The second step

A few weeks ago, I published a post discussing the minimum acceptable level of Fed accountability.  At a minimum, any institution needs to establish some procedure to evaluate how they are doing their job.  The Fed’s main job is to use its policy instruments to nudge AD up or down in a way that they think is most likely to hit their inflation and employment targets.  That’s monetary policy.

Because of policy lags it’s not always clear what current instrument setting is most likely to lead to an increase in AD that is compatible with on-target inflation and employment.  Thus the Fed needs to periodically evaluate past FOMC meetings, and tell the public whether, in retrospect, the policy stance set at the earlier meeting was too expansionary, too contractionary, or about right.  They can use any criteria they wish, it’s up to them.  Just tell us how well they are hitting they AD goals. Who could object to that?

It’s rather shocking the Fed doesn’t currently meet even that extremely minimal level of accountability.  Of course more would be better.  Ken Duda sent me some ideas that form a useful second step, still falling well short of NGDP targeting (an idea rapidly gaining popularity among the elite.)  Here’s Ken’s still extremely modest second set of steps:

1) publishing an NGDP forecast

2) publishing a forecast of how policy instrument settings would affect NGDP (“if we were to raise interest rates, we’d expect the NGDP level to be X% lower than if we hold interest rates at zero”).

3) forecasting what are desirable levels of NGDP, i.e., what NGDP level-path would be most consistent with the dual mandate, or what NGDP level-path would be consistent with what level of unemployment or inflation

4) operating a prediction market for any of the three above

I can’t even imagine how anyone could oppose any of those 4 steps, even if they were 100% opposed to NGDP targeting.  How would that information not be useful? Of course it would be useful, it would help markets to better understand what the Fed is doing.  Instead we see statements from Fed officials implying that the economy is currently skating on the edge of recession (my words not hers) and also that the Fed may well increase interest rates in the near future. No wonder markets are confused.

PS.  The first quarter was negative for both real and nominal GDP, and Cleveland Fed president Federal Reserve Governor Lael Brainard sees no bounce back in Q2.  Obviously I meant “recession”, not actual recession, which won’t happen even if we have 2 negative quarters.

PPS.  Over at Econlog I have an update on Summers’ NGDP targeting comments.


Tags:

 
 
 

53 Responses to “The second step”

  1. Gravatar of CMA CMA
    3. June 2015 at 05:54

    The fed doesnt want to be accountable so even minimal levels of accountability will be avoided.

  2. Gravatar of Matt McOsker Matt McOsker
    3. June 2015 at 06:21

    Can we get a good definition of full employment? I certainly don’t think we are close, and shouldn’t full employment be a scenario where wage growth exceeds a some level, and drives up inflation past an acceptable level? The we have the inflation target should it be a sustained average over say a 2 year period? Further if NGDP is the target – shouldn’t that be coupled with satisfactory employment/wage growth?

  3. Gravatar of Julius Probst Julius Probst
    3. June 2015 at 06:26

    WOW. I did not imagine that I would cause such a stir !!!
    I have emailed the DIW and asked when the video would be published – no response yet.
    Summers indeed said that he would favor a NGDP target over a HIGHER inflation target.
    I understood him as fully endorsing the NGDP target also over the current target whereas he doesn’t seem to be entirely there yet, but almost.

  4. Gravatar of Ray Lopez Ray Lopez
    3. June 2015 at 06:50

    Sumner: “I can’t even imagine how anyone could oppose any of those 4 steps” – well I oppose these four steps as a waste of time. First, “publishing an NGDP forecast” is a waste of time. Who cares what the Fed thinks? The Fed by even MM analysis has no long term impact on the GDP, nominal or real. Second, “publishing a forecast of how policy instrument settings would affect NGDP” – what part of “zero” don’t you people understand? And if the Fed doesn’t think money is neutral, who cares? Third, “forecasting what are desirable levels of NGDP [are]” – absurd. If the Fed desires a high NGDP, who outside people like you believe they can deliver? Finally, “operating a prediction market for any of the three above” – why should the Fed do the work of iPredict?

  5. Gravatar of Scott Sumner Scott Sumner
    3. June 2015 at 06:53

    CMA, Congress can force the fed to be accountable.

    The Fed can argue against that Congressional action.

    But there are no arguments against that action.

    Hence if Congress wants to force the Fed to be accountable, they can do so.

    Matt, I don’t think there is any way to estimate the natural rate, except very approximately. It’s probably close to 5% unemployment, and time varying.

    Fortunately there is no need to estimate the natural rate.

    Julius, You da man!!

    (In case you are German, that’s an American expression.)

