The “shock” was Fed incompetence
The Cleveland Fed has a paper that shows the likely path of the fed funds rate in response to the 2008 macroeconomic “shock” had there been no zero lower bound:
I have a couple observations. Note that the appropriate rate is viewed as being roughly zero percent when monetary stimulus was desperately needed to prevent the Great NGDP crash in late 2008, and roughly minus 5% in late 2009 when it was much too late to prevent the crash. That’s a perfect illustration of the folly of backward–looking monetary policies. And it shows why we need to “target the forecast,” preferably market forecasts.
More importantly, this exercise ignores the fact the the “shock” was not exogenous, rather it was a market recognition that the Fed was deviating from its multi-decade policy of keeping NGDP growing at about 5%. The markets began to realize in late 2008 that the Fed had no “plan B,” despite all the academic writings by Bernanke. There was no plan to prop up NGDP through unconventional policies, and no plan to engage in level targeting. The Fed was going to let NGDP crash, and not make up the ground later.
If the Fed had been able to cut rates below zero, markets would have had confidence that any economic weakness would be temporary, and that we’d quickly return to a healthy level of NGDP, as in Australia. This would have supported asset prices, and prevented the big “shock” to NGDP from occurring in the first place. The irony is that if the Fed had been able to push the fed funds rate negative, it might not have had to do so, or perhaps it might have only required a negative 1% or 2% target.
This example perfectly illustrates why interest rate targeting must be ended. The problem that occurred in this recession will almost certainly occur again in the next one. The Fed wasn’t ready in 2008, will they be ready in 2018? So far there are only a few hints that they may be considering some other type of targeting regime. It’s time for the policy model builders inside the Fed to get busy.
HT: Ryan Avent
PS. Movie buffs should definitely try to catch “Wake in Fright” on the big screen. The film had been believed lost, then a copy was recently found in a warehouse in Pittsburgh. Ohio. It’s now been painstakingly restored to its full circa-1970 Technicolor glory. Scorcese says it’s one of his favorite films and I’m sure Tarantino would also love the film. It’s pathetic how much effort society puts into preserving “historical” buildings with no historical interest, while film (arguably the art form of the 20th century) is allowed to get lost or deteriorate. The Golden Age of Australian film (the 1970s) just got even more golden.
And I’d like Saturos to tell me if the depiction of Australia is accurate. My only experience kangaroo hunting in the outback was quite different from the episode portrayed in this film.
PPS. Saturos linked to a video that indicated it was discovered in a pile of films waiting to be destroyed.
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14. October 2012 at 09:25
If the market crashes NGDP without the Fed destroying or hoarding dollars, then this shows NGDP is too high.
Not all NGDPs are created equal. There are a practically infinite number of compositions of a given NGDP, both in terms of where money is being spent, and in relation to the aggregate money supply.
A 5% NGDP growth rate for 20 years may be associated, and the way our monetary system works is almost certainly associated, with a very unhealthy investment trajectory, and not only that, but the unhealthy investment trajectory can be, and almost certainly is, caused by that which is generating a constant 5% NGDP growth.
Just like it is rather easy to understand that should a central bank print money and send the funds to a single company, to ensure it receives 5% revenue growth each and every year no matter what decisions the company’s owners make, that the market test of profit and loss would be all but eliminated, and the coordinating mechanism for integrating that company’s investments with other company’s investments would be lost…..so too should it be easy to understand that should a central bank print money and send the funds to a select few companies, to ensure that an entire country’s population of company owners receive 5% revenue growth each and every year no matter what decisions the whole population of company owners made, that the market test of profit and loss would be all but eliminated, and the coordinating mechanism for integrating that country’s investments with other country’s investments would be lost.
14. October 2012 at 09:28
Maybe market monetarists should get a crude market monetarist model going that determines what the quarterly growth in the monetary base should be based on the difference between actual(measured)GDPn and desired GDPn.
14. October 2012 at 09:34
Maybe market monetarists should get a crude market monetarist model going that determines what the quarterly growth in the monetary base should be based on the difference between actual(measured)GDPn and desired GDPn.
No constants exist for such a relation, so no model can be made. Humans aren’t robots.
