The Money Demand

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

Monday, January 31, 2011

Really good links - Deficit - Ireland - China - Schuldenbegrenzungsregelung - Netherlands - A cross of rubber - Germany - Carry trade

Karl Smith - Federal deficit - "If the government takes out a loan and then gives that proceeds of that loan to taxpayers, the balance sheet of the US as a whole has not deteriorated. The government owes more, the people owe less.
        So increasing the supply of US debt in and of itself doesn’t hurt the US’s asset position. It does, however, arbitrage the difference between private borrowing costs and public borrowing costs.
        Performing this type of credit arbitrage is one the main functions of a financial system, however, ours is still working its kinks out and building back up its capital base. Thus, its helpful for the Feds to step in and do the arbitrage for us."

Ralph Atkins - ECB tells Ireland to avoid bank run - "The European Central Bank still faces a stand-off with Dublin. The FT reports today the warning by Lorenzo Bini Smaghi, an ECB executive board member, that Ireland cannot expect to renegotiate the terms of its bail-out. The matter has become an issue in the country’s election campaign.<..>
        Diplomatically but firmly, Mr Bini Smaghi warns Ireland’s politicians that if they imposed losses (a “haircut”) on Irish senior bank bondholders, “immediately you would have a run on the banks”. Irish account holders themselves would worry about the security of their savings. The end result could be a collapse of the banking system – and the Irish taxpayers would face an even larger bill."

Scott Sumner - China and us - "For China to blame the US for its inflation, when they refused to cut back on the number of Treasury bonds they bought as a way of tightening monetary policy and boosting the yuan, would be like the US blaming China for high unemployment, when we refused to buy more Treasury bonds to weaken the dollar and boost the prices of commodities, stocks, TIPS and foreign currencies. Bernanke and company showed in November that they are quite capable of taking affirmative steps to solve our own problems (although I’d like to see even bigger steps.) Now China needs to show the same can-do spirit, and stop blaming foreigners for its problems."

EurActiv - Schuldenbegrenzungsregelung - "Interestingly, the Brussels lawyers are reportedly working on a draft policy to replicate the 2009 German debt brake across the EU, something sources say is also being touted by the Swedish government.
        If member states want to increase the size or scope of the fund, then the German government will expect them to imitate the German brake, the 'Schuldenbegrenzungsregelung', which writes deficit limits into the country's constitution, according to an EU diplomat.
        French President Nicolas Sarkozy came out in favour of an EU-wide adoption of constitutionally-bound debt brakes in June last year."

Robert Shiller - Are Dutch thrifty? - "I bet it’s not true. Because if the Dutch had been conspicuous savers for centuries, they would be vastly richer than any of us. It would accumulate over centuries. I like to use another example from Holland, which is that home prices in Amsterdam, according to Piet Eichholtz at Maastricht University, haven’t gone up – they’re no higher in real terms today than they were 300 years ago. So, I’m sorry, but you can’t be right.
        The amazing thing about saving is that if you really save a lot and you do it for a hundred years, reinvesting interest, you will get awfully rich, and that’s a fact. The best example of that is not Holland, it’s Singapore, which has had a government imposed saving plan. In Singapore, they have a mandatory saving plan that has propelled that nation up rapidly. It’s just arithmetic. If you save and invest, it adds up, because of the power of compound interest."

Kantoos - What do Germans hate more, inflation or bailouts?