  6. Gravatar of Jim Glass Jim Glass
    3. June 2015 at 07:11

    Re Summers, the obscure becomes less obscure. To quote the Politico story lede…

    Over the past few years, an obscure economic policy idea has slowly been gaining support among liberal and conservative economists. It hasn’t made it into the mainstream agendas of either the Democratic or Republican Party. But every few weeks, it seems, another top economist endorses the idea. On Monday, Larry Summers, formerly both the Treasury Secretary in Bill Clinton’s White House and a top Obama administration official, nearly became the most important person to do so.

    Technically known as nominal GDP (NGDP) targeting…

    http://www.politico.com/agenda/story/2015/06/does-larry-summers-support-ngdp-targeting-almost-000061

  7. Gravatar of TallDave TallDave
    3. June 2015 at 09:03

    All great ideas, Congress should mandate these. Granted, it’s a tough hill to climb politically, but other monetary movements have managed to get things done. Apparently there was a short-lived party in the 1800s devoted to fiat money called the Greenbacks, and hey look around.

    You know, you hear some words that seem to indicate the Fed is figuring things out, and then the next day they seem to confuse nominal interest rates with the stance of monetary policy. Sigh.

  8. Gravatar of Randomize Randomize
    3. June 2015 at 09:16

    It’d be very interesting to see the Fed put together a Balanced Scorecard. What weighting would they give unemployment vs. inflation? What metrics would they used to grade how close they were to meeting their goals and what grade would they receive? It’d be a whole new level of transparency.

  9. Gravatar of E. Harding E. Harding
    3. June 2015 at 09:59

    Obviously I meant “recession”, not actual recession, which won’t happen even if we have 2 negative quarters.

    -Scott, did countries at full employment ever have recessions?

  10. Gravatar of collin collin
    3. June 2015 at 10:49

    Is the Federal Reserve main goal ‘Price Stability?’ And since the Great Recession ending 2010, has there not the most stable prices ever? When has the Fed had such stable prices with low inflation? Never as long as you don’t include the WW2 years in which the US economy was run by the military.

  11. Gravatar of Scott Sumner Scott Sumner
    3. June 2015 at 10:57

    Randomize, I’m not even asking them to tell us whether they hit their goals for inflation and unemployment, just AD.

    E. Harding, Are you thinking of something like 1946, when we went from over full employment to full employment?

    Collin, You asked:

    “Is the Federal Reserve main goal ‘Price Stability?'”

    No. It has two goals—2% PCE inflation and unemployment close to the natural rate. It puts equal weight on both.

  12. Gravatar of E. Harding E. Harding
    3. June 2015 at 12:51

    I was thinking more Communist countries.

  13. Gravatar of Major__Freedom Major__Freedom
    3. June 2015 at 15:06

    Such information is not “useful” in the broader public.

    If it were, then everyone would already be MMs.

  14. Gravatar of benjamin cole benjamin cole
    3. June 2015 at 16:09

    Bravo. However I still worry that whatever NGDPLT is chosen, it will be too tight. Australia seems to be doing well with 6.5% NGDP growth.

    Why not shoot for for 7% NGDP growth? What would be the costs, and what would be the benefits?

    Seems to me the cost would be a minor increase inflation at worst; the benefits would be increased production and employment.

  15. Gravatar of benjamin cole benjamin cole
    3. June 2015 at 16:12

    Add on: indeed this may be the reason for Summers’ oblique reservations about NGDPLT.

    The inflation-hysterics can simply set a very low NGDP growth target.

  16. Gravatar of Major_Freedom Major_Freedom
    3. June 2015 at 17:13

    Well gosh golly gee! Why shoot for 7% when it is as arbitrary as shooting for 8%?

    What would be the costs and what would be the benefits? I don’t see any costs from choosing 8%! Heck, why don’t “we” shoot for a nice round 10%?

    Let’s put the peddle to the metal folks!

    Wait, maybe 10% is too tight. I know, let “us” go full tilt everyone! Print away the disease and hunger and unemployment! Do 20%! No, 30%!

    What is wrong with 30%? I don’t understand any costs with this! 30% will reduce employment to negative 1%! That’s right, there is no such thing as an employment lower bound!

    Wowee everybody, this is great, just great.

    Gosh darn it, I should not have said 30%. Make it an A+. 80% minimum. Then see what happens!

