Tim Duy on monetary offset

Tim Duy was recently interviewed by Bloomberg:

The Fed ramped up its quantitative-easing program late in 2012, helping to keep the recovery on track last year in the face of higher taxes and reduced government spending. With that drag set to fade this year, the central bank started to scale back its stimulus in December.

Offsetting Austerity

“They offset fiscal austerity on the downside but then arguably also offset the upside,” Duy said. “They seem to have lost interest in speeding the pace of the recovery.”

Soss said Fed officials may be realizing there are limits to how much they can spur growth in the aftermath of a financial crisis that’s made consumers and companies more cautious.

Some policy makers are becoming wary of the potential costs of providing more stimulus to the economy.

“We’re exactly on the right track” with current policy, Federal Reserve Bank of San Francisco President John Williams said in an April 21 interview, predicting unemployment will fall to 5.5 percent by the end of next year.

People have all sorts of ideas on how to speed up the recovery.  Everything from boosting mortgage lending (Congress and Obama) to building more infrastructure (Larry Summers.)  Unfortunately you can’t really do anything meaningful when the Fed thinks the economy is “exactly on the right track,” and does whatever is necessary to keep it on that track.

It’s the Fed’s nominal economy, we just live in it.


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21 Responses to “Tim Duy on monetary offset”

  1. Gravatar of Philippe Philippe
    29. May 2014 at 05:39

    Scott,

    just because you’re “on the right track” doesn’t mean you can’t go faster along that track. If on the current settings the Fed thinks that unemployment will fall to 5.5 percent by the end of next year, why not use fiscal policy to bring it down to 5.5 percent before then?

  2. Gravatar of foosion foosion
    29. May 2014 at 05:52

    >>Unfortunately you can’t really do anything meaningful when the Fed thinks the economy is “exactly on the right track,” and does whatever is necessary to keep it on that track.>>

    Alas.

    There’s an old column by Krugman in which he recounts being asked how NAFTA would affect employment. His answer was the effect would be whatever the Fed wants it to be. The parallels to the effects of fiscal policy, infrastructure, etc. are obvious. (This doesn’t means fiscal policy, etc. would have no effect, just that the Fed could offset.)

    >>just because you’re “on the right track” doesn’t mean you can’t go faster along that track.>>

    On the right track, especially in context, implies the correct direction and speed. The Fed does not want to go faster and is prepared to slow things down.

  3. Gravatar of Philippe Philippe
    29. May 2014 at 06:05

    “The Fed does not want to go faster”

    Assume that the Fed will make some changes to its policy when unemployment falls to 5.5% as predicted.

    Let’s say that on December 1st 2015, unemployment finally falls to 5.5%, leading the Fed to change its policy.

    Now imagine instead that unemployment falls to 5.5% on December 1st 2014, leading the Fed to change its policy.

    What’s the difference? The only difference is that in the second case unemployment fell to 5.5% sooner, and a whole year of waste was avoided.

    So why not use fiscal policy to make the second case happen, instead of the first?

  4. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. May 2014 at 06:40

    Philippe,
    The “right track” comment seems to imply the FOMC is satisfied not only with the forecasted level but with the pace at which it is attained. Under those circumstances fiscal policy will accomplish zip.

  5. Gravatar of Bob Bob
    29. May 2014 at 06:44

    You are assuming that the fed would do nothing immediately after seeing fiscal policy changes. You are also assuming that people will not expect the Fed to react. Markets are forward looking.

    The argument is not that we shouldn’t use fiscal policy, but that we can’t as long as the Fed doesn’t want it to work. Monetary action can counter any fiscal policy, as far as NGDP is concerned.

  6. Gravatar of ssumner ssumner
    29. May 2014 at 06:53

    Philippe. The “track” refers to a graph with time on the horizontal axis. Thus going faster means going onto an entirely different track.

  7. Gravatar of Britmouse Britmouse
    29. May 2014 at 08:04

    foosion, nice. Krugman is the greatest pop econ writer ever, isn’t he? http://www.pkarchive.org/trade/ForeignPolicyStupid.html

    Think of the U.S. economy over the next decade as an automobile driving from Boston to New York. Let the average speed of that automobile over the route represent the average level of employment over that decade. And let the dispute over the direct employment effects of NAFTA be represented as an argument over whether there will be a head wind or a tailwind as the car makes its way along the interstate. Then assessing NAFTA’s overall job impact is like predicting how the extra wind will affect the car’s speed. Job-counting exercises do this by assuming that nothing else changes–in effect, they assume that the engine in our car will receive exactly the same flow of gas that it would have been given in the absence of any wind.

    Reads like a Nick Rowe post.

  8. Gravatar of Philippe Philippe
    29. May 2014 at 08:51

    “The “right track” comment seems to imply the FOMC is satisfied not only with the forecasted level but with the pace at which it is attained.”

    Here’s the quote from Bloomberg:

    “We’re exactly on the right track” with current policy, Federal Reserve Bank of San Francisco President John Williams said in an April 21 interview, predicting unemployment will fall to 5.5 percent by the end of next year. Trying to achieve the Fed’s goals sooner “would take policy actions that might have more negative effects,” such as encouraging excessive risk-taking in financial markets.”

