Identifying monetary policy shocks

People generally visualize monetary shocks as a univariate phenomenon, perhaps a change in the short-term interest rate, or a change in the monetary base. Up or down.

Over at Econlog, I recently argued that monetary shocks are a multivariate phenomenon. For example, a monetary shock might impact both the spot exchange rate and the forward exchange rate.

Here I’ll present a graph that illustrates various possible monetary shocks. I define Et at the spot price of foreign currency. Thus if Et gets bigger, then the domestic currency depreciates, and if Et gets smaller than the domestic currency appreciates.

In the graph below, the vertical axis shows the change in the one year forward exchange rate (Et+1), while the horizontal axis shows the change in the spot exchange rate (Et). Each point the response of forex markets to an important monetary policy announcement:

The galaxy of points in the upper right quadrant represent expansionary monetary shocks, which cause the currency to depreciate in both the spot and forward markets, that is, “E” gets larger. I provide an example of when the US announced QE1 on March 18, 2009.

The galaxy of points in the lower left quadrant are contractionary monetary shocks, such as the Swiss decision to let the franc float (appreciate) in January 2015.

You’ll notice that I also provided a 45 degree line, which shows whether the spot or the forward exchange rate responds more strongly to the monetary shock. Does it matter whether points lie slightly above or slightly below that 45 degree line? I’d say almost certainly not, but 99% of economists probably disagree with me.

If the spot rate moves by more than the forward rate, as in the March 2009 example, then nominal interest rates will fall with expansionary policy and rise with contractionary policy. If the spot rate moves by less than the forward rate, as in the January 2015 example, then nominal interest rates will rise with expansionary policy and fall with contractionary policy.

The impact of policy doesn’t depend on whether interest rates rise or fall, it depends on whether the exchange rate rises or falls. It doesn’t much matter whether you are slightly above or below the dotted line, it matters whether you are in the upper right quadrant or the lower left quadrant.

Keynesians and NeoFisherians don’t agree with me. Keynesians thinks lower interest rates are expansionary. They assume that monetary shocks lie in areas “K”, and affect spot exchange rates by more than forward rates (Dornbusch overshooting). NeoFisherians assume lower rates are contractionary. They assume that monetary shocks lie in areas “NF”, causing forward exchange rates to move more than spot rates.

Actually, the shocks occur in both areas, but movements in interest rates are inconsequential epiphenomena to the real action, the way that monetary shocks impact spot and future exchange rates, or better yet NGDP futures prices.

In January 2015, the Swiss franc suddenly rose more than 10% in response to a monetary shock. I don’t have forward exchange rate data, but I believe the forward Swiss franc appreciated about 1/4% more than the spot rate, say 10.25% instead of 10%. That’s because Swiss interest rates fell about 1/4%.

In March 2009, the US dollar suddenly fell about 4% on the announcement of QE1. Because one year T-bill yields fell about 11 basis points on the news, the forward rate might have only fallen 3.89%, vs. 4% for the spot rate (all figures in this post are rough estimates.)

If you believe that interest rates are the essence of monetary policy, then you believe that the fact that forward rates changed slightly more or less than spot rates is far more important than the fact that both spot and forward rates moved in the same direction. That’s crazy.

A Keynesian might view both the 2009 US shock and the 2015 Swiss shock as expansionary, as rates fell in both cases. A NeoFisherian might view them both as contractionary for the same reason. In contrast, when I see the dollar plunge 4% and the franc surge 10% after major monetary policy announcements, I see tighter money in Switzerland and easier money in the US. Judging by the co-movements in the various stock markets, I suspect investors agree with me.

Just to be clear, I don’t view exchange rate movements as being “monetary policy”, just a better policy indicator than interest rate movements. More specifically, I believe that by looking at exchange rate movements immediately after a major money announcement we can reasonably infer whether the monetary shock was expansionary or contractionary. Of course, exchange rates also move during periods when there is no monetary shock, for a variety of other reasons. Those movements are no “monetary policy”.

PS. You could do the same exercise for change in the “spot” money supply and change in the 10-year forward expected money supply. But again, NGDP futures prices are best.

PS. I have a new article at The Hill, which points out that the Fed is not “monetizing the debt”.


