Andolfatto interviews Woodford
David Andolfatto is a very knowledgeable monetary policy blogger, and here he interviews Michael Woodford, perhaps the world’s leading monetary theorist. I’ll just focus on one issue:
Andolfatto
There is a conventional wisdom of how these tools might work. Can you explain to us the findings of your own research, how they might corroborate these findings or these beliefs? Or go against them in some manner? Is there something surprising that emerges from what you’ve discovered?
Woodford
I think so. I think a lot of the discussion that you see of the point of asset purchases suggests that there should be a lot of similarity between the effects of purchasing long-term assets and the effects of cuts in the federal funds rate, the Fed’s traditional tool. People say the whole point of cutting the federal funds rate is longer-term bond yields would also go down, and if you can just buy longer-term bonds, push up their prices, that’s doing the same thing with a different mechanism. It’s a different way of doing the same thing. And if you can’t cut the federal funds rate further, then there’s an obvious reason to use the other method.
And our analysis suggests that this analogy between the two tools is not nearly as strong as you might have expected.
Andolfatto
Why is that exactly?
Woodford
Well, one reason is that the question of whether it’s clear that Fed purchases of longer-term assets can affect the prices of those assets as directly as traditional interest rate policy would. But I think the more surprising thing is that our analysis suggests that even under circumstances when the central bank finds that its purchases do affect the market price of the longer-term assets, the connection between that and spending in the economy, and then the effects on inflationary pressure, are not necessarily at all similar to those of conventional interest rate policy.
Andolfatto
So you’re suggesting that it is possible, at least in theory, that the Fed engages in the large purchase of a certain class of assets? Injects money into the economy by purchasing a particular class of assets? And that this may, in fact, have very exact opposite sort of effects than conventional data might suggest?
Woodford
Right. We clearly show that that’s at least a theoretical possibility. And obviously then deciding whether you think that’s actually happening is another thing. But I think the analysis points out that you shouldn’t assume that the mere fact that you could raise the price of the bonds answers then the question about what effect you’re having on the economy.
Andolfatto
So can you explain the economic intuition for that effect and whether or not it has some bearing as to the conduct of Fed policy today?
Woodford
I think the point is a fairly simple one, and it has to do with the question of why the central bank purchases should be able to move the market price anyway, which, again, people thought was kind of obvious. They said if you’re buying more of something, surely that will tend to make it more expensive. But when you ask whether that should actually happen with a lot of sophisticated traders out there in the market that are also trading against the central bank, what we argue is that if the other traders in the economy aren’t constrained in the financing they can mobilize to take the positions that make sense for them, they will tend to automatically have an incentive to trade against the central bank and to neutralize then the effects of the central bank’s trades.
Two things struck me. First, Woodford has a contrarian view of the effects of QE on long-term interest rates. Second, market monetarists have a similar counterintuitive view, but for very different reasons.
Woodford starts by pointing out that people expected QE to reduce long-term rates, just as traditional fed funds rate cuts reduce long term rates. But MM doesn’t even accept the premise. Some of the most dramatic Fed moves toward cutting short-term rates have actually boosted long term rates, via the inflation and income effects. We think QE also has an ambiguous impact on rates, for similar reasons. In contrast, Woodford focuses on the risk channel (you should read the whole thing to get his explanation.)
Then Woodford suggests that the relationship between long-term rates and the economy is not as clear as with traditional tools. We agree that it’s not at all clear (never reason from a price change), but we think that’s also true of traditional tools. One cannot assume that lower interest rates produced by the Fed will lead to strong growth in AD. It depends on the relative strength of the liquidity, income and Fisher effects.
In the final paragraph I quote, Woodford points out that most people think that Fed purchases “obviously” boost the price of the asset being purchased. They misuse the S&D model. Some commenters are outraged that the Fed is helping group X, because group X owns lots of the assets that the Fed is buying. They see dark conspiracies. But the purchase of bonds is also the sale of cash. And more cash boosts inflation, which reduces bond prices. During the 1964-81 period the Fed radically increased the amount of bonds it was buying, this led to rapid growth in the monetary base, higher inflation, and much lower bond prices. So much for Cantillon effects.
