Archive for July 2012


Ryan Avent on monetary policy

Ryan Avent has an outstanding essay on monetary policy that traces out how monetary policy ended up on the wrong path:

But the total amount of spending in the economy is nothing more and nothing less than aggregate demand. If demand were higher, people would have spent more. If it were lower, less. Monetary policy, at all times, controls demand. In the short run, higher demand will generate an uncertain mix of changes in the economy””some price and wage increases but also some real output increases””so that higher inflation is, at all times, likely to accompany higher demand. There is no pure, sterile stimulus that the Fed can deliver that will bring higher real growth without higher prices, as Bernanke now claims he would like to do.

.  .  .

Central banks should focus their efforts on measures of demand — nominal GDP, nominal income, nominal spending””rather than measures of inflation. If nominal GDP is at a level that’s inconsistent with full employment, demand is too low and the central bank should do more. That might take inflation above some arbitrary level, and that’s totally fine. It won’t stay above that arbitrary level and accelerate unless the central bank keeps raising demand indefinitely. This is not to say that there are no costs to having 4% inflation for a year rather than 2%. There are surely some efficiency costs to changes in relative prices. But if the alternative is a trillion dollar output gap and 6 million unnecessarily unemployed workers, that’s probably a pretty good trade-off to make.

We learned a hugely important lesson from the Depression””that central banks could influence the economy and prevent demand-side macroeconomic disasters. But we took a wrong turn in thinking that the way they did this was by moderating inflation. It was as if we discovered a magical sword in the woods and then went about confronting enemies by whacking them with the sheath.

Read the whole thing.

I was perplexed by a recent Tyler Cowen post:

3. Price inflation and stock returns (pdf), and here, and here, and most recently here; “There is a consistent lack of positive relation between stock returns and inflation in most of the countries.”  I am urging a) a bit of caution, and b) engagement with the literature on this topic.  I do favor a more expansionary monetary policy, but I see the balance of evidence as different from how it is frequently portrayed in the blogosphere.

The study he cites looks at data from 1966-2009.  Market monetarists have argued that higher inflation did not help either the economy or the stock market prior to 2008.  After 2008 stock prices became strongly correlated with inflation expectations from the TIPS markets.  (David Glasner has documented this pattern, which is actually pretty obvious to anyone who followed the TIPS spreads and equity prices in recent years.)

Stocks and TIPS spreads became highly correlated after 2008 because the economy’s main problem was too little NGDP, and higher inflation expectations were correlated with higher NGDP growth expectations.  Prior to 2008 higher inflation merely pushed up real tax rates on capital.  Maybe I misread Tyler’s post, but he seems to imply that this study was somehow in conflict with the argument for monetary stimulus, when in fact it supports our argument.  Indeed the pattern found by David Glasner (and other researchers) may be the single most powerful piece of evidence in favor of our position.

PS.  Robert Hetzel sent me this interesting article by Dylan Matthews in the Washington Post:

Alternatively, the Fed could have targeted nominal GDP “” that is, the real size of the economy multiplied by the rate of inflation. This idea, made famous by Bentley University’s Scott Sumner and embraced by the likes of former White House chief economist Christina Romer, would have the Fed allow inflation to rise during an economic downturn, and tamp back on growth if inflation is getting too high during an upswing. Though Bank of Israel governor Stanley Fischer “” coincidentally, Ben Bernanke’s dissertation adviser “” hasn’t explicitly embraced this idea, economic wunderkind Evan Soltas has mustered some evidence that Fischer has been following this policy. Israel let inflation rise when the recession hit by the same amount as economic growth fell, and as a consequence, the economy quickly rebounded:

Source: Evan Soltas.

In the United States, by contrast, inflation stayed constant while both real and nominal GDP fell considerably:

Of course, the United States and Israel are very different countries and what worked for them may not have worked here. But the evidence suggests they were doing something right.

Does the Fed affect markets? And is the sky blue?

Casey Mulligan starts off a new column as follows:

New research confirms that the Federal Reserve’s monetary policy has little effect on a number of financial markets, let alone the wider economy.

Let’s start with the fact that everyone who works in the financial markets thinks this is nonsense.  Of course they also think the EMH is nonsense, and it’s true . . . er  . . .  truish.  But this time they are right.  Here’s the market response to the Fed’s unexpectedly large rate cut of January 3, 2001:

I presume this graph shows a futures market in Chicago, central time.  Does anyone want to take a wild guess as to what time of day (in Chicago) the Fed makes it’s interest rate announcement?  BTW, the more comprehensive S&P rose even more that day, by 5%.

And then there’s September 2007, when another larger than expected Fed rate cut was associated with an immediate rise of several hundred points.  And December 2007 when a smaller than expected rate cut was associated with an immediate fall of several hundred points.  Funny how the stock market often randomly goes completely nuts at 2:15 EST.  Even more amazingly, in the latter two cases the market thought that either a 25 or 50 basis point cut was likely, and using fed funds futures we pretty much know that roughly 5% of US (and world!) stock market wealth hinged on whether the Fed cut rates by 1/4% or 1/2%.  That’s a couple of trillion dollars folks.  I don’t think many people would regard that as “little effect.”

