Dudley on price level targeting
Slowly but surely the Fed is discovering the components of a sound monetary policy. Here New York Fed President William Dudley discusses the advantages of price level targeting:
If we judged it desirable, we could go still further and provide more guidance on how monetary policy would react to deviations from any stated inflation objective. One possibility would be to keep track of inflation shortfalls when the federal funds rate is constrained by the zero bound, as is the case today. For example, if inflation in 2011 were a 0.5 percentage point below the Fed’s inflation objective, the Fed might aim to offset this miss by an additional 0.5 percentage point rise in the price level in future years.
If only they had gone with level targeting in 2008, and used a 4.5% NGDP trajectory rather than the price level, we’d have mostly avoided the Great Recession. NGDP would be about 8% above its current level. Even core CPI level targeting would have made the recession far milder.
The last half of the speech is worth reading. He is clearly in the dovish camp, and it’s hard not to conclude that the Fed will move in November—especially with two Obama people coming on board.
On another topic, long time commenter Marcus Nunes has a new blog. Unfortunately for me, it’s in Portuguese. Are Spanish speakers able to read economics articles in Portuguese? In any case, Marcus is one of my most valuable commenters, having provided me with many very valuable links, including those Bernanke papers from 1998 and 2003 that showed how much the Fed’s current policy has differed from what Bernanke recommended to the Japanese. The papers were later cited by many other bloggers and news magazines—which shows how much influence a single commenter can have.
HT: Bruce Bartlett
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2. October 2010 at 11:09
One has to imagine that the man is speaking for Bernanke.
But why doesn’t Bernanke speak for himself?
And why didn’t the Fed do this long ago?
And is this enough to stop the crazed Krugman and his trade war dreams? He should join the Tea Party.
And if only – if only – Dudley had spokes about “income” or “spending” rather than inflation.
2. October 2010 at 11:28
I would think Spanish speakers would understand most of what is written in the blog.
Portuguese is my first language, but as a check I copied and pasted Marcus’ last post into Google Translate (http://translate.google.com/) and what comes up is pretty good. There are a few improprieties, but overall the translation is really good and you will be able to understand what he is talking about.
2. October 2010 at 12:02
“Are Spanish speakers able to read economics articles in Portuguese?”
Sure we can, particularly those from Galicia, a region in the north-west of Spain, whose inhabitants speak Galician (as well as Spanish), a language similar to both Spanish and Portuguese.
2. October 2010 at 12:37
Scott
Thanks for the link (hope those that can read this “out of the way” language enjoy it). The link below worries me. Suddenly different people are “catching on”, but go on to propose their “preffered” nominal level target for different “constituencies”. Below is Harvard´s Jeffrey Frankel´s suggestion for commodity exporters.
http://www.voxeu.org/index.php?q=node/5595
2. October 2010 at 12:52
It is puzzling to read the commentary of certain Fed presidents, who darkly hint that QE “might lead to inflation.’
“Might”?
First off, we hope it does.
Second off, we are at zero inflation right now, if one considers the finding of the Boskin Commission. The CPI likely overstates inflation.
Not growing the economy now, due to a vague inflationary threat in the future strikes me as folly.
2. October 2010 at 13:33
This is a great one from Charles Schwab (in a not so subtle way he´s complaining about loosing “customeres”):
“Our economy is ready to heal. It just lacks broad-based confidence among consumers and business people. It would be a giant boost to confidence if the Fed stood aside and returned to its traditional role as defender of monetary stability”.
http://online.wsj.com/article/SB10001424052748704654004575517940057210022.html?mod=WSJ_Opinion_LEFTTopOpinion
2. October 2010 at 13:56
Benjamin Cole,
Remember, it’s not inflation: it’s “normal monetary conditions”. Which it would be. Right now is NOT the norm, but the deviation. QE is a stablisation measure.
