Academics are rapidly catching up to market monetarists
Market monetarists have consistently argued that:
1. QE is not risky, stopping QE is risky.
2. Abenomics would modestly boost NGDP and RGDP.
3. NGDP targeting wouldn’t just stabilize the labor market, it would also reduce volatility in the credit markets.
Here’s The Economist:
Jitters about market bubbles are one reason the Federal Reserve is dialling down its bond buying. A new study by Gabriel Chodorow-Reich of Harvard University shows that since 2013 Federal Reserve committee members, including Mr Bernanke, have cited concerns over increased financial-sector risk-taking as a reason to mute QE. Their anxiety is understandable: central bankers are still scarred by the lessons of the mid-2000s when banks “searched for yield” amid low interest rates, financing riskier projects and pumping up leverage to improve profits. After five years of shedding risk since the crisis that followed, some fret they could flip back into risk-seeking mode.
But those worries wither under closer scrutiny, as Mr Chodorow-Reich shows. He starts his hunt for a link between QE and risk with banks and life insurers, examining market reactions to 14 Federal Reserve policy announcements between 2008 and 2013. Using minute-by-minute data, and isolating small windows either side of each statement, Mr Chodorow-Reich measures market perceptions of risk. He finds that QE extensions are associated with a drop in the costs of default insurance that protects against a bank or insurer going bust. Markets, then, are not worried about QE, even if the central bank is.
And this:
And bold monetary policy has a big upside, suggests a new paper on Japan’s “Abenomics” by Joshua Hausman of the University of Michigan and Johannes Wieland of the University of California, San Diego. Japan’s monetary boost is huge, including a new 2% inflation target, unlimited asset purchases and a doubling of the money supply. Many worried, however, that it would not work. Japan’s slump is decades old and QE had already been tried. Between 2001 and 2006 the Bank of Japan boosted the cash that lenders held from ¥5 trillion ($46 billion) to almost ¥35 trillion using QE. Yet not much happened. Although inflation nudged above zero, policymakers increased rates too soon. By the time Shinzo Abe took office in December 2012 prices were falling by 0.1% a year and the economy was drifting sideways.
But Abenomics has lifted Japan’s GDP by up to 1.7%, according to Messrs Hausman and Wieland: up to a percentage point of that may be due to monetary policy. The market effects are clear: stock indices jumped and the exchange rate depreciated sharply when the policy was announced (see left-hand chart). The effects on broad money, which rises with bank lending, have been much stronger than with previous QE attempts (see right-hand chart).Inflation expectations explain the difference. Abenomics was announced not as a temporary boost but a permanent change in policy. People quickly anticipated that prices would begin rising by 2% a year, instead of remaining flat. Long-run inflation predictions have risen too. This means borrowing looks more manageable and gives shoppers confidence to spend more. Nonetheless, Japan’s economy remains weak. Reinforcing the commitment to monetary boldness would give it a boost, the researchers say.
As far as I can tell, Japanese annual inflation rates (CPI) rose above US inflation last November, for the first time in nearly 40 years (excluding a period of a few months after the Japanese instituted a national sales tax in 1997.) However the plan is still flawed as it does not represent level targeting. Japan needs to do more to assure that it doesn’t slip back into deflation. And why not do more? All the good things predicted have happened, and none of the bad things critics worried about (like higher Japanese government bond yields.) It was a free bento box. When the world offers free lunches, go to Jiro’s in Tokyo and pig out.
There are even more radical options. Kevin Sheedy of the London School of Economics reckons that gains may be made from replacing an inflation target with a nominal-GDP (NGDP) target. Typically central banks focus on inflation as this helps stabilise the value of pay, which might otherwise be eroded by rising prices. But wages are not the only rigid contracts workers face””their debts are fixed too. This means that a GDP shock which lowers incomes can cause a big jump in their debt burden.
A central bank focused on NGDP would help, Mr Sheedy argues. Take a supply shock, which tends to lower GDP without causing prices to fall. A central bank focused on prices might not respond at all due to the absence of inflation. An NGDP targeter would be bolder, stimulating the economy to generate inflation and keep the value of debt and GDP aligned. Hard-wiring a shift like this into the monetary system will take a lot of persuasion. But household debt-to-income ratios were much lower when inflation targeting was set up in the early 1990s. In today’s high-debt world, an NGDP target looks more attractive.
How influential these studies will be remains to be seen.
A few comments:
All three papers were published by the Brookings Institution—a respected think tank.
Ben Bernanke recently joined the Brookings Institution.
Even though MM is winning, we aren’t given credit. But that’s always the way things work. What matters is that the ideas get adopted. If not being associated with a fringe groups of academics at small institutions helps the ideas gain respect, then I hope we MMs remain completely anonymous.
PS. Congratulations to Bentley’s women basketball team for winning the national championship (division 2.) And for the University of Wisconsin (my alma mater) making the Final 4.
PPS. I have a multiplier post that comments on Nick Rowe, over at Econlog.
Tags:
31. March 2014 at 06:38
Right. Market monetarist ideas are far more influential than they used to be. That’s why U.S. stock prices are so much higher! The market recognizes that the next ten years will be far more stable than the last ten years.
Sumner, Woodford and Shinzo Abe have made the U.S. economy a safer place to invest in. As a result of their efforts:
(1) Central bankers have a better grasp of the importance of forward guidance than they did in 2008/09; and
(2) Central bankers are more comfortable with “unconventional monetary policy” (such as QE) than they were in 2008/09.
As a result, when “the next bust” happens, the unemployment rate will not increase nearly as much as it did in 2008/09.
31. March 2014 at 07:46
Here’s an interesting comment:
“The low rate of wage growth is, to me, another sign that the Fed’s job is not yet done,” Yellen said.
http://money.cnn.com/2014/03/31/news/economy/janet-yellen-raise/index.html?iid=Lead
——————-
Maybe she read your “Re-Targeting the Fed” piece.
31. March 2014 at 08:05
I wish we could kill this notion of “reaching for yield”. It’s similar to the idea of measuring monetary policy with interest rates, in that it turns good news into bad news & vice versa. A mind muddied by this notion sees declining risk free rates and rising credit spreads as superior to declining risk free rates and declining credit spreads. In fact, the opposite is clearly more nearly the truth, and is a good indication of whether the Fed is leading or following changes in market sentiment.