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34 Responses to “Identifying monetary policy shocks”

  1. Gravatar of Postkey Postkey
    30. June 2020 at 12:37

    From The Hill.
    “This encourages banks to hold on to more reserves rather than lending the money out. It changed everything.”

    ‘Lending the money out’ Really?

    “This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.”
    http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

  2. Gravatar of Postkey Postkey
    30. June 2020 at 12:47

    Also. ‘But the implications of these purchases are not what people who downplay deficits tend to assume. They do not constitute “monetization of the debt,” ‘

    The 18 June 2020 ‘missive’ from the I.E.A. would disagree?

    “The policy reaction to the Covid-19 pandemic will increase budget deficits massively in all the world’s leading countries. The deficits will to a significant extent be monetised, with heavy state borrowing from both national central banks and commercial banks.

    The monetisation of budget deficits, . . . ”
    https://iea.org.uk/publications/33536/

  3. Gravatar of Benjamin Cole Benjamin Cole
    30. June 2020 at 15:16

    I think i agree with this post.

    The Swiss National Bank story is fascinating. To limit the appreciation of the Swiss franc, the Swiss National Bank has accumulated a balance sheet of about $100,000 for every Swiss resident. This was accomplished, primarily, by the Swiss National Bank buying sovereign bonds of other nations.

    The Swiss National Bank recently indicated it would become even more aggressive in currency intervention.

    Through the Swiss National Bank, the Swiss people now own assets about triple their national debt. They have become a net creditor nation by exporting money. The Swiss economy faces deflation and very slow growth, although the current C19 situation makes a hash of economic analysis.

    Scott Sumner posits that the Swiss National Bank currency intervention is an expansionist monetary policy. Perhaps it is but it is not showing up in the Swiss national economic statistics.

    What if the Swiss National Bank had instead printed and given $25,000 to each Swiss resident under the condition they must spend it?

  4. Gravatar of P Burgos P Burgos
    30. June 2020 at 16:13

    Let me see if I am following this correctly. Expansionary monetary policy should cause a nation’s currency to depreciate against other currencies because… it lowers the real interest rate?

    One thing I am curious about is how this analysis applies to the US dollar, when the US dollar is the world’s reserve currency and also the currency of the world’s largest economy. My suspicion is that genuinely expansive monetary policy by the Fed lowers demand for the US dollar as a safety investment. But I would also think that if the US economy is being treated to expansionary monetary policy, that means returns on US equities is higher, leading to more demand for dollars.

  5. Gravatar of ssumner ssumner
    30. June 2020 at 16:23

    Postkey, Yes, I know. The banking system has no way to get rid of excess reserves.

    Sigh. . . .

    Burgos, You said:

    “Expansionary monetary policy should cause a nation’s currency to depreciate”

    Perhaps we should ask the Zimbabweans what happened to the value of the Zimbabwe dollar in foreign exchange markets. Do you think they would agree?

  6. Gravatar of Benjamin Cole Benjamin Cole
    30. June 2020 at 16:56

    I would like David Beckworth to organize a podcast and discussion between Scott Sumner and Stanley Fischer.

  7. Gravatar of Nick S Nick S
    30. June 2020 at 18:04

    Sumner,

    1.) Again, your lack of experience in real world finance became even more apparent as I read this latest post, fumbling over the relationship between exchange rates and interest rates…. the two are intertwined.. try reading a Wikipedia article on “carry trade” before you veer outside your lane next time.

    2.) Regarding the nonsense you wrote in “the hill”…… so as long as the Fed continues to pay interest on excess reserves, there can be no monetization of debt? Hmmm. So as long as the Fed continues to finance government debt purchases with interest bearing liabilities, there is no debt monetization. “Hey Guys, I got a great idea how we can stop monetizing govt debt! Let’s just continue to make the mechanism by which we finance our govt purchases more expensive, by arbitrarily raising the rate we pay on excess reserves! After all, we can just print more money to service the additional interest we have to pay… and even though we’re creating negative equity at an exponential pace, we just remit our earnings back to the US treasury anyways, so who cares!”

