Archive for April 2016


The Fed did monetary offset and the ECB did not

Who just posted this right-wing market monetarist interpretation of recent events?

Well, the euro area has had a (slightly) shrinking population aged 15-64 since 2008, while the US has not (although our growth is slowing). How does this affect the picture, and what changes?

Europe still does badly, but not by as bad a margin as the raw numbers say:


CreditAMECO database

Furthermore, the shortfall doesn’t start right away. Things really go off track only in 2011-2012, when the U.S. recovery continues but Europe slides into a second recession. That’s also when the euro area inflation rate slips definitively below target, where the US rate doesn’t to the same degree:


CreditEurostat, FRED

What was happening in 2011-2012? Europe was doing a lot of austerity. But so, actually, was the U.S., between the expiration of stimulus and cutbacks at the state and local level. The big difference was monetary: the ECB’s utterly wrong-headed interest rate hikes in 2011, and its refusal to do its job as lender of last resort as the debt crisis turned into a liquidity panic, even as the Fed was pursuing aggressive easing.

Policy improved after that, with Mario Draghi’s “whatever it takes” stabilizing bond markets and a leveling off of austerity. But I think you can make the case that the policy errors of 2011-2012 rocked the euro economy back on its heels, pushed inflation down by around a percentage point, and created enduring weakness — because it’s really hard to recover from deflationary mistakes when you’re in a liquidity trap.

Surprisingly, it was Paul Krugman. I’m thrilled, I just wish he’d given us credit for writing lots of posts almost exactly like this one.

And as far as all you Keynesian commenters who complained when I said we’d done as much austerity as Europe, and the real difference was monetary policy, what do you say now?

And all you Keynesian commenters who insisted the ECB could not have offset fiscal austerity because the eurozone was at the zero bound (it wasn’t) what do you say now?

Is Krugman just as clueless as we are?

PS.  People sometimes ask me if I’m depressed that I’ve been unable to get the Fed to do NGDPLT.  I try to be polite, but My God!  We MMs have succeeded beyond our wildest dreams.  An increasing number of famous economists favor NGDP targeting. An increasing number of people acknowledge that monetary policy was actually too tight in 2008.  The idea that the Fed offset fiscal austerity in 2013 has increasing support.  Japan switched policy in 2013, and their CPI is up about 4% (there’s much more work to be done, but previously they were in deflation.)  MMs developed the idea of negative IOR, and then major central banks start adopting it.  Even better, asset market responses to negative IOR announcement are consistent with MM predictions and inconsistent with the heterodox views you get in the financial press.  We predict 2 rate increases in 2016 when the Fed says there’ll be 4, and now the Fed predicts 2.  I could go on and on.  And remember, within the economics profession we are a bunch of nobodies.  If this is failure, I can’t wait for success.

HT:  Michael Darda

PS.  Here’s a screen shot of the PP presentation I’ve been giving for years (I believe I originally got the graph from David Beckworth.)

Screen Shot 2016-04-30 at 5.16.11 PM

Beckworth interviews Taylor and Cochrane

Each day my time management spirals more and more out of control.  If only there were 73 hours in a day.  And now there are new “must listen to” podcasts by Tyler Cowen and David Beckworth.  I finally caught up with David’s two most recent offerings. After starting off his podcast series interviewing me, he dug up a couple of obscure economists named John Taylor and John Cochrane.

Not surprisingly, the Taylor interview focused on the Taylor Rule.  I have mixed feelings about this rule.  I do think that something close to the Taylor Rule (not exactly the same) largely explains the Great Moderation.  However, after 2008 I became increasingly disillusioned with this approach, for a couple reasons.  First, it’s hard to know what to do when rates hit zero.  And second, it looks like the equilibrium real interest rate might be more unstable than we had assumed.

I still favor the concept of policy rules, but would prefer an instrument with no zero bound issues, such as Singapore’s exchange rate instrument, or the quantity of base money, or even better, the price of NGDP futures contracts.

