Take it easy ECB; don’t over exert yourself

In recent months there has been a rising chorus of calls for fiscal stimulus, from pundits all over the world.  If I didn’t know better I’d conclude that the world’s major central banks had run out of paper and ink, and that only fiscal policy remained effective.

And then I get jolted back into the real world:

Many international investors had feared a Brexit vote would undermine the EU and hurt business and market confidence across the euro zone. But surveys point to little impact so far.

As a result, many banks are revising forecasts for further European Central Bank stimulus. JPMorgan says it no longer expects the ECB to cut rates or announce an extension of its bond-buying programme in September after solid growth data.

Well that’s a relief.  For a moment there I had thought that there were other reasons why the ECB might prefer to adopt a policy of monetary stimulus:

Screen Shot 2016-08-28 at 10.01.06 PMSeriously, I don’t think I ever recall a time when so many economists were so out of touch with what’s actually going on in the real world.

As usual, Paul Krugman is able to express my frustration much better than I can. Here’s what he wrote in 1999, one year after his famous 1998 liquidity trap paper that he always likes to cite, and at a time when a bunch of pundits were insisting that Japan needed fiscal stimulus:

“What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?”

PS.  For years I had wondered if I was the first to publish a paper discussing negative IOR as an option.  Not surprisingly, I was not.  Marvin Goodfriend of the Richmond Fed did so in 2000.

 


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34 Responses to “Take it easy ECB; don’t over exert yourself”

  1. Gravatar of Gary Anderson Gary Anderson
    28. August 2016 at 21:47

    Kevin Erdmann said something interesting. He said that if banks loaned against their excess reserves the Fed would probably just lower the amount of reserves in the system.

    And besides, as I wrote (article at my name), the banks want a little raise in yields so they can get a boost from IOR, which is like a welfare check to them from the people.

    It is the counterparties and clearinghouses that are at risk. The banks are fine, but the folks with most of the collateral are counterparties to the banks. Greenspan wanted it that way. He wanted TBTF and he got it.

    Of course, the counterparties can’t provide enough collateral to the casino if the Fed raises yields. You think bonds are hoarded now. Wait till short rates are raised and you will see a massive “conundrum” of demand for long bonds. And of course, really, it is not a conundrum at all. Even Greenspan knew this and said:

    “To be sure, the benefits of derivatives, both to individual institutions and to the financial system and the economy as a whole, could be diminished, and financial instability could result, if the risks associated with their use are not managed effectively. Of particular importance is the management of counterparty credit risks. Risk transfer through derivatives is effective only if the parties to whom risk is transferred can perform their contractual obligations. These parties include both derivatives dealers that act as intermediaries in these markets and hedge funds and other nonbank financial entities that increasingly are the ultimate bearers of risk.”

  2. Gravatar of W. Peden W. Peden
    28. August 2016 at 23:56

    I reall do wonder if this is as simple as people thinking that-

    FISCAL STIMULUS

    Strengths: boosts growth.

    Weaknesses: increases public debt.

    MONETARY STIMULUS

    Strengths: prevents deflation, which causes problems because people delay purchases to profit from price decreases. Therefore, can have some positive effect if prices are falling.

    Weaknesses: inflation and low interest rates hurt savers, especially poorer savers who can’t afford to take on risky investments, so monetary stimulus can hurt those on low incomes. Can also cause bubbles and increase inequality.

    Insofar as you can put together a model out of all the popular mistakes about fiscal and monetary stimulus, it looks something like the above. Ugh.

  3. Gravatar of Ray Lopez Ray Lopez
    29. August 2016 at 00:06

    I’m not sure Sumner is the best authority for summarizing Krugman’s views. Krugman changes his views over time, and what he advocated in 1998 or 1999 may not be his view today.

    @Gary Anderson – thanks but why would anybody care what Keven Erdmann says about a hypothetical? Erdmann looked at the housing bubble in the USA and came to the ludicrous conclusion that there was no bubble. Reminds me of a revisionist take on the Dutch Tulip Mania by Peter Garber back in the 1980s that concluded it was “rational”, no bubble, due to the scarcity of the tulips at the time. Amusing but absurd. Kind of like this blog.