31. March 2014 at 08:42
The Financial Services Regulatory Relief Act of 2006 gives the Board of Governors added authority to lower reserve requirements to as low as “zero” percent. The rationale: “These measures should help the banking sector attract liquid funds in competition with nonbank institutions and direct market investments by businesses”.
This is of course complete economic nonsense. The non-banks can’t compete with the CBs. Savings flowing thru the non-banks never leaves the CB system. Lending by the CBs is determined by monetary policy – not the savings practices of the public. The CBs could continue to lend even if depositors ceased to save altogether.
The IOeR policy (Oct 9th 2008) emasculates the Fed’s “open market power” (limits the effectiveness of QE programs). Now the “trading desk” has no idea what will happen when it conducts open market operations of the buying type (POMOs).
Now we get “pushing on a string” (in which the Fed uses the payment of interest on excess reserve balances to finance our fiscal deficits).
The Fed’s IOeR policy makes monetary policy temporarily impotent. Before Oct 9, 2008 the CBs would attempt to remain fully “lent up” (from c. 1942) & buy t-bills – thereby expanding the money stock. Now the CBs hoard the interbank demand deposits they get in return for selling their bills & bonds to William Dudley.
31. March 2014 at 09:44
Re: getting credit.
http://en.wikipedia.org/wiki/Market_monetarism
Sumner has been described as the “eminence grise” of market monetarism.
31. March 2014 at 10:12
We need a ranking of whose ideas have been most critical for the development of Market Monetarism. Candidates:
Milton Friedman
Ralph Hawtrey
Robert Lucas
Eugene Fama
Lars Svensson
Michael Woodford
Robert King
31. March 2014 at 10:28
Thanks everyone–lots of good comments.
Brian, I don’t recall seeing that before, or at least the current version which is very extensive.
31. March 2014 at 10:35
I liked “Godfather of MM” better.
31. March 2014 at 10:40
Michael, Is it correct that Yellen’s comment boosted the stock market?
Travis, Good choices, although I’d put Robert Hall ahead of King, even though I do recall King talking about an upward sloping IS curve way back around 1993.
Earl Thompson had a big impact on David Glasner. Irving Fisher is another possible name. Also Bennett McCallum.
31. March 2014 at 11:16
Maybe it should become MMM, for MOOCing Market Monetarism;
http://www.econtalk.org/archives/2014/03/cochrane_on_edu.html
31. March 2014 at 11:28
David Zervos on Yellen’s speech:
http://blogs.wsj.com/economics/2014/03/31/janet-yellen-gives-one-of-the-most-dovish-speeches-i-have-ever-read
“Ok, I just read Janet’s speech in Chicago today. Holy dovish deepdish pizza batman!! I have no recollection of a Fed Chair’s speech where the lives of three down-on-their-luck job seeking individuals were discussed in detail. This is one loving and caring Fed Chair – I must send her a “no haters” hat immediately! If anyone doubts Janet’s commitment to fighting for more job creation – read the tape. If anyone doubts Janet’s belief that there is excessive slack in labor markets – read the tape. And if anyone doubt’s Janet conviction that there are no material inflation risks on the horizon – read the tape. This could be one of the most dovish speeches I have ever read from a Federal Reserve official! Janet has quickly redeemed her poor performance from 12 days ago. On this assignment she gets an A+. Somehow I always knew she would pull through.”
31. March 2014 at 12:51
Travis/Scott,
What about Christina Romer? I think she got MM some mainstream attention by taking it seriously. She had her class read Scott and linked to him in an open letter to Ben Bernanke (http://www.themoneyillusion.com/?p=11564). I think even small things like that probably make a difference.
31. March 2014 at 13:05
I think Yellen’s Fed might find soon another benefit in NGDPLT: It creates an environment that makes it far easier to end High Frequency Trading.
The Rigged Market topic is going to continue to get lots of play, and most powerful argument from the HFT guys is going to be that stocks will fall short term.
Yellen can say NO THEY WON’T.
It’d be a nice way of showing off what stability allows: it makes it far easier to make large scale changes in economic structures.
31. March 2014 at 13:09
Prof. Sumner,
Thanks! At some point, it might be fun to specify the unique insights each of those names contributed. Also, is this roughly what happened:
Irving Fisher’s insights were improved by Milton Friedman. However, there were several huge flaws with Friedman’s theories (particularly long and variable lags), which were corrected by the insights of Fama, Lucas, Svensson, Woodford, etc. etc……
31. March 2014 at 13:11
It’s far better than Yellen having to go out and tell pity stories every time the topic comes up.
31. March 2014 at 14:51
Scott,
Off Topic.
Here’s a strange article that left me a little perplexed as how to respond:
http://www.voxeu.org/article/europe-s-banking-problems-and-secular-stagnation
March 28, 2014
Europe’s banking problem through the lens of secular stagnation
Jan Willem van den End , Jakob de Haan
“What is the economy’s new normal? Will it be secular stagnation as suggested by Summers (2013)? According to this view, the economy will be in a permanent state of recession because aggregate demand is below potential output. As the actual real interest rate exceeds the negative equilibrium real interest rate (the natural rate), investment activity is too low. In the secular stagnation view, the zero lower bound (ZLB) prevents an adjustment of the interest rate to the (negative) equilibrium rate. Consequently, the economy ends up in a liquidity trap (Krugman 2013).
Low inflation – a feature of secular stagnation – constrains the real interest rate to become negative. To get out of this bad equilibrium, several economists propose policies that raise inflation expectations (cf. Krugman 1998). Quantitative easing (QE) may contribute by boosting aggregate demand through wealth effects. That could raise inflation and result in a negative real interest rate.
However, others argue that QE is not a good remedy for secular stagnation. According to Bernstein (2013), liquidity injections by the central bank will only stimulate unprofitable activities and bubbles due to lack of investment opportunities in the real economy. Others point out that due to the unequal distribution of wealth, asset price inflation will only have limited effects on the real economy (cf. Dobb el al. 2013). Furthermore it is not obvious that low interest rates stimulate demand if households and firms are credit constrained and/or suffer from a debt overhang.
