5 year bond yields down to 0.87%
Stocks, oil, and bond yields plunge on investor fear of (high inflation/low inflation.) Pick one.
This is what tight money looks like.
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94 Responses to “5 year bond yields down to 0.87%”
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A slightly off-center perspective on monetary problems.
Stocks, oil, and bond yields plunge on investor fear of (high inflation/low inflation.) Pick one.
This is what tight money looks like.
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This entry was posted on August 18th, 2011
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94 Responses to “5 year bond yields down to 0.87%”
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18. August 2011 at 09:25
Are you reasoning from price changes in stocks, oil, and bonds?
18. August 2011 at 09:25
This is a monetary horror show!
18. August 2011 at 09:30
Scott, please explain tight money vs. easy money.
18. August 2011 at 09:32
The 30 year yield also looks like it fell off a cliff!
18. August 2011 at 09:32
Baba…never reason from ONE price but always reason from a number of price. If commodity prices and equities drop, the dollar strengthen and yields drop then it is always that money is getting tighter – money demand growth outpaces money supply growth.
18. August 2011 at 09:38
The signs of loose money are an upward sloping yield curve and low or negative REAL interest rate targets by the central bank. The fact that these policies don’t always lead to the type of NGDP growth economists want them to is a larger issue than simple monetary policy.
18. August 2011 at 10:08
This is what tight money looks like.
Your definition of “tight money” is purely tautological, it means “crisis”, and since the definition of “crisis” already exists, creating another one with the same meaning only serves to obfuscate things.
It was proven to you by MMT that the money stock is endogenous – the Fed cannot impact the money supply in other way than changing rates. The private sector decided based on demand how much money it wants to create by borrowing, and the Fed accomodates. Since the rates cannot be lowered anymore, now it is over to the treasury. Fiscal policy has an advantage that it repairs the private sector balance sheets too, not simply induces it to leverage up.
Why do you continue to push your failed idea when it was shown to you that it relies on the Fed forcing reluctant banks to lend out suitcases of cash to unwilling borrowers – something that never actually happens on this planet, is beyond me.
18. August 2011 at 10:24
John (I realize this is confusing because I’m also a John):
Let’s assume that you’re correct, and that loose monetary policy = low/negative real interest rates. At this point, does the central bank have any power over nominal interest rates?
Yes. Say the fed promised to double the money supply every day for the next 20 years. Pretty clearly we’d get Zimbabwe-style inflation immediately. Real interest rates might stay low, but nominal interest rates would rise dramatically. So even if we define “loose” policy your way, it’s clear that nominal interest rates can still be changed by “looser” policy.
Thus, given Scott’s goal of 5% NGDP growth (or the Fed’s implicit vague goal of ~2.5% inflation and ~2.5% RGDP growth), why doesn’t the Fed loosen up, increase nominal interest rates, and actually meet its inflation target? As Scott just pointed out a few posts ago, the worst-case scenario is an inflation rate that’d be roughly at the historical norm. That doesn’t seem like the end of the world to me.
Of course this all assumes that you’re correct and low/negative interest rates equal easy monetary policy. That raises the question: low relative to what? If we accept the possibility of negative real interest rates, our spectrum of possible real rates is basically infinite–the zero lower bound is a lie!
So say you’re playing baseball, and you want to hit a home run. To do so, you need to hit the ball “hard.” You hit the ball “hard,” and it falls short. To me, this suggests that whether or not we define how hard you just hit the ball as “hard,” you should probably try hitting the ball “harder.” In the same way, we can define our low real interest rates as “loose,” but we have the ability to make policy “looser.” Since we’re falling way short of every conceivable target, it seems to me that maybe we should give that a try.
18. August 2011 at 10:27
I just realized how confusing my third-to-last sentence was. I should have written “This suggests that no matter what your definition of ‘hard’ was, you should probably try hitting the ball ‘harder.'”
18. August 2011 at 10:28
I never thought I’d agree with an MMTer ever, period but I agree that Scott’s definition of tight money lacks meaning as it is simply a synonym for a recession.
18. August 2011 at 10:29
The Cleveland Fed today puts the market’s 10-year expected inflation at 1.63 percent, and falling.
18. August 2011 at 10:36
Ron, that’s not Scott’s definition of tight money at all. You’re claiming that a crisis resulting in, say, 0% real growth for 10 years would *by definition* result in “tight money” as Scott sees it.
Scott has repeatedly emphasized his 5% NGDP growth target. 5% inflation + 0% RGDP growth = 5% NGDP growth. That’s right on target–not “tight money.”
18. August 2011 at 11:22
Dr. Sumner,
I really do not see how anyone believes monetary policy is so loose it will cause excess inflation. If anything we are below trend and in a period of disinflation, here http://i.imgur.com/Zamrz.png I used corecpi(t)=corecpi(t-1)(1+coreinflation(t)/100)^(1/12)and corecpi(0)=CPI at 2007-01-01 and the trend assumes a 2% inflation rate per year. Even if you look at the normal CPI after the 2003-2008 oil shock, it still tells you the same thing http://i.imgur.com/APjhr.png.
18. August 2011 at 11:31
Ron T,
M0 > cash balances > financial assets > nominal wealth > bank lending > broad money > NGDP, so there is a transmission mechanism that isn’t limited to interest rates and so MMT is wrong. QED.
Incidentally, quite a few MMT’ers in the last MMT thread are claiming that MMT is compatible with exogenous money. You might want to sort them out.
18. August 2011 at 11:32
John,
Wrong again. Is anyone arguing that, if output fell and NGDP was at trend, that that wouldn’t be a recession?
18. August 2011 at 11:34
W. Peden
Scott might argue that I think. He at least seems to imply it, or that a recession at least would be extremely unlikely or painless if NGDP grows at trend.
18. August 2011 at 11:44
John,
Back up a second there. We have several possible positions there-
1. Falling output with no big fall in NGDP growth is not a recession.
2. Falling output with no big fall in NGDP growth is a recession, but it is very unlikely.
3. Falling output with no big fall in NGDP growth is a recession, but it is very unlikely and painless.
4. Falling output with no big fall in NGDP growth is a recession, but it is painless.
Only 1 would be a position where “falling NGDP growth” (meaning tight money as far as a monetarist is concerned) and “recession” are being used as synonyms.
