Reasoning from a price change, on steriods.

Here’s CNBC:

Let’s say that the market believes Bernanke’s theory about the effectiveness of forward guidance in boosting the speed of the economy. In that case, the market should react to by raising longer-term interest rates sooner than it would otherwise””because it should expect to pass the Fed’s economic condition thresholds for higher short-term rates sooner.

Obviously this makes forward guidance at least somewhat self-defeating.

As economist Warren Mosler points out, this has an ironic consequence: forward guidance will only work if the market doubts its effectiveness.

What would happen if rates were low because the public didn’t expect the policy to be effective?


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29 Responses to “Reasoning from a price change, on steriods.”

  1. Gravatar of Benoit Essiambre Benoit Essiambre
    21. November 2013 at 10:47

    As a non economist, before I read a lot of this blog, this argument would have been over my head. I will try to translate for other laymen (tell me if I wrong).

    Warren Mosler has it upside down. If the long-term nominal rates go up because the market thinks monetary stimulus, in the form of forward guidance is actually going to work, it’s the right kind of rates going up. It means amongst other things:
    -Inflation is going to catch up to long term targets
    -Real long term rates are not necessarily going to go up much
    -But in as much as real long term rates are going to go up, it will be because the market expects the economy to get better and no longer because it expects central banks to understimulate.
    – Short to medium real rates are probably going down thus stimulating investment. Another way to see this is that expected inflation means businesses expect to be able to charge higher prices soon, stimulating investment.

    Alternately, if long-term rates stay low because the market isn’t confident enough about this monetary stimulus, we will get a (very pretty) Japanese style economic disaster.

  2. Gravatar of Steve Steve
    21. November 2013 at 11:19

    Obama’s “Hugo Chavez quotient” just increased from 15% to 25%.

    Reid, Democrats trigger ‘nuclear’ option; eliminate most filibusters on nominees

  3. Gravatar of SG SG
    21. November 2013 at 11:50

    Keep fighting the good fight, Scott.

    Here’s Paul Krugman on the eurozone this morning:

    “The euro area as a whole has record high unemployment and record low inflation. By any normal standards, this says that monetary policy is too tight.”

    This it’s what its all about. I’m convinced that if Krugman beat the tight money drum with a fraction of the energy he’s devoted to fiscal austerity, there would be thousands more people with jobs right now.

    In a sane world, the only question Bernanke would be getting from Senators during those ridiculous hearings would be why money isn’t looser when we have high unemployment and low inflation. But we don’t live in a sane world, so we end up with Obama appointing people like Jeremy Stein or (nearly) Larry Summers who go on and on about BS like “financial stability” “asset price inflation” or “secular stagnation.”

    Thank you, Scott, for keeping it simple.

  4. Gravatar of Dan W. Dan W.
    21. November 2013 at 12:00

    Here’s a thought:

    Eliminate welfare and eliminate the minimum wage and you will create millions of jobs and this will happen no matter the monetary policy or lack thereof.

    You guys talk as if monetary policy can be rocket fuel when in fact it is just changing the additives in the regular gasoline. If you want economic growth you have to provide the incentives to individuals to create that growth. Without those incentives no amount of pushing on the string will matter.

  5. Gravatar of Tommy Dorsett Tommy Dorsett
    21. November 2013 at 12:16

    The markets expect tapering to be associated with faster NGDP and job growth. There is no other logical explaination for higher long term rates and higher stock prices. If the taper was in some way expected to run athwart of the fundamentals, long rates and stock prices would fall – as they did after QE1 and QE2 came to a premature end. The financial commentariat doesn’t get it, but markets do.

  6. Gravatar of Edward Edward
    21. November 2013 at 12:18

    Dan W.

    It IS rocket fuel. Conservatives need to wake up to that fact

  7. Gravatar of Mark A. Sadowski Mark A. Sadowski
    21. November 2013 at 12:26

    November 21, 2013

    QE, The People And The Damage Done
    By Raúl Ilargi Meijer

    “…And no, you’re right, the excess reserves don’t yet quite add up to the total bonds and MBS purchases. So what happened to the rest of it? Easy. I give you, from Fortune two months ago:

    [Quote from Fortune showing assets at six largest US banks are up by 37% in five years]…”

    This is without a doubt the biggest nonsequitor I’ve read all day (and that’s saying a lot).