A question for younger academics who know more about this than I do.  What sort of studies show “little effect” on financial markets?  The announcement effects are obvious.  Are these academics relying on VAR models using quarterly data?  As my daughter would say, “I’m confuzzled.”

And that’s ignoring the fact that many monetary shocks don’t even show up in the fed funds market, an issue Mulligan overlooks in the rest of his column.

Yes, Mulligan is a UC economics professor.  And yes, Milton Friedman is spinning faster and faster in his grave.

PS.  The graph is from a Stefan Klossner paper linked to above.  Please tell me if I misspelled his name, I’m not good with German letters.

Magical realism in Latin America

Do you believe in magic?  I do.  I believe that if you have a country mired deep in a deflationary depression, you can spur a recovery simply by debasing its currency.  That’s right folks; to make a country richer you take the public’s money and make it worth less.  (Not worthless.)  If that doesn’t count as magic I don’t know what does.

Arnold Kling does not believe in magic:

Scott Sumner writes,

If the Spanish and Greek governments shrank enough to balance their budgets, they’d still have 24% unemployment, if not more. Their economies are hopelessly uncompetitive at the current exchange rate.

And if those countries had a huge currency devaluation, what would the unemployment rates look like? My guess: still more than 20 percent.

I believe that you could take a country with a Latin culture, and lots of statist policies, and a population about halfway between Greece and Spain, that was mired in a deflationary depression with more than 20% unemployment due to an ill-advised and rigid monetary regime (currency board) with no flexibility, and magically create a rapid recovery by simply debasing its currency.  And I believe you could still do that even if every other policy adopted by the government during the recovery was a horrible statist boondoggle that would, ceteris paribus, reduce RGDP.  That’s powerful magic; even Julio Cortazar could never dream up something so unlikely.

The world’s least sentimental economist

I noticed this article:

NEW YORK (CNNMoney) — During tough economic times with high unemployment, Americans should be jumping at any chance to work, but trucking companies are struggling to hire drivers.

There are as many as 200,000 job openings nationwide for long haul truckers, according to David Heller, director of safety and policy for the Truckload Carriers Association.

The U.S. Bureau of Labor Statistics also sees the demand for truckers increasing, up from the 1.5 million drivers on the road now. It expects trucking to add 330,100 jobs between 2010 and 2020, an increase of 20%.

But these positions are difficult to fill, and even harder to keep filled.

“Nobody wants to drive a truck,” said Heller.

The pay isn’t bad: Truckers earn a median annual wage of $37,930, which is $4,000 more than the median wage for all jobs, according to the BLS. The top 10% of truck drivers make more than $58,000 per year.

You’ve already jumped to conclusions.  You’ve formed an opinion.  And it’s wrong (unless your first name is Bryan.)

So what do we do about this trucker shortage?  Raise wages?  Why should they do that?  They are monopsonists.  We need to bring in 200,000 Mexican truckers, pronto.  Except there’s just one problem, a bill to do so would not attract a single vote in Congress.  Why not?  Because Congressmen are sentimental.  Conservatives should support it, because it’s a Reaganite pro-growth, pro free-market idea.  Liberals should like the fact that while it might reduce the welfare of American workers a bit, it will be more than compensated by a big boost the the welfare of the much poorer Mexicans.  And after all, we’re all people, aren’t we?

Actually we aren’t.  We are nationalists.  Conservatives recall a golden age in the 1950s when our demographics were dominated by Anglos.  Liberals remember a golden age in the 1950s when American truckers earned high wages, thanks to Jimmy Hoffa.  Both groups are sentimental, and hence both would oppose the idea.

Who would favor it?  I’m pretty sure Bryan Caplan would, who I designate “the world’s least sentimental economist.”  He recently did a wonderful post that is a sort of riff on an equally excellent post by Matt Yglesias (Of course I’d say Matt’s post is excellent, I’ve made similar arguments, just not as cleverly.)

Bryan tries to show that poor people are not victims; it’s their own fault.  And he shows that this follows from the exact same logic used by Yglesias.  Now Matt Yglesias is himself pretty damn unsentimental compared to almost all progressives, but he’s not even in Caplan’s league for ruthless, cold-blooded, logical, unsentimental analysis (except perhaps when right-wing pundits die at a young age.)  So I’m pretty sure he’s not going to sign on to Caplan’s logic.

Now I’ve changed my mind, I don’t think Caplan’s the least sentimental economist.  That’s because Caplan doesn’t take his cold, hard, ruthless logic far enough.  Let’s say that people are poor due to behavioral problems.  Let’s suppose some of them are too impatient, or don’t study hard enough.  Why would that be?  Do they want to fail?  Did they choose to be born in that neighborhood, that family, that body?  Clearly not, they’d probably rather have been born in one of those Tolstoyan families that are all alike.  It’s not their fault; it’s bad luck.  When you start thinking about this in a completely unsentimental way, there are no longer any “just deserts.”  Indeed push this line of thought far enough, and you might end up  . . . God forbid . . .  a utilitarian.