2 is an empirical generalisation that is true, as far as I know. The truth of the others depends on what one means by “painless”. I’d say that, insofar as an economy is a market economy, supply-side driven recessions are self-adjusting in the long run if demand doesn’t fall, since higher prices act as incentives for producers to make up the shortfall in supply.
Now, one can object to using NGDP as a proxy for the tightness of money, but only if one has a good story about how money is endogenous. Kaldor came closest and was thwarted only by the fact that bankers are not the kind of psychotics required to fit his theory.
18. August 2011 at 11:44
W. Peden,
A situation where you have -1% rgdp and a deflator of 6% is possible (even under an output gap), and it would be a recession. The problem for NGDP targeting is, how does this condition in any way relate to a favorable trend in the underlying variables? It implies, of course, that the Fed would consider a l.t. stagflation trend a monetary policy success.
18. August 2011 at 11:45
(Of course, falls in supply can be extremely painful e.g. a major earthquake is terrible. However, the brilliant thing about market prices is that they create signals to producers to produce more in such circumstances.)
18. August 2011 at 11:48
David Pearson,
I think it tells us about the limits of the Fed. The Fed cannot increase the real growth rate of an economy above potential; it can only NOT decrease it below potential. Monetary policy cannot magic away earthquakes, oil crises, strikes etc. Nor can increasing demand increase the natural productivity of an economy (contra Kaldor again) which is ultimately a matter of good supply-side policies.
The purpose of NGDP targeting is not to solve the economies problems, but to limit the extent to which the state- through its monopoly of money- causes NEW problems for the economy.
18. August 2011 at 11:49
W. Peden:
So you’re saying that Scott’s definition of “tight” money is below-trend NGDP growth? Could you point me to where Scott has stated this?
18. August 2011 at 12:01
“The purpose of NGDP targeting is not to solve the economies problems, but to limit the extent to which the state- through its monopoly of money- causes NEW problems for the economy.”
Uhm, so why would anyone have a problem with with me delaying NGDP targeting until after we have pulled Obamacare up by the roots? Ending minimum wage? Cutting back regulations?
These keep the government from causing new problems.
18. August 2011 at 12:10
“Uhm, so why would anyone have a problem with with me delaying NGDP targeting until after we have pulled Obamacare up by the roots? Ending minimum wage? Cutting back regulations?”
Ask them. My interest is not in internal US politics- a spectator sport from my perspective- but the technical questions. Of course, if the scenario you lay out happened, well… One has to endure certain twists of fate.
However, from a realpolitik POV, presumably your ideal situation would be NGDP targeting adopted shortly after/before Obama loses the 2012 election? That way, people would associate the recovery with the supply-side reforms…
18. August 2011 at 12:35
Good article in The Atlantic on the importance of monetary policy: http://www.theatlantic.com/business/archive/2011/08/hey-rick-perry-printing-money-is-patriotic/243722/
To me the money quote is:
“When Reinhart and Rogoff said that bad things would happen if the national debt exceeded 90 percent of GDP, that became the hottest issue in popular economic debates (and was cited by Paul Ryan as a reason for budget-cutting). But when Rogoff says we need more aggressive monetary policy and even higher inflation to recover from the current economic crisis, people change the subject.”
18. August 2011 at 12:46
W. Peden,
As for using NGDP as a measure of the tightness of money, I am confused on that score. As I understand it, today we have tight money because, despite an NGDP recovery, we have a shortfall of NGDP from the trend level. In 1933-1936, monetary policy was apparently loose, and yet we had a much more severe shortfall from the trend level. So the amount of the shortfall does not define the policy stance, and neither does the presence of an NGDP recovery. What does?
Perhaps an NGDP trajectory that put us back to trend levels in two years. In that case, was Fed/FDR policy in 1933-1936 “tight” as it did not accomplish this trajectory? If not, then why was our 2010-2011 4% NGDP trajectory “tight”?
What is “trend” NGDP growth in Japan? The pre-deflationary (1980’s) trend, or one that encompasses the deflationary period? How do we define “easy” or “tight” there?
What was “trend” NGDP growth in Brazil in the 80’s and 90’s? Would it have been necessary for Brazil to have NGDP fall steeply for two years in order to return to that trend level? And if it didn’t, was policy “easy”?
18. August 2011 at 12:56
Oh Morgan,
“Uhm, so why would anyone have a problem with with me delaying NGDP targeting until after we have pulled Obamacare up by the roots? Ending minimum wage? Cutting back regulations?”
Because I assume you believe this will happen after Perry wins along with large Tea Party gains in the House and the Senate. For the sake of argument, let us pretend that will happen. What you’re calling for delays action until after January 2013 (at the soonest). So that’s one reason someone might have a problem with your suggestions.
@johnleemk: that is indeed the money quote, very nice
18. August 2011 at 13:00
David Pearson,
I think that this is where additional premises really get involved. I’m not much of a fan of looking at trend shortfalls over the long term, because wages &c. will adjust over time. Nor do I think that monetary policy in the US is particularly tight right now; the demand problems in the US seem to be more with expectations.
In one sense of tightness, I would say that NGDP is loose if it’s above trend productivity growth + tight if it’s below trend productivity growth PLUS inbuilt inflationary expectations. If inflation was beaten out of an economy and we had a very flexible labour market, then the answer to “what is tight or loose?” would be very straightforward, because we could take out that additional “plus”.
I don’t know much about Brazil, but for Japan I’d say that the best option at this point is probably to pick some NGDP target around the productivity trend and stick to it, even if it means inflation at times.
18. August 2011 at 13:42
“Stocks, oil, and bond yields plunge on investor fear of (high inflation/low inflation.) Pick one.”
Neither. This has to due with perceptions of real risks, not expectations about monetary phenomena.
18. August 2011 at 13:50
W. Peden,
Any fall in output is painful for the consumer. Advocating inflation to keep NGDP in line just seems like masochism as people will have less goods available and have to pay higher prices for them.
