Stock markets say the darndest things
We all know that little kids will often blurt out an uncomfortable truth, which is not supposed to be spoken in polite society. Stock markets also tend to mention the unmentionable:
Governor Masaaki Shirakawa expanded the Bank of Japan‘s assets by 50 percent, introduced an inflation target and safeguarded his nation’s banking system from shocks. Yet when he announced he was leaving three weeks early, stocks soared to a four-year high.
I suppose that’s not a very polite way to send him off, but markets can’t help telling the truth. This discouraged me:
Shirakawa, a career BOJ bureaucrat who trained in economics at the University of Chicago, wasn’t supposed to become governor. Originally picked for deputy, he was a compromise after two candidates failed to get parliamentary approval.
At a press conference on April 9, 2008, his first day on the job, Shirakawa warned that too much short-term stimulus could hurt long-term growth. At a press conference yesterday, he said the government and BOJ need to have discipline.
. . .
Not Shoboi
Shirakawa bristled at unfavorable comparisons with the Fed, chiding a reporter in 2011 for characterizing the BOJ’s efforts as “shoboi,” meaning lame or shabby.
“I want to strongly say that none of the policy board members, including me, think it’s shoboi,” Shirakawa said at a press conference in March of that year. He also repeatedly stressed that the BOJ’s balance sheet, currently at 163.5 trillion yen, is larger than the Fed’s as a share of the economy.
I also went to the University of Chicago. We were taught that when money is very tight, as in the 1930s, the Fed’s balance sheet will be very large as a share of GDP. And when money is very easy, as during the German hyperinflation, the balance sheet will be small as a share of GDP. Indeed I seem to recall that the German Reichbank’s balance sheet fell to less than 1% of GDP in late 1923.
I know I’m just repeating myself over and over again, but the people running the world economy really do not know what they are doing. I don’t think they are making precisely the mistakes that Paul Krugman thinks they are making, but he’s right that they are in way over their heads. And that’s true even if my policy views are 100% wrong. Sure, a hawk my have a valid reason for disagreeing with me. But to claim policy was expansionary with a bogus argument about the size of the balance sheet as a share of GDP, reveals a lack of understanding of the basic principles of monetary economics.
PS. I recall a story, perhaps apocryphal, about a stock that soared in price each time the CEO was hospitalized with heart problems, and then plunged when he recovered. Was it St. Joe Paper? Perhaps someone else heard the story.
PPS. Tyler Cowen says (in the European context) that the problem is interest groups, not stupidity. I disagree. I’ve talked to lots of people at all levels. I’ve read all sorts of things written by economists, pundits, reporters, policymakers, etc. I see no evidence that people understand what’s going on. Some interest groups may believe they benefit from tight money, but they are almost certainly wrong. (They seem to think low interest rates imply easy money.) Indeed I often hear economists claim they would be hurt by monetary stimulus, and they are in the same interest group as I am! I’d benefit from easier money, just as I was hurt by the tight money of 2008-09. The key here is the non-zero sum nature of monetary stimulus during mass unemployment. The ECB could boost RGDP growth significantly while keeping inflation around 2% or 3%. That would help both the employed and the unemployed, workers and capitalists, rich and poor, governments and private sectors, as there’d be a bigger pie to share. Taxpayers would benefit big time. It would even help holders of government bonds on the periphery. Perhaps people who depend entirely on income from longer term German government bonds would be hurt. I’d guess that’s less than 1/2% of the eurozone population.
On the other hand I agree with Tyler’s more recent post claiming the US labor market has structural problems. Unlike Tyler, I think more AD could help fix those structural problems (by pushing Congress to lower maximum UI from 73 weeks to 26 weeks). Tyler’s right that the big problem is among the young. The fact that we are thinking of again boosting the minimum wage boggles the mind. The recent rise in youth unemployment can NOT be fully explained by the recession.
Tags:
9. March 2013 at 07:18
W.r.t. eurozone, problem is complete lack of recognition that monetary policy is a thing. All discussion about tight vs easy money policy at the ECB happens in US/UK. Inside the Eurozone, there is no discussion of monetary policy. None.