    It seems from this that the Fed would prefer unemployment to fall sooner, but they are worried that more monetary stimulus might have negative effects.

    In this situation, if fiscal policy were used to bring unemployment down sooner, why would the Fed want to sabotage that and maintain higher unemployment? The sooner the Fed’s unemployment target is reached, the sooner it can ‘tighten’ monetary policy, if that’s what it wants to do.

    Here’s Yellen, from the same piece:

    “Our baseline outlook has changed as we have learned about the degree of structural damage to the economy wrought by the crisis and the subsequent pace of healing,”

    It seems clear from this that she thinks slow recovery and high unemployment does long-term ‘structural damage’ to the economy. If this is the case, why would she want to slow down the recovery, or slow down the rate at which unemployment falls? Wouldn’t that just do more structural damage?

  9. Gravatar of benjamin cole benjamin cole
    29. May 2014 at 11:53

    Excellent post. Except who sez the FOMC cares about growth? You have copious board minutes and public proclamations by FOMC members attesting to their fixation on inflation. Some board members effectively subscribe to the idea that the Fed has a single mandate to obtain zero inflation, as measured by dubious indices.

  10. Gravatar of ssumner ssumner
    29. May 2014 at 18:26

    Britmouse, Yes, that’s excellent.

    Philippe, You can certainly make that argument, but the meaning of “right track” is very clear. If it was expected that unemployment would take 8 years to fall to 5.5%, Williams would not claim we were on the right track.

    I think most people missed the point of this post. It is Tim Duy describing monetary offset, not me. This post is not aimed at proving monetary offset, that’s another argument. The purpose of this post is to establish that when a thoughtful Keynesian commenter thinks about the issue with an open mind, it’s pretty hard not to come to the conclusion that the Fed is engaged in monetary offset. That’s the “headline story.”

    Regarding Yellen, you raise a good question. I’m not sure she’s able to provide a good answer.

  11. Gravatar of Ralph Musgrave Ralph Musgrave
    29. May 2014 at 21:20

    It’s obvious that the Fed can nullify fiscal stimulus (or the opposite, austerity).

    However, the advocates of “monetary offset” then take the argument too far, and claim that the above phenomenon proves that monetary stimulus is INHERENTLY SUPERIOR to fiscal stimulus.

    That is complete nonsense.

    In fact it would be perfectly feasible to set up a “fiscal offset” arrangement. I.e. have the fiscal authorities offset whatever the Fed did. Likewise that would not prove that fiscal policy is inherently superior to monetary.

  12. Gravatar of Lorenzo from Oz Lorenzo from Oz
    29. May 2014 at 23:55

    Except for those of us who live in the RBA’s nominal economy. (Sorry, couldn’t resist.)

    Of course, our area of the world is looking like it might get increasingly exciting:
    http://www.the-american-interest.com/blog/2014/05/29/china-to-vietnam-if-theres-gas-in-the-south-china-sea-its-ours/

    I wish the People’s Republic reminded me a little less of the Second Reich, c.1910.

  13. Gravatar of Lorenzo from Oz Lorenzo from Oz
    29. May 2014 at 23:56

    Ralph: surely fiscal policy is more expensive, and slower reacting. They would seem to be serious disadvantages.

  14. Gravatar of ssumner ssumner
    30. May 2014 at 02:40

    Ralph, You said.

    “In fact it would be perfectly feasible to set up a “fiscal offset” arrangement.”

    Actually it would not, the government would quickly go broke. Fiscal stimulus is costly, monetary stimulus is costless.

  15. Gravatar of libertaer libertaer
    30. May 2014 at 05:57

    Off topic, but this is frightening. Draghi openly shows who his real masters are.

    At the end of the article:

    http://blogs.ft.com/money-supply/2014/05/27/krugman-gives-draghi-some-advice/

    “What would it mean for Germany to have a 5 per cent level? I wouldn’t want to think of that,” Mr Draghi said.

  16. Gravatar of Garrett Garrett
    30. May 2014 at 07:24

    Duy also has a blog post talking about the Fed’s recent policies compared to recent economic performance:

    http://economistsview.typepad.com/timduy/2014/05/policy-induced-mediocraty.html

    The 10-year has rallied 60 bps this year (keeping up with stocks performance-wise). Seemingly everyone on Wall Street was short duration going into this year and got crushed.

    I wonder if the rate rally is due to the market pricing in reduced average NGDP growth in the medium term (and therefore pricing in increased recession risk).

  17. Gravatar of Ralph Musgrave Ralph Musgrave
    30. May 2014 at 07:48

    Lorenzo and Scott,

    Re fiscal being slower acting than monetary, I’m not the world’s expert, but from what I’ve seen, there isn’t much difference, e.g. word search for “lag” here:

    http://findarticles.com/p/articles/mi_m1093/is_n1_v41/ai_20485331/
    http://www.blackwellpublishing.com/specialarticles/INFI097.pdf
    http://www.bankofengland.co.uk/monetarypolicy/how.htm

    Re the idea that my hypothetical “fiscal offset” arrangement would result in government going broke, I don’t agree, and for the following reasons.

    First, definitions. What I mean by fiscal policy is: “government borrows and spends and/or cuts taxes. By monetary policy, I mean: “central bank buys assets”.

    Certainly if fiscal ALONE were used to impart stimulus and with no monetary element ever being used, then you’d get a rapidly increasing national debt (as Scott suggested). But “offset” (monetary or fiscal) does not consist of using mon or fisc EXCLUSIVELY. It consists of using one to damp down a temporary excessive use of the other. Ergo, “fiscal offset” does not lead to government going broke.

    Using monetary or fiscal policy alone leads to equally absurd outcomes, far as I can see. Fiscal alone leads to excessive debt, as just stated. As to using monetary alone, that leads to government eventually buying all private sector assets, and for the following reasons.

    To keep it simple, assume constant GDP and that inflation is at the 2% target. That means the real value of the monetary base falls by 2%pa. So the Fed buys enough assets to rectify that. Next year the same happens, and the next. Eventually, the Fed ends up owning all assets.

    Personally I regard the distinction between monetary and fiscal as nonsense, which is why I support the idea which I think most MMTers adhere to, namely just having the government & Fed create and spend new money (and/or cut taxes) when stimulus is needed. Milton Friedman also favored that idea, at least at one stage in his career.

  18. Gravatar of ssumner ssumner
    31. May 2014 at 05:41

    libertaer, Draghi doesn’t seem to know that German inflation is not part of his mandate.

    Thanks Garrett.

    Ralph, You said:

    “To keep it simple, assume constant GDP and that inflation is at the 2% target. That means the real value of the monetary base falls by 2%pa. So the Fed buys enough assets to rectify that. Next year the same happens, and the next. Eventually, the Fed ends up owning all assets.”

    This is wrong. In any plausible steady state with a stable MB/NGDP ratio, the Fed owns a constant share of Treasury debt. Unless you assume the Treasury debt falls over time as a share of GDP. But why would you make that assumption?

  19. Gravatar of Ralph Musgrave Ralph Musgrave
    2. June 2014 at 02:08

    Scott,

    I’ve no quarrel with your assumption that the Fed owns a constant share of Treasury debt. I’ll re-state my point incorporating that assumption.

    To reiterate, the assumptions are: 1, inflation is at the 2% target, 2, the total of MB+national debt (in real terms) is constant relative to real GDP. And, 3, your above assumption.

    At the end of year 1, MB and national debt will have shrunk by 2%. So government will need to borrow and spend (and/or cut taxes) by enough to bring total debt back up to its initial level, i.e. government will need to do some fiscal stimulus. It will also need to borrow and spend a bit more, and have the Fed buy back the relevant chunk of debt so as to bring MB back to its initial level in real terms.

    However, if there is NO FISCAL POLICY (i.e. no borrowing and spending / tax cutting), then in order to bring MB back to its initial level, the Fed will have to buy other assets, e.g. houses, factories, etc.

    So in the long run, and given no fiscal, the Fed ends up owning all assets.

    Incidentally, the above assumption that MB plus debt should remain constant relative to GDP is not just an assumption that is convenient for making the above argument. As MMTers keep pointing out, private sector spending is related to what MMTers call “private sector net financial assets”: i.e. MB plus debt. Thus the sum of the latter two, all else equal, will actually need to be held constant (or in the real world, “approximately constant”).

  20. Gravatar of ssumner ssumner
    2. June 2014 at 07:53

    Ralph, Of course any time you have a government you have “fiscal policy” of some sort. Just as the existence of money implies monetary policy. The question is whether you want to use fiscal policy for stabilization purposes.

    If your only point is that the national debt must gradually grow to prevent the Fed from eventually holding 100% of the debt, then I agree. I just don’t consider that gradual growth to be “fiscal policy” the way the term is used in the stabilization debate.

  21. Gravatar of Ralph Musgrave Ralph Musgrave
    3. June 2014 at 01:46

    Scott, So the only difference between us is: which is best for fine tuning purposes – monetary or fiscal? And a big part of that question is: which involves the longer lags?

    I fully accept that given the existing political set up, monetary is to a large extent the only option because the “fiscal authorities” consists of a bunch of economic illiterates known as “politicians” who spend their time squabbling with each other. However, looking to the longer term, I think it’s possible to set up a system where politicians retain control of strictly POLITICAL decisions (e.g. what proportion of GDP is allocated to public spending), while some sort of committee of economists decides what the TOTAL STIMULUS should be: monetary or fiscal or whatever combination they think best.

    Assuming that system IS SET UP, there is then the question as to which is best for fine tuning: monetary or fiscal. And that depends largely in which involves the longer lags. As I said above, I’m not the expert on that. But I suspect fiscal is better. Can you point to any good evidence on the latter “lag” point?

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