Recent links

Paul Krugman is just as confused by Koo as I am:

Finally, Koo seems to regard higher inflation expectations as a disaster, when in reality they are the whole point of the exercise. What?

I guess I’ve always found Koo fairly incomprehensible on monetary policy. . . .

As I said, I just don’t understand Koo’s position here. If he wants to argue that monetary policy is unlikely to be effective, fine; but he wants to claim that it’s positively harmful, and I just don’t get the logic.

Anyway, back to Japanese interest rates: they really don’t pose a puzzle, nor, at least so far, do they pose a threat.

I mostly agree, but would strong take issue with the term ‘fine.’  It’s not fine to argue Japan is in a liquidity “trap,” it’s flat out wrong, and those views have been very harmful to the Japanese people.

Speaking of Krugman, he really needs to address this criticism by Steven Landsburg, linked to by Greg Mankiw.  If he doesn’t, look for people like Rogoff to say “I told you so.”

Tyler Cowen suggests that Bernanke might scale back QE in order to minimize the risk of another bubble.  I have a couple problems with that view.  First, it’s not clear that QE has the potential to create bubbles, except in the obvious sense that a bubble might be more likely in a prosperous economy than a depressed economy.  But Bernanke would not move on that basis.  Another argument is that fiscal austerity is less likely to prevent bubbles than removing QE, even though both keep an economy depressed, because removing QE will lead to higher interest rates.  But we know from multiple historical examples that monetary tightening at the zero bound tends to lower interest rates, not raise them.

Of course just because I believe something doesn’t mean Bernanke buys my analysis, and Tyler refers to the risk of unlikely but very harmful outcomes.  Still, based on everything I’ve heard from Bernanke over the past few years, he sees the biggest tail risk as a repeat of 1937, not another bubble.

In my view a tapering of QE, if it occurs this year, will be motivated by Fed fears of capital losses on its large bond portfolio.  That’s an even more inexcusable fear than bubbles, because the Fed is part of the Federal government.  But then I don’t have to go to Congress and explain why the Fed went broke.

David Glasner has a post on the weakening correlation between inflation expectations and stock prices, and I believe he gets it exactly right:

What does this mean for policy? The empirical correlation between inflation expectations and asset prices is subject to an identification problem. Just because recent developments may have caused the observed correlation between inflation expectations and stock prices to disappear, one can’t conclude that, in the “true” structural model, the effect of a monetary policy that raised inflation expectations would not be to raise asset prices. The current semi-normal is not necessarily a true normal.

So my cautionary message is: Don’t use the recent disappearance of the correlation between inflation expectations and asset prices to conclude that it’s safe to abandon QE.



23 Responses to “Recent links”

  1. Gravatar of Jon Jon
    10. June 2013 at 06:45

    The fed should start negotiations with congress for a put, before the crisis hits.

  2. Gravatar of Rob Rawlings Rob Rawlings
    10. June 2013 at 07:01

    I just read Krugman’s “itsy-bitsy liquidity trap model” that he refers to in that post

    He starts out by assuming that Japan must be in a liquidity trap (I guess that’s just what his model tells him must be the case). He then argues that the liquidity trap could be broken if the CB could convince people that any expansion in the money supply in the present will not be withdrawn in the next period.

    The obvious conclusion to this is that if the CB had a credible policy-based rule (like NGDPT) then no-one would have a reason to fear the kind of future monetary tightening that Krugman claims maintains the liquidity trap.

    In Krugman’s model it is fear of future bad monetary policy that maintains the symptoms of the liquidity trap rather than anything intrinsically “Keynesian” about the way the economy works. Its a shame that he won’t draw the obvious conclusions from his own model and embrace targets-based monetary policy fully, especially in the light of the points raised by Noah Smith about how the overhang of past (failed) fiscal policy in Japan may be drag on the recovery.

  3. Gravatar of jknarr jknarr
    10. June 2013 at 07:55

    Scott – tight money (that results in slow growth and low yields), created financial asset bubbles. Savers are forced to stretch for returns, cash flows are scarce by definition, and the currency is “hard”. 1970s inflation saw no financial asset bubbles. Tight money produces bubbles, loose policy unwinds bubbles.

  4. Gravatar of Doug M Doug M
    10. June 2013 at 08:13

    “Tapering off” will be a multi-step move. First the Fed will have to say that they will not be adding more assets to their ballance sheet.

    Then there will a period were assets as they pay down will be replaced on the Feds ballance sheet, which will keep the fed still active in the MBS market.

    Then assets will be allowed to roll of the ballance sheet at maturity.

    Finally, they fed might begin to actually sell assets.

    There will be many efforts to telegraph each transition, with market gyrations with each attemp to clairify the path.

    However, I don’t think that anyone is expecting a change in stance from the fed before year end, and most expect the fed to stay in their current mode through 2014.

  5. Gravatar of Geoff Geoff
    10. June 2013 at 08:16


    “If he wants to argue that monetary policy is unlikely to be effective, fine; but he wants to claim that it’s positively harmful, and I just don’t get the logic.”