There may be prejudices in favour of certain policies which may semi-align with certain interest groups, but interest groups are mostly absent from the non-existing debate.
Note that there are big fights about who gets the seignorage benefit from the ECB. PIIGS have been getting most of it, so will often argue for more. Germany/Finland/Holland are upset about this and want to reduce the amount of seignorage given out. Of course, this is arguing for crumbs and totally missing the point.
Sometimes, the old idiocy of devaluing the currency for competitive gain shows up and it would, at least, lead to the right policy (for the wrong reasons). The idiocy is then exposed when Trichet says that “if we all devalue, nobody does” and proceeds to argue against anyone devaluing.
In sum, at least if there were interest groups fighting for this, that would be evidence of a fight.
9. March 2013 at 07:29
I guess you could say that in Europe, it’s still 2009, before you made NGDP “a thing” 🙂
So, by 2018, we can expect that a French socialist will advocate NGPDLT (and be accused by her party of being a tool of anglo-saxon neoliberalism).
9. March 2013 at 07:41
[…] Sumner notes that the market wants easy money. This shouldn’t be coming as news to anyone, but we do have Congressmen that confuse […]
9. March 2013 at 07:43
Too bad no one cares about the market. For example, if the all-knowing market actually believed the interest rate hawks, expected rises in rates would actually bring rates up. But no one save a vocal few actually believe this.
By the way, I found your take on recent increases in youth unemployment interesting, and I agree that now isn’t a great time to increase wage controls for the youth, but I don’t think the data agree that the ‘recent rise’ is anything more than cyclical. I briefly outline my take here:
http://ashokarao.com/2013/03/09/youth-unemployment-and-recession/
9. March 2013 at 07:52
And the sad thing is, because people don’t believe this it means regardless of what some people have to say about “Dow 36000”, the market is predicting an era of slow growth.
I’d love to know that in five or six years rates are up to 5%. It means deficits are coming down, and employment is up.
9. March 2013 at 08:35
Luis, Sad but true.
Ashok, You might be right. I was thinking of this graph.
http://research.stlouisfed.org/fred2/series/LNS14000012
Notice that youth unemployment is higher than in the 1982 recession, even though overall unemployment is lower than the 1982 recession.
There’s also a massive drop in the 16 to 19 employment/pop ratio, unlike anything you see for other age groups, and totally unlike earlier recessions.
But I don’t doubt there are other factors besides the minimum wage law in that ratio.
9. March 2013 at 09:22
Interesting, didn’t consider unemployment 16-19. I know dropout rates are down (at least since the 80s, I believe) but I also think college attendance is down.
I think this recession affected matriculation into college far more than 1982, because of above-inflation costs. No less, we agree that it’s not a brilliant time to impose unqualified controls.
9. March 2013 at 09:58
Suggestion: read less Friedman, more Dickens.
9. March 2013 at 10:32
Eurosclerosis in the new world.
9. March 2013 at 11:24
Prof Sumner,
On closer look, even that theory doesn’t hold:
http://research.stlouisfed.org/fredgraph.png?g=goG
If anything, the relative effect of this recession has been better on our youth than 1982. Indeed, for 16-19 year olds the point I made in my post is even more the case, where the relative unemployment decreased throughout.
Is there some flaw in using a relative model? To me sharp increases in youth unemployment mean nothing special unless in the absence of corresponding increases in the total civilian unemployment, which is captured by a relative rate.
It seems mostly cyclical to me.
9. March 2013 at 11:52
I like the send off the bond markets gave to Hugo Chavez. Venezuelan Bonds soared and CDS spreads fell dramatically when it was announced Chavez died. And actually bonds have been rising and CDS spreads have been falling all year as news of Chavez’s worsening health continued to slip out.
Talk about an inconvenient truth.
9. March 2013 at 13:33
Dr. Sumner:
“But to claim policy was expansionary with a bogus argument about the size of the balance sheet as a share of GDP, reveals a lack of understanding of the basic principles of monetary economics.”
Please explain.