Yes, there are cases where large asset purchases are associated with low inflation (such as recently); my point is that there is no consistent relationship between Fed asset purchases and the price of that asset.
HT: Tom Brown, TravisV.
Tags:
27. July 2014 at 07:48
Final paragraphs:
Andolfatto
If you were Chairman of the Federal Reserve, what sort of policy or policy intervention would you be favoring at this time, just endowed with the situation as it has developed to this point?
Woodford
It’s obviously a very complex situation. In general, I wish the Fed were speaking more about the need for fiscal policy to take on more of the burden of trying to get the economy moving. [… it continues …]
27. July 2014 at 09:21
Tom, Yes, I strongly disagree with that. We haven’t even scratched the surface of what monetary policy can achieve.
27. July 2014 at 09:25
For instance NGDPLT is 100 times more potent than fiscal stimulus.
27. July 2014 at 10:13
Scott, can you direct me to where you calculate that monetary policy via NGDPLT is 100 times more potent? Thanks.
27. July 2014 at 10:23
Andolfatto is my idea of what an economist should be. His analysis–and in particular, his charts–are inevitably thought-provoking.
I wish he would cross-post his blog entries. They are inevitably worth reading, but as he only posts every few weeks or so, I only become aware of them if a high volume poster like Scott or Econbrowser links them.
27. July 2014 at 12:15
What distinguishes monetary stimulus from fiscal stimulus? At the zero lower bound, trading money for short-term debt accomplishes nothing. Hence trading money for long-term debt, which is equivalent to trading money for short-term debt, then trading short-term debt for long-term debt, is equivalent to just trading short-term debt for long-term debt. Does it really makes sense to think of this as monetary stimulus, if the fiscal authority could do exactly the same thing? Is what matters WHO does the trading?
If we think of monetary policy in terms of targets, then the question is how does the monetary authority hit the target at the zero lower bound? One way is to convince the markets that enough money will be traded for short-term debt after the zero lower bound ceases to bind that the economy will catch up to the target, so that the expectation of eventual catch-up leads to faster catch-up now. This is pretty clearly monetary stimulus. Another way is to trade money for other stuff, but this is basically fiscal policy. Nothing wrong with that, to be sure, but some fiscal policies are better than others, and if we go this route it is worth thinking through the optimal form of fiscal stimulus.
Of course, if the target is high enough, and the monetary authority is sufficiently credible, the zero lower bound will not in general come to bind. So it is fair enough to say monetary policy can do everything without fiscal policy, and if it does, then fiscal stimulus becomes inconsequential to AD. But if the zero lower bound does come to bind, and if we choose to address that in part by trading money for unconventional stuff, it is worth recognizing that we’re engaged in fiscal policy, and that some fiscal policies are better than others. I think that’s really all Woodford is getting at here–fundamentally he agrees that good monetary policy could prevent the zero lower bound from ever binding, and that even if it did bind good monetary policy alone could get us out. But that’s the road not taken.
27. July 2014 at 13:45
Scott, one of the things which struck me about the interview was how qualified and careful most of Woodford’s statements were. I’d never seen him talk before. By chance I happened to read this old Noah Smith post yesterday (along with this other post in which he reviews a John Cochrane speech that he was surprised to find he largely agreed with): the main idea of both of which seems to be that macro data is largely uninformative and will likely remain so for the foreseeable future.
Do you mostly agree or disagree with Noah? If Noah is correct, then perhaps this explains Woodford’s general cautiousness. If the data really sucks that bad, then I can see how it would be tough to justify any strong opinions.
27. July 2014 at 15:27
Question: If we set NGDPLT at 4%… to be rejiggered every month, and did futures market, and didn’t use it as transmission mech like I want to.
