Reinhart on Yellen
Stephen Kirchner sent me an excellent AEI piece by Vincent Reinhart:
That Yellen may go down in central banking history as “The Great Tightener” appears to pose more than a little irony, perhaps to the coming surprise and irritation of Senate Democrats who signed a letter to the president endorsing her Fed-chair candidacy in 2013. Yet, the shift in policy does not reflect a transformation of her beliefs, but rather their pursuit by different means. Tightening now follows logically from Yellen’s understanding of the economic outlook and the dynamics of the Fed’s policymaking group, the Federal Open Market Committee (FOMC). Hiking the funds rate, even as economic growth disappoints and inflation remains subdued, buys Yellen the credibility with her colleagues and market participants to subsequently tighten slowly. That is, Yellen positions herself now as a conservative central banker to ensure that she can be a compassionate one later by allowing Fed policy to remain considerably accommodative for a considerable time.
Central bankers sometimes argue that a rate increase will give them more “ammunition” to cut rates in the future. That’s actually a moronic argument, as it does exactly the opposite. Fed funds target rate increases tend to reduce the Wicksellian equilibrium interest rate, and hence give them less ammunition for the future. The ECB in 2011 is now the classic example, but you can cite Sweden, or Japan (2000 and 2006) or the US (1937) as well.
In contrast, Reinhart has provided what seems to me to be the most plausible explanation for Yellen’s oddly hawkish views. She’s storing up reputational ammunition, which can be used in the future.
The entire article is worth reading.
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14. December 2015 at 08:40
So this is the argument that, e.g., a temporary freeze on immigration or visas gives more credibility to prevent permanent cuts? How frequently does this argument actually work, instead of shifting the window of possible responses in the wrong direction?
14. December 2015 at 08:42
The markets seem, er, far from persuaded. They seem to view her tightening as tightening. Nice little market collapse over the past week.
14. December 2015 at 08:52
Bernanke spent ’06-’08 building up reputation ammunition so that he could be easier from ’09-’14. Yep, the strategy works!
14. December 2015 at 09:14
“That’s actually a moronic argument”
Couldn’t agree more!
14. December 2015 at 10:03
Kinda the opposite of Krugman’s credibly promising to be irresponsible?
🙂
14. December 2015 at 10:22
Have you seen Larry Summers’ latest? http://larrysummers.com/2015/12/14/neutral-rate-news/
14. December 2015 at 11:44
This paper appears to me as an appalling gulp of Fedborg Kool-aid that, if it were in print form, I’d gladly use to line my birdcage.
14. December 2015 at 11:59
Scott have you seen this roundup of the missing inflation:
http://www.wsj.com/articles/the-mystery-of-missing-inflation-weighs-on-fed-rate-move-1450056838
Some choice quotes from some of your peeps like Bernanke, Yellen, etc.
14. December 2015 at 12:04
John, Is there much evidence that the recent market declines are due to Fed policy? Hasn’t a rate increase been priced in for weeks?
foosion, No, but I’ll take a look.
Bonnie. I haven’t seen a better explanation for Yellen’s views.
Benny, Yes, I’ll probably do a post.
14. December 2015 at 12:26
Scott, I think this explanation is wrong. The fact is that Yellen is a “Phillip curv’ian” and as unemployment drops she thinks we will get inflation soon through a cost-push mechanism. She is simply Arthur Burns (with no Nixon) and low rather than high unemployment.
http://marketmonetarist.com/2015/08/08/yellen-should-re-read-friedmans-the-role-of-monetary-policy-and-lay-the-phillips-curve-to-rest/
14. December 2015 at 13:50
“Hasn’t a rate increase been priced in for weeks?”
Passive tightening?
Credit markets are in big trouble. Initially it was just energy, but two junk funds halted redemptions and now there is a contagion spreading through emerging markets, industrials, leveraged loans, and now spreading into banks and Baa investment grade.
14. December 2015 at 13:56
Interesting comparison: you believe that keeping interest rates ABOVE the wicksellian rate today reduces the Wicksellian rate tomorrow. OTOH Austrians believe that keeping rates BELOW the wicksellian rate today reduces the wicksellian rate tomorrow. (indeed they believe today’s low wicksellian rate is caused by the Fed which kept interest rates too low yesterday)
14. December 2015 at 16:05
Yellen must genuflect to the tight-money totem.
I am trying to think: is there a modern major developed economy where tight money has worked?
14. December 2015 at 17:46
Maurizio wrote:
“OTOH Austrians believe that keeping rates BELOW the wicksellian rate today reduces the wicksellian rate tomorrow.”