Why can’t people consider the absolute percentage increase in the Fed’s balance sheet over time, or relative to GDP, and make conclusions on whether or not monetary policy was “expansionary” or “contractionary”? If they define it that way, then you can’t say they’re wrong just because they aren’t defining “tight” and “loose” according to NGDP.
Why do they have to be OK with the Fed’s balance sheet doubling or tripling in size in just a few short years? I think a strong argument can be made that if the Fed’s balance sheet has to increase by that much that fast, just to maintain some historical trend in variables such as price inflation or NGDP, shows that those trends may be too high, despite the fact that one may subjectively believe that 2% price inflation growth or 5% NGDP growth is what “should” occur.
Really, I am being serious, what is the intellectual foundation for the proposition that the US should have 5% NGDP growth? Where is the market test consideration? If the Fed’s balance sheet has to double in size in just a few years, then why can’t we interpret that as “the market” saying that there should be a huge deflation, no matter how painful it would be? The market isn’t a caregiver. It is ruthless. It is pure efficiency.
I would seriously question my worldview if it is OK with a CB doubling almost 100 years of balance sheet accumulation, in just a few years.
9. March 2013 at 13:37
“Unlike Tyler, I think more AD could help fix those structural problems (by pushing Congress to lower maximum UI from 73 weeks to 26 weeks).”
More inflation would create a perception of reward for Congress’ current UI program.
More inflation does not help fix the structural problem of too long UI. More inflation would increase revenues, profits, and tax revenues. More tax revenues means more money available to spend on 73 week UI.
9. March 2013 at 14:36
I think your sentences …
“We were taught that when money is very tight, as in the 1930s, the Fed’s balance sheet will be very large as a share of GDP. And when money is very easy, as during the German hyperinflation, the balance sheet will be small as a share of GDP.”
… really crystallized it for me.
http://alfred.stlouisfed.org/graph/?g=goY
There was a currency intervention in 1929 (about half of the Fed’s QE response in 2009, the base being mostly currency in the 1920s and 30s) and then there was a cutback followed by a second currency response in 1940 or so along with whatever the large asset purchases were that have been sold off slowly since the 1950s (War bonds?). We finally reached an equilibrium in the 1980s that continued until 2008, and so the Fed bought a bunch of assets again.
Although there are only two events, this looks a bit like a series of peaks (if you were to cyclicly repeat the pattern) followed by exponential decay … like this model of earthquake intermittency:
http://ej.iop.org/images/0295-5075/76/5/979/Full/img61.gif
(The fed balance sheet would be a measure of the probability of the next collapse in NGDP … you can see recessions are more concentrated on the 1940-1980 side as opposed to the 1980-2010 side. This may get causality wrong … the fact that the Fed balance sheet is large may lead to them cutting back too fast leading to a recession.)
9. March 2013 at 14:39
(In that analogy at the end of my comment, the post-war recessions are like the aftershocks of the Great Depression and the Great Moderation was just the lull after the aftershocks tapered off … )
9. March 2013 at 17:18
W.R.T. to Luis regarding the eurozone + NGDPLT: its nigh impossible to run an optimal monetary policy in a non-optimal currency area.
9. March 2013 at 18:47
Ashok, Maybe, but it’s not obvious why your criterion is better than mine.
Liberal Roman, Nice example. Is there a link?
Geoff, I would question any worldview that said money was ultra-tight during the German hyperinflation, and ultra-easy during the 1930s. But to each their own. You are free to define terms as you like, and express your views in the comment section.
Jason, And of course 1980 was the peak of the post-war inflation cycle.
9. March 2013 at 19:01
[…] Source […]
9. March 2013 at 19:10
I’m struck again by the notion the stock markets are strongly endorsing looser money right now.
I also went to the University of Chicago.
Heh, reminds me the other day a lawyer told me they studied economics “under Nobel Prizewinners” at UoChi. This person was absolutely convinced owning land was a rentseeking behavior. Apparently mileage varies 🙂
9. March 2013 at 19:34
“Tyler’s right that the big problem is among the young. The fact that we are thinking of again boosting the minimum wage boggles the mind. The recent rise in youth unemployment can NOT be fully explained by the recession.”
