My satire can’t keep up with reality
A couple posts back I did a satire about how the plunging long term bond yields was actually “good news,” as it showed Operation Twist is working.
Now commenter Steve sent me some information suggesting that no matter how hard we try to be satirical, there’s no way we can keep up with reality:
[Richard] Fisher pointed out that long-term bond yields are already low as investors flock to the dollar and away from the euro.
“It helps to be the best looking horse in the glue factory! Monetary policy has done all it can, in my view,” Fisher said.
Charles Plosser also sees good news in the plunging bond yields:
Moreover, he said on the Journal’s Monday online edition that “a flood of liquidity” into the United States, as investors seek safer assets, is more likely “than the drying up of liquidity.”
Uncertainty in Europe might even help the U.S. economy in the short run by pushing down U.S. interest rates and energy prices, Plosser said in an interview, conducted in Eltville, Germany.
That’s right, a stronger dollar is expansionary. These are undergraduate-type mistakes (confusing a change in money demand with a change in money supply in Plosser’s case), by people who are given the awesome responsibility of running macroeconomic policy. Policy that affects the employment opportunities of millions of real people. I can’t even imagine what Bernanke thinks when he reads stuff like this.
Thank God the people who invest in equity markets know how to interpret a fall in bond yields, TIPS spreads, and commodity prices. Just one more reason to take monetary policy away from unelected fools, and turn it over to an NGDP futures market.
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1. June 2012 at 18:58
if the mortgage market was not frozen, might disagree. only about 30% of homeowners are “tier 1” (good credit, positive equity) based on stuff ive seen.
low rates might have some marginal impact, but compared to the “oh god were doomed” uncertainty about unemployment… who’s going to build a project with .o demand (revenue is first order, rates are second order).
1. June 2012 at 18:59
Scott wrote:
“That’s right, a stronger dollar is expansionary. These are undergraduate-type mistakes (confusing a change in money demand with a change in money supply in Plosser’s case), by people who are given the awesome responsibility of running macroeconomic policy.”
Plosser, one the founding fathers of RBC, is no undergraduate. He knows it means the opposite but he’s far too busy spinning it his way. To Plosser everything is an excuse to tighten monetary policy.
By the way, take a look at the dollar. It’s up over 4% in three months.
https://research.stlouisfed.org/fred2/graph/?graph_id=76922&category_id=0
1. June 2012 at 19:04
stronger dollar is expansionary and lets tame those oil prices please! hey, we’ll all be unemployed- but gas will be cheap!
1. June 2012 at 19:11
also: remember FOMC members are just economists with friends. ive interviewed 3 people smarter than half the FOMC in the last week. as bad as they are though, i blame Bernanke Dudley and Williams, cause they are smart enough to know better.
1. June 2012 at 19:55
I just can’t get my head around it. I was taught in introductory finance that interest includes future expected inflation (Interest = Risk + Inflation). In a recession, I would expect that investment risk increases, pushing interest higher, so low interest rates should signal high deflation. How hard a concept is it?… or am I completely wrong.
Second, if a bunch of horses go to a trough to drink they will be draining the trough, not filling it up!
1. June 2012 at 20:15
And I was rummaging through old posts and came across this one from 9 jobs report ago. You guess, Plosser features prominently and he´s like a broken record…
http://thefaintofheart.wordpress.com/2011/09/08/%E2%80%9Cmulticulturalism%E2%80%9D/
1. June 2012 at 20:48
Marcus, from the Sept 8, 2011 post you linked to, here’s Plosser:
“If there were some kind of financial crisis, like Europe, it would be appropriate for us to step in”
If deflationary fears “became a real threat again, that would be a justification for the Fed to step in again.”
“I don’t see either one of those happening,” Plosser said.
—————-
Now that both are happening, will Plosser change his tune?
1. June 2012 at 21:10
Steve – You sent Scott his most recent “wisdom”. Now the uncertainty in Europe will HELP the US. So no need for any explicit action by the Fed! They´re a bunch of morons!
1. June 2012 at 21:15
“we’ll all be unemployed- but gas will be cheap!”
That’ll be good for me since I’m planning to live in a car.
1. June 2012 at 21:22
Gas should be cheap because we ALL know environmentalists don’t matter.
Every time you make a hippie cry, you get to print money.
Fact.
So we judge if you really wat printed money, by how many hippies are crying.
If you care about something you pay for it yourself.
Hippies pay for nothing. If you pay for things, you have an obligation to make hippies dance.
1. June 2012 at 21:51
Scott,
I probably shouldn’t admit this on the internet, but I used to work for “Big Unnamed Financial Company” (BUFC). It was implicitly understood that the way to get promoted was to use the WSJ editorial page verbatim in macro research. The research published was always bullish, especially after a sharp rise in the dollar and a sharp fall in interest rates or commodities. Unfortunately the Plosser views are absolutely pervasive. The executives of BUFC were door-slamming head-exploding angry after the Fed announced ZIRP.
The Bigs used to bring in mercenary “macro” researchers who pushed the WSJ editorial viewpoints. My views were always “eccentric” and not particularly valued. This is why I sympathize with Krugman; his intuitions about the conservative group think and mercenary researchers in the economics community are spot-on. It’s too bad that Krugman doesn’t appreciate monetary policy. If he did he could be first rate.
I can’t be more specific about BUFC or the bad reseachers, because I don’t want to blacklist my employment prospects for life. But this is why I flip out sometimes.
2. June 2012 at 00:45
Your new favorite blogger, Miles Kimball, displays everything that is wrong with New Keynesian Economics, or as Stephen Williamson calls it the “Conventional View”. A very instructive post – for all the wrong reasons: http://blog.supplysideliberal.com/post/24118420584/balance-sheet-monetary-policy-a-primer
2. June 2012 at 00:46
Hint: you could do a great post dissecting what is wrong with Kimball’s post point by point.
2. June 2012 at 00:47
As his previous post indicates, this is a guy with the ear of policymakers. So people like him are exactly the ones whose views you’re trying to change, right?
2. June 2012 at 01:47
So what exactly is wrong with these two comments? Obviously, they focus on just one, hopeful, aspect of the process, and may be a bit sloppy in their use of terms for concepts like “liquidity”, but the comments don’t seem unreasonable to me for a non-technical audience. The bottom line here is that foreigners want to supply more current resources to the United States at low prices, which must be in some sense, good for you.
And can we please – calling here on all commentators including Krugman rather than singling out Scott – have an end to pathetic comments about “undergraduate mistakes”, “Econ101” etc. Explain precisely what you think is wrong with was said and people will learn, and, who knows, you may even learn yourself from engaging with the ways other people see things and from the exercise of finding new ways to explain your view.