The ineffectiveness of QE has also been explained by the breakdown of the money multiplier at the ZLB (Krugman 1998). When economic agents are indifferent between holding base money and bonds, additional base money will be held as excess reserves by the banks. As reserves no longer constrain banks, credit supply does not rise in tandem with an expansion of base money (Martin et al. 2013)…”
Basically this reads like a laundry list of reasons to question the efficacy of monetary policy in a low interest rate environment all given by mainstream economists who probably should all know better. It almost seems as though van de End and de Haan are throwing anything and everything just hoping to stir doubts about QE.
Then they supply their own reasons:
“…The supply side view
Rajan (2013) argues that the debt-fuelled boom has created an economy that supplies too much of the wrong kind of goods. A sustainable solution would be to adjust the supply side through relative price adjustments and structural reforms.
Rajan’s view is particularly relevant for the Eurozone, where the recovery is held back by high levels of debt that reduce banks’ intermediation capacity through the balance sheet channel (high credit risk of borrowers makes banks reluctant to lend) and the bank-lending channel (rising non-performing loans erode banks’ capital position). The current gap between corporate borrowing rates on bank loans versus rates on bonds is in line with this view (see Figure 1).
The higher margin on bank lending reflects bottlenecks in the credit intermediation by banks. The contraction of bank loans to firms in the Eurozone since mid-2012 is another indication of this. Low credit supply by banks is arguably related to uncertainty about corporate balance sheets, in particular those of SMEs. These high credit risks explain banks’ preference for safe assets, such as government bonds.
[Graph]
In stylised form, there is segmentation between the market of perceived safe assets and risky assets. It results in two equilibria (Figure 2). The market for safe assets clears at low or negative real rates, due to a negative risk premium (Bernanke 2013). In this framework, the low real rate is explained by temporary factors, such as safe haven demand and asset purchases by central banks and not by a negative natural rate. In the market for risky assets the supply of funds (S* in Figure 2.b) falls behind demand (I), due to high credit risks of borrowers, whose financial condition is impaired by the recession. As a consequence, banks are reluctant to lend and the market for risky assets clears at a positive real rate.
[Graph]
Uncertainty over the extent to which banks are exposed to risky assets negatively affects their funding possibilities. This constrains banks to strengthen their capital base, which is needed to write-off bad assets and extend new loans. Hence, as long as the financial supply side issue is not adequately dealt with, the problem of low credit supply will linger. In the words of the secular stagnation view, the risk premium will keep the actual rate above the equilibrium rate.
Cleansing and strengthening banks’ balance sheets will reduce the uncertainties related to their asset quality. An important contribution to this will be the ECB’s comprehensive assessment of banks’ balance sheets and risk profiles (see ECB 2013). It addresses the supply side issue at the core by enhancing the transparency on banks’ financial health and setting in motion necessary corrective actions. This is an important condition to restore credit intermediation and reduce the risk premium on lending…”
The strange thing for me was the fact that they directly compare low risk bond rates with prime bank lending rates and use that to conclude that the risk premia in bank lending has gone up. Yes we might expect the two rates to track each other, but normally the risk premia is estimated by calculating a spread between a low risk apple and a high risk apple, not between a low risk apple and a low risk orange.
This caused me to go look up estimates of risk premia for bond and bank financing in the US, the Euro Area and the UK:
http://www.bis.org/publ/qtrpdf/r_qt1312a.pdf
Corporate bond spreads can be found on the left hand side of graph 3 and bank spreads can be found on the left hand side of graph 5. They’re both trending downward everywhere. Interestingly Euro Area spreads are between US spreads (low) and UK spreads (high) although I don’t think the differences are that significant.
Moreover, is bank lending to businesses really the thing which is holding back the Euro Area recovery?
Loans to the non-financial business sector peaked in the US and the UK in 2008Q4. Between then and 2013Q3 they have fallen by 10.1% and 13.0% in the US and the UK respectively. In contrast loans to the non-financial business sector are *up* by 0.5% in the Euro Area. And yet while NGDP is up by 16.3% and 13.5% in the US and the UK respectively, NGDP is up by only 5.0% in the Euro Area. It’s worth reminding onself that both the US and the UK have done significant amounts of QE, while the Euro Area has never done any.
And securities issued by the non-financial business sector are up by 54.6% and 42.3% in the US and the UK respectively between 2008Q4 and 2013Q3, but they are up by 57.8% in the Euro Area.
So the Euro Area leads both the US and the UK in both the growth of loans to, and securities issued by, the non-financial business sector, and yet despite this the Euro Area lags both the US and the UK by a significant amount in terms of NGDP growth.
And because of that, whereas non-financial business sector loans and securities have declined from 80.2% and 104.5% of GDP in the US and the UK respectively in 2008Q4 to 79.2% and 89.7% of GDP in 2013Q3, they have only decreased from 100.2% of GDP in 2008Q4 to 100.0% of GDP in 2013Q3 in the Euro Area.
So maybe what the Euro Area needs is less fiddling with the financial supply side in order to stimulate more bank lending, and a little good old fashioned demand side monetary policy.
In any case van de End and de Haan go on to conclude:
“…Conclusion
We think that the diagnosis of secular stagnation is doubtful or, at the very least, incomplete. The low growth, low inflation regimes in various regions in the world can have different causes. In the Eurozone, it arguably relates to a supply side issue rooting in the balance sheets of banks and their borrowers.
Expectations that monetary policy can solve this will be disappointed (Orphanides 2013). To avoid a secular credit crunch in the Eurozone, the debt overhang and asset quality problems should be adequately dealt with. The comprehensive assessment by the ECB will be an important contribution to this and can prepare the ground for a sustainable recovery.”
So the authors admit they don’t really believe in the secular stagnation hypothesis, they were just throwing that out there for a little blue smoke. What they really believe is that the Euro Area’s problems are financial supply side related, which is something they believe monetary policy can do little to rectify.
And yet in the US and the UK, where QE has been done, NGDP growth is much higher despite loan growth to, and security issuance by, the non-financial business sector being lower, and consequently the debt overhang in that sector is lower and decreasing faster in both countries.
So it seems to me that van den End and de Haan go about misdiagnosing the Euro Area’s problems in a rather unorthodox fashion, and consequently prescribe the wrong cure, all the while totally ignoring the success that the US and the UK have had with the very therapy that they go out of their way to cast aspersions about.