14. October 2012 at 09:57
Scott: oficial statment of Reserve Bank of Australia: where did you see any reference to NGDP?
The Reserve Bank is responsible for Australia’s monetary policy. Monetary policy involves setting the interest rate on overnight loans in the money market (‘the cash rate’). The cash rate influences other interest rates in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately the rate of inflation.
In determining monetary policy, the Bank has a duty to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2-3 per cent, on average, over the medium term. Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.
14. October 2012 at 10:13
Sweden Riksbank Statment:
According to the Sveriges Riksbank Act, the objective of monetary policy is to “maintain price stability”. The Riksbank has interpreted this objective to mean a low, stable rate of inflation. More precisely, the Riksbank’s objective is to keep inflation around 2 per cent per year.
14. October 2012 at 11:13
Not old enough to remember the film (not cultured enough to have seen it anyway), but those guys seem familiar, I can find blokes just like them at the local pub (accents don’t sound quite like that these days, but still). Of course Australians have a dark side; witness the schizophrenic public debate on whether we are a racist country, and the misogynist comments recently made in public by our prime-ministerial hopeful. There’s even been a couple of series on public television this year: “Dumb, Drunk and Racist” and “Go Back to Where You Came From”. Granted that wasn’t quite John Grant’s problem, but I have often observed patently poor behavior distinctly attributable to our nationality being rationalised as “being a larrikin” – a degree of symbolic uncouthness is almost a cultural totem.
I don’t think people hunt kangaroos for sport these days (I think you need a license to cull the meat). I actually live only about thirty minutes’ walk away from a reserve full of kangaroos. But my own experiences with that species have not always been, shall we say, pleasant…
14. October 2012 at 11:18
Richard, the relevant difference is between currently expected future NGDP and desired future NGDP. And MF is right; which is why you need to keep targeting the (constantly changing) forecast in response to policy tweaks. But human behavior is stable enough to allow convergence to a policy goal (the demand for holding money is independent of any incremental expansion in its supply).
14. October 2012 at 11:20
This was about the pattern of the path which was followed in Turkey. The interest rate went down with about 17% (it had above 20% inflation in 2008 which has come down quite a bit). Turkey did well.
14. October 2012 at 11:35
According to this clip they found the reel (under the title “Outback”) in Ohio: http://www.youtube.com/watch?v=RF6mW1-sroI
14. October 2012 at 11:43
To be clear, I’m pretty sure the blokes down at the pub aren’t wife-murderers or child-rapists. On the other hand that sort of thing happens all the time in isolated Aboriginal (PC term: “Indigenous”) communities in the outback.
The film as a whole seems kind of Expressionist, in the broad sense, so I don’t think you’re supposed to expect to find such a large concentration of people like that anywhere in reality. I don’t think Australians in isolated communities are that crazy (except possibly Tasmanians).
14. October 2012 at 11:45
Fingerslip: They found the clip in Pittsburgh, which is in PA isn’t it?
14. October 2012 at 11:58
What might a crude market monetarist model look like?
∆M1(T) = α[GDPn*(T) – GDP(T-1)]/V
where
∆M1(T) is equal to the needed change in the size of M1 for the current quarter.
α is a coefficient.
GDPn*(T) is the desired nominal GDP for the current quarter.
GDP(T-1) is measured nominal GDP from the past quarter.
For monetary base ∆b
∆b = ∆M1/mm
where mm equals the M1 monetary base.
14. October 2012 at 12:17
where mm equals the M1 monetary base.
That should read
where mm equals the M1 monetary multiplier.
14. October 2012 at 12:19
Actually, it should read
where mm equals the M1 money multiplier.
14. October 2012 at 12:38
Richard, we wouldn’t use your model. Market monetarists are forward-looking. Did you not read the post?
14. October 2012 at 12:47
Luis, I didn’t mean to suggest they were explicitly targeting NGDP.
Saturos, Don’t worry, there aren’t any murderers of child molesters in the film.
Richard, I prefer to rely on market forecasts.
14. October 2012 at 13:03
Saturos, in order to have a forward looking model, I think you are going to need a market in nominal GDP futures–something that does not exist now. With that crude model, we could get something up and running.