2. June 2012 at 03:33
Yeah I see Williamson went after Kimball with both guns blazing. And Kimball said basically he can’t answer everything in one post but will over time. Which makes it seem like Williamson got the better of him.
After all by not responding the question begs if he is stumped and can’t respond. Mind you I’m no fan of Williamson but this is the way things seem right now.
2. June 2012 at 03:35
So Sautaros-as my previos post shows Williamson himself already went after Kimball point after point. So would Scott;s critique be anything like Williamson’s? Or would he also critique Williamson’s critique…
2. June 2012 at 03:41
This is the Williamson rebuttal
http://newmonetarism.blogspot.com/2012/06/quantitative-easing-conventional-view.html
2. June 2012 at 06:03
Can somemone explain to me why so many conservatives favor fixed exchange rates and regard devaluation or falling currencies as such a disaster? I can understand it in people with no economic training — a “strong” dollar sounds good. But even a lot of conservative economists seem to see things that way.
In an economic crisis you have three options to revive the economy — fiscal stimulus, monetary expansion, or let the currency fall and have an exports boom. So if you oppose all government intervention in the economy, that rules out fiscal stimulus. And central banks are part of government too, so that can rule out monetary expansion for some people (together with the fear of inflation). But what’s wrong with letting your currency fall? It requires no government intervention, and the boost comes entirely from the private sector. (Yeah, I know, you can’t do that now when the whole world is hitting the wall at once, but I’m talking about an ordinary economic crisis).
Even if you see maintaining a currency peg as a useful tool to tie government’s hands and keep it from doing anything to boost the economy, the peg doesn’t prevent government intervention. It just changes it from intervention to boost the economy to intervention to maintain a currency peg, i.e., intervention to make the economy worse instead of better. Why would anyone want that?
I mean, for God’s sake, there are even conservatives who praise Latvia as an ideal role model. Sure, they had the worse economic downturn of any country in this crisis, but let’s stick to what’s important. They maintained their currency peg. WTF?
2. June 2012 at 06:33
Hi Scott,
Unrelated to this post, but I wrote up a few criticisms of NGDPLT: https://plus.google.com/u/0/111643364718750270983/posts/Nj5zzYXALtL
I’d love to hear your thoughts. I’m a huge fan of your blog. Keep up the great work.
-Joe
2. June 2012 at 06:42
All this talk about satire led me to write a post about Major Freedom and some other cool Austrans like Mises and Hermann Hoppe.
Hey you get to have some levity sometimes. And reading the Mises website interview Hoppe is about as much levity as you get
Hope y’all are having a good weekend I have some fun with Austrians http://diaryofarepublicanhater.blogspot.com/2012/06/fun-with-austrains-major-freedom-and.html
2. June 2012 at 06:43
Yes Major you are right I am a fan
2. June 2012 at 06:46
I am not sure that taking monetary policy away from the unelected fools will lead to better decisions. Putting those decisions into the hands of elected fools would better ?
Keeping things the way they are, If American’s politicians had the knowledge and the guts to demand a change in monetary policy I believe we would see some action.
But they have neither the guts nor the knowledge. Do they ?
I hate to think how politicized and distorted monetary policy would become when seen through the lens of billions of dollars of special interest generated election year commercials.
I am sure President Ron Paul would love the Idea.
Here’s an Idea… Sumner/ Krugman 2012
2. June 2012 at 06:51
Libfree said…”Second, if a bunch of horses go to a trough to drink they will be draining the trough, not filling it up!”
Love it. Great metaphor. And what happens next is a good metaphor for “trickle down economics”
2. June 2012 at 07:12
“Just one more reason to take monetary policy away from unelected fools, and turn it over to an NGDP futures market.”
Except you can’t actually do that. The unelected fools would still control monetary policy; it’s just that they would have more accountability, because we would see the losses (at the time they roll over into the next futures contract) when they failed. (We’d also see gains if they succeeded better than the market expected.)
I’ve been thinking about this and may do a blog post about it. Futures targeting ensures Fed credibility in somewhat the same way that a loan shark ensures his customers’ creditworthiness: by threatening the Fed’s metaphorical kneecaps. But loan sharks, no matter how tough they are, don’t always get repaid. Presumably there will be cases where the Fed gets behind the curve, develops large inventories (i.e. net short or long positions), and has to take losses at rollover time.
The nice thing, though, is that there is an automatic fix for Krugman’s expectations trap. Essentially, the punishment for extreme failure is hyperinflation — which is what happens when a central bank goes severely bankrupt. If the Fed is dramatically undershooting NGDP, it will develop a very large long position in the futures market, on which it will likely have to take a very large loss when it rolls over the contract. As the Fed’s financial position deteriorates, the risk of hyperinflation increases, and this increased risk should raise average NGDP expectations and bring the Fed back closer to target. With NGDP futures targeting, the deflationary equilibrium doesn’t exist, because prolonged deflation implies hyperinflation.
2. June 2012 at 07:31
And it continues with the latest NYT abomination about monetary policy:
“What began as a one-time jolt in 2008, an unprecedented effort to revive economic activity, has become an uncomfortable status quo, an enduring reality in which savers are punished and borrowers rewarded by a permafrost of low interest rates.
And the Fed, acutely uneasy with this new role in the American economy, may now find itself unable to avoid doubling down.”
I’d like to know what the reporter thinks the Fed’s old role was.
2. June 2012 at 07:45
dwb, It’s never reason from a price change again.
Mark, I agree.
libfree, Good point.
Marcus, The Fed people are really all over the map. There’s no single model they are working from.
Steve, And Plosser doesn’t seem to realize the Fed’s inflation goal is 2%, not 0%. Sorry to hear about “macro research” out in the real world. But stock investors know better.
Saturos, I had some problems with it, but didn’t think it was that bad. Didn’t he say that the “worst case” was that America owns the entire world?
Rebeleconomist, More European demand for dollars is deflationary. That’s EC101. It causes the dollar to rise, commodity prices to fall, and long term bond yields to fall, and TIPS spreads to fall.
Mike Sax, I’ll take a look.
Essayist-lawyer, It’s not just conservatives, throughout history liberals (like Keynes.) have also strongly favored fixed rates. The euro was a liberal idea, opposed by Thatcher and the conservatives in Germany were skeptical.
Jseydl, I’ll take a look.
Bill, Markets should implement policy.
Andy, In my plan the Fed has no real discretion, and doesn’t take on risk. It’s just a market maker. The futures traders set the money supply and interest rates.
But perhaps I misunderstood your comment–I look forward to your post.