For me, the most interesting part of the interview was the discussion of David’s “monetary superpower” theory of the Fed, which Taylor thought had a lot of merit.

The Cochrane interview was focused on the Fiscal Theory of the Price Level, and not surprisingly I have a lot of reservations about this idea, except for countries like Zimbabwe or Venezuela, where it’s clear the fiscal authorities are the dog and the central bank is the tail.  In the US, however, I believe it’s exactly the opposite. Let me respond to a few of Cochrane’s points, and apologize ahead of time if I’ve mischaracterized his views.

1. Cochrane contrasts the FTPL with traditional monetary theories, which imply that a swap of base money for government bonds has important macroeconomic effects. He suggests it’s more like exchanging two fives for a ten dollar bill, just swapping one government liability for another.  But if so, why is it that open market operations (OMOs) clearly do have important macro effects?  The Fed used OMOs to keep inflation close to 2% during the Great Moderation.  Asset markets respond to changes in monetary policy (even before IOR in 2008) in a way that suggests it has powerful effects on the economy.  Global stock indices can move 2%, 3% or even 5% in just minutes after an unexpected quarter point change in the fed funds target.  And until 2008, those changes in the fed funds target merely reflected the impact of OMOs.  So I don’t quite get the FTPL.

2. Cochrane says that in the FTPL the entire future path of government debt matters, not just the current level of debt, and contrasts that with what he calls the M*V = P*Y approach, which (he says) focuses on the current money supply.  But in modern monetary models (market monetarist or New Keynesian) the entire future path of the money supply matters for current prices.

3.  He doesn’t think 30-year T-bonds are currently a good investment, because he’s pessimistic about our future fiscal policies.  And he doesn’t think the Fed would be able to prevent the future inflation that would result from a debt situation that deteriorated sharply.  I’m also pessimistic about our fiscal situation, but believe the Fed can offset the effects of deficits.  Hence I don’t expect much inflation.  My views are consistent with current market expectations, whereas Cochrane seems to have doubts about market efficiency, at least in the case of 30-year T-bonds.

4.  I also read the historical record differently than Cochrane.  I don’t believe the FTPL can explain either the onset of the Great Inflation, or its end.  I don’t believe the common myth that LBJ ran big budget deficits during Vietnam.  I would note that LBJ raised taxes in 1968, and yet inflation continued to rise, because it’s monetary policy that drives inflation.  I also don’t agree with Cochrane’s view that Reaganomics made the deficit situation look better after 1981, because it increased expected future growth. Reaganomics led to much bigger budget deficits, and so if I had believed in the FTPL, I would have forecast higher inflation in 1981, not the much lower inflation we actually got.  Unlike Cochrane, I don’t believe that Reaganomics unleashed a surge in real economic growth, even though I am a fan of Reaganomics, and believe it did lead to higher growth that we would have had under alternative policy regimes.

Screen Shot 2016-04-30 at 2.19.53 PM

To clarify, I believe growth rates in many other developed countries fell below US levels after 1982, precisely because their policies were less neoliberal.  Thus in criticizing Cochrane’s claims about Reaganomics, I’m actually starting from a much more sympathetic position that someone like Paul Krugman.  To summarize, I do not believe that the FTPL offers any explanation for the onset of the Great Inflation, or its end.  Monetary policy clearly explains the onset (base growth rates soared), and can also explain the end with a bit more difficulty (money growth was strong in the early 1980s, as lower inflation led to a one time rise in velocity.)

John Cochrane favors the same sort of market approach to monetary targeting as we MMs favor.  His specific suggestion was something like Robert Hetzel’s 1989 proposal to target TIPS spreads, although you could also use CPI futures prices.  He basically views this as a more sophisticated version of the gold standard, which has always been my view as well.  Unlike Cochrane, however, I believe the CPI is essentially meaningless; it doesn’t track anything meaningful in any economic model.  (No, it’s not the average price at which stuff sells.  The CPI is based on hedonics, which have no role to play in macro.)  Thus I think the most useful definition of the “value of money” is 1/NGDP, that is, the share of nominal output that can be purchased with a dollar bill.  That’s the variable I want stabilized, along a 3% or 4% per capita growth path.  To his credit, Cochrane favors level targeting, and so do I.

