Markets > God > Woodford >>>>>>>>>>>> me

jnarr and Morgan directed me to this article on Michael Woodford’s support for tapering:

For Woodford, the most important point is that the Fed’s balance sheet cannot keep growing without imposing costs on the financial system and broader economy — even when inflation is low and unemployment is high. While Woodford didn’t explicitly tell me what those costs were, a possible explanation can be found in this brief passage from the paperhe presented at last year’s Jackson Hole Economic Symposium:

An increase in the safety premium obtained by making “safe assets” (in the relevant sense) more scarce would in itself be welfare-reducing. If Treasuries provide a convenience yield not available from other assets (including bank reserves), then reducing the quantity of Treasuries in the hands of the public reduces the benefits obtained from this service flow.

I’m going to have to coin a new maxim; “That may be true in theory but is it true in the financial markets?” Financial markets suggests that tapering will hurt the economy.  It’s our job as economists to figure out why.  If the nuns were right that it’s disrespectful to question God’s infinite wisdom, then it’s even more disrespectful to questions the “wisdom of the crowd.”

I believe tapering hurts because the market monetarist model is correct, more money boosts expected future NGDP, which boosts current NGDP.  But then I would think that, wouldn’t I?



26 Responses to “Markets > God > Woodford >>>>>>>>>>>> me”

  1. Gravatar of Justin Irving Justin Irving
    13. September 2013 at 05:56

    If Woodford would have only made his wish for a QE drawdown conditional on his version of NGDP level targeting (or at least no more interest of reserves), it would be easier to agree with him. I can’t buy that even lower NGDP growth would be worth the price of lowering the liquidity effect on Treasuries.

    BTW, the Fed’s share of Treasury debt is still more or less in line with historical averages right? So his argument about soaking up the supply of risk free assets is moot.

  2. Gravatar of effem effem
    13. September 2013 at 06:04

    Which “crowd” to listen to? If you judge by consumer confidence or overall satisfaction surveys you could easily argue that things have barely improved since the financial crisis. You could possibly go even further and suggest that rising asset prices are having a negative effect on the population broadly as the vast majority feel “left out.” Just saying…there are many “crowds” you could listen to.

  3. Gravatar of Justin Irving Justin Irving
    13. September 2013 at 06:09


    You listen to the crowd that pays to speak. Confidence surveys are meaningless when we have the S&P 500, term premiums and TIPS spreads. Someone going out and buying a stock is a much louder signal than a random citizen trying to make a survey taker go away.

  4. Gravatar of jknarr jknarr
    13. September 2013 at 06:26

    Summers is the hatchetman for the USD. If he’s in, the clock is now ticking for the great reset. They took too long to bomb Syria, and they’re not making the same mistake twice.

  5. Gravatar of effem effem
    13. September 2013 at 06:28


    I disagree. The stock market is simply a reflection of corporate profits. As we know, corporate profits are driven by consumer and government dis-saving. So it is entirely possibly to have record profits while the average person is going further and further into debt. Frankly, I believe that is the situation we are faced with. Since when are corporate profits the ultimate barometer for the health of an economy?

    As for your “skin in the game” theory…i disagree. The wealthy have far more votes in any pay-to-play contest..therefore i don’t see how results could be representative.

  6. Gravatar of Vaidas Urba Vaidas Urba
    13. September 2013 at 07:11

    Here is Krugman on the same article:
    ” If MBS and Treasuries are poor substitutes, the MBS curve may be very steep; and if Treasuries and short-term assets are close substitutes, the Treasury curve may not move much. I’m pretty sure Woodford believes in the second point, as do I;”

    Well, Treasuries and monetary base are no longer close substitutes, as term premium has sharply increased since May.

  7. Gravatar of Don Don
    13. September 2013 at 07:11

    This reminds me of the talk in 2000 about the apocalypse of the US budget surpluses. I don’t see the “lack of debt” for the US a problem in my lifetime.

  8. Gravatar of nickik nickik
    13. September 2013 at 07:20

    Why does the Fed have to buy save assets. I mean they dont really have to make profit, its not criticlly importent that they even make money, the balance sheet is big enougth that you dont need to fear that they will run out of stuff to sell if inflation gets out of hand.

    Why does the fed not by random assets, random bonds from all over the world? Then you dont have the problem Woodford discribes, and you dont have to problem with relative prices of one asset.