Paul Krugman - A cross of rubber - "What about commodity prices? The Fed normally focuses on “core” inflation, which excludes food and energy, rather than “headline” inflation, because experience shows that while some prices fluctuate widely from month to month, others have a lot of inertia — and it’s the ones with inertia you want to worry about, because once either inflation or deflation gets built into these prices, it’s hard to get rid of.
        And this focus has served the Fed well in the past. In particular, the Fed was right not to raise rates in 2007-8, when commodity prices soared — briefly pushing headline inflation above 5 percent — only to plunge right back to earth. It’s hard to see why the Fed should behave differently this time, with inflation nowhere near as high as it was during the last commodity boom.
        So why the demand for higher rates? Well, bankers have a long history of getting fixated on commodity prices. Traditionally, that meant insisting that any rise in the price of gold would mean the end of Western civilization. These days it means demanding that interest rates be raised because the prices of copper, rubber, cotton and tin have gone up, even though underlying inflation is on the decline.
        Ben Bernanke clearly understands that raising rates now would be a huge mistake. But Jean-Claude Trichet, his European counterpart, is making hawkish noises — and both the Fed and the European Central Bank are under a lot of external pressure to do the wrong thing.
        They need to resist this pressure. Yes, commodity prices are up — but that’s no reason to perpetuate mass unemployment. To paraphrase William Jennings Bryan, we must not crucify our economies upon a cross of rubber."

Pasquale Della Corte, Lucio Sarno, Ilias Tsiakas - Carry trade and forward volatility trade - "The standard “carry trade” is a popular currency speculation strategy that invests in high-interest currencies by borrowing in low-interest currencies. This strategy works well if, for example, spot exchange rates are unpredictable. There is ample empirical evidence pointing in that direction or, in academic jargon, showing that exchange rates follow a random walk (Meese and Rogoff 1983). In this case, investors engaging in carry trading will on average earn the difference in interest rates without having to worry about movements in exchange rates. The return to currency speculation can be substantial over time. It should be no surprise, therefore, that the carry trade has attracted considerable attention from academics and practitioners over the years.
        In recent years, investors have been able to speculate not only on the value of currencies but also on the level of volatility of these currencies."

Thursday, January 20, 2011

Really good links - QE2 - ECB and BoE - Mid 2000s boom - Fed Laugh Track - Easier money in October 2008 - Price-level targeting

Perry Mehrling - QE2 - "Normal expansionary monetary policy provides additional low-cost repo financing to dealers, which they are free to use to expand their security holdings—that is how monetary expansion gets into asset prices. QE2, by contrast, removes high-quality collateral from the system, and with it the low-cost financing that makes use of that collateral.
        In times of uncertainty, the Fed is in effect joining everyone one else in the flight to quality, demanding $600 billion of the best securities in the system and supplying in return its own reserve liabilities that can be held only by member banks that are already stuffed full."

Hugh Hendry - Europe risks getting it wrong again on rate rises - "[T]he shadow of policy error lurks once more. The European Central Bank’s president even proclaimed his satisfaction with his bank’s decision to raise rates back in the cauldron month of July 2008. I salute him for his willingness to subject the bank’s decisions to open scrutiny. But tightening monetary policy amid the deepest economic crisis of the past 50 years was perhaps not his institution’s finest hour. And with headline inflation rates being boosted by relative price rises in the commodity sector, as Chinese policymakers continue to plug 10 per cent into their GDP calculators, another poorly-timed rise in European rates cannot be so easily dismissed.
        The markets are already pricing in the near certainty of a quarter-point rise from the Bank of England by May with another increase expected before October. But perhaps not wanting to be left out, the zealous guardians of Europe’s monetary system, who measure inflation rates across the 17-country bloc to the second decimal point, have recently raised their rhetoric to such an extent that investors are openly speculating that in spite of the continent’s tight fiscal policy European rates are now likely to rise before the end of summer. As they say in the land of macro investing, the cycle isn’t over until the Europeans lift rates. Just don’t bet on money staying tight for long."

David Beckworth - Interest rates in the early-to-mid 2000s were too low

WSJ - Fed Laugh Track: ‘Can We Borrow from the Greeks?’ - Best jokes from the 2005 FOMC Transcripts

David Beckworth - Nominal spending in Great Depression

Scott Sumner - 90 macroeconomists out of 100 agree with Keynes, Friedman and Krugman - "Why weren’t those 90 macroeconomists out picketing the Fed in October 2008, demanding easier money? Well 89 of the 90, the other is in the Fed. Back in late 2008 and early 2009 a few of us quasi-monetarists were just about the only people insisting on the urgent need for much more monetary stimulus. A tiny handful of others (including Krugman) half-heartedly agreed it was worth a shot, and almost everyone else completely ignored monetary policy. One argument was they assumed we were at the zero bound. Actually, we weren’t at the zero bound in October 2008, but let’s say we were close. The main problem with the zero bound argument is that there was no general understanding that monetary policy was ineffective at the zero bound among the macro elite. Indeed many of them (Bernanke included) argued forcefully that the BOJ needed to do much more in the late 1990s and early 2000s."