  17. Gravatar of Ray Lopez Ray Lopez
    3. June 2015 at 18:34

    @MF – lol! Great parody that underscores the absurdity of NGDPLT. While you may disagree with my view that short term (not just long term as Sumner admits) MM is impotent, and money is largely neutral and super-neutral, we both agree that printing money irresponsibly eventually leads to some form of malinvestment, even as trivial as shoe leather costs and menu costs (which indeed are trivial BTW). In Brazil, with inflation in the high teens and in double digits for 40 years, one estimate was it led to up to a -5% drag on GDP (source: Calomiris book “Fragile by Design”, chart therein, and my eyeballing of the chart shows it was typically less than 5%, and in fact during brief periods of peak inflation the public quickly adapted–prices are *not* sticky–and the cost was less than before). In the USA this drag would be greater than the GDP the USA could naturally produce, so the net result would be a slow decline of living standards. If the net was say -2%/yr then over 35 years it would half the US standard of living. At the very worse NGDPLT could lead to hyperinflation, if the Fed put the ‘pedal to the medal’.

  18. Gravatar of Major_Freedom Major_Freedom
    3. June 2015 at 19:47

    Ray, if money were neutral then malinvestment would not take place. Money has is a tool that people use to achieve goals. If you say that manipulating money brings about any effects, then you are saying money is not neutral.

    The reason why inflation in the form of credit expansion thwarts economic coordination is because changes in money do have an effect on the relative structure and usage of real variables, not just nominal ones.

    Imagine a person quitting their jobs and initiating a counterfeiting operation out of their basement. The change here would be that the person’s particular contribution would change. They would go from producing widgets to consuming widgets. And the more money they print, the more widgets get diverted to their consumption. Since these particular widgets do not make up all of supply, what happens is that the money printing (and spending) invariably has non-universal effects on real activity. The real structure of the economy would go on a different path of change.

    Money is absolutely without a doubt, no ifs ands or buts about it, not neutral in any way shape or form. It is highly non-neutral, or, perhaps in better terminology, money is highly affectual.

    The business cycle as per ABCT would not occur if money were neutral.

    As Mises showed, a neutral money is actually a contradiction in terms.

    You don’t have to argue that money is neutral if you have some belief or nagging feeling that inflation does not “help” the general economy. You are not conceding a picometer to any inflationist by saying that what they advocate brings about real effects.

  19. Gravatar of ssumner ssumner
    4. June 2015 at 05:24

    Ben, I believe that since 2012 they’ve slowed down to about 3% to 4%.

    Ray, So money is neutral but leads to malinvestment? What will you think of next? Give this man a Nobel Prize.

  20. Gravatar of Jim Glass Jim Glass
    4. June 2015 at 06:53

    Noted in passing, WSJ…

    Inflation Misses Fed’s 2% Target for 36th Straight Month

    The personal consumption expenditures price index, the Fed’s preferred inflation gauge, rose just 0.1% in April from a year earlier, the lowest level since October 2009 and a little softer than the 0.3% reading in February and March.

    April 2012 was the last time the inflation rate was on target. That’s the longest such stretch of sub-2% inflation since the 1960s.

    Excluding the volatile food and energy categories, prices climbed 1.2% in April from a year earlier, a slight downshift from the 1.3% reading the prior four months…

    “It won’t be current inflation that prompts the first Fed hikes, it will be the tightness of the labor market and the signal it sends about future inflation risk, given the extraordinarily easy stance of policy,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in a note to clients.

    ‘Opportunistic disinflation’ lives!

  21. Gravatar of Philo Philo
    4. June 2015 at 07:08

    @MF–

    Don’t peddle that stuff around here!

  22. Gravatar of Ray Lopez Ray Lopez
    4. June 2015 at 07:18

    Sumner: “Ray, So money is neutral but leads to malinvestment? What will you think of next? Give this man a Nobel Prize” – accepted!

    Simple experiment: put a coin on a textbook, the old fashioned kind with a cloth cover. Gently tilt the textbook. The coin stays stable–akin to money being neutral–until “too much tilt” occurs, then it quickly slides off. Engineers talk of coefficients of static and dynamic friction, but the takeaway for us is that different laws apply for different regimes. If too much inflation, money ceases being neutral. That’s the fear behind the untested NGDPLT–it could produce high inflation (high teens or more, like Brazil) or Weimer Germany hyperinflation. But ordinarily, say with less than 10% inflation or constant inflation (second derivative of prices is zero) then money is neutral. I win, Thread and Nobel.

