Breathing Room?

A recent FT article encapsulates everything I don’t like about how the press is covering monetary policy.  Or perhaps it is actually showing what I don’t like about monetary policy itself.  You decide:

The US Federal Reserve is roughly halfway through completing its planned purchases of mortgage and Treasury debt, which constitutes its quantitative easing programme, writes Michael Mackenzie.

.  .  .
The Fed’s buying has not prevented either Treasury yields or mortgage rates from rising, complicating efforts to provide relief for homeowners and other long-term borrowers.

.  .  .

The recent rise in rates, which accelerated in early June, sparked expectations among some bond traders that the Fed would increase its planned purchases of US Treasuries.

In March the Fed announced its target of buying $300bn in Treasuries and also raised its planned purchases of mortgages from $500bn to $1,250bn and doubled its planned agency buying to $200bn.

The scope of the Fed’s QE programme has aroused concerns it will nurture higher inflation and debase the currency. At its June policy meeting, the Fed stuck to its QE targets and said it would “continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets”.

With long-term rates having eased back and recent Treasury auctions attracting strong foreign buying, the central bank has some breathing room for now, say analysts. Should credit conditions deteriorate later this year or the economy’s recovery falter, the Fed may step up its purchases of Treasury debt.

One problem is that the FT doesn’t really seem all that interested in whether the Fed is actually engaged in QE.  I recently mentioned that in the first half of 2009 the monetary base declined at near record rates.  A few commenters pointed out, probably correctly, that the Fed wasn’t actually engaged in QE, but rather was trying to influence mortgage rates.  That’s fine, but the press can’t have it both ways.  If it’s not QE, don’t say it is.  And if you’re telling your readers the Fed is engaged in QE, at least check the monetary base numbers to see if it actually has done any QE in the first half of 2009.

But that’s a minor point.  The much bigger problem is the way they interpret interest rates.  Between March and early June nominal interest rates rose strongly.  This was the “green shoots” period, when there was increased optimism about the world economy after Asia began recovering.  Stock prices rose strongly.  So did oil prices.  Inflation spreads on the 5-year TIPS widened dramatically from 0.38% in early March, to a peak of 1.85% on June 10th.  Things were looking up.

Then things started deteriorating again.  Oil prices started falling, so did stock prices.  So did nominal interest rates, real interest rates and inflation spreads.  Today the 5-year TIPS spread fell to only 1.15%, far too low for a healthy recovery.  And how does the FT interpret this bad news?  They say that “analysts” suggest lower interest rates give the Fed “some breathing room for now.”  God help us if this reflects Fed thinking.



19 Responses to “Breathing Room?”

  1. Gravatar of JKH JKH
    9. July 2009 at 15:01

    I thought the Fed had taken pains to emphasize it is not targeting the monetary base. It hasn’t used the terminology “quantitative easing” either, has it? (Or maybe I missed that.) It’s targeting specific asset markets, including mortgages, treasuries, and mortgage interest rates. The base effect is a by product in their view, as far as I can tell and read into their speeches.

    Not what you want to see or hear, but the Fed is being consistent in articulating what it is doing I think. Just because it has a treasury purchase program doesn’t mean it thinks about this program as “quantitative easing” the way much of the world seems to want to think about it.

    And the fact that they’ve held back on the monetary base is not inconsistent with their own view that they are not engaged in “quantitative easing”. Again, I appreciate that’s not what you want to see.

    Moreover, given that they don’t think of what they’re doing in the conventional view sense, it makes the conceptual leap to charging interest on reserves that much greater, I think. How will they come to such a decision if they don’t really think of their strategy as targeting the monetary base at this point?

    I have a problem with the conventional definition of QE in any event. Why should the idea of targeted base expansion be dependent on the idea of treasury purchases anyway?

    QE is a bad definition concept for an important idea as far as I’m concerned.

    As far as the press or the media in general are concerned – give us all strength to withstand their scrambled chatter and analysis by regurgitation.

  2. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    9. July 2009 at 16:51

    Try this post:

    “Keep the money flowing to stave off deflation

    By Tim Congdon

    Published: July 8 2009 19:53 | Last updated: July 8 2009 19:53”

    “But the darkest hour was just before the dawn. The start of QE in early March coincided almost precisely with an abrupt improvement in nearly all macroeconomic indicators.”