2. June 2012 at 07:52
Jseydl, Don’t have time for everything, but a few quick comments:
1. Yes, NGDPLT is broadly consistent with the Fed’s dual mandate. That’s a good thing, and argument in favor. But they aren’t implementing that mandate, NGDPLT would make it much more obvious where they’ve gone wrong–put more pressure on the fed to do the right thing.
2. You fail to understand the logic of level targeting. Under growth rate targeting velocity will be much more destabilizing. With level targeting, expectations of returning to the trend line in the future will cause current velocity to move in a stabilizing fashion. Thus if NGDP falls, expected future NGDP growth will rise, raising the current velocity of circulation. That doesn’t happen with growth rate targeting.
2. June 2012 at 07:58
Andy Harless,
“As the Fed’s financial position deteriorates, the risk of hyperinflation increases.”
What I see is most economists treat the central bank as being free of asset impairment risk.
If instead, one thinks of the central bank as just a bank with irredeemable deposits, then asset impairment is a risk inherent to its operations. The greater the balance sheet growth on a fixed amount of capital, the higher the risk that impairment leads either to: 1) a desire to avoid the bank’s liabilities (a risk transfer to currency holders); or 2) a recapitalization (a risk transfer to taxpayers).
Scott gets around the asset risk issue by implying that expectations have low volatility (no extreme deviations, no inertia) when a central bank is credible. A period of “prolonged deflation” is impossible: just as in a heating system, the temperature has no reason to deviate significantly from the thermostat setting as long as the heat input can “promise” to immediately swamp any burst of “cold air” (i.e. any supply shock, demand shocks being ruled out).
The problem is that in the case of targeting a credible “promise” is an assumption rather than a result. What happens if we relax the assumption? First, a credit-driven supply shock (credit is, after all, an unreliable technology) can produce a large deviation from the thermostat setting. Second, such a deviation would result in inertia in expectations. Under such conditions, asset impairment would become a very real risk.
Perfect central bank credibility seems to be an assumption rather than an observation or result. In the real world, even instances of high central bank credibility create observed volatility. The more credible a promise, the lower the degree of hedging against its being broken; the lower the degree of hedging, the more vulnerable the system to catastrophic loss. Pegs produce discontinuities. Periods of “great moderation” are followed by abrupt swings. The swings are rarely diagnosed as arising from the very nature of the pegs themselves.
2. June 2012 at 08:37
Scott, thanks for the response.
1. “But they aren’t implementing that mandate, NGDPLT would make it much more obvious where they’ve gone wrong.” Maybe. But it’s already pretty obvious that the Fed is favoring low inflation over job growth. NGDPLT might make that distinction more obvious to economists, but it would probably just confuse the general public, which is where you really want the criticism to come from.
2. I understand all of that, but it wasn’t really my argument. My argument was that under a quasi-rate targeting regime, the Fed still couldn’t prevent NGDP from collapsing in late-2008. Now, it may be the case that the recovery back to trend would be smoother under a level-targeting regime — because of the velocity argument — but that doesn’t show that the Fed would be able to prevent NGDP from collapsing from a severe nominal shock, like that experienced in late-2008. Correct me if I’m wrong, but I always thought your argument was that under a level-targeting regime, NGDP should never fall.
2. June 2012 at 08:55
Good Lord, Scott, I thought this was everything you had been campaigning against. Let me have a go.
Kimball believes:
1. Money has no effect on the economy at the ZLB
2. The Fed is wise to promise to withdraw the expansion of the money supply as soon as interest rates or inflation starts rising.
3. Relatedly, he judges that the economy is at the natural level of output whenever core inflation is stable.
4. The goal is to push down yields on an increasing variety of assets. The Fed prints money and buys stuff, not because it would accept more inflation, but because it wants to see lower yields on other assets. (But remember to pull back at the first sign of inflation!)
5. Apparently the Fed is powerless once all assets have zero yields. Money has no effect on the economy if it’s not being lent out, and apparently asset prices can’t rise high enough to make yields go negative, no matter how much money is printed.
6. Operation Twist is a great idea: the Fed’s best hope is to stimulate the economy by changing the composition of its balance sheet
7. Of course, “lowering any interest rate will stimulate the economy”.
8. Again, because money doesn’t mean anything other than its transmission through credit, if all interest rates in the economy hit zero (and effective monetary policy would certainly move them in that direction) then the Fed really is out of ammo. Of course we mustn’t allow the money we create to be permanent – that would cause hyperinflation. But velocity may rise as interest rates fall (???)
9. Of course, the economy is only stimulated to the extent that assets are bought. So although we actually don’t want to increase the money supply per se, we certainly are relying on the lowering of interest rates achieved by purchases. So we would probably have to buy an enormous amount to stabilize, say, European AD. Just remember to promise to pull out all the new money as soon as it begins to circulate, then it won’t overshoot.
10. Expectations? Expectations of what, exactly? Oh you mean lowering interest rates? That’s right, we need to lower them, and the way to do that is buy more and more stuff. Effective stimulus is needed to establish the desired expectations – remember monetary policy works with long and variable lags.
11.But that’s not a pressing concern right now, we may need a “moderate amount of stimulus” in Europe in “the near future”. We’ll see – if core inflation drops then we’ll know that we’re behind the natural level of output.
Mike, Williamson is a “New Monetarist”, not a “Market Monetarist”, don’t expect us to agree with him.
2. June 2012 at 08:59
Scott, I hope you’re not suffering from “myside bias”. Don’t be afraid to rip into his conventionally misguided views, just because he’s a kindred spirit.
2. June 2012 at 09:04
While I’ve got you’re attention, could you please take a look at this exchange I just had with Nick Rowe (in the comments; but read the post first): http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/06/counterfactuals.html
Is this just Nick’s latent Keynesianism showing through, or does he have a point?
Also, I found his next post extremely interesting.
2. June 2012 at 09:08
I think Kimball, along with DeLong and Hamilton all believe the above, this way of thinking which is dominant among everyone with policy-making power. As long as we still see people like him doing posts like that, Scott, you’ve got your work cut out for you.
2. June 2012 at 09:10
Oh I know that Sautors-not sure what a New Monetarist is even. All I really know is that Williamson is some sort of Monetarists but absolutely hates Krugman for attacking Macro back in 2009 and seems to be opposed to stimulus yet somehow claims he’s an Obama supporter.
I just meant that you were crticial of Kimball yet Williamson already ripped into him.
2. June 2012 at 09:13
“It’s too bad that Krugman doesn’t appreciate monetary policy. If he did he could be first rate.”
If Krugman understood that we are not in a liquidity trap, but, rather under a regime of monetary austerity, he would be first rate.
2. June 2012 at 09:15
“Monetary policy has done all it can, in my view,” Fisher said.”
So Fisher, at least implicitly, thinks we are in a liquidity trap.
