How news affects markets

Tyler Cowen linked to a new NBER study by Scott R. Baker, Nicholas Bloom, Steven J. Davis, and Marco C. Sammon, which looks at the response of asset prices to various types of news. Here I’ll discuss the paper’s abstract:

We examine next-day newspaper accounts of large daily jumps in 16 national stock markets to assess their proximate cause, clarity as to cause, and the geographic source of the market-moving news. Our sample of 6,200 market jumps yields several findings. First, policy news – mainly associated with monetary policy and government spending – triggers a greater share of upward than downward jumps in all countries.

I’m not surprised that monetary policy is important, or that the effects are asymmetric. While one can find occasional examples of markets falling sharply on monetary policy announcements, as in December 2007, major changes are usually in the upward direction. This is because bad monetary policy generally involves errors of omission—the central bank fails to adjust its policy rate when the natural rate of interest is falling (as in mid-2008.) When the central bank does make a major move, it generally helps the situation. The problem, of course, is that central banks are too passive; too unwilling to move when economic conditions change.

Second, the policy share of upward jumps is inversely related to stock market performance in the preceding three months. This pattern strengthens in the postwar period.

Beneficial policy adjustments are less likely to occur if the economy (and the markets) has previously been doing well.

Third, market volatility is much lower after jumps triggered by monetary policy news than after other jumps, unconditionally and conditional on past volatility and other controls. Fourth, greater clarity as to jump reason also foreshadows lower volatility.

A monetary policy announcement often helps to clarify the situation. Other shocks, such as the failure of Lehman Brothers, make the situation even more confusing.

Clarity in this sense has trended upwards over the past century.

When I studied monetary policy in the 1930s monetary policy, I noticed that the policy environment was far more unstable than today, and also that the stock market was far more volatile than today. The average daily move in the DJIA was around 2%.

Finally, and excluding U.S. jumps, leading newspapers attribute one-third of jumps in their own national stock markets to developments that originate in or relate to the United States. The U.S. role in this regard dwarfs that of Europe and China.

This fits in with David Beckworth’s claim that the Fed is a monetary superpower due to the dollar’s role in the global economy. (Eurozone GDP is similar in size to the US GDP, but the ECB is far less influential.)

PS. There are schools of thought on both the left and the right that claim monetary policy doesn’t matter, that it’s just swapping base money for T-bills. They have no explanation for these empirical facts, and presumably either deny them or ignore them.

A very scary headline

This Bloomberg headline doesn’t look very promising:

SALT-Cap Repeal Gains Momentum With House Bipartisan Caucus

It”s hard to think of any plausible legislative action that would be worse—a huge tax cut going mostly to people making over $1,000,000/ year, which also somehow makes the economy less efficient. Oh, and it would give me headaches (not that anyone cares), as I’d have to go back to itemizing all my deductions instead of taking the standard deduction. And it would encourage state and local governments to spend money on wasteful boondoggles that don’t make sense on a cost/benefit basis.

Repeal of the SALT cap would undo one of the few helpful policy reforms of the Trump era. It would also confirm that the Biden administration is not serious about trying to improve the economy.

Eventually, the lost revenue would have to be recouped somewhere else. I doubt it will be through spending cuts; more likely Biden will have to raise taxes on average people. How long before they start discussing a VAT?

Of course some progressives will say that no one has to pay. We’ll just keep borrowing money for this and all the other shiny new toys coming out of Congress. No one has to pay for any of it.

The woke embrace white identity

Razib Khan has an excellent post discussing the recent trend of woke private schools setting up white affinity groups:

But the real problem I have is the white affinity groups. I am not happy with the “people of color” affinity groups either, but in some way, these have been around since the 1960’s. The emergence of white affinity groups seems a nod to the re-racialization of society as the explicit text. The fundamental issue is simple: I do not want white people to think about their race. I do not want white people to think of themselves in racial terms. The history of white Americans thinking in racialized terms is not good for people who look like me. These fools are going to get us killed!

Taking activists who are nonwhite at their word rather than self-interest, they believe white examination and embrace of their racial identity will allow for true anti-racism and justice. My rejoinder is simple: you put far too much faith in the innate goodness of these white people. My wife’s grandparents were good people, yes, but I know for a fact they were opposed to integration. They were good people, but of their time. Most people conform and follow the spirit of the times. Don’t tempt fate to think you can tame the snake of racial identity. It’s evil among all races and all people. It is always with us, but it is sin. As a brown-skinned minority in a majority-white country, I do not want white people to think in racial terms.

Read the whole thing.