  9. Gravatar of Michael Michael
    13. September 2013 at 07:26

    From the Krugman blog linked by V. Urba, he also noted:

    “On the other hand, right now investors are not making a clear distinction between QE and forward guidance; taper talk has been accompanied by a clear shift in expectations toward the notion that the Fed will raise short-term rates sooner rather than later. So I wouldn’t be tapering now “” it sends a bad signal at a time when recovery remains very weak and fragile.”

    This would be one explanation for why markets react negatively tothe taper.

  10. Gravatar of migas migas
    13. September 2013 at 07:40

    Market monetarists say:
    – Rising treasuries yields signals that the economy is recovering. We don’t need to worry about that;
    – Tapering will hurt the economy.

    Well, what I saw in the markets (maybe I am wrong here) were rising yields especially after tapering rumors started making the headlines.

    And this, in my opinion, refutes markets monetarists analysis (beliefs).

  11. Gravatar of ssumner ssumner
    13. September 2013 at 07:40

    Justin, Good point.

    effem, That’s why we need an NGDP futures market.

    Vaidas, Thanks for the link.

    Michael. Yes, I agree. But that also implies a lower expected future path for the monetary base, which is what really matters.

  12. Gravatar of benjamin cole benjamin cole
    13. September 2013 at 07:57

    What is it with economists and QE?
    QE will lead to hyperinflation except it is inert, well except it will cause asset bubbles and “unquantifiable financial risks” and now thd silliest argument get, it will deprive some bond buyers of perceived safe assets.

    This Woodford is a star economist?

  13. Gravatar of Edward Edward
    13. September 2013 at 08:00

    I really despise Woodford. He really is making up nonsense to justify Fed tightening. For Gods sake Scott, why are you so damn respectful to this man, a twenty first century VSP analogue for apologists of the Fed Crowd of 1929-1933?

  14. Gravatar of Edward Edward
    13. September 2013 at 08:47

    Safe Asset shortage? Its the existence of such “safe assets” to begin with that pay interest 30 year Treasury’s that pay 3.85%, and so on on down, and also IROR, that prevent investors from investing in the private economy.

    BALANCE SHEET OF THE FED!?????!!! This one drives me crazy as a bat. Its otherwise respectable economists, worrying about ridiculous, insane, non-issues. How is the Fed going to unwind its balance sheet? The Fed needs to have an exit strategy!

    WHO CARES! We have an official unemployment rate of 7.3% and an unofficial one that is much higher. The Fed isn’t a private, profit making institution, and shouldn’t be treated as such.

    Besides, market monetarism teaches us that “passive tightening” is just as effective as “active tightening.” So the balance sheet issue is really the most ridiculous you can imagine

  15. Gravatar of ssumner ssumner
    13. September 2013 at 12:24

    migas, Yields can rise because of tight money, or because of a strengthening economy, or both. Recently it’s been both.

  16. Gravatar of Morgan Warstler Morgan Warstler
    13. September 2013 at 13:00


    That’s what I’ve been telling Scott.

    Life after Debt:

    It’s batshitcrazy to formulate MP in such a way that “safe assets” is a neccessary condition. Less than 15 years ago, we were preparing to do just that.

  17. Gravatar of John John
    13. September 2013 at 13:02

    Is there a policy or piece of news that would cause the markets to rally that you would consider “bad” for the economy. Do you think looking at minute to minute results of the financial market is ever short sighted or do the markets account for long term consequences as quickly as short term consequences?

  18. Gravatar of Morgan Warstler Morgan Warstler
    13. September 2013 at 13:11

    To go further from my twitchat with Waldman, here is Greenspan before Congress telling them to cut taxes:

    Note he starts off with: “I want to emphasize that I speak for myself and not necessarily for the Federal Reserve.”

    The Chair of the Fed walked into Congress and said “YO, I’ve come to talk Fiscal!”

    He literally doesn’t mention MP AT ALL.

    He doesn’t say “Um, we need safe assets to conduct MP!”

    His main concern is that the Federal government might need to buy private assets with their surplus.

    “Some holders of long-term Treasury securities may be reluctant to give them up, especially those who highly value the risk-free status of those issues. Inducing such holders, including foreign holders, to willingly offer to sell their securities prior to maturity could require paying premiums that far exceed any realistic value of retiring the debt before maturity. ”

    Finally, bc this is so nice to hear from a Fed Chair and I like to remember it:

    “In general, for reasons I have testified to previously, if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases.”

    The above quote I think is why DeLong wants Summers so bad…

    I think he wants payback.

  19. Gravatar of migas migas
    13. September 2013 at 14:00


    Quoting Lars:

    “…when bond yields drop it is normally a sign that monetary policy is becoming tighter rather than easier.”