Ed Dolan - Price-level targeting - "We can look forward to a renewed debate on price-level targeting in 2011. Support for the policy will be strengthened a bit by the fact that the Chicago Fed has a voting seat on the FOMC in odd-numbered years. If inflation remains stubbornly low, as it did throughout the fall, perhaps Chairman Bernanke will become less confident that "both inflation expectations and actual inflation remain within a range consistent with price stability," one of the reasons he gave for rejecting price-level targeting in his August speech. It is even possible that the FOMC has already committed to de-facto price level targeting without saying so explicitly."

Wednesday, January 12, 2011

Really good links - Treasury is sterilizing QE2 - Credit spreads and Modigliani-Miller - Household saving - QE2 - Nature vs. environment - Utility vs. Happiness

Andy Harless - Why is the Treasury hoarding reserves and sterilizing QE2? - "Under the circumstances, sterilization makes sense because it reduces the cost of government financing and (not coincidentally) provides a more effective stimulus. Giving banks more reserves will not give them an incentive to lend, nor will it encourage anyone to convert bank deposits into cash. Banks have far more reserves than they need and are constrained by capital, not by liquidity. On the margin, from a bank's point of view, reserves are just a safe asset like T-bills. The special properties that reserves have -- that they can be used to satisfy reserve requirements and settle transactions -- are, on the margin, irrelevant, given that banks have far more than they could conceivably need for those purposes. From the point of view of the public sector, reserves are just another way to borrow: the Fed can borrow by creating bank reserves, or the Treasury can borrow by issuing T-bills. But 3-month T-bills are paying 13 basis points, while reserves are paying 25, so naturally the government prefers to borrow using the cheaper method. This also means that the interest rates earned by the private sector are lower and there is thus more incentive to move out the yield and credit curves and to undertake real investments (or to move nominal investments into foreign currencies, thus weakening the dollar and stimulating the US economy)."

Michael Woodford - Credit spreads and Modigliani-Miller - "Once one's model has multiple interest rates in it, and the possibility of variable spreads between them, there arises the possibility that different dimensions of financial conditions will be differentially affected by alternative central-bank policies. Under the conditions discussed above that imply a Modigliani-Miller theorem, one can actually show that there is only one relevant dimension of central-bank policy, namely, traditional interest-rate policy; but under almost any assumptions that break the Modigliani-Miller theorem, alternative central-bank policies will be able to influence more than one dimension of financial conditions. Moreover, changes in the structure of relative yields on different kinds of financial claims will generally have consequences for the allocation of resources, so that there is no reason in general to suppose that interest-rate policy alone will suffice to achieve desirable adjustments of financial conditions in response to the disturbances to which the economy may be subject. The possible welfare gains from active use of central-bank credit policy alongside interest-rate policy are illustrated in Curdia and Woodford (2010) in the context of one particular (fairly simple) model with endogenous credit spreads. Yet despite this general observation, it is worth noting that the effectiveness of central-bank credit policy does depend on binding financial constraints of one kind or another, that break the Modigliani-Miller theorem. One can also reasonably expect that the effects of such policies are only substantial when the financial constraints are significant."