No, they can’t possibly believe that. Isn’t their story of the crisis, the Fed kept interest rates too low for too long, leading to the housing boom (and subsequent crash)?
14. December 2015 at 17:48
George Selgin was on Econtalk today (talking about his recent Alt-M posts on the Fed and the crisis). Interesting stuff.
http://www.econtalk.org/archives/2015/12/george_selgin_o.html
14. December 2015 at 18:01
Ugh, I saw that WSJ article on MR. Well, sort of. Tyler’s link is broken. The link was posted in the comment and is probably what Tyler’s link was supposed to be. Here’s my comment on it.
“The article’s a mess. There’s a straight-forward explanation for tepid inflation: loose employment markets. The prime-age ratio shows many missing workers, unless stay-at-home parenting or getting three Phd’s really became much more popular since 2008. Even if everybody out of the labor force truly couldn’t be reemployed, an unemployment rate of 5% would not be grounds for tightening if interest rates were at 4%. With the same current inflation level and unemployment, rates would not be raised at 4%.
Of course the only reason for a rate change now is significant pressure to increase rates, or the drum beat of “normal interest rate” environment. But if the role of the Fed is not to control inflation and unemployment, then what exactly is the role of the Fed? Trying to use interest rates to increase real interest rates will not work for most investors. Basically, the Fed trying to dictate real interest rates amounts to the government dictating minimum wages. Just because wage is set at a level doesn’t mean employers will pay it.”
It’s crazy. For the sake of brevity, I didn’t address the demographic explanation. For one, it’s disproven by Abenomics. Unemployment went down and inflation went up, as Phillips curve and sticky wages would predict. I also don’t think the goods seniors buy are that different, at least not different enough to impact the US just over the last seven years.
14. December 2015 at 18:17
Looking at my comment again, it’s wrong that the Fed couldn’t necessarily dictate high real interest rates. Increasing interest rates significantly could be done if the Fed either destroyed a ton of money (sold assets) or increased interest on excess reserves.
The “normal interest rate environment” stuff somehow assumes the current recovery would become like the economic environment of the 90’s and pre-2008 00’s. The unemployment pressures will kill the higher rates very soon, as they did in Japan and Europe.
As long as the Fed will not tolerate mass unemployment, it cannot raise real interest rates. Even if it did, many investors would lose a lot of money. Investors in stock lose money. Investors in bonds with any decent term also lose money.
ONLY investors in short-term bonds or cash would gain money through higher real interest rates. The only other group I can think of who gains are union employees or pensioners who have their benefits set to interest rates rather than inflation. SS is set to wage inflation and so the benefits would stay flat or decline (as they would have in 2008).
If THAT is the role of the Fed: only help those two groups at the expense of everyone else, then that’s a strange goal. New investment would also earn higher real returns, but if the Fed created another Great Depression in service of higher real interest rates, how many people would have new money to invest?
14. December 2015 at 19:38
So, in Sweden, we have loose money and never ending interest only loans. The dark side is that there seems to be nothing to stop house prices from going up. Stockholm is more expensive than San Francisco! This is pricing to the moon.
The only things that could temper this are a dampening of the economy, which probably won’t happen soon, or down payments that become so expensive that they are prohibitive.
That is the flip side of the Yellen, tight money, doctrine. It has its own risks.
14. December 2015 at 20:45
“In contrast, Reinhart has provided what seems to me to be the most plausible explanation for Yellen’s oddly hawkish views.”
I also meant to say I agree that Reinhart’s observation is highly plausible. However it is also highly disturbing; it is saying that we now have a “Fed Chair Economic Cycle” where each new Fed head has to tank the economy in a central bank hazing exercise. Once done, they have proved they have the mettle to run the fraternity.
14. December 2015 at 22:19
@Michael Byrnes:
“No, they can’t possibly believe that. Isn’t their story of the crisis, the Fed kept interest rates too low for too long”
Yes. But too low relative to what? To what they call the natural rate. That is, the wicksellian rate.
To sum up: they say that the Fed (before 2008 I presume) kept rates lower than the wicksellian rate, and this created malinvestment, consuming capital and making it less productive (= lowering the wicksellian rate in Sumner terms).
14. December 2015 at 23:15
Foosion, reading the article at the Summers blog, it looks like Larry Summers believes that you have to have ammunition to fight the next downturn. He says you need at least 3 percent so when you lower rates you will not have to go negative. But then he never has a good time for raising so maybe that is just a futile wish on his part.