2. June 2012 at 09:26
Oh, and 12. IOR is a great idea, gotta make sure that money stays dormant.
If the economy recovers, then interest rates might rise, and money might have an effect, so we have to vacuum the money back out again. So what will have caused the recovery? Spending money on assets to lower interest rates. Which will then have to rise. So we keep buying assets, keep lowering interest rates, might have to buy ****loads, and don’t stop until rates start rising.
Kimball, like many commentators, seems to have a piecemeal perspective on the macroeconomy. Spending good, inflation bad, lower interest rates are stimulus, but more printed money causes hyperinflation when it circulates. But then money doesn’t do anything when interest rates are zero, but we still want to lower interest rates to stimulate spending, stimulate the economy, but Lord forbid we should see core inflation rise, then we have to start pulling money out, not that money means anything apart from interest rates, unless rates rise, which would signal a recovery caused by pushing rates down… What was it you said about Keynesianism? Oh yeah, “mind-numbingly illogical”.
2. June 2012 at 09:28
FEH, or he thinks we have enough AD.
2. June 2012 at 09:30
Just one more reason to take monetary policy away from unelected fools, and turn it over to an NGDP futures market.
Elected politicians would be worse. After all the current fools were put in position by the politicians. IMO it is the monopoly power that enables the foolishness.
2. June 2012 at 09:34
Just read the new post. I forgot to add 12. Printing money becomes especially ineffective at the ZLB. It’s the ZLB that does it, otherwise money printing is inflationary. Unless you promise to pull it out. Then you can still stimulate by lowering the Funds rate.
2. June 2012 at 10:12
Oh, and rising asset prices mean two completely different things depending on if it’s stocks or bonds. C’mon everybody, see if you can find more.
2. June 2012 at 10:13
For that last one I meant that’s what Kimball overlooks, not what he believes.
2. June 2012 at 10:36
Scott,
I don’t see how you get around discretion. As I understand it, there are two parts to your suggested policy:
1. The Fed makes a market in NGDP futures at the target price (with no discretion for changing the target, in that respect different from most private sector market makers).
2. The Fed does whatever is necessary (using its usual instruments to influence market expectations) to avoid building up a substantial net position in NGDP futures.
The problem is that “whatever is necessary” is not a rule. You can make rules to specify what exactly the Fed will do in response to various changes in its NGDP futures position under various circumstances, but coming up with an exhaustive set of rules would be a very tall order. Moreover, even an exhaustive set of rules is not guaranteed to be successful in avoiding a buildup of futures exposure. The rules can get “behind the curve” just as a discretionary Fed can, if the market comes to believe that the rules are not adequate. In theory you could avoid this problem by having a very aggressive set of rules, but the tradeoff is that there will be instrument instability, which will be more severe the more fail-safe the rules are.
In any case, it’s probably better not to specify rules at all (other than the requirement to make a market at the target price), because I would expect that the directive “Try to avoid building up significant positions” would be as effective as a set of rules (provided there was sufficient transparency) and would allow for a greater variety of unexpected circumstances. But with or without rules, there is a danger that the public will lose confidence in the Fed and build up a net position in NGDP futures faster than the Fed can respond. In that case (barring a market reversal) the Fed would have to take a loss when it rolled over the contract.
Similar problems might exist with a commodity standard, but at least with a commodity standard, there is no leverage. The Fed can only take losses on its physical gold, or (in the other direction) it can run out of physical gold. If the Fed fails to adequately support a gold peg, either it has to take a moderate loss (if it accumulated too much gold) or it has to abandon the peg (if it runs out of gold). If a futures peg fails, there is no limit to the size of the potential loss and nothing that would immediately force the peg to be abandoned, so there is more risk that things will get way out of hand and eventually result in a large, even devastating, loss.
My view is that the possibility of a devastating loss is actually a feature rather than a bug, because it would tend to destroy the Fed’s credibility against inflation at just the time when it has too much. Of course the Fed could also get behind the curve in the other direction, in which case the feedback mechanism would be positive rather than negative, but presumably (as long as there was enough transparency to avoid hiding losses) the Fed would eventually do what was necessary to avoid a catastrophe.
2. June 2012 at 10:57
David, It makes no sense to think of the Fed as a private bank–it’s part of the government. Almost all it’s earnings go to the Treasury. Any losses it takes on T-bonds falling during a reflation are more than offset by gains to the Treasury from T-bonds falling during a reflation. It’s not a practical problem. But it it were, the solution is not to go away from my proposal, but to raise the NGDP growth target to Aussie levels, so the balance sheet always stays very small.
Jseydl, I strongly disagree. Most economists think Bernanke is doing a good job. If the NGDP explicit target was 16 trillion, and actual NGDP was 14 trillion, no one would think he was doing a good job.
You said;
“I understand all of that, but it wasn’t really my argument. My argument was that under a quasi-rate targeting regime, the Fed still couldn’t prevent NGDP from collapsing in late-2008.”
Then you don’t “understand all that” I’m arguing that level targeting makes the fall much, much smaller, because velocity is much higher when it starts to fall. Now I’d never claim it completely avoids a fall in NGDP, that would be crazy. But we can do much better than we are doing.
Saturos, On second thought you are right. I should have had you write the next post.
FEH, Agree about Krugman’s weak spot. Fisher’s so vague one can’t tell whether he’s making a LTrap or a RBC argument.
Floccina, I agree.
Andy, I see your point now. I always assumed the NGDP futures market would be very small, after all, the market doesn’t even exist today. There’s simply not much interest. So any net position taken by the Fed would be utterly trivial, in the thousands, or millions, certainly not in the billions. And losses would be far smaller still. Utterly insignificant compared to the $30 billion annual profit. I’d guess losses would be in the thousands, at most.
The biggest cost to the Fed would not be trading losses, but the subsidy to make sure enough trades occur.
The Fed would probably have at least a 1000-1 ratio between futures trades and the (much larger) parallel OMOs that actually move the monetary base.
2. June 2012 at 11:34
Scott,
“Most economists think Bernanke is doing a good job. If the NGDP explicit target was 16 trillion, and actual NGDP was 14 trillion, no one would think he was doing a good job.”
OK, it might help economists see the Fed’s failure. But again, I think it just confuses the general public. The general public likes to think in terms of unemployment and inflation, not in terms of NGDP. I guess you could argue that it doesn’t matter what the general public thinks; but that’s sort of a slippery slope, which I don’t think any reasonable economist would want to go down.
“I’m arguing that level targeting makes the fall much, much smaller, because velocity is much higher when it starts to fall. Now I’d never claim it completely avoids a fall in NGDP, that would be crazy. But we can do much better than we are doing.”
