Brad DeLong - Uncertainty and aggregate demand - "The future is always uncertain--and how uncertain it is fluctuates. When the future is more than unusually uncertain, economic players want the security of extra financial asset holdings before they are willing to spend to put people to work. It is, then, the business of the government to make sure that they have the amount and the kinds of financial assets they need to sleep easily. That was one of the insights of John Maynard Keynes. That was one of the insights of Milton Friedman."
Jeremy Grantham - Cash is the king - "We've already started to sell [stocks]. We're not even— averagely weighted. We're modestly underweighted. And you must remember bonds are even worse than stocks on a seven-year forecast. So, you get caught in this paradox. It's very tempting— and this is what the Fed wants by the way.
It wants us to go out there and buy stocks, which are overpriced because bonds they have manipulated into being even less attractive. So, we’re being forced to choose between two overpriced assets. That is not always a terrific choice to make because there is a third choice, and that is don't play the game and hold money in cash.
And cash has a— a virtue that people don't appreciate fully. And that is its— its optionality. In other words, if anything crashes and burns in value— say the U.S. stock market, if you have no resources, it doesn't help you. If the bond market crashes, and you have no resources, it doesn't help you. And what cash is is an available resource. It buys you the right to buy the U.S. market if the S&P drops from 1,220 today to 900, which is what we think is fair value."
Mark Thoma - Interest on reserves - "There’s been a lot of talk lately about the Fed’s policy of paying interest on reserves with many claiming that this has caused banks to retain reserves that might have otherwise been turned into loans, and thus the policy has depressed aggregate activity. However, paying interest on reserves is a safety net for the Fed that allowed them to do QEI and QEII. If the Fed wasn’t paying interest on reserves, QEI would have likely been smaller, and QEII may not have happened at all. <..>
The tool the Fed has for removing reserves from the system is open market operations (QEI and QEII are essentially traditional open market operations, but the Fed buys long-term rather than the more traditional short-term financial assets). So why do they need another tool — interest on reserves — to control reserves? Removing reserves too fast through open market operations could disrupt financial markets. Paying interest on reserves gives the Fed a way to remove reserves in a more leisurely fashion while still maintaining control over inflation."
Steve Landsburg - Cut agencies - "Like I said, cut agencies. And cut them in bunches, to dilute opposition. As I’ve said before on this blog, the department of commerce steals from workers and farmers to subsidize businesses; the department of agriculture steals from workers and businesses to subsidize farmers, and the department of labor steals from businesses and farmers to subsidize workers. Eliminate them all at once and every American will lose one friend and two enemies."
Monday, November 29, 2010
Saturday, November 27, 2010
Really good links - Case against the Fed - Fiscal democracy - IOR - Bernanke and Palin - EMU - Boom-bust-bailout
Tyler Cowen - The case against the Fed is weak - "To whatever extent we can do without a Fed, it's because there are so many Treasury securities, which should be a sobering thought to a market-oriented perspective. If the Fed were shut down, over time the new base money would not be gold, "Hayeks," or a commodity bundle. It would be T-Bills. We would have achieved the full integration of the monetary and fiscal authority but to what useful end? (Better not balance the budget!) The real question is whether the Treasury should be the Fed or whether the Fed should be the Fed, but you won't often see it framed that way."
John McDermott - Democracy as a solution for fiscal crisis - "Imagine that in country X, measure A receives 90 per cent support in parliament but measure B squeezes through with only 51 per cent. The bond issued to pay for measure A is given seniority. Its holders get paid before those with the bond behind measure B. (If measure C then receives 98 per cent support it would trump A, and so on.)
[Hans Gerbach of the ETH says:] Vote-share government bonds align the strength of the political support for particular government activities with the pledge to repay debt. This is desirable in its own right, as voting for debt-financed government expenditures is connected to the willingness to repay. Accordingly, it may have a favourable effect on deliberation in democracy by linking debt-financing with repayment promises when political debates about new government expenditures take place."