    I am having a bit of fun here, but I honestly, have zero clue how you can logically assert that there is no debt monetization, simply by looking at whether or not the liabilities taken on to finance the debt purchases are interest bearing or not. This is not relevant whatsoever. And then considering that these liabilities are serviced with additional money printing…. I really want to have an intelligent conversation here, but your reluctance to admit that some people get wet when it rains is supremely frustrating.

  8. Gravatar of Michael Sandifer Michael Sandifer
    30. June 2020 at 19:29

    Scott,

    First, this is a very interesting observation. Thank you. It never occurred to me to look for such a simple indicator of changes in monetary stance in changes in spot rates versus forward rates.

    Second, I didn’t express myself well on your related post at econlog. I use real interest rates to help me think about the effects of monetary policy on exchange rates. My point was, the expected composition of real rates versus inflation, in the context of a central bank’s reaction function, determines projected future nominal rates.

    It matters whether forward rates rise due to an expected increase in real GDP, or merely inflation. For example, see:

    https://fred.stlouisfed.org/graph/?g=su4p

  9. Gravatar of Postkey Postkey
    30. June 2020 at 23:00

    From The Hill.
    “This encourages banks to hold on to more reserves rather than lending the money out. It changed everything.”

    So what part of the increase in aggregate demand is determined by ‘lending’ and what part by potatoes, hot or otherwise?

  10. Gravatar of Postkey Postkey
    30. June 2020 at 23:05

    ‘An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, “out of thin air”. . . .
    Thus it can now be said with confidence for the first time – possibly in the 5000 years’ history of banking – that it has been empirically demonstrated that each individual bank creates credit and money out of nothing, when it extends what is called a ‘bank loan’. The bank does not loan any existing money, but instead creates new money. The money supply is created as ‘fairy dust’ produced by the banks out of thin air.32 The implications are far-reaching.’
    https://www.sciencedirect.com/science/article/pii/S1057521914001070

    Sigh.

  11. Gravatar of Benjamin Cole Benjamin Cole
    30. June 2020 at 23:10

    Waaay OT, but fun:

    https://www.caixinglobal.com/2020-06-29/cover-story-the-mystery-of-2-billion-of-loans-backed-by-fake-gold-101572911.html

    Fake gold! $2.8 billion worth (“worthless,” I should say).

    Copper-gilded lead!

    Old-timers will remember the “salad-oil scandal”

    Some people rhapsodize about the gold-standard. Just remember, piles of gold can be piles of gilded lead.

    In Russia or China…would you take bets? How about the Philippines? Ukraine? Saudi Arabia? Latin America? Africa?

  12. Gravatar of Benjamin Cole Benjamin Cole
    1. July 2020 at 03:12

    OT, but may come to have monetary policy implications.

    From Tyler Cowen’s MR:

    “Chinese authorities are carrying out forced sterilisations of women in an apparent campaign to curb the growth of ethnic minority populations in the western Xinjiang region, according to research published on Monday.

    The report, based on a combination of official regional data, policy documents and interviews with ethnic minority women, has prompted an international group of lawmakers to call for a United Nations investigation into China’s policies in the region.

    The move is likely to enrage Beijing, which has denied trampling on the rights of ethnic groups in Xinjiang, and which on Monday called the allegations “baseless”.

    —30—

    Hard to verify any info from inside China. See Wuhan labs. The nation operates under a real-news blackout.

    But perhaps the US will de-couple from China. Would a de-coupling lead to a more-expansive monetary policy?

  13. Gravatar of Rajat Rajat
    1. July 2020 at 04:27

    Interesting post. I agree that the exchange rate is the clearest indicator of the effect of a change in monetary policy. Are the implications of interest rate changes less ambiguous the longer the duration of the bond yield in question? The effect of an expansionary policy change on one year bonds may be uncertain because policy changes that are only mildly-to-moderately expansionary may not result in higher expected inflation and hence higher nominal interest rates through the Fisher Effect so quickly. But looking at 5 or 10 year yields, it would seem harder to reconcile lower bond yields with an expansionary policy. I wonder how often one could observe a currency depreciating simultaneously with its long bond yields falling?

  14. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 07:52

    Wrong Postkey.

    Re: “Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories.”