  3. Gravatar of Jon Jon
    9. July 2009 at 20:46

    We cannot expect the press to get monetary policy right when even Krugman cannot accurately describe how Fed normally conducts policy. That said, I seem to recall Krugman making a big show of saying several months ago that the Fed’s QE program was for ‘Quality Easing’ not ‘Quantitative Easing’.

    He had it right. Of course he used this mainly as a chance to sneer at the monetarists…

  4. Gravatar of Bill Woolsey Bill Woolsey
    10. July 2009 at 03:17

    How does higher expected inflation impact nominal interest rates and spending?

    There appears to be an assumption that expected inflation only impacts the supply of funds by lenders.

    When lenders expect higher inflation they reduce the supply of funds.

    The assumption appears to be that the nigher nominal interest rates reduce the quantity of funds demanded by borrowers. And so, less current expenditure is funded by borrowers. (For expanmple, fewer new homes are purchased.)

    What are do the lenders supposedly doing with the funds instead? I am not sure. Do they hoard base money? Is it a reduction in the supply of long term loans and an increase in the supply of short term loans?

    More importantly, the Fisher effect is based on the assumption that borrowers increase the demand for funds in response to higher expected inflation. They do so becuase they will be paying back the loans with money of lower purchasing power. Of course, what are they doing with the funds? They are spending on current output.

    The point of the Fisher effect is that the increase in nominal interest rate due to higher expected inflation leaves the real interest rate unchanged and the real interest rate is what matters.

    And so, in reality, the higher nominal interest rates due to higher expected inflation have no impact on current expenditures and so there is no need to worry what the borrowers do with any additional funds borrowed or what lenders do with the funds they don’t lend.

    And so, to the degree that higher expected inflation raises nominal interest rates this has no implication on the short run impact of quantitative easing on current nominal expenditure.

    The expected inflation rate rises. The supply of funds falls. The demand for funds rises. The nominal interest rate raises, and the real interest rate stays the same. The lenders transfer the same amount of funds to borrowers to finance the same level of real expenditures.

    But, if quantitative easing lowers the real interest rate on long term loans, then the nominal interest rate rises less than expected inflation, and the Fed (creating money) and all the other lenders together, provide more funds to borrowers, who undertake more real expenditures.

    It seems to me that this is the effect to be expected from quantitative easing (newly created money used to purchase long term bonds.) For it not to work this way, we must assume that the decrease in the supply of lending by everyone other than the Fed occurs according to the Fisher effect, but the increase in the demand for borrowing occurs less than predicted by the Fisher effect. And so, the decrease in the supply of lending by the market is equal (or greater than) the increase in lending by the Fed. The real interest rate doesn’t fall (and maybe rises.) Nominal interest rates rise because of the higher expected inflation. And real interest rates remain the same (or even rises.) Quantitative easing has failed (or was counterproductive.)

    I think, however, that the actual analysis in the press doesn’t distinguish between real and nominal interest rates.

  5. Gravatar of Current Current
    10. July 2009 at 04:33

    Bill, do you have a blog?

    Also, what do you think about the effect of uncertainty? I think the main problem to lending/borrowing in potentially inflationary or deflationary situation is the degree of certainty that inflation will do what you think it will.

  6. Gravatar of Nick Rowe Nick Rowe
    10. July 2009 at 04:46

    Scott: Slightly off topic, but I think you will find this post very useful, in getting a measure of expected inflation:

  7. Gravatar of ssumner ssumner
    10. July 2009 at 04:49

    JKH, Yes, I think you are right about the Fed. And, alas, also about the media.

    I’ve never viewed QE as the key. For me is has always been

    1. Inflation or NGDP forecast targeting, level targeting.

    2. Stop paying interest on reserves, consider an interest penalty.

    3. QE if necessary.

    Thanks Don, I like Congdon’s stuff. I did a post earlier on how the “greenshoots” period coincided with the start of QE in March. I don’t know about the UK, but in the US QE has been reversed, and the base is now lower than at the beginning of the year. I have an open mind on the question of how much of the improvement was due to QE. My view is some, but much more was due to the Asian recovery.