Would it be better to buy and sell short terms?
Seems like buying and selling long terms would gunk up works, but I have no idea.
27. July 2014 at 16:43
Scott,
A couple of comments.
I think it would clarify things if Woodford and others stated.
1. When the Fed (or banking) system buys financials assets from the the non-banking system, it effectively initiates an exchange by the non-banking sector of financial assets for real goods and services.
I.e. Don’t think about the impact on asset prices, but think about the end results. This is especially true since end results depend not just on asset prices but also on expectations of future NGDP.
2. The whole discussion of risk and term of assets is distracting. It’s a lot easier to just think about a single risk adjusted return. Relative prices may change a little based on Fed buying, but that doesn’t change the underlying real risks (or expected returns) and the market will quickly arbitrage any short term changes. It’s like talking about the stiffness of the golf shaft. Maybe you can hit the ball five yards farther, but you can do the same thing by swinging harder as well. What assets you buy is maybe interesting to Woodford or economists at the Fed, but fundamentally the basic monetary tool (OMO) and mechanisms (NGPD expectations and/or asset prices) are unchanged.
27. July 2014 at 18:11
Scott, not only did treasuy yields tend to go up during QE, but so did term premiums http://macromarketmusings.blogspot.com/2014/07/a-look-back-at-feds-qe-programs.html?m=1
27. July 2014 at 20:47
“In the final paragraph I quote, Woodford points out that most people think that Fed purchases “obviously” boost the price of the asset being purchased. They misuse the S&D model. Some commenters are outraged that the Fed is helping group X, because group X owns lots of the assets that the Fed is buying. They see dark conspiracies. But the purchase of bonds is also the sale of cash. And more cash boosts inflation, which reduces bond prices. During the 1964-81 period the Fed radically increased the amount of bonds it was buying, this led to rapid growth in the monetary base, higher inflation, and much lower bond prices. So much for Cantillon effects. ”
Ceteris paribus increasing the demand for an asset (or reducing the supply) through an asset purchase will increase its price. Asset purchases by the fed aren’t the only thing affecting the supply and demand for the asset though. Other effects like the income effect may be stronger and adversely affect demand for a treasury to a greater extent than the than the increased demand for asset by fed.
Put another way the fed could generate the same income effect without purchasing the asset. In this scenario the demand for the treasury would be lower if the treasury’s weren’t on fed balance sheet.
Owners of treasuries are benefiting because of the higher demand for the asset under asset purchase regime when compared to a regime when assets aren’t purchased even when you take into account the income effect.
28. July 2014 at 05:51
Tom, First of all thanks for the tip, I originally HTed the wrong person.
Second, I shouldn’t have said 100, for a couple reasons. I don’t know exactly, my sense is several orders of magnitude more powerful. The other problem is that the units are non-comparable, so it’s not clear what to compare.
Ram, You said;
What distinguishes monetary stimulus from fiscal stimulus? At the zero lower bound, trading money for short-term debt accomplishes nothing.”
This is not the right way to think about the problem. The point of monetary policy is not to “accomplish something” but rather to meet the public’s demand for base money when NGDP expectations are on target. Assume you are at the zero bound and the NGDP expectations are right on target (say via NGDP futures targeting), the the point of OMOs is to make sure the public is holding the amount of base money they want to hold. If you must boost NGDP expectations than policy has already failed–your regime is flawed.
I don’t agree that buying unconventional stuff is fiscal policy, as I’ll explain in a post over at Econlog in the next day or two.
Tom, No I don’t agree that macro data is largely uninformative. If I viewed the world through the lens of IS-LM then I’d strongly agree with Noah, as the data doesn’t even come close to being consistent with the IS-LM approach.
Morgan, I doubt it makes much difference whether we buy short or long, unless we are buying massive quantities, even then the difference is small.
dtoh, I agree that risk shifting is a minor issue.