That’s why Bryan is not the least sentimental economist in the world.  I am.  Which means I’m probably a horrible person.

Ezra Klein’s stimulus proposal

Tim Duy sent me an interesting proposal by Ezra Klein:

I am convinced that there is something more the Fed can do, and that now is the right time for them to do it. I call it Uncle Ben’s Crazy Housing Sale.

Tomorrow morning, Bernanke could walk in front of a camera and announce that the Federal Reserve intends to begin buying huge numbers of mortgage-backed securities with the simple intention of bringing the interest rate on a 30-year mortgage down to about 2.5 percent and holding it there for one year, and one year only.

The message would be clear: If you have any intention of ever buying a house, the next 12 months is the time to do it. This is Uncle Ben’s Crazy Housing Sale, and you’d be crazy to miss it.

This is a particularly good time for Uncle Ben to launch his sale, because the housing market appears to be turning: More houses are being built, the price of existing homes is beginning to rise, and inventory levels are falling. A recent Wall Street Journal poll of economic forecasters found that 44 percent thought housing had bottomed out, while only 3 percent thought the housing market had further to fall.

This isn’t going to happen for a variety of reasons.  But even though it’s neither my first nor second choice, it’s an interesting proposal and might be re-shaped into something that’s “worth a shot.”  So here’s my attempt:

1.  No discussion of “crazy” and no discussion of housing (I presume he was kidding about crazy’.)  Let news people tell the public what it implies about when to buy housing.  Just say you are trying to reduce rates to spur aggregate demand.

2.  Target the 10 year bond, not the 30 year bond, and target a lower rate, not the current rate.  Thus set a 1.25% peg for the 10 year.  I like Klein’s 1 year window, I think that’s about right.

3.  Announce that the policy will terminate if it seems to be working, and will continue beyond one year if not.  This is why I propose 1.25%, not the current 1.5%.  The idea is not to have tight money after one year, but just return to the current policy (status quo ante for you ancient Romans) if the plan worked.  It’s like a sales tax holiday that gets everyone out shopping on a given weekend.

4.  Is it possible to (routinely) replace the fed funds rate with the 10 year T-bond yield as a policy target once rates hit zero?  I’ve never given this much thought, but then I’m no Keynesian.  I’m kind of surprised this hasn’t received more discussion.  I think Nick Rowe is right that the Fed’s lack of ability to communicate effectively once rates hit zero was a big problem.  So why not keep communicating using longer term bonds? I suppose the recent promise to keep short rates low for a specified period tries to do the same thing. But that ties the Fed’s hands for much longer.  I’m just thinking out loud here, but it seems like the one year promise on a long rate provides less risk of allowing inflation to become unanchored (a risk I think is pretty low right now, but can always pop up when targeting nominal rates) as compared to promising to keep short rates low until 2015 or whenever. Is there a model that supports this intuition?

In June I did a post with my second choice (NGDPLT is number one) which was to have the Fed promise open-ended QE continually until certain macro objectives were achieved.  A few days ago I did a post pointing out that the Fed is now considering a similar idea.  Tim Duy sent me a link to a Jon Hilsenrath WSJ piece that confirms this idea is under consideration, and also that lower IOR is being considered.  That brings me a certain satisfaction as my very first blog post (after the welcome post) was on the topic of IOR, pointing out that it was contractionary.  I think I was a bit ahead of the curve on that issue (along with David Beckworth and a few others.)  In any case Hilsenrath said negative IOR is unlikely, and even I would agree there are probably better ways to do stimulus, as it might screw up the money market industry.  But even a lower rate would be a modest step in the right direction.

Hilsenrath suggests the Fed’s mood is definitely one of increased frustration—with most officials viewing the economy’s recent trajectory as unacceptable.  I think it’s easiest to think of that in terms of NGDP.  He mentions the disappointing 2% RGDP growth rate, but if the deflator was going up at 4% it would be much harder to make a case for stimulus.  If Q2 NGDP growth is around 3%, look for much more pressure for stimulus.

PS.  If you are wondering how my first post began, it was with a quotation:

“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

What better way to distinguish market monetarism from old-style monetarism—V matters too!

Off topic:  I get lots of span comments that you guys never see—they get deleted.  Other bloggers will know what I mean, as they almost all sound roughly the same (Hi, I love your writing style, where can I learn more about your blog?”) with commercial addresses attached for dog grooming or whatever.  A few are so bizarre they are amusing.  Here’s a recent one from “Afghanistan Directors:”

I’m comfort acquisition from you, but I’m trying to achieve my goals. I utterly copulate reading all that is posted on your site. Save the tips future. I enjoyed it!

All I can say is I also utterly “love” reading comments like yours.  And BTW, you might consider getting a new thesaurus.