Archive for June 2020


Identifying monetary policy shocks

People generally visualize monetary shocks as a univariate phenomenon, perhaps a change in the short-term interest rate, or a change in the monetary base. Up or down.

Over at Econlog, I recently argued that monetary shocks are a multivariate phenomenon. For example, a monetary shock might impact both the spot exchange rate and the forward exchange rate.

Here I’ll present a graph that illustrates various possible monetary shocks. I define Et at the spot price of foreign currency. Thus if Et gets bigger, then the domestic currency depreciates, and if Et gets smaller than the domestic currency appreciates.

In the graph below, the vertical axis shows the change in the one year forward exchange rate (Et+1), while the horizontal axis shows the change in the spot exchange rate (Et). Each point the response of forex markets to an important monetary policy announcement:

The galaxy of points in the upper right quadrant represent expansionary monetary shocks, which cause the currency to depreciate in both the spot and forward markets, that is, “E” gets larger. I provide an example of when the US announced QE1 on March 18, 2009.

The galaxy of points in the lower left quadrant are contractionary monetary shocks, such as the Swiss decision to let the franc float (appreciate) in January 2015.

You’ll notice that I also provided a 45 degree line, which shows whether the spot or the forward exchange rate responds more strongly to the monetary shock. Does it matter whether points lie slightly above or slightly below that 45 degree line? I’d say almost certainly not, but 99% of economists probably disagree with me.

If the spot rate moves by more than the forward rate, as in the March 2009 example, then nominal interest rates will fall with expansionary policy and rise with contractionary policy. If the spot rate moves by less than the forward rate, as in the January 2015 example, then nominal interest rates will rise with expansionary policy and fall with contractionary policy.

The impact of policy doesn’t depend on whether interest rates rise or fall, it depends on whether the exchange rate rises or falls. It doesn’t much matter whether you are slightly above or below the dotted line, it matters whether you are in the upper right quadrant or the lower left quadrant.

Keynesians and NeoFisherians don’t agree with me. Keynesians thinks lower interest rates are expansionary. They assume that monetary shocks lie in areas “K”, and affect spot exchange rates by more than forward rates (Dornbusch overshooting). NeoFisherians assume lower rates are contractionary. They assume that monetary shocks lie in areas “NF”, causing forward exchange rates to move more than spot rates.

Actually, the shocks occur in both areas, but movements in interest rates are inconsequential epiphenomena to the real action, the way that monetary shocks impact spot and future exchange rates, or better yet NGDP futures prices.

In January 2015, the Swiss franc suddenly rose more than 10% in response to a monetary shock. I don’t have forward exchange rate data, but I believe the forward Swiss franc appreciated about 1/4% more than the spot rate, say 10.25% instead of 10%. That’s because Swiss interest rates fell about 1/4%.

In March 2009, the US dollar suddenly fell about 4% on the announcement of QE1. Because one year T-bill yields fell about 11 basis points on the news, the forward rate might have only fallen 3.89%, vs. 4% for the spot rate (all figures in this post are rough estimates.)

If you believe that interest rates are the essence of monetary policy, then you believe that the fact that forward rates changed slightly more or less than spot rates is far more important than the fact that both spot and forward rates moved in the same direction. That’s crazy.

A Keynesian might view both the 2009 US shock and the 2015 Swiss shock as expansionary, as rates fell in both cases. A NeoFisherian might view them both as contractionary for the same reason. In contrast, when I see the dollar plunge 4% and the franc surge 10% after major monetary policy announcements, I see tighter money in Switzerland and easier money in the US. Judging by the co-movements in the various stock markets, I suspect investors agree with me.

Just to be clear, I don’t view exchange rate movements as being “monetary policy”, just a better policy indicator than interest rate movements. More specifically, I believe that by looking at exchange rate movements immediately after a major money announcement we can reasonably infer whether the monetary shock was expansionary or contractionary. Of course, exchange rates also move during periods when there is no monetary shock, for a variety of other reasons. Those movements are no “monetary policy”.