18. August 2011 at 13:54
John,
Per capita output, anyway. If 10 million Americans went to a colony on Mars , this would reduce output, but I’m not sure it would be painful.
As for higher prices, what is the function of higher prices in a market economy? Why do we have a price system at all?
18. August 2011 at 13:58
John S,
I see your point, but the Fed is absolutely limited under the current system to buying treasury issues. Once they’ve bought them all up (I have no idea how close they are to doing that but they are the largest holder of Treasuries) there’s nothing left to do. They aren’t literally going to drop money out of a helicopter like Bernanke said.
Ultimately, I’ll never agree with Sumner’s position because I believe that recessions play a role in rebalancing the economy. When government’s intervene they prolong recessions and create depressions. The worst things they can do in order of effectiveness in making the recession worse are: bailing out or supporting certain industries, increasing regulations, increasing government spending, and finally printing money which prevents prices from falling back into configurations the consumer wants and can afford. If you look at Depressions you’ll generally see that governments did all of the above. So no, I don’t believe the Fed should try to “hit the ball harder” and think there policy of relative looseness has been a disaster so far.
18. August 2011 at 14:00
John-
You’re looking at the issue backwards:
If the yield curve is downward sloping, it is because markets believe that money will be tighter in the future (otherwise, why not just lend short and roll it over year-to-year?). That means that the high interest rate, downward sloping yield curve is relative loose at that moment, but will not be in the future.
Similarly, a low interest rate / upward sloping yield curve indicates that money is currently very tight compared to a (relatively) loose-money future.
18. August 2011 at 14:01
“That means that the high interest rate, downward sloping yield curve is relative loose”
Bah. “Is indicative of relatively loose money” – that’s how I meant to phrase that awkward sentence.
18. August 2011 at 14:39
Actually, now that I think about 1933-1936, wasn’t output well below trend during that period as well? Of course, one would expect some slowdown due to the New Deal et al, but still…
18. August 2011 at 16:08
Bababooey, I’m not reasoning from “a” price change, I’m reasoning from multiple price changes. Falling short term interest rates could be easy or tight money (you are right about that.) So look at long rates, look at oil, look at stocks. Easy and tight money have very different effects on those variables.
Lars, I agree.
Morgan, Easy money is monetary policy expected to produce above target growth in the Fed’s nominal target, and vice versa. I favor NGDP targeting, but money’s also too tight to hit the Fed’s 2% expected inflation target over the next couple years. Easy and tight are always relative concepts, relative to the target. One can’t look at interest rates alone.
BintheD, Markets are seriously entertaining the Japan scenario.
John, Sometimes, but not always.
Ron, No, it’s not tautological. It’s based on expected NGDP growth.
Any open market purchase increases the base, regardless of whether rates go up, down, or stay the same. The highest interest rates are in countries with the fastest money supply growth, one of the inconvenient facts the MMTers overlook.
John, You said;
“Scott’s definition of tight money lacks meaning as it is simply a synonym for a recession.”
No, my definition has nothing at all to do with RGDP or unemployment or any other real variable. A recession can occur with NGDP on trend.
Jim Glass, Thanks, that doesn’t get enough attention. There are flaws in the TIPS spreads which the Cleveland Fed corrects. Inflation expectations are actually slightly lower than the TIPS spread.
Spencer, I agree.
David Pearson; You said;
“A situation where you have -1% rgdp and a deflator of 6% is possible (even under an output gap), and it would be a recession. The problem for NGDP targeting is, how does this condition in any way relate to a favorable trend in the underlying variables? It implies, of course, that the Fed would consider a l.t. stagflation trend a monetary policy success.”
That makes no sense. Suppose a house burns down and no one does anything. Is that a failure of the police department? Does the police department need to change their policies? Or perhaps is that the responsibility of the fire department? It’s insane to blame monetary policy for stagflation–there is nothing they can do about it if NGDP is on target. Nothing.
o. nate, W. Peden is right.
johnleemk, Good Rogoff example.
JP Konig, No, it’s due to rapidly falling expectations of NGDP growth–that’s what the bond market is telling us.
W. Peden, 1933-36 is complicated. Dollar devaluation led to 57% growth in industrial production from March to July 1933. Then the NIRA raised wages 20%, and IP did nothing for 2 years. The NIRA is declared unconstitutional in mid-1935, and then rapid growth resumes. Until the next wage shock (in early 1937.)
18. August 2011 at 16:11
John, I actually completely agree with you that recessions are necessary for adjustments in the economy. If we suddenly realize we have too many widget producers and not enough gadget producers, we want the relative prices of widgets and gadgets to change so that we actually change our patterns of trade to fit our new knowledge. And of course in the actual impossibly complex economy, that process can take some time before we return to full employment of our resources. I share your desire not to short-circuit that search process.
My question for you is this: why does the overall price level need to fall/not rise in order for relative prices to change?
18. August 2011 at 17:12
Scott,
I disagree. The police (or rather fire) department would be responsible for setting the fire. High inflation reduces trend growth for a host of reasons evident to anyone that has lived in Latin America. The essence of stagflation is not an unhappy coincidence of inflation and slow growth; it is a period during which inflation causes slow growth.
18. August 2011 at 18:07
David P: inflation, or price uncertainty? If prices rose a reliable x%, everyone could manage that. But if prices rise in large and unpredictable ways not connected to output or demand changes, that is going to depress trend growth. In other words, if money performs its basic function of simplifying transactions and recording obligations, things are fine. If money’s “barter price(s)” (prices in terms of goods and services) engage in continuing large and variable shifts, then things are not.
18. August 2011 at 20:23
John, I forgot to respond to one of your claims: “I see your point, but the Fed is absolutely limited under the current system to buying treasury issues.” Not so–the fed bought corporate bonds, mortgage backed securities, etc. in order to increase the money supply during QE. Even if the “only buy federal debt” limitation did exist, I think it’s fairly unlikely that the Fed could ever buy up 100% of federal securities, but it’s a moot point anyway since that limitation has already been abandoned.
