Archive for October 2014


Ben Southwood finds lots of evidence for (market) monetarism

Ben Southwood of the Adam Smith Institute has several recent blog posts that are well worth reading.

When the Bank moves its key policy rate, commentators talk about it hiking or cutting interest rates; on top of this, we’ve seen extremely low effective interest rates in the marketplace; together this makes it reasonable to believe that the central bank is the cause of these low effective rates.

There are lots of reasons to doubt this claim. In a previous post I pointed out that the spreads between Bank Rate and market rates seem to be narrow and fairly consistent””until they’re not. I made the case that markets set rates in an open economy. And I arguedthat lowering Bank Rate or buying up assets with quantitative easing (QE) may well boost market rates because they raise the expected path of demand, the expected amount of profit opportunities in the future, and thus investment.

Since then I came across an elegant and compelling explanation of exactly why this is. In a 1998 paper, Tore Ellingsen and Ulf Söderström show that this is because some monetary policy changes are purely expected and ‘endogenous’ responses to economic events, whereas some monetary policy changes are unexpected ‘exogenous’ changes to the central bank’s overall policy framework (like raising or lowering the inflation rate that markets believe they really want).

When changes are expected, market rates keep a tight spread around policy rates; when changes are a surprise, cutting Bank Rate actually results in higher interest rates in the marketplace.

The post has some nice graphs showing this distinction.  He has another post citing no less that 4 papers with monetarist-friendly findings.  Here’s one example:

In “QE and the bank lending channel in the United Kingdom”, BoE economists Nick Butt, Rohan Churm, Michael McMahon, Arpad Morotz and Jochen Schanz tackle the popular creditist view that movements in lending drive overall activity, and that quantitative easing works by stimulating lending, and find “no evidence to suggest that quantitative easing (QE) operated via a traditional bank lending channel”. Instead, their evidence is consistent with the monetarist view, that “QE boosted aggregate demand and inflation via portfolio rebalancing channels.”

They find this result by looking at the difference between banks that dealt directly with the Bank of England when it was buying gilts (UK government bonds) with new money in its QE programme. If the creditist view held, these banks would be more able to expand their lending with the extra deposits created when the BoE hands over new money for gilts.

And a post exposing the silliness of internet Austrian commenters, who seem to think that anyone who is not an Austrian is a Keynesian.

Ben’s colleague Sam Bowman (also at the ASI) has a good post explaining NGDP targeting.

Meanwhile, the only head of a major central bank ever to say good things about NGDP targeting now presides over an economy that is creating jobs at a rate no one could have imagined 18 months ago.

Quick update on NGDP futures

No one told me it was going to be hard to give away money!  Seriously, there are a few more complications than I anticipated, and I am now waiting for specific instructions from iPredict and Hypermind about how to proceed.  But it will get worked out.

Meanwhile the early Hypermind Q3 futures contract, with 100 euros in prize money, has now been upgraded to a combined Q3 and Q4 with 1000 euros in prize money. So it just became much more attractive.  Recall that at Hypermind, traders do not have to put up their own money–it’s not “gambling.”  But you do need to register first.  

Eventually we will deliver much more money for prizes at Hypermind.

Update:  I was sent the following information:

The real-time forecasts are published on this page, which requires the password: “illusion“.

The contracts are at about 34/35 right now, which means 3.4% to 3.5% annualized growth.  That seems like an opportunity.  🙂

PS.  Super busy this week.  All I have time for is to point out that the collapse of the Chinese economy, predicted for 20 years, once again failed to materialize in Q3.  Now some brave souls are predicting Chinese growth will slow over time.  You mean they won’t keep growing at 10% as they become highly developed?  I never would have guessed.

Tyler Cowen on exports

Tyler Cowen has a wonderful new post pointing out that all countries can increase their exports at the same time, and this may boost global output.  I’m going to try to make it even wonderfuler (is that a German word?)

[Update: When I say “exports” I mean “exports”, not “exports minus imports” (a category no one should pay any attention to.)]

Let’s avoid reasoning from an export change, and ask why exports might increase:

1.  Supply-side reforms that boost the efficiency of the export sector, perhaps by removing tax/regulatory barriers.

2.  Monetary stimulus aimed at currency depreciation.

3.  More government saving, which depreciates the real exchange rate.

My claim is that if these things are done on a global scale, the first two are expansionary in net terms, and the third is neutral.

Supply-side reforms boost output under either an inflation target, or a dual mandate.  If you want to use the Keynesian model, these reforms boost the Wicksellian equilibrium interest rate, which makes NGDP grow faster, even at the zero bound.

For years I’ve been pointing out that a (mild) international currency war would be great.  All currencies can depreciate at the same time, against goods and services. We know that monetary stimulus in the US makes European stocks go up, and vice versa.  But it isn’t just market monetarists; Keynesians like Barry Eichengreen have also noted that a currency war would be expansionary, as it was in the 1930s. These first two points are probably what Tyler had in his mind when he criticized the mercantilist mindset.

