Archive for May 2018


Two examples of low interest rate monetary policies

I’ve done a number of posts comparing New Keynesian and NeoFisherian views on the relationship between monetary policy and interest rates.  Here I’d like to illustrate the problem with a picture, as people often have trouble understanding this issue.  It’s really hard to not reason from a price change.  It’s hard to stop thinking of interest rate movements as a “policy” rather than an outcome.

These two graphs show the path of the exchange rate (E) over time, under two different monetary policies.  In both cases a higher exchange rate (E rising) reflects domestic currency appreciation.  Importantly, both of these examples are “low interest rate policies”, when the central bank reduces interest rates to a lower level than before.  But case #1 is an easy money policy, whereas case #2 is a tight money policy:

Screen Shot 2018-05-26 at 4.51.28 PM

To focus on the essentials, I’d like to assume that a policy change occurs at time = T’, and that the following movement in the exchange rate is anticipated, once policy has shifted.  (The policy move itself was unanticipated beforehand.)

Notice that in both cases, the exchange rate is expected to appreciate after time = T’.  Because of the interest parity theory, this expected appreciation means that interest rates will be lower than before the policy change, when the exchange rate was stable and interest rates were the same as in the other country.  So from the interest parity theory we know that these two cases are both shifts to a lower interest rate policy.

But now let’s look at the long run impact of the two policies on the level of the exchange rate.  In case #1, the exchange rate ends up lower (depreciated) in the long run, despite the near-term expectation of appreciation.  Because of PPP, that means the policy is expected to increase the price level in the long run.  In other words, it’s an expansionary monetary policy.

In case #2, the exchange rate appreciates in the long run, yielding a lower price level.  That’s a contractionary policy.

Because the first case looks so convoluted—a currency that is expected to appreciate over time but still end up lower than before—you might think it represents the “weird and controversial model”.  Just the opposite, the first case is the New Keynesian model of easy money, and more specifically the Dornbusch overshooting version.  The second more straightforward case reflects the weird and controversial NeoFisherian model.  Just looking at the second graph, it’s easy to see how the NeoFisherians are able to get their result from mainstream mathematical models of the economy.

Here’s another way of thinking about the two cases.  In case #1, there is a one-time increase in the money supply (and/or reduction in money demand).  It reduces interest rates (due to the liquidity effect.)  But it also leads to expectations of a higher price level in the long run, due to currency depreciation and PPP.  Because prices are sticky in the short run, the effect of easy money is to initially depreciate the currency, not raise the price level in proportion.

In case #2, there is a permanent decrease in the growth rate of the money supply (and/or increase in money demand growth).  Because of the quantity theory of money, that leads to a permanent decrease in the inflation rate.  And because of the Fisher effect, the lower inflation leads to lower nominal interest rates.  And because of interest parity, lower nominal interest rates lead to an expected appreciation in the currency.  But you don’t even need the interest parity relationship.  By itself, the lower expected inflation combined with PPP leads to the expected appreciation in the currency.

So how does this help us to better understand the New Keynesian/NeoFisherian dispute?  It may be helpful to contrast the “highly visible” with the “highly important”.  The New Keynesians are focused on the highly visible, while the NeoFisherians are focused on the highly important.

The vast majority of specific, short-term decisions by central banks are better viewed as one-time shifts in the money supply, rather than permanent changes in the growth rate of the money supply.  Thus “easy money” announcements often make short-term interest rates fall, even as inflation expectations rise.  At the same time, the truly major moves in interest rates over time largely reflect longer-term changes in the growth rate of the money supply (and money demand—in more recent years).  Thus the low nominal rates in Japan are primarily due to tight money, not easy money.

Both the New Keynesian and the NeoFisherian models are wrong, as both sides engage in reasoning from a price change.  The correct (market monetarist) model says that low rates can reflect easy or tight money, and that one should not draw any inferences about the current stance of monetary policy by looking at interest rates.