  4. Gravatar of Christian List Christian List
    29. August 2016 at 02:53

    That was the reasonable Krugman back in 1999. Not the crazy Krugman of today who talks about fiscal stimulus, politics and “liquidity traps” all the time. So what happend in all those years? Did the reasonable Krugman get hit by a truck?

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    29. August 2016 at 04:36

    Off topic, unless it’s the general inability of economists to communiate textbook principles to the general public, but has anyone seen any commentary about EPI-PEN that mentions either ‘discriminatory pricing’ or Obamacare?

    http://www.wsj.com/articles/mylan-to-launch-cheaper-generic-epipen-alternative-1472467730

    ———–quote———-
    Mylan NV on Monday said it would launch a generic alternative to EpiPen at a 50% discount after being criticized for dramatically raising the price of the lifesaving drug.

    The company said it would list the authorized generic—which will be identical to the branded product—for $300 per two-pack carton. Mylan said it expects to launch the generic in “several weeks,” after labeling revisions.

    ….Chief Executive Heather Bresch. …said bypassing the brand system and offering an additional alternative was the best option “because of the complexity and opaqueness of today’s branded supply chain and the increased shifting of costs to patients as a result of high deductible health plans.”
    ————–endquote————–

    Krugman? …Krugman?

  6. Gravatar of Chuck Biscuits Chuck Biscuits
    29. August 2016 at 05:04

    @Christian List

    Are you being sarcastic, or just stupid?

  7. Gravatar of ssumner ssumner
    29. August 2016 at 05:41

    W. Peden, I have the same fear.

    Christian, I also wonder what happened.

  8. Gravatar of Gary Anderson Gary Anderson
    29. August 2016 at 05:56

    @Ray Kevin would not really say that there was no speculation. He has said there was speculation. He just says, rightly, that the entire subprime did not deserve liquidation by the Fed failing to buy commercial paper in mid 2007. I happen to agree with that. There was plenty of subprime that was soundly underwritten, but 4 states led to a complete liquidation of subprime, and ultimately, as Marcus Nunez has said, once the Fed took away HELOC financing a year later, the whole economy entered the Great Recession.

    If you read the article at my name on this post you will see that the Fed destroyed subprime in states where prices remained low. The Fed even saved junk bonds over MBSes. The Fed saved what it wanted to save, probably because it wanted certain bonds saved for the derivatives markets.

    And that resulted in home ownership being severely curtailed for main street, and in millennials who do not want to buy houses because they know real estate prices are not stable.

  9. Gravatar of Benjamin Cole Benjamin Cole
    29. August 2016 at 08:55

    Not only the ECB. The oddsmakers (and our new favorite regional Fed banker, Ester George) say a Fed rate hike may be on the way.

    I guess sending in the Sikorskys is not on the table.

  10. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    29. August 2016 at 09:05

    One person’s big time inconsistency often happen. Don’t blame it.
    Well, is he using IS-LM?

  11. Gravatar of Ray Lopez Ray Lopez
    29. August 2016 at 10:54

    @Gary Anderson – I happen to agree with you that the Fed selectively saved who they wanted, and expanded their balance sheet from below 1T to 4T in part by buying toxic, junk mortgages from their pet member banks. Our host, however, thinks that once this toxic paper was bought by the Fed, it magically turned good, and it’s as “good as gold”. Sounds like magical thinking to me, but I’m not the money expert. I wish he would blog on that topic to educate us (lol).

  12. Gravatar of Major.Freedom Major.Freedom
    29. August 2016 at 15:51

    We are almost certainly in the biggest debt bubble the world has ever seen, courtesy of the central banks.

    With the massive transfer of spending and price inflation away from a good chunk of the “basket” of consumer goods and services, and towards bonds, housing, tuition, healthcare, and other significantly debt related expenditures, the last thing the world needs is more money printing.

    It is not the aggregates that matter. It is the relative values that matter, for it is the relative values that direct resource allocation, and stable resource allocation requires a free market in money. Fist money gives us perpetual business cycles towards monetary breakdown sooner or later.

  13. Gravatar of Major.Freedom Major.Freedom
    29. August 2016 at 15:59

    Yeah ECB, Japan is now the new psycho standard:

    http://wolfstreet.com/2016/08/29/qe-end-of-private-sector-japanese-government-now-largest-shareholder-of-474-companies/

    Listen to Sumner. His socialism is called libertarianism.