18. August 2011 at 20:49
“Easy money is monetary policy expected to produce above target growth in the Fed’s nominal target, and vice versa”
Ok, so what is tight money?
18. August 2011 at 20:52
Lorenzo,
“If prices rose a reliable x%, everyone could manage that.”
I disagree. A continues rise of prices only happens when the government has its fingers in everything… and that means slow growth.
18. August 2011 at 21:02
Morgan,
Just switch that statement around to get: “tight money is monetary policy expected to produce below target growth in the Fed’s nominal target.” How is that definition unsatisfactory?
18. August 2011 at 21:16
Lorenzo,
Uncertainty is a big source of the problem. Another is unproductive hedging behavior, as in where firms make more money from managing working capital or speculating in commodities/currencies than they do from production. Yet another is chronically low savings brought about by negative real rates, something which increases the dependency on volatile external financing.
18. August 2011 at 21:36
Scott, I don’t remember you predicting that this would happen once QE2 ended? In fact, I thought you wrote that QE2 would work. Or are we just pushing on piece of string?
18. August 2011 at 21:40
David P: that all makes sense, thanks.
Morgan: you are importing an extra cause, I am merely considering the effect of continuing large increases in spending over and above changes output.
18. August 2011 at 21:44
Anyway, QE2 ec i the US probably is “working” juddging M2 and this sort of story n Bloomberg this morning:
“Retailers, Restaurants Raise Prices to Offset U.S. Labor Costs
QBy Anna-Louise Jackson and Anthony Feld – Aug 19, 2011 5:01 AM GMT+0100 .
Retailers and restaurants are raising consumer prices to help compensate for higher labor costs, which increased the most in almost three years during the second quarter.”
18. August 2011 at 21:46
Morgan again,
Do you have any evidence at all for your claim that “a continuous rise of prices only happens when the government has its fingers in everything”? Replace “its fingers in everything” with “control over the money supply” and you’d be making a vaguely true point. Otherwise, want to provide some inflation figures (presumably showing zero average inflation) for libertarian(ish) countries around the world?
18. August 2011 at 22:41
John S.
I would never say that prices in general have to rise or fall in order for relative adjustments to take place. Changes in the “price level” are necessary when there are changes in the supply and demand for money in order to bring the total volume of spending in line with the total volume of goods available.
18. August 2011 at 22:47
W. Peden,
It depends which 10 million Americans. If we sent the least productive ones away it might not hurt, if we sent the most productive ones it would be very painful.
When you ask what the function of market prices are my first thought is what does that have to do with the discussion we’re having. My second thought is that I’ll explain it to you because I think econ is cool. Changes in relative prices between goods (including interest rates) are necessary to align production with consumer preferences across the entire economy and through time. Rises or falls in prices in general happen when the supply and/or demand for money changes. For instance if 50% of the money disappears, prices would have to fall 50% in general to align the available goods and services with the total volume of spending.
19. August 2011 at 05:44
David, No, high inflation doesn’t reduce growth, high NGDP growth does. The Latin American data you cite is countries with high NGDP growth.
Morgan, I said and vice versa, meaning tight money is expected to produce lower than target nominal growth.
James, I said QE2 was too weak. I also said the markets expected it to boost NGDP growth above the non-QE2 scenario. Were those predictions inaccurate?
All long time readers of my blog know I have contempt for unconditional forecasters. I liken them to “Nostradamus.”
I pointed out that since 2008 the markets have been telling us that we need faster NGDP growth. Do you think the markets were correct?
I favor targeting the forecast, my policy doesn’t depend on whether I can predict, it stabilizes NGDP growth expectations.
James, Anecdotal evidence is the last refuge of the failed inflation fear-mongers. The CPI is up 3% in the past three years–that’s 1% per year. Anyone can find a price here or there that has risen much faster. But I noticed when the inflation fear-mongers failed in their predictions over the past two years, the best of them admitted it, (people like Bob Murphy) and the worst just started to grasp for any individual price that proved their point.
19. August 2011 at 06:28
“Easy money” is monetary policy expected to produce above target growth in the Fed’s nominal target.
“Tight money” is expected to produce lower than target nominal growth.
——-
Ok, now what are we supposed to call it when any business without a “cracked out” business plan can raise funds?
Or when anyone likely to be able to pay back a loan, who wants a loan, can get a loan?
Silas got me thinking about how odd it is you use a term tight / loose that has NOTHING to do with what I see on the street.
It is almost like you are saying, “under a given business / government environment, even if everyone who is WORTH giving a loan, who wants a loan, has a loan – money can still be too tight.”
Which immediately means you are arguing for cracked out business plans.
And I’m saying, the operable issue is the business / government environment. Change that, and you change loan demand.
AT SOME POINT SCOTT, you are INSISTING that in your grasp of the business reality, you don’t think things are too screwed up.
Meaning, say I told you about an alternative universe, where yesterday a new regulation was passed that made cars illegal today, and the market was crashing to zero.
You WOULDN’T say, “Monetary can solve this!!!!”
But in this circumstance you are.
That means when business guys talk about too much regulation, you are mentally discounting it.
19. August 2011 at 06:38
Replace “its fingers in everything” with “control over the money supply” and you’d be making a vaguely true point.
That’s about right.
My point is simply historically a government say like Turkey where they had a bunch of money printing year after year – they were also the kind of government that had their fingers in everything else too.
Whereas a country that thinks it is not supposed to have it’s fingers in everything – I’d assume they are less likely to be printing money. Wouldn’t you?
Until the Internet really takes hold, it is very hard to point to libertarian countries, and since money began there has been a tendency to devalue it. To muddy the silver pieces.
19. August 2011 at 07:34
Right now, under non-sumnerian-ian definitions of money tightness its very loose, as well, checking accounts have negative effective interest rates (fees are higher than interest) and so do many savings accounts. Many banks are actually trying to get rid of depositors (NY Mellon has started charging interest to depositors so they won’t put money in its bank) and one bank here in Texas is actually trying to give up its charter and all of its depositors.
