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

Tuesday, October 5, 2010

Really good links - Zero bound - Bad news and stocks - Labor market - Countercyclical protectionism - Currency wars

William Dudley - Zero bound and inflation expectations - "Clear communication on the part of a central bank is important at all times, but it is even more critical when the federal funds rate is at or near its effective lower bound. In this environment, a decline in inflation expectations that drives up the real interest rate and thereby increases the real cost of credit cannot be offset by simply lowering the federal funds rate. Thus, in a very direct sense, a fall in inflation expectations when the target interest rate is at the zero bound represents a de facto tightening of monetary policy and of financial conditions. Such a tightening would clearly be highly undesirable at a moment when unemployment is too high, inflation is too low and the economy has only moderate forward momentum. <..>
        If we judged it desirable, we could go still further and provide more guidance on how monetary policy would react to deviations from any stated inflation objective. One possibility would be to keep track of inflation shortfalls when the federal funds rate is constrained by the zero bound, as is the case today. For example, if inflation in 2011 were a 0.5 percentage point below the Fed’s inflation objective, the Fed might aim to offset this miss by an additional 0.5 percentage point rise in the price level in future years."

Nick Rowe - Bad news and stocks - "With a consistent inflation targeting central bank, it used to make sense that weak data causes stock prices to rise. Weak data is news that the natural rate of interest is lower than we thought it was. The central bank will adjust monetary policy to keep AD and earnings on target, but the lower natural rate means a higher PV of those earnings."

Eric S. Rosengren - Dislocations in the Labor Market? - "In fact, in each of the three previous recessions there was a decline of 5 percent or more in no more than two industry categories – as the figure shows – with many industries experiencing little or no net job loss over the course of the recession. Structural shifts across industries are not uncommon in recessions – and also, some structural dislocation seems inevitable as it will always take some time for capital and labor to flow to those industries with the greatest opportunities.
        In rather stark contrast, the most recent recession is far less a reflection of dislocation in a few industries but rather reflects a general decline in almost all industries. As the chart on the far right shows, in this recession there has been a peak to trough loss of employment of 5 percent or greater in construction, manufacturing, retail trade, wholesale trade, transportation, information technology, financial activities, and professional and business services. To me, this does not suggest that the driver is structural change in the economy increasing job mismatches – although no doubt some of that exists – but instead I see here a widespread decline in demand across most industries."

Stephen Gordon - Some implications of thinking of trade as a form of technology - "One issue where I wish I had remembered this story was when it was suggested that protectionism could be used as a counter-cyclical policy instrument. Yes, I would have replied, in much the same way that forbidding the use of excavators and backhoes would be a counter-cyclical policy instrument: construction firms would have been forced to hire any number of extra workers to dig by hand. Both measures would have put people to work doing tasks that had not been hitherto performed by Canadian workers. And in both cases, it's not at all clear what the exit strategy would have been."

Paul Krugman - Currency wars - " ...rates are pretty much at zero. And in that case, it’s hard to see what mutual intervention accomplishes. Suppose the Fed buys a bunch of euros, and the ECB a bunch of dollars. Suppose also that they do the usual thing and hold the newly acquired reserves in short-term debt — Treasury bills. Then the net effect is just as if each central bank had done a conventional open-market operation in its own T-bills.
        And the whole point of the liquidity trap literature is that such conventional open-market operations have no effect — they just swap one zero-rate asset, monetary base, for another, short-term government debt. So the currency interventions accomplish nothing.
        It would be different if the central banks acquired long-term assets instead; then we’re talking about quantitative easing through the back door."

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