Got it. Sorry about the confusion; though I do think it would probably take many years to establish the sort of credible expectational component you’re describing. But that’s certainly not an argument for why the Fed shouldn’t start to establish that credibility now.
Thanks for your time.
2. June 2012 at 11:38
The NGDP futures market might remain small (or it might not) as long as people have confidence in the Fed. (Actually I think it would get much larger once it was perceived to be the Fed’s target.) The problem is that, when people lose confidence in the Fed, the market would suddenly get much larger. It’s like a currency peg for a small country. Before the peg is introduced, there won’t be much trading in the currency because nobody cares about a random small country. After the peg is introduced, if people have confidence in policy, there won’t be much trading, because still nobody cares about a random small country, and there is no obvious chance to get rich by trading it. But what happens when people lose confidence in the peg? Suddenly everyone wants to sell the currency short because they perceive a strong chance of a forced devaluation and essentially zero chance of a forced revaluation. If the Fed’s policy under futures targeting is perceived to be off the mark, you will get more and more people interested in what they see as a one-sided bet. (In this case, the Fed doesn’t have to abandon the peg for the bet to pay off, because it will have to roll forward the futures contract in any case.)
2. June 2012 at 11:50
Jseydl, You said;
“The general public likes to think in terms of unemployment and inflation, not in terms of NGDP.”
I assure the general public doesn’t think in those terms, I’ve never met an ordinary person that does. There’s no point in even discussing the general public. What matters is the views of experts, people who might influence policy.
You should read my National Affairs piece, most of your questions are answered there. The public would much rather hear the Fed is trying to raise their income, than that the Fed is trying to raise their cost of living.
Andy, I still think you are missing the point. Go back to my 1000-1 leverage assumption. If you think the market would still be too big for comfort, make it 10,000 to 1, you’ve just reduced the Fed’s market risk another 10 fold.
2. June 2012 at 12:14
“Any losses it takes on T-bonds falling during a reflation are more than offset by gains to the Treasury from T-bonds falling during a reflation.”
I think this confuses two different dynamics. First, a government may choose to go short duration. This is a conscious choice that results in a desired set of risks and returns for taxpayers. The flip side of that risk is usually taken on by bank shareholders (who are long duration).
Second, the Fed decides to go long duration. Some of that risk is transferred from private bank balance sheets to the Fed’s, and ultimately to taxpayers.
So we start out an optimal government portfolio that is long duration, and end up with one that is flat. This portfolio is undesirable: if the government wanted to be flat duration, it could have bought interest rate swaps on its long maturity debt in the first place.
An expansion of the Fed’s balance sheet thus results in a deviation from the optimal taxpayer portfolio. If the gains from the portfolio fall short of expected gains due to Fed actions, this is a cost to the taxpayer. Thus, QE results in a contingent taxpayer liability.
2. June 2012 at 14:28
“You should read my National Affairs piece, most of your questions are answered there.”
Will do. Thx.
2. June 2012 at 15:17
“Levitt Says Bankers’ Role At Fed Should Be Curtailed” on Bloomberg Surveillance.
In the interview he says that the five Federal Reserve Bank presidents shouldn’t be voting members of the FOMC.
Link: http://media.bloomberg.com/bb/avfile/vsDLBeX1UK.Y.mp3
Description: May 31 Bloomberg — Arthur Levitt, former chairman of the U.S. Securities and Exchange Commission and senior adviser to Goldman Sachs, says the influence of bankers on Federal Reserve policy should be “limited.”
(from http://ow.ly/1N9z3K)
2. June 2012 at 16:10
Kevin Johnson –
That’s music to my ears. Bankers should get no vote on Fed policy. Either take the vote away from the Federal Reserve Bank Presidents, or better yet, make the Federal Reserve Bank Presidents appointed by the President and confirmed by the Senate.
3. June 2012 at 00:20
@Scott
@Andy Harless
“The Fed does whatever is necessary (using its usual instruments to influence market expectations) to avoid building up a substantial net position in NGDP futures.”
Here is my reply that is based on my recent tweets. Long and short NGDP futures positions should be matched by design. NGDP futures market is not needed as we should use central bank balance sheet for that purpose. The best indicator of policy quality is the degree to which central bank assets and liabilities differ from NGDP futures. Central banks should require strong collateral for long futures positions to preserve capital needed to fight hyperinflation. Short NGDP positions of central banks should be unsecured short term liabilities. Pay IOR according to the NGDP gap.
3. June 2012 at 06:50
David, You lost me there. The Fed is part of the government. Thus if the Fed holds government debt, then what difference does it make if the price changes? Any welfare losses to taxpayers would be many orders of magnitude less than the losses from recessions. And as I said, if this is a problem, raise the trend rate of NGDP growth.
Kevin, I agree.
123, You lost me there. Is your final comment about IOR a version of Hall’s 1983 proposal (JME) to index IOR to inflation in such a way as to stabilize the price level?
3. June 2012 at 10:17
Scott,
I don’t know what your “1000-1 leverage assumption” refers to. And I don’t see how additional leverage would reduce the Fed’s risk. The Fed is like a market maker that promises an infinitely deep market but never changes his price. If the market develops a strong consensus that the price is wrong, the market maker will eventually go broke. The Fed has two advantages over the hypothetical market maker: (1) it can print money to meet margin calls and (2) it can use its other instruments to influence market expectations. But neither of these is entirely fail-safe.
3. June 2012 at 10:35
ssumner:
Any welfare losses to taxpayers would be many orders of magnitude less than the losses from recessions.
Shouldn’t that be up to the individual to decide what they want? Welfare gains and losses only exist for the individual.
You keep thinking like a central planner. Why is that? You lack the knowledge to be able to do such a thing.
3. June 2012 at 13:14
Andy, I think you are envisioning an entirely different system from what I am thinking about. Under my proposal the Fed’s net long or short position each day is connected to the change in the money base by the ratio of regular OMOs to NGDP futures transactions. Suppose the ratio were 100 to 1, and suppose the monetary base rose by $2 billion more than the Fed had estimated (based on usual seasonal trends) on that particular day. In that case NGDP futures investors would have bought $20 million more in NGDP contracts than they would have sold. The net long position of $20 million causes a $2 billion rise in the base.
However, the Fed can easily offload most of that risk on to the next days traders, but starting off the base at $2 billion above where they expect trading to end.
And don’t forget that the likely losses would be far below $20 million, as the difference between actual and target NGDP is rarely more than a few percentage points, i.e a few $100,000s. That’s pocket change to an institution that makes $30 billion a year. And the EMH says gains and losses will tend to cancel out in the long run.
Trust me, there’s a million ways to set this up where the Fed takes on little risk. It’s really nothing more than a sort of Intrade instructing the Fed what to do.