  14. Gravatar of Gary Anderson Gary Anderson
    29. August 2016 at 20:00

    @Ray

    I make the case in my article that the GSE’s bought the subprime mortgages and from then on they were guaranteed. That happened alot, even after the crashes.

    I am not sure what you mean about toxic paper. The Fed, being lender of last resort exchanged treasury bonds for paper from frozen markets, frozen mainly because Basel 2 mispriced the risk from David X Li’s copula, and as far as I know, is just keeping paper until the bonds reach maturity. I guess they have tried to get rid of some of them.

    I think the Fed then exchanged many bonds for excess reserves, since the Fed had run out of bonds. Kevin said the sterilization of those reserves sent to the banks was through withholding credit to the subprime market.

    It would be nice if people did studies on the timeline of all that. Clearly the Fed failed to protect the commercial paper market until AFTER it crashed. The Fed just twiddled until this happened: https://fred.stlouisfed.org/series/COMPOUT

    The commercial paper market was the foundation of commercial banks’ involvement in financing subprime. When that market was permitted to crater, subprime was dead, even the good subprime, and people lost their houses. Now prices are as high or higher in many of the markets that saw lending evaporate due to the Fed’s failure to save the commercial paper market.

    And the Fed was responsible. It finally opened a commercial paper facility, BUT IT WAS TOO LATE TO SAVE MAINSTREET.

    The Fed took part in the biggest, and most dishonest, real estate theft in modern times.

    But as Kevin said, the Fed didn’t have many bonds to exchange for

  15. Gravatar of Chuck Biscuits Chuck Biscuits
    30. August 2016 at 04:00

    @MF

    Agreed, “libertarian” Sumner seems totally fine with central banks controlling more and more economic activity.

    BTW, even a casual glance at the pronouncements coming out of Jackson Hole last week reveals that central banks are urging governments to get involved with some kind of fiscal policy. Maybe academic bloggers think central banks cannot run out of ammo, but the people actually running these organizations seem to disagree.

  16. Gravatar of Joe Leider Joe Leider
    30. August 2016 at 05:29

    Good post. Not sure if you’ve seen yet, but the Economist seems to be jumping whole hog into the market monetarist camp. The last three articles I’ve read from them on monetary policy shows that they seem to completely get it now, which is nice.

    http://www.economist.com/blogs/freeexchange/2016/08/jackson-lol

    http://www.economist.com/news/finance-and-economics/21705832-should-fed-adopt-indias-inflation-target-jackson-four

    http://www.economist.com/news/leaders/21705826-rich-worlds-central-banks-need-new-target-when-2-not-enough

  17. Gravatar of Joe Leider Joe Leider
    30. August 2016 at 05:34

    Chuck Biscuits, central banks already control the expected path of NGDP growth, they just don’t know it yet. Either they explicitly target a path that allows debt contracts to clear without periods of massive unemployment, or they end up like a child pulling levels this way and that without taking any responsibility for the result. Then they can blame the banks like in 2008, or blame the lack of fiscal policy, and we’ll get more and more statism over time.

  18. Gravatar of Chuck Biscuits Chuck Biscuits
    30. August 2016 at 05:57

    @Joe Leider

    Again, a blog commentor who thinks he knows more about the operations of central banks than the bankers themselves. Why are market monetarists so eager to make fools of themselves?

  19. Gravatar of Brian Donohue Brian Donohue
    30. August 2016 at 06:11

    Good post, Scott! Say it over and over.

  20. Gravatar of ssumner ssumner
    30. August 2016 at 07:43

    Chuck, You said:

    “Agreed, “libertarian” Sumner seems totally fine with central banks controlling more and more economic activity.”

    I see you are trying to compete with Ray for title of the class clown. I have proposed exactly the opposite.

    You said:

    “Maybe academic bloggers think central banks cannot run out of ammo, but the people actually running these organizations seem to disagree.”

    Actually they do not. Bernanke used to mock the idea that central banks could ever run out of ammo. Neither the BOJ nor the ECB say they are out of ammo, indeed the BOJ just said a few days ago that they have lots more ammo left.

    In the future you might want to actually learn something about the subject you comment on, if you don’t want to end up like Ray and Gary.

    Thanks Joe and Brian.

