Archive for February 2009

 
 

Should the Fed engage in insider trading? Maybe.

Earlier I argued for Lars Svensson’s definition of policy efficiency, equate the policy forecast and the policy target.  (Bernanke sort of endorses Svensson’s idea here.)  In other words, if your goal is 5% growth in nominal GDP, then increase the money supply until nominal growth is expected to be roughly 5%.  But what if conventional monetary policy has run out of ammunition, if buying ever more zero yield T-bills has no effect?

Some are now advocating unconventional open market purchases, involving long term bonds, stocks, and Hamilton even suggested foreign bonds.  If the policy of reflation succeeds then long term T-bond prices might fall, but stocks and foreign bonds might well appreciate in value.  This is important because bank reserves have risen to more than 10 times their normal level, and it is widely expected that the Fed will have to sell some assets to rein in the monetary base once we escape from the “liquidity trap.”


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Krugman vs. Hamilton/Cole/Ohanian on FDR’s high wage policy

There’s been a lot of recent debate about Cole and Ohanian’s claim that FDR’s New Deal slowed the recovery.  Here I’ll focus on his high wage policies, which Krugman argues could have actually increased output (as the AD curve may slope upward in a liquidity trap.)  While there are lots of sophisticated econometric studies (often using highly misleading annual data), I don’t know of anyone else who has simply looked at the monthly industrial production data around each wage shock.

There were actually five wage shocks, four of which are easily dated.  As part of the National Industrial Recovery Act, FDR ordered an across the board 20% hourly wage increase in late July 1933, and then further increases in the spring of 1934.  At the same time the workweek was reduced about 20%.  The NIRA was declared unconstitutional in 1935, but a minimum wage was instituted in November 1938, and raised a year later. To say the IP data is bad for the Krugman interpretation would be an understatement.  These numbers are horrendous:


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Friedman’s 4% Rule, Version 2.0

I need a short post.  Here’s a monetary policy for all seasons:

Have the Fed commit to buy and sell unlimited quantities of 12 month forward nominal GDP futures.  The price paid by the Fed will start at a level 4% above current nominal GDP, and rise by 4% per year.

The purchases and sales will constitute open market operations, and will continue until the monetary base settles at a level expected to produce 4% nominal growth.  Voila, no need for DSGE models, no liquidity traps, no worries about policy lags.  Dual mandate addressed.  It even overcomes Bernanke and Woodford’s “circularity problem,” as the market doesn’t just forecast GDP, it forecasts the instrument setting required to meet the Fed’s target GDP.


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Do We Want Civil Engineers to Predict Bridge Failures?

No.  We want them take whatever steps necessary to prevent bridge failures. At least if given the tools and resources to do so. We now have an economist leading the Federal Reserve, and have given the Fed almost unlimited power to print currency and buy tens of trillions of dollars worth of various assets. We have also given them the responsibility stabilizing the macroeconomy using the best economic advice available. Do we really want economists to be able to predict recessions? As James Hamilton noted:

“You could argue that if the Fed is doing its job properly, any recession should have been impossible to predict ahead of time.”

Strictly speaking, Hamilton’s observation only applies to recessions caused by demand shocks, but in practice, supply shocks are also pretty unpredictable.


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Hume and Hall call out the Fed

“If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.” David Hume — Of Money

Consider the following: For the first time in its 95 year history, the Fed begins paying interest on bank reserves on October 6, 2008. The U.S. stock market falls roughly 40% in 2008, with over one half of the decline occurring in the first ten days of October. Much as I’d like to draw a connection, I know of no evidence linking these two events. Even so, Susan Woodward and Robert Hall found this policy just as puzzling as I did:

“Oddly, he [Bernanke] explained the new policy of paying 1 percent interest on reserves as a way of elevating short-term rates up to the Fed’s target level of 1 percent. This amounts to a confession of the contractionary effect of the reserve interest policy.”


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