Bill Woolsey - Interest on reserves and inflation - "Murphy does make an odd error when discussing the possible strategy of the Fed paying higher interest on reserves. He says that investors will figure out that an exponential increase in reserves will hardly allow the Fed to control inflation. Now, suppose the expected inflation rate does rise to 10 percent and that a 12 percent interest rate is needed so that the demand for reserves will be high enough so that the demand for base money remains $2.6 trillion. Murphy seems to imagine that since each reserve balance would increase by 12 percent each year, base money would rise at a 12 percent annual rate. No. The Fed would simply have to sell between $200 billion and $300 billion in assets each year to leave base money the same. Rather than having to sell off $1.8 trillion in assets post haste, they could sell much fewer assets and prevent any excess inflation."
Scott Sumner - Ben Bernanke and Sarah Palin - "The reason QE worked was not the operation itself (which I agree does little or nothing) but rather because it tells the market that the Fed is now more serious about boosting long term prices and NGDP. In other words they are now willing to leave that base money out there long enough to get closer to their implicit inflation target. The Fed was afraid to directly call for higher inflation (something Krugman thinks could work) so they spoke in code, hoping the markets would understand them but Sarah Palin would not. Unfortunately for Bernanke, Sarah Palin has advisers who know exactly what the Fed was up to. "
Ambrose Evans-Pritchard - Way out for EMU - "A reader asked me this week whether there is any graceful way to avoid this coming chain of disasters.
Yes, there are two options, neither entirely graceful. The European Central Bank can print money like a drunken sailor, flood the bond markets with €2 trillion, and tank the euro against China’s yuan for good measure.
If the Germans refuse to accept this, they should abandon EMU at once, leaving France and southern Europe with the residual euro and the institutions of monetary union. Existing euro debt contracts would be upheld. Germany would revalue – alone or with Finns, Dutch, etc - so holders of Bunds would enjoy a windfall gain.
France could revive the Latin Union of the late 19th Century, a more benign venture than the Máquina Infernal now asphyxiating Portugal, and deflating Spain.
Any better ideas out there?"
Simon Johnson - Boom-Bust-Bailout - "In “The Quiet Coup,” published in Atlantic magazine in May 2009, I compared the U.S. economic boom-bust-bailout cycle to what has become typical in emerging middle-income countries such as Russia, Argentina or Indonesia. Just don’t think these problems are limited to emerging markets.
There is a much more general or global phenomenon in which powerful people cooperate to build an economic model that provides growth based on a great deal of debt. When the crisis comes, those who control the state try to save their favorite oligarchs, but there aren’t enough resources to go around."
John McDermott - Democracy as a solution for fiscal crisis - "Imagine that in country X, measure A receives 90 per cent support in parliament but measure B squeezes through with only 51 per cent. The bond issued to pay for measure A is given seniority. Its holders get paid before those with the bond behind measure B. (If measure C then receives 98 per cent support it would trump A, and so on.)
[Hans Gerbach of the ETH says:] Vote-share government bonds align the strength of the political support for particular government activities with the pledge to repay debt. This is desirable in its own right, as voting for debt-financed government expenditures is connected to the willingness to repay. Accordingly, it may have a favourable effect on deliberation in democracy by linking debt-financing with repayment promises when political debates about new government expenditures take place."
Bill Woolsey - Interest on reserves and inflation - "Murphy does make an odd error when discussing the possible strategy of the Fed paying higher interest on reserves. He says that investors will figure out that an exponential increase in reserves will hardly allow the Fed to control inflation. Now, suppose the expected inflation rate does rise to 10 percent and that a 12 percent interest rate is needed so that the demand for reserves will be high enough so that the demand for base money remains $2.6 trillion. Murphy seems to imagine that since each reserve balance would increase by 12 percent each year, base money would rise at a 12 percent annual rate. No. The Fed would simply have to sell between $200 billion and $300 billion in assets each year to leave base money the same. Rather than having to sell off $1.8 trillion in assets post haste, they could sell much fewer assets and prevent any excess inflation."
Scott Sumner - Ben Bernanke and Sarah Palin - "The reason QE worked was not the operation itself (which I agree does little or nothing) but rather because it tells the market that the Fed is now more serious about boosting long term prices and NGDP. In other words they are now willing to leave that base money out there long enough to get closer to their implicit inflation target. The Fed was afraid to directly call for higher inflation (something Krugman thinks could work) so they spoke in code, hoping the markets would understand them but Sarah Palin would not. Unfortunately for Bernanke, Sarah Palin has advisers who know exactly what the Fed was up to. "
Ambrose Evans-Pritchard - Way out for EMU - "A reader asked me this week whether there is any graceful way to avoid this coming chain of disasters.