    And there you have it. Krugman declares his own ignorance of basic economic concepts such as economic calculation, and malinvestment.

    It’s funny, isn’t it? While Krugman’s critics get his worldview, he doesn’t get his critic’s worldview. Not just in the sphere of agreement/disagreement, he doesn’t even understand the arguments.

    He’s in his own little bubble.

  6. Gravatar of Scott N Scott N
    10. June 2013 at 08:34

    Why does it matter whether the Fed loses money on its bond purchases? The Fed printed the money in the first place to stimulate the economy so who cares if the assets the Fed purchased end up losing money. Is the Fed supposed to function as the U.S. government’s hedge fund?

  7. Gravatar of TallDave TallDave
    10. June 2013 at 09:28

    “false, misleading data and analysis “” that’s SOP at Heritage”

    This for using real data instead of projections of what politicians claim they are planning to do. If you want to know what Krugman’s up to, look no further than what he accuses others of doing. In a saner world he’d be shunned.

  8. Gravatar of Tom Brown Tom Brown
    10. June 2013 at 09:28

    @Scott N,

    The Fed “printed” the money (Fed deposits) as a liability on its balance sheet (and as assets on the banks’) in exchange for offsetting financial assets (Tsy debt, MBSs, etc.) on its balance sheet. The Fed maintains positive or zero equity. That’s whats important from the accounting standpoint. If the Fed ends up incurring negative equity, then I believe that Treasury is charged with making that up. Now should the Fed be allowed to have negative equity just like Treasury can and does? That’s another question, but I believe that currently Treasury is on the hook for making good on large negative equity positions at the Fed.

    As it stands, can you imagine the political fallout from the Treasury having to bail out the Fed? Rand Paul would grandstand with his extremist gold-standard-libertarian nonsense for month about it! It would be Benghazi^2. The Republican party already has proposes to study a return to the gold standard in their platform (“possible ways to set a fixed value for the dollar” is the current wording)… this would be the kick in the pants needed to finally bring Bernanke up on those treason charges that Gov. Perry was so keen on. Such an event would give the gold-standard elements of the party a lot more clout and the Pauls could both grandstand until “adopt gold standard” became the official party line. Talk radio would LOVE IT!!!

  9. Gravatar of Jon Rodney Jon Rodney
    10. June 2013 at 09:42

    @TallDave: It sounds like the senator berating the heritage analyst was using bogus data, but that doesn’t mean the analysis was on the level. The argument he was making (no significant austerity in most of Europe) isn’t backed up by the data. To disguise that, he started his data set in 2007, well before the EU’s pivot to austerity, and including stimulus packages that were passed to combat the recession.

  10. Gravatar of ssumner ssumner
    10. June 2013 at 09:56

    Rob, He does favor a target approach, but worries that it might not be credible. That’s where I disagree with him.

    jknarr, I’m not sure that’s right either, but it’s more defensible than the “easy money causes bubbles” argument.

    Doug, That’s bascially my post from last week.

    Scott, Good question. I’ve made the same argument many times.

    Jon, Yes, and just because Rogoff made mistakes doesn’t mean high debt levels don’t slow growth.

    Krugman either needs to explain why the senator was right, or else apologize.

    When you accuse someone of lying, and are shown you were wrong, it’s not a defense to say “well I disagree with their methodology in some other area.”

  11. Gravatar of Ciceron Ciceron
    10. June 2013 at 10:20

    If the Fed pulls the plug on QE and the prices on a number of assets plunge because of bleak growth prospects, current asset prices will look like a bubble. And hawks will claim they were right.

  12. Gravatar of Rob Rawlings Rob Rawlings
    10. June 2013 at 11:19

    On “He [Krugman]does favor a target approach, but worries that it might not be credible”

    Well, his support for targets seems half-heated and vague based on today’s post:

    “I want the Fed, the Bank of Japan, etc. to target higher inflation, in the hope that it might help, but it’s a hope”

    Given that further fiscal policy in Japan may be untenable because of debt concerns , and that his own models tells him that monetary policy works as long as it credible, then I don’t understand why he does posts like that that can only undermine that very credibility.

  13. Gravatar of Garrett M Garrett M
    10. June 2013 at 11:39

    The weakening stocks/inflation expectations correlation seems to be coinciding with a strengthening stocks/dollar correlation:

    Any thoughts on this?

  14. Gravatar of J Mann J Mann
    10. June 2013 at 11:47

    I hate this personalization – it’s really counterproductive.

    Instead of saying “Heritage are a bunch of liars,” somebody could just say “I think comparing 2012 structural deficits to 2007 numbers is not helpful, because if you started a stimulus in 08, and now are tapering off your stimulus, that’s austerity.” Then the other side could say “when are we allowed to stop the stimulus,” and we could go from there.

    As it is, Landsburg is at least right to say that it’s laughable to burn Furth and leave Senator Whitehouse untouched.

    If Krugman and Wonkblog wanted to say “Senator Whitehouse is also a deceptive liar who should be ignored in future policy debates,” then at least they might be consistent. Or they could just explain why they disagree with both people on the facts.