    And: “Thus it can now be said with confidence for the first time – possibly in the 5000 years’ history of banking – that it has been empirically demonstrated that each individual bank creates credit and money out of nothing, when it extends what is called a ‘bank loan’.

    Reductio ad absurdum. I saved some handouts prepared by Dr. Leland J. Pritchard, Department of Economics, University of Kansas more than 40 years ago. The figures presented are no longer published in today’s world. It represents double-entry book keeping on a national scale, i.e., all factors that affect bank deposits, e.g., Reserve Bank credit, increase in currency held by the nonbank public, increase in bank capital accounts, etc.

    The Consolidated Condition Statement for Commercial Banks and the Monetary System:

    1. Net effect on the volume of time and demand deposits and borrowing of all factors, except commercial bank credit (principally capital accounts)
    2. Net expansion of commercial bank credit (e.g., the Savings and Loan Associations are missing today).
    3. Net increase in time and demand deposits and borrowings (principally E-$ borrowings beginning in 1969).

    1973
    1 = 6.4
    2 = 643.1
    3 = 649.5
    1974
    1 = -.8
    2 = 699.1
    3 = 698.3

    1976
    1 = 27.8
    2 = 785.7
    3 = 813.5

    1978
    1 = 84.2
    2 = 1010.6
    3 = 1094.8

    1979
    1 = 13.5
    2 = 1189.1
    3 = 1202.6

    All monetary savings originate within the payment’s system. The source of time deposits is demand deposits, directly or indirectly via the currency route or through the bank’s undivided profits accounts.

    There is a one-to-one relationship between time and demand deposits. An increase in TDs depletes DDs by an equivalent amount. And the source of bank deposits (loans=deposits, not the other way around), can be largely accounted for by the expansion of Reserve bank credit.

    That there is a close connection between aggregate bank credit and the aggregate volume of bank deposits can be verified by comparing the net changes in commercial bank credit to the net changes in total deposits for any given time period.

  15. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 08:02

    re: “Stocks rose sharply on the US expansionary policy of lower interest rates when QE1 was announced”

    Dead wrong. Stocks moved higher because the rate-of-change in monetary flows, volume times transactions’ velocity, reversed from its decline. I precisely predicted both the drop and the recovery.

    But otherwise, Sumner is right. Interest is the price of loan funds. The price of money is the reciprocal of the price level.

    See: Daniel L. Thornton, Vice President and Economic Adviser:
    Research Division, Federal Reserve Bank of St. Louis, Working Paper Series

    “Monetary Policy: Why Money Matters and Interest Rates Don’t”
    http://bit.ly/1OJ9jhU

    Thornton: “the interest rate is the price of credit, not the price of money (i.e., the price level.)”

  16. Gravatar of ssumner ssumner
    1. July 2020 at 08:07

    Nick, You said:

    “Again, your lack of experience in real world finance became even more apparent as I read this latest post, fumbling over the relationship between exchange rates and interest rates…. the two are intertwined..”

    LOL. Of course they are intertwined, that’s the entire point of my post!

    As for the Hill column, you are the kind of person who’d claim that replacing 6 month T-bills with 3 month T-bills is “debt monetization”. Government liabilities are government liabilities.

    Postkey, I’d say almost 100% by hot potatoes.

    Rajat, You said:

    “Interesting post. I agree that the exchange rate is the clearest indicator of the effect of a change in monetary policy.”

    I’m not saying it’s the clearest, just much clearer than interest rates. And since we already have the interest parity condition, it facilitates the comparison of the two.

    You said:

    “Are the implications of interest rate changes less ambiguous the longer the duration of the bond yield in question? ”

    You think so, but I’d say no. I see long bond yields frequently rise with easier money, but also frequently fall, as in March 2009.

    I will that say this confuses me, and I don’t have a good explanation for the lack of a consistent pattern.

  17. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 08:10

    Re: “The Fed had the option of switching to level targeting, and blinked”

    Reductio ad absurdum. The FED can’t exercise N-gDp level targeting, can’t make up for past mistakes.