Oddly, Cochrane and I end up with fairly similar views on the optimal monetary policy, despite having radically different views on the theory of money.  Indeed I favor having the Fed use OMOs with ordinary T-bonds as a way of stabilizing NGDP futures prices, and as far as I can tell Cochrane doesn’t think OMOs do anything. Unless I’m mistaken, Cochrane thinks the gold standard only worked because central banks promised to buy and sell unlimited amounts of gold at the legal price, or at least something other than T-bonds.  (To head off objections from George Selgin, you don’t need a central bank; private banknote issuers can also assure redeemability into gold.)

In contrast, I believe the central bank could have pegged the price of gold merely using OMOs with Treasuries.  Alternatively, in the 1990s the Fed could have used the Taylor rule without buying any bonds at all.  It was the liquidity effect from monetary injections that caused fed funds rates to change, and hence the Fed could have bought and sold gold or zinc to target fed funds prices, and used that instrument to keep inflation close to 2% via the Taylor Rule. In other words, it’s all about the Fed’s liability (base money); the asset side of the balance sheet hardly matters, at least when not at the zero bound, and hence when OMOs are small in size.

PS.  Over at Econlog, I have a new post discussing a NBER study that is critical of the New Keynesian claim that artificial attempts to raise wages can be expansionary.  Their result supports my claims in The Midas Paradox.

PPS. George Selgin is putting together a very nice series on monetary economics.  The second entry discusses the demand for money, and why the price of money and the price of credit are two entirely different things.

Stop Making Sense

Narayana Kocherlakota has a new post entitled, “Trump Starts Making Economic Sense”:

About a month ago, I urged the presidential candidates to explain what policies and leadership they would like to see at the Federal Reserve. So I was glad to see Trump address Fed-related issues in an interview with Fortune magazine last week.

His key comments: “We have to rebuild the infrastructure of our country. We have to rebuild our military, which is being decimated by bad decisions. We have to do a lot of things. We have to reduce our debt, and the best thing we have going now is that interest rates are so low that lots of good things can be done that aren’t being done, amazingly.”

I read this as calling for two forms of fiscal stimulus.

That’s funny, I read the statement “we have to reduce our debt” as calling for austerity. Of course the second half of that sentence is a call for fiscal stimulus.  I attribute the contradiction to either:

1.  Trump having an IQ in the 80 to 85 range, or . . .

2.  Trump being a shameless demagogue.

I would also point out that Mr. Trump was actually discussing fiscal policy, not monetary policy.  That’s a distinction I worked really hard making in my economics classes, back when I taught at Bentley.

Kocherlakota continues:

Another question is whether Trump would be comfortable with the Fed pursuing an inflation target higher than 2 percent (such as the 4 percent target suggested by Professor Larry Ball of Johns Hopkins University). This has been advocated as a way to give the central bank more ammunition to fight future recessions (by generating higher nominal interest rates, it would provide more space to lower them before hitting zero). But it would also give the Fed more room to support fiscal stimulus of the kind suggested by Trump.

I’m not quite sure what Kocherlakota is trying to say here.  The whole point of raising the inflation target to 4% is so that you don’t have to use fiscal stimulus in the first place, not as a way of “supporting” fiscal stimulus.

Undoubtedly all these things that make no sense to me are perfectly clear in the mind of The Donald.  Recall that Trump will pay off the national debt in 8 years, a “making sense” proposal that Kocherlakota does not comment on.  Nor does he comment on the fact that Trump will achieve this miracle by shielding entitlements from cuts, sharply boosting spending on the military and infrastructure and reducing the top tax rate to 25% percent (all while raising taxes on “the rich”) and eliminating taxes entirely on 75 million Americans.  What’s the secret sauce that will make this all possible?