3. June 2012 at 13:30
Scott,
My comment was inspired by three sources:
1. Friedman ’59 and his proposal to pay IOR
2. central bank practices in some countries where IOR closely tracks the Taylor rule
3. your futures targeting proposals
But actually yes, Hall ’83 is also somewhat related to this. This is where I differ from Hall:
– I focus on NGDP gaps instead of deviations from price level. Hall is too much of a RBC guy
– For me the quantity of base money is much more important. Both of us want to use IOR to regulate money demand, in addition to this, I want to use the quantity of money to control NGDP expectations.
– My views on the asset side of central bank are different. He views the central bank as a sort of fiscal agent so the asset side of the central bank is not important. For me the central bank should be an independent entity whose working should not depend on the existence of government debt. Central banks should hold long NGDP futures on the asset side by accepting safe private sector collateral at market prices. I view central bank as a bank that provides NGDP intermediation services.
3. June 2012 at 13:44
Scott,
I agree with Andy that risk of central bank losses limits the ability of central banks to peg the NGDP expectations. You underestimate the volatility of volumes in NGDP futures markets. NGDP futures are a good hedge for those S&P 500 crashes that are caused by low AD, so via cross-market hedging you could get enormous levels of activity in the NGDP futures markets. The volumes in NGDP futures market could reach the volumes in the S&P 500 futures markets on days stock market investors fear an AD shock.
In some of your proposals you limit the central bank losses from NGDP futures by requiring that NGDP future traders post deposits at the central bank. But then NGDP futures that would be traded in markets with lower collateral requirements would sometimes diverge sharply from the NGDP futures market that is organized by the central bank.
My proposal is different – the only assets and liabilities of the central bank should be the NGDP futures. All liabilities of central bank represent the short NGDP position for the central bank, and as they are base money, no collateral is required. Long NGDP positions of the central bank should be overcollateralized by a wide range of private sector collateral at market prices – for me it is important that all the economic agents could easily short NGDP if need arises. The risk of central bank losses in my scheme is reduced by marking collateral daily to market, and the central bank also earns a spread between long and short NGDP positions.
3. June 2012 at 14:27
Scott,
I see S. Williamson is criticizing QE here:
http://newmonetarism.blogspot.com/2012/06/quantitative-easing-conventional-view.html
In my view, QE works because QE is similar to central bank increasing both long and short NGDP futures positions. QE works to the extent the payoffs of hoarding base money approximate the payoffs of NGDP futures. QE works to the extent the payoffs of assets the central bank purchases approximate the payoffs of NGDP futures.
3. June 2012 at 14:57
@123,
Also SW responded over at Noah Smiths blog.
my opinion is the QE works only to the extent the Fed wants it to work.
3. June 2012 at 15:23
OK, Scott, obviously I’ve misunderstood what you’re proposing, but the way you describe it here, it makes even less sense to me. (Possibly you misstated something?) First, do I understand correctly that the Fed would be making a market in NGDP futures (that is, private agents would always have the opportunity to buy or sell such futures at the target price, so private agents would always have the opportunity to hedge against target misses), just as the Treasury (under the gold standard) used to make a market in gold at the official price? If so, is there any limit on how much private agents can force the Fed to buy or sell?
In your example, you have a net long position by investors resulting in an increase in the monetary base. By my logic that seems backward. If investors expect NGDP to be too high (i.e., if they are long the futures at the target price), then the Fed should be contracting the base so as to reduce expected NGDP.
Do you have a link to where you describe this proposal in detail? (I may have read it already but maybe it didn’t sink in.)
123,
I don’t understand you proposal either.
“All liabilities of central bank represent the short NGDP position for the central bank, and as they are base money.”
This doesn’t make sense to me, because a futures position is not an asset or a liability, except when it has unrealized gains or losses. In some idealized world, the central bank could promise to redeem base money directly for some basket of goods and services equal to a certain fraction of the national product, in which case there would be a genuine link between central bank liabilities and NGDP, but obviously that kind of redemption promise isn’t practicable. But base money somehow has to be an actual liability of the central bank; that is, it has to have some positive value even after the gains and losses on everyone’s futures positions have been settled. Both you and Scott seem to be trying to link something that has a positive value to something that has a value of zero, and I don’t see how that can happen.
3. June 2012 at 15:53
*sigh* judging by the comments on SW and Noah’s thread on QE we are all still confused. “how can we get 2% inflation if we have a large output gap” “there must be a way that the Fed can generate inflation eif it really wanted to”
we’re doomed aren’t we.
3. June 2012 at 15:58
Actually dwb Miles Kimball has a real good post in reply to SW
http://blog.supplysideliberal.com/post/24342534092/trillions-and-trillions-getting-used-to-balance-sheet
3. June 2012 at 16:40
Sax honestly, I’mve read it twice, and it comes across very squirrely.
3. June 2012 at 16:46
i read Kimballs post twice and i didnt get it, honestly. try again later.
3. June 2012 at 16:51
noah smith has an update that summarizes Kimballs post as ” The upshot: It might take trillions and trillions of dollars of Fed asset purchases to have an effect on “the real economy”
if thats true i disagree like 150 million percent.
3. June 2012 at 17:02
that’s the punchline, but it proves Noah is not logical.
There was no argument to reach the conclusion, whats worse is he signposted at the beginning he’d specifically explain it.
I REALLY wish we could just stipulate that NGDP futures means:
1. It is run like forex.
2. The PRINTS new money and pays off winners, keeps money of losers.
Regardless of law etc. THAT shoudl be what we call NGDP Futures becuase the Tea Party will SUPPORT it.
Hell even MF will support it.
It really chaffs the ass of Ron Paul types that the new money enters through GS, that one little change – you actually have hand the new money to grandma directly – will alter people’s perceptions of this.
3. June 2012 at 17:03
123, First of all, Hall is certainly not an RBC-type.
Second, I can’t imagine why you think there’d be heavy volume in an NGDP futures market, there is so little interest that the market doesn’t even exist now! And that’s saying a lot, as there are now markets in almost everything. I see exceedingly little evidence of interest in an NGDP futures market.
Also see my reply to Andy, I don’t think either of you understand my proposal. Probably my fault.
Andy, I apologize. I got the net long position exactly backward. As you say, if the base increased they be taking a net short position.
It works this way. Each futures transaction triggers a parallel OMO to change the monetary base. In the example I provided the change in the base was 100 times larger than the net short or long futures position of the Fed.
It doesn’t matter how much trading occurs in the market, the Fed’s only risk is to the extent that it adopts a net long or short position. So even if a quadrillion shares are bought and sold, there is little risk to the Fed because the net long or short position of the Fed ends up (by assumption) only 1/100 as big as the change in the monetary base. And since daily changes in the monetary base tend to be small, the net long or short position would be very small.