Menzie Chinn - Explaining Recent Trends in Household Saving

Stephen Williamson - QE2, Preferred-habitat asset pricing, FRB/US model and Lucas Critique, Fed as a "shadow bank"

Tyler Cowen - New paper on gene-environment interaction

Scott Sumner - Utility vs. Happiness

Thursday, January 6, 2011

Really good links - Barro on Bernanke - Rubin's strong dollar legacy - Minsky bailout - Selection and insurance - New orders - Mutual funds vs. ETFs

Robert Barro interview - Ben Bernanke, Great Depression and Lehman Brothers (H/T Marcus Nunes) - "I think they made a big mistake by not bailing out Lehman Brothers – I think they recognized that two days later. That was Paulson’s individual fault and responsibility from what I can gather. <..>
        Q: So what else should I be reading on the Great Depression? A: There’s Ben Bernanke’s research in the 1980s – that’s probably his most important contribution in terms of macroeconomics and financial economics.
        Yes, I saw the Dow Jones Newswires quote on Bernanke’s book, Essays on the Great Depression, which made me laugh: “With some observers saying that the ongoing financial crisis could be the worst since the Great Depression, the greatest living expert on that period is getting the chance to apply its economic lessons.”
        Well Bernanke was thinking that way in April 2008. I remember talking to him at the time, just after the Bear Stearns initial intervention. I got a chance to ask him a question about why they were so aggressive at that time when things didn’t look so bad. And his response was that basically he was worrying about a Depression-type scenario – and trying to act early to nip that in the bud.
        Q: So what is the thrust of his book and why is it important? A: It’s focusing on the Great Depression as a credit implosion, not so much the money supply, which Friedman and Schwartz had emphasized, but a somewhat related phenomenon, which is credit availability. That had been imploding from 1929 through to the trough, early in 1933. So it’s really focusing on the credit aspects and trying to measure that, particularly by looking at patterns in interest rates.
        Today, for example, if you look at the spread between lower quality bonds – like B-rated corporate bonds, say – and compare those to treasury yields, that’s a good indicator of the extent of stress in the credit markets. And actually the recent period is going back to the kinds of spreads that you saw in the early 1930s. Well, perhaps not quite as much, but certainly reminiscent of that. So he’s focused on that as a measure of the extent of the credit stress, and on the other side he focused on how what turned things around was when the credit problems were being eased."

Tim Duy - Rubin's strong dollar legacy - "[W]hat I believe was a central element of the Rubin agenda, and an element that was in fact the most disastrous in the long run - the strong Dollar policy.
        The strong Dollar policy takes shape in 1995. At that point, Rubin made it clear that the rest of the world was free to manipulate the value of the US Dollar to pursue their own mercantilist interests. This should have been more obvious at the time given that China was last named a currency manipulator in 1994, but the immensity of that decision was lost as the tech boom engulfed America.
        Moreover, Rubin adds insult to injury in the Asian Financial Crisis, by using the IMF as a club to enact far reaching reforms on nations seeking aid. The lesson learned - never, ever run a current account deficit. Accumulating massive reserves is the absolute only way to guarantee you can always tell the nice men from the IMF and the US Treasury to get off your front porch.
        In effect, Rubin encourages the US to unilaterally enact a new Plaza Accord on itself."

Hyman Minsky - Minsky bailout - "The lender of last resort must intervene promptly and assure the availability of refinancing to prevent financial difficulties from turning into an interactive cumulative decline that could lead to a great depression. <..> The need for lender-of-last-resort operations will often occur before income falls steeply and before the well nigh automatic income and financial stabilizing effects of Big Government come into play. If the institutions responsible for the lender-of-last resort function stand aside and allow market forces to operate, then the decline in asset values relative to current output prices will be larger than with intervention; investment and debt financed consumption will fall by larger amounts; and the decline in income, employment and profits will be greater.<..>
        Even though the lender-of-last-resort function of the Federal Reserve was of vital importance in stabilizing the economy in 1966, 1969-70, 1974-75, and 1981-82, this function and operations it entails are poorly understood. A lender of last resort is necessary because our economy has inherent and inescapable flaws that lead to intermittent financial instability.<..>
        The creation of a lender-of-last-resort function was a major objective of the legislation establishing the Federal Reserve System in 1913, but that original objective was subverted by a view that the primary and dominant function of the Federal Reserve System is controlling the money supply. <..> Because the Federal Reserve has the responsibility, so to speak, to pick up the pieces when things go wrong, it must be concerned with and guide the growth and evolution of financial practices in periods of tranquility as well as when circumstance forces it to intervene."