15. December 2015 at 02:22
Gary Anderson,
If Stockholm wants lower prices it should allow more housing to be built.
15. December 2015 at 07:14
Out of topic: here is an interesting interview with Bernanke ahead of the Fed hike, where he talks about negative interest rates, fiscal policy, short term rates as the prefered tool, the CB being out of ammo, …
http://www.marketwatch.com/story/bernanke-says-he-never-expected-rates-to-be-at-zero-for-so-long-2015-12-15?page=1
15. December 2015 at 07:53
Boring.
Off-topic: going through my Econ 101 book by Blanchard, as a refresher and it’s amazing how the IS-LM curves are assumed to exist as downward sloping and upward sloping, respectively. Though I kind of get why the former is downward sloping, (“an increase in the interest rate decreases investment”), why the latter is upward sloping seems completely arbitrary (“when income increases, money demand increases”). In fact, I can see the LM curve being flat or even downward sloping (the rich need less money as they get richer, so money demand could decrease). Also amusing, as I’ve remarked before, is how Blanchard cites an econometrics study that ‘proves’ LS-IM works in real life, but to 60% confidence level, not the usual 95% confidence. That’s not much better than 50% chance. Yet I bet Sumner believes this stuff. Monetarism is a colossus with feet of clay.
15. December 2015 at 08:28
Charger Karl, yes, it is quite regulated. I don’t know why, do you? Oh, and I mentioned Scott’s view that negative interest rates on excess bank reserves are expansionary here: http://www.talkmarkets.com/content/global-markets/swedish-cashless-negative-rate-ponzi-real-estate-society-still-a-good-investment?post=80375
15. December 2015 at 10:07
There is no point appointing doves to chair the Fed if they give the hawks a policy veto.
15. December 2015 at 17:12
Lars, That’s part of it, but I think he’s on to something here.
Maurizio, I doubt they believe that, it’s not rocket science.
Matt, I have an Econlog post on that.
Thanks MFFA.
Ray, Two idiotic things today. You don’t have a clue as to what IS-LM is about, and you claim that I like the model, which has me rolling on the floor. Like a kid with a blindfold playing pin the tail on the donkey.
15. December 2015 at 18:54
Sumner: “Ray, Two idiotic things today. You don’t have a clue as to what IS-LM is about, and you claim that I like the model, which has me rolling on the floor.?” –
First, I did not even say what the IS-LM is “about”, I just said the upward sloping LM curve is not obvious to me. Second, I qualified that you “probably” believe in monetarism as evidenced by IS-LM. I now see you don’t; good on you.
16. December 2015 at 08:09
This post and some comments just show how political this whole thing has become. The world need a rules based FED ASAP.
16. December 2015 at 09:56
@Jose Romeu Robazzi – we did have a rules based central bank system, it was called The Gold Standard. Sumner et al ruined it. Not that it really matters, as money is largely neutral.
Off-topic: I’m curious as to what part of the IS-LM model Sumner disagrees with.
16. December 2015 at 10:33
“Maurizio, I doubt they believe that, it’s not rocket science.”
Prof. Sumner, I think I may have reconciled the Austrian theory with Market Monetarism. Everything falls in its place 🙂
I think you and Austrians are both right: in the first phase, the boom, rates where too low (as Austrians say). Now, in the second phase, after the bust, they are too high. (as you say).
To elaborate: in the first phase, the “boom”, the Fed keeps rates too low, i.e. below the wicksellian rate. This causes malinvestment. Sooner or later the malinvestment reveals itself (bust): all of a sudden we realize we have a lot of capital which cannot be put to any good use. The return to capital suddenly goes down. But this is like saying the wicksellian rate has gone down. And it has gone down so much that it has crossed the rate set by the Fed. So, in the second phase, the bust, the rates set by the Fed are actually too high (whereas in the boom phase they were too low).
So you and the Austrians are both right. But the Austrians do not understand that rates now are too high; and you (I think) do not understand that this is caused by the fact that they have been too low in the previous phase.
16. December 2015 at 12:18
“the Fed keeps rates too low, i.e. below the wicksellian rate. This causes malinvestment. Sooner or later the malinvestment reveals itself (bust)”
Next time I go to Austria (maybe Feb-Mar this year). When I am on the gondola, I am going to ask some Austrian to explain this to me. I keep hearing it again and again but just don’t seem to grasp the mechanics.
Take the current poster child for mal-investment, the oil paw paw patch, now if you tell me that this was interest rate led investment I would assume you would be saying this while sitting in a bathtub farting and giggling having gone full out retard.
