Super long and variable lags?

For quite some time the old-style monetarists have been warning that all this “easy money” (what would Milton say!) will produce high inflation, with long and variable lags.  The recent passivity by the Fed has caused TIPS spreads to plummet in the last couple days.  Today for the first time that I can recall the 30 year TIPS spread fell below 2%.  Thirty years is a pretty long lag before that high inflation kicks in.

In fact, monetary policy works with leads, not lags.  Markets are plunging right now on expectations that future monetary policy will be tight, will allow NGDP growth to fall well below even the woefully inadequate 4% of this “recovery.”  The Fed has lost control of the nominal economy.

I hope all you hard money fans are happy—this is what hard money looks like.


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17 Responses to “Super long and variable lags?”

  1. Gravatar of W. Peden W. Peden
    22. September 2011 at 06:08

    I notice that the dollar is up against almost every currency in the world right now (yen excluded) and gold is falling through the floor. So it’s not just stocks which are indicating tight money.

    As for leads rather than lags: the more I think about it, the more this seems to be true. For example, the Medium-Term Financial Strategy of the Conservatives in the UK back in March 1980 started contracting NGDP on its announcement, around 12 months before M3 started falling. The monetary policy contraction of 1955 was ineffective because it wasn’t credible i.e. the government was not willing to tolerate a higher short-run unemployment rate in order to compensate for the effects of the 1955 budget on demand.

    Presumably you would allow for some lags with unannounced policies e.g. the broad money explosion of the early 1970s?

  2. Gravatar of Lars Christensen Lars Christensen
    22. September 2011 at 06:16

    Scott, I can’t helpension thinking that if we could adjust money supply data based on market signals then we might have some truly reliable money data…it’s pretty clear the Fed has just tightened monetary policy!

  3. Gravatar of Scott Sumner Scott Sumner
    22. September 2011 at 06:53

    W. Peden, Even with unannounced policies there is no lag with the markets, and a very very short lag with the economy.

    Lars, I agree.

  4. Gravatar of W. Peden W. Peden
    22. September 2011 at 06:57

    I see- you mean no lag with markets. I was thinking in terms of effects of changes in monetary policy on final goods transactions i.e. NGDP.

  5. Gravatar of Master of None Master of None
    22. September 2011 at 08:48

    “Thirty years is a pretty long lag before that high inflation kicks in.”

    The <2% current 30yr spread doesn't necessarily imply 30 years until we see inflation.

    The market could just as easily be pricing in a 20% deflation over the next 12 months followed by 3% inflation for the subsequent 29 years.

  6. Gravatar of Master of None Master of None
    22. September 2011 at 08:50

    (BTW I know that is NOT what the market is pricing in, but you have to look at other data to figure that out)

  7. Gravatar of Full Employment Hawk Full Employment Hawk
    22. September 2011 at 08:58

    Another thing wrong with traditional monetarism is its concentration on M2. There is little, if any, structural relationship between the monetary base and NM1M2. Changes in NM1M2 are much more likely to be reverse caused. That is changes in NGDP cause changes in it and not the other way around.

  8. Gravatar of W. Peden W. Peden
    22. September 2011 at 09:27

    Full Employment Hawk,

    M2 hasn’t been of interest to careful observers for a long time, since it excludes corporate deposits above $100,000. In the UK, M2 has never had a good relationship with NGDP (either way) and attention traditionally focused* on broader aggregates: M3 prior to the 1980s, and (when changes in the position of building societies caused an artificial fall in M3 velocity) M4.

    * Excluding some monetarists like Alan Watson, who were more interested in M1 and M0.

    And, of course, one could get into the reasons why there was briefly interest during the 1980s in [i]M5[/i]…

  9. Gravatar of Martin Martin
    22. September 2011 at 14:30

    Scott,

    “In fact, monetary policy works with leads, not lags. Markets are plunging right now on expectations that future monetary policy will be tight, will allow NGDP growth to fall well below even the woefully inadequate 4% of this “recovery.” The Fed has lost control of the nominal economy.”

    I don’t know if you’ve ever looked at this, but this illustrates your point beautifully I think.

    http://research.stlouisfed.org/fredgraph.png?g=2nM

  10. Gravatar of Scott Sumner Scott Sumner
    22. September 2011 at 16:14

    W. Peden, I think even NGDP responds within a few months–I think the aggregates were a flawed indicator.

    Master of None, I can’t argue with your logic, but . . . won’t happen.

    FEH, I tend to agree. I see the base plus future expected growth in the base causing future expected NGDP. That influences current NGDP, which influences current M2. If there’s a big change in reserve requirements, then the aggregates can be important.

    Martin, But is inflation expectations the same as monetary policy?

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. September 2011 at 18:56

    Scott wrote:
    “The Fed has lost control of the nominal economy.”

    This is by far the most succinct, depressing and yet realistic appraisal of monetary developments I have read in the past few hectic days.

    What on earth is the FOMC thinking?

  12. Gravatar of Full Employment Hawk Full Employment Hawk
    22. September 2011 at 21:45

    If Obama wants to have any hope of getting reelected he is going to have to find a way of promptly recess appointing people who take the Fed’s mandate to achieve maximum employment seriously to the two vacancies. Preferrably people who favor NGDP targeting. Brad DeLong would be a likely choice since he is a Democrat. If Obama wants to still be bipartisan and appoint someone on the right who favors expansionary monetary policy now, Scott would be an obvious choice.

    As I said before DeSumner could get monetary policy back on the right track.

  13. Gravatar of Full Employment Hawk Full Employment Hawk
    22. September 2011 at 21:48

    “If there’s a big change in reserve requirements, then the aggregates can be important.”

    If the interest rate on excess reserves are reduced or eliminated, wouldn’t what happens to M1 be important. There is, after all a structural relationship between the base and M1, although the relationship depends on a number of other variables.

  14. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. September 2011 at 22:20

    FEH,
    There can be no doubt that eliminating IOER and expanding the base would lead to increased NGDP expectations.

    But Republicans are opposed to this for treasonous reasons as Scott has pointed out.

    That’s why they need to be subject to public shame (or much worse).

  15. Gravatar of Martin Martin
    23. September 2011 at 01:38

    Scott,

    “Martin, But is inflation expectations the same as monetary policy?”

    Doesn’t the Central Bank – if it wants to – control inflation by controlling future inflation and thus inflation expectations?

    I am slightly puzzled by your usage of ‘monetary policy’ in that context. Arguably inflation expectations, just as the spread between TIPS and non-indexed treasuries, is merely an indicator of monetary policy, but isn’t everything then?

  16. Gravatar of Scott Sumner Scott Sumner
    26. September 2011 at 06:53

    Thanks Mark.

    FEH, Yes, IOR has a similar effect to reserve requirements.

    Martin, Fair point, I was thinking that part of inflation is supply shocks that leave NGDP unchanged. But you are right, it is a valid indicator to some extent.

  17. Gravatar of Don’t Bail Out the Banks, Bail Out the Economy | Morton and George Don’t Bail Out the Banks, Bail Out the Economy | Morton and George
    7. December 2011 at 09:45

    […] to each other or anyone else. However, what the Fed is often doing when solving liquidity crises is managing expectations — will the money supply shrink? Will assets that we thought were safe stay valuable? Will […]

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