    Jon, Those are good points, but I’m not sure Krugman expected the MB to fall. My thought was he expected it to rise, but that it would not help. And I think he was wrong on both counts. In the long run it didn’t rise, but in the two months when it did, it did help at least a bit.

    This is just from memory, and obviously if he called it qualitative easing he was right. But again, I had the impression he thought quantitative easing would occur, but that it would only be effective to the extent that it absorbed risk from the private sector.

    You are right about Krugman misrepresenting normal policy. That was something I didn’t know until you mentioned it earlier.

    Bill, I have a different view of QE and interest rates. I do not believe that monetary expansion must reduce real rates in order to be effective. Rather it is more likely to raise real rates if it is expected to be effective. Suppose an aggressive QE policy is expected to sharply boost AD. In that case it will be expected to raise both inflation and real growth. And this will almost certainly raise long term nominal interest rates, and may raise long term real rates as well.

    But let’s focus on inflation expectations, and for the moment assume that the real rate is unchanged. In that case does QE help? Absolutely, because the SRAS is upward sloping. So if the markets expect more inflation today than they did yesterday, that means the market also expects more real growth. Why? Because wages are sticky, and so if expenditure rises rapidly it won’t be all inflation, some of it will be real growth. And this is true irregardless of what happens to real rates.

    This is a point I keep coming back to. The Keynesians all want to look at real and nominal rates for a sign of recovery. But Robert King showed back in 1993 that that gets things exactly backward. Don’t think about real rates, think about the SRAS. And then think about what sort of policy is EXPECTED to shift you up and to the right along the SRAS. It is a policy that is expected to produce more AD, or more NGDP. And how do we know when we have actually implemented such a policy? When expected inflation rises.

    [BTW, if the extra real growth is expected to be robust enough, it could even result in higher real rates.]

  8. Gravatar of StatsGuy StatsGuy
    10. July 2009 at 06:01


    “Quantitative easing has failed (or was counterproductive.)”

    That depends on what you mean by failed. As Don and others have noted several times, QE coincided with the stock market recovery. That announcement helped break the deflationary expectations (for a short while). The June peak/dip coincided with our central bankers seeing short term (5 year) inflation expectations starting to approach 2%, and getting suddenly jittery, then deciding to strongly signal their intention to remember their Hooverite roots.

    So, two things: a) without the “QE” announcement in March, we’d probably be in much worse shape. b) it’s not too hard to argue that the recent problem was the signalling that QE would not be sustained.

    And I believe what drove the sudden Fed retreat was fears of a dollar run, combined with the noisy ideological assault of the Chicago/Austrian crowd. Bernanke (although better than Summers by a mile) has been a sheep in wolves’ clothing from the start. At least, unlike Summers, I think he’s honest and sincere. Just deluded. A sad disappointment from the “scholar of the Great Depression” that he presented himself as.

  9. Gravatar of Bill Woosley Bill Woosley
    10. July 2009 at 07:39


    I am not making any claims about what happened with quantitative easing. I am not saying it failed. Obviously, I was unclear. I was describing a view that I think is false–that higher expected inflation raised interest rates and caused it to fail.


    I am puzzled as to why people think that increased nominal interest rates caused by higher expected inflation mean that quantitative easing has failed.

    I think the assumption is that the higher expected inflation raises the nominal interest rate by reducing the supply of loans, and that the increase in the nominal interest rate then reduced the quantity of borrowing and so reduces real expenditure.

    I think that this is wrong because it ignores the increase in the demand for borrowing caused by higher expected inflation. The impact of expected inflation on nominal interest rates shouldn’t impact the real interest rate or borrowing. (Well, they are also ignoring what the lenders do with the money they don’t lend.)

    Anyway, I understand and agree with the argument that real interest rates can be depressed now because of expectaions of low future output that might be caused by expectations of bad monetary policy. And, that if people come to expect a better monetary policy and higher future output that this will increase real interest rates.

    I am also well aware that you don’t have a good theory about how increases in base money translate into increases in aggregate demand. I certainly agree that if aggregate demand increases, real output and the price level both rise. And so, if “the market” believes that the incease in base money will raise aggregate demand and believes that this increase in aggregrate demand is going to raise prices, then “the market” will expect higher inflation because of the increase in base money. I also agree that a sensible way to judge whether base money is high enough is to look at what is happening to expected inflation. I am less and less sure that comparing TIPS to a 2% target makes sense.