A Fine Theorem - Insurance, adverse selection and advantageous selection - "But what of the case where people with lower risk are the ones demanding more insurance, or “advantageous selection”?
        Consider long-term care insurance. The type of people who buy a lot of such coverage are also likely people who are thoughtful and careful in other areas of their life, and hence people who will have lower long-term care costs otherwise. In such a case of advantageous selection, we avoid the usual informational problems. How true is this empirically? <..> In some markets, these two empirical facts combined can tell us why adverse selection does not destroy the market: in the standard adverse selection story, more life insurance is demanded by those who know they will die sooner, but because of heterogeneity is preferences for risk, those who live longer also turn out to be those who demand more life insurance. "

Annaly Salvos - Manufacturers’ new orders

Sandeep Baliga - Mutual Funds vs. ETFs - "First, ETFs are cheaper than the corresponding mutual fund so the first puzzle is why mutual funds are not driven out by ETFs. This is one answer: there is demand for mutual funds from people with self-control problems and in fact they are willing to pay to commit. There is a value to commitment.
        Second, investors who think they cannot beat the market but believe they have self-control should buy ETFs. If their belief in their self-control is na├»ve, they will trade anyway and get worse returns than investors who bought mutual funds.<..>
        There is a value to commitment but there is also a value to self-knowledge: recognizing your self-control helps you to know that you should commit and if you commit, you will lose less money."

Thursday, December 30, 2010

Really good links - Germany and the solution for the Eurozone crisis - Krugman in 1998 - Money and Metaphysics - Deflation - Equilibrium and institutional process - Consumer confidence - Taxes and government spending

Crispin Odey - Towards a more balanced Eurozone - "The key feature of the European “now” is not government debt nor under-capitalised banks. It is Germany with an inflationary boom under way. German growth means rapid growth of imports from the eurozone worth significant percentage points on non-German eurozone GDP and a far easier path out of recession for the European periphery than is priced into bonds and equities.
        Those with long memories would argue that the German authorities will spot where all this is heading and will do what is necessary to trample on growth. But Europe and Germany have changed. Sovereign power is not what it was. The German authorities no longer have control of their own policy. <..>
        Of course, Germany will be divided in its attitude to this boom and if it were down to the authorities, interest rates would rise and the currency strengthen. But they are going to be as unable to reach the brake pedal next year, as Ireland et al were unable to reach the accelerator this year."

Tyler Cowen - Paul Krugman's predictions from 1998

Matthew Yglesias - Money and Metaphysics

Dave Altig - Probability of deflation has fallen to the levels observed prior to the economy's summer soft patch

Arnold Kling - Equilibrium vs. institutional process - "As Boettke points out, the profession is split between economists who work out the properties of equilibrium and economists who focus on institutional processes. The latter are marginalized, although they include many Nobel Laureates, including Douglass North and Elinor Ostrom.
        The focus on properties of equilibrium attracts interventionists. You point out an undesirable property of an equilibrium, and then you propose a fix. For example, Stiglitz and Rothschild pointed out that a health insurance market could collapse because of adverse selection, so it follows that government should impose a mandate to purchase health insurance.
        The focus on institutional processes attracts libertarians. You see the benefits of the forces of competition and creative destruction. You see the adverse institutional properties of government."

Tim Duy - Curiously Weak Consumer Confidence - "Consumer confidence figures appear inconsistent with actual spending patterns. That inconsistency will be resolved by either confidence rising or falling spending growth, with more or less obvious policy implications. There will be a tendency to assume the resolution will come from decelerating spending growth. To be sure, the recent trend appears unsustainable. But I also think it is worth paying attention to the more positive household spending data."