    QE adds directly to the monetary base, which by definition equal to the sum of reserve balances (the deposits of banks with the Federal Reserve) and currency (physical cash):

    Between August 2008 and October 2013 the monetary base has increased by $2.74 trillion which is equal to the $1.23 trillion in assets purchased under QE1, plus the $570 billion in assets purchased under QE2, plus the $940 billion in assets purchased under QE3. Reserve balances have increased by $2.36 trillion. The difference is due entirely to the $380 billion increase in the amount of currency.

    Now, how one goes from an increase in currency, to an increase in the assets at the six largest banks, remains something of a mystery. (Blame it on the Underwear Gnomes?)

  8. Gravatar of Dan W. Dan W.
    21. November 2013 at 12:48


    On what basis does manipulation of interest rates and the value of the national currency motivate economic activity? Oh, and not just motivate it but HIGHLY motivate it, like “rocket fuel”.

    The problem for Bernanke and Monetarists in general is that the more visible the hand, the less effective the policy. Why? Well for one reason the money interests adapt and make gaming the policy the #1 objective. So rather than spending effort creating real wealth, the effort is spent trying to manipulate the manipulators.

    All the while all this visible manipulation creates economic uncertainty about when it will end or how. You see, Bernanke thought all he needed to do was to fly the helicopter and drop the money. He forget that rational people expect the helicopter to land and they are waiting for that to happen. Unfortunately, Bernanke never planned for a landing. Would you ever take off in a helicopter that couldn’t land? Perhaps the Fed Governors should have asked about that before starting the QE journey.

  9. Gravatar of John Carney John Carney
    21. November 2013 at 13:26

    I wrote the post linked to above. I don’t see how it’s an instance of reasoning from a price change.

    Look at it from the perspective of a bond trader. If you think forward guidance is working to stimulate the economy toward the Fed’s goals, then you expect that we’ll reach those goals sooner than we otherwise would. Since the Fed has said that the goals are thresholds for target rate hikes, this means you expect the target rate to rise faster than it otherwise would. Based on this, you adjust your view of the appropriate pricing for long term bonds.


  10. Gravatar of Brian Donohue Brian Donohue
    21. November 2013 at 14:15

    Tommy Dorsett,

    Good comment. I’m not sure Scott’s NGDPLT policy would have worked much better, and it prolly wouldn’t have reduced government payrolls by 1 million over the past three years.

    But the whole QE dance, it seems to me, enjoys substantial negative feedback stabilization. Saying ‘taper’ is like taking the economy’s temperature- if the markets have a conniption fit, backtrack. If not, inch forward.

  11. Gravatar of Daniel Daniel
    21. November 2013 at 14:37

    manipulation of interest rates and the value of the national currency

    Oh good, another austro-sadist who thinks sticky wages are the gubmint’s fault.

  12. Gravatar of Geoff Geoff
    21. November 2013 at 15:14

    This blogpost is reasoning from aggregates on steroids.

    If interest rates rise, due to an inflation premium, then it is not the case that every single business will experience a sufficient rise in income such that they would be able to handle increased borrowing costs.

    What tends to actually happen is that interest rates rise while most companies and sellers have not yet experienced a rise in incomes because Bernanke’s printing press paper hasn’t yet reached them. When this happens, widespread losses and unemployment results.

  13. Gravatar of Geoff Geoff
    21. November 2013 at 15:16

    “Oh good, another austro-sadist who thinks sticky wages are the gubmint’s fault.”

    O good, another statist-sadist who thinks sticky wages are not exacerbated in any way by perpetual inflation from the “gubmint”.

  14. Gravatar of Daniel Daniel
    21. November 2013 at 15:39

    sticky wages are not exacerbated in any way by perpetual inflation

    Stopped clock, twice a day.
    Do note that even a brainwashed austrian cannot bring himself to say that wage stickiness doesn’t have human cognitive limitations (of which you provide an outstanding example) as a fundamental cause.

    Not to mention stuff like debts – they’re sticky too, moron. Is that the gubmint’s fault, too ?

    So what’s easier and less painful ? Getting people to accept pay cuts, causing bankruptcies, etc – or printing some money ?

    On a related note, what’s more pointless ? Discussing biology with a creationist or macroeconomics with an austro-nut ?

  15. Gravatar of Ram Ram
    21. November 2013 at 15:48

    I think you’ve missed the point, John. You’re correct that if the Fed is successful, this will tend to raise, rather than lower, long-term rates. The reasoning from a price change comes in when you judge this to be partly self-defeating. Higher interest rates are only a symptom of monetary contraction when they result from the liquidity effect. When they result from higher expected inflation or economic growth, they’re a symptom of monetary expansion. Instead of wondering about the effects of a rise in interest rates, we should first ask why interest rates rose. If they rose because of expansionary forward guidance, then it’s pure expansion. If they rose because the Fed is contracting the money supply, then it’s pure contraction. The change in interest rates by itself tells you nothing about the policy.

