"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Friday, August 27, 2010

Really good links - Fed&TIPS - Monetary policy - Bailout risks - Krugman, Christ and the resurrection of Milton Friedman - Kocherlakota and Zimbabwe - Scott Sumner - 3% inflation

Steve - Fed and TIPS spreads - "If the Fed makes a policy announcement that the market deems deflationary, TIPS spreads will *immediately* shrink. Directionally, the market renders an immediate verdict on the Fed decision as you said.
        However, the *magnitude* of the reaction depends on circularity: does the Fed trust the market (they will correct their decision next time) and does the market trust the Fed.
        If the Fed renders a “bad” decision, but their is mutual trust between the market and the Fed, TIPS spreads will fall a little and stocks will fall a little, even if the decision is terrible. What is the cost of six weeks?
        However, if the Fed renders a “bad” decision and says it is smarter than the market, the TIPS spreads and the stocks will both crash. If the Fed thinks it knows better than the market, the market will price in the full extent of any perceived bad decision immediately. See September/October 2008."

Scott Sumner - The empathetic, the amoral, and the sadistic monetary policy - "Instead, I’d like to argue that central bankers are a bunch of well-meaning (or at worst amoral) people who act like sadists because they have the wrong model in their heads. They think that it is “natural” for inflation to fall during periods of high unemployment. And we know that ‘natural’ means good. After all, natural foods are good for you, aren’t they? Why do they think low inflation is natural in a weak economy? Because it almost always happens. When it doesn’t happen, e.g. 1974, the event is viewed as bizarre. "

Andy Harless - The Real Activity Suspension Program - "Think of this as a guest post by the Cynic in me. <..> Now this bailout program is not without its risks. The biggest risk is that the economy will recover, which would be a disaster for the program. Suddenly, not only would banks be holding losses on their Treasury notes, but their cost of funds would go up, as depositors realized that there were more attractive investments available than zero-interest bank deposits."

Paul Krugman - Christ and the resurrection of Milton Friedman

Karl Smith - Kocherlakota on Deflation - Apparently Kocherlakota was right - zero interest rates will cause deflation. But he forgot to tell us that we are going to see hyperinflation before that. Case study - hyperinflation and deflation in Zimbabwe.

Tweet of the day - Garett Jones - Scott Sumner - "If the U.S. Congress were functional, then Scott Sumner would be testifying monthly."

Ben Bernanke (Jackson Hole) - 3% inflation - Price level targeting is a bad idea because we didn't screw things up that much  - "A rather different type of policy option, which has been proposed by a number of economists, would have the Committee increase its medium-term inflation goals above levels consistent with price stability. I see no support for this option on the FOMC. Conceivably, such a step might make sense in a situation in which a prolonged period of deflation had greatly weakened the confidence of the public in the ability of the central bank to achieve price stability, so that drastic measures were required to shift expectations. Also, in such a situation, higher inflation for a time, by compensating for the prior period of deflation, could help return the price level to what was expected by people who signed long-term contracts, such as debt contracts, before the deflation began.
        However, such a strategy is inappropriate for the United States in current circumstances. Inflation expectations appear reasonably well-anchored, and both inflation expectations and actual inflation remain within a range consistent with price stability. In this context, raising the inflation objective would likely entail much greater costs than benefits. Inflation would be higher and probably more volatile under such a policy, undermining confidence and the ability of firms and households to make longer-term plans, while squandering the Fed's hard-won inflation credibility. Inflation expectations would also likely become significantly less stable, and risk premiums in asset markets--including inflation risk premiums--would rise. The combination of increased uncertainty for households and businesses, higher risk premiums in financial markets, and the potential for destabilizing movements in commodity and currency markets would likely overwhelm any benefits arising from this strategy."

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