16. December 2015 at 13:49
Ray, You still don’t know? Really?
I think the IS curve often slopes upward.
Maurizio, How do Austrians know what the Wicksellian equilibrium rate is?
16. December 2015 at 18:39
Sumner: [on what part of the IS-LM curve he disagrees with, after I pointed out I thought a downward sloping LM curve is not always obvious}
” Ray, You still don’t know? Really?
I think the IS curve often slopes upward. ”
Really? Where in your numerous blogs or papers have you ever said this? Is this obvious from your writings so that I should know?
To me the upward sloping IS curve was more logical than the downward sloping LM curve.
Refresher from my notes (yes I’m a skolar):
Y = Supply of goods = LHS = demand of goods = RHS at equilibrium
Y = Consumption*(Y-Taxes) + Investment(Y,i) + GovernmentNet + 0(closed economy, ignoring exports/imports)
Where Investment=Investment(Y,i)(+,-), meaning it’s assumed that investment depends on production such that if production increases so does investment,and *** if interest rate i increases then investment decreases *** (emphasis)
So we can agree that investment depends positively on production? I think so, it’s pretty logical, as most business people are not counter-cyclical but pro-cyclical meaning they invest more when times are good. Therefore the part you disagree with seems to be the emphasis above, that if interest rates increase then investment decreases, and vice versa. Why do you find this controversial? It’s logical from a supply perspective: when businessmen like me (I’m presently, among other things, a chicken farmer in the Philippines) plan projects, they look at the interest rate when doing present value analysis, concerning the discount rate. So a higher interest rate makes an investment less attractive, since you can park your money in the bank and make a lot of money, rather than risking it on a business investment.
Please blog on this, we readers are fascinated how unconventional your thinking is.
16. December 2015 at 18:42
Sigh…WordPress.
To me the *upward sloping* IS curve was more logical than the *downward sloping* LM curve.
should read: ‘downward sloping’ and ‘upward sloping’, respectively.
16. December 2015 at 23:55
@sumner
“How do Austrians know what the Wicksellian equilibrium rate is?”
They don’t think it is possible to know it, prof. (They don’t buy the Wicksell method to watch for inflation or deflation). Why do you ask?
17. December 2015 at 09:44
@derivs
“I just don’t seem to grasp the mechanics.”
the mechanics is this: if the natural rate decreases, it becomes profitable to build more capital, capital that previously would not have been profitable.
But entrepreneurs cannot observe the natural rate, they can only observe the Fed-set rate. So they can only react to that rate. If the Fed rate is set below the natural rate, entrepreneurs will start building new capital AS IF it were profitable. But they are actually buinding capital that cannot be put to good use. This means that, when they finish building the capital, they realize all at once that it cannot be put to good use. In other words, that the return to capital has fallen to zero. This is like saying that the natural rate has decreased. If we summarize that, we have obtained that keeping the Fed rates below natural rate in period one causes the natural rate to fall in period 2.
17. December 2015 at 10:15
Maurizio…
And you really believe the main driver to mal-investment is interest rates??????
Using the oil industry, can you show me how it was very low interest rates that led to any of the mal-investment, because it was not.
I for one never cared about the “natural rate”. Just cared where the market is so I could hedge out my damn i rate risk…. After which rates had my permission to do whatever they wanted…
17. December 2015 at 15:21
“And you really believe the main driver to mal-investment is interest rates??????”
what do you think caused the housing bubble? Do you think it would have been possible without Fed rates below the natural rate?
And why are you talking about the oil industry at all?
17. December 2015 at 16:49
Ray, You asked:
“Is this obvious from your writings so that I should know?”
Yes.
Maurizio, I misunderstood you—I thought you were suggesting that Austrians claimed the interest rates was below the neutral rate during the housing boom.
You asked:
“what do you think caused the housing bubble? Do you think it would have been possible without Fed rates below the natural rate?”
Obviously yes.
17. December 2015 at 18:10
Derivs:
“And you really believe the main driver to mal-investment is interest rates??????”
For the specific type of malinvestment that leads to the inter-temporal discoordination of capital, which you know as the business cycle, yes, it is interest rate manipulation that is the key driver.
Malinvestment is NOT “too much investment”. Malinvestment is the WRONG investment. There is room enough in the economy for practically unlimited investment in the abstract. The maximum of course is the totality of all resources capable of being produced minus those few goods that are just sufficient to sustaining human health and existence pursuant to enabling the high investment to be maintained.