PS. You could do the same exercise for change in the “spot” money supply and change in the 10-year forward expected money supply. But again, NGDP futures prices are best.

PS. I have a new article at The Hill, which points out that the Fed is not “monetizing the debt”.

A monologue about “a conversation about race”

I’m hardly the first person to notice that we haven’t yet had a useful “conversation about race”, and are not likely to have one in the future.

There are multiple reasons for this. Many on the right have an unimaginative view of the black community, seeing it as “the other”. Thus problems of unemployment and drug use are assumed to reflect cultural failings in the black community. When the same sorts of problems of unemployment and drug use hit many working class whites in the eastern Rust Belt, those impacted were romanticized by some conservatives as innocent victims of Globalization and Neoliberalism. Republican politicians who opposed providing economic help to inner city blacks suddenly began favoring policies to help unemployed working class whites.

Conservative politicians who took an uncompromisingly hard line on heroin use in the inner city suddenly began to see abuse of opioids in rural American as a medical problem. People disdainful of the idea of prosecutorial abuse directed against blacks changed their tune when the prosecutors came after top Republican officials.

So perhaps the left can lead a conversation on race? Unfortunately, most people on the left discuss race as if they are walking on eggshells, trying so hard not to offend that they say almost nothing of value. At times they seem to deny minorities the dignity of personal agency, which is to dehumanize an entire population.

When the average American hears a leftist tell them “we need to have a conversation about race”, they are about as enthused as a Chinese academic in 1967 being told by the Red Guard that it was time for a conversation about communism. “Please, just tell me what I’m supposed to say, and let’s get this over with.”

A recent essay by Jonathan Chait discusses political correctness. What can we infer from his essay?

1. Political incorrectness is about identity. The left cares a lot about all sorts of issues, not just identity. But identity is a sort or religion, which has much stronger taboos than other issues.

Just to be clear, it’s not that left-leaning people are not required to hold certain views on a wide range of issues in order to get elected, or even be nominated. It’s pretty hard for a Democrat to hold pro-life views or oppose national health care. Rather it’s comments on identity issues that get even non-politicians into hot water.

2. The victims of PCism run amok are often on the left. All three of Chait’s examples are left-leaning individuals who got in trouble for saying or tweeting things about race, or allowing a controversial editorial. To almost everyone on both the left and the right, except a few illiberal radicals who oppose free speech, these three individuals would be viewed as having received “unfair” treatment.

3. The relatively small mob of illiberal leftists is apparently more influential than their numbers would suggest, as the broader progressive movement is clearly intimidated by their criticism. Mainstream liberals often feel they need to sacrifice someone in their own tribe, to placate these radicals.

4. Chait’s essay is not a defense of liberal ideas. He clearly sees the radical left as primarily being a threat to the mainstream left. Thus he does not cite a single example of a conservative who is victimized by PCism run amok, and in places seems to edge close to defending certain forms of left wing illiberalism:

It is easy to understand why somebody — especially one predisposed against Fang — would view this comment with suspicion. Bringing up crime in black communities to deflect away from systemic racism is a conservative trope so familiar and clichéd it is often summarized with the mocking shorthand “what about black-on-black crime?” And the simplistic comparison of deaths at the hands of white police versus minorities fails to acknowledge both the broader patterns of mistreatment by police that falls short of outright murder, and the fear this creates, so that a single police murder can terrorize thousands and shape their view of the state in a way that a local murder cannot.

Fang’s interview subject probably lacks familiarity with the history of this issue being used as an excuse for racism, and almost surely didn’t realize the cruel resonance of the phrase “black-on-black crime.”

When a discussion of “true facts” is taboo, you know that a political movement has gone off the rails.

Chait presumably picked sympathetic left-of-center victims of witch hunts in order to be more persuasive with his readers. He’s not trying to defend liberalism (although he may well privately support the concept); he’s trying to persuade other left leaning readers to cool it, in order to save the left from itself.