David Andolfatto - Robert Shiller's bad idea of a tax-financed increase in government spending - "Its not that I'm against increasing (components of) G. Public works projects of the sort mentioned by Shiller (building highways and improving our schools) were advocated by sensible economists long before Keynes (as evidence of this, note that public works were implemented in the Depression well before publication of the General Theory). What I have a problem with is in using some silly theory to support the notion, for example, that taxes should be raised to finance a large public capital expenditure. Shiller has been rightly celebrated for his work in the theory of finance, and on asset price bubbles in particular. But is this not a rather odd stand to take for a professor of finance?
        Now, I'm no expert in finance myself, so maybe I should be careful in what I'm about to say. But it seems to me that a large capital expenditure should be financed with debt. The debt service could be supported by toll revenue (on bridges and roads) and user fees in general, backed by the Treasury, if needed. The use of tax finance advocated by Shiller in his balanced-budget exercise implicitly assumes (among other things) lump-sum taxes. For some thought experiments, the assumption of lump-sum taxes is innocuous enough. But this is not one of those cases. Taxes are distortionary and to the extent that they are needed to support public spending, they should be spread out over time. This is a standard principle of public finance (I think). "

Monday, December 27, 2010

Really good links - Nominal GDP targeting - Shadow banking - Milton Friedman's thermostat - Origins of the national debt - QE2 and market factors

David Beckworth - The case for nominal GDP targeting - "Mark Thoma wants to hear the case for nominal GDP targeting. This approach to monetary policy requires the Fed stabilize the growth path for total current dollar spending. As an advocate of nominal GDP level targeting, I am more than happy to respond to Mark's request. I will focus my response on what I see as its three most appealing aspects: (1) it provides a simple and intuitive approach to monetary policy, (2) it focuses monetary policy on that over which it has meaningful influence, and (3) its simplicity makes it easier to implement than other popular alternatives. "

Interview with Gary Gorton - Shadow Banking; The Rise of Repo; Growth of Securitization; Information Sensitivity; The Collapse of Repo; Regulatory Reform; Creating Collateral, not Insurance; Vulnerability to Panic

Nick Rowe - Milton Friedman's Thermostat

Brad DeLong - Alexander Hamilton and the Origins of the National Debt - "Back in the early 1790s, the national debt was close to 40% of annual GDP. It was close to 40% because the first Treasury Secretary, Alexander Hamilton, thought it was a good idea to make it close to 40%. <..>
        The most important reason, however, was that Alexander Hamilton was Secretary of the Treasury in a country where the rich were at best uneasy about the revolution and independence. Of America's upper class as it stood in 1775, full half of them were gone: had fled to Britain or Canada during the Revolutionary War. Those who remained remembered that back before 1775 the British monarch had protected property, that the British army and navy had protected them against deprivations of all kinds, that it was quite clear who the police worked for. Now you have a republic with a much broader electorate. Might politicians run on a platform of soaking the rich and redistributing wealth to the poor? Thus the rich people were nervous--and at least thinking about how maybe it would be good if the British came back and ruled again.
        This was where Alexander Hamilton had his good idea. Suppose, he thought, he could set things up so that the rich owned a lot of U.S. government bonds. Then if the British returned--well, the British were not going to pay off the Revolutionary War debt of the United States of America under any circumstances. Having a national debt was a way to bind the United States rich to the country--giving them a stake in the new republic's survival. And by large it worked: the national debt was a national blessing."

John Hussman - QE2 and market factor analysis - "The key event related to QE2 wasn't its formal announcement, but was instead the Op-Ed piece that Ben Bernanke published a few days later in the Washington Post, which essentially advanced the argument that the Fed was targeting a "wealth effect" in stocks and other risky assets, in hopes of getting people to consume off of that perceived wealth. At that moment, Bernanke unleashed a speculative bubble in risky assets, and a selloff in safe ones. This has rewarded risk-seeking and punished risk-aversion, but it has also unfortunately driven the markets into an overvalued, overbought, overbullish, rising-yields condition that has historically ended in steep and abrupt losses.
        Ned Davis Research tracks a set of "factor attribution" portfolios, which measure the performance between the top 10% of stocks ranked by a given factor, and the bottom 10% of stocks as ranked by that factor. The factors are things like market beta, dividend yield, 26-week momentum, and so forth. Essentially, the these factor portfolios track the return of hypothetical portfolios that are long the top 10% and short the bottom 10% of stocks based on any given variable.
        The performance of these 133 factor portfolios over the past 13 weeks offers tremendous insight into the extent to which the Federal Reserve has encouraged speculative risk. Investors are chasing stocks with the greatest exposure to market fluctuations, commodities, credit risk, small-cap risk and volatility. Conversely, securities demonstrating reasonable valuation, stability, quality, or payout have been virtually abandoned by investors. Here is a sampling:

Market Beta
Raw Materials Beta
Commodity Sensitivity
Credit Spread Beta
Macro Economic Sensitivity
Small vs. Large Beta
Style Sensitivity
Silver Beta
Commodity Sensitivity
Sigma Risk (Volatility)
Operating Cash Flow Yield
EPS Stability
Value vs. Growth Beta
Style Sensitivity
Return on Invested Capital
Dividend Yield
10-Year T-Note Beta
Macro Economic Sensitivity
High vs. Low Quality Beta
Style Sensitivity

Saturday, December 18, 2010

Monetary policy and Minsky cycles

1. It is impossible to understand the Great Recession without invoking Minsky's cycle theory.

2. Minsky cycle creates the least damage if Minsky recession takes place in the context of stable NGDP growth. Minsky crash creates collateral damage if there is a downward deviation from the NGDP trend.

3. We observe the asymmetry of Minsky booms and Minsky crashes. Traditional monetary policy is a very powerful AD fine-tuning tool during the Minsky boom, on the other hand, monetary policy is prone to crashes and mistakes during the Minsky bust.

4. Monetary authorities usually operate some kind of peg, this peg may crash or lose credibility when the Minsky moment arrives. During the Great Depression, the dollar gold peg lost credibility, and the AD was too low until the Roosevelt devaluation. These days the Fed is operating a crawling fed funds rate peg, this peg has crashed after the bankruptcy of Lehman, and the AD was too low during the crash. During the collapse of the fed funds rate peg, we had the flight to liquidity problem, not the flight to safety problem, so the root cause of low AD was monetary, not Minskyite. The fed funds rate peg was restored in late October 2008.

5. When the monetary peg is restored, it is important that it is restored at the levels where it promotes the speedy recovery. Roosevelt repegged the dollar at the level that generated a fast recovery, on the other hand, the federal funds rate was too high when the fed funds rate peg was restored in late October 2008. Scott Sumner's NGDP expectations peg is useful in this regard. If the NGDP expectations peg crashes, most likely it will be restored at the previous NGDP trend.

6. If the neutral short term risk free interest rate drops below zero during the Minsky bust, the risk of monetary policy mistakes increases. Monetary tools that bring the neutral interest rate back into the positive territory need to be aggressively employed. There are three such tools - higher inflation targets, quantitative easing, credit easing.

7. Higher inflation targets are undesirable, as credibility of monetary policy is diminished during normal times. NGDP path targeting removes the need to change the goals of the monetary policy during the Minsky cycle.

8. Quantitative easing is powerful only until the term risk premium is lowered to zero. After that, it loses the direct effect and only signalling effect remains. The power of quantitative easing is limited, so Bernanke did not use this tool until March 2009.

9. Credit easing is the most powerful non-traditional monetary tool. Bernanke started using it in 2007. However, the extensive use of credit easing increases the risk of Fed's insolvency, it also creates various legal, technical and political problems. Credit easing programs were not expanded to the extent needed to stabilize AD. Bernanke has indicated that additional fiscal stimulus is needed to increase AD.

10. Measures that increase the use of credit easing would be helpful. Larger Fed's capital base could reduce the risk of Fed's insolvency. Development of broad short term credit market indexes could help us design credit easing programs that are not discriminatory and thus more attractive politically.

11. NGDP path pegging is the policy that could prevent the collateral damage caused by the Minsky crash. NGDP path peg gives us a speedy recovery when monetary policy temporarily loses credibility. NGDP path provides a good focal point for the coordination of monetary and fiscal policies when the zero interest rate constraint is binding.

The Money Demand