    Also, I don’t think this describes a process by which an increase in base money raises aggregate demand. I want a process by which aggregate demand rises even if people think it won’t rise, or if it does rise, it won’t raise output or prices. I want a process that would work if the increase in base money were a secret. A process by which each person looks only at existing price signals and endowments, and the result of their independent self-interested action is more spending, more production, and higher prices. Now, _if_ some part of this process (say the output impact) were to only happen because of the secrecy or ignorance, then depending on it to happen would be a mistake. But for a key part of the process (say, the increase in aggregate demand) to require knowlege of Fed policy or to have some correct view about how Fed policy will impact output or prices is not adequate.

    There are a lot of people who don’t believe that increases in base money will impact aggregate demand, output, or prices.

    Anyway, if it is true that the fisher effect only impacts lenders (reduces the supply of lending) and borrowers care only about nominal interest rates, then it is hard to see how higher expected inflation will not lower aggregate demand now. (That isn’t to say that it might not be rising for some other reason.) I THINK THIS IS AN ERROR!

    Look, I don’t think that government budget deficits cause a drop in aggregate demand because they raise interest rates. It is rather that the higher interest rates caused by government borrowing dampens down the increase in spending that would otherwise occur. But I have heard this story.. high budget deficit, high interest rates, less spending.

    Well, quantitative easing, high (nominal) interest rates, less spending on housing.. oh, it didn’t work… seems to me to be a similar error. Here, the problem is how higher expected inflation should impact the demand for credit. (Or, higher expected inflation, housing prices will be higher than otherwise (not fall as much….)


    You are correct about uncertainty (I think.) Greater uncertainty about inflation is disrputive. But it should reduce both the supply and demand for loanable funds. The effect on nominal and real interest rates is ambigious, and just less credit transacted. What do the lenders do with the funds they would have lent? IF we assume they would be hoarded, then that is less spending. More plausibly, keep them short.. which exacerbates problems with the zero nominal bound.

  10. Gravatar of David Pearson David Pearson
    10. July 2009 at 08:03


    I think the Fed is in a box of its own making.

    It told us no QE, only “credit easing”. So what metric should be used to measure the program’s success? Not inflation expectations or NGDP, but credit spreads. As long as spreads behaved, the Fed could expect VELOCITY to rise in the future. Or so they thought.

    The problem is bank lending shows no sign of picking up. In fact, it is falling, and so are the measures of inflation expectations.

    So if you’re the Fed, what do you do? Admit credit easing didn’t work? Start targeting inflation expectations? How do you communicate the change — reversal — in policy?

    I would argue that somewhere along the road to Damascus Ben Bernanke had a conversion — he came to believe that the Fed should attack deflation without raising inflation expectations. Perhaps, if he is now a true-believer in this creed, he is the wrong man for the job. Perhaps, Mr. Obama will figure this out.

  11. Gravatar of Jon Jon
    10. July 2009 at 08:36

    I am puzzled as to why people think that increased nominal interest rates caused by higher expected inflation mean that quantitative easing has failed.

    Because they are neo-Keynesians not montarists. They place all of the emphasis on lower-rates as the transmission mechanism per-se.

  12. Gravatar of StatsGuy StatsGuy
    10. July 2009 at 09:42

    From David:

    “…As long as spreads behaved, the Fed could expect VELOCITY to rise in the future… The problem is bank lending shows no sign of picking up. In fact, it is falling, and so are the measures of inflation expectations.”

    That’s because from the start, the Geithner/Summers/Bernanke (and even Paulson) team insisted that the problem with banks was not insolvency but rather illiquidity of “misunderstood” assets. Thus, all efforts focused on “unclogging” the “frozen” credit markets. The presumption – as echoed even in Obama’s inauguration speech – was that restoring the flow of credit would inherently restore Aggregate demand, the flow of credit would restore as a simple function of recapitalizing banks.

    And notably, Bernanke’s popularity among bankers has seen a marked increase!