Re: CPI, doesn’t the US have an retail price index? I’ve always thought that RPI targeting makes more sense than CPI targeting, because RPI includes important elements of the macroeconomy like housing. Excluding these things causes misleading figures, e.g. sanguine inflation figures during an unsustainable property boom and steady inflation figures during a period of deflation/zero inflation.
If I was to be cynical (and often I am) I would say that CPI tends to be targeted because politicians and central bankers are willing to use quickly rising property prices as a form of welfare to the middle class (I use this in the British sense to mean “home-owners or their children with a university education, a fairly steady job or profession, and a substantial disposable income above the standard expectations of the epoch”, a group that includes me personally) voters, who have come to expect rising property prices as a reliable (though unearnt) source of income. It’s like income support, for those who can already afford a mortgage.
This combined with the China factor (cheap consumer goods) and an interest-rates regime that didn’t target the housing boom, to create a situation where the money supply was being soaked-up into housing. This was quite a pleasant situation: consumer goods, which everyone buys but few sell, were cheap; housing, which the middle class sell as well as buy, increased in value dramatically.
As Milton Friedman pointed out, we all want inflation in the prices of the things we sell and deflation in the prices of the things we buy. Given the political clout of the middle class (who, in Britain at least, make up a lot of the marginal voters) while taking into account the fact that house prices are to the middle class what biofuel is to farmers in Iowa, the disincentive to target RPI is very strong.
That said, there may well be a very good reason to target CPI rather than RPI and I haven’t heard it yet.
If there was price level targeting or transitive inflation targeting (i.e. where significant deviations from the target are passed on to the next year’s target) would people favour CPI or RPI? RPI seems to be more representative of overall monetary conditions and aside from better reflecting the cost of living for some groups (like pensioners, the poor or children) CPI seems to have very few benefits as an index to target. But it can’t be purely politics, can it?
2. October 2010 at 14:38
And – if you want to know where all that money went – well here is where it went:
http://www.youtube.com/improbableresearch#p/u/7/w45yyscBqwg
http://improbable.com/2010/01/08/the-big-bank-opera-video/
2. October 2010 at 17:35
JimP, Yes, NGDP targets would be better.
Portuguese speaker and Miguel, Thanks for the info.
Marcus, Thanks for those links. I should do a post on the optimal monetary policy for smaller countries.
Benjamin, Yes, I agree.
W. Peden, Of course NGDP sidesteps all those tricky price indices issues.
JimP, Thanks for the videos.
2. October 2010 at 17:38
Scott, have you read Alchian and Klein’s 1973 paper “On a Correct Measure of Inflation”? If not, I strongly encourage you to read it. They argue that the theoretical ideal for a measure of the price of lifetime consumption would include asset prices. In particular, if the measure of inflation just looks at the prices of current services, then it will lead to poor policy.
2. October 2010 at 17:57
Bob, Yes I have and I’ve made the same argument.
2. October 2010 at 18:31
Scott, I’m not trying to be a wiseguy. Alchian and Klein were saying it’s a bad idea for the Fed to target CPI.
In this post, it sure looks like you are relieved the Fed is starting to target CPI.
Are you just saying, targeting CPI would be better than what they’re doing now, though you agree with Alchian and Klein that targeting CPI is itself flawed?
2. October 2010 at 18:37
Bob, Yes.
2. October 2010 at 19:41
Eichengreen again:
http://www.voxeu.org/index.php?q=node/5580
If only Krugman actually knew what he was talking about. But he doesn’t. And he has never let a little thing like that stop him.
2. October 2010 at 20:03
Egads. Is Sumner ever going to pick up some “position-framing” skills?
“The last half of the speech is worth reading. He (Dudley) is clearly in the dovish camp, and it’s hard not to conclude that the Fed will move in November””especially with two Obama people coming on board.”
Dudley is not “dovish.” He is a “monetary bull.”
Just who are we going to switch to QE if we call ourselves “dovish.” That quickly leads to “weak on inflation,” and visions of Jimmy Carter and perhaps Argentina or worse.