If that doesn’t work, scale up to 1000 to one.
Quite frankly, the objection I usually get is that no one would be interested in trading. That’s why I proposed having the Fed subsidize trading.
3. June 2012 at 17:45
Look I never said Kimball is a Market Monetarist. I was more talking about his answer to SW who is always weird.
3. June 2012 at 17:54
Look I never said Kimball is a Market Monetarist. I was more talking about his answer to SW who is always weird.
I was not suggesting you said that, all i meant was that Kimball’s response was incomprehensible to me, in the sense that after reading it twice i did not even understand the point he was actually making. SW’s post, after a few clarifying comments, i finally understood. He is basically saying that QE is ineffective because under the interest on reserves policy, they merely lie fallow as excess reserves. In his world, the money multiplier i guess dominates. I don’t agree with his point, but at least i get it. Kimball’s i still have to go back and read again…I don’t get how he gets to “trillions and trillions” to make QE effective.
3. June 2012 at 18:10
dwb that retort was more aimed at Morgan.
Yeah that part about trillions and trillions certainly will not please any MMer.
I guess I kind of like Kimball’s overall style and I find his term for quantiative easing helpful-balance sheet monetary policy. I find that easier to coneptualize than QE.
As I had read Kimball he was contradicitng SW’s pessimism, but it’s true with that “trillions and trillions” comment it almost seems like he ends up condeding quite a bit to SW overall I guess.
3. June 2012 at 18:12
But I suppose that it might seem that both SW and Kimball believe in the liquidity trap.
3. June 2012 at 18:20
There was no argument to reach the conclusion, whats worse is he signposted at the beginning he’d specifically explain it.
i must be really dense. I re-re-re-read it, i got to the bottom and after something about Fermats last theorem, physics, and “Balance sheet monetary policy is like moving the economy with a giant fan” i felt like he waved his hands and said “it works!! But you might have to do trillions and trillions!” maybe i am stupid, i did not see an argument there.
I actually read Wallace’s paper, and SW’s objection to QE IMO is basically that the IOR policy sterilizes QE insofart as the “hot potato” excess reserves channel. I think i have to agree with SW there.
However there are (as Mark “Maserati” Sadowski likes to say) 8 other cylinders of monetary policy. And: IOR is a policy choice. So ultimately it comes down to central bank credibility and willingness to deploy Chuck Norris.
3. June 2012 at 18:30
Just to clarify: my interpretation of what SW is saying is mostly because of some clarifying comments on Noah’s blog, for example he says “All you need is the large quantity of excess reserves (no transactions role for reserves at the margin), and the interest rate on reserves essentially determining the split of outside money between reserves and currency. It’s a liquidity trap, but a deeper trap than just a traditional currency shortage.”
blah blah, but I don’t really think you need a fancy model to understand his point (see the figure p 3 in the Goodfriend paper).
http://www.newyorkfed.org/research/epr/02v08n1/0205good.pdf
SW is saying QE is ineffective because the IOR policy means that QE just ends up as excess reserves. true! the Fed wants it that way!
so the IOR policy maintains the liquidity trap. well, but isn’t that just a policy trap??
3. June 2012 at 18:32
This was SW’s comment on Noah’s post
“The idea is that the price level is purely passive right now, given a fixed interest rate on reserves. If the private sector creates more liquid assets that compete with reserves, then you get more inflation. If the demand for US-dollar-denominated safe assets goes up in the world, then we get less. But the Fed can’t change the inflation rate without changing the interest rate on reserves”
http://noahpinionblog.blogspot.com/2012/06/does-steve-williamson-think-that.html
So he does mention reserves dwb which would seem to give validity to your point. Ie, there’s no incentive to do anything but hold onto cash as the Fed is paying interest on it.
3. June 2012 at 18:33
Only thing that will make you let go of them is if the private sector gives you a sweeter deal in more liquid assets.
3. June 2012 at 18:38
he also said on his blog with respect to Wallace’s paper and the “irrelevance”: “1. The reserve requirement obviously isn’t binding, so that doesn’t matter. 2. Interest on reserves does not make a difference either. Of course changing the interest rate on reserves is NOT irrelevant.”
so… changing IOR would give effect to inflationary effects of QE.
3. June 2012 at 18:43
Yeah IOR definetly seems about as counterproductive a thing you can do if your goal is to discourage hoarding
3. June 2012 at 18:43
“Ie, there’s no incentive to do anything but hold onto cash as the Fed is paying interest on it.”
right, and again, that’s a choice the Fed made to stem the potentially hyperinflationary effects of 2 Tn of QE. It appears to be working!
The Fed could change this if they were serious, heck they could make IOR negative if they wanted! It all comes down to what do they want to do.
3. June 2012 at 18:48
Right so just to get rid of IOR-much less make it negative-would be really greasing the wheels to start lending
3. June 2012 at 18:52
I think Scott has probably done 100 posts on the IOR policy.
In any event, i understand where SW is coming from, wierd though his posts are. Kimball’s still no idea!
3. June 2012 at 18:54
You genearlly get where SW is coming from? About the only thing I feel I kjnow for sure about SW is that he hates Krugman yet claims to be a loyal Obama supporter and is a “New Monetarist” whatever that is.
3. June 2012 at 19:07
You genearlly get where SW is coming from?
that statement was limited to why he thinks QE is ineffective, and it took me a while, nor does that mean i #agree#. i am too busy to read his papers.
3. June 2012 at 19:11
Ok if you got him usually I was going to ask you to explain it to me sometime-LOL
3. June 2012 at 20:39
Andy, suppose the only assets of the central bank are NGDP linked collateralized loans, and monetary liabilities are NGDP linked accounts at the central bank.
Collateral arrangements of futures have positive value.
3. June 2012 at 20:41
Scott, NGDP futures don’t exist as there is no natural seller of such futures. There are lots of natural buyers, so the market would be vibrant once the Fed steps in.
4. June 2012 at 08:03
123. How’s is that a reason for no market. There’s no natural selling of toasters. Toaster sellers exist because people want to buy toasters. But it’s a mute point, because a quadrillion dollars worth of NGDP contracts doesn’t put significant risk on the Fed. The Fed’s mostly an intermediary.
4. June 2012 at 08:14
Scott,
OK, I think I get it, but I still disagree with your conclusion. In my terminology, you’re specifying a monetary policy rule to ensure that the Fed doesn’t develop a large outstanding position. But it is subject to the problem with all such rules, namely that you face a tradeoff between instrument instability and the risk that people will lose confidence in the rule. And this one has the additional problem that, even if the instrument itself is stable, it will result in more interest rate fluctuations than one would prefer (as you may recall from the early 80’s).