When you have a finite supply of goods at any given time, you can only either consume it now, or invest it for production of consumer goods at later dates. Now the later dates are not just “later”, but a specific kind of later. The more later the goods will be ready, the more you must be compensated, which is to say the further out the prospect of consuming, the higher the payoff must be.
Interest rates in a free market are a vital, super important, crucial, totally unappreciated by Keynesianism including its offshoots such as market monetarism, REGULATORY mechanism that forces us to make sure that the investments we do make, are made such that the intended time of consumption, matches up with the resources available to complete those investments for those future consumption activities.
What the central bank does when it encourages credit expansion, is not only an aggregate increase in spending for everything, but more importantly, it encourages specific increases in specific expenditures. By artificially lowering interest rates below market rates, what that does is make it impossible for us to know whether or not our investments for future consumption will have an adequate supply of complimentary resources to complete. Not only that, but it encourages, indeed forces through regular economic competition, resources to be invested in project timelines that always and without exception lack the sufficient resources to enable completion.
This theory does not assert that investors lead into this mess time and time again because they are for some reason unable to learn the information that can be learned. The problem is that the information and the resultant property allocations needed by investors to learn and complete their investments does not even exist. Market interest rates do not exist. The resources needed to complete all the projects started on the basis of below market rates does not exist.
Investors are not being called incompetent. They are being identified as victimized by an absence of market signals and market determined material allocations.
It is impossible for investors to someday transcend this. Sumner falsely believes that with enough time of “stable NGDP”, then investors will at some point learn to adapt in such a way that the type of malinvestment caused by artificially low interest rates, will become such a minor factor, due to the claimed miracle of ending socialist money induced recessions forever (is that ever naive and silly!) that we may as well ignore it. You know, bigger fish to fry and everything, which really means “Don’t talk to me about it, I don’t have an answer for that because I am too busy trying to gain for myself in the short term, screw the future generations”.
Artificially low interest rates, in combination with regular economic competition, forces resources to invested in either too many projects for near term consumption and not enough future term projects, or, what is more common, too many projects for future term consumption and not enough for near term consumption.
Houses are an example of longer term, capital intensive projects, because not only is the construction of houses a longer term project, but far more importantly, all the machines and materials that go into the construction of houses, and the machines that are used to produce those machines, and the machines that help produce those machine producing machines, we are talking about investment horizons that stretch a decade, and more.
The housing boom, as huge as it was, was actually only a relatively small boom on top of the much larger capital boom that was sustained as long as it had been because of China. It was reignited with the central banks around the world accelerating inflation to even more absurd levels. They could do this because for the first time in history, the prevention of a world depression could be made on the basis of the entire world being on a fiat standard, and the central banks around the world could inflate together to bring about a world malinvestment boom.
This of course could never be sustained, because printing money to keep an economy from correcting in a necessarily deflationary manner has never worked and never will work, but they tried, and they brought interest rates down to practically zero, even negative for certain rates in the world. The world is on the cusp of the biggest economic boom ever. This has been essentially forgotten by even the most ardent free market economists. Even they were unprepared for just how long and extensive this boom could be, that some of them have even started questioning their theoretical framework and are in a kind of no man’s land, temporarily leaving aside the “doom and gloom” theory that isn’t palatable to the “I only think what I see” mainstream discourse.
Mark my words. When this boom ends, as it will, it will be the biggest correction you or anyone in history will have ever experienced, save perhaps the collapse of the Roman Empire (which was also caused by a collapse of the Denarius due to devaluation and an unsustainable boom).
It is so incredibly easy to become complacent and to practically accept what has happened since 2009 such that what occurred then was simply not enough money printing at the time. That view is so wrong and so irresponsible.
This boom could last another 10 years, if there are enough resources to stretch and distort the world’s capital structure even more. Or it could last just one more year. It is impossible to predict, not because the theory above is useless or impractical, but because it is impossible to predict what people will learn and WHEN they will learn it. That is why no economic models can predict anything in the realm of human activity.
Every consistent model of man is incomplete, and every complete model of man is inconsistent.
Sumner has made a huge malinvestment in his career. And just like the home builders who made lots of money in the housing boom but then retired and got out before the music ended, it appears as though what he is doing is a service. In the short run, possibly. But the entire school of monetarism is itself a malinvestment. Sustained and indirectly propped up continuously by the very inflation it depends on for validity. If the socialist central banks around the world stopped financing academia, bye bye monetarism. This is why Sumner is unable/unwilling to truly engage criticisms of central banks at the core. His career depends on doing otherwise. It likely feels a little like a child having to reject their own parents and fend for oneself. That is why we often see the “Everything is happy and fine and nice and normal and fine and nice and good” posts from time to time. Little reminders that mommy and daddy are still putting food on the table.