W. Peden: I find much of you say interesting, but not sure if it applies to the USA. The US property boom was caused by global cash flows into all US real estate, including commercial, industrial and residential. The MBS market aided and abetted.
Oftimes, I find US national policies of all kinds are the result of paralysis, inertia or simple blundering. Our system of government, so shrewdly set up to foil abuse of liberty, also foils deft economic or foreign policy management.
2. October 2010 at 21:51
@Scott,
“Are Spanish speakers able to read economics articles in Portuguese?”
Yes, we can. In fact, learning Spanish is often regarded as a smart way to start learning Romance languages [1]
“I should do a post on the optimal monetary policy for smaller countries.”
As an Argentine I’d be very interested on this. Currently, we have a very heterodox central banker [2] and as a result we have high inflation (upwards of 25%). Fortunately, growth is strong at 7% on an annual basis.
@Benjamin Cole,
“Just who are we going to switch to QE if we call ourselves “dovish.” That quickly leads to “weak on inflation,” and visions of Jimmy Carter and perhaps Argentina or worse.”
Actually, Argentina is both an example of the perils of hyperinflation and deflation. Look at the inflation figures of 1999, 2000 and 2001 and the general economic performance of those years [3] Frightening, isn’t it?
1- http://how-to-learn-any-language.com/e/languages/spanish/index.html#transparency
2- http://en.wikipedia.org/wiki/Mercedes_Marc%C3%B3_del_Pont
3- http://en.wikipedia.org/wiki/Economy_of_Argentina#Macroeconomic_indicators
2. October 2010 at 21:52
[…] (h/t Sumner) […]
3. October 2010 at 01:29
Benjamin Cole,
Certainly I’m not offering a monocausal explanation, but if we work from first principles-
(1) Import prices, particularly for consumer durables like CD players and I-Pods, have low cost-push inflation.
(2) The money supply does not grow more slowly.
Therefore, the increased money in the economy will be spent somewhere else. If there isn’t high CPI, then people will be able to spend more of their money on mortgage payments and the like. Now, add a third premise-
(3) The Chinese (and everyone else) do not export housing to the US.
So cost-push inflation in housing is not reduced. Therefore, consumers have more money to spend and inflation in housing is high relative to other goods & services. This creates a situation with (a) consumers with disposable money that they can spend on an appreciating asset and (b) no possibility for a China factor in housing. That seems ripe for a boom, especially if monetary policy isn’t geared to take house-price inflation into account.
Consider the counter-factual scenario: for some reason (say an import blockade or an oil crisis) cost-push inflation in consumer prices is equal to inflation in housing. The money supply remains growing at an equal rate. Now, consumers don’t have those savings to be made on consumer prices, so they can spend less money on housing. In other words, if you take away the China factor then expenditure on housing would suffer from the need to spend money on other products. The fact that there hasn’t been a MAJOR oil crisis since 1979 has helped as well.
It’s an extension of the principle that, cateris paribus, rationing for product A will make people spend more money on product B in an economy with only products A and B.
I suppose a way to check this empirically would be to compare the housing market in periods of high cost-push inflation in consumer goods with the housing market in periods of low cost-push inflation. If the China factor has played a role, you’d expect periods of low-labour/energy costs and cheap imports to correlate with relatively higher prices for things like housing. Money does not disappear because of cheap imports and people would rather spend their money on mortgages for an appreciating asset rather than locking it up in savings.
However, I’m not sure how one would fit foreign demand for US property into all this.
As for US policy, one thing that surprises me is how separated the fiscal and the monetary are. In the UK, since 1997 interest rates and general monetary policy have been the perogative of the Bank of England, but the Bank of England’s Monetary Policy Committee has nothing like the independence of the Federal Reserve in practice. Thus far (and it’s only been 13 years) fiscal policy and monetary policy have marched in step, just as they did before 1997. The accountability of the Governor of the BoE to the Chancellor of the Exchequer probably helps, though this requires a clear set of success/failure criteria for the BoE e.g. the Gov. must send a public explanation to the Chancellor when inflation significantly deviates from its target.
