Monetary policy: Levels and Growth Rates

In a recent Mercatus working paper, I argued that monetary policy works in two dimensions, by changing levels of key macro variables and by changing expected future growth rates of those variables.

This is easiest to see when looking at the impact of monetary policy announcements on the spot and forward exchange rate. A monetary policy announcement might cause the spot exchange rate to depreciate while also reducing the expected future appreciation in the currency. Or, it might cause the spot exchange rate to depreciate while raising the expected future appreciation in the currency. There are different kinds of “easy money” policies, and the actual outcome depends in part on “forward guidance”.

After writing this paper, I came across an interesting 2005 paper by Refet S. Gürkaynak, Brian Sack, and Eric T. Swanson. Here is the abstract:

We investigate the effects of U.S. monetary policy on asset prices using a high-frequency event-study analysis. We
test whether these effects are adequately captured by a single factor—changes in the federal funds rate target—and find that they are not. Instead, we find that two factors are required. These factors have a structural interpretation as a “current federal funds rate target” factor and a “future path of policy” factor, with the latter closely associated with Federal Open Market Committee statements. We measure the effects of these two factors on bond yields and stock prices using a new intraday data set going back to 1990. According to our estimates, both monetary policy actions and statements have important but differing effects on asset prices, with statements having a much greater impact on longer-term Treasury yields.

I like the way they look at policy shocks in two dimensions—immediate effects and changes in the expected future path of policy. It’s interesting that the impact on the future expected path of policy comes mostly from the policy statements that accompany the interest rate announcement.

Of course signals are only effective to the extent that they credibly describe future concrete actions by the central bank:

We emphasize that our findings do not imply that FOMC statements represent an independent policy tool. In particular, FOMC statements likely exert their effects on financial markets through their influence on financial market expectations of future policy actions. Viewed in this light, our results do not indicate that policy actions are secondary so much as that their influence comes earlier—when investors build in expectations of those actions in response to FOMC statements (and perhaps other events, such as speeches and testimony by FOMC members).

This is what I’ve been calling “long and variable leads”.

They also suggest that the findings support claims that monetary policy is still quite effective at the zero bound:

This finding has important implications for the conduct of monetary policy in a low-inflation environment—in particular, even when faced with a low or zero nominal funds rate, our results directly support the theoretical analysis of Reifschneider and Williams (2000) and Eggertsson and Woodford (2003) that the FOMC is largely unhindered in its ability to conduct policy, because it has the ability to manipulate financial market expectations of future policy actions and thereby longer-term interest rates and the economy more generally



23 Responses to “Monetary policy: Levels and Growth Rates”

  1. Gravatar of marcus nunes marcus nunes
    15. October 2021 at 17:54

    “A monetary policy announcement might cause the spot exchange rate to depreciate while also reducing the expected future appreciation in the currency.”
    This seems to be exactly what happened in the second half of 2008. The “announcement” crashed NGDP and reduced the expected future growth in NGDP, in fact decreasing the level of NGDP permanently.

    Going into the Great Recession (GR), the Fed let NGDP fall way below trend over a period of several months. Unemployment went to 10% over this period.

    Then, the Fed placed NGDP on a stable rising trend (albeit quite a bit lower than the previous one). With NGDP growth stable, unemployment embarked on a long & gentle downtrend.

  2. Gravatar of Michael Sandifer Michael Sandifer
    15. October 2021 at 21:03

    I think you should promote that paper you wrote more, particularly using spot verus forward exchange rates as indicators of changes in monetary policy stances. You’re selling yourself, and that very unique and important metric short. Perhaps even consider writing a separate paper on that metric?

  3. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    16. October 2021 at 07:59

    re: “The “announcement” crashed NGDP”

    We knew the precise “Minskey Moment” of the GFC:
    AS I POSTED: Dec 13 2007 06:55 PM |
    The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
    10/1/2007,,,,,,,-0.47 * temporary bottom
    11/1/2007,,,,,,, 0.14
    12/1/2007,,,,,,, 0.44
    01/1/2008,,,,,,, 0.59
    02/1/2008,,,,,,, 0.45
    03/1/2008,,,,,,, 0.06
    04/1/2008,,,,,,, 0.04
    05/1/2008,,,,,,, 0.09
    06/1/2008,,,,,,, 0.20
    07/1/2008,,,,,,, 0.32 peak
    08/1/2008,,,,,,, 0.15
    09/1/2008,,,,,,, 0.00
    10/1/2008,,,,,, -0.20 * possible recession
    11/1/2008,,,,,, -0.10 * possible recession
    12/1/2008,,,,,,, 0.10 * possible recession
    RoC trajectory as predicted.

  4. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    16. October 2021 at 08:05

    re: “and reduced the expected future growth in NGDP, in fact decreasing the level of NGDP permanently.”