    As Dr. Philip George says:: “The Riddle of Money Finally Solved”:

    #1 “The velocity of money is a function of interest rates”
    #2 “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”
    #3 “When the interest rate is zero the velocity of money will tend to zero. This is because there is no incentive to move their accumulated savings out of demand deposits.”
    #4 “When interest rates go up, flows into savings and time deposits increase.”
    #5 “Holding interest rates down does nothing to boost investment because the problem is falling consumption.”

    Banks, DFIs, do not loan out existing deposits. Deposits that are saved and shifted into interest-bearing accounts represent albeit temporarily, idled funds. It is stock vs. flow. These funds have a zero payment’s velocity.

    Thus, a lower M1 (transactions based deposits) vs. M2 (which comprises non-M1 components) indicates a higher demand for money (which is inversely related to velocity).

    As Dr. Leland J. Pritchard, Ph.D. Chicago – Economics 1933, M.S Statistics, Syracuse predicted after the passage of (1) the DIDMCA of March 31st 1980, i.e., coinciding with his prediction of the (2) “time bomb”, the widespread introduction of ATS, NOW, & MMDA accounts, that money velocity had reached a permanently high plateau. Vt peaked when the FED imposed reserve requirements on these new money products in April 1981.

    Prichard in May 1980 pontificated that: “The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”. The DIDMCA destroyed the nonbanks (where savings are put back to work and the ownership of saved / borrowed funds is exchanged in the payment’s system). The only way to activate savings is for their owners, saver-holders, to spend/invest either directly or indirectly entirely outside of the payment’s system (where money fundamentally circulates).

  18. Gravatar of Ray Lopez Ray Lopez
    1. July 2020 at 08:26

    I’m not qualified to comment on this post by Dr. Sumner but I’m calling B.S. (btw most of the commentators are not qualified but won’t admit it).

    First, the graph correlation is way too tight, R approaches 1. Is this a real graph or something Sumner cooked up on a napkin (I’m betting it’s the latter)?

    This seems suspicious (Sumner): “Does it matter whether points lie slightly above or slightly below that 45 degree line? I’d say almost certainly not, but 99% of economists probably disagree with me.” – what? I doubt 99% of economists would deny such a strong correlation. Usually instead of something so strong, most economics scatter plots look like some punk with a paint spray can.

    Finally, this Sumner passage rings true: (Sumner) “The galaxy of points in the lower left quadrant are contractionary monetary shocks, such as the Swiss decision to let the franc float (appreciate) in January 2015.” – very true. Even a diehard ‘money is neutral short term and long” advocate like me was impressed by the Jan. 2015 Swiss natural experiment, which seemed to show after the Swiss franc appreciation, the Swiss economy went into a slight (1 or 2 quarters) recession. But one data point does not a theory make, and I’m not convinced it was due to monetary reasons anymore than the mid-March 2020 US Fed “QE-forever” announcement is responsible for the incredible V-shaped recovery in the US stock market (and US labor market and US economy actually). Even Sumner denies any link between the US stock market recovery in mid-March 2020 and the Fed March announcement (incredible to me that Sumner won’t take credit for such an obvious win, though for me I tend to agree that the V-shaped recovery was just a coincidence).

  19. Gravatar of Nick S Nick S
    1. July 2020 at 08:41

    Scott said – “As for the Hill column, you are the kind of person who’d claim that replacing 6 month T-bills with 3 month T-bills is “debt monetization”. Government liabilities are government liabilities.“

    You’re missing my point. The Fed is financing its purchase of govt liabilities with liabilities of its own which show up in the form of excess reserves. The excess reserve balances show up out of thin air. Print > buy USTs > Print > buy USTs > Print > buy USTs. “How do we service the internet due on our excess reserve liabilities?…. Oh yeah.. Print”

  20. Gravatar of Postkey Postkey
    1. July 2020 at 09:11

    “Postkey, I’d say almost 100% by hot potatoes.”

    Thank you.

  21. Gravatar of Paul Paul
    1. July 2020 at 11:28

    Hi Scott,

    Thank you for this clear explantion of an appealing way to calculate whether fed actions are expansionary.

    Where on the graph are the points for fed actions since Feb 2020?