31. March 2014 at 15:04
Go MM’ers and kudos to tenacious MM’ers such as Sumner, Marcus Nunes, Lars C. who challenged orthodoxy, armed only with keyboards and an Internet connection.
BTW, the Japan experience with QE in 2001-6 was largely positive…it was when stopped that their economy started sinking again…which raises the point—what if QE should be the conventional tool in a new economy of very low rates?
31. March 2014 at 15:46
Scott,
Off Topic,
Here’s an interesting paper:
http://www.frbsf.org/economic-research/events/2014/march/monetary-policy-financial-markets/agenda/Exiting-from-QE.pdf
EXITING FROM QE
Fumio Hayashi and Junko Koeda
February 2014
Abstract:
“We develop a regime-switching SVAR (structural vector autoregression) in which the monetary policy regime, chosen by the central bank responding to economic conditions, is endogenous and observable. There are two regimes, one of which is QE (quantitative easing). The model can incorporate the exit condition for terminating QE. We then apply the model to Japan, a country that has accumulated, by our count, 130 months of QE as of December 2012. Our impulse response and counter-factual analyses yield two findings about QE. First, an increase in reserves raises inflation and output. Second, terminating QE can be expansionary.”
By my count, so far this is only the fifth paper that estimates a VAR that explicitly measures the effect of the monetary base or reserve balances on the economy during a zero lower bound episode (abstracts and links in replies):
http://macromarketmusings.blogspot.com/2013/12/taking-model-to-data.html?showComment=1386360709428#c1184851556167733360
Hayashi and Koeda estimate a monthly frequency four variable SVAR using inflation, the output gap, the policy rate and excess reserves as variables.
They define QE according to those months when the BOJ’s call rate was at about 0.1% or below. Thus they count three episodes: 1) March 1999 through July 2000, 2) March 2001 through June 2006 and 3) December 2008 to December 2012, or a total of 130 months. This is exactly the approach I took when doing my Granger causality tests on Japan in 2001-06. I didn’t consider the first episode because it was far too short, and I haven’t yet looked at the most recent episode because monetary base expansion only started in earnest in April 2013.
Hayashi and Koeda look at the entire period from January 1980 to December 2012, but regime switching enables them to focus in on the effect of excess reserves on inflation and the output gap during zero lower bound episodes. Thus they can include the extremely short first episode in 1999-2000 in their data.
Note that they find that QE significantly increases inflation and decreases the output gap (Figure 5A on page 61).
Thus, this is one more empirical nail in the coffin of Stephen Williamson’s bizarre theoretical ditherings that expansionary monetary policy causes deflation.
31. March 2014 at 16:10
“Mr Chodorow-Reich measures market perceptions of risk. He finds that QE extensions are associated with a drop in the costs of default insurance that protects against a bank or insurer going bust. Markets, then, are not worried about QE, even if the central bank is.”
Did anyone else chuckle at what is being deduced from this? We’re supposed to infer lower risk in the market from risk being priced lower due to QE.
That is exactly why QE increases risk in the market! It’s the law of demand. If risk is priced lower, then a higher quantity of risk will be demanded, ceteris paribus.
Is The Economist joking? Is Sumner just latching onto anything that comes within a mile of “Don’t tighten now!”, however flawed?
31. March 2014 at 16:10
Sorry for formatting
31. March 2014 at 16:42
Is The Economist joking? Is Sumner just latching onto anything that comes within a mile of “Don’t tighten now!”, however flawed?”
That’s rich, coming from you, mr. “tighten at any costs” major freedom. You wrongly assume that a “free market in money” would produce less money than the Fed is creating now, when it would probably produce MORE.
31. March 2014 at 18:00
Scott,
Off Topic.
All of the recent talk about endogenous money and the money multiplier caused me to do some calculations on deposit creation in the big four advanced currency areas.
Let me refer to the BOE’s recent paper on money creation:
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
In particular I want to refer to Figure 3 and the related text concerning the impact of QE on balance sheets.
What is interesting about this example is that it involves a non-bank (a pension fund). It shows that when a non-bank sells government debt to the central bank this creates a deposit. More generally, when a non-bank sells an asset to the central bank this increases the broad money supply.
Not shown is that if a commercial bank sells an asset to the central bank this has no necessary effect on the supply of broad money because it occurs entirely on the asset side of the commercial bank’s balance sheet. Thus QE must directly increase the broad money supply only if it does not involve purchasing assets from commercial banks.
The question is, as a practical matter, how much of QE involves purchases of assets from non-banks and how much of it involves purchases of assets from banks?
It stands to reason, if commercial banks in aggregate have increased their holdings of the kinds of assets that have been bought by central banks under QE, then the effect of QE must have been felt entirely in the form of increased deposits (or, of course, as currency in circulation), rather than as a reduction on the asset side of the commercial bank balance sheet of the kinds of assets bought by the central bank during QE.
So let’s look at the kinds of assets bought by the central banks of the big four advanced currency areas from mid-2008 to the present and see if commercial banks have increased or decreased their holdings of them.
1) The Federal Reserve
The Federal Reserve has bought Treasury and Agency securities during its QEs. Private Depository Institutions (commercial banks, savings institutions and credit unions) increased their holdings of Treasury securities from $124.5 billion in 2008Q2 to $305.2 billion in 2013Q4. Private Depository Institutions have increased their holdings of Agency securities (Agency Bonds and Agency MBS) from $1,381.4 billion in 2008Q2 to $1,948.5 billion in 2013Q4.
2) The ECB
Technically the ECB has never done QE, but for the purposes of this analysis we will ignore that fact for the moment. (We’ll see that this is largely true later.) The ECB has impacted the monetary base chiefly through two items: 1) lending to euro area credit institutions (MRO and LTRO) and 2) purchases of securities of euro area residents denominated in euro (SMP and CBPP). Both SMP and CBPP were completely sterilized, but again, we’ll ignore that for the moment. Lending is fairly fungible, but SMP and CBPP involve purchases of central government securities and covered bonds (commercial bank bonds) respectively. SMP and CBPP didn’t start until July 2009. Monetary finance institutions (MFIs) increased their holdings of general government securities from €1,466.4 billion in June 2009 to €1,768.3 billion in February 2014. MFIs decreased their holdings of MFI securities from €2,122.7 billion in June 2009 to €1,666.1 billion in February 2014. So CBPP may have have have had no effect on deposits.