Because of the role of government borrowing in the monetary economy, I don’t think that a sharp distinction between monetary policy and fiscal policy is tenable; therefore, a sharp distinction of powers with respect to monetary policy and fiscal policy doesn’t seem a good idea either.
3. October 2010 at 01:31
Prof. Sumner,
NGDP does seem a preferrable option than both CPI and RPI. There are both economic and political reasons for this; one political reason that has been pointed out before in passing, but which I think deserves to be stated explictly, is that in the event of conditions like the present it is easier to say “We need more NGDP growth!” than “We need more inflation!”.
3. October 2010 at 06:46
[B]ut which I think deserves to be stated explictly, is that in the event of conditions like the present it is easier to say “We need more NGDP growth!” than “We need more inflation!”.
Yes. I think this is more important than most economists are willing to warrant. Don’t even say “NGDP growth.” Just say “growth.” A central bank that has a “growth target” should be able to say “we need to do blah blah blah to catch up to the growth target” or else “we’re at risk of exceeding our growth target and sparking inflation.”
People have just decided that “inflation” is “bad” so you can never argue in favor of more of it which is further complicated by the fact that people seem to systematically overestimate the actual quantity of inflation in the economy by conveniently forgetting about improved quality, new goods, etc.
3. October 2010 at 09:18
JimP, Yeah, I saw that one. It was a good piece by Eichengreen.
Benjamin, Unfortunately I have to communicate with a wider audience and thus use some generally accepted terms. I am trying to move the debate toward NGDP and away from inflation–so that’s my contribution to the evolution of language.
Lucas, Thanks for the info, I thought that might be true of Spanish.
I will probably argue that for small countries there should be more weight on inflation, and less weight on real growth. Of course Argentina is too expansionary by either criteria. Unfortunately your country tends to swing between extremes, as you doubtlessly know.
W. Peden, Yes just about a week ago I did a post criticizing inflation targeting, and mentioned a half dozen advantages of NGDP. The point you mentioned was one of them.
Matt, I agree. See my previous response. Unfortunately, economists have mangled the language in a very confusing way. If you say “wages” or “interest rates” the default assumption is that you mean nominal. But if you say “GDP” or “growth” the default assumption is that you mean real (unless you specify nominal.) This leads to needless confusion. If you talk about targeting growth, many economists will assume you mean RGDP. And that leads to an indeterminate price level. So I’d recommend ‘nominal growth’ even though it sounds a bit more ungainly, it’s necessary to avoid confusion.
3. October 2010 at 10:28
Matt is a fat poodle of Soros. Until he converts fully to “never again, fiscal stimulus” he is not to be trusted. He should concern himself with fixing the comment system of his site… that’s a far better use of his brain cycles.
The only legitimate form of GROWTH is Productivity Gains.
The only legitimate form of investment comes from capital formation as a result of productivity gains.
QE’s function is limited to offsetting losses in V, driven by its natural slowing (it was too fast before) + productivity gains (cheaper prices). Let’s not bastardize poor uncle Milton anymore, k?
W. Peden, does a nice job of accenting the basic micro truth of allowing Housing Prices to fall… it frees up spending for other forms of goods, which many in this country need for food, energy, etc.
3. October 2010 at 10:50
I’m actually getting the hang of getting the rhetoric when doing the technical arguments for monetary stimulus. The Right loves it when the Fed gets blamed for anything, especially “anti-business bleeding of the economy that erodes American power, the potential tax-base to reduce the deficit and creates a vassal-class of welfare dependents on the government”. The Left loves it when “timid out-of-touch economists” get blamed for “bleeding the US economy by denying it the fuel for the engine of growth, prosperity, a better tax base and less fear of unemployment for the ordinary American”. Like much of the best rhetoric, it’s even true.