    Thank you
    Paul

  22. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 12:00

    I don’t think economists know a debit from a credit. And I got the bottom on the 23rd too:

    On the day the market bottomed:
    That’s B.S.
    Bottom’s in.
    Mar 23, 2020. 10:34 AM
    Link
    Margin Call: The Story Of A Historic Week – The Heisenberg
    Bottom for stocks, not the economy. It will decouple.
    Mar 23, 2020. 10:33 AM
    Link
    We Likely Saw The Bottom – Michael A. Gayed, CFA
    The bottom’s in.
    Mar 23, 2020. 10:28 AM
    Link
    Sentiment Speaks: Many Did Not Believe We Would See 2200SPX Again, And Many Will Not Believe What I Am Thinking Now – Avi Gilburt
    My take, with the FED’s recent moves, the bottom is now in.
    Mar 23, 2020. 10:26 AM

  23. Gravatar of Rajat Rajat
    1. July 2020 at 14:04

    I went back to the videotape of early 2009. I can only access weekly data, but US stocks bottomed on the 1st March (I think the S&P500 hit the infamous 666 around the 3rd from memory). Meanwhile, the USD was locally strongest against the Euro (1.26) around the same date and subsequently fell to 1.41 by late May. Conversely, the 10yr bond yield had a local bottom on 16th March (2.62% after being as low as 2.13% in December 2008), before rising through the course of the next several months to 3.86% in June 2009. I’m not sure if the Fed said anything in early March, but on 18th March 2009 Bernanke announced an expansion of QE to unsterilised purchases of $750bn in agency-backed RMBSs and $300bn Treasuries. That has been described as the real start of QE1: https://en.wikipedia.org/wiki/History_of_Federal_Open_Market_Committee_actions#Quantitative_Easing_1_(QE1,_December_2008_to_March_2010).

    So either the equity and currency markets knew about the expansion of QE1 two weeks before the bond market, or the equity and currency markets jumped the gun?? What we can say is all three markets eventually moved in the way one might expect.

  24. Gravatar of Benjamin Cole Benjamin Cole
    1. July 2020 at 15:18

    Ray Lopez: if money is neutral in the long run…but a central bank can print money and acquire sovereign bonds and other financial assets in gigantic globalized capital markets… well then, why not have the US central bank buy $20 trillion of financial assets on global capital markets and funnel the interest into the US Treasury, thus reducing taxes on US taxpayers?

    Also, if the US Federal Reserve owns $20 trillion in global financial assets, that would more or less eliminate any concerns the US would be unable to honor its debts (given some minor changes of law).

  25. Gravatar of ssumner ssumner
    1. July 2020 at 16:04

    Nick, You said:

    “How do we service the internet due on our excess reserve liabilities?…. Oh yeah.. Print”

    With all due respect, you are in way over your head. They pay the reserve interest with interest they earn on their assets.

    There’s a big difference between monetizing debt and adjusting the maturity of debt.

    Paul, I only show two specific points, the others are imaginary.

    Spencer, I’m so happy for you!

    Rajat, Based on the market response, the action was not fully anticipated. But it might have been partially anticipated.

  26. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 17:02

    I know the GOSPEL. I’ve haven’t missed a turn in the economy since 1973 (just equities in QE2). I denigrated Nassim Nicholas Taleb’s “Black Swan” theory (unforeseeaable event), 6 months in advance and within one day. I.e., I predicted both the flash crash in stocks, May 6, 2010, and the flash crash in bonds, October 15, 2014.

    “Diminishing market depth and a surge in volatility were both on display Oct. 15, when Treasuries experienced the biggest yield fluctuations in a quarter century in the absence of any concrete news. The swings were so unusual that officials from the New York Fed met the next day to try and figure out what actually happened”

    Link: “Diminished Liquidity in Treasury Market” or:
    https://acrossthecurve.com/?p=19499

    “(Bloomberg) — Trading Treasuries keeps getting tougher and tougher.

    For decades, the $12.5 trillion market for U.S. government debt was renowned for its “depth,” Wall Street’s way of talking about a market’s ability to handle large trades without big moves in prices. But lately, that resiliency has practically vanished — and that’s a big worry.”

    Don’t believe everything you read. Economists don’t know money from mud pie. N-gDp level targeting cannot work period.