  23. Gravatar of David de los Ángeles Buendía David de los Ángeles Buendía
    4. June 2015 at 07:56

    Dr. Sumner,

    There is no problem with the Federal Reserve Bank (FRB) projecting Nominal Gross Domestic Product (NGDP) or even targeting NGDP. The problems are:

    1) Increasing NGDP cannot be achieved solely through monetary policy. All that monetary policy can do is make obtaining credit easier or more difficult, i.e. tighten or loosen monetary policy. If businesses do not see an opportunity to invest profitably, they will not borrow money no matter how loose the monetary stance. NGDP is not going to expand even in the loosest monetary stance if no profits can be generated by doing so. How can the FRB be held accountable for reaching a goal it cannot achieve alone.

    2) Is the economy of the United States even capable of achieving a sustained healthy growth of NGDP? The engine of growth in what had been the “Advanced Industrialized Nations” was manufacturing. With that gone, the profit making that occurs within the appropriate borders is dominated by finance, insurance, and real estate (FIRE). FIRE does not generate much in the way of jobs or collateral growth, when Bank of America earns record profits, those profits do not generate much economic growth. A FIRE dominated economy, one heavily “financialized”, simply cannot produce very much in the way of growth. In such an environment, what difference does it make whether inflation, employment, or NGDP is targeted, healthy targets will never be achieved.

  24. Gravatar of Don Geddis Don Geddis
    4. June 2015 at 08:31

    @David de los Ángeles Buendía: “make obtaining credit easier or more difficult, i.e. tighten or loosen monetary policy

    The answer is simple: you’ve only imagined a single monetary policy transmission mechanism, and the one you’ve imagined isn’t even the most important one.

    Tight or loose monetary policy can easily affect NGDP, even in an economy with no banks and no credit. The simple way out of your dilemma, is that bank lending is not the important channel.

  25. Gravatar of Don Geddis Don Geddis
    4. June 2015 at 08:35

    Love to see Ray and MF arguing with each other over the neutrality of money. It’s like a couple of aborigines fighting over which mobile phone makes the best hammer for pounding sticks into the ground.

  26. Gravatar of TallDave TallDave
    4. June 2015 at 10:01

    Nice find, Jim. They still consider missing low a win, even with weak growth.

  27. Gravatar of Britonomist Britonomist
    4. June 2015 at 15:37

    @David

    Manufacturing is not in any meaningful sense actually gone from the US. And you’re ignoring many many other industries like I.T. and media/entertainment for example.

    @Don

    And what’s the important channel?

  28. Gravatar of ssumner ssumner
    4. June 2015 at 17:56

    David, Pretty much everything you said is wrong. Monetary policy has nothing to do with credit markets. I suggest looking at my short course on money.

  29. Gravatar of Don Geddis Don Geddis
    4. June 2015 at 18:21

    Britonomist: “And what’s the important channel?

    This isn’t the first time you’ve asked that question here, so you’re being disingenuous. You already know the answer (HPE — plus a dozen other channels). But you’re not really intending an honest discussion.

  30. Gravatar of Ray Lopez Ray Lopez
    4. June 2015 at 18:33

    LOL, Don Geddis saying to Britonomist, who is more of a scholar than a troll: “But you’re not really intending an honest discussion” (!), after Don mocks me for arguing with MF. Projection noted Don.

    As for Sumner’s response to David, it was a one-liner insult to David’s reasonable question. Indeed, FIRE has replaced US manufacturing, to the detriment of the US economy (since papers have shown excess FIRE will actually decrease GDP in an developed economy) and I would argue (I have experience in the field of manufacturing) that only the US IP (Int Property) is keeping the US ‘in the game’. That’s one reason the US is keen to strengthen existing IP in the latest round of trade talks. Meanwhile the MMs like Sumner rearrange the deck chairs of the Titanic with their silly, non-structural NGDPLT remedies.

  31. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 18:56

    Summer wrote:

    “Monetary policy has nothing to do with credit markets.”

    You have already been corrected on that false claim umpteen times.

    Monetary policy has a LOT to do with credit markets.

    Most of what constitutes the broadest supply of money, such as M3, was created by way of credit expansion from the Federal Reserve System (central counterfeiter plus “member” lenders).

    The reason why the monetary base is only a fraction of the total supply of money, is because most money is created by way of ex nihilo credit.

    What’s more, is that aggregate price levels, and aggregate spending levels, these are determined by the aggregate supply of money. It is not the case that only the monetary base is exchanged. All the deposits in addition to be money, is all credit expansion created.

    The Fed depends on the member lenders to lend more money in order to expand the broader supply of money and the volume of spending. If the Fed prints money, but the banks do not lend more, then aggregate spending will only rise to the extent that the member bank owners spend the additional reserves on their own consumption, or purchase stocks. But these are very modest relative to lending. It is lending that is the primary driver of how spending increases out of the bank’s activity.