3) The BOJ
The BOJ has bought five different kinds of securities under its various security purchase programs: 1) Treasury discount bills, 2) central government securities and FILP bonds, 3) Industrial securities, 4) commercial paper, and 5) investment trust beneficiary certificates. Depository corporations have increased their holdings of Treasury discount bills from ¥31.7 trillion in 2008Q2 to ¥42.0 trillion in 2013Q4. Depository corporations have increased their holdings of central government securities and FILP bonds from ¥274.0 trillion in 2008Q2 to ¥287.5 trillion in 2013Q4. Depository corporations have increased their holdings of industrial securities from ¥31.5 trillion in 2008Q2 to ¥31.8 trillion in 2013Q4. Depository corporations have decreased their holdings of commercial paper from ¥7.2 trillion in 2008Q2 to ¥5.5 trillion in 2013Q4. Depository corporations have decreased their holdings of investment trust beneficiary certificates from ¥10.9 trillion in 2008Q2 to ¥8.9 trillion in 2013Q4. So the BOJ’s purchases of commercial paper and investment trust beneficiary certificates may have had no effect on deposits.
4) The BOE
The BOE bought gilts, corporate bonds and corporate paper as part of its Asset Purchase Facility (APF). But its holdings of corporate bonds and corporate paper are currently zero, so we need only worry about gilts for the sake of this analysis. MFIs have increased their holdings of gilts from (-£7.0) billion (negative means repo) in August 2008 to £125.8 billion in January 2014.
So apart from the ECB’s CBPP (and keep in mind the ECB has never done QE), and a couple of minor categories of private asset purchases by the BOJ, the balance sheet activities of the central banks of the big four advanced currency areas must have directly increased the broad money supply.
(continued)
31. March 2014 at 18:10
Edward:
“That’s rich, coming from you, mr. “tighten at any costs” major freedom.”
No, I want to loosen free market money, and tighten socialist paper imposed by threats of force.
“You wrongly assume that a “free market in money” would produce less money than the Fed is creating now, when it would probably produce MORE.”
That isn’t a “wrong” assumption. On what grounds are you basing the conjecture that a free market would have more money today? Remember, the whole purpose of central banking is to enable the state and politically connected bankers to increase the quantity of money they acquire beyond what they otherwise could have acquired without the central bank. The central bank does not exist to reduce the quantity of money the state and bankers can acquire. That is silly in theory.
Empirically, your claim is not any better either. For if we assume that in this age a free market in money would be precious metals based, then a decent proxy for the supply and production of free market money is the gold industry.
Recent (2011) stats of gold:
Average production: 2500 tons/year.
Total supply: 165,000 tons
That’s a rate of gold supply growth of 2.5/165 = 1.5152% per year.
Compare that to fiat M1/M2:
Percent change at seasonally adjusted annual rates
3 Months from Nov. 2013 TO Feb. 2014
M1 18.3%
M2 7.5%
You don’t seem to want to appreciate that prices would likely be falling with a free market in money as production expands. Just because you might be observing a positive 1.5% price inflation in a fiat system, it doesn’t mean that the money expansion doesn’t represent significantly higher than market rates of money production. (Sorry for double negative).
The reason I am always “tighten now”, is because it is reasonable to assume that the central bank is ALWAYS issuing more currency than what the government and elite bankers could acquire on a free market. If they could acquire more on a free market, they wouldn’t have central banking.
Plus, it is ridiculous on common sense grounds to expect that an owner of a money printing press will print fewer dollars than they otherwise could have acquired in a free market.
31. March 2014 at 18:46
Mark Sadowski
“Thus QE must directly increase the broad money supply only if it does not involve purchasing assets from commercial banks.”
Yes but just because the broad money supply is increased doesn’t mean you will get an adequate increase in GDP or inflation. QE has had an effect but so far weak. Some of the broader money expansion has resulted in spending but more spending would result if money was expanded more broadly as opposed to large cap corporates. Propensity to spend increases in money of current QE counterparties is lower than average person. Increases in broad money become similar to excess reserves in that they just sit there too much of the time.
31. March 2014 at 19:11
Mostly off topic, re Keynesian v Monetarism and the great ‘austerity’ wars, from a new blog…
~~~
“Australia and New Zealand came out of the Depression earlier than most other countries because of the fiscal austerity under the Premiers’ Plan …
“See Keynes’ 1932 letter where he says: ‘I am sure the Premiers’ Plan last year saved the economic structure of Australia.'”
http://utopiayouarestandinginit.com/2014/03/31/lessons-from-how-australia-came-out-of-the-great-depression/
31. March 2014 at 19:38
(continued)
The next step in this estimation process is to see how much deposits and reserve balances have increased.
1) The Federal Reserve
Deposits (demand, savings and time) and Private Depository Institutions increased from $8,582.5 billion in 2008Q2 to $11,703.6 billion in 2013Q4, or by $3,121.1 billion. Reserve balances increased from $33.5 billion in 2008Q2 to $2,249.1 billion in 2013Q4, or by $2,215.6 billion. Thus 71.0% of the increase in deposits is directly attributable to QE.
2) The ECB
Deposits (overnight, agreed maturity and redeemable at notice) increased from €7,131.7 billion in August 2008 to €8,354.2 in February 2014, or by €1,222.5 billion. Reserve balances (current accounts and deposit facility) increased from €215.1 billion in August 2008 to €230.6 in February 2014, or by €15.5 billion. The amount of securities purchased under CBPP is equal to €37.9 billion, which in turn is less than the decrease in MFI securities held by MFIs. Thus it is possible that none of the increase in deposits is attributable to the increase in the monetary base.
3) The BOJ
Deposits (deposit money and quasi money) increased from ¥941.7 trillion in June 2008 to ¥1,057.5 trillion in December 2014, or by ¥115.8 trillion. Reserve balances increased from ¥8.3 trillion in June 2008 to ¥101.8 trillion in December 2014, or by ¥93.5 trillion. The decrease in depository holdings of commercial paper and investment trust beneficiary certificates between June 2008 and December 2013 of ¥1.7 trillion and ¥2.0 trillion respectively is less than the increase in the BOJ’s holdings of those securities so let’s assume that they were purchased under QE. Thus subtracting them from the increase in reserves results in a minimum figure of ¥89.8 trillion for the change in deposits attributable to QE. Thus at least 77.5% of the increase in deposits is directly attributable to QE.