David, Yes, I was thinking of that. But the data is not 100% clear on causation. Rumors of tapering also boosted long term yields.
CMA, That’s right, I was addressing the “QE or not QE” issue. I’d also note that they gain when the Fed buys more than expected and they lose when the Fed buys less than expected. In the long run it nets out to zero, so it’s not an important equity issue.
28. July 2014 at 10:10
Scott, Thanks for you remarks. reg: the H/T: I wondered about that myself… but I did find where TravisV mentioned something Arnold Kling wrote about the interview prior to my comment…. so I’m happy to share it. 😀
28. July 2014 at 10:30
Scott, I notice that Nick Rowe writes in his summary of Lloyd Meltzer’s paper:
“…the theoretically “pure” monetary policy is a helicopter drop.”
It seems like Nick is agreeing, but I’m not 100% on that. What about you?
28. July 2014 at 11:08
Interesting paper by Woodford. Is the result driven by the assumption that central bank liabilities are not allowed to serve as a collateral? Or does the model assume that central bank liabilities can serve as a collateral too?
28. July 2014 at 17:07
“CMA, That’s right, I was addressing the “QE or not QE” issue. I’d also note that they gain when the Fed buys more than expected and they lose when the Fed buys less than expected. In the long run it nets out to zero, so it’s not an important equity issue.”
So you agree there is Cantillon effects? Any purchases by the fed of an asset like a treasury benefits the holders because of the increase in demand for them ceteris paribus. In the long run it doesn’t net out to zero unless the fed stops holding treasuries on its balance sheet. Remember I am comparing a situation where you have on target ngdp growth through asset purchases to on target ngdp growth through fed heli drops where the fed has no assets on its balance sheet.
“they gain when the Fed buys more than expected and they lose when the Fed buys less than expected.”
They gain more than expected when the fed buys more than expected and they gain less than expected when the fed buys less than expected. They only lose if the fed reduces its holding of a particular asset. They give back their previous gains they realized when the fed purchased these assets. They don’t lose when the fed buys less than expected.
28. July 2014 at 17:10
CMA gets the mechanics.
28. July 2014 at 18:30
Tom, “Pure” is in the eye of the beholder.
Vaidas, I’m not sure.
CMA, So let’s see. The Fed was created in 1913. For 100 years they’ve run inflationary policies that have hurt bondholders, at least relative to the gold standard. And yet you complain that because they have bought bonds instead of some other asset (maybe one you own) they have not hurt bondholders enough for your taste. Sorry if I don’t shed any tears for non-bondholders.
I’d add that any effects on bondholders are tiny. And you do realize that not all current bondholders are over 100 years old? Some bought bonds at prices reflecting expectations that the Fed would buy bonds when injecting money. Add in rational expectations and you really don’t have any argument at all.
28. July 2014 at 18:50
Scott Sumner
Yes inflation hurts bondholders. My point is that cantillon effects exist. If the fed generates equal inflation through direct fed heli drops or treasury purchases you get different effects on bond demand. You benefit asset holders if you buy an asset to achieve something compared to if you dont. Cantillon effects exist is my point.
The effects on bondholders may or may not be tiny but it doesnt matter there is a Cantillon effect. If the fed holds a significant portion of treasuries the effect may not be insignificant. Thats not my point though. My main idea is Cantillon effects exist.
“Some bought bonds at prices reflecting expectations that the Fed would buy bonds when injecting money. Add in rational expectations and you really don’t have any argument at all.”
People rationally expect under asset purchase the increase in MB to affect ngdp and the increase in D for bonds to increase its demand by amount of fed purchase. Under heli people rationally expect increase in MB to increase ngdp but they dont expect the same demand increase by the fed. There is a difference.
Prefferably the fed can expand the money base into my account directly. If we don’t get enough ngdp just expand harder is my solution to this. A more viable solution is just fed heli drops people might turn on me.