As I see it, monetary stimulus is something that both right-wingers and left-wingers can appreciate, provided one emphasises their particular concerns. But it requires talking about “higher NGDP growth” and “stimulus without debt” rather than increased inflation.
3. October 2010 at 10:57
Morgan,
I don’t actually care too much about the relative prices of houses and food. Who knows what they right balance is? I don’t.
What concerns me is central banks that use misleading indexes that lead to bad monetary policies. Whatever the central bank targets with monetary policy, it should be something that is representative of monetary trends in the whole economy. An index like CPI, which is vulnerable to microeconomic factors like the China factor, is therefore a bad candidate for something to target. One is liable to get interest rates that are too low during housing booms and too high during housing busts.
I am ready to let the market decide the costs of houses, provided that the central bank does its role of properly regulating monetary conditions by looking at broad indexes and having appropriate monetary policies.
3. October 2010 at 11:14
Without rents in CPI, we’re at our inflation target(2%).
The issue I have is WHO holds the hard assets by the end of 2011, the Fed’s policies have prolonged the existence of zombie banks.. in fact the Friday Night Lottery of banks closing looks suspiciously like a damn good reason for banks in general not to be lending… they all want their balance sheets in order, so when they Fed comes calling, they can “share the losses” of their neighboring dying bank – what a frigging joke that is.
Look at the new banks popping up, that are BASED on acquiring the failing banks… the names are the same.
What we need to do is allow housing price to drop, liquidate the assets behind the toxic MBS, and let the local guys with cash, buy 6M houses for pennies on the dollar.
A nation of 6M new renters is fine. And bonus! we can use the MERS violations to let the old home owners out without affecting their credit – that’s a nice trade. What we have now is untenable, people living in foreclosed houses not making payments, is exactly wrong.
Then in the face of that deflation, Scott can have some QE.
The Fed is meant to be a neutral referee, and in this game, the banks are the ones who should be losing their hard assets, and the millions of guys with dry capital should be CROWING about their new rental properties.
3. October 2010 at 11:49
If only Krugman actually knew what he was talking about. But he doesn’t. And he has never let a little thing like that stop him.
Which brings to mind perhaps my favorite Krugman quote of all, from his Slate days:
“I do not think of myself as an all-purpose pundit. I remember once (during the air phase of the Gulf War) seeing John Kenneth Galbraith making pronouncements on TV about the military situation, and telling friends that if I ever start pontificating in public about a technical subject I don’t understand, they should gag me.”
3. October 2010 at 18:47
Scott,
One thing I’m not clear on is what NGDP level target would do in the case of a large, positive supply shock like the 1950 one David Beckworth recently commented about. When Y is increasing but P is falling. If P falls far enough to bring NGDP below target, wouldn’t the central bank respond with un-needed monetary stimulus?
Beckworth contends that monetary policy was too loose in 2003 because the Fed was concerned about AD-induced deflation when it was actually just an increase in productivity (AS moving right). How would NGDP level targeting avoid this mistake? (Do you have a post on this somewhere that I’m not finding?)
3. October 2010 at 23:12
JTapp said: “Beckworth contends that monetary policy was too loose in 2003 because the Fed was concerned about AD-induced deflation when it was actually just an increase in productivity (AS moving right).”
What about cheap labor being used to expand AS?
3. October 2010 at 23:13
JTapp said: “Scott,
One thing I’m not clear on is what NGDP level target would do in the case of a large, positive supply shock like the 1950 one David Beckworth recently commented about. When Y is increasing but P is falling. If P falls far enough to bring NGDP below target, wouldn’t the central bank respond with un-needed monetary stimulus?
Beckworth contends that monetary policy was too loose in 2003 because the Fed was concerned about AD-induced deflation when it was actually just an increase in productivity (AS moving right). How would NGDP level targeting avoid this mistake? (Do you have a post on this somewhere that I’m not finding?)”
What about price inflating with currency instead of debt?
3. October 2010 at 23:26
JTapp, I believe that is a post that is worthwhile to go over.