As far as government saving (fiscal austerity), I’d say it’s a net wash, for monetary offset reasons.

PS.  Roughly 100% of the time when people blame virtue in one country (Germany, China, Japan, etc.) for problems in the global economy, they are working with a flawed model.  Classical economics (Hume’s Of the Jealousy of Trade) was supposed to be about overcoming that xenophobia.  We still have work to do.

PPS,  I once published a paper claiming that IS-LM was essentially a gold standard model.  Here’s Tyler:

It sometimes feels like the IS-LM users have a mercantilist gold standard model, where the commodity base money can only be shuffled around in zero-sum fashion and not much more can happen in a positive direction.




A nod toward market monetarism at the FT?

I suppose I sometimes read too much into things, but I couldn’t help thinking that the conclusion of a recent Financial Times editorial had a sort of market monetarist flavor.  See what you think:

The other positive is the quick reaction from central bankers to the market alarm. James Bullard and Andrew Haldane, who vote on interest rate in the US and UK respectively, have spoken of their concern about increasing downside risks to growth. Their hints that interest rate rises have been pushed into the future met with a bullish reaction. For all the controversy about how quantitative easing works, markets clearly understand that monetary policy still matters.

On this subject it would be unwise to question the market view. This week has been about macroeconomic concerns. The big worry is that aggregate demand may fail to keep up with potential supply, thereby generating a perilous deflationary dynamic. Fighting deflation is a job central bankers can do – so long as they remain alert.

This week the gloomsters harked back to the economic collapse that started in the summer of 2008. Such talk is premature, but lessons from that disaster are still relevant. Six years ago, the markets’ warnings of an impending global recession were met with hawkish noises from many central banks, and even a rate rise from the European Central Bank. This time so far has been different. For that, if nothing else, there are reasons to be modestly cheerful. [emphasis added]

I really do believe there is more understanding of the need for aggressive monetary actions this time around.  Some have mocked James Bullard for doing a 180 in a single week, and I see their point. But I prefer to applaud people who understand it’s not the job of central banks to change their AD forecasts, it’s the job of central banks to move aggressively enough that they don’t need to change their forecast.  Give Bullard points for open-mindedness, humility, and honesty.  All good qualities in a central banker.

PS.  I have a heavy grading load for the next two weeks, and as if that isn’t enough I’m simultaneously involved in putting together several big proposals that may have a huge payoff later.  I’m discouraged that the predictions markets are taking longer than I’d hoped (perhaps I was naive about the complexities of these things) but at the same time I am increasingly optimistic that we can aim even higher next year.  This will happen.  

The Fed finally says “enough”

It would be interesting to know what Fed people like Bernanke and Yellen privately think of the ECB.  Here’s an interesting story on Draghi (who is actually one of the more competent people over there):

Europe is leading a rout that has wiped more than $5.5 trillion from the value of equities worldwide. While data on everything from industrial production in Germany to manufacturing in the U.K. has contributed to the gloom, sentiment began souring on Oct. 2, when European Central Bank President Mario Draghi stopped short of spelling out how many assets the ECB might buy to head off deflation.

“The shock to markets has been so big in the past days, I have doubt that equities will recover from this very quickly,” Francois Savary, chief investment officer of management firm Reyl & Cie., said in a phone interview from Geneva. “Draghi’s latest communication to the market was a nightmare.”

A few years back I used to occasionally point out how much market wealth could be destroyed by the statement of a Fed official.  Of course real economists pay no attention to stock market reactions because everyone (wrongly) knows that stock traders are irrational.  I’m tempted to compare central bankers to children playing with matches, except that children rarely do $5.5 trillion in damage.

In one of the most bewildering statements I’ve ever seen Paul Krugman make, he seems to excuse the ECB’s ineptitude:

Europe has surprised many people, myself included, with its resilience. And I do think the Draghi-era ECB has become a major source of strength.

I suppose Krugman’s defenders will insist he meant “strength” being applied in evil ways.  If so, I’d have to agree.  But most normal people would assume he’s defending the ECB.  Unbelievable.

Meanwhile, in the US things are a bit more sane:

About an hour into the trading day Thursday, with the S&P 500 (^GSPC) at its lows and the smell of fear in the air Bullard took the mic and had his Battle of Agincourt “Once more into the breach…” moment.

“We have to make sure that inflation expectations remain near our target,” said Bullard in reference to the FOMC’s ongoing war against deflation. “And for that reason, I think a reasonable response by the Fed in this situation would be to…. pause the taper at this juncture.”

Just like that feverish selling broke. Bullard’s stirring cry to non-action ringing in their ears, traders began furiously bidding for shares. Yes, a non-voting Fed board member’s oblique reference to the possibility that the Fed may not completely eliminate its now $15 billion monthly QE program this month marked the lows for the correction thus far.

How big was Bullard’s bluster? Based on the World Bank’s estimate of the total market capitalization of US stocks the 2.5% gain in equities just in the States is worth about $420 to $450 billion.

HT:  TravisV,  J.V. Dubois