Yes, there are two options, neither entirely graceful. The European Central Bank can print money like a drunken sailor, flood the bond markets with €2 trillion, and tank the euro against China’s yuan for good measure.
If the Germans refuse to accept this, they should abandon EMU at once, leaving France and southern Europe with the residual euro and the institutions of monetary union. Existing euro debt contracts would be upheld. Germany would revalue – alone or with Finns, Dutch, etc - so holders of Bunds would enjoy a windfall gain.
France could revive the Latin Union of the late 19th Century, a more benign venture than the Máquina Infernal now asphyxiating Portugal, and deflating Spain.
Any better ideas out there?"
Simon Johnson - Boom-Bust-Bailout - "In “The Quiet Coup,” published in Atlantic magazine in May 2009, I compared the U.S. economic boom-bust-bailout cycle to what has become typical in emerging middle-income countries such as Russia, Argentina or Indonesia. Just don’t think these problems are limited to emerging markets.
There is a much more general or global phenomenon in which powerful people cooperate to build an economic model that provides growth based on a great deal of debt. When the crisis comes, those who control the state try to save their favorite oligarchs, but there aren’t enough resources to go around."
Thursday, November 25, 2010
Really good links - Sovereign default - Brad DeLong and Larry Summers - No Trade Theorem - Austrian zero bound - Billion prices - Interest elasticity
Simon Johnson and Peter Boone - Sovereign default - "The Germans should recall the last episode of widespread sovereign default – Latin America in the 1970’s. That experience showed that countries default when the costs are lower than the benefits. Recent German statements have pushed key European countries decisively closer to that point. <..>
Bond-market participants naturally turn now to calculating “recovery values” – what creditors will get if countries default today. For example, Greece’s debt stock, including required bridge financing under the IMF program, should peak at around 150% of GNP in 2014; much of this debt is external. If a country can support debt totaling 80% of GNP (a rough but reasonable rule of thumb), then we need approximately 50% “haircuts” on this existing and forthcoming debt (reducing it to 75% of its nominal value).
However, of this 150% of GNP, at least half is or will be official in some form. If it is fully protected, as seems likely (the IMF always gets paid in full), then the haircut on private debt rises to an eye-popping 90%. And this leaves out government spending that may be needed for further recapitalization of Greek banks."
Robert Waldman - Brad DeLong and Larry Summers - "You [DeLong] thought the problem was George Bush not Joe Cassano. You thought the fundamental problem with the US economy was the huge federal budget deficit. You thought the crisis would come when the People's Bank of China got tired of throwing good money after bad and let the dollar collapse and US long term interest rates shoot up.
Why did you think this (aside from evidence and logic) ? Well you are much inclined to think that the Clinton economic team did a very good job. So you are much inclined to think that Bush did a terrible job. Also you can't stand him.
The idea high deficits cause high real interest rates which are terrible for growth is very dear to you (not to mention overwhelmingly supported by massive evidence).
I think this is also true of Larry Summers. He put Harvard's money where his mouth was. He bet on high interest rates on US Treasuries. That most definitely was not because he thought that Greenspan could control everything. That was because he was sure that Bush would cause a catastrophe not just by neglecting dangerous Wall Street developments but by undoing the great work of Clinton, Bentson, Rubin and Summers."
Alex Tabarrok - No Trade Theorem
Tweet of the day - Garrett Jones - "In Austrian term-structure-of-capital theory, the zero nominal bound would seem particularly perilous."
James Hamilton - Billion prices project
Jeremy Grantham - Interest elasticity of consumption - "And let me point out that the Fed's actions are taking money away from retirees.
They're the guys, and near retirees, who want to part their money on something safe as they near retirement. And they're offered minus after-inflation adjustment. There's no return at all. And where does that money go? It goes to relate the banks so that they're well capitalized again. Even though they were the people who exacerbated our problems.