14. October 2012 at 13:35
Yeah. As Fed.
14. October 2012 at 17:30
Scott, as an Australian, and someone who has seen the film. I think I can attempt to answer some of the questions you raised about the film and its depiction us Aussies. I’m basing this on my experience and based on interviews by the director of Wake in Fright, Ted Kotcheff, a Canadian.
The town that Wake in Fright is set in, ‘The Yabba’, is clearly based on the mining town Broken Hill, which most Australians would pick even if the film had not been filmed there. Now, to give you an idea of the circumstances in Broken Hill, I will construct a thought experiment: imagine a rural American town (no, it is not necessary it be American, it could be in any country and the conditions would still hold), population around 20,000 with an entirely white population.
Not only is the town mono-cultural, it is also mono-gender, over 90% of its inhabitants are male. And no, those 10% who are female, they are not prostitutes servicing the other 90% of men. At the time Wake in Fright was made, there were practically no women in the town, but there were certainly no prostitutes in the town. How do I know this? Because the films director, Ted Kotcheff, who studied the town for research and spent months there filming, said so in an interview. In fact, the first thing he asked when he arrived in Broken Hill was, ‘so where are the prostitutes?’ There were none. He looked for them. They weren’t there. Kotcheff recalls being asked by a local in a bar to punch him on the chin. Kotcheff’s theory for this behaviour (yes, spelt with a u)was that men substituted a lack of female intimacy with male intimacy, not in a homosexual way but an aggressive way. So there would be a lot of fights, but in the sweet kind of way where they just want to be in contact with another human being.
And this town is isolated. It is very isolated. Broken Hill is in the state of New South Wales. But it is so geographically isolated from the rest of that state that its inhabitants identify themselves as much with South Australia, the neighbouring (yes, with a u) state. But why wouldn’t they, as the capital of South Australia, Adelaide, population one million, is a mere 500 kilometres (yes, re, not er, do we even speak the same language!) away, twice as close as the New South Wales capital Sydney. Broken Hill’s time zone isn’t even part of New South Wales, it shares its time zone with South Australia.
Now, this town, with no women, that is all white, that is completely isolated and where there is absolutely nothing to do, what do you think it is going to look like? I’m thinking Mad Max 2. If anything I’m amazed at how tame we Australians were depicted in that film, considering ‘The Yabba’s’ conditions.
How do I feel about how us Aussie’s were depicted in the film? I’m fine with it. I’m fine with it. If I were in their situation I’d probably have acted the same. No, that is not true. Remember, the film was set in the pre-internet era. No women, nothing to do, not even the damn internet! Too scary to think about.
As for my own experiences as an Australian? I live in Adelaide, which is larger than all but nine US cities. In Australia its seen as the Australian version of Cleveland, it can’t compete with Sydney or Melbourne, it doesn’t have Brisbane’s sun and surf and it has lacked Perth’s mining boom river of gold. Still, we hosted Formula One for decades, Lance Armstrong’s drug filled legs powered around are hills twice in our cycling tournament and we have a world class arts festival. Its a multi-cultural city, huge Chinese and South-East Asian influence, huge Sub-continental influence and ten thousand overseas students, mostly Chinese, Indian and South East Asian go to our universities.
Now, my parents live only forty minutes drive from the central business district of Adelaide, in the Adelaide Hills. They live fifteen minutes drive from the suburbs. But the hills aren’t part of the city, they are bush and farms dotted with towns of 1000 or so. So the Adelaide Hills high school I went to, in my final year, there were 100 students, two of whom were not Caucasian. One of them wrote in his year book that he was remembered for being Asian (the other non Caucasian was from the Pacific Islands).
So you can see how rapidly Australia changes once you leave the city. I lived fifteen minutes from the suburbs, forty from the central business district and that meant a return to White Australia. Imagine what it looks like say, an hours drive from the suburbs.