If one cannot draw any inferences about the current stance of policy by looking at rates, can one draw any inferences at all?  I see two:

1.  On any given day, a decision by a central bank to cut rates by more than the market expected is usually (not always) expansionary.  It reflects “expansionary intent” and may be viewed as a signal by the central bank of a desire to make policy more expansionary.  This is, of course, consistent with New Keynesianism.  But it does not mean the current stance of policy is expansionary.

2.  When nominal interest rates fall persistently over a long period of time, it is usually (not always) evidence that monetary policy has been contractionary.  (This is more consistent with NeoFisherism).  But it does not mean that the current stance of monetary policy is contractionary.  As usual, Milton Friedman was decades ahead of the rest of the profession:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.  .  .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

In America, monetary policy in 2017 and 2018 became a bit more expansionary, despite higher rates.

Religion plays almost no role in politics

I suppose some people were surprised to see heavily Catholic Ireland vote overwhelming in favor of legal abortion.  But they really shouldn’t have been.  Religion plays almost no role in politics, in Ireland, in America, and in Saudi Arabia.  It’s simply not a factor.

Readers of the Washington Post should not have been surprised to learn that White Evangelicals are the least likely group to support providing shelter to desperate refugees from troubled countries:

In February 2017, as debate raged nationally over President Trump’s decision to curtail immigration to the United States, the conservative Christian Broadcasting Network dipped into the Bible to share what that sacred text said about refugees.

“Treat refugees the way you want to be treated,” it said, quoting Leviticus. “Invite the stranger in” (Matthew) and “Open your door to the traveler” (Job).

The first comment in reply to the article captures the tone of the rest of the feedback the site received: “Shame on CBN for this very poorly written article full of political rhetoric. This is not a Biblical issue.”

Screen Shot 2018-05-26 at 2.26.56 PMNor should people be surprised to learn that the leader of the conservative Southern Baptists was a strong supporter of abortion rights, back in 1970.  Why shouldn’t he have supported abortion rights?  After all, religion plays no role on politics.

Some readers may still have a nagging doubt about this claim.  What about Saudi Arabia?  It is a conservative Muslim country that does not allow women to drive.  Except now they do allow women to drive.  Is that because Saudi Arabia is no longer Muslim?  Is it because of what the Koran says about women driving?  Probably not.

So why are people confused on this point?  Perhaps because they confuse “religion” with “cultural beliefs held by religious people.”  And cultural views do play a big role in politics.  In 1970, it was culturally acceptable to walk down the street in Tehran or Kabul wearing a miniskirt.  Now it isn’t.   In 2050?

OK, so why is my distinction important?  Am I just splitting hairs? Even I agree that the cultural views held by religious people are an important factor in politics.

I would argue that if you think in terms of culture, rather than religion, it makes it much easier to understand poll number such as the following:

Screen Shot 2018-05-26 at 2.34.13 PMIf you naively thought that the political views of people reflected their religion, then you might be surprised by these numbers.  Why would White evangelicals change their views so dramatically, in just a period of 5 years?  Why would they have been horrified by the behavior of Bill Clinton, and then in 2016 suddenly decide that it didn’t matter if politicians had a sleazy personal life?

In my view, these pollsters are wasting their time.  They are trying to ascertain the views of voters on certain issues of principle, whereas most voters actually have no fixed principles.  (I mean political principles, they may well be otherwise fine people.)  They are guided by convenience, by expediency.  However you wish to define religion, it’s certainly not supposed to be about convenience and expediency.

In this post, I’ve focused on conservative religious groups, but in this excellent Freddie deBoer post we learns that Social Justice Warriors are no different—lacking in principles.  It would not surprise me in the least if 40 years from now conservative Christians are overwhelmingly pro-choice, supporters of “Me-Too” and welcoming to refugees, and SJWs are the exact opposite.

PS.  The deBoer post (especially the second half), is also a brilliant explanation of the internal dynamics of China’s Cultural Revolution–and he doesn’t even mention China.

PPS.  I’d like to see a Venn Diagram of the overlap between people who:

1. Agree with Jordan Peterson on the importance of character

2. Actually like Trump

PPPS.  Ramesh Ponnuru makes a very persuasive case that someone in the Trump Administration is out to get him.