And, hopefully, the redeeming feature in that infamous trade is that your corporations go out there, borrow money, build factories, hire people, which they're not doing because consumption is weak and because they were also terrified by the crunch. I— I think, therefore, under these conditions, low rates is actually hurting the economy. It's taking more money away from people who would have spent it —retirees — than are being spent by passing it on to financial enterprises and being distributed as bonuses to people who are rich and, therefore, save more."
Bond-market participants naturally turn now to calculating “recovery values” – what creditors will get if countries default today. For example, Greece’s debt stock, including required bridge financing under the IMF program, should peak at around 150% of GNP in 2014; much of this debt is external. If a country can support debt totaling 80% of GNP (a rough but reasonable rule of thumb), then we need approximately 50% “haircuts” on this existing and forthcoming debt (reducing it to 75% of its nominal value).
However, of this 150% of GNP, at least half is or will be official in some form. If it is fully protected, as seems likely (the IMF always gets paid in full), then the haircut on private debt rises to an eye-popping 90%. And this leaves out government spending that may be needed for further recapitalization of Greek banks."
Robert Waldman - Brad DeLong and Larry Summers - "You [DeLong] thought the problem was George Bush not Joe Cassano. You thought the fundamental problem with the US economy was the huge federal budget deficit. You thought the crisis would come when the People's Bank of China got tired of throwing good money after bad and let the dollar collapse and US long term interest rates shoot up.
Why did you think this (aside from evidence and logic) ? Well you are much inclined to think that the Clinton economic team did a very good job. So you are much inclined to think that Bush did a terrible job. Also you can't stand him.
The idea high deficits cause high real interest rates which are terrible for growth is very dear to you (not to mention overwhelmingly supported by massive evidence).
I think this is also true of Larry Summers. He put Harvard's money where his mouth was. He bet on high interest rates on US Treasuries. That most definitely was not because he thought that Greenspan could control everything. That was because he was sure that Bush would cause a catastrophe not just by neglecting dangerous Wall Street developments but by undoing the great work of Clinton, Bentson, Rubin and Summers."
Alex Tabarrok - No Trade Theorem
Tweet of the day - Garrett Jones - "In Austrian term-structure-of-capital theory, the zero nominal bound would seem particularly perilous."
James Hamilton - Billion prices project
Jeremy Grantham - Interest elasticity of consumption - "And let me point out that the Fed's actions are taking money away from retirees.
They're the guys, and near retirees, who want to part their money on something safe as they near retirement. And they're offered minus after-inflation adjustment. There's no return at all. And where does that money go? It goes to relate the banks so that they're well capitalized again. Even though they were the people who exacerbated our problems.
And, hopefully, the redeeming feature in that infamous trade is that your corporations go out there, borrow money, build factories, hire people, which they're not doing because consumption is weak and because they were also terrified by the crunch. I— I think, therefore, under these conditions, low rates is actually hurting the economy. It's taking more money away from people who would have spent it —retirees — than are being spent by passing it on to financial enterprises and being distributed as bonuses to people who are rich and, therefore, save more."
Monday, November 22, 2010
Really good links - Deleveraging - Bernanke and tax cuts - Pain caucus - Causes of economic downturns - Critics of QE2 - Sustainability - Hugh Hendry video
Paul Krugman - Deleveraging - "The situation: over the past decade, households ran up what is almost universally regarded as an excessive amount of debt — shown here for the United States, but also in the UK, Spain, and elsewhere. They are now being forced to pay down that debt by cutting spending.
The question is, what will replace their spending? We’re told that we can’t have fiscal expansion, because that’s Big Government. And now we’re being told that we can’t have monetary expansion, which might induce businesses and low-debt consumers to spend more, because that’s debasing the dollar. Oh, and while we’re on that, we can’t allow the dollar to fall, which might help exports."
Ben Bernanke (2002) - Tax cuts - "A pledge by the Fed to keep the Treasury's borrowing costs low, as would be the case under my preferred alternative of fixing portions of the Treasury yield curve, might increase the willingness of the fiscal authorities to cut taxes."
Scott Sumner - Open letter to fellow conservatives
Brad DeLong - What is wrong with American macroeconomics? - "What is wrong with American macroeconomics? In a nutshell, when 2007-9 came along every single macro textbook (including mine) and every single macro course (save possibly Perry Mehrling's) was of little or no use in helping people who had read or taken them to read publications like the FT as they chronicled the downturn or understand the policy debates hosted by the FT.