My auntie, who lives 70 kilometres from the centre of Adelaide, in the far more rural Barossa, recently had to go to the hospital in the centre of Adelaide. Her son went for a walk through Adelaide’s China town and was shocked to see so many Asians. This is what he thought when he lived an hours drive from town! He also goes hunting, he shoots kangaroos and non native goats where he lives and non native boar interstate. At the moment, he is in the French countryside learning about wine making. He was captain of his school and is the mildest person you’d ever meet. People are complicated. He hunts, I’m vegan, he never sees anyone but English, Dutch or German ancestors, my co-workers are Nepalese, Indian, Argentinian, Colombian, Venezuelan, Chilean, Italian, Greek, Polish and Chinese. meh
Interestingly, in Australia today there is a kind of culture-wars going on about the Australian films we make today. The war is fought between those who want to see more Australian rom-coms and less ‘dark’ films depicted the underside of Australian life (drug abuse, violence, adolescent rage, racism, anything that makes films interesting), this side is championed almost exclusively in the pages of the Murdoch papers who would prefere our films not to mention that we, um, took Aboriginal children from their parents and, um, aren’t always nice to people with funny names. On the other side are the film critics, who all worship the Australian films of the seventies and love to see realism depicted on the screen.
Sorry about the length, to paraphrase you, ‘I am not a natural commenter’.
14. October 2012 at 17:35
NGDP is goods and services, but what about the turnover of assets. I don’t see a way to explain this crisis without including the role of debt and asset turnover. Almost every single depression(or extended recession) has been associated with falling debt(a deleveraging). The thing that I really like about NGDP targeting is that you’re enabling the economy to grow out of its debt overhang (and you’re not targeting something that’s basically impossible to measure/target accurately like inflation).
The next paper by Ray Dalio explains this really clearly(I think so at least):
http://www.bwater.com/Uploads/FileManager/research/how-the-economic-machine-works/How-the-Economic-Machine%20Works–A-Template-for-Understanding-What-is-Happening-Now-Ray-Dalio-Bridgewater.pdf
I really like NGDP targeting because you can set the NGDP target above the rate at which it takes to service the debts so the debts can get systematically wiped out. Here’s another article by Dalio, one that focuses more on deleveragings.
http://www.bwater.com/Uploads/FileManager/research/deleveraging/an-in-depth-look-at-deleveragings–ray-dalio-bridgewater.pdf
14. October 2012 at 22:03
Richard, the Fed could also target its own internal forecast. Or the market forecasts that we always look at on this blog.
Simon, isn’t Broken Hill also where they made the Mad Max movies? I’ve seen those, pretty bleak. Also reminds me of “On the Beach”. I’ve been to Broome, Alice, Coober Pedy, is it anything like those?
At the end of the day I tend to feel that all Australian cities are relatively similar (though I haven’t been to Darwin yet).
“Her son went for a walk through Adelaide’s China town and was shocked to see so many Asians.”
Similar stories could be told about Perth. You can watch the population distribution change as you head down towards the river.
To be fair, a lot of the stuff with the Stolen Generation was just the colonial authorities trying to grapple with the same issue that eats away at us today: how to fix the inequality between us and indigenous society, how to restrain their society’s visible collapse. They took, shall we say, drastic measures. But we’re still willing to use a brute force approach to try and cure their problems (c.f. Howard).
“On the other side are the film critics, who all worship the Australian films of the seventies and love to see realism depicted on the screen.”
So much so that we’ve spent the past couple of months treated to endless depictions of teenagers in the 70’s having sex all over our TV sets…
Guess I was wrong about the leisure kangaroo hunting…
Simon, I don’t think Scott really cares about the spelling. I use American spelling, but that’s just a habit I’ve developed from hanging out on the internets. (I even think in American English sometimes when responding to commenters…)
14. October 2012 at 22:37
By the way, I also found this. It says that the amount of home loans that are being taken in Australia are increasing again–and by a good margin too.
http://www.thebull.com.au/articles/a/32235-data-shows-housing-stabilisation:-experts.html
Apparently in Australia, people are starting to borrow more to buy assets(houses via mortgages) again(like it says in the article). I also found out that the household debt/disposable income is over 180%. They’ve also had a huge mining boom due to China’s use of commodities. The price/rent ratios of houses are also extremely high and have basically doubled in the past 15-20 years.