4) The BOE
Deposits (retail and wholesale) increased from £1,753.1 billion in August 2008 to £2,066.5 billion in January 2014, or by £313.4 billion. Reserve balances increased from £28.7 billion in August 2008 to £300.0 billion in January 2014, or by £271.3 billion. Thus at least 86.6% of the increase in deposits is directly attributable to QE.
31. March 2014 at 19:59
dannyb2b,
Derp.
31. March 2014 at 20:05
Dear Market Monetarists,
Why don’t you guys give Jeffrey Hummel more attention?
http://www.themoneyillusion.com/?p=20400
http://moneymarketsandmisperceptions.blogspot.com/2014/03/wheres-inflation-at-review-of-and.html
http://monetaryfreedom-billwoolsey.blogspot.com/2009/09/jeffrey-hummel-on-sumner-1.html
31. March 2014 at 20:26
Mark Sadowski
Is that how you avoid questions?
31. March 2014 at 21:24
dannyb2b,
Don’t you mean fact free assertion?
31. March 2014 at 21:32
So QE is working just fine?
31. March 2014 at 23:02
Mark, why aren’t you blogging yet? (I am going to try to annoy you into starting a blog)
1. April 2014 at 04:39
Mark, It’s amazing how blind people in Europe are to the possibility if an AD shortfall in the eurozone.
On the Japanese study, I’d be careful with the claim that ending QE is expansionary, as VAR studies can’t always sort out cause and effect.
And on the third comment, I agree that it matters whether the bonds are bought from the banks or the private sector, however I’m not sure it matters where the bonds are originally purchased from, but rather the final effect on balance sheets. They might be bought from private sector investors, who then turn around and buy a bond from a commercial bank to replace it. Does that seem right?
1. April 2014 at 05:44
Mark,
It’a clear that the central bank can increase broad money directly by buying assets from non-banks. Doing this increases both bank reserves and deposits. As a side note, it’s also possible that such an increase could be offset by an overall contraction of lending and borrowing, such that overall there is a net decrease in broad money. However the fact that central banks can increase deposits directly by buying assets is separate from the debate around the money multiplier.
1. April 2014 at 06:11
Jim Glass,
Fascinating. I’d love to hear Scott’s reaction.
1. April 2014 at 06:25
Scott,
“On the Japanese study, I’d be careful with the claim that ending QE is expansionary, as VAR studies can’t always sort out cause and effect.”
Personally I didn’t attach too much importance to that claim although that’s obviously the name of the paper. It seemed like a forced title to highlight what is supposedly unique about the paper.
In my opinion key thing about this paper is that the economic effect of excess reserves shows up primarily when the policy rate is fixed at ZIRP. The regime switching technique enables them to include the short 1999-2000 QE episode in their estimates.
“They might be bought from private sector investors, who then turn around and buy a bond from a commercial bank to replace it. Does that seem right?”
From a balance sheet perspective what matters is whether commercial banks have increased or decreased their holdings of the kinds of assets purchased under QE. What happened to their holdings between the actual purchase and the present time shouldn’t really matter.
1. April 2014 at 06:29
When Major Freedom talks about “free market money”, what he’s actually talking about is a world in which there is no state and thus no state taxation, legal tender laws or any other manifestations of the state. Any talk about such a situation is purely speculative. It might just be chaos controlled by rival gangs and warlords, who knows?
1. April 2014 at 06:52
Philippe,
“As a side note, it’s also possible that such an increase could be offset by an overall contraction of lending and borrowing, such that overall there is a net decrease in broad money.”
This is an excellent point and one that I actually had in mind throughout this exercise. Looking at balance sheets isn’t going to tell us much if anything about the counterfactuals (i.e. are deposits higher than they would have been without QE).
However, VAR Granger causality tests show that in the case of the US the monetary base causes loans and leases at commercial banks and the impulse response is positive. On the other hand similar tests for the UK showed no significant correlation. I haven’t looked at the Euro Area or Japan because the ECB hasn’t done QE and the Japan only has been doing it in earnest since April 2013.
So this implies that not only has QE increased deposits directly in the US, it has catylized further deposit creation through the generation of new loans. In the case of the UK, the fact that there is no negative correlation between QE and the lending counterpart of broad money implies there has been no offset of the deposits created by QE through loan reduction.
“However the fact that central banks can increase deposits directly by buying assets is separate from the debate around the money multiplier.”
I disagree, I think this is obviously related, especially in light of the Granger causality test results.
1. April 2014 at 07:15
Mark,
I haven’t studied the granger-causality research myself. What about the recent paper by Joshua Wojnilower, didn’t that find the opposite result in the case of the US?
1. April 2014 at 07:49
Philippe,
I’ve read Joshua’s paper and gave him some feedback on econometrics which he has incorporated into its latest version (the use of the Toda and Yamamato technique). He studied the period 1971-2008 so his paper explicitly excludes the period when the US has been doing QE.
Granger causality results on the endogeneity of money are highly sensitive to the monetary regime.
When the central bank is targeting short term interest rates as the instrument of moentary policy, loans tend to Granger cause the monetary base and broad money supply. In a regime when interest rates are fixed and the central bank is changing the monetary base in ad hoc amounts as with QE, the monetary base and broad money supplu tends to Granger cause loans.
So the direction of causality depends greatly on what the central bank is doing.
1. April 2014 at 08:53
Mark,
you wrote: “VAR Granger causality tests show that in the case of the US the monetary base causes loans and leases at commercial banks and the impulse response is positive. On the other hand similar tests for the UK showed no significant correlation.”
This discrepancy suggests that maybe something else was at work. In both cases there was an increase in reserves and bank deposits directly as a result of QE asset purchases, but only in the US can you identify a granger-causality relationship between the increase in reserves and the quantity of bank loans. And in the case of the US, any posited effect of the monetary base on loans must be quite small given the relatively small increase in loans vs the relatively huge increase in base, no?