  16. Gravatar of Vivian Darkbloom Vivian Darkbloom
    21. November 2013 at 15:48

    “Look at it from the perspective of a bond trader.”

    I’m not a bond trader, but I doubt traders immediately price into their trades events they think may happen in a year, two years, three years or even longer out.

    If the Fed is able to affect current prices through their purchases of longer term bonds then this will surely affect what a trader thinks about the price today. If the Fed is successful this may certainly influence the speed of the recovery and also bring forward the date that interest rates would rise due to the improving economy (and end of the Fed’s purchases). But, will that factor into how much a trader will pay for a bond *today*? I doubt it and it would only be “self-defeating” of the Fed if they did. It would likely affect how much an *investor* would pay for a long bond, but not a trader. And, there appear to be far more traders in the market than investors.

    Suppose that a “bond trader” (Carney’s term) thinks that the economy might recover sufficiently that rates would begin to increase in three years time. But, further assume that that same trader thinks that the Fed’s forward guidance (combined with their current purchases) would move that date up to two years in the future. Would a *trader* factor the forward guidance into *today’s price*? I doubt it. In fact, if you think about it, why wouldn’t that trader factor into today’s price the recovery that he expects to happen in three years? I don’t think this is a matter of deriving today’s price by discounting to present value the date of the future expected recovery. The trader is more interested, I think, in what the Fed says it will not do now and for some time then they are with what the Fed signals it will do when that time is up.

    I also think that this is a shortcoming of the EMH which is often expressed as the idea that all available information is factored into the market price today. Of course, this could also be a shortcoming of how the EMH is described and understood. I think the fallacy here is that while “information” may be available to the market, that “information” may be ignored and not factored into today’s market price. If one is trading a 30 year bond, are you really concerned about what you think inflation and interest rates might be 30 years from now? I think traders and markets are (more) often like car drivers in a game of chicken. Everyone knows that there is a cliff ahead, but until the cliff is reached, it is what the other driver now does (or does not do) that is influencing your decision making. And, what I’m willing to pay for a bond today is based on whether the Fed is in the market today, not whether they may exit the market in a few years’ time. Of course, once they think the cliff is *imminent*, traders will make their move, but not before they have to. I think this is supported by the reactions to the Fed’s taper talk. Traders are reacting to what they think might happen a few months from now and not a few years from now.

  17. Gravatar of benjamin cole benjamin cole
    21. November 2013 at 17:37

    I always wondered why the BoJ was too tight…now with the lesson of Japan as a guide…I am wondering why the Fed and ECB are too tight….Central banking cannot be left in the hands of central bankers…

  18. Gravatar of Scott Sumner Scott Sumner
    21. November 2013 at 17:40

    Benoit, Yes, the implicit assumption is that low rates are good news for the recovery. Sometimes true, but not if caused by bearish expectations.

    Thanks SG.

    Dan, Yes, supply side reforms too.

    Tommy, Be careful. It’s true that growth expectations have risen modestly in the past year. But market response to tapering rumors suggests that tapering information is still bearish, at the margin.

    Mark, There’s a certain type of commenter that always forgets about the currency stock.

    Dan, Not sure why you are lumping Bernanke and monetarists together . . .

    John, I should have been clearer. There’s no problem with the claim that expectations of stronger growth could lead to higher rates, the problem is the claim that it might be better if we didn’t have expectations of faster growth, as rates would rise less. Higher rates are not a cause of anything, they are an effect of other shifts in the economy. If they are caused by faster NGDP growth expectations, that’s bullish.

    Ram, As usual you state it more clearly than I did.

  19. Gravatar of jknarr jknarr
    21. November 2013 at 17:41

    John C, it’s not the doubt about anticipated effectiveness, it is the reality of its effectiveness. These traders are only price speculators, not NGDP creators.

    Nothing a bond trader says or does will ever influence the nominal economy, and hence nominal yields — traders will only ultimately price in NGDP reality: they are price takers.

    If the economy cannot take higher rates, then by definition it won’t expand, and anticipatory price speculation will fail — and that’s the economy talking, not traders and prices. Don’t reason from yield changes, but instead reason from monetary base versus NGDP changes — only the monetary base affects the nominal economy. That is, yields/prices are symptoms, not causes.