    From an wsj article: (

    “Mr. Bernanke’s reputation on Wall Street has ebbed and flowed. But a Wall Street Journal survey conducted this week of 46 private-sector economists found that 43 endorsed his reappointment. “Bernanke’s leadership during this financial crisis was outstanding, but not flawless,” said Scott Anderson of Wells Fargo & Co., one of those surveyed. “But given human limitations and the limitations of economic and financial knowledge he deserves another tour of duty.” ”

    Remember what the Fed is, and what its ideology is. We may think its mission is promoting growth in the US economy, but the Fed believes its mission to be defending the integrity of the US currency. They’ve overdosed on the commitment coolaid. They believe that (in the long run) keeping focused on defending the currency is more important than any ‘temporary’ economic contraction. And the reason Bernanke harps on the deficit is because it’s making that otherwise easy task harder (how can he control inflation when the market is pricing default risk?).

    The ECB follows the same model. They recently announced that their contractionary policies have been ‘vindicated’ by the market response. I laughed at this… I will laugh even harder as the dollar depreciates and European exports tank even more.

    From today:

    “…the U.S. trade deficit with other big trading partners declined, falling to $2.8 billion with the European Union in May, for the lowest reading since March 1999, and retreating to $1.9 billion with Japan, which was the lowest since February 1984.”

    Realistically one would hope the Fed has a 2% inflation target without biases in terms of upside/downside risk. In practice, they have a 2% inflation target with tremendous downside bias – they would much much rather err on the low end of the 2% than the high end, and that means money supply expansion will _always_ be lagging policy in a recession. Thus we have “wait and see”.

    Or maybe it’s all about stopping a dollar run, since the ECB has decided to hold to a strong-Euro. In which case the Fed might be trying to ease-down the dollar without a run until the EU export decline forces the ECB to act. If Bernanke was really that sophisticated and strategic, then I’d be impressed.

  13. Gravatar of Jake Jake
    10. July 2009 at 09:43


    Why do you focus on the monetary base versus M1 or some other measure?



  14. Gravatar of Thorstein Veblen Thorstein Veblen
    10. July 2009 at 17:47

    Scott– I’m coming around. I’m starting to conclude that the only reason this recession continues is that Ben Bernanke lacks the cojones to end it…

    For the life of me I can’t figure out why the Fed just doesn’t print money (or just credit its accounts or whatever) on a grand(er) scale, gin up at least 3% inflation, reduce our debt burden, and sink the dollar a bit… The solution is so simple, and yet, here we are in the 19th month of recession…

  15. Gravatar of Bill Woolsey Bill Woolsey
    11. July 2009 at 03:34


    Neo-Keynesians see the transmission mechanism as open market operations, nominal interest rates, real interest rates, real expenditures… correct?

    The money creation, high inflation expecations, high nominal interest rates should be irrelevant. What is happening to real interest rates should count.

    “Conventional” monetary policy impacts short term nominal interest rates directly. And long term nominal interest rates indirectly. And, given inflation expectations, that impacts real interest rates.

    But, at the zero nominal bound, open market operations can’t lower short term nominal interest rates. And so, it can’t lower short term real interest rates (well, other than causing higher expected inflation.) And so, cannot influence long term nominal or real interest rates.

    But, if the open market operations are in long term assets, the nominal interest rates on those should fall. But, higher inflationary expectations cause them to rise. But, that is perfectly consistent with the real interest rate on them falling.

    And so, the “problem” with the analysis here isn’t neo-Keynesianism, (interest rate targetting and transmission mechanism,) but rather, a failure to distinguish real and nominal interest rates. And, as I have been saying, and assumption that borrowers care about nominal rather than real rates, or more plausibly, that borrowers have lower inflation expectations than lenders.

  16. Gravatar of StatsGuy StatsGuy
    11. July 2009 at 06:27


    First, lenders, practically, care more about the cost of acquiring funds that they lend out than inflation per se. That is, they care about the spread. If household demand for liquidity is high then households keep assets in draw accounts (and the banking industry is not perfectly competitive) and banks can make more money even if real interest rates are not high. This represents a hidden transfer of purchasing power from consumers to banks.

    But then, what DO banks do with the money? Other than sit on reserves (which is partly what they’re doing right now)? It’s either loans, profits, or reserves… Or to cover loan losses.