From it and bernanke’s speech:
“The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.(1) Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending–namely, recession, rising unemployment, and financial stress.”
And, “Conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. I don’t know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession.”
Will an AS shock that is not handled properly (wrong handling is allowing debt levels to rise) eventually show up as what appears to be an AD shock?
Those two paragraphs should disqualify bernanke from being on the fed and probably even being a macroeconomist.
3. October 2010 at 23:30
JTapp, here is a good post.
http://www.nakedcapitalism.com/2010/01/why-bernankes-defense-of-super-low-interest-rates-does-not-hold-up.html
4. October 2010 at 05:38
W Peden, That’s a good point.
Jim Glass, That’s very funny.
JTapp, Supply shocks are exactly when NGDP is most superior to inflation targeting. That is Beckworth’s argument–that NGDP targeting would result in tighter money when AS increases, as compared to inflation targeting.
Suppose an AS shock increased RGDP by 4%. Under 5% NGDP targeting, you’d allow only 1% inflation. But if you were targeting inflation at 2%, the Fed would be forced to stimulate the economy even though RGDP growth was already 4%. That’s David’s complaint about inflation targeting in 2003.
Fed up, See my answer to JTapp. Bernanke’s comment is reasonable if he is just thinking about the modern world. Obviously there was supply-side deflation in the late 1800s.
4. October 2010 at 11:56
Thanks for the answer. I was thinking RGDP increasing by 4% and deflation of, say, -1%, means NGDP of 3%. If your NGDP target is 5%, wouldn’t you run into the same problem of wanting to stimulate, ie: too much M growth during a boom?
But I guess it wouldn’t matter because if you overshoot and inflation rises to put NGDP above target the next year, you simply reduce the rate of growth.
And I suppose the instability of my above example is corrected by the Fed targeting NGDP futures, as you have proposed…
It just always seems like such a free lunch to me.
4. October 2010 at 22:01
scott sumner said: “Fed up, See my answer to JTapp. Bernanke’s comment is reasonable if he is just thinking about the modern world. Obviously there was supply-side deflation in the late 1800s.”
Has there been supply-side price deflation since the late 1800’s and has it been covered up by debt?
4. October 2010 at 22:05
JTapp said: “Thanks for the answer. I was thinking RGDP increasing by 4% and deflation of, say, -1%, means NGDP of 3%. If your NGDP target is 5%, wouldn’t you run into the same problem of wanting to stimulate, ie: too much M growth during a boom?”
For Jtapp, scott sumner, or anyone else, I’m thinking along those same lines. With NGDP targeting, which M increases and exactly how does that come about?
4. October 2010 at 22:08
scott sumner said: “Suppose an AS shock increased RGDP by 4%.”
Is the fed set up to handle AS shocks, AD shocks, or both?
4. October 2010 at 22:10
scott sumner said: “Suppose an AS shock increased RGDP by 4%.”
Why are you assuming an AS shock increases RGDP by 4%? Can you think of a scenario where is does not?
5. October 2010 at 06:07
Jtap, You’ll get the same result for any NGDP growth rate, as long as you compare apples with apples. If it is 3% NGDP growth, it needs to be compared to a 0% inflation target.
Fed up, The Fed controls the monetary base, and through that controls AD. They do not control AS.
Of course not all AS shocks increase RGDP by 4%, I was just taking an example.
I don’t know of any recent supply-side deflation, except the Chinese example mentioned by Bernanke.
5. October 2010 at 13:23
“Fed up, The Fed controls the monetary base, and through that controls AD.”
For the most part, I get that for currency. How does that work for central bank reserves (maybe you think of them as excess reserves)?
“They do not control AS.”
What if a company borrows so that demand deposits are created that can be spent on equipment that increases supply in the present?
“Of course not all AS shocks increase RGDP by 4%, I was just taking an example.”
Can an AS shock decrease employment?
“I don’t know of any recent supply-side deflation, except the Chinese example mentioned by Bernanke.”