    Bottom line, NGDP does not need a longer- or shorter- period with zero interest rates, it needs huge volumes of base money circulating in the economy.

    Friedman alludes to the issue:
    “As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

    During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”

    It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

    The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy.”

  20. Gravatar of Geoff Geoff
    21. November 2013 at 19:23


    “The change in interest rates by itself tells you nothing about the policy.”

    Same thing is true for changes in NGDP. NGDP could grow because of a decline in cash holding waiting times, or it could grow because of inflation of the money supply. The change in NGDP by itself tells you nothing about the policy.

  21. Gravatar of Saturos Saturos
    21. November 2013 at 21:31

    To be even clearer, when Scott posts that beautiful picture of Mt. Fuji, he’s not suggesting that Japan is a good outcome for the US.

  22. Gravatar of Ralph Musgrave Ralph Musgrave
    22. November 2013 at 05:52

    Dan W,

    Re your “rational people expecting the helicopter to land” argument, that isn’t clear. But whatever interpretation is put on the phrase, the idea falls apart. E.g….

    First, the helicopter has NEVER LANDED in the sense that the monetary base has grown steadily in dollar terms for the last seven decades or more.

    Second, the Fed won’t slow down the rate of base expansion as long as the existing rate of expansion is needed. So why would “rational people” expect the helicopter to land?

    Of course if the private sector confidence rises significantly, then the Fed may slow down or stop or even reverse the expansion. The problem with that being what exactly?

  23. Gravatar of Dan W. Dan W.
    22. November 2013 at 07:15


    The problem is that the markets are not linear and the central planners have no ability to know the precise change in inputs to realize a successful taper.

    I suggest you revisit the history of 2008. Look at the price changes that occurred throughout the economy. Certainly no one intended there to be a crash. But there was a crash. Why? I submit it was because the Federal Reserve assumed the impossible task of levitating the general economy (following the popping of the mortgage bubble) while hoping to prevent a subsequent bubble in commodities. Commodity prices started to get out of hand, the Fed pressed the brake a bit harder and then the floor fell out from under them.

    The answer is to not give the Federal Reserve more levers to pull. The answer is to stop assuming they can fly the helicopter in the first place!

  24. Gravatar of Daniel Daniel
    22. November 2013 at 08:17

    But there was a crash. Why?

    Edumacate yourself, bro.

    You might find yourself spewing less nonsense.

    FYI, the housing “bubble” popped in 2006. 2 years- that’s one hell of a transmission mechanism.

  25. Gravatar of Cory Cory
    22. November 2013 at 09:54

    So, from RAM’s post, if long-term rates are rising because the market expects faster economic growth that is a good thing.

    But, what if the real-world effects of those higher rates stop the expected faster growth from actually coming to pass? Is there any concern over that at all?

    So, Person X reads the WSJ and sees long-term rates rise and he says, “Hey, I think this is because the markets expect faster growth! These are the good types of rate increases, so it appears”

    Feeling confident, he no longer feels the need to sit on his savings as he expects sales to increase at his business and so he goes to buy a new Dodge Durango because of the new Commercials with Ron Burgundy in them and to buy a new bachelor pad so he can live like Ron Burgundy.

    Unfortunately he is saddened as mortgage rates and automobile rates have increased along with other long term rates in expectation of faster growth. He instead chooses not to purchase the new car or the new home and this type of thing actually harms GDP.

    Seems like a conundrum to me but I am not sure. Maybe the positive effects of faster economic growth expectations outweigh any contractionary effects to AD from the concurrent rate increases?

    I.E. Maybe business people will have to buy new equipment, trucks, properties, etc. financed at the slightly higher long-term rates in order to match increased sales projections that may come with expecting faster growth and that outweighs any decreased consumption or what have you???

  26. Gravatar of ssumner ssumner
    23. November 2013 at 10:28

    Cory, Anything is possible, but do you want to base an argument on irrational expectations?

  27. Gravatar of John Carney John Carney
    26. November 2013 at 06:40


    Thanks for your clarification.

    I don’t think Cory’s story is about irrational expectations at all. It’s about reflexivity.

  28. Gravatar of ssumner ssumner
    29. November 2013 at 08:45

    John, What is reflexivity?

  29. Gravatar of Sumner and Warren Mosler on Forward Guidance | Last Men and OverMen Sumner and Warren Mosler on Forward Guidance | Last Men and OverMen
    17. February 2017 at 09:09

    […] the public didn’t expect the policy to be effective?”      What I find notable about his is that Sumner is replying to something Mosler […]

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