    “…markets over the past four years completely confirms Milton Friedman’s view that tighter monetary policy is associated with lower bond yields.”

    In the past weeks, bond markets are telling a different story. Tighter money = higher yields.

    Could it be a sign that tighter money won’t hurt the economy? Stocks are at record highs.

  20. Gravatar of Joe Eagar Joe Eagar
    13. September 2013 at 15:47

    I wasn’t aware the downsides of QE weren’t widely known. I’m not an expert, but I’ll try and sum it up. Basically:

    * QE affects the Fed’s ability to conduct monetary policy. This isn’t an issue now, but there does come a point where a central bank’s balance sheet is so large that it loses control over monetary policy (e.g. if it buys so many long-term bonds that long rates become too low to fund an IOR-driven tightening cycle).

    * There’s actually quite a large risk of capital losses. People instinctively assume that central bank capital losses aren’t a big deal, but this isn’t the case: a sufficiently large capital loss can damage a central bank’s ability to tighten monetary policy. National governments usually bail out their central banks in this case, which (other than costing the taxpayer money) can affect the stability of the financial system if it calls the sovereign’s credit into question.

    * QE distorts capital markets. Central banks invariably find themselves buying assets other than sovereign debt, which can lead to capital misapplication and a loss of productivity (“picking winners and losers”). Another commonly mentioned side effect is bubbles, though I personally don’t believe that (capital flows produce bubbles, not monetary policy).

    * And of course, there’s the effect of lowering long-term interest rates on saving and investment behaviour. Given that Americans don’t save (privately) to begin with (we rely on the federal government and corporations to do that), I don’t think this is an issue.

    Anyway, I hope that helps.

  21. Gravatar of ssumner ssumner
    14. September 2013 at 06:00

    John, Sure, but it depends on the market. Bad news often makes gold and bonds rise, so I presume you mean stocks. Making intellectual property laws stronger might help stocks, but hurt the economy. High inflation would boost nominal stock prices and hurt the economy. Etc.

    Migas, I agree with both Lars quotes. This pattern is not “normal”. I don’t think tighter money would help stocks now. Stocks still fall on rumors of tapering. What’s happening is that other news (stronger growth?) is pushing stocks up by more than the taper is reducing them.

    Joe, I don’t agree with those at all. Take the easiest example. You claim easier money reduces investment. That’s just not true.

    Yes, the Fed should avoid risky assets, and I believe they are doing so. As a practical matter, potential Fed losses are not an issue right now. And as a theoretical matter the Fed is part of the federal government, so QE reduces risk on a consolidated basis.

  22. Gravatar of Joe Eagar Joe Eagar
    14. September 2013 at 06:06

    Eh. . .I didn’t say easier money led to less investment. To quote:

    “Given that Americans don’t save (privately) to begin with (we rely on the federal government and corporations to do that), I don’t think this is an issue.”

    My position is that since personal savings rates are so low to begin with, easier money doesn’t really affect the level of savings and investment. Like the notion that easy money leads to bubbles, I mentioned it because it’s one of the common views of the downsides of QE, not because I agree with said views.

  23. Gravatar of Geoff Geoff
    14. September 2013 at 16:47

    To be more representative of Dr. Sumner’s views, the title should read

    The State > Me > Markets > God > Woodford

  24. Gravatar of Geoff Geoff
    14. September 2013 at 16:48

    “I’m going to have to coin a new maxim; “That may be true in theory but is it true in the financial markets?””

    Cough…NGDP futures…COUGH

  25. Gravatar of Andy Harless Andy Harless
    14. September 2013 at 19:00

    Falling stock prices in response to taper rumors don’t necessarily mean markets think tapering is bad for the economy. If stock prices are determined by discounted expected cash flows, the impact is ambiguous if there is a simultaneous increase in both expected cash flows and the discount rate. My sense is that bond yields react more strongly to taper rumors than do stock prices, which might suggest that markets don’t actually think tapering is bad for the economy. It’s hard to separate the impact of taper rumors from everything else that’s going on (has anyone done an event study?) but it seems plausible that implied expected cash flows remain steady or even rise in response to taper rumors.

  26. Gravatar of ssumner ssumner
    15. September 2013 at 07:14

    Joe, OK, I misread your comment.

    Andy, Good point, and just one more reason why the failure to create and subsidize trading in an NGDP futures market represents criminal negligence on the part of policymakers. Perhaps someone could check to see how TIPS spreads responded to the taper news.

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