PPPPS.  Some commenters recently suggested that the FBI had spied on the Trump campaign.  If so, this is really odd:

Meanwhile, Democrats who attended a classified briefing about the informant with top DOJ officials last week said they saw “no evidence to support any allegation that the FBI or any intelligence agency placed a spy in the Trump campaign.” Top Republicans who also attended the briefing have remained silent, however.

NOW you want more than 2% inflation?!?!?

Reading the Fed minutes can sometimes make me want to tear my hair out.  During the long recovery from the Great Recession, the Fed frequently told us that we could not do more stimulus due to the danger of inflation exceeding 2%.  The taper tantrum was caused by Fed hints that monetary tightening was on the horizon, motivated by a fear of higher inflation.  In 2015, the Fed began raising interest rates, with the goal of preventing inflation from overshooting 2%.

And now, with unemployment down to 3.9%, we are suddenly told that the Fed would actually welcome above 2% inflation?  This makes no sense at all.

It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.

Just to be clear, it’s perfectly fine to argue that the Fed should overshoot their 2% inflation target right now.  Thus a market monetarist might favor overshooting for “level targeting” reasons.  There are good arguments on both sides of that question, but it’s certainly a defensible argument.  However these MMs that favor overshooting were also favoring more monetary stimulus during the recovery from the Great Recession.

What’s not defensible is to have have opposed additional monetary stimulus during the recovery from the Great Recession, even as inflation was running well under 2%, and then now suddenly favor above 2% inflation.

Most business cycles are caused by procyclical monetary policy.  A monetary policy that causes inflation to run below 2% during periods of high unemployment and above 2% during booms is procyclical, and hence bad.  Why does the Fed have so much trouble understanding such a basic point?  I don’t get it.

I can already anticipate commenters talking about whether money is too easy or too tight without reference to the monetary REGIME.  That’s just stupid.  Monetary policy is not about whether the fed funds rate should be raised or lowered at a given meeting, it’s about what sort of policy regime you have.  The Fed still hasn’t figured out that a procyclical policy regime is destabilizing.  It’s the primary cause of the business cycle.

PS. I have a blog post at a new AEI symposium on how the US can best compete with China.

Regime change

So Trump recently announced that the intelligence services and federal law enforcement hide a “criminal deep state”, which is out to get him.  Of course the heads of all of these agencies (appointed by Trump) think this is nonsense, and they say so publicly.  Almost every day Trump does something that is an impeachable offense, and these paranoid lunatic ravings about a deep state are no different.  But the Dems are wasting their time thinking about impeachment, as the GOP would not impeach Trump if he murdered someone in broad daylight in the middle of 5th Avenue.  (Actually, I stole that idea from Trump himself.)

So what’s going on here?  Why does Trump say such ridiculous things?  Let’s go back to the 2008 campaign, and look at something that I did not fully appreciate at the time:

Ugly whispers about Barack Obama’s race, birthplace and religion that began during the Democratic primary erupted into full-scale conspiracy theories among some Republicans, including McCain’s supporters.

At a town hall in Ohio that September, just days after he had officially claimed the GOP nomination, McCain was on stage speaking about Obama when someone in the crowd yelled, referring to the Democratic nominee, “Terrorist!” A few weeks later, while McCain was campaigning with his running mate, then-Alaska Gov. Sarah Palin, in Pennsylvania, rally-goers greeted mentions Obama with calls of “Treason!” and “Off with his head!”

After a particularly raucous rally in New Mexico, McCain aides told the candidate about some of the slurs shouted by the audience, and the senator, who hadn’t heard them, was shocked. “Where is this crap coming from?” he asked an aide. . . .

Down in the polls, McCain was in Minnesota looking for a lifeline among working-class voters in the upper Midwest, but what he found were anxious voters who turned their rage on him when he pushed back against attacks on Obama and defended his rival from what would now be described as “fake news.”

When a man stood up and told him he was “scared … to bring a child up” under an Obama presidency, McCain winced visibly. “I want to be president of the United States, and obviously, I do not want Sen. Obama to be, but I have to tell you … he is a decent person and a person that you do not have to be scared of as president,” McCain replied, prompting loud boos and cries of disapproval from the audience.

