger problem. But it’s worth thinking about. Of course NGDP targeting is a sort of compromise, which addresses both issues.

  59. Gravatar of Kevin Erdmann Kevin Erdmann
    17. February 2016 at 08:29

    Prakash, I kind of agree with you. I think the most significant benefit of NGDP targeting would be from stabilizing capital income. But, good policy is invariably politically unpopular, so stabilizing NGDP is probably as close as we could get, and it would get pretty close to stabilizing capital income.

  60. Gravatar of Shmebulock, Crusher of Pussy Shmebulock, Crusher of Pussy
    17. February 2016 at 17:46

    Kevin Erdmann, even by the low standards of Scott’s idiot fan boys, you are a tool.

    Well Scott, you’re the one who appealed to the Wicksellian rate in response to E Harding’s statement about the Canadian CB. But we know (straight from the horse’s mouth) that what you mean by this is that the Canadian CB didn’t cause NGDP to fall because the Canadian CB didn’t cause NGDP to fall. If not circular, that definitely falls under the “no shit, Dick Tracy” category.

  61. Gravatar of ssumner ssumner
    18. February 2016 at 19:52

    Crusher, You are in way over your head. Why not take a course in monetary economics, and come back when you know something.

    For one last time—I answer the question that commenters ask, not the one you might prefer I had answered.

  62. Gravatar of Prakash Prakash
    18. February 2016 at 22:28

    Prof Sumner, Kevin,

    Thanks for your answers. I agree that a politically feasible (relatively) solution is better than a perfect solution. I had an intuition a while back about targeting a nominal growth path for wealth, but the stability of targeting capital income was probably what I was going for then.

    Targeting Risk based capital income (excluding land rent) might be very nice, but too many measurement problems and gaming problems would arise.

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