    Well, one option is to purchase foreign assets, or make loans to hedge funds who purchase foreign assets… If the cost of money is cheap (it is) and the dollar is expected to depreciate due to inflation (yep), and then shifting money into foreign economies makes sense. And this money does not get spent (and recycled) locally, but rather gets spent abroad. That’s the problem with capital flight.

    And when money bleeds into foreign economies, the circle for monetarists doesn’t close perfectly at the national level. Just as when fiscal stimulus bleeds due to imports, the closed circle for keynesians doesn’t close perfectly.

    The worst case scenario, btw, is a dollar run in which we have imported-commodity-driven inflation (rather than wage or domestic-asset driven inflation). Expectations of inflation accelerate, and money continues to rapidly flee… And doesn’t recycle locally.

    Perhaps this started to happen in August (with oil peaking at 147, and the dollar plummeting to lows). But this was when the theory of China-decoupling was strong. When the financial crash hit, Chinese and EA exports plummeted (along with local economies), and so did demand for commodities worldwide. Perhaps we’ll see rolling waves of dollar-flight, commodity price jumps, asian export crashes, and flight-back-to-safety until China completes its decoupling and can sustain demand for its own goods…

    In any case, the international aspects of the money supply seem to get short attention by both the neo-keynesians and monetarists, but I suspect they’re getting a LOT of attention by traders, big banks, and the Fed/Treasury.

  17. Gravatar of Scott Sumner Scott Sumner
    11. July 2009 at 07:11

    Statsguy, You have a very interesting thesis there, and might be right. I sure hope the Fed has not been influenced by all those conservative voices warning about inflation. If they were, then it really would be a repeat of 1930 and 1938.

    Bill, I agree with the first part of your comment. Later you said:

    “Also, I don’t think this describes a process by which an increase in base money raises aggregate demand. I want a process by which aggregate demand rises even if people think it won’t rise, or if it does rise, it won’t raise output or prices. I want a process that would work if the increase in base money were a secret. A process by which each person looks only at existing price signals and endowments, and the result of their independent self-interested action is more spending, more production, and higher prices. Now, _if_ some part of this process (say the output impact) were to only happen because of the secrecy or ignorance, then depending on it to happen would be a mistake. But for a key part of the process (say, the increase in aggregate demand) to require knowledge of Fed policy or to have some correct view about how Fed policy will impact output or prices is not adequate.”

    This is a very interesting way of looking at it. In a post back a few months I laid out my two part view of the money transmission mechanism:

    1. In long run money affects prices only, as the excess cash balance mechanism causes nominal monetary shocks to leave real money demand unchanged in the long run. Interest rates play no role in this process. And this can occur in secret. So that’s my answer.

    2. But, and this is a big, big qualifier, I don’t think this explains the short run process. The short run process could occur in three ways:

    a. Low interest rates boost AD.
    b. Excess cash balances spur AD. ( I see this as one mechanism that you, Nick, and Yeager emphasize. Is that right?)
    c. Expectations of higher future AD cause increases in current AD. Many asset prices respond quickly. House prices rise faster than construction worker wages. Home building increases. This one can’t work in secret, but it’s the one that I think actually is most important in the real world. Note, however, that my explanation for the expectation that long run NGDP will rise is the same as the monetarist one, excess cash balances.

    On another issue you raise, I do think TIPS are very useful, as they track the stock market reasonably well. But I do agree the 2% number is arbitrary. In addition, it varies by maturity. I actually think the two year spread is more informative, and it is currently much below the 5 year spread. I report the 5 year because it is easy to find. But even if the 5 year hit 2%, the two year would remain much lower. I’d like to see the 2 year get up close to 2%, but it ain’t going to happen anytime soon.

    When you say lots of people think more MB won’t raise AD, we have to be careful. Lots of people think a current increase in the MB that is viewed as temporary won’t increase AD, and they may be approximately right. But any good economist knows that a MB expected to be permanent will raise AD. That’s why policy credibility is so important. The biggest single mistake the Fed has made is its decision not to promise to catch up to some price level or NGDP trajectory. Indeed, their failure to do this IS THE CAUSE OF THE CRASH OF 2008.

    David, This is a very good question:

    “So if you’re the Fed, what do you do? Admit credit easing didn’t work? Start targeting inflation expectations? How do you communicate the change “” reversal “” in policy?”