    When we see the monetary base expand a lot compared to aggregate spending, then chances are bank credit expansion is increasing at a slow pace. And vice versa.

    For Sumner to say that monetary policy has nothing to do with credit markets on the basis that the Fed does not officially “target” the quantity of credit expansion, is about as silly as Sumner’s claim a few years ago that the growth in the aggregate supply of money during the 1920s could not have been highly inflationary because the Fed was not tracking M3 at the time. Preposterous.

  32. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 19:00

    Geddis:

    There is no innovation in the quality of money in your ancient Roman ideal (see Emperor Diocletean).

    If you are going to attempt a burn, then you have to at least have the intellectual high ground compared to me. Technological progress in the quality of your ideal money has not changed since 1913. You’re not even using a hammer, but rather a rock.

    Watching you debate me is like watching a pigeon playing chess.

  33. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 19:03

    Philo:

    I will peddle it, and I will enjoy it.

  34. Gravatar of Major_Freedom Major_Freedom
    4. June 2015 at 19:13

    Geddis’s nonsense here is so easy to demolish, all you have to do is read it and use more than one brain cell.

    “Tight or loose monetary policy can easily affect NGDP, even in an economy with no banks and no credit. The simple way out of your dilemma, is that bank lending is not the important channel.”

    This is such bad logic that a 5 year old could pick it up.

    According to this “logic”, guns are not an important factor in war deaths, because hypothetically speaking soldiers could use knives instead.

    Also, by saying tight or loose monetary policy affects NGDP, which implies tight or loose money is distinct from NGDP, Geddis is contradicting his earlier claim that tight and loose money IS lower and higher NGDP, respectively.

    The derp is strong.

  35. Gravatar of CA CA
    4. June 2015 at 20:31

    Geddis absolutely owns MF. Not even close.

  36. Gravatar of ngdp minimalism ngdp minimalism
    4. June 2015 at 21:04

    […] That is from Scott Sumner, the full post is here. […]

  37. Gravatar of Major_Freedom Major_Freedom
    5. June 2015 at 03:20

    CA,

    Your stretched cheer leading suggests otherwise.

  38. Gravatar of Britonomist Britonomist
    5. June 2015 at 11:51

    “This isn’t the first time you’ve asked that question here, so you’re being disingenuous. You already know the answer (HPE “” plus a dozen other channels). But you’re not really intending an honest discussion.”

    Yes I am intending an honest discussion. I know I ask this all the time, but it’s because I have yet to get a satisfactory answer – the transmission is so fundamental, so important and so central – it’s 100% the thing that can make and break the case of market-monetarists. I’m sympathetic to market-monetarists, I’d love to be able to believe that problems like low aggregate demand can easily be solved using monetary policy alone even at the ZLB, rather than having to rely on politicians to enact policy to drive growth.

    But when I see so many other economists and experts in finance point out again and again the unreality of assumptions used in many monetarist models, the extreme importance of banking and bank money & how banking is absolutely central to determining the broad money supply – I have absolutely nothing to counter them. I can mention vague ideas about alternative ways to boost broad money via portfolio-re-balancing, they can counter with all kinds of technical discussion to show this would never be enough, and because I’ve still yet to see a tractable model of the actual transmission from market monetarists, I’m completely unable to make a case for MM. If I at least had an explicit model of the transmission mechanism (taking actual economic reality into account, rather than just assuming the monetary policy = giving everyone more M directly) I could vouch for you guys properly, which is why I keep asking for one here.

  39. Gravatar of A A
    5. June 2015 at 13:19

    Jeez, these are sensible suggestions even under an inflation targeting regime. Certainly, they are better than the current condition of parsing Fed minutes and governor speeches to discern shadow targets.

  40. Gravatar of Don Geddis Don Geddis
    5. June 2015 at 15:16

    @Britonomist: OK, you’re serious (again). So the first question is, does the Fed possess a “nuclear option”, to force NGDP to rise even if everybody else in the nation/world doesn’t want it to?

    The answer to that is: start with buying all the Treasury bonds (retire the entire national debt, completely costlessly). Then buy other financial assets (MBSes). Then perhaps an index of stocks. Then anything else for sale, in any market at all. At some point, the Fed will own the entire world, in exchange for costless little pieces of paper. Why would this “never be enough”? Do you really mean to assert that you believe the Fed could own the whole world, and everybody would just sit on their cash, and nobody would change spending behavior at all? NGDP remains unmoved? You think that’s plausible? People will just be incorporating new startups, for no other reason than to immediately flip them to the Fed … but then they’ll take the proceeds of the sale, and just leaving those funds in their savings accounts, and never spend them?