28. July 2014 at 21:46
I guess I’m not talking about the “point” of monetary policy. Whether the central bank trades money for short-term debt or not is irrelevant at the zero lower bound. If the central bank trades money for other things, then it is in effect just trading short-term debt for those other things, and that may have consequences, but these are not usefully thought of as monetary actions since the fiscal authority can accomplish exactly the same thing. The question of whether monetary policy is good or bad, or what the objective is, is separate from this issue.
28. July 2014 at 23:24
Scott,
If the worry is that too large a fraction of the supply of the asset used as collateral comes to be held by the central bank – the solution is simple – allow central bank liabilities to be used as a collateral. This is exactly what the Fed is trying to achieve with reverse repo.
The interview is a little bit misleading, as it discusses fed fund rate cuts vs QE, while the real choice is forward guidance vs QE.
29. July 2014 at 05:01
CMA, For the government to just give you money is one of the worst ideas imaginable. Think of all the better things the government could do with the money they simply give to you.
I don’t think you followed my comment on ratex.
Ram, I don’t agree. You can’t look at monetary policy from the perspective of what happens if the Fed does or does not do an OMO. An OMO is not (by itself) monetary policy. Monetary policy includes a monetary regime. An OMO at the zero bound under 5% NGDPLT is very different from an OMO at the zero bound under discretion. If you are targeting NGDP futures contracts and do an OMO at the zero bound to keep the contracts on target, then the policy is effective, even if you simply buy short term debt.
The way to think about this issue is to first ask how big is the public’s demand for base money at the zero bound, and then ask what sort of OMOs are needed to satisfy the demand. If you don’t like my NGDP futures idea think about the Swiss. Krugman said they couldn’t do enough OMOs to keep the SF from rising against the euro. But as soon as they set a target for the SF, and kept it at that target, it was easy to do enough OMOs. The OMOs were effective, despite Switzerland being at the zero bound, because the SNB was simply accommodating the public’s demand for base money. That’s something OMOs can do at the zero bound.
Zero bounds are not easy money failing to “work”, they are caused by monetary policy too tight to target the forecast.
I have more on this at a post over at Econlog.
Vaidas, There’s a much simpler solution. If you don’t want the central bank to hold a lot of an asset, set NGDP growth high enough so that T-bill yields are positive. That’s all you have to do. We did fine with that for decades–in contrast look how the big balance sheet and slow NGDP growth is working out.
29. July 2014 at 05:26
“CMA, For the government to just give you money is one of the worst ideas imaginable. Think of all the better things the government could do with the money they simply give to you.”
Monetary policy is always about giving something. Its only a matter of what form does the gift manifest as and who gets the gift. Lowering interbank rates is a gift to banks by lowering their funding costs. Purchasing assets is a gift to asset holders through wealth effects. Heli drops are the most efficient, equitable and therefore neutral gift of all. Its not the govenment gifting money by increasing taxes or borrowing its the fed printing money and conducting policy in the most effective manner.
29. July 2014 at 12:43
ssumner:
“Think of all the better things the government could do with the money they simply give to you.”
It would accomplish NGDPLT.
Wait a minute, are you saying that it is better if the Fed sent checks to owners of certain financial securities only? What about the old stubbornness that it doesn’t matter who gets the new money first? If it doesn’t matter, then sending checks to homeless people who have nothing to…”swap” (haha!), would make zero difference.
CMA, you’re hitting on the proof that inflation is not at all “stimulative” in the way MMs believe it is.
The actual “stimulus” from inflation is caused by its heterogeneous effects between individuals and industries. Sending checks to the banks in exchange for their treasuries is “stimulative” not because it boosts NGDP or aggregate wages, but because of the fact the initial recievers and latest recievers taken together behave differently than they would if everyone recieved heli drops of money. The “stimulus” is actually deceit, misleading signals, false information, certain economic activity being promoted while others are not.