What about Japan and the Great Depression without debt?
7. October 2010 at 05:53
Fed up, Japan and the Great Depression are demand side depressions. Yes, you can have negative supply shocks. The base is C+R. The Fed controls the total, the market allocates between the two.
The capital stock is assumed constant in the short run.
10. October 2010 at 16:47
scott sumner said: “Fed up, Japan and the Great Depression are demand side depressions.”
Were they really AS shocks that were not handled properly (debt was allowed to rise to prevent price deflation whether by accident or not) and later showed up as AD shocks? Notice the time difference(s).
And, “Yes, you can have negative supply shocks.”
Actaully, I’m thinking positive supply shock. However, the quantity of the good being produced stays the same. That means less capital/machinery (not sure if my terms are correct) are needed along with fewer workers to produce the same number of a certain good.
Here is a current example. Let’s say demand for vehicles stays at about 12 million a year for the next 10 years. If there are productivity gains, will we need fewer workers to make vehicles in 10 years?
10. October 2010 at 16:54
scott sumner said: “The Fed controls the total, the market allocates between the two.”
I think I need some more detail there. Bear in mind, I am of the view that loans create deposits and that the fed will supply reserves or find some way to lower the reserve requirement if needed to maintain the fed funds rate where they want it.
“The capital stock is assumed constant in the short run.”
Not sure about how short term you mean, but can debt bring forward from the future capital stock?
10. October 2010 at 18:54
scott sumner said: “Fed up, Japan and the Great Depression are demand side depressions.”
Were there demand side depressions because the supply of medium of exchange fell because the amount of demand deposits fell because of the amount of debt defaults above the amount of capital set aside for losses?
11. October 2010 at 05:53
Fed up, When output and inflation both fall sharply, it is an AD shock. That means monetary policy is to blame.
I don’t know what you mean by “more detail,” don’t you determine how much cash you carry in your wallet?
I have no idea what “bring forward from the future capital stock” means.
The Japanese and US depressions were very complicated, but the big problem was more demand for base money.
11. October 2010 at 22:33
“Fed up, When output and inflation both fall sharply, it is an AD shock. That means monetary policy is to blame.”
But was the mistake in the past? As in the medium of exchange should have increased with currency instead of debt when supply increased?
Are you assuming unlimited aggregate demand?
***
“I don’t know what you mean by “more detail,” don’t you determine how much cash you carry in your wallet?”
I’ll have to think about how to rephrase that one.
***
“I have no idea what “bring forward from the future capital stock” means.”
I hope this will be a good example. A car company thinks it can sell an extra 100,000 vehicles a year for 5 years but can’t produce anymore now or in the next 5 years without more machinery. It believes there will be enough workers. It can’t afford the new machinery right now because it has not saved enough. In 5 years, it will have saved enough. The fed lowers interest rates, and now it believes it can afford the interest payments and repay the debt. It goes to a bank and borrows. The low interest rate debt has allowed the car company to bring forward from the future the machinery increasing supply. I believe the machinery would be considered capital.
Does that help?
***
“The Japanese and US depressions were very complicated, but the big problem was more demand for base money.”
Was it actually more demand for medium of exchange with the highest yield that would not default or go down in price? Did part of the supply of medium of exchange fall (demand deposits) because of debt defaults?
I’m thinking the Great Depression, Japan, and today in the USA are all medium of exchange problems that occurred PRIOR to the crises.
11. October 2010 at 22:36
EDIT: “The fed lowers interest rates,” to “The fed lowers the fed funds rate with other rates falling too,”
12. October 2010 at 05:12
Fed up, No AD is not unlimited. The mistake was in the second half of 2008.
It would have helped if you’d just said lower interest rates cause more investment–sometimes your language is very opaque.
I don’t agree on your medium of exchange argument, it doesn’t fit the data for this recession, as M1 and M2 rose sharply between 2008-09.
12. October 2010 at 19:14
“Fed up, No AD is not unlimited. The mistake was in the second half of 2008.”