  27. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 17:22

    N-gDp level targeting was denigrated in 2018 (because money velocity fell). Remember the stagflationists? Link: “Rethink 2%”
    http://bit.ly/2s67De9

    Prima Facie Evidence. The 2018 pivot:
    As Dr. Philip George says: “When interest rates go up, flows into savings and time deposits increase.” (thereby destroying money velocity)

    The interest-bearing character of the DFI’s deposits which result in any sudden larger proportion of commercial bank deposits in the interest-bearing category destroys money velocity.

    2018-11-05 0.49
    2018-11-12 0.49
    2018-11-19 0.56 [spike]
    2018-11-26 0.57

    This is also an excellent device for the banking system to reduce its aggregate profits (as all savings originate within the confines of the payment’s system, and an individual bank’s primary deposit is a derivative deposit – from a system’s perspective).

    It is hard for the average person to believe that banks do not loan out savings or existing deposits – demand or time. But the DFIs always create money by making loans to, or buying securities from, the non-bank public.

    This results in a double-bind for the Fed (FOMC schizophrenia: Do I stop because inflation is increasing? Or do I go because R-gDp is falling?). If it pursues a rather restrictive monetary policy, e.g., QT, interest rates tend to rise.

    This places a damper on the creation of new money but, paradoxically drives existing money (savings) out of circulation into frozen deposits (un-used and un-spent, lost to both consumption and investment). In a twinkling, the economy begins to suffer.

    The GFC example:
    “Matthew O’Brien of the “Washington Post” undertaking a simple yet illuminating word count in a blog post for the Brussels-based Bruegel think tank. He found that, in the run-up to the Lehman collapse, the mentions of “inflation” in the transcripts vastly outnumbered those for “systemic risks/crises”: 468 versus 35 at the June 2008 FOMC meeting and 322 versus 19 at the August meeting. Even more notable: “At the September 16, 2008 meeting [that is the day after Lehman failed] there were 129 mentions of inflation…and only 4 of systemic risks/crisis”.

    Prices peaked in July 2008 – which was reported with a lag on Aug 14, 2008 – when the government announced that the annual inflation rate surged to 5.6% in July – the highest point in 17 years.

    2018 pivot continued:

    % Deposits vs. large CDs on “Assets and Liabilities of Commercial Banks in the United States – H.8”
    Jul ,,,,, 12227 ,,,,, 1638.6 ,,,,, 7.46
    Aug ,,,,, 12236 ,,,,, 1629.4 ,,,,, 7.51
    Sep ,,,,, 12268 ,,,,, 1662.4 ,,,,, 7.38
    Oct ,,,,, 12318 ,,,,, 1685.8 ,,,,, 7.31 (twinkling)
    Nov ,,,,, 12313 ,,,,, 1680.1 ,,,,, 7.33
    Dec ,,,,, 12425 ,,,,, 1698.6 ,,,,, 7.31
    Jan ,,,,, 12465 ,,,,, 1732.9 ,,,,, 7.19
    Feb ,,,,, 12494 ,,,,, 1744.6 ,,,,, 7.16
    ——————–|

    See: Dr. Philip George – October 9, 2018: “At the moment, one can safely say that the Fed’s plan for three more rate hikes in 2019 will not materialise. The US economy will go into a tailspin much before that.”

    Or you could look at the Calafia Beach Pundit: “money demand fell from mid-2017 to mid-2018 as confidence soared and the economy strengthened”
    Link: September 25, 2018: “An Emerging And Important Secular Trend”
    https://scottgrannis.blogspot.com/2018/09/an-emerging-and-important-secular-trend.html
    Link: “Demand for money; what went up will soon come down”
    https://scottgrannis.blogspot.com/2020/05/demand-for-money-what-went-up-will-soon.html

  28. Gravatar of Spencer Hall Spencer Hall
    1. July 2020 at 17:24

    The fact is that N-gDp level targeting is STUPID.

  29. Gravatar of Benjamin Cole Benjamin Cole
    1. July 2020 at 18:33

    Here is a interesting idea:

    Fifteen years ago, if I had proposed that US central bank acquire $20 trillion in global financial assets, to “balance” the national debt, the idea would have sounded like lunacy.