As he tried to calm the audience, the crowd only seemed to get more riled up. “We want to fight, and I will fight,” McCain said. “But I will be respectful. I admire Sen. Obama and his accomplishments, and I will respect him.”

The audience erupted in loud jeers, including shouts of “Liar!” “Come on, John!” a woman yelled.

“I don’t mean that has to reduce your ferocity,” McCain said, trying to speak over loud boos from his supporters. “I just mean to say you have to be respectful.”

A few minutes later, an elderly woman stood and told McCain she could not trust Obama because was he was an “Arab.” McCain shook his head and took the microphone back, interrupting the woman mid-sentence, something he almost never did. “No, ma’am,” he said, correcting her. “He’s a decent family man, citizen, who I just happen to have disagreements with on fundamental issues, and that’s what this campaign is about,” McCain said. This time, some in the crowd clapped, but the candidate looked aggrieved.

McCain didn’t understand that the GOP had changed, that they no longer sought out candidates with dignity and character.  His supporters wanted a bigoted demagogue that would feed them fake news about the people they hated.  Even by 2008, this was no longer the party of Goldwater, Reagan and Bush. Regime change happened in 2008, not 2016.

It no longer matters that Trump’s own law enforcement and intelligence officials repudiate him every day, on issues ranging from Iran to Russia.  That would have mattered in 20th century America, but we have a new political regime, more akin to Venezuela under Chavez, or Italy under Berlusconi.  Ross Douthat has a interesting column that warns the Dems about playing into Trump’s hands:

One of the few people to really see Donald Trump coming was the University of Chicago economist Luigi Zingales, who warned way back in 2011 that American politics was going the way of his native Italy, that we could easily produce our own version of Silvio Berlusconi, and that Trump was an obvious candidate to bottle the celebrity-populist-outsider cocktail.

So Zingales’s advice to Democrats after their 2016 defeat carried more weight than the average act of punditry. On the evidence of Berlusconi’s many victories and rare defeats, he argued, the best way to beat Trump was to do exactly what many liberals understandably didn’t want to do — to essentially normalize him, to treat him “as an ordinary opponent” rather than an existential threat, to focus on issues rather than character debates, to deny him both the public carnival and the tone of outraged hysteria in which his brand of politics tends to thrive.

Maybe that’s the least bad approach, but I’m not so sure even that will work.  Bush was hammered by the media in 2005 because of the perception that the federal relief effort after Katrina was incompetent.  His poll numbers fell sharply.  The relief effort after the recent hurricane in Puerto Rico has been equally ineffective, and yet Trump’s polls numbers were unaffected.  Perhaps part of the difference is that Puerto Rico is not a state, but I suspect there’s more to it than that.  Trump is not seen by voters as heading a government in the same way that Bush was seen as heading a government.  Remember, Trump says his own government is a criminal conspiracy that is trying to bring him down.  So why would his supporters blame Trump for how that criminal conspiracy did in Puerto Rico, or even New Orleans for that matter?  Trump did so well campaigning against the government that he decided to keep doing so even after being elected.

People often point to his hypocrisy:

Attacking Obama for playing lots of golf and then doing the same.

Attacking Hillary for the lack of a secure email system, and then relying on an insecure cell phone.

Attacking previous administrations for giving in to China, and then caving in to China himself.

Attacking fake news, and then engaging in fake news.

Attacking the “swamp”, then engaging in lots of corruption to enrich himself and his family.

Attacking the fake unemployment data under Obama, and then citing the same data as evidence of a strong labor market today.

There are dozens more such examples, probably hundreds, but none of it matters.  His supporters want the government to keep their hands off their Medicare, and they want the government to stop sabotaging Trump.  The Dems won’t win back the presidency until they figure out that Trump is not the leader of the government.