At the very minimum, a macro course should teach people enough about the macroeconomy that they can then read the reporting of the FT. And it should teach people enough about the theoretical approaches that underpin policy advocacy that they can then understand and evaluate the policies proposed in contributions to the FT.
What would such a macroeconomics course look like?
It would, I think, teach the five still-live theories of the causes of economic downturns that underpin people's analyses. <..>
All five of these theories are best taught sympathetically by being taught historically: as long traditions of thought that smart people have used to try to understand a changing and confused world. Thus Minskyism from its nineteenth century roots with Walter Bagehot or perhaps Adam Smith grappling with nineteenth-century financial crises, Keynesianism from its roots in Knut Wicksell's studies of disturbances to the flow-of-funds, monetarism from its roots in John Stuart Mill trying to understand the first industrial downturn in England in 1825, overinvestment theories from their roots in Karl Marx grappling with the crisis of 1848, high-real-wage from its roots in Nassau Senior's examinations of technological unemployment in the pre-1850 Midlands--all tussling with a set of problems first raised by Jean-Baptiste Say and Thomas Robert Malthus.
That would be a macro course that would turn out graduates who could read the FT--and who would be of great value to all the employers who need people to process information from the FT."
Bill Woolsey - Why are many free market economists so critical of the Fed's proposed quantitative easing?
David D. Friedman - Sustainability - "Generalizing the point, "sustainability" becomes an argument against whatever policies one disapproves of, in favor of whatever policies one approves of, and adds nothing beyond a rhetorical club with which partisans can beat on those who disagree with them."
BBC Video - Fund manager Hugh Hendry vs. politicians and audience
Cartoon - QE2, Hayek and Scott Sumner
The question is, what will replace their spending? We’re told that we can’t have fiscal expansion, because that’s Big Government. And now we’re being told that we can’t have monetary expansion, which might induce businesses and low-debt consumers to spend more, because that’s debasing the dollar. Oh, and while we’re on that, we can’t allow the dollar to fall, which might help exports."
Ben Bernanke (2002) - Tax cuts - "A pledge by the Fed to keep the Treasury's borrowing costs low, as would be the case under my preferred alternative of fixing portions of the Treasury yield curve, might increase the willingness of the fiscal authorities to cut taxes."
Scott Sumner - Open letter to fellow conservatives
Brad DeLong - What is wrong with American macroeconomics? - "What is wrong with American macroeconomics? In a nutshell, when 2007-9 came along every single macro textbook (including mine) and every single macro course (save possibly Perry Mehrling's) was of little or no use in helping people who had read or taken them to read publications like the FT as they chronicled the downturn or understand the policy debates hosted by the FT.
At the very minimum, a macro course should teach people enough about the macroeconomy that they can then read the reporting of the FT. And it should teach people enough about the theoretical approaches that underpin policy advocacy that they can then understand and evaluate the policies proposed in contributions to the FT.
What would such a macroeconomics course look like?
It would, I think, teach the five still-live theories of the causes of economic downturns that underpin people's analyses. <..>
All five of these theories are best taught sympathetically by being taught historically: as long traditions of thought that smart people have used to try to understand a changing and confused world. Thus Minskyism from its nineteenth century roots with Walter Bagehot or perhaps Adam Smith grappling with nineteenth-century financial crises, Keynesianism from its roots in Knut Wicksell's studies of disturbances to the flow-of-funds, monetarism from its roots in John Stuart Mill trying to understand the first industrial downturn in England in 1825, overinvestment theories from their roots in Karl Marx grappling with the crisis of 1848, high-real-wage from its roots in Nassau Senior's examinations of technological unemployment in the pre-1850 Midlands--all tussling with a set of problems first raised by Jean-Baptiste Say and Thomas Robert Malthus.
That would be a macro course that would turn out graduates who could read the FT--and who would be of great value to all the employers who need people to process information from the FT."
Bill Woolsey - Why are many free market economists so critical of the Fed's proposed quantitative easing?
David D. Friedman - Sustainability - "Generalizing the point, "sustainability" becomes an argument against whatever policies one disapproves of, in favor of whatever policies one approves of, and adds nothing beyond a rhetorical club with which partisans can beat on those who disagree with them."