    That’s absurd. When people acquire excess cash, they’ll begin exchanging them for other assets, which will cause the price of those assets to rise (the HPE). And thus NGDP to rise.

    A second mechanism is expectations, aka Nick Rowe’s Chuck Norris effect. Once a nuclear option is feasible, you don’t actually need to pull the trigger. You can change current behavior and get the effect you want, just via the threat of this possible future.

    So there are two mechanisms: HPE, and expectations. Neither of which involve banks or lending. If you have a concern about either explanation (which you’ve seen before), and you really want to be productive, then you’re going to need to ask a more specific question than merely, “And what’s the important channel?”

  41. Gravatar of Britonomist Britonomist
    5. June 2015 at 15:55

    @Don

    The Fed can’t just buy anything, I remember getting into a conversation with JKH (I think? Maybe it was someone else) about this, and it was determined that the Fed can only legally purchase a selection of safe assets, it can’t buy stocks. I also, for the 1000th time, never said the Fed can’t move NGDP at the ZLB, only that it has to go absurdly overkill (trillions and trillions in QE) to initiate even tiny movements when in the middle of a slump*, which makes this far less effective than direct fiscal stimulus or helicopter drops. I argue that Fed policy is weak at the ZLB, not that it’s completely ineffective. I know what you’re going to say (“if it takes 20 trillion then just print 20 trillion!”), but the difference between a strong and a weak Fed is extremely important. If the only policies the fed can engage in to really move NGDP are buying absurdly ginormous quantities of federal debt and MBS then that presents a serious question, because we all know the Fed does not have the political capital to do such a thing at all (and if it can’t do that, this affects its credibility and expectations as well). Which means MM need to spend their focus on either coming up with new tools that don’t require the Fed to print 20 trillion dollars, or they need to convince the public/academics/politicians that doing so is perfectly acceptable and not dangerous, rather than focusing on academic debates about increasing inflation target vs NGDP targeting while ignoring this giant elephant in the room.

    *obviously it depends on the circumstance, if the stock market is tanking due to expectations of policy tightening, then the Fed can still reverse this decline easily by easing, causing a boom in asset prices and helping NGDP, but when you have a weird situation where the economy is in a slump but stocks are bullish or stable, OR stocks are falling despite expectations of loose monetary policy, then this particular transmission mechanism is significantly diminished

  42. Gravatar of Ray Lopez Ray Lopez
    5. June 2015 at 18:28

    Britonomist vs Don: like Mike Tyson in his prime vs Mayweather, no contest, the former wins.

    @Britonomist – you are correct, there’s a missing link in the transmission between bankers and borrowers that makes MM bogus, even if you accept their premise that money is not neutral. To this end such luminaries as P. Krugman, J. Cochrane, M. Wolf, M. Minsky, L.Kotlikoff and others have advocated “Full Reserve Banking” or “Narrow Banking” or “Limited Purpose Banking” or variants of the old “Chicago Plan” that I. Fisher and others endorsed, that eliminates fractional reserve banking (or rather, pushes such practices to the shadow banks, where they belong, and are outside of public support). Cochrane’s paper is a good overview, found in the Wikipedia link on Full Reserve banking. As Cochrane notes, the liquidity purpose of having fractional reserve banking is now moot due to point-to-point transactions technology, and you don’t need that much money in circulation (10T as I recall) to achieve narrow banking, which outstanding Fed paper can provide. That’s why indeed, as you note, fiscal policy makes more sense than monetary policy if you believe giving money to people will increase AD. Helicopter drop vs QE where bankers make money off the Fed just parking their lent money in US securities: helicopter drop wins.

  43. Gravatar of Don Geddis Don Geddis
    5. June 2015 at 19:11

    @Britonomist: If the Fed retired all of the national debt, and all MBSes, and bought up all the foreign bonds of all 1st world nations … and still NGDP didn’t move at all … I suspect there wouldn’t be much problem convincing Congress to authorize the Fed to buy other things (like stocks) as well. But in any case the whole scenario is absurd, because NGDP would rise long, long before the Fed completed buying all currently authorized assets.

    it has to go absurdly overkill (trillions and trillions in QE) to initiate even tiny movements when in the middle of a slump” I don’t believe you. You agree that expansion of the money supply causes “some” increase in NGDP (even at the ZLB). But you don’t even give a rate. You say it would take $20T in purchases … in order to accomplish what? Even in your model, what does $20T get you? And then: why should I believe your model?

    You’ve also ignored what is by far the most powerful tool, expectations. Purchases by themselves do very little, “concretely”. Their primary function is to signal a future path of monetary policy. Most of the actual work is done by expectations of that future path. (This is yet another reason why it would be silly of you to talk about “the” effect of $20T in purchases.)