  15. Gravatar of ssumner ssumner
    10. June 2013 at 14:13

    Ciceron, That’s right.

    Garrett, I think you have a similar identification problem there.

    Strong growth leads to a strong currency.

    Easy money leads to a weak currency.

    But easy money leads to stronger growth.

    So the correlation will be time-varying.

    For instance, Japanese stimulus probably helps the dollar and boosts US stock prices.

    JMann, That’s right.

  16. Gravatar of Ashok Rao Ashok Rao
    10. June 2013 at 14:56

    The above identification problem is why long-run classical style autocorrections make a lot of sense. Also why NGDPLT isn’t “easy”, contrary to any logic. It just happens to be today.

    OT: would be curious on your thoughts of ( a response to Smith and DeLong about the risks of Abenomics. After discussing this briefly w/ Nick Rowe I’d add the following comment (posted from his blog):

    “However, to the extent a small Mundell-Tobin effect is working, wouldn’t the risk that debt/GDP to crowd out capital significantly fall? Right now, at or near the zero bound that is obviously not the case. Inflation should just erode that, so the Mundell-Tobin would pick up over time, and the risk of crowding out should fall. If our initial premise that r < g is correct. The extension here is that it *stays* correct until debt becomes fundamentally manageable.

    In some sense, the question here is protecting against tail risks, and the way to do that would be to make the short run, perhaps non-neutral, period as long as possible. The best way to do this is to maximize change in inflationary expectations: target NGDP or 4% inflation .

    But let's say we're in DeLong's medium run where expected real yields are increasing. By definition we're no longer at the zero lower bound, which means an unexpected monetary base expansion can also trigger Mundell-Tobin like effects (without the contingent "credibly commit to irresponsibility" clause we have today) and provide the economy breathing room, though it seems we both doubt this is very likely.

    All said, however, the number of feedback loops in this mechanism *does* challenge my confidence.."

    Making the first point more clear, I think each debt/GDP (outside of ZLB) can be associated with some sort of prior probability on "crowding out", which naturally falls with the ratio (though not necessarily in proportion). As a rough heuristic I'd think of "crowding out" as digital rather than continuous as a 40% ratio – with lower secular rates – may not be that much less expensive than 80% but the "tail risk" of high cost falls, so to speak.

  17. Gravatar of jknarr jknarr
    10. June 2013 at 18:51

    I’ll modify. Tightening money causes bubbles. 1918-1929, 1955-1965, and 1980-present. Defined: SPX to GDP.

  18. Gravatar of John Thacker John Thacker
    10. June 2013 at 19:39

    The Heritage guy has replied here, and apparently Sen. Whitehouse’s mistake was even worse. Not only did he use projections, but he apparently took numbers that were already cumulative, and then added them together. As a result, his numbers are even crazier, implying that, for example, Ireland is going to cut spending / raise taxes by a total of 95% of its GDP.

    As Salim Furth points out, “[t]his is clearly the result of incompetence, not dishonesty,” because the double cumulative effect adds extra things that have already happened, which is weighted towards the tax increases, not the spending cuts. If Sen. Whitehouse had done the right thing, then the data would look like the total fiscal consolidation was based more on spending cuts than by his incorrect math. If, of course, you trust the projections. (Some might easily argue that since the tax increases have happened already, but the spending cuts are in the nebulous and promised future, then perhaps the cuts won’t happen.)

    Furth also notes that it was Sen. Whitehouse who used nominal and cyclically unadjusted data, thus making it look like the (future, promised) mostly spending cuts were bigger than the (already happened) mostly tax increases.

  19. Gravatar of ssumner ssumner
    11. June 2013 at 05:25

    Ashok, I agree with Nick.

    Thanks for the update John.

  20. Gravatar of Ashok Rao Ashok Rao
    11. June 2013 at 05:50

    “Ashok, I agree with Nick.” Bit confused, the comment was me in response to Nick on his blog (which I didn’t make clear). Not exactly sure what you’re agreeing with, apologies..

    Btw, Stiglitz has a very interesting take on Japan’s lost decade.

  21. Gravatar of ssumner ssumner
    11. June 2013 at 12:30

    Ashok, When he started comparing the gini of Japan and the US I gave up. What’s the ethnic diversity of Japan? 99% Japanese?

    A few years ago he was criticizing QE, now he praises it.

  22. Gravatar of Ashok Rao Ashok Rao
    11. June 2013 at 18:36

    Not saying I agree, but I did find it interesting.

    “A few years ago he was criticizing QE, now he praises it.” This is a good thing, right?

  23. Gravatar of Dan W. Dan W.
    11. June 2013 at 18:46


    What if debt is the last bubble? What happens when it pops? What happens when yields return to historical averages? It won’t just be the Federal Reserve that will go bankrupt. Who will be buying $300,000 houses when mortgage payments double?

    Fact is the economy is doing just fine for 80% of Americans. No amount of QE is going to fix the economy for the 20% but persistent manipulation may very well ruin the party for everyone.

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