1. April 2014 at 09:21
Mark, re: QE and bank deposits. Does Glasner’s post here speak to that at all?
http://uneasymoney.com/2014/03/31/can-there-really-be-an-excess-supply-of-commercial-bank-money/#comment-80406
1. April 2014 at 10:02
Jim Glass, I would have expected a 10% nominal wage cut plus currency devaluation to work.
Mark, OK.
1. April 2014 at 10:10
Philippe,
“This discrepancy suggests that maybe something else was at work. In both cases there was an increase in reserves and bank deposits directly as a result of QE asset purchases, but only in the US can you identify a granger-causality relationship between the increase in reserves and the quantity of bank loans.”
First of all, I should point out the fact that although the results for the UK were not statistically significant, the impulse response is strictly positive over any reasonable time frame with the sole exception of month two.
It’s not unusual to find that the monetary base Granger causes loans, and that the impulse response is positive. In fact bidirectional causality between the monetary base and loans is posited by Structural Endogeneity (e.g. Palley, Pollin). Japan has two measures of lending counterparts to broad money: 1) “loans and discounts” and 2) “loans and discounted bills”. I find there is bidirectional Granger causality between the monetary base and lending (both measures) from March 2001 through June 2006 (the period of Japan’s first official QE).
What is unusual is to find strictly one way Granger causality from the monetary base to loans, as I find with the US from December 2008 to present. But when the monetary base is being increased in ad hoc amounts, and short term interest rates are fixed near zero, which is admittedly rare, the probability of this occuring seems to increase substantially. This makes sense since, theoretically and operationally, the stock of loans should have no effect at all on the size of the monetary base in such a situation. Thus I also find for example that the monetary base Granger causes loans at Federal Reserve member banks from May 1933 through February 1937, but not the other way around.
“And in the case of the US, any posited effect of the monetary base on loans must be quite small given the relatively small increase in loans vs the relatively huge increase in base, no?”
The effect is statistically significant at the 5% level from 2 through 7 months out. A one standard deviation innovation to the monetary base is equal to about $65 billion during the period I tested (December 2008 through September 2013). The peak mean effect on loans and leases at commercial banks occurs in the 7th month and is equal to about $145 billion. So the effect is not inconsequential.
1. April 2014 at 10:40
Mark,
given that, what do you think explains the ‘statistically insignificant’ result in the case of the UK?
1. April 2014 at 10:42
Tom Brown,
Yes, I think it’s related, but please don’t construe anything I’ve said here as an opinion of the current round of debates between Glasner and Rowe (is this year three?).
I *think* I may agree more with Glasner on this issue, but that is mostly because I’m still not sure what Rowe’s point is. Sometimes it seems to me as though Rowe is enthralled with the notion of disequilibrium to the point where he loses sight of what he is trying to prove (or forgets to let us in on what he is trying to prove). An “excess supply of commercial bank money” seems only possible to me if some agent (commercial banks?) is not maximizing its utility.
1. April 2014 at 10:51
Philippe,
“given that, what do you think explains the ‘statistically insignificant’ result in the case of the UK?”
I really haven’t given it much thought. But bank lending has been unusually weak in the UK, with leverage in the non-financial business sector dropping at an extremely fast rate, all of it explained by bank lending. And much of the productivity losses in the UK’s much publicised negative supply shock are attributable to the financial sector. Maybe this is all related?
1. April 2014 at 11:31
From the Keynes letter;
‘I believe that a period of ultra-cheap money is in prospect, that the day is not far off when respectable borrowers will be greatly sought.’
Economics is hard.
1. April 2014 at 11:43
MF,
“Remember, the whole purpose of central banking is to enable the state and politically connected bankers to increase the quantity of money they acquire beyond what they otherwise could have acquired without the central bank.”
I don’t care necessarily about the state and “politically connected bankers.”
The whole premise of your post is wrong. I care about the entire private sector.
“The central bank does not exist to reduce the quantity of money the state and bankers can acquire. That is silly in theory.”
It may not intend to inflict harm to the private sector, but it does massively undersupply the non banking sector’s needs, hence the general glut of goods and services, and the dearth of cash available for households to spend.
“Empirically, your claim is not any better either. For if we assume that in this age a free market in money would be precious metals based, then a decent proxy for the supply and production of free market money is the gold industry.”
WOW, you really are a gold bug troglodyte with no imagination whatsoever, aren’t you?
First it doesn’t have to be precious metal based. Any valuable commodity in high demand for its own sake thats portable, divisible and able to serve as a measurable unit of account will do. (Barrels of oil will do, coal, so will tobacco leaves and cigarettes, which served as monies at one time or another)
Second even if it IS precious metals based, who’s to say it will be only gold? A lot of people like silver, copper is also good. nickel, aluminum bronze, zinc, palladium, platinum, diamonds, the list of possibilities is endless. Historically, silver was very popular along with gold in the 19th century.
“If they could acquire more on a free market, they wouldn’t have central banking.”
True, but thats not the only reason we have central banking. I would assume that a lot those banks genuinely delude themselves into thinking that whats good for them is good for the American economy as a whole.
“Plus, it is ridiculous on common sense grounds to expect that an owner of a money printing press will print fewer dollars than they otherwise could have acquired in a free market.”
Inflation phobia and mindless lunacy runs deep in people like Richard Fisher and Charles Plossser. (They may be too inflationary by your standards, but to everyone else they are super hawkish.)
“On what grounds are you basing the conjecture that a free market would have more money today? ”
On the grounds that is a scarcity of MV/NGDP which is still causing the unemployment gap. Its mainly theoretical reasoning. (You’re right in a way, about Monetarists and Keynesians having certain a priori assumptions. But while our assumptions are coherent in their own terms and respond well to real world evidence, Austrian assumptions do not. {At least those assumptions that are beyond what is trivially and tautologically true, such as “man acts, and marginal utility, ordinal not cardinal”}
1. April 2014 at 11:45
And this Patrick:
“Do not suppose I am so foolishly optimistic as to rely on adequate or even material rise of prices in the near future. I am pessimistic regarding the progress of the time-table. I believe the leading financial centres of the world will have to enjoy a prolonged period of ultra-cheap money before enterprise lifts its head again. Until enterprise puts more spending power into circulation prices cannot rise. I am saying that a prudent country will lay its plans for orderly reconstruction on the assumption of a much higher world price level than the present, because unless this assumption is realized so much else will happen, so many other things will be broken, and the whole structure of national and international indebtedness will have collapsed so completely that its pains will have been wasted.”