    Then, in the 2009 Great Recession, the Fed upped its balance sheet to $4 trillion. Didn’t seem to do much for domestic inflation or real growth.

    Okay, to the present day, the Fed now has a balance sheet of $7 trillion. Still a long way from $20 trillion….but I see a trend, no?

    And in the next recession?

    At some point, the interest earned on the Fed’s balance sheet will offset the interest paid on the national debt.

    The Swiss National Bank has acquired a balance sheet three times that nation’s national debt…and yet the problem is the Swiss franc appreciates, not depreciates! I do not know what happens to SNB interest earned, but if it is funneled into the Swiss Treasury, then Swiss citizens every year get a tax break, ceteris paribus.

    I must say, orthodox macroeconomists, confronted with these irrefutable observations…change the topic.

    What say Scott Sumner? Should the Fed acquire a balance sheet of $20 trillion..what would be the ramifications…beyond cancelling out national debt payments?

    That is the sort of “cancel culture” I like!

  30. Gravatar of Nick S Nick S
    2. July 2020 at 05:17

    Sumner Said – “ With all due respect, you are in way over your head. They pay the reserve interest with interest they earn on their assets.”

    Yeah I get it Scott. But what happens when the interest generated by their “assets” is insufficient to service the interest in their liabilities? This scenario is not inconceivable, especially given the increasing frequency of inverted yield curves. I’m sure it will all be fine though. Who doesn’t want a central bank that carries a negative equity balance anyway?

  31. Gravatar of ssumner ssumner
    2. July 2020 at 08:07

    Nick, Yeah, they are taking a risk, as when they replace 30-year T-bonds with 3-month T-bills. Is that “monetization?”. It seems to take you a long time to understand even the most basic points.

  32. Gravatar of Ray Lopez Ray Lopez
    2. July 2020 at 09:39

    @Ben Cole who says: “Ray Lopez: if money is neutral in the long run…but a central bank can print money and acquire sovereign bonds and other financial assets in gigantic globalized capital markets… ” – central banks essentially do this all the time, it’s called ‘intervention in Fx markets’. All the time, especially Japan’s central bank. And it has no real effect on the economy in the short or long run (pace what you hear about Japan ‘holding their yen too low’, nonsense). Money = neutral.

  33. Gravatar of Nick S Nick S
    3. July 2020 at 13:35

    Scott – i think you’re the one who is lost here. The fact that the Fed purchased govt bonds via money creation in the first place is monetization. “Adjusting Maturities” can also be a form of monetization. Imagine the Fed bought $100 of the long bond purchased by increasing the monetary base. Now imagine that the govt services the interest and principal due on that bond by issuing 3-month bills, which are purchased by the Fed by creating new money. This could be seen simply an adjustment of duration in the Fed portfolio, however, it is really a masquerade for a debt monetization scheme. So according to your infinite wisdom, I guess an infinitely increasing Fed balance sheet that is financed with money it creates, and who’s asset’s principal and interest obligations are serviced via new govt issuance, which is again bought by the Fed with new money it creates, is not debt monetization, as long as they shift the maturity of the portfolio around every once in a while. What don’t you get about this? And why can you never properly refute any of my logically laid out explanations? Instead, you resort to throwing in some incomplete, one-liner. I think you’re afraid to engage in any thought experiment that may be contrary to your work, especially when it’s coming from a 30 year old, non PHD, who’s actual real world, private sector experience, threatens what has become a joke of an institution that is economics in academics today. Talk about not evolving at all in the last 50 years.

  34. Gravatar of abc abc
    4. July 2020 at 13:54

    Scott’s discussion goes more into the dynamics (spot vs. forward; current vs. expected future path of rates) aspect of the issue, but there is a decent argument that the most important channel for monetary policy is through the exchange rate, even if (all) exchange rate adjustment is not monetary policy per se. I imagine that the smaller / more open the economy, the more this is true. For the US, being (relatively) closed and also weird exchange rate dynamics due to being the reserve currency (see the work of Gopinath and others on the “dominant currency paradigm”).

    Also, a very valuable take on this issue, w.r.t. to the Phillips curve “puzzle”

    https://fgeerolf.com/phillips.pdf

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