Housing starts February 2008 = 1.10 million.  Unemployment = 4.9%

Housing starts November 2013 = 1.09 million.  Unemployment  = 7.0%

It’s not about housing, and never was.

PS.  Alex Tabarrok has a very good post on Robert Shiller’s proposal for “trills,” which would be Treasury bonds with interest payments indexed to (one-trillionth of) nominal GDP.  He sort of skims over the most important use, however.  The market price of the interest payments (sold as a derivative) would be a market forecast of NGDP, available in real time, and hence could be pegged by the Fed.

I proposed the creation of a nominal GDP futures market in a paper published way back in 1989. Tabarrok concludes with the following observation:

I featured Shiller’s work on macro markets in my book Entrepreneurial Economics: Bright Ideas from the Dismal Science. I think of this body of work as his most visionary and deserving of the Nobel.

Naturally I agree.

1.  Dow was up almost 300.  This is a reasonably expansionary move.  Not a game changer, but significant.

2.  Lots of wild swings, but ten year yields ended almost unchanged.  That tells us that the liquidity effect and the longer term effects (from faster expected NGDP growth) were both powerful, but fought to a draw. A classic example of how interest rates tell us very little about the stance of monetary policy.  The simplistic liquidity view is clearly wrong.  The simple contrarian view is also clearly wrong.  It’s complicated.  I’ve always believed it’s complicated, but some of my past posts emphasized the contrarian view, and today made those posts seem off base.  As did the modest run up in rates when taper talk first surfaced. I need to be more clear. But we also learned in September that most of the run-up was due to stronger growth expectations, perhaps only about 20 basis points was taper talk.

3.  Back in 2009 and 2010 I frequently argued that the fiscal multiplier might be negative.  Many people had trouble understanding this idea, which was based on monetary offset overreaction.  Suppose Congress does nothing in 2009.  Bernanke thinks; “Oh my God we have a Great Depression on our hands.”  He doesn’t want to go down in history as the Fed chair who presides over another Great Depression.  Not after being a scholar who devoted his life to showing how the Fed could have prevented the Depression.  My claim was that in the absence of fiscal stimulus the Fed would have offset Congress’s failure with some really powerful monetary stimulus, probably the level targeting that he recommended to the Japanese, but which the Fed itself never did (perhaps because Bernanke could never convince “Fedborg.”)

OK, but that’s just monetary offset, a zero multiplier.  How could I claim the multiplier might be negative? The second part of my argument was that the Fed overestimated the power of QE and underestimated the power of forward guidance, such as level targeting.  Had there been no fiscal stimulus, they would have done something else dramatic in order to prevent a depression.  And that “something else” would have been far more powerful than the Fed anticipated, indeed more powerful than QE plus the ARRA fiscal stimulus.  Some of what Bernanke calls “Rooseveltian resolve.”

So how does today support my negative multiplier theory?  The Fed felt uncomfortable doing so much QE. They wanted to taper.  But they didn’t really want to tighten.  So they tried to offset the taper with a modest increase in forward guidance.  But they didn’t realize how powerful forward guidance is, and actually ended up more than offsetting.  Much more.  It’s like the first time I went to England and had a few pints of beer.  The pint glass was much bigger than in America and it was 6% alcohol, not 3.5% like American “beer.”  I was almost drunk.  Or to paraphrase Bob Dylan:

The Fed started out on burgundy but soon hit the harder stuff.

[Check out map of the battle at the bottom of post before reading]

Initially the people of the concrete steppes had the upper hand.  Emboldened by the cry of “taper now!” they charged Woodford’s army and pushed them back.  It looked like the battle was over, as the initial push in these economic battles usually determines the final outcome.  Indeed this pattern is sometimes called “the efficient battle hypothesis.”

But Woodford’s army regrouped and charged to the call for Forward Guidance!! They pushed back and regained all of the lost ground, and then some.  By 2:30 in the afternoon it was the people of the concrete steppes who were on the run.  It looked like nothing could stop the NKs.

But wait, a third army suddenly swept onto the field!  Sensing that Woodford’s army was weakened by the long battle, the market monetarists rallied to the cries of “income effect” and “Fisher effect.”  Woodford’s early successes actually helped the market monetarists, by convincing everyone to be more bullish.  That meant Woodford’s army was over extended, as it relied exclusively on the liquidity effect and was mired in bearish territory.  His soldiers became confused by cause and effect.  Which way do we go Mr. Woodford!?!?!?!

By late afternoon it began it look the like the Korean peninsula in 1953.  The battle had raged back and forth, and the front lines ended up little changed from the beginning.  One can only imagine the mood swings of the spectators.  When stocks shot up Mr. Williamson had sudden visions of a Nobel Prize in economics. But those hopes were quickly dashed by the charge of Woodford’s army.  He had forgotten about the forward guidance.  Mr. Krugman was able to maintain an upbeat mood by continually revising his analysis, from “taper talk” to “promise to be irresponsible,” to “none of this really matters because we are at the zero bound stupid.”  He was much more clever than the other spectators, and was prepared for any outcome.  He was determined to be proved right, whatever happened.

I thank Nick Rowe for the concrete steppes metaphor.

Here’s what I recommended back in October:

The forward guidance policy announced last fall was widely seen as a partial victory for the NGDP targeting approach:

1.  It combined inflation with a variable closely linked to RGDP growth.

2.  It made policy conditional on the state of the economy.

The basic idea was that the Fed promised they would not raise rates AT LEAST until one of the following two things happened:

1.  Unemployment fell to 6.5%

2.  Inflation had risen to 2.5%, on a forward-looking basis.

Dropping the unemployment trigger would make policy more expansionary, and that’s a good thing.

Today’s decision did not drop the unemployment threshold, but it weakened it.  It should simply be removed.  If they promised to wait until expected inflation rose to 2.5% before raising rates, it would mean roughly 2% inflation over the next few years, as the inflation rate is now running below 2%. That’s still too tight, but much better than the old policy, and even better than today’s revision.  Unemployment should never have been made a part of the forward guidance.

This is excellent:

A lot of confusion results from the fact that both the availability of capital and the availability of reserves are constraints on banking. However, the nature of these constraints is different. The availability of capital is a real constraint that determines the real size of the banking industry (the ratio of nominal bank assets to nominal GDP). The availability of reserves is a nominal constraint that determines the nominal GDP.

There are many people who don’t seem to be able to grasp this distinction.