However, under the non-standard sumnerian definition of easy money, money is very tight right now.
19. August 2011 at 08:05
All those Israelis camping on the streets don’t believe their government’s economic statistics, I am not sure why Americans believe their government’s statistics. “GDP” numbers certainly seem to shift about a lot. The average family has faced inflation, is not better off than 20 years ago. And anyway it is coming, QE2 and other measures are working. And it won’t change the unemployment rate unless there is some more reallocation of resources (cue the “liqidationist” rant from your followers).
19. August 2011 at 10:53
Morgan, one huge problem with the idea that “a country that thinks it is not supposed to have its fingers in everything” is “less likely to be printing money” is that beliefs about the proper size of government are endogenous. If we’d gone off the gold standard under Hoover, wouldn’t we be a more libertarian country today?
As for your response to Scott, how many times has this blog said this:
****Low interest rates are a sign of tight money.****
People aren’t failing to find investment opportunities despite very low interest rates. People are failing to find investment opportunities because of tight money. This lowers interest rates. (You make the error because you are reasoning from a price change.)
Quasi-monetarists want higher interest rates, which can only come about through looser monetary policy.
19. August 2011 at 11:19
John S.
“If we’d gone off the gold standard under Hoover, wouldn’t we be a more libertarian country today?”
I really doubt that. Hoover was a fan of central planning, and I don’t buy the macro explanation for the great recession when the micro reasons are so much more compelling. I mean, wage and price fixing across the entire country?, banning people from growing crops?, the government buying up crops and destroying them? Also note that the recession ended around the same time that the NRA was revoked by the supreme court.
This all sounds like a microeconomic-caused recession to me.
19. August 2011 at 16:55
Morgan, You are talking about easy credit, not easy money.
Doc, Yep, others say money is easy, I say it’s tight.
James, We agree that the economy sucks right now.
22. August 2011 at 11:34
W Peden,
M0 > cash balances > financial assets > nominal wealth > bank lending > broad money > NGDP
the first two links don’t exist as Bernanke has been proving since 2008. QED.
22. August 2011 at 13:30
Ron T,
Only if M0 can bear interest.
22. August 2011 at 13:36
That is to say that the payment of interest on M0 (recall that M0 is high powered only if doesn’t appreciate in value) makes it LESS related to asset prices. Clearly, there has still been a relationship between increases in the monetary base and asset prices since then, from the point of anticipation onwards. Just look at what happened with QE1 and QE2, particularly as regards the US stock markets.
22. August 2011 at 13:40
(Also, the demand for base money changes during recessions. This is not news to anyone.)
22. August 2011 at 20:02
W Peden,
You don’t know what you are talking about. Paying .25% of interest all of a sudden makes the monetary base impotent? Ou-kay. Hint: monetary base cannot be lent out outside of the banking system. So actually paying interest on it pushes the asset prices (slightly) higher. Yes, I know Sumner claims the opposite.
See secong graphe here (your “asset prices” sit in the inflation): http://krugman.blogs.nytimes.com/2011/08/20/fancy-theorists-of-the-world-unite/
I guess Bernanke should have tried harder, right?
23. August 2011 at 14:20
Ron T,
“Paying .25% of interest all of a sudden makes the monetary base impotent? Ou-kay.”
No, but it radically changes the attractiveness of holding base money, particularly at a time when the demand for base money is high anyway and ESPECIALLY when other assets are unattractive. Since base money is risk free anyway, interest payments augment this effect.
In short, recent years (and the Great Depression, for that matter) would refute the account of the transmission mechanism I gave if there was nothing unusual about these periods re: the demand for base money. However, since that’s not the case, neither the Great Depression nor the Great Recession refute the link between M0 and asset prices.
“monetary base cannot be lent out outside of the banking system. So actually paying interest on it pushes the asset prices (slightly) higher”
I never said that the money was ‘lent out’. Consider the following case: a bank has more cash than it wants to hold. How does it get to its desired cash ratio?
“I guess Bernanke should have tried harder, right?”
Yep. Then he wouldn’t just have boosted NGDP growth a little, but a lot.
24. August 2011 at 06:07
Since we *are* in unusual times, and as you say yourself in unusual times there is indeed no link between M0 and asset prices, why even talk about it?
Do you understand that when banks have more base money than they demand, they cannot get rid of it by lending? As a system, the banks can only get rid of it by giving it to the Fed, not the public (only banks have reserve accounts).
24. August 2011 at 07:23
“Since we *are* in unusual times, and as you say yourself in unusual times there is indeed no link between M0 and asset prices, why even talk about it?”
That is an incorrect premise. It’s not that there is NO link between M0 and asset prices; it’s just that the link is much much weaker. This creates the requirement that anticipated increases in M0 have to be much bigger to have the same effect that they would have under normal circumstances.
“Do you understand that when banks have more base money than they demand, they cannot get rid of it by lending?”
They can, just not directly-
Premise 1: Loans create deposits.
Premise 2: Deposits are liabilities.
Premise 3: Liabilities on a bank are liabilities to supply cash on demand.
Conclusion: A bank’s cash reserves must be sufficient to meet their liabilities. (Indeed, this is the only reason why banks hold cash at all, apart from meeting reserve requirements, IF there is no interest paid on excess reserves.)
Of course, in a banking system with a lender of last resort function, it is the cash reserves which are modified in line with the bank’s deposit-liabilities, because the central bank will always ensure that the bank can meet its liabilities to depositors.
However, if the bank buys a lot of non-loan assets, then its erswhile excess cash holdings will not allow additional expansion of its loan-deposit balance sheet. Meeting its liabilities to depositors is one way that a bank sheds cash.
“As a system, the banks can only get rid of it by giving it to the Fed, not the public (only banks have reserve accounts).”
Inaccurate, otherwise the banks would be unable to shed unwanted cash, which in normal times makes up only a tiny fraction of their total assets. Banks are in the BUSINESS of acquiring assets and profiting from their appreciation. Banks can use cash to acquire a variety of kinds of asset-
1. Hard assets, which are about 1/10th of a normal bank’s assets.
2. Securities, which are necessary to meet liquidity requirements and make up about 1/5th of a normal bank’s assets.
3. Loans, which make up the rest of a bank’s non-cash assets and create liabilities on a bank’s cash holdings, which are withdrawn when a customer demands cash.