“We come finally to a variety of suggestions put forward by the experts for attacking directly the volume of unemployment. I am in complete agreement with these, especially the proposed loan for relief works. They should be pushed forward as rapidly as prudence permits. Thus my counsel would be:
Reduce budget deficits to a figure allowed by the experts.
Satisfy yourselves that the trade balance is adequate to meet pressing requirements.
Perhaps depreciate the Australian pound 5 or 10 per cent unless sterling itself is allowed to fall a little.
Under cover of this, undertake the necessary down ward readjustment of tariffs, which are crippling efficiency.
Above all, expand internal bank credit and stimulate capital expenditure as much as courage and prudence allow. The substitution of wages for doles needs more credit, but not necessarily much more currency.”
1. April 2014 at 12:09
Mark,
I don’t know. But it seems to me that if in one case you find granger-causality from QE to loans, and in another case you don’t really, then it’s possible that the granger-causality doesn’t reflect actual causality in the observed case.
1. April 2014 at 12:18
Also we know that from observing other cases, markets tend to equilibrate, shortages tend to be eliminated (at least those not caused by government intervention) by entrepreneurs seeking to cash in on the high profit margin to be made by creating more of a scarce but valuable commodity. A credit crisis is characterized by “secondary” deflation or slowing inflation. which is the same thing as saying acquiring income is more expensive. Since the money illusion would be fundamental even in a world WITHOUT legal tender (for psychological reasons) the high demand for gold cash would be probably satisfied By people switching to a cheaper commodity to use as money, rather than continually falling wages.
This makes nonsense of your self-righteous and pedantic efforts to set yourself up as a martyr for the cause of freedom. (And free market money)
1. April 2014 at 12:21
Edward,
the corporations that would take over the roles of government in an imaginary ‘anarcho-capitalist’ world could issue token money, which could then be used to pay taxes, er I mean rents and fees, owed to the corporations.
1. April 2014 at 12:27
Mark,
Wouldn’t the commercial banks abhorrence of risk drive them to reduce creating loans? Thus, impacting their own utility?
1. April 2014 at 12:29
You’re probably right Philippe.
An anarcho-capitalist world would be ruled by corporations, with probably CEO kings using their power to create themselves as new governments.
Still I am sympathetic to certain TENETS of A.C. For example, the idea of self-determination or secession. If the people of Quebec take a free and fair vote to secede from Canada, Or East Timor from Indonesia, or Scotland from the U.K, or Crimea from Ukraine, then they should be allowed to do so.
I’m more of a libertarian consequentialist, a pragmatist, than a pedantic absolutist like MF
1. April 2014 at 12:35
And of course in that imaginary ancap world there’s no reason why banks couldn’t do what they do, which is leverage their capital by issuing liquid money-like liabilities that serve as a medium of exchange.
Assuming that imaginary ancap world is even a realistic possibility of course.
1. April 2014 at 12:45
Hayek also theorized that in a supposed ‘free market’ monetary system, banks and other companies could/would issue token currencies, which would not be promises to pay or redeemable liabilities of the issuer, but rather virtual commodities a bit like bitcoin. He thought the issuers of these token currencies would seek to maintain a stable non-inflationary and non-deflationary value for them, by varying the outstanding quantity. That was his theory anyway.
But a major flaw in his particular theory is he argued that those privately-issued currencies could be used to pay taxes, which would effectively turn them into a form of state money.
1. April 2014 at 13:02
Edward / Scott,
Something I wrestle with is that sure we expect Housing to cost more and energy and food are must buys…
But on countless other consumables, especially the ones we long for… we have a Better Tomorrow Reality that offsets our Money Illusion.
We EXPECT to have a bigger TV and a better phone and more bandwidth, and a VR rig, and more free music and movies and tv shows, and more choice in clothes, and better features in cars without spending or making any more money, in future.
Digital deflation is a real thing, and EVEN OUR POOREST expect to have a better standing of living even if they don’t make any more money.
That has to offset money illusion, no?
1. April 2014 at 13:42
Philippe,
“I don’t know. But it seems to me that if in one case you find granger-causality from QE to loans, and in another case you don’t really, then it’s possible that the granger-causality doesn’t reflect actual causality in the observed case.”
Actually I’ve mentioned four cases (so far) and all four find a positive effect for the monetary base on loans, but only three are statistically significant. Moreover two of the three are strictly one way from the monetary base to loans.
The principle way one can get a false positive significance result for a Granger causality test is if there is some third factor which causes the other two factors. Personally I think that’s a highly problematic argument to be making with respect to something as ad hoc as QE.
Moreover, my general perception is that people (present company excepted of course) who question Granger causality test results only do so when it produces a result they don’t like, and rarely apply the same degree of skepticism to ordinary least squares (OLS), which produces correlations which are far less robust.
1. April 2014 at 13:53
He he. I don’t know much about Granger causality tests so I only ask as an amateur outsider.
1. April 2014 at 14:01
Chuck E,
“Wouldn’t the commercial banks abhorrence of risk drive them to reduce creating loans? Thus, impacting their own utility?”
You mean with respect to the UK? (I assume so, since what Glasner and Rowe are talking about is an excess supply of commercial bank money which would require an unusually large stock of loans.)
You seem to be proposing that UK commercial banks are less than fully rational or, perhaps, they are fully rational but that a an unusually high level of risk aversion enters into their utility function in some fashion.
Maybe. All I know is the UK’s economic behavior seems to be even more like a nation recovering from a major financial crisis than any of the other countries recovering from a major financial crisis (e.g. a negative aggregate supply shock).
2. April 2014 at 16:28
Morgan, Money illusion is not about living standards, it’s about confusing real and nominal variables.
3. April 2014 at 09:41
I get that Scott, you have a instinct to not want to be paid less money in numbers.
BUT, in the past it has occurred in a rigid atomic price system.
Digital deflation isn’t just a conversion to equity instead of debt…
To some degree, for the first time, people have a REAL sense that making less money doesn’t keep them from having better life.
It just stands to reason, this could be a competing mindset.