“…even if a quadrillion shares are bought and sold, there is little risk to the Fed because the net long or short position of the Fed ends up (by assumption) only 1/100 as big as the change in the monetary base. And since daily changes in the monetary base tend to be small, the net long or short position would be very small.”
I don’t get the causation here. Daily changes in the monetary base are small now, because there is no reason for them to be large. But if you link them to the futures market, and if there are big fluctuations in demand in the futures market, then monetary base changes will be large. Right now the Fed controls the monetary base, and the Fed prefers that it not fluctuate a lot. When you hand that control to the market, there’s no guarantee that the market’s preferences will be compatible with a stable monetary base.
I’d be particularly concerned about the situation where base money becomes an increasingly good substitute for the Fed’s assets, as is the situation right now. Who knows how many bonds the Fed will have to buy to raise NGDP expectations up to target? Maybe 100 times isn’t enough. Maybe 1000 times isn’t enough. Maybe it’s way too much and would result in crazy fluctuations in the base. The problem is that you have to decide the ratio beforehand, so you’re risking going off the rails in one direction or the other: either the increase in the base isn’t enough to satisfy market expectations and the Fed ends up developing a large long position, or else the increase in the base is too much and you end up with wild fluctuations in the base.
4. June 2012 at 09:01
Scott, I agree with Andy’s latest comment.
“Also see my reply to Andy, I don’t think either of you understand my proposal. Probably my fault.”
I understand your proposal. The Fed is safe, because it is protected by margin deposits. The volatility of monetary base is not a big deal. The problem is with arbitrage between your extra safe NGDP futures market and other markets. When the required return on arbitrage activities increases, the disconnect between the NGDP futures market and other markets increases too.
My proposal differs from your proposal in two ways:
1. I combine base money with NGDP futures where the central bank is short NGDP, this way I can implement IOR
2. When the central bank is long NGDP, I allow private sector collateral for such positions in order to address the arbitrage problem I have mentioned above.
” How’s is that a reason for no market. There’s no natural selling of toasters. Toaster sellers exist because people want to buy toasters. But it’s a mute point, because a quadrillion dollars worth of NGDP contracts doesn’t put significant risk on the Fed. The Fed’s mostly an intermediary.”
Natural sellers of toasters have got huge cost advantages in producing toasters. That’s why we have got a vibrant market in toasters. But who has the cost advantage in selling NGDP insurance? I’m too busy right now but I will email you a story how Warren Buffett has lost billions by underestimating how costly it is to produce NGDP insurance.
“123, First of all, Hall is certainly not an RBC-type.”
He is 30% more RBC than me: http://www.stanford.edu/~rehall/HowMuch2007.pdf
5. June 2012 at 13:24
Andy, You said;
“OK, I think I get it, but I still disagree with your conclusion. In my terminology, you’re specifying a monetary policy rule to ensure that the Fed doesn’t develop a large outstanding position. But it is subject to the problem with all such rules, namely that you face a trade-off between instrument instability and the risk that people will lose confidence in the rule. And this one has the additional problem that, even if the instrument itself is stable, it will result in more interest rate fluctuations than one would prefer (as you may recall from the early 80’s).”
I disagree on two counts, I don’t see that fluctuating interest rates are bad if NGDP growth is stable, and I don’t think the early 1980s tells us anything about interest rate instability under NGDPLT. Rates where highly unstable because NGDP was wildly unstable. Growth at a 19% annual rate in late 1980 and early 1981, plunging to near zero a year later. Two recessions in two years.
I don’t think economists are thinking clearly about the question of the monetary base. We as a society need to decide whether we want a small stable base like Australia, or a massive unstable base like Japan. I see that decision as being unrelated to NGDP targeting. If we go the Japanese route the central bank will take on lots of extra risk regardless of the monetary rule. It’s simple the nature of monetary policy–the Fed doesn’t give money away for free, and even if they did they couldn’t get it back for free. So they’ll deal in assets. If it’s 23% of GDP and highly unstable like like Japan, the CB will absorb lots of risk. If it’s 4% of GDP and stable, like Australia, very little risk. We need to decide what sort of monetary system we want. I vote for Australia.
I’ve published other papers where the CB takes zero risk. You run the sort of auction they do for Treasury securities, where you ask investors to write down how much they want to buy and sell at a list of instrument settings, and only execute the ones at the instrument setting where the net long and short positions balance. And there are still other options, like velocity futures, where markets forecast the ratio of future NGDP to current base settings. In that market, the Fed need not make any sales or purchases, they just observe the equilibrium. Aaron Jackson and I published that paper in Economic Inquiry in 2006.
123, I don’t care if the NGDP market is “disconnected” from other markets, indeed I’m not even sure what that means.
If you agree with Andy you’ll want to read my reply, as NGDP targeting need not impose any risk on the central bank.
No one has a natural advantage in toasters of NGDP insurance, they are both products that are easy to supply, and would be supplied in someone cared. You invest in T-bonds, or some other asset that rises as NGDP falls.
6. June 2012 at 12:34
Scott, markets get disconnected from each other when the required return on arbitrage activities increases. Suppose inflation swaps decouple from TIPS spreads, what should inflation targeting central bank do in this case?
I certainly agree that in your favorite proposals central bank is very safe, but it is true that in these cases central bank does nothing to address the arbitrage problem. You may call the elevated required return on arbitrage an AS problem, but this is an AS problem that cincreases the volatility of NGDP. On the other hand, I favor proposals where central bank does more to address the arbitrage problem by engaging in more risky activities.
Some manufacturing companies have large cost advantages in manufacturing toasters, that’s why the toaster market works so well. You say that holders of assets that apreciate when NGDP falls have cost advantage in selling NGDP insurance, but the problem is that this is not a perfect hedge. Holders of treasuries and shorters of stocks have developed markets where the hedging is much easier – for example, VIX market is huge. And VIX itself is sometimes insanely expensive:
http://finance.yahoo.com/q/bc?s=%5EVXO+Basic+Chart&t=my
Add a stock market – NGDP correlation risk premium to the price of VIX and you will get a 10000USD toaster instead of an affordable NGDP insurance. Only the central banks could produce affordable NGDP insurance.
7. June 2012 at 11:42
123, As long as the expected future NGDP doesn’t deviate far from the NGDP futures price, you have no problem. And I don’t think it would deviate very far. I hope I’m wrong so I can get rich in the market.
7. June 2012 at 13:47
Scott, yes if you can afford to wait three years until TIPS and inflation swaps converge, you have got a huge advantage over many market players.
7. June 2012 at 13:51
… and remember that TIPS – swaps divergence has reached enormous levels in early 2009.