Did you not know that banks owned securities?
24. August 2011 at 07:24
* “Indeed, this is the only reason why banks hold cash at all, apart from meeting reserve requirements, IF there is no interest paid on excess reserves.”
That is to say, reserve requirements over and above the legal cash requirement necessary to take on liabilities, e.g. supplementary deposits held at the central bank.
24. August 2011 at 12:10
W Peden,
Premise 1: Loans create deposits.
Premise 2: Deposits are liabilities.
Premise 3: Liabilities on a bank are liabilities to supply cash on demand.
– yes, this depends on the public demand for cash. MMT went over this with Sumner like 10x now. He can’t admit this, because it makes everything he says irrelevant. But you could afford to understand it. Unless the public wants more cash as opposed to checks/deposits, nothing will come out of it. If banks start pay out cash on every withdrawal demand – people spend this cash, and if the receiver wants deposits, like people usually do, – they deposit the cash and poof! it is back in the banking system. So the grand idea depends on changed propensity to hold cash on the part of the private sector. Do you understand it?
24. August 2011 at 12:31
Ron T,
And just in your last post, you claimed that banks only got rid of excess cash by depositing it at the central bank…
24. August 2011 at 12:38
Also, the public’s demand for cash rises during a recession. It is easy for banks to shed excess cash during a recession, but they will only do this if their actual cash balances are in excess of their desired cash balances.
24. August 2011 at 15:01
W Peden,
And just in your last post, you claimed that banks only got rid of excess cash by depositing it at the central bank…
Exactly, because they cannot influence how much cash the private sector wants. If they want to get rid of it – the Fed is the only way to go. What is hard to understand here?
Also, the public’s demand for cash rises during a recession.
The public demand for cash can rise or fall – irrelevant. You cannot influence how much cash the public holds. The private sector determines this and nobody else.
24. August 2011 at 15:58
“Exactly, because they cannot influence how much cash the private sector wants. If they want to get rid of it – the Fed is the only way to go.”
Nope. What do you think banks buy securities with?
“You cannot influence how much cash the public holds.”
Two words: interest rates. Unless you’re going to argue that the demand for money is interest rate-insensitive…
24. August 2011 at 15:59
Also, if a bank has excess cash, then it can meet its reserve requirements without using the lender of last resort function. Of course, in practice, this isn’t a profitable way to shed excess cash; the bank can simply purchase securities.
24. August 2011 at 16:28
W Peden,
“Exactly, because they cannot influence how much cash the private sector wants. If they want to get rid of it – the Fed is the only way to go.”
Nope. What do you think banks buy securities with?
You are going in circles. Buy from whom? The Fed? Exactly, they can get rid of reserves by giving them to the Fed. Like I said. They cannot give them to the public – the public doesn’t have accounts with the Fed.
Interest rates? It has nothing to do with demand for *cash*, but for loans. You should get it by now: yes, the monetary policy is about interest rates, not the quantity of the reserves/cash. Reserves cannot be given to the public, unless in form of cash – and you cannot influence how much cash vs deposits the public wants. Case closed.
24. August 2011 at 16:37
Ron T,
“Buy from whom? The Fed?”
I’m flabbergasted. Are you saying that only the Fed and commercial banks own securities?
“Interest rates? It has nothing to do with demand for *cash*, but for loans… and you cannot influence how much cash vs deposits the public wants.”
Let’s say deposits are paying real interest rates at 2%. The real interest rate then falls to -2%. Are you saying that this doesn’t change the public’s demand to hold cash?
24. August 2011 at 17:01
By the way, even if there was some law that banned banks from buying securities with cash (which would make much of investment banking operations illegal) insurance companies and pension funds own securities and hate to own cash. QE can theoretically work even in an economy without commercial banks, though of course the effect of QE on asset prices makes QE much more effective because of its effects on bank lending.
(In practice, by the way, banks don’t remit their purchases of securities using physical transfers of cash; they do it via orders on correspondent banks or state banks.)
24. August 2011 at 17:06
Anyway, the point is that purchases of securities create deposits, i.e. the bank’s purchase of a security is balanced out by the creation of a liability on the bank’s cash holdings. Banks can and do shed excess M0 and this affects asset prices.
24. August 2011 at 17:41
So, in summary, QE has effects through the following channels-
1. The interest rate channel, which affects both the demand for credit and the demand for cash.
2. The exchange rate channel.
3. The first asset price channel, which is the effect of the purchases involved in QE in themselves on asset prices.
4. The second asset price channel, whereby banks shed excess cash balances by purchasing securities, which increases the willingness and capacity of the public to borrow.
5. The third asset price channel, which is that the sellers of the bonds can use the proceeds to invest.
6. The fourth asset price channel, which is that pension funds and insurance companies go through a “dance of the dollar” to try and shed their excess cash
holdings, which bids up asset prices.
7. The fifth asset price channel, by which pension funds and insurance companies pass on the profits of the sale.
(Obviously, expectations effects precede the straightforward effects i.e. even anticipations of QE boost asset prices and broad money.)
What does theory tell us about these channels? I haven’t heard a cogent argument against any of them. What does experience tell us? Permanent increases in the monetary base boost asset prices and broad money, even when bank rate is near 0%.
24. August 2011 at 18:41
W Peden,
You got completely lost in you own rhetoric.
We were talking about “M0 > cash balances > financial assets” Neither of the two links exist. So you changed the topic to interest rates.
“Buy from whom? The Fed?”
I’m flabbergasted. Are you saying that only the Fed and commercial banks own securities?
Only Fed and commercial banks can take reserves as payment. Remember? We established this above. Sigh. You were trying to prove that banks can push reserves to the public. Nope, unless the public wants more cash. And sure they can push them on the Fed, but this is opposite to what you argued.
“Interest rates? It has nothing to do with demand for *cash*, but for loans… and you cannot influence how much cash vs deposits the public wants.”