  21. Gravatar of Gary Anderson Gary Anderson
    30. August 2016 at 08:29

    @Scott: I never said that the Fed was out of ammo, Scott. Ray may have, but I never said that.

    I said the Fed is afraid of counterparty risk and the creation of a need for more bond buying, more collateral needed, which could cause problems if rates are raised. That is all I said. Greenspan said virtually the same thing back in 2007 when he said counterparty risk to the banks is the most important concern going forward. It still is.

    My only gripe with market monetarism is that it doesn’t speak to the relentless decline in long bond yields taking into account the massive demand for them and hoarding of them in the system Greenspan essentially created.

    I think the Fed thinks it can get away with a few little raises to give the banks their welfare checks on excess reserves. You even agree that is wrong.

  22. Gravatar of Randomize Randomize
    30. August 2016 at 10:38

    Re: Major Freedom,

    It’s true that buying common stock gives the central banks (unwanted?) control over private companies. However, that’s not the case for bonds and I would argue that if the central banks aren’t able to find enough bonds to buy, it’s because they aren’t offering high enough prices. Companies aren’t stupid and will gladly sell debt to buy back stock if the banks drive interest rates low enough.

  23. Gravatar of Joe Leider Joe Leider
    30. August 2016 at 11:15

    @Chuck Biscuits – it doesn’t take a genius or a banker to know that:

    1) You say your target is 2%
    2) You assure markets that you’re so in danger of overshooting your target that you need to tighten
    3) You’ve been saying this almost every quarter, but you haven’t overshot it by even a little bit in 4 years

    Then you’re not doing a very good job.

  24. Gravatar of Bill Ellis Bill Ellis
    30. August 2016 at 11:38

    hey Major freedom…So this is where inflation has been hiding for eight years now ??? LOL

    “With the massive transfer of spending and price inflation away from a good chunk of the “basket” of consumer goods and services, and towards bonds, housing, tuition, healthcare, and other significantly debt related expenditures,”

    MF, you have been selling this same doom at least since 2009…and yet the bubble never pops…

    I think Scott’s whole “bubbles don’t exist” story is wrong…but when it comes to bubbles as you understand them…i’d say he’s right…

    so MF…when is this massive debt bubble going to blow up..??? Will it cause inflation ? Deflation !
    Tell us all you see !

    When ? Someday ? If you can’t put an expiration date on it… it’s statistically random… and meaningless…

    But you are guaranteed to die having at least never been proved wrong on it…

    Nice….

  25. Gravatar of Christian List Christian List
    30. August 2016 at 14:29

    @Chuck
    “Are you being sarcastic, or just stupid?”

    I’ll give the question back to you. At least people like Ray and Major are polite and/or funny. You are neither. You are just stupid. I don’t think we’ll need an unfunny rude version of Ray here.

  26. Gravatar of Major.Freedom Major.Freedom
    30. August 2016 at 15:19

    Bill Ellis:

    “hey Major freedom…So this is where inflation has been hiding for eight years now ??? LOL”

    It isn’t hiding. Inflation is an increase the in the money supply. What people do with the inflation is a separate, but related question. You have already flame baited this point at least twice in the last couple of months.

    With respect to price inflation, perhaps you do not look at all prices. With the substantial decline in so-called velocity, the inflation has had a less than one to one effect on prices. But I am not and never have been fear mongering or even raising any alarm bells on prices. I do not look at aggregate prices. Even if prices are flat, or falling, I still focus on real economic coordination. Coordination is hampered not more or less along with aggregate price inflation, but rather along with relative price inflation.

    Regardless of whether aggregate prices are rising or falling, the central bank is, by virtue of it operating outside the system of private property subject to profit and loss, distorting the economy that is so subject.

    You have me confused with those people who try to gain popularity by predicting the CPI or some such. I am not one of those people.

    “With the massive transfer of spending and price inflation away from a good chunk of the “basket” of consumer goods and services, and towards bonds, housing, tuition, healthcare, and other significantly debt related expenditures,”

    “MF, you have been selling this same doom at least since 2009…and yet the bubble never pops…”

    WELL WHEN YOU ARE LIVING IN LA LA LAND, where the bubble bursting in 2008-2009 somehow did not exist, nor the previous bubbles, then yes of course your brain will contain the belief that bubbles never exist and have never burst.

    The boom of the 1920s last ten years.