It’s a bit depressing when minority groups engage in identity politics. It’s downright scary when the majority group does so.

Puritanism bleg

Why does Puritanism go in and out of style? What explains the Victorian era? Was it the rise of the middle class? How about the loosening of sexual mores in the 20th century? What has caused the recent revival of Puritanism?

Can the 20th century be explained as a sort of liberation of women from a double standard? Books like The Scarlet Letter suggested that women suffered much more than men when sex was viewed as shameful. Hence free sex was seen (by some) as a way to liberate women. That is the idea that seemed to be “in the air” when I was young.

In the 21st century, it seems like the argument is reversed. Now the double standard argument is used in favor of Puritanism, as (it is assumed) the power imbalance in our society means that free sex opens the door for powerful sexual predators (men) to take advantage of the less powerful (women, children.) Unlike in the Victorian era, however, the emphasis is on shaming men, not women.

1900s and 2000s—empower women

1800s and 2000s—shame, shame, shame

I’d guess others have written on this. Is this the consensus view?

Nick Rowe on interest rates and inflation

Nick Rowe has an excellent twitter thread on interest rates and inflation:

Here I will focus on what I see as the most important parts of his analysis. (I pretty much agree with all his points, but sometimes it’s useful to have ideas reframed in a slightly different fashion.)

So how can we resolve this, and figure out which of those theoretical possibilities is right? 1. Empirically. But CB actions don’t give us a nice RCT. “Friedman’s Thermostat” says targeting inflation is like the *worst possible* experimental design. 18/n

NeoFisherian has a certain appeal because it’s generally true that rising interest rates are associated with rising inflation, and vice versa. In the New Keynesian model this can be explained as follows. When the natural interest rate is rising, the central bank usually raises the policy rate, but more slowly (and vice versa) As a result, the gap between the natural and policy rate widens, which makes monetary policy more expansionary.

The act of raising interest rates is generally a signal of disinflationary intent, but periods of rising interest rates are often inflationary (i.e. the 1960s and 1970s). As an analogy, the act of pressing the accelerator in my car tends to cause acceleration, but during periods when I press hard (going up a steep hill) the car is often slowing down.

If the Japanese suddenly adopt a policy of depreciating the yen at 1%/ month, and also commit to maintain this policy for many decades, the immediate impact will be much higher interest rates in Japan, and double digit inflation. So why is this (NeoFisherian) example not typical of periods where the central bank raises interest rates? Here’s Nick:

But this [NeoFisherian result] requires that everyone interprets the higher r as the CB’s signal of a higher inflation target, plus 100% CB credibility. Nope.

Most central banks use interest rates (not exchange rates) as a policy signal. Raising the interest rate target (fed funds target) is a signal that the central bank intends to take other actions to reduce inflation. (AFAIK, all central banks speak in this language.) Those other actions are either less supply of money (open market sales) or more demand for money (higher IOR or higher reserve requirements.)

Even in cases where the NeoFisherian result holds in the short run, as with the Swiss decision to revalue the franc in January 2011, there were actually two signals sent out. The revaluation led to expectations of lower Swiss inflation. The concurrent cut in Swiss interest rates was a signal intended to make the revaluation smaller, and hence reduce the amount of disinflation. This combined exchange rate/interest rate policy was disinflationary, despite the lower interest rates, but only because the impact of the exchange rate signal dominated.

So here are *my* ultimate things: 1. “Never reason from an interest rate change”. NeoFisherians illustrate one example of how this can go badly wrong. Nominal (even real) interest rates are a bad measure of the tightness/looseness of monetary policy.

That’s also my ultimate thing. Keynesianism is another example of how this can go badly wrong. Not ideal New Keynesianism, but actual, real world Keynesianism. The unfortunate tendency of actual Keynesian economists to assume that when a central bank has been cutting interest rates it has also been making monetary policy more expansionary.

As in 2007-08.

PS. Why does a 1% a month (expected) yen depreciation lead to inflation? Because of PPP. In addition, this announcement would immediately raise Japanese nominal interest rates 12% above US levels due to the interest parity condition. If we assume zero IOR in Japan, then this sort of high nominal interest rate would lead to a flight from the yen, and the Japanese monetary base would quickly fall from 140% of GDP to under 10%. The nominal monetary base would also have to be reduced sharply, in order to avoid even sharper currency depreciation and hyperinflation.

Try to explain that process with MMT!

PPS. Some commenters want me to condemn Biden’s continuation of Trump’s policies of bloated government spending and tariffs on China. OK, I condemn Biden’s economic policies.