If everyone recieved heli drops of money, in such a way that NGDPLT was met, then the “stimulus” effects would soon collapse to nothing. And worse, production would plummet, as the incentive to produce would fall even more. And in addition, economic chaos would be even greater, because the connection between value of an individual’s income and their productive activity in a divison of labor would be all but totally severed.
Inflation in the form of OMOs only “works” because of the alterations to relative real activity. It has nothing to do with NGDP. Zippo.
30. July 2014 at 08:00
CMA, There’s nothing more I can say if you don’t know the difference between spending money and giving it away.
30. July 2014 at 18:39
“CMA, There’s nothing more I can say if you don’t know the difference between spending money and giving it away.”
New money creation is always a giveaway in some form. Lower funding costs for banks, higher asset prices to asset holders, lower rates on treasuries etc…
All Im saying is make the giveaway as effective and equitable as possible. Give everyone an increase in monetary wealth not just lower rates to a handful of banks or increase asset prices of the few asset holders which own a large share of assets.
30. July 2014 at 21:53
Hey now Sumner, someone can be perfectly willing to accept the Fed’s offer to buy their garbage, or worn out clothing, or old beat up cars, or something else they don’t want to own any longer.
Problem solved. That would not be giving money away. It would be a “swap.” All the problems and mechanics of inflation associated with heli drops would completely and totally and fully and entirely disappear. It would be just like the status quo, only poor people could participate in addition to millionaire and billionaire (and obedient!) bankers.
30. July 2014 at 21:57
Of course, the prices of garbage or clothing or cars might increase significantly if the Fed starting buying those things, but not to worry! We can just say the market prices have gone up for them, and the Fed is just paying the market price.
31. July 2014 at 06:55
CMA, Saying there are side effects to printing money (which can be positive or negative to bond holders, it’s not clear), has nothing to do with the claim that money is being “given away.” It just doesn’t. You need to make a serious economic argument using theory and logic, you are simply throw words around in a meaningless way. Show me how your proposal maximizes aggregate welfare, don’t just make the claim. Don’t say it’s “equitable” to give anyone money. (BTW it’s not, as those who are paying for this giveaway are not being taxed equally to pay for it.) I want to know why it’s a good idea.
31. July 2014 at 08:10
ssumner:
“Show me how your proposal maximizes aggregate welfare”
Impossible to do, because conceptions of increased welfare are unique to the individual. Only a pure laissez faire society, including in money, can enable you or I or anyone else to know what is maximal welfare generating. Everything else is one person or one group of people imposing their personal values on everyone else, and claiming it is superior than their own values for themselves. This is the arrogance and elitism that utterly plagues everyday, “macro” debates and discussions. Here you are just sitting their talking about how my person and property should be used, and you don’t even have the common courtesy to ASK me first. You just ex cathedra declare how other people’s lives should be controlled, and you call it “theoretically and logically sound.”
You never once proposed ANY theory to me personally or anyone else personally, on how my own and their own life is to be run. As far as your ideology is concerned, those who don’t want for themselves what you want for them e.g. NGDPLT, progressive taxation, etc, are sub-human irritants who are somehow destroyers of society for simply wanting the ability to opt out of all these grand macro “plans”. No, you are not helping me or any other freedom lover by fighting for what you believe is a better macro plan than someone else’s macro plan. I don’t want your plan at gun point. If the plan were so good, no guns would be needed to convince the person. If the plan were so good, you would encounter zero defensive resistence.
The best “plan” for all is nobody having any plan for all. Let each individual determine what is welfare maximizing for themselves, constrained to other individuals determining what is welfare maximizing for themselves. You don’t have to be responsible for me. I can take care of myself. You don’t have to feel obligated to change the plan. You can reject all plans. With enough people who reject all plans, your professed stated goal of welfare maximization will actually be attainable. You would likely be surprised how many trading and cooperation opportunities suddenly arise when individuals have total mastery over their own lives. Letting go is the best way to connect with people. Do you get along better with people who are trying to run your life, or do you get along better with people who treat you as an end in yourself and only run their own lives?