PS.  People have offered three explanations for the rise of Trump, struggling blue-collar workers, trade and immigration.  All three are false.  The Economist reports that Trump voters are skewed toward the over $100,000 group.  A new poll shows surging support for the claim that immigrants help the country.  And other polls show surging support for the view that trade is an opportunity, not a problem.

Sorry Pat Buchanan, the rise of Trump is not about your issues—it’s not about Making America Great Again.  He’ll drop your issues the day he takes office.  It’s about Making Donald Trump Great Again.

PPS.  People think I’m exaggerating when I compare Trump talk to a baby’s “ga ga” talk.  I’m dead serious.  Read this sentence 100 times in a row, until you have it figured out:

We have to reduce our debt, and the best thing we have going now is that interest rates are so low that lots of good things can be done that aren’t being done, amazingly.

Yes, reducing the debt by borrowing more would be amazing.  

Trump says:

I know words, I have the best words

Yes, Trump has some excellent words.  But he does not yet have sentences with meaning.  He needs to work on that before becoming President.  Not just words, words that are grouped together to produce meaning.

Just once, I’d like to hear Trump say:

I am familiar with many terms, I possess a quite sophisticated vocabulary.

Case closed

Last week, I pointed to a Financial Times headline that suggested the yen was falling on rumors of a cut in the interest rate on reserves (which is already negative):

In the long run, you want to rely on a worldview that allows you to make sense out of the myriad news events that are reported each day.  I believe that framework is market monetarism.  Let’s take an example, a headline from today’s FT:

Yen dives on talk of negative rates on loans

If you relied on the mainstream media, that headline would make no sense.  “Wait, weren’t we told on Twitter that Sumner was foolishly attached to the notion that negative IOR was expansionary, despite all indications to the contrary?  If so, how are we to understand this headline?”  On the other hand if you relied on market monetarism, there would be no cognitive dissonance to deal with.  It would all make perfect sense.

Tuesday, Tyler pointed to another FT story, this time claiming the exact opposite:

Ten weeks after BoJ governor Haruhiko Kuroda startled both financial markets and parliamentarians with Nirp, the yen has appreciated by some 8 per cent against the dollar. The stock market has rebounded sharply this month, however the Topix bank index remains 11 per cent lower since the advent of Nirp.

Under such a policy, risk assets were supposed to rise, but instead demand for Japanese government bonds rallied, rewarding the risk averse. Meanwhile, even finance ministry officials concede that the deflationary mindset is more entrenched than ever. There is agreement that Nirp has backfired and such an unsustainable monetary policy cannot support growth, let alone help financial asset prices.

Who to believe, the FT, or the FT?  Answer, the FT.  Today’s Financial Times provides the results of about as dramatic an event study as you could ever want:

Yen surges and stocks hit as BoJ stands pat

So much for the theory that negative IOR is contractionary.  And the concurrent fall in global stock markets puts another nail in the theory of “currency wars” and “beggar-thy-neighbor”.  The failure of the BOJ to devalue the yen is going to hurt the US and European economies.

Why so much confusion?  Because people forget that while a lower policy rate is expansionary on any given day, low rates are also an indication that money has been too tight.  This paradox is resolved if we make the (quite plausible) assumption that when the Wicksellian natural rate is falling, the policy rate usually tends to fall more slowly, making policy effectively tighter (as in 2008).  And when the Wicksellian rate is rising, the policy rate usually tends to rise more slowly, making policy effectively looser (as in the 1970s.)

It doesn’t take a genius to understand that you evaluate a policy’s effect by looking at the immediate market reaction, not market moves in the following weeks, which could be caused by 101 factors.  Oh wait, I guess it does take a genius.

Here’s a graph showing the fall in the yen last week on rumors of a rate cut, and the more than 3% gain today on the market disappointment at the BOJ’s inaction:

Screen Shot 2016-04-28 at 8.53.33 AMA few weeks ago, I did a post suggesting that the BOJ appears to be giving up on its 2% inflation target.  I suggested that this meeting would give us an answer:

What should Japan do?  I suppose they should do whatever they want to do.  It doesn’t make much sense to target inflation at 2% if you don’t want to target inflation at 2%.