And there’s good reason for mainstream liberalism to be terrified of PCism. First, it helps people like Trump at the polls. Second, the victims are likely to be mostly other people on the left. Conservatives are less likely to work in jobs where they are victimized by PCism, and radical leftists view them as the enemy—people completely beyond the pale. The radicals instead focus on trying to “purify” their side of the ideological spectrum, to eliminate dissent from their ever-shifting dogma on identity.

[I’ve seen people argue that just as the purpose of fashion is to exclude people too unfashionable to keep up with changing trends, the purpose of continually shifting acceptable political views on identity is to exclude those who are not cool enough to keep up with the latest shifts in dogma. In both cases, ambitious young people are the villains—just as old people are the villains who push reactionary policies.]

Some argue that PCism is an overrated issue, as the outrages you hear about in the press are relatively rare. There are two problems with that argument. First, the cost of a repressive apparatus is not accurately measured by the number of transgressors who are caught. If only two people were caught last year protesting for democratic rights in Tiananmen Square and sent to concentration camps, that doesn’t mean that Chinese repression was not severe, rather it means most people chose not to do things that would lead them to be sent to concentration camps.

Second, it’s a mistake to view cases of outright dismissal from a job as the biggest cost. Most people on the left don’t want to be attacked by a twitter mob of illiberal radicals calling them “racist”. People who are seen as being on the “right” (even those incorrectly seen as being on the right, like me) don’t mind such attacks nearly as much. The Noah Smiths of the world insinuate that right wingers are just a bunch of racists that are not worth listening to. So what do they have to lose by being called racist?

I don’t go to cocktail parties or participate in Twitter. Unless I’m criticized by someone I respect, I’m not going to lose sleep over it. I have no fear in pointing out that “black on black crime is a problem“. But I also have no problem in annoying conservatives, as you see at the top of my post. Most of all, I don’t feel I have anything very useful to say about racial problems in America, so I don’t tend to blog on the subject very often. At best, I might argue that some of the policy reforms I favor would help black Americans, including drug legalization, kidney markets, zoning reforms, school choice, challenge studies of Covid-19 vaccines, etc. But these reforms would also help whites.

In contrast, progressives have a much more ambitious agenda:

1. Cancel and publicly shame progressive intellectuals who say something a tiny, tiny, tiny, tiny bit politically incorrect.

2. Tear down statues.

3. Defund the police.

I have to admit that my policy proposals are not in that class, at least from a utilitarian perspective. (I’ll let the reader decide whether my ideas would help more or less.)

Is it impossible to have an intelligent conversation on race? If it is possible, it’s likely to meet these criteria:

1. The participants need to have an understanding of the black community and a sympathy for the problems faced by blacks. (Yes, other races matter, but in America “race” is a code word for black issues.)

2. The participants must be able to boldly speak the truth, even if it makes some people feel uncomfortable.

If you look hard enough, you can find an occasional bona fide conversation on race. But they are exceedingly rare.

When pundits go on TV and say “Americans need to have a conversation about race”, they might just as well ask for a conversation about string theory or neutron stars. Such conversations can happen, but the number intelligent conversations about the issue is rather small.

Most Nordic countries flattened the curve

I’m not sure the precise definition of “Nordic”, but these countries seem to fit the bill:

Switzerland was hit hardest in its Italian section, so it’s less of an outlier than it appears. The Netherlands is clearly an outlier, although it has also flattened the curve.

In the US, the death rate appears to be falling rapidly. The average death rate has been about 5% of reported cases (although closer to 1% of actual cases.) Now the marginal death rate of newly reported cases is falling very fast, and may soon fall close to 1%. The actual death rate relative to total actual cases will likely fall far below 1%, albeit not as low as in Singapore.

A portion of this may be increased testing or better medical care, but it seems to be mostly due to illnesses shifting from the old to the young. Of course this is exactly what economic theory would predict, as the cost of socializing for the young is far smaller (much less risk of death) and the benefit is probably higher—romance!!

I don’t have any normative claims here, just some data I thought were interesting.

PS. Check out the link above; you can create your own graph.

PPS. The US is a bit above the Netherlands, with a steeper line. Most of the big European countries are similar to Sweden, if not higher. But Sweden is rising faster.