31. July 2014 at 08:22
And by “getting along” I mean the worst that happens is you loathing that person and don’t want anything to do with them, yet there are no physical conflicts. Kind of like, well no, exactly like, this blog. The way everyone actually behaves with their bodies on this blog are as anarchists.
Yes, there is a LOT of talk that is counter-anarchist, but that is the beauty of anarchism. We can say anything we want, subject to the rules of the property owner, namely you. The only real difference between myself and most others here, is that I strive for my talk to match my actions. Doing so keeps a lot of things in clear perspective. I don’t advocate for anything that I am not myself doing, or I should say, I strive not to do anything that contradicts my advocacies.
31. July 2014 at 18:12
Scott Sumner
I wouldn’t call the wealth effect a side effect. Its quite clear that if you achieve 5% ngdp growth through treasury purchases or equal distribution direct fed transfers you will get a different effect on the treasury the fed purchases if you believe in supply/demand. You may call that a side effect but I don’t because expected wealth effects are key in expectations formation. I would call this increase in treasury prices free wealth for existing treasury holders just as a fed transfer would be free wealth to recipient.
A heli drop is more equitable though because all people get the direct increase in monetary wealth. No one is being taxed to pay for the heli drop if done by fed.
If everyone can hold reserves an increase in supply of reserves reduce rates to all and not just reserve account holders.
If money is placed into circulation by fed without purchase of an asset then money increase is permanent. Increasing the MB through an asset purchase is more questionable as to permanence because the asset the fed holds is drawing money from the system back to the fed through coupon and principle payments.
31. July 2014 at 19:59
I wouldn’t call the wealth effect a side effect. Its quite clear that if you achieve 5% ngdp growth through treasury purchases … this increase in treasury prices free wealth for existing treasury holders
Unless the now higher expected NGDP growth increases interest rates which drives down the price of treasuries, which reduces Treasury prices, a “gratuitous wealth reduction” for T-holders — which is also observed.
Recently observed frequently enough for the expected result of these operations to be “ambiguous” in the word of our host.
But I’m old enough to remember when it was “quite clear” to damn near everybody that increasing the rate of NGDP thru open market operation purchases of T-securities destroyed their value in the market, back in the days when long T-bonds plunged 30%.
31. July 2014 at 20:56
Jim, your comment just made me realize how refutably wrong the idea is that QE was inflating asset prices, and that it was working through a liquidity effect that pushed interest rates down.
First, there is the notion that QE led to higher bond prices. When I point out to people that rates tended to rise during QE, they would say, “Well, the markets are forward looking. Bonds were bid up after QE was announced, and by the time the Fed was engaged in actual buying, the yields had already been depressed, based on market expectations, then yields went up during QE in anticipation of the end of QE.”
(First, if the liquidity effect basically comes about because of market inefficiencies, I’ve never understood how you can even have a forward looking liquidity effect.)
But, the thing is, the stock market went up and down along with bond yields and the QE’s.
http://research.stlouisfed.org/fred2/graph/?g=GNN
So, stocks weren’t forward looking. They went up during QE and down between QE. So, why are bonds forward looking, but stocks aren’t? And, it’s kind of hard to claim that QE inflated asset prices if you think about bonds in the same framing as we think about other assets. At precisely the same times that stocks were going up, bond prices were going down, and vice versa.
How else can this be explained, except that the main effect of QE’s was to lower risk premiums and to reinflate inadequate aggregate demand?
31. July 2014 at 22:11
Jim Glass
“Unless the now higher expected NGDP growth increases interest rates which drives down the price of treasuries, which reduces Treasury prices, a “gratuitous wealth reduction” for T-holders “” which is also observed.”
You took out part of my sentence and changed the context. Here’s my sentence again:
“Its quite clear that if you achieve 5% ngdp growth through treasury purchases or equal distribution direct fed transfers you will get a different effect on the treasury the fed purchases if you believe in supply/demand.”