The more interesting question is what should they want to do?  I’d say NGDPLT. But they seem to have other ideas.

Either way, we should have an answer by the end of the month.

Today we got the answer.  The FT also reports the following:

The BoJ also changed its guess of when inflation will reach 2 per cent from the “first half of fiscal 2017” to “fiscal 2017”. Any further delay would mean admitting Mr Kuroda will not reach the target during his term in office.

The whole point is to not adjust the forecast, but rather to adjust the policy instruments.  A very disappointing performance by Mr. Kuroda.  That’s not to say it couldn’t be worse, he has gotten Japan out of its nearly two-decade bout of deflation. But he’ll need to be far more aggressive at the July meeting if he doesn’t want to lose all credibility.  As it is, the BOJ lost a significant amount of credibility today.  Here’s Bloomberg:

A majority of economists surveyed by Bloomberg had predicted some action to counter a strengthening yen that had cast a shadow over the outlook for wage gains and investment spending. The explosion of volatility shows how investors have singled out central banks as the key driver for global financial markets.  .   .   .

“It’s the central banks that still set the course,” said Jan Von Gerich, chief strategist at Nordea Bank AB in Helsinki. “Even slight deviations from what people are expecting are enough to trigger market moves.” .   .   .

“The BOJ had an opportunity to at least temporarily short-circuit the yen trend but failed to act,” said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. “It has provided the green light for further yen strength in the near-term.”

2 questions for IT fans

This post is aimed at economists who know more about formal monetary models than I do.  I am interested in why so many economists seem to favor inflation targeting, whereas price level targeting seems preferable to me.  I am especially interested in whether the models used to compare these two policy regimes incorporate pertinent facts about the real world.

Models often contain “shocks”, which temporarily throw the economy off course.  One question I have is:

1.  Does the size of shocks in these models depend on the type of monetary regime?

Let me explain with an example.  We are back in June 2008, about to be hit by a severe banking crisis.  In my view the severity of the banking crisis depends to a great extent on whether the central bank is doing growth rate or level targeting.  Under level targeting, investors will expect the economy to bounce back strongly after any severe crisis, and hence asset prices will not fall anywhere near as sharply in the short run.  And with asset prices being more stable, the financial crisis (i.e. the “shock”) will be much milder.

Under level targeting of prices, investors would have expected the price level (PCE) to be about 22% higher in the 10 years after June 2008.  We are now almost 8 years past June 2008, and the price level has rising by 8%.  It looks like it will be about 11% or 12% higher after 10 years, not the 22% expected under level targeting.  Thus under level targeting, investors would have expected a far more expansionary monetary policy over the past 8 years.  That would have made the 2008 financial crisis much milder.  For a recent example of the role of expectations, look at how Brazilian asset prices have been recovering under expectations of impeachment.  Brazil is a mess, but investors are already looking beyond the current inept government.

2.  Is the governing board of the central bank (in these models) split between hawks and doves under inflation targeting, under price level growth rate targeting, or under both?

There is only one correct answer.  Under IT, central banks are split between hawks and doves, and under price level targeting they are not.  Indeed under level targeting the terms “hawk” and “dove” have no meaning.  The only difference is the aggressiveness in which they want to return to the trend line.

Because there is no hawk/dove split under price level targeting, markets have less uncertainty about where the price level will be in the future.  In contrast, under IT you may have some people viewing 2% inflation as a target, and others viewing it as a ceiling.  Or they may differ in terms of whether they’d rather risk erring on the side of too much inflation, or too little.  In contrast, under price level targeting the long run inflation rate is essentially identical regardless of whether the central bank views the target as symmetrical or as a ceiling.

To summarize, I’m asking those who know the literature on IT whether existing models take relevant real world considerations into account.  If not, perhaps someone should create more realistic models.