I agree, but why is it so easy to assume it’s M/W? From 1992 to 2000 U/E declined every year, including two consecutive years where the M/W increased (a total of 21% over those two increases).
As you note, relative to the 1982 recession, today teen U/E is higher while overall U/E is lower. So, something structural in our labor markets have changed. How about these two scenarios?
First, we often hear of a skills gap for older workers what with advances in technology, the need for computer skills, etc. Are these skills likely to be found in younger workers? In other words, were workers able to get jobs in industries in the 1980s with skills one could develop in high school, but now need college level skills for?
Second, of course people will argue–well, you don’t need a college to degree to [fill in remedial job]. Agreed. But with the advances in productivity (hence, reduced labor for certain industries), coupled with the inability of certain laborers to enter into other fields, more and more 19+ year olds might be filling the jobs once held/sought by the youth. This could be the result of the recession, or this could be a structural change in the economy.
I’m not sure–you need someone smarter than I to thresh out that issue. But, they seem a bit more plausible than the usual, ‘min. wage is creating unemployment.’ If that were the case, than I am sincerely interested to understand why the 1990s were an aberration.
10. March 2013 at 06:28
Ricardo: Yes, the eurozone, like all other currency areas, is not optimal, but what’s your point?
With better monetary policy, it would work better.
There is no going back in time and undoing the eurozone (even leaving the eurozone now, which I think the PIGS should do, has costs that never having joined would not have had).
10. March 2013 at 07:01
Maybe I missed it, can someone simply spell out the reasoning for smaller balance sheet with easy money and vice versa?
10. March 2013 at 07:43
jurisdebtor, It’s not clear that the 1990s were an abberation. Perhaps unemployment in the 1990s would have been even lower without the minimum wage increases.
I wasn’t trying to prove the minimum wage has caused higher youth unemployment, merely that there is a youth unemployment problem.
AD, Easier money leads to higher nominal interest rates, which reduces the demand for money as a share of GDP.
10. March 2013 at 09:20
“AD, Easier money leads to higher nominal interest rates, which reduces the demand for money as a share of GDP.”
This is incomplete. Nominal interest rates don’t only include final goods price inflation expectations. They also include other monetary factors that put downward pressure on rates. These two factors, along with other factors, trade off against each other, and the end result can be one overruling the others, such that the temporal trend in rates goes in the opposite direction that the single component thinking (such as a final goods price inflation premium) would suggest.
10. March 2013 at 11:52
“Some interest groups may believe they benefit from tight money, but they are almost certainly wrong. (They seem to think low interest rates imply easy money.) Indeed I often hear economists claim they would be hurt by monetary stimulus, and they are in the same interest group as I am! I’d benefit from easier money, just as I was hurt by the tight money of 2008-09. The key here is the non-zero sum nature of monetary stimulus during mass unemployment. The ECB could boost RGDP growth significantly while keeping inflation around 2% or 3%. That would help both the employed and the unemployed, workers and capitalists, rich and poor, governments and private sectors, as there’d be a bigger pie to share.”
Very strange. Either they think there is a ceteris paribus aspect to the discussion where they can separate the effects of monetary stimulus from the broader economic growth it engenders (you can’t); or they are trapped in zero-sum thinking, which is especially weird since economics as a discipline is at its most potent and valuable when it undermines exactly that kind of thinking.
10. March 2013 at 16:09
Reality check: the lower seignorage since 2008 caused the currency/GDP ratio to increase by about 1%. Big deal.
The demand for money has almost nothing to do with the current size of the Fed’s balance sheet, which since 2008 has been dominated by credit market interventions. Currency is only 1/3 of liabilities and is completely independent of incremental Fed purchases.
Only by making currency seignorage *negative* could the central bank flood the economy with currency. Which it could do, but would be totally pointless. (The currency would be “idle”, not used as a medium of exchange).
11. March 2013 at 06:23
Squarely, Economics is not very potent right now.