1. August 2014 at 05:43
CMA:
“Its quite clear that if you achieve 5% ngdp growth through treasury purchases or equal distribution direct fed transfers you will get a different effect on the treasury the fed purchases if you believe in supply/demand.”
That last part about supply and demand is very important.
If NGDP increases, and the demand for treasuries increases, then interest rates can fall, or at least be lower than they otherwise would have been had the demand for treasuries not increased, or not increased by enough.
As everyone knows, the size of, and hence spending on, treasuries has without exaggeration exploded since the last financial crisis, and really has been accelerating for many years prior.
Hence the “low interest rates”. Hence MMs concluding “low interest rates show money HAS been tight all along just like Friedman said.”
Money is also tight to MMs if there is a fall in spending on GDP and an equivalent rise in spending on stocks and bonds, with no change to absolute total spending on everything. Or, another way of looking at it, if inflation of the money supply leads to significant increased spending on stocks and bonds, but not consumer goods, or not enough additional spending on consumer goods to make the prices rise by much, then even with huge run ups in stock and bond prices, they will view money to be “tight” and ask for more inflation, even if it will make stock prices and bond prices soar even more. This is MM’s blindspot. Same blindspot as price inflation targeting.
Investors cannot know or predict what the proper ratio between stock/bond spending and consumer/capital spending should be ex ante on any given day. The price system can only work if nobody controls it. Just like friendships, and labor allocations, the price system cannot work if there is some absolute dictator controlling relative spending (which is what controlling total spending implies, unless perhaps CMA’s heli drops is the method, but even then it would not be precise, for reasons outside the scope of this comment). Investors who are not guided and constrained by free market forces in money can and do fail to allocate spending and hence fail to regulate real capital allocation and production into sustainable lines.
1. August 2014 at 05:57
by “free market in money” what you are actually referring to is ancapistan, an imaginary world that exists inside your head and nowhere else in reality or history. Ancapistan is a nonsense concept, and any pronouncements about how ‘the economy’ would function in ancapistan are just wild-eyed speculations about about the imaginary workings of nonsensical imaginary worlds.
1. August 2014 at 06:20
CMA, You said;
“If money is placed into circulation by fed without purchase of an asset then money increase is permanent.”
That’s false.
The rest of your comment keeps repeating the same mistakes. Your windfall to bondholder idea ignores the EMH. You ignore the fact that gains to bondholders are utterly trivial in any case. You are wasting time on a side issue of no importance.
1. August 2014 at 07:18
Scott Sumner
“CMA, You said;
“If money is placed into circulation by fed without purchase of an asset then money increase is permanent.”
That’s false.
The rest of your comment keeps repeating the same mistakes. Your windfall to bondholder idea ignores the EMH. You ignore the fact that gains to bondholders are utterly trivial in any case. You are wasting time on a side issue of no importance.”
Put it this way. You wont be able to increase the MB to 4 trillion in today’s economy under direct fed direct heli drops. The hit to expectations would be huge. If the fed was targeting a 1-2% inflation corridor like Beckworth says then it would only be increasing the MB moderately like at 2-3% rate per anum. You will not be able to increase the MB massively into peoples account without them spending. Just imagine the 3 odd trillion in excess reserves were passed on to people evenly tomorrow. It would send expectations through the roof.
Under the EMH prices would adjust today to expectations of higher fed demand by amount of fed purchases. Bonds would also adjust to whatever ngdp is expected to be. Under direct fed heli drops bond prices would adjust according to what ngdp is expected to be but they wouldn’t adjust for expectations of fed purchases. Two different end results on bonds. There is opposing effects occurring but that doesn’t mean that wealth effects don’t exist due to fed purchases. Just because a plane is ascending doesn’t mean gravity doesn’t exist.
1. August 2014 at 07:21
Major Freedom
Really good observation. I have thought before whether gdp should include all forms of value added. Like value added on goods that arent new, financial assets etc…