Let’s say deposits are paying real interest rates at 2%. The real interest rate then falls to -2%. Are you saying that this doesn’t change the public’s demand to hold cash?
Reminder: we were not talking about the interest rates, but about “M0 > cash balances > financial assets”. The links don’t exist. So do you withdraw this statement? The only Fed action that can have impact is interest rates, not messing with M0. Agreed?
Even if you assume that the public wants more cash – it means they are withdrawing deposits as cash. So you have more cash and less deposits, by the same amount, to the dollar. How are you are gonna argue that this will inflate financial assets? Good luck.
24. August 2011 at 18:58
“You were trying to prove that banks can push reserves to the public.”
And they can. When a bank buys a security, a deposit is created. This deposit is a liability on the reserves of the bank. What part of this is unclear?
I also notice that you have no argument against the effect of increases in M0 through QE purchases of securities from insurance companies and pension funds. So even if banks couldn’t swap their cash liabilities for securities- which they blatantly can- “M0 > cash balances > financial assets” would still hold.
Like I said, there is no cogent argument against any of these channels. Boosting cash balances of banks, pension funds and insurance companies boosts financial assets. It’s irrefutable.
24. August 2011 at 19:16
“You were trying to prove that banks can push reserves to the public.”
And they can. When a bank buys a security, a deposit is created. This deposit is a liability on the reserves of the bank. What part of this is unclear?
What is clear is that you know very little how banks work. Seller’s deposit is created, buyer’s is destroyed. The reserves shift between the banks that hold the accounts of the buyer and seller. The amount of reserves is the same. Big nothing.
You need to come back to you idea of pushing cash on the public, as this is the only way how you can indeed push the reserves outside of the banking system. But there again – the demand for cash is determined by the public, not the Fed. And, if the public wants more cash, it get fewer deposits, so this cancels out. Big nothing again.
I also notice that you have no argument against the effect of increases in M0 through QE purchases of securities from insurance companies and pension funds.
My argument holds for all entities, pension funds, insurance companies, pawn shops and pet hospitals. There are only two types of entities: those who have accounts at the Fed and can take reserves as payment, and those who don’t and need to have banks accounts with banks that do. That is basics of how the banking system is set up. So now: when banks exchange payments, they shift reserves, the amount stays constant. The reserves can get pushed out of the banking system in two directions: the Fed and the public, only when it takes more cash (but then deposits decrease by the same amount).
So your grand idea is that destroying deposits and creating equal amount of cash will boost financial assets. You don’t begin to understand how laughable this is.
25. August 2011 at 02:53
“What is clear is that you know very little how banks work. Seller’s deposit is created, buyer’s is destroyed. The reserves shift between the banks that hold the accounts of the buyer and seller. The amount of reserves is the same. Big nothing.
You need to come back to you idea of pushing cash on the public, as this is the only way how you can indeed push the reserves outside of the banking system. But there again – the demand for cash is determined by the public, not the Fed. And, if the public wants more cash, it get fewer deposits, so this cancels out. Big nothing again.”
Let’s take the following case: a bank sells government bonds to the central bank for base money. The bank, not wanting to hold this base money, buys a security from a pension fund. Assuming the transaction doesn’t take place in cash, the pension fund now has a deposit with that bank. But pension funds are hardly going to want to hold a deposit at <0.5% interest, so they exchange that money for another security.
However, now another holder of securities has more (effectively) non-interest bearing money. So they buy another security. And so on: the hot potato gets passed around until equilibrium, as the securities increase in value with the volume of transactions. Hence the "dance of the dollar". As a result, the nominal wealth of the public has increased.
"So your grand idea is that destroying deposits and creating equal amount of cash will boost financial assets."
Wrong again. Say the central bank buys a government bond from an insurance company. The insurance company now has non-interest money instead of a bond, i.e. it has an excess cash balance. So it buys another security and so the dance of the dollar begins again.
The fact that these institutions take their cash balances as demand-deposits at a bank rather than as physical currency is utterly irrelevant under current circumstances, because a demand-deposit is basically indistinguishable from cash under current circumstances and no sane pension fund, insurance company, saver or whatever is going to hold such a deposit.
Unless, of course, they want to engage in a transaction. But this just shifts things one step along: now someone else has the money and so the dance of the dollar continues. It doesn't stop until no-one has excess cash balances.
Which is why recent experiences of QE has financial assets.
25. August 2011 at 05:06
Let’s take the following case: a bank sells government bonds to the central bank for base money. The bank, not wanting to hold this base money…
Good laugh here. So your thinking about econ is: “X buys Y, but doesn’t really want it so it sells it!”. Memo: nobody, ever, buys a single thing they don’t want. Weird that people reading a blog of a guy supposedly believing in rationality come up with nonsense like that. Memo2: if some employee of a bank actually bought something the bank doesn’t want and needs to go around and immediately sell, they would be fired.
Your idea how the monetary policy/system works is based on repeated behaviors that never take place. it is not even clear that this process would increase the value of the securities: nobody wants them, everybody wants to sell. So the price would go…up, right? Hmmm.
I totally agree with you though: if the whole market bought stuff they don’t want and then immediately sold it, god only knows what would prices look like. Maybe Sumnernomics would even work, who knows? As MMT people always said, you guys have a good theory of the Martian financial system workings, here on Earth it is just a big joke.
25. August 2011 at 06:05
“So your thinking about econ is: “X buys Y, but doesn’t really want it so it sells it!”. Memo: nobody, ever, buys a single thing they don’t want.”
Ever heard about indirect exchange?
“Memo2: if some employee of a bank actually bought something the bank doesn’t want and needs to go around and immediately sell, they would be fired.”
This is called ‘trading’, contrary to your belief, those people are actually quite well paid.
25. August 2011 at 07:39
Martin,
I heard about indirect exchange, irrelevant. Nobody is ever forced to buy stuff, from Fed or otherwise, that they don’t want.
I work in trading. Memo for you: nobody buys at a loss. If people bought reserves to sell them, it would only be to sell them at a higher price, not lower, as Peden wants. Lol.