So if the lower and middle class (mostly workers) are suffering negative real earnings growth and using debt to make up the difference, will they eventually have budget problems that will show up as an AD deficiency? It seems to me the fed does not believe this.
***
“It would have helped if you’d just said lower interest rates cause more investment-sometimes your language is very opaque.”
Sorry about that. I will try to work on it. I just want to make the points about low interest rate debt, budgeting, and debt bringing something forward from future, in this case 5 years and machinery.
***
“I don’t agree on your medium of exchange argument, it doesn’t fit the data for this recession, as M1 and M2 rose sharply between 2008-09.”
What happened out in the shadow banking system?
15. October 2010 at 15:26
Fed up, I don’t know what happened in shadow banking, but I thought we were talking about monetary aggregates.
AD is determined by the Fed, it has nothing to do with consumers being strapped for cash. The fastest AD growth in the world was in Zimbabwe a few years back, and their workers weren’t doing well at all.
15. October 2010 at 17:02
“Fed up, I don’t know what happened in shadow banking, but I thought we were talking about monetary aggregates.”
I’m trying to get to the broadest monetary aggregate (the medium of exchange supply), which I consider to be either demand deposits or demand deposits plus some or all currency. The fed flow of funds says there is either about 52 trillion in debt (or 58 trillion depending on how gov’t debt is counted) and the St. Louis FRED says about 1 trillion in currency. I’m assuming every loan creates a demand deposit.
Were the losses in the shadow banking system as large or larger than your M1 and/or M2 increase so that the supply of demand deposits was falling?
Were the losses going to show up in the money markets (like The Reserve Fund)? Was there going to be a run on the shadow banking system because it was bankrupt?
15. October 2010 at 17:22
“AD is determined by the Fed, it has nothing to do with consumers being strapped for cash. The fastest AD growth in the world was in Zimbabwe a few years back, and their workers weren’t doing well at all.”
I believe Zimbabwe had a fall in supply without the medium of exchange supply falling. So, was most if not almost all the AD growth just price inflation?
Besides I don’t think the fed wants to overtly pick winners and losers. They know what the ramifications will be then.
I think it does matter that a lot to most consumers are strapped for cash/wages (showing up in their budgets). I probably will need to rephrase this later, but in a wealth/income inequality economy, it is the entity experiencing negative real earnings growth that drives that economy. If they (the lower and middle class) smarten up and don’t deficit spend mostly with debt, I don’t believe the economy will grow much at all.
That brings me back to the M argument. The way the system is set up now, is ALL NEW medium of exchange demand deposits from debt?
17. October 2010 at 05:55
Fed Up, I believe MZM is the monetary aggregate that most comprehensively includes all media of exchange, but I am not certain, as I pay no attention to media of exchange.
Yes, Zimbabwe had price inflation, but that’s just a much a part of AD as real growth.
20. October 2010 at 22:25
I would think that the medium of exchange supply is the most important “money supply”.
Is it possible for the medium of exchange supply to be falling a lot while some other monetary aggregates might be increasing a little?
It seems to me that price inflation needs to be low enough that it is near productivity growth so that entities earn more by getting more productive, not by trying to earn more thru constant price changes.
21. October 2010 at 05:50
Fed up, Yes them medium of exchange can fall while other types of money rise. It happened in the Depression.
27. October 2010 at 17:47
OK. Then it seems to me that the M in MV=PY should be the medium of exchange supply.
It also seems to me the Great Depression had too much debt. Specifically, too much of the medium of exchange supply was demand deposits created from debt. When the loan losses went above capital levels set aside for the losses, the amount of demand deposits fell.
I’d like to know what the “effective” capital requirement was back then. I’m thinking the defaults were from people speculating in stocks when the margin requirement was 10% to people buying radios, furniture, or other items on relatively new “installment credit” (as in the monthly payment consumer).
4. November 2010 at 17:17
Fed up, DDs were far too low in the depression, not too high.