    Sidney Homer and Henry Kaufman, economists at Salomon Brothers in the 1960’s, coined the term “crunch” to describe how the 1966 episode differed from those in the 1950’s. Although Homer and Kaufman did not formally define a crunch, Homer (1966) offered the following explanation:

    The words squeeze or pinch have gentle connotations. The prehensile male sometimes “squeezes” or “pinches”, with the most affectionate intentions. No bruises need result, no pain need be inflicted. A “crunch” is different. It is painful by definition, and it can even break bones.”

    See: “Identifying Credit Crunches” by Raymond E. Owens and Stacey L. Schreft. Federal Reserve Bank of Richmond, March 1993.

    The deregulation of interest rates, elimination of Reg Q ceilings, was supposed to thwart disintermediation. But the GFC suffered the worst bout of disintermediation in all of history.

    The remuneration of IBDDs was the coup de grâce.

  5. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    16. October 2021 at 08:14

    re: “long and variable leads”

    No such phenomenon. And “expectations” are a result, not a cause.

  6. Gravatar of Ray Lopez Ray Lopez
    16. October 2021 at 12:58

    So Sumner’s recent paper was superseded and anticipated by an earlier paper from 16 years ago? What’s the purpose of this mea culpa by Sumner, except to highlight he doesn’t read the existing literature?

    BTW, can any long-time readers tell me if Sumner has ever acknowledged that the US Fed’s March 2020 “QE-infinity” announcement was the cause of the U-turn the stock market made that month? To date, Sumner has been silent on this issue, which even I, who believes money is largely short-term neutral, was impressed by.

  7. Gravatar of Kester Pembroke Kester Pembroke
    17. October 2021 at 08:13

    He’s missing experience in actual business. Tiny marginal changes in the cost of credit are not a driving factor.

    The rates tend not to affect anything much, which is why MMT doesn’t use rate changes. A better system is to withdraw demand via a Job Guarantee backing off, progressive taxation and government not getting its price and delaying projects. That’s a far better stabilisation system.

    MMT looks at money neutrality in a different way – because we take into account the excess financial savings that stops money being neutral.

    Understanding that government can set the price level alters the game.

    The state should determine the price it is prepared to pay for things and let the market price come to them. When some government supplier says “we’re putting the price up because of the cost of living”, the state should always say no. There should never be wage increases on government salaries. If the private sector is poaching too many staff, then that is an indication that productivity has risen and taxes need to be increased to release the resources government requires. Taxes are therefore a way of making sure people will work for the amount the government is paying, and by doing that the price of goods and services is forced to decline over time as productivity improves.

    That means MMT can achieve the same systemic position mainstream proposes – wages stay static and prices decrease over time as productivity improves due to the effect of competition, thereby increasing the real wage. Except that the MMT approach actually works and doesn’t require millions of people unemployed.

    So which is the better ‘money neutral’ stabilisation system?

    – one where unelected wonks in a central bank try to manipulate credit expansion and contraction indirectly to generate the 5% unemployment necessary to stop wages rising, using an interest rate steering process that doesn’t work, and which actually drives up prices due to the forward pricing effect.

    – or one where government makes ‘offers of last resort’ for most of its spending and leaves the fiscal drag generated by taxation to force both firms and individuals to take those offers. Since one of those offers is ’employer of last resort’ nobody ever needs to be unemployed.

  8. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    17. October 2021 at 08:28

    MMTer’s don’t understand velocity, stock vs. flows. They confuse money and liquid assets. And the gov’t is the price regulatory, come on.

    Powell radically changed monetary policy. The FOMC is now stuck with the manipulation of interest rates.

  9. Gravatar of rinat rinat
    17. October 2021 at 11:10

    When will Americans realize the truth,
    that the Fed is designed to steal your due,
    they love economist thugs, because they propagate nonsense
    and they expect you to be too stupid to comprehend.

    Rates at zero, give the banks free money,
    riskless investment is better than honey,
    go bankrupt, no problem right,
    the banks can always depend on the govt’s might.

    Sorry loser common folk, you lose it all,
    what’s that I hear, you want to brawl?
    well, okay loser, we’ll call the crown and complain now,
    for I think we have a “domestic terrorist” on the prowl.

    why so much dissent in the air,
    don’t you know how much we care?
    Call the propaganda board and kick it into overdrive
    for we need to convince those young minds to go along for the ride.

    Let’s go abroad and do it all again,
    until we increase our wealth by 1 trillion * 10.
    consolidate, consolidate, isn’t it great,
    it’s so nice to live behind this golden gate.