Trump’s support is like a religious cult.  Eventually the spell will break, and if there were a deep recession that hit ordinary Americans this would somewhat reduce Trump’s poll numbers.  But I don’t expect a deep recession, and smaller issues that don’t affect average people won’t dent his (modest) popularity.  While it’s true that he only polls in the low 40s, there are just enough anti-Trump Republicans who will hold their noses and vote for him anyway to put him over the top in a general election, especially against a left wing candidate like Sanders or Warren.  (Especially Warren, as gender is also a problem for the modern Democratic party.)  If only they’d nominated Biden in 2016, we wouldn’t be stuck with Trump for 4 years.

Or maybe 8.

PS.  Yes, part of the problem in Puerto Rico is the incompetence of local officials.  But that was equally true in New Orleans in 2005.  So why did Bush get more blame?  Maybe conservatives don’t care about Spanish speakers in Puerto Rico, but even the liberal media was far tougher on Bush than Trump.

Again, he’s not viewed as the head of the government, he’s at war with the government.  If Mueller didn’t exist, Trump would have had to invent him.

Commodities are fungible

Here’s the Financial Times, discussing recent trade negotiations with China:

They said that after two days of “constructive talks” China had agreed to “significantly increase” its purchases of US goods and services and on the need for “meaningful increases” in US agricultural and energy exports to China.

Beijing had agreed, they said, to amend relevant laws and regulations, including its patent law, to address US intellectual property complaints that have fuelled Mr Trump’s recent threats to impose tariffs on up to $150bn in imports from China. They also pledged to continue engagement to resolve their differences.

In recent years we’ve heard a lot of complaints about a “China Shock”, the idea that a surge in Chinese exports to the US has cost jobs in manufacturing.  And now the US is pushing China to import more US food and energy, which would create an even bigger China shock, if it were successful. That’s because any trade policy that leads more food and energy exports also tends to lead to more imports of manufactured goods.

On the other hand, the policy is not likely to be successful.  If the Chinese buy more corn and oil for the US, they will buy less corn and oil from Brazil.  Brazil will send those goods to the countries that previously were buying the US corn and oil that are being redirected to China.  The bilateral deficit with China will shrink, but the overall US trade deficit with the rest of the world will not change.  Commodities are fungible.  All that will happen is that trade patterns will be rearranged, imposing more transportation costs.  A deadweight loss for the global economy.  And of course Trump’s fiscal policy will make the trade deficit “worse”.

The Chinese surely understand this, but I suspect the Trump administration does not.  Or perhaps people like Larry Kudlow do understand, but are keeping quiet because they wish to avoid something much worse.

Saturday’s vague statement did not mention telecommunications company ZTE and its lack of firm targets highlighted a continuing gap between both sides’ priorities.

The apparent failure came as political reaction forced the Trump administration to back away from a presidential commitment to resolve a dispute over ZTE, which was forced to suspend business operations after being banned from buying US components. . . . Mr Trump’s tweet provoked a backlash from both Republicans and Democrats in Congress who pointed to US intelligence agencies’ longstanding security concerns about ZTE. Politicians across the US political spectrum warned the president on Friday not to cave in to China.

Trump’s negotiating has been so ineffective that both Dems and Republicans are complaining he’s too weak on China, not nationalistic enough.  ROFL.

Trump is discovering that trade is like health care, much more complicated than he imagined.  It’s already clear that the Bannon wing of the GOP has lost on trade; there will be no meaningful actions to reduce the US trade deficit.  Indeed Trump’s policies will likely widen the deficit.  The alt-right has successfully transformed the GOP into an alt-right party in terms of rhetoric.  You see mainstream GOP politicians like Mike Pence heaping praise on criminal, racist, right-wing extremists like Sheriff Arpaio.  The alt-right can also take comfort in the fact that we have despicable, stupid, bigoted preachers represent the US at the Jerusalem embassy opening.  But the alt-right is losing on policy.  They failed to get an alt-right foreign policy, they failed to get a Mexican wall or a sizable cut in immigration (except refugees, a tiny portion of immigration), they failed to get a big increase in infrastructure spending, and they will fail to get an alt-right trade policy.

The one signature success of Trump—big tax cuts for corporations—is not an alt-right policy. It’s from the traditional Mitt Romney GOP playbook.