25. August 2011 at 10:08
You work in trading, so when you buy something do you buy it because you want that specific thing or do you buy it because you think you can sell it for more later?
In the latter case, you just bought something you didn’t want just to go around and sell it later for something you do (more money).
25. August 2011 at 10:14
Yes, more money, not less money as W Peden wants. One always buys the stuff one wants more giving up the stuff one wants less. W Peden hopes it is the other way round. He requires the initial OMO transaction with the Fed to leave banks with less stuff that they want (securities) and more of what they don’t want (reserves). Do you get it now?
25. August 2011 at 10:41
This then is in direct contradiction to what you said here:
“”So your thinking about econ is: “X buys Y, but doesn’t really want it so it sells it!”. Memo: nobody, ever, buys a single thing they don’t want.””
You buy stuff you don’t want every day to get what you do want.
25. August 2011 at 11:57
LOL, you are seriously lost here.
25. August 2011 at 13:29
Ugh.
“So your thinking about econ is: “X buys Y, but doesn’t really want it so it sells it!”. Memo: nobody, ever, buys a single thing they don’t want.”
Person 1 holds A, but wants C. Person 2 holds B but wants A, Person 3 holds C but wants B. Person 1 trades with Person 2 so that it obtains B, and consequently trades with Person 3 to obtain C.
According to you this is impossible. According to W Peden, this is possible. Now imagine B is money and you have a phenomenon that happens every single day.
The only reason you can argue this:
“He requires the initial OMO transaction with the Fed to leave banks with less stuff that they want (securities) and more of what they don’t want (reserves).”,
is by assuming that the above is the sole possible explanation to this statement by W Peden:
“Let’s take the following case: a bank sells government bonds to the central bank for base money. The bank, not wanting to hold this base money, buys a security from a pension fund.”
The thing that puzzles me is that you’re a trader, you do these kind of transactions every single day, but when it comes to your argument with W Peden, the fact that those transactions happen, doesn’t even occur to you.
27. August 2011 at 05:25
Ron T,
By the way, I think I’ve discovered a source of confusion: by “cash balances”, I don’t mean cash-in-circulation, but the overall holdings of cash other than by the centrla bankl (including the cash holdings financial institutions). I was wondering why we were going through all that stuff about the cash leaving the financial system.
So the central bank increases M0 when it buys securities, which increases the cash holdings of the institutions (banks, pension funds, insurance companies etc.) that it buys the securities from.
“Good laugh here. So your thinking about econ is: “X buys Y, but doesn’t really want it so it sells it!”. Memo: nobody, ever, buys a single thing they don’t want. Weird that people reading a blog of a guy supposedly believing in rationality come up with nonsense like that. Memo2: if some employee of a bank actually bought something the bank doesn’t want and needs to go around and immediately sell, they would be fired.”
Yet banks buy these securities and then expand their assets, which is observable through the effect of QE on broad money. So what’s the explanation? Clearly, the banks aim to make a profit by selling the assets at a profit.
But selling something at a profit doesn’t necessarily mean you want to keep the extra cash. If I sell something, I want to get rid of the cash as quickly as possible, which also hints at the answer to your second memo: businesses acquire cash because it can be easily exchanged for something worth having.
In the case of banks in QE, demand for securities has increased by the open-market operations (and anticipation of future demand on the part of the central bank). In addition, the selling of securities increases the asset side of the banks’ balance sheets, because these securities are sold for a return.
So the banks profit out of holding that cash, even if they don’t want to hold so much cash as a proportion of their assets. The “hot potato” cannot be disposed of, and so ultimately the only way the banks can reduce their cash holdings is as a proportion of their asset sheets, which they do as follows: assume a bank has the following asset sheet-
Loans: 70
Securities: 27
Cash reserves: 2
Misc. assets: 3
– and for the sake of simplicity let’s assume it wants to hold that mix of assets. Then, the central bank exchanges cash for some of those securities, such that the bank’s new asset sheet looks like this-
Loans: 70
Securities: 22
Cash reserves: 8
Misc assets: 3
So the bank gets back to its desired position by exchanging its cash reserves for more securities, buying them from other banks, insurance companies, pension funds and holders of securities generally.
At the level of the firm, thus far, nothing has changed. However, at the marcoeconomic level, the financial system as a whole cannot succeed in returning to its desired asset mix, as things stand, because for every purchase of securities there is now a NEW institution with more cash than it wants to hold. The supply of securities in the economy has fallen, and so the price of securities will rise, pushing up asset prices. Hence M0 > cash balances > financial asset prices.
The next stage is obvious: a rise in prices will make an increase in supply possible. Say you have a corporation that wants to raise funds for investment at the new price of corporate bonds. The corporation sells bonds to the bank, such that the bank’s asset sheet looks like this-
Loans: 70
Securities: 30.15
Cash reserves: 8
Other assets: 3
The bank’s securities are now in line with the proportion of securities it wants to hold.
The bank’s asset sheet has expanded and by an accounting identity so has its liabilities (new securities create deposits). The supply of broad money, therefore, has increased. So M0 > cash balances > financial asset prices > broad money. Mars has invaded Earth.
27. August 2011 at 07:51
“your thinking about econ is: “X buys Y, but doesn’t really want it so it sells it!”. Memo: nobody, ever, buys a single thing they don’t want.”
If this was the case, then a monetary economy would not work. People “buy” money when they sell something, but they don’t want to hold that money forever. Generally, transaction money is not “bought” to be held for any significant period of time, but for the purpose of transactions.
So I “buy” cash with my labour, even if I don’t want to hold that money (I exchange it for something that I do want to hold/consume).
27. August 2011 at 09:12
* “Misc/other assets” should be 1, not 3.
27. August 2011 at 09:13
(In both cases.)
10. September 2011 at 07:48
Ron, The fact that rates are zero and cash and T-bills seem like close substitutes does not constrain monetary policy, unless rates are always expected to be zero. In that case the government shouldn’t even have interest bearing debt. If interest rates are expected to rise some day then permanent increases in the base will raise inflation expectations and cut real interest rates at the zero bound.