17. December 2015 at 18:19
It is quite possible that the industry I am in is in a malinvestment boom as well, but I don’t worry about losing my job.
17. December 2015 at 21:11
@MF- the investment manager Hussman of Hussmanfunds dot com mentioned malinvestment in his latest musings. I personally believe in malinvestment (herd behavior) but don’t think interest rates nor money supply have much to do with it.
@Sumner -which of your writings supports the thesis that the LM curve is downward sloping?
Just for completeness, here is the rest of the equation of IS-LM, for the other blade of the scissors, supply of money M/P (real):
M/P = Y*L(i) (real), where L(i) interest rate curve, and, it is assumed, an increase in income will increase the demand for money, or, for any given M, increase in Y will increase i. “higher economic activity puts pressure on interest rates”
18. December 2015 at 00:41
Prof. Sumner, when someone asks “what caused the great recession”, I know your reply is “the Fed did”. And I agree (you mean, I believe, that their failure too keep NGDP on its path caused the recession. i.e. the Fed kept rates much higher than the wicksellian rate.). But I don’t think this really answers the question, because the true sense of the question is “what caused the wicksellian rate to drop so much?”. What would you reply to the question posed that way? Thanks a lot
18. December 2015 at 09:33
“what do you think caused the housing bubble? Do you think it would have been possible without Fed rates below the natural rate?
And why are you talking about the oil industry at all?”
1- Yes, yes, and yes…. Housing bubble I saw coming a mile away. When I hear the word debt I think of cash flow repayment capacity and intrinsic value of the underlying asset, and the first of those 2 were being completely ignored and the second one went tits up when prices started dropping. Can’t lend money to people without the capacity to repay. Always leads to bad things happening.
Now in all my few years in banking, dealing with M+A and P+E guys i have NEVER heard anyone ever discuss Wilkensinian anything as related to an investment. The guy might as well be the Defensive End for the NY Jets for all anyone cares about him.
I keep mentioning the oil industry because it is the current poster child of mal-investment. You draw the conclusion mal-investment is caused by interest rates. So show me.
18. December 2015 at 12:22
Ray, That just reflects the fact that money demand is negatively related to the interest rate and positively related to the level of real output.
Maurizio, The Wicksellian rate fell sharply for two reasons:
1. Tight money slowed NGDP growth.
2. The housing slump reduced credit demand.
20. December 2015 at 07:44
Prof. Sumner, thank you for your patient explanations. I am still trying to understand the implications of what you say.
“Maurizio, The Wicksellian rate fell sharply for two reasons: 1. Tight money slowed NGDP growth.”
I am not sure I get this. The question is “why did the wicksellian rate fall so much that the huge amount of money printed was still too little?” And you respond “because the money printed was too little”. Isn’t this circular?
“2. The housing slump reduced credit demand.”
Ok, so you are saying that the fact that too many bad loans were made reduced the wicksellian rate. Why were too many bad loans made? Can we conceive this to happen unless the Fed rates are lower than the wicksellian rate?
20. December 2015 at 18:03
Sumner: “Ray, That just reflects the fact that money demand is negatively related to the interest rate and positively related to the level of real output” – wow, that’s quite a concession. I would have said, if I was a monetarist, that the IS curve represents real demand of goods based on money, which as you say is negatively related to the interest rate, while, unlike your implication, the LM curve represents real supply of goods based on money as issued by the monopoly central bank, and can be manipulated to affect real output since real output increases linearly with income Y and interest rates i. The way you said it (“money demand is negatively related to the interest rate and positively related to the level of real output”), implies in my mind the more correct interpretation of money neutrality, which is money (both its level and rate of change) is just a facilitator for goods & services and has no sizable effect on real output. Since this is a not a distance learning site I’ll leave it at that and will probably not return to this thread.
21. December 2015 at 17:42
Maurizio, You asked:
“Why were too many bad loans made? Can we conceive this to happen unless the Fed rates are lower than the wicksellian rate?”
Of course, indeed I don’t even understand how an excessively low interest rate would cause banks to make bad loans–no one is putting a gun to their heads.
As far as money, printing too little money in late 2007 and early 2008 caused NGDP to slump, which caused the Wicksellian equilibrium rate to fall. Once it hit zero even large increases in the base have little effect.