    The business cycle is NOT subject to any objective law of length of time or frequency. Every bubble is different in composition, as well as in the people’s information, learning, and other factors.

    If you understood economic theory, then you would know that bubbles can be lengthened over time if the errors can be spread across a larger capital domain. It is obvious that with the world being the most connected it has ever been in terms of capital allocation, with worldwide central bank coordination of inflation, that the opportunity for booms to last for a long time is very highly probable.

    It is like the difference between a small house being built over a month, and a Superdome sports arena being built over 10 years. If there is an error in calculating the quantity, quality, and cost of materials, it is not surprising that errors would be caught earlier with the small house than with the Superdome. For the complexity and length of time taken to complete each building is drastically different.

    What you are saying is effectively “Hey, if it has taken on average 2 weeks for the builders of small homes to learn of their errors, then it should take the exact same time to learn of errors for everything else than can possibly be built no matter how big or how complex. But because I haven’t seen a bust for at least 2 weeks now, it means you saying there are errors is foolishness and it is making me feel scared so I dislike what you say and conflate disliking it for being theoretically wrong.”

    Bill, your theory is garbage. There is no possible way you could even understand what it is you are fumbling over yourself trying to insult, for you to be saying anything that is in any way a contribution. All you have are your gut feelings.

    If you have anything SUBSTANTIVE, please I am all ears. Anything but this metaphorical sticking your fingers in your ears and just spewing disagreement will be a welcome change.

  27. Gravatar of Major.Freedom Major.Freedom
    30. August 2016 at 15:21

    Joe Leider:

    “… central banks already control the expected path of NGDP growth, they just don’t know it yet.”

    Central banks control the expected path of my own salary, they just don’t know it yet?

  28. Gravatar of Gary Anderson Gary Anderson
    30. August 2016 at 17:34

    Hey guys, part of the bubble bursting was the taking away of credit. So, the bubble may not have been such a big bubble had the Fed bought commercial paper allowing the bad loans to stay with the SIVs instead of migrating back onto the balance sheets of the commercial banks which financed subprime.

  29. Gravatar of Chuck Biscuits Chuck Biscuits
    30. August 2016 at 17:41

    @christian list

    Instead of spending time in the choir wondering why Krugman departed from the true path of market monetarism or New Keynesianism (no real difference), why don’t you simply ask him what’s wrong with his 1998 argument about central bank “credibility”? After, if all that was required for Japan to escape a liquidity trap was for the CB to take “credible” action, it should hold true today as well, no? What’s changed? You should find out, since YOU’RE the one who’s puzzled. (My guess is Krugman realizes the argument is stupid since it’s operationally vacuous and meaningless.)

  30. Gravatar of Chuck Biscuits Chuck Biscuits
    30. August 2016 at 17:44

    I should add, Krugman is indeed a partisan asshole, but he at least seems intellectually honest enough to reexamine his position. That’s a lot more than can be said about market onetarists.

  31. Gravatar of ssumner ssumner
    31. August 2016 at 17:10

    Chuck, Krugman still points to the 1998 paper as his current view. You really ought to do some research on this stuff, or else stop blabbering on things you know nothing about.

    When Abenomics started working in 2014, Krugman said it was because they were following the ideas in his 1998 paper.

  32. Gravatar of Chuck Biscuits Chuck Biscuits
    1. September 2016 at 03:53

    Krugman always supported Abenomics because he viewed it as comprising three pillars: monetary, fiscal, and structural. It failed (to the extent it could ever be said to have been “succeeding”) because it pursued monetary policy only. Fair point that maybe his views have not changed as much from 1998 as I claimed. However, Krugman was never a simplistic market monetarist, so puzzlement over “what happened” to him is totally misplaced.

  33. Gravatar of ssumner ssumner
    1. September 2016 at 05:10

    Chuck, Wrong, and wrong again. Abe ran a contractionary fiscal policy during his first few years (huge VAT increase), so Krugman gave fiscal policy zero credit back in 2014. And structural reforms were trivial, and Krugman doesn’t think those matter anyway. Krugman said it ended deflation because it shifted expectations by raising the inflation target.

  34. Gravatar of Chuck Biscuits Chuck Biscuits
    1. September 2016 at 18:16

    That’s rather the point, isn’t it? Fiscal offset.

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