PPPS. Quebec, the northeastern US, France, Italy, Spain and Belgium were all hit very hard. What would happen if an epidemiological study put in a dummy variable for “historically Catholic”?

Trump doesn’t kid. (Just kidding)

[This post is silly. If you want a good post then check out my newest at Econlog.]

Reporters asked Trump if he was kidding when he discouraged testing for coronavirus:

“I don’t kid,” Trump said when pressed by reporters on Tuesday. “Let me make it clear.”

Most people were sucked in by that. But not me. I suggested that he might be one of those Andy Kaufman type comedians, who prolonged the act far past the point where most comedians give up. And now Trump has confirmed that hypothesis:

President Donald Trump on Thursday said he had “sarcastically” claimed that a decrease in coronavirus testing would lower U.S. infection rates, adding a new twist to the weeklong scramble by the White House to clarify the president’s comments on virus testing.

“Sometimes I jokingly say, or sarcastically say, if we didn’t do tests we would look great,” Trump said in an interview and Fox News town hall with Sean Hannity. “But you know what? It’s not the right thing to do.”

Perhaps this is why all his former advisors describe him as an idiot; they don’t get that deadpan Kaufman-type humor:

On different occasions, people close to Trump in an official sense have been described in books or journalistic accounts referring to their boss as an “idiot” (former chief of staff John Kelly and former national security adviser H.R. McMaster), a “moron,” (former secretary of state Rex Tillerson), “like an 11-year-old child” (former aide Steve Bannon) with an understanding of world affairs akin to “a fifth- or sixth-grader” (former defense secretary James Mattis).

These are Very Serious People, and they don’t understand that when Trump discusses issues like bombing Syrian or a trade war with China, he’s just kidding around. They have no sense of humor. Look at their faces—they never smile.

Venezuelan-Americans also fail to understand Trump’s sense of humor:

In an interview with Axios, Trump second-guessed his own decision to recognize opposition leader Juan Guaidó as Venezuela’s legitimate leader and suggested he would meet with Maduro. The comment created a firestorm in the state, especially in South Florida, home to more than 400,000 Hispanics of Venezuelan originTrump quickly distanced himself from his own comments.

People need to lighten up; our president is a post-modern comedian. From day one, it’s all been an act.

As I keep saying, lockdowns are mostly endogenous

Roughly 99% of people think that low interest rates are an expansionary monetary policy. But the readers of this blog know otherwise. They know that low rates often reflect the delayed effect of previous tight money policies.

Roughly 99% of people think lockdowns are a restrictive Covid-19 policy. I hope to convince you that lockdowns are mostly endogenous. That countries like Taiwan did not close their restaurants precisely because they had quite effective Covid-19 policies. That lockdowns are often (not always) a sign of failure, of previous excessively lax policies.

Check out today’s Bloomberg headline:

Hmm, two states going in opposite directions. Who has the more lax polices? It’s a complicated question, isn’t it?

It’s not about a single “concrete step”, it about the overall policy regime.

I.e. never reason from a lockdown.

PS. I said “mostly endogenous”, because there are (exogenous) exceptions, such as Sweden.

PPS. The graph below shows the pathetically weak growth in nominal GDP since 1995 in Italy (red line), and also the mindbogglingly and almost incomprehensible lack of spending growth in Japan (blue line). Which one do you think the MMTers keep citing as a successful example of their (aggregate demand) policies in action? Yup—Japan.

If conventional macro occasionally lapses into reasoning from a price change, MMT is reasoning from a price change on steroids.

Yes, Italy’s population rose by roughly 6%, vs. almost no growth in Japan, but that explains only a tiny portion of the divergence. And again, I am comparing Japan to ultra-pathetic Italy.

And yes, Japan looks somewhat better using RGDP, but when evaluating AD policies it’s NGDP that matters, not RGDP. The latter is also influenced by supply factors. Do MMTers distinguish between NGDP and RGDP?

Off topic, check out Alex Tabarrok’s great post. I had thought I was crazy when almost no one agreed with me: