Welcome Ashok Rao to the club
Ashok Rao has a new post that contains one of the better examples of market monetarist analysis that I have seen. Here is an excerpt:
Even Paul Krugman, the high priest of “monetary policy probably can’t gain traction in a liquidity trap”, agrees this has nothing to do with economic constraints of monetary policy as much as the conservatism of the central banking profession. That is to say, no one believes the central bank is sufficiently radical. In which case, we ask, what exactly is the point of militating for the abolishment of paper money – which is a far more radical experiment altogether?
Kimball – and maybe Yglesias – might argue that bringing it to the front of economic dialogue will make it easier for future crises to be handled effectively. But that would suppose getting rid of paper money is somehow fundamentally better than other unconventional options – given central banks were the right level of radical. We must make this stipulation because it makes no sense comparing a world where we are too timid to follow the policies proposed by Scott Sumner or Paul Krugman, but crazy enough to burn away paper.
And this contention is questionable at best. For example, even with negative interest rates, the central bank would need to set some sort of policy target. A lot of bloggers and forward-thinking economists like the idea of a nominal income target. I think Paul Krugman prefers a 4% inflation target (I don’t really know). If the latter – a higher inflation target – was the “optimal” solution between the two, then electronic money is most likely superior. The only point of a higher inflation target is to vastly reduce the risk of future recessions driving the equilibrium interest rate to the point of liquidity trap, and there’s some evidence that this is not optimal.
For reasons noted here, I don’t think a higher inflation target is superior to nominal income level targeting. In this case, it’s worth wondering whether negative interest rates really add a whole lot to the monetary policy arsenal, again, provided, markets didn’t think the central bank was skittish about its policies. The answer, I expect, is a probable “no” for reasons listed below:
- A nominal income target works as much through expectations of action as much as action. So once such a regime is credibly instituted, money velocity is unlikely to fall as much as it did even during a pretty serious crash. This doesn’t require lower interest rates.
- A proper quantitative easing plan can very easily provide above expectations with adequate firepower. What would such a plan look like? A symmetric Evans Rule. That is, for every month that the Federal Reserve misses its nominal income target, the scale of asset purchases are increased by some percent n. The exponential growth here would immediately convince investors that inflation is coming, stabilizing nominal income growth.
The only reason we would need negative interest rates under a nominal income target is if quantitative easing was somehow less welfare efficient than negative interest rates. This is likely to be the case if the central bank was forced to inject liquidity via the purchase of many private assets. However, with government debt levels where they are, this is not a significant concern, and can always be fixed with the issuance of higher maturity debt.
Another contention might be that it is easier to implement a “rules based” rather than “discretionary” monetary policy with the ability to vary interest rates below zero. While there is a sense that quantitative easing is discretionary, that only has to do with the conservative nature of the Federal Reserve, and there’s no reason why following a Taylor Rule when rates exceed zero, and an “exponential growth of asset purchases” when rates fall below zero is any more discretionary. It’s just as algorithmic, but with one extra condition. Die hard monetarists even want to institute a “nominal income prediction market” which would remove the discretionary element of maintaining the rule entirely.
Michael Woodford or Paul Krugman’s preferred monetary policy – “credibly promising to be irresponsible” – might be better achieved under negative interest rates but, even then, that’s not a clear conclusion. If central banks can’t credibly commit to keep interest rates at zero for a long time due to institutional conservatism, I’m not sure how we could a) abolish paper money, and b) credibly convince the market that we’ll bring them below zero for long enough. That the Bank of Japan increased interest rates whenever the economy was just about to recover is an example of this difficulty.
Anyway, if Bernanke could somehow promise that interest rates will be zero on January 01, 2017 there’s a very good chance we’d hit escape velocity from the liquidity trap. And that’s a less radical promise than getting rid of paper money altogether. (Can you imagine what Austrians and their ilk who dominate America’s policy minds on both sides of the aisle would say about NEGATIVE interest rates?) By the time we reach a political consensus that paper money is archaic, we’ll have a far better monetary policy to begin with by virtue of the fact that it is less radical. (Not to mention the fact that in modern markets simply holding a foreign currency won’t be a bad choice, either).
I sometimes feel arguments for a negative interest rate are substituted in place of arguments for a better policy target. But the latter is the important debate, and the former is only a tool to achieve the latter. If an optimal target necessitated negative interest rates, I’d be writing about them every day. But I’ve yet to see an argument why a nominal income level target requires negative interest rates. Importantly, the central bank can technically levy a penalty on excess reserves which has the same benefits.
Paper money is killing the economy, but so is central bank conservatism. The former is just a symptom, the latter a disease.
Outstanding! (Emphasis added.)
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11. September 2013 at 18:51
Ashok!
Being the least crazy crazy guy is EXACTLY like being the nicest mean guy.
Rhetoric is the study of making the weaker argument the stronger.
If it exists…
Than doing the opposite of rhetoric to both sides of the argument, will quickly distill you down to:
The nicest of the mean arguments.
Never fear, in today’s world, there’s something deeply compelling about identifying the argument that feels OK, even tho there was zero effort to convince you on your terms.
Scott doesn’t have to be nice about NGDPLT, more importantly he shouldn’t feel bad attacking the crazier ideas than his, and those who suggest them, with both barrels.
11. September 2013 at 19:09
Excellent blogging, yes it is mostly good news, especially the part about tapering up until minimal economic conditions are met….but
Only real-world tapering up will work. Why?
In Japan they did hold rates to zero and probably the public believed rates would stay at zero for eternity…and still they were in perma-deflation-very slow growth-recession for decades. ZLB alone will not revive an economy. AD remains dead.
In the USA we have another problem: The FOMC and freedom of the press and punditry.
Various FOMC members are like loose cannons rolling around on deck, firing in all directions, erratically, but usually when it can cause the most damage—to the economy, that is. And, as a public agency, the Fed suffers from the same lack of credibility and respect that all federal agencies suffer from.
So what value is guidance from the Fed if the public thinks the Fed can change directions at the very next meeting, or is merely blowing PR smoke anyway? (That small sliver of the public that understands the Fed and QE, btw).
Add on: Various pundits, and even icon of economics, such as Volcker, Meltzer, Taylor or Krugman, have said QE is ineffective. So, is the public to believe the Fed, or these towering figures of finance and economics?
All the Fed can do is commit to higher levels of QE every month, and damn the torpedoes, full steam ahead. Sadly, the Fed lacks the resolve to do this.
QE will result in greater AD and higher asset prices, and if done hard and long enough, it will work.
But we may be talking years and a few trillion more in QE. But the alternative is somewhere in Euro-Japan land.
11. September 2013 at 20:24
Good points.
The problem with “credibly promising to be irresponsible” is that it assumes the Fed is being responsible now. Everyone is still paranoid about inflation. But the Fed has already won the war against the Great Inflation, to the point that Milton Friedman’s statement about a decades-long gradual lowering of interest rates in response to tight monetary policy is now the dominant paradigm.
11. September 2013 at 21:14
And now we have a new guest blogger (hopefully).
11. September 2013 at 23:12
Krugman is the high priest of pretty much everything, at least he thinks so.
Thnx Ashok Rao for (another) great post!
11. September 2013 at 23:57
What I nice text. I specially like the bit about ‘institutional conservatism’. It is simple not credible for a partly political institution to do nothing other then promising that intrest rate will be 0% in ten years.
That basiclly says the will do nothing in the next 10 years.
If the markent does not buy this (and they should), or do something for politcal reasons, it will further reduce the credibilty.
You are credible when you act in a matter of what you say you want to do.
12. September 2013 at 00:27
Scott (and Ashok), what do you think of this remark by Raghuram Rajan?
http://www.project-syndicate.org/commentary/how-to-fix-india-s-economy-in-the-short-term-by-raghuram-rajan
Note that NGDP growth was high but falling over the past 3 years.
12. September 2013 at 02:47
Krugman has the secrets of the monetary universe.
12. September 2013 at 03:01
“A proper quantitative easing plan can very easily provide above expectations with adequate firepower. What would such a plan look like? A symmetric Evans Rule. That is, for every month that the Federal Reserve misses its nominal income target, the scale of asset purchases are increased by some percent n. The exponential growth here would immediately convince investors that inflation is coming, stabilizing nominal income growth.”
Why would investors be convinced of inflation? Mortgage rates going down and longer term rates going down as a result of QE might not be enough to make people confident at all. Maybe prices go down instead of up becuase of lower interest costs. The private sector may want to deleverage so lower rates might not help at all.
12. September 2013 at 03:40
Off-topic:
https://pbs.twimg.com/media/BT6O2tBIQAAwIYc.png
12. September 2013 at 04:35
“@themoneygame: WOW: INITIAL JOBLESS CLAIMS PLUNGE TO 292,000 (Est. 330,000) http://t.co/p6Cx29uaFX“
12. September 2013 at 05:35
Saturos, I don’t know enough about India to comment on that, but I suspect much of their problem is supply-side.
lxdr, If the “percent n” was big enough people would expect inflation. I’ve suggested 20% per month.
Aldrey, Those are boom time levels of jobless claims, I did a post on this issue a few months back.
12. September 2013 at 05:53
Scott, so reading the rest of the piece, Rajan is wrong that structural reforms are not pressing?
12. September 2013 at 08:17
1) short term rates are not at zero.
2) “conservatism” is not a systematic variable. It’s a tautology.
What is so frightening about taking the central bank actions at face value? Perhaps we should assume that they are getting exactly what they want.
Tight money might just possibly be established policy, and not some sort of cosmic mistake.
12. September 2013 at 10:09
Scott and everyone – thanks!
Saturos you said, “[S]o reading the rest of the piece, Rajan is wrong that structural reforms are not pressing?”
It depends what you mean by structural reform. Fuel subsidies are very big in India, and 100% of growth in the market will be coming from imports. Since that’s all denominated in dollars, having a captive demand for fuel – as a consequence of political constraints – is dangerous. That’s a fiscal policy, but structural in the political system.
For India it’s also worth looking at net, rather than gross, income. I think capital depreciation is higher than estimated. But altogether I’m not too sure how to read ngdp in recent years.
“Why would investors be convinced of inflation? Mortgage rates going down and longer term rates going down as a result of QE might not be enough to make people confident at all. Maybe prices go down instead of up becuase of lower interest costs. The private sector may want to deleverage so lower rates might not help at all.”
That’s much, much too complicated a way of looking at the scenario. Sure, in econ there’s always some contrary effect and we can always contrive scenarios with perverse consequences.
Look at it this way. If the Fed increases its purchases even by 5% a month, there are literally only two things that can happen: we violate the laws of physics, or inflate. That is because without inflation the real value of the Fed’s balance sheet will represent a claim on future consumption greater than the world can possibly produce given our scientific and physical constraints.
In other words imagine a completely money financed tax cut of every revenue. We either get inflation (good) or magically run the world’s largest army, insurance company, and health center by printing paper (amazing).
Those are very literally the only options. And since physics is not wrong, inflation has to happen.
12. September 2013 at 10:50
[…] quantitative easing is deflationary. Their reasons and political affiliations are diverse but, a comment like this left on Scott Sumner’s blog, captures that sentiment […]
12. September 2013 at 17:12
Saturos, Just the opposite, I equate “structural” and “supply-side.”
12. September 2013 at 20:08
Welcome indeed, Ashok Rao! You’re off to a good start!
13. September 2013 at 20:10
“lxdr, If the “percent n” was big enough people would expect inflation. I’ve suggested 20% per month.”
But why is it always assumed that if people expect inflation it will change their behavior in a positive manner? People could save more for example if they expect prices to increase.
14. September 2013 at 06:14
lxdr, More saving leads to more investment. What’s wrong with saving?
Perhaps you mean people could engage in more money hoarding. Yes, that’s possible, but I very much doubt it would happen. It would be highly irrational.
14. September 2013 at 14:33
Yes hoarding is what I meant. Leaving funds in deposit accounts instead of consuming for example.
Saving is good but as long as it is not happening because of negative expectations of the future economy. I think it would be rational if people expect higher inflation in consumer prices be more negative about the outlook of the economy and hence become more risk averse.