    But oddly enough I think there is a solution. Remember I said the Fed’s March decision was viewed by the press as QE. So if the Fed were now to do some real QE, say raise the MB by several hundred billion, it wouldn’t be perceived as a flip flop (even if as you say it actually would be.) I’m not sure QE alone is enough but it’s worth a shot.

    The same odd logic applies to my negative interest on reserves idea. If the Fed just abandoned interest on reserves, it would look like a flip flop. But if they set it as negative 0.25% they could say “we will continue to maintain our interest on reserves program, and simply adjust the rate to the needs of the macroeconomy.” That’s sounds better than “we will abandon the failed interest on reserves experiment.”

    Does any of this make any sense?

    These were great questions, I’ll answer the rest a bit later.

  18. Gravatar of Scott Sumner Scott Sumner
    11. July 2009 at 07:29

    Nick, Thank you, that is very helpful. I’ve always wanted a convenient 2-year forecast, and now I have one. These seem a bit higher than the TIPS spread (1.5 vs. 1.15% on the 5 year) Could it be because if this factor:

    “As usual, these payments will be multiplied by the “notional value” of our swap, which we will state in our contract. Typically, “you” are some poor sod seeking inflation protection, and “I” am a commercial or investment bank.”

    This suggests investors will use the market as an inflation hedge, in which case there might be a risk premium that would push the market price above the actual rate of inflation. Does that make sense? So “true” inflation expectations may be even lower than the figures derived from this market.

    David, In my previous response I forgot one thing. If “Obama figures it out” (to replace Bernanke) it will probably be too late. He will wait until mid-2010, by which time (if inflation stays at 1%) wages will adjust and we will start to get a recovery on a lower trend rate. Plus I think the people around Obama are Keynesians, and I’m not sure they blame the Fed.

    Jon, Yes, and I’d say they are not even “new Keynesians” but are old Keynesians. Is that how people are using the term “neo-Keynesians” It is getting very confusing.

    More to come . . .

  19. Gravatar of Scott Sumner Scott Sumner
    11. July 2009 at 08:27

    Statsguy, I hope you are not right, but I fear you may be. I am more and more coming to the conclusion that macro needs to been torn down and rebuilt from the ground up. 43 out of 46 economists think Bernanke’s done a good job? How bad does the recession have to be before they thinks it’s a bad job. If monetary policy had caused NGDP to fall 15%, and thus the financial crisis got much worse, and Bernanke did even more “rescue operations,” would they think he did an even better job?

    If you are right it is even worse than you think. We are not just talking about disinflationary bias. I would almost guarantee that a big chunk of those 43 economists who think monetary policy has been just fine, also supported the fiscal stimulus. Didn’t polls show most economists supported the fiscal stimulus? But then how could they think monetary policy had done a good job. It literally makes no sense.

    Jake, I should explain that I don’t personally think the MB is a very reliable indicator. But it is the variable controlled by the Fed, and it is the indicator of QE that most people use. My point was that by this indicator we really haven’t had any QE in the first half of 2009. So the press is clueless as to what is really going on.

    M1 is also unreliable, but for slightly different reasons. the only reliable indicator is market expectations of inflation and NGDP growth.

    Thorstein, Thanks, I am also very frustrated.

    Bill, I agree, but would add that when you get this deep in a severe recession, the real rate also falls. So it is a double problem–failure to distinguish between nominal and real rates, and failure to recognize that real rates reflect the condition of the economy.

    Statsguy, I partly disagree with a couple of your comments.

    1. When households want a lot of liquidity, and hold safe bank deposits, it partly reflects the weak condition of the economy. So banks don’t automatically make a lot of money. To do so they need to buy risky assets (as T-bill yields are very low.) But these assets are riskier now than in normal times, so banks risk capital losses.

    What you call the “worst case scenario,” is close to what I see as the best case. In 1933 currency depreciation did trigger much higher prices on imported commodities, and wages initially didn’t keep up, but this spurred rapid growth in output until the NIRA artificially forced wages higher. So I don’t worry about a weak dollar at all.

    Last year: Oil $147, unemployment 5.5%.
    This year: Oil $60, unemployment 9.5%.

    I like last year better.

Leave a Reply