    You talk about “helicopter drops”, but in previous comment threads it has already been clear that you don’t mean the same thing that everyone else means by that term. (You’ve confused it with “permanent vs. temporary”, for example.)

    In any case, all this obvious context makes your original comment, “And what’s the important channel?” kind of snarky. David had claimed that “all that monetary policy can do” is affect bank lending. There are dozens of monetary policy transmission mechanisms — as you well know — so pointing out that David was wrong to equate bank lending with monetary policy, shouldn’t have gotten such a pithy skeptical rhetorical query from you.

    (All giving you the benefit of the doubt, that you actually did intend some kind of honest discussion, as you now claim.)

  44. Gravatar of Don Geddis Don Geddis
    5. June 2015 at 19:17

    @Ray: Always a pleasure to read your unique combination of random chatbot economic phrases and irrelevant wikipedia links.

  45. Gravatar of Major_Freedom Major_Freedom
    5. June 2015 at 19:46

    Geddis:

    An apt characterization of your own posts.

    The lack of self-reflection is palpable.

  46. Gravatar of Britonomist Britonomist
    5. June 2015 at 20:20

    “Even in your model, what does $20T get you? And then: why should I believe your model?”

    I don’t have a model, but I’ve seen models that suggest that QE may have absolutely ZERO effect, now I’m not an extremist so I will never say it has zero effect. However, what’s troubling is that I never ever see a model from market monetarists. Where is your model? Show me how QE affects NGDP, it’s your duty as advocates to actually argue your case, rather than evade it by coming up with extreme scenarios where the Fed buys everything.

    “You’ve also ignored what is by far the most powerful tool, expectations.”

    No I have not, I said:

    “and if it can’t do that, this affects its credibility and expectations as well”

    The expectations channel alone doesn’t work unless you have an effective monetary instrument and credibility. When I studied New Keynesian DSGE models at university for instance, expectations in these models weren’t created ex-nihilo, they’re based on expectations of future interest rates – which have a modeled relationship to the NK ‘IS’ curve. Expectations amplify or nullify effective instruments, they do not turn non effective instruments into effective ones (except through irrationality). It’s a weak argument for QE to say its effective because it signals the path of future interest rates (you don’t need QE to signal that!) so presumably you’re talking about expected future QE.

    Now maybe there is a way to show/model that expectations of future QE can have a profound effect on current NGDP, I’m not dismissing that. But until someone actually produces this model to show how this could possibly work, the skeptics are still winning the debate for me – I have nothing to counter them, no model.

    “You talk about “helicopter drops”, but in previous comment threads it has already been clear that you don’t mean the same thing that everyone else means by that term. ”

    I use helicopter drops how people like Michael Woodford, Wren-Lewis & Adair Turner use them, I do not recall anyone showing me that my use of the term is incorrect, are you sure you’re not confusing me with someone else? For the record, any helicopter drop that is ‘temporary’ is not really a helicopter drop at all – a good way to think about it is to compare it to the literal analogy, there is nothing temporary about money dropped out of a helicopter to a member of the public.

  47. Gravatar of Don Geddis Don Geddis
    6. June 2015 at 08:50

    @Britonomist: “Show me how QE affects NGDP” Hot potato effect. Force an excess of currency, onto a public that does not currently have a desire to hold that much. The attempts to get rid of the excess currency (by using it to purchase something) will raise velocity until prices finally rise sufficiently so that the amount of currency matches the public’s desire to hold it. I.e., NGDP rises.

    evade it by coming up with extreme scenarios where the Fed buys everything” Why do you dismiss it as an evasion? It’s a legitimate threat, that provides the raw material for the expectation channel.

    The expectations channel alone doesn’t work unless you have an effective monetary instrument and credibility.” Agreed, but QE + the tens of trillions of dollars of easily available financial assets, provides more than enough to base expectations off of.

    I use helicopter drops how people like…” Not really. For example, you saidIf you instead bought risky, high yielding assets which aren’t a close substitute with money […] to me that’s not really QE and is closer to helicopter drops.” Most people would say that the term “helicopter drops” refers to giving people money, not to purchasing financial assets on an open market.

  48. Gravatar of Britonomist Britonomist
    6. June 2015 at 15:56

    ” Hot potato effect. Force an excess of currency, onto a public that does not currently have a desire to hold that much. The attempts to get rid of the excess currency (by using it to purchase something) will raise velocity until prices finally rise sufficiently so that the amount of currency matches the public’s desire to hold it. I.e., NGDP rises.”