I tend to think that there are feedback mechanisms–both on the way up and the way down–between people buying more assets(in this case houses), the price of the houses, and the leveraging up to do so. Combine that with debt/income ratios at all-time highs, it makes me feel like the Australian economy is built on quicksand. It seems to me like any small shock could blow up their entire economy. Australia could still be booming for another 5-10 years, but this kind of growth doesn’t seem sustainable. I think that when it does blow, it’ll blow big time.
I don’t know, maybe this time is different. Or maybe it’s the exact same.
14. October 2012 at 22:40
By the way, here’s a bunch of data on house prices across the globe. It’s a little app from The Economist that’s really neat. It’s got house-price indexes, prices in real terms, price/rent ratios, price/income ratios, and percentage change.
Here it is:
http://www.economist.com/blogs/dailychart/2011/11/global-house-prices
15. October 2012 at 04:02
Scott,
I was in Singapore earlier this year and learnt about the islands history as a magnet for workers from India, China and Malaysia. What was interesting was that those workers were almost all exclusively male and the gender ratio was greatly skewed towards males, even at the start of the 20th century males outnumbered females by over 2:1.
When I found that out, I immediately thought that Singapore was once just like ‘The Yabba’ from Wake in Fright. Could you have set ‘Wake in Fright’ in Singapore in the nineteenth century? I think I did read something about prostitution being a big problem in Singapore at this time while i was over there.
I also found out why Singapore has such great street food (indeed always has). Street food instantly appears when male workers have no mothers or wives to cook for them. (Warning, this is not a universal rule, never eat street food from Broken Hill.)
Singapore also gave me my first experience feeling like I lived in a developing economy…
Saturos, of the towns you mention, I have only been to Alice Springs, so cannot really say, but I would assume that Coober Pedy would be the most similar to Broken Hill. Alice Springs has trappings to keep tourists amused while they wait for their flight to Uluru and Broome is a town built around tourists. What brought you to Coober Pedy, that is way, way, way of the beaten track.
What I find interesting about the United States is how a country with 300 million people can have so few large cities. If Australia became the 51st state of America, five of the top nine largest cities by population would be Australian cities. Two of the top three largest cities would be Australian. (These numbers are not including Chicago-Land, San Jose/San Francisco etc.
What amazes me is how rural the US is. If you got all your information about the two countries from TV and movies, you would think every American lives in NY or LA (and Twin Peaks…) and every Australian lives in the outback, when the reverse may be closer to the truth.
15. October 2012 at 04:16
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15. October 2012 at 08:41
Simon, there’s like a whole debate in economics as to whether the US arrangement is efficient. Whether people should cluster in cities or whether they should excercise their preference for quiet spacious towns. US cities are small, but there’s a lot of them – a whole civilization in itself. You’re making the Americans sound like they’re still an agrarian society. (Though have you seen the farm subsidies…)
My uncle used to work in Roxby Downs, so it was a trip from there.
Singapore is awesome, but too tiny. If I could select any nationality I wouldn’t pick that one, despite the healthcare system…
15. October 2012 at 11:58
“If you got all your information about the two countries from TV and movies, you would think every American lives in NY or LA”
If you spent any time in California you would say that no one actually lives in LA. Acutally about 3 million people live in LA proper but close to 20million live in “Greater Los Angeles.”
700,000 live in San Francisco but 7 million live in “the Bay Area.”
15. October 2012 at 13:34
700,000 live in San Francisco but 7 million live in “the Bay Area.”
8 million if you include the homeless people. Goodness.
15. October 2012 at 17:58
Simon, Thanks for all that info.
No one was surprised that I once went kangaroo hunting?
15. October 2012 at 19:12
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16. October 2012 at 03:01
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16. October 2012 at 03:05
What can I say? You are a man of many talents.
22. October 2012 at 10:35
Update: Our country really is like that sometimes: http://www.smh.com.au/entertainment/music/vines-singer-craig-nicholls-arrested-over-violent-rampage-at-home-20121016-27nuv.html
They were a cool band too, I used to like them.
22. October 2012 at 10:36
That picture should be the new webmeme for “douchebag”. Someone post it on 4chan…