  10. Gravatar of postkey postkey
    17. October 2021 at 11:35

    The Fed is saving ‘us’?
    “The names of the banks and the eyebrow-raising amounts they borrowed from the New York Fed do not square with the official story at the time – that the liquidity crisis occurred because U.S. corporations withdrew large amounts from the banks in order to make quarterly tax payments. The fact that so many huge loans ended up going to foreign banks, as well as Goldman Sachs and JPMorgan Securities, suggests that this was a derivatives counterparty problem, potentially triggered by Deutsche Bank’s crisis at the time.”

  11. Gravatar of MichaelM MichaelM
    17. October 2021 at 15:47

    This is as good a post as any to task: Scott, have you had the opportunity to read Bob Hetzel’s book on the Great Recession from a decade ago? I just finished it and there were parts where, if someone had told me you wrote it and I didn’t already know Hetzel did, I would absolutely believe them.

  12. Gravatar of Matthias Matthias
    18. October 2021 at 02:25

    > This is what I’ve been calling “long and variable leads”.

    It’s really weird, but this seems to be one of your more controversial ideas.

    I say weird, because anything _but_ long leads and immediate reactions would require market participants to be stupid and easily taken advantage of. And not just some of them, there are always a few idiots, but virtually everyone.

    (Similar logic applies when Internet-Austrians want to make a big deal out of a presumed Cantillon effect.)

  13. Gravatar of ssumner ssumner
    18. October 2021 at 08:12

    Kester, You said:

    “He’s missing experience in actual business. Tiny marginal changes in the cost of credit are not a driving factor.”

    You are confusing interest rates and monetary policy.

    Yes, I really like Hetzel’s book.

    Matthias, Yes, it shouldn’t even be controversial.

  14. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    18. October 2021 at 10:16

    An injection of new money by the Reserve authorities can be robust, neutral, or harmful. There is a “sweet spot”. But the O/N RRP facility took away William McChesney Martin’s punch bowl. The economic axiom is that the money stock can never be properly managed by any attempt to control the cost of credit.

    Atlanta gDpNow Latest estimate: 1.2 percent — October 15, 2021 is down from 6.6%. That’s a huge, and an unexpected drop. So, the policy mix is stagflation, business stagnation accompanied by inflation.

  15. Gravatar of Justin Irving Justin Irving
    18. October 2021 at 10:50

    It’s been a slow process, but I see an unmistakable dip in discussion of interest rates in the business press.

    Does anyone have a sense of what younger macro researchers make of Sumnerism? My impression, from years ago when I was paying attention, was that macro research was heavily gerontocratic, a mystery cult where overwrought models were cranked out as a ritual. junior people given little room to revise the established models.

    Prediction: when this stuff does take over the profession, it will come from the Fed, not the universities.

  16. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    18. October 2021 at 12:09

    You wonder if the money stock is being reported correctly? The O/N RRP draining doesn’t show up in the stats.

  17. Gravatar of MichaelM MichaelM
    18. October 2021 at 15:55

    “Yes, I really like Hetzel’s book.”

    Glad to hear. I hope you won’t be offended that I got drawn into it reading the first dozen or so pages that I temporarily put The Midas Paradox to finish it! I have picked your book back up, though, and it’s actually rather enriching to be able to have both in mind at the same time.

  18. Gravatar of nick nick
    19. October 2021 at 15:06

    That communist son of bitch is trying to monitor our bank accounts now.

    We need to put a bounty on all economist heads working at IRS, or Fed.

    Take them out, before they take us out.

    They will come for your guns soon. Polish the barrels. Greet them with a big beautiful bang!!

  19. Gravatar of ssumner ssumner
    20. October 2021 at 18:21

    Michael, Thanks for reading it.

  20. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    21. October 2021 at 09:08

    “In a recent paper “The People’s Ledger,” Ms. Omarova proposed that the Federal Reserve take over consumer bank deposits, “effectively ‘end banking,’ as we know it,” and become “the ultimate public platform for generating, modulating, and allocating financial resources in a modern economy.” She’d also like the U.S. to create a central bank digital currency—as Venezuela and China are doing—to “redesign our financial system & turn Fed’s balance sheet into a true ‘People’s Ledger,’” she tweeted this summer. What could possibly go wrong? -WSJ”

    Link: “David Stockman on the Banking Ponzi Scheme That’s Savaging Depositors”

    The banks should be nationalized. There is no justification for giving the banksters the exclusive and sovereign right to create and grow bank earning assets and thus legal tender, in whatever form, digitized or cash and coin.

  21. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    22. October 2021 at 05:50

    “Whip Inflation Now”

  22. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    22. October 2021 at 07:01

    O/N RRPs have exceeded the growth in the narrow measure of money by $725b since the beginning of 2021. The upcoming drop in inflation, due to the FOMC’s tightening, is going to surprise.

  23. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    23. October 2021 at 01:36

    There’s a high probability that the FED doesn’t report the money stock figures correctly (O/N RRPs, where the money goes from the banks to the Central Bank), a good example is sweep accounts (where the money changes counterparties inside the banks).

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