    But at the ZLB, short term safe debt and ‘currency’ become substitutes, which makes the HPE very unclear. Here’s John Cochrane for example: http://faculty.chicagobooth.edu/john.cochrane/research/papers/QEII.html

    This won’t get resolved until a proper mathematical model is presented.

    “Most people would say that the term “helicopter drops” refers to giving people money, not to purchasing financial assets on an open market.”

    Yes, I also define it as giving people money unconditionally. If the Fed does something which results in someone getting wealthier than they otherwise would be in the counter-factual, such as buying stocks and inflating up their price, this could be seen as ‘giving people money’. Buying safe debt at the ZLB however means these bonds can’t really increase in price any further, so their net-worth barely improves, so they barely have any more money than they could have otherwise.

  49. Gravatar of Don Geddis Don Geddis
    6. June 2015 at 16:59

    @Britonomist: Cochrane (in that article) claims that banks are indifferent between reserves and short-term bonds (at the ZLB). Of course, that’s just a claim, not an established economic fact. But even if true, there are sellers of Treasury debt that are not banks.

    Cochrane also can’t seem to come up with very good arguments for 2% inflation over 0%. He never mentions sticky wages or debts in the article, and he never mentions the observed resistance to nominal wage cuts. You can’t offer a plausible theory about macro inflation and deflation and the ZLB, without at least addressing those critical points.

    As for “helicopter drops”, I see you’ve now added an important criteria that Fed purchases need to “inflate up their price”. You never mentioned that before when you were commenting, and that was a critical omission. Most Fed purchases have only trivial effects on the net worth of the sellers.

    BTW: the HPE model is trivial. But just presenting a model doesn’t resolve anything. All the interesting questions are about how closely the model’s assumptions match the real economy.

  50. Gravatar of ssumner ssumner
    7. June 2015 at 05:20

    Britonomist, Soon I’ll do an Econlog post addressing your question.

    Thanks A.

  51. Gravatar of Jim Glass Jim Glass
    7. June 2015 at 06:17

    “ Hot potato effect. Force an excess of currency, onto a public that does not currently have a desire to hold that much. The attempts to get rid of the excess currency (by using it to purchase something) will raise velocity until prices finally rise sufficiently so that the amount of currency matches the public’s desire to hold it. I.e., NGDP rises.”

    But at the ZLB, short term safe debt and ‘currency’ become substitutes,

    If what were bought and sold were such very close substitutes, then why did the seller bother to sell? If not very close substitutes, then there is no objection. The seller will follow-up by re-arranging his portfolio to get back to its initial characteristics, as per the HPE.

    I just sold my parents’ house and received a lot of cash. I didn’t place it all in close-substitute 30-day T-bills. I went to Foxwoods and then to Belmont yesterday and re-established my former portfolio profile of debt up to my neck. Granted, I didn’t sell the house to the Fed. But if I had, the whole process would have stimulated AD even much more than it did.

  52. Gravatar of Britonomist Britonomist
    7. June 2015 at 06:33

    @Don

    “that’s just a claim, not an established economic fact.”

    Sure, do you have anything to disprove Cochrane though?

    “But even if true, there are sellers of Treasury debt that are not banks.”

    Yes, actually the banks largely act as intermediaries for the non-bank sector, such as pension funds – who are also largely indifferent from what I’ve read.

    I’m not really interested in his other stuff regarding inflation, I don’t agree with Cochrane about everything.

    “Most Fed purchases have only trivial effects on the net worth of the sellers.”

    It definitely would not be trivial for stocks. Also I’m pretty sure I said the Fed buying stocks was only ‘closer’ to being helicopter drops, not that it necessarily is. At some point though fed purchases, especially if they are bought for above market value, become equivalent to helicopter drops. As Cullen Roche said, if the Fed started buying bags of dirt from people for $5000 a bag, that becomes functionally equivalent to the Fed just giving them money.

  53. Gravatar of Britonomist Britonomist
    7. June 2015 at 06:43

    @Scott

    Looking forward to it.

    @Jim Glass

    “If what were bought and sold were such very close substitutes, then why did the seller bother to sell? If not very close substitutes, then there is no objection. The seller will follow-up by re-arranging his portfolio to get back to its initial characteristics, as per the HPE.”

    I personally think QE will boost your t-bill holding values by a few basis points, at least temporarily, so you may as well sell. I don’t think T-bills and money are perfect substitutes, but for large institutions like banks, pension funds etc…, they are very close substitutes and it likely makes very little difference if they hold cash or very low yielding t-bills.

Leave a Reply