BBC Video - Fund manager Hugh Hendry vs. politicians and audience
Cartoon - QE2, Hayek and Scott Sumner
Thursday, November 18, 2010
Really good links - Too little money chasing too many goods - Credit Easing - Will the Fed Scale Up QE2? - Leverage as a positive good - Currency war - Fed - IOR
Bill Woolsey - Recession - "Recession is NOT too little money chasing too many goods.
It is too little money chasing too few goods."
Ben Bernanke, please bring credit easing back! Here is what you said about it in 2002:
"If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities."
Tim Duy - Will the Fed Scale Up QE2? - "But we shouldn't kid ourselves. Flooding the market with money is dangerous business. It risks distorting prices and capital allocations. We simply don't know where the money will wash up. I know that is in vogue to believe there is a nice, obvious story that links an increase in the money supply to an increase in nominal GDP, but that only works on paper. In the real world, the paths between money and output and prices are complicated. The ultimate composition of aggregate demand matters. It matters a lot - distortions have consequences. Warsh's risks amount to a laundry list of the possible distortions that might occur as the result of ongoing quantitative easing. And he clearly takes those risks seriously.
It makes me think that I haven't been taking those risks seriously enough. But when monetary policy is the only game in town, what choice do you have? You do what you can up to a point…but then you throw it back to Congress and say "you take responsibility for the mess you created by abdicating your role in crafting long run, stabilizing macroeconomic policies." Warsh has set the stage for doing exactly that.
Of course, seriously, if we really have to throw this back to Congress, we are absolutely done for. Cooked. Toast. Somebody remember to tell the last guy to turn off the lights on his way out. Better to take our chances with the next bubble.
Bottom Line: One can tell a seemingly optimistic story - the threat of the double dip is behind us, setting the stage for a nice return to potential growth. But that story holds the dark side of persistent, pernicious low levels of labor utilization. Still, I think now the Federal Reserve would have chosen the optimistic narrative had it not been for the obvious slowdown midyear. Which suggests to me they are not eager to do more, especially if growth settles back in at trend. Reinforcing that belief is the Warsh speech, which makes a strong case that further monetary policy is increasingly ineffectual and very risky. But even more important, he makes clear a belief that only Congress and the Administration have the tools to restore growth. I imagine if that view is, or becomes, a widespread opinion among policymakers, we have seen the last gasp of quantitative easing. They have abated the financial crisis, serving as the lender of last resort, and flooded the economy with cash. They have done what they can. The rest is up to the fiscal authorities. "
Brad DeLong - Leverage as a positive good - "Once we had concluded that the Federal Reserve had the tools and the competence to absorb financial shocks, the jaws of the trap snap shut. Leverage then appears to be a positive good rather than a danger. Why? Because if the past two centuries of financial market history prove anything, it is that the markets are woefully short of patent capital willing to bear risks. The financial rich are overwhelmingly the patient risk-bearers. The financial poor are those who sought safety, or who were unwilling or unable to hold their positions and wait for fundamentals to reassert themselves. Leverage then becomes a way of taking the money of the risk-averse of whom the market has too many--for that is what low long-term returns on "safe" portfolios tell us--and putting it too work in the hands of the too-few who will use it to take the long-term risks that the market, historically, has always handsomely rewarded. And financial sophistication becomes a way of concentrating and amplifying the rewards of risk-bearing to call forth additional risk-bearing capital to bolster the numbers of the too-few."
Menzie Chinn - QE2 and currency war - "I have also been thinking about the anger with which the policymakers and economists in the rest-of-the-world (as well as certain US politicians) have greeted QE2 with. In some ways, the fact that they are angry speaks volumes about the effectiveness or ineffectiveness of QE2. (In other words, to criticize QE2 as having no effect, and then to be angry that it is being undertaken, are internally inconsistent views.)
My view is that anger at the US position is currently being driven by an understanding that QE2 has been surprisingly effective at depreciating the dollar, and that the rest-of-the-world has limited scope in countering that depreciation."
Statsguy - Fed and the support of financial system - "Finally, the one CONSISTENT principle the Fed has pursued has been to support the financial system. Period. I would challenge you to name a single decision in the last 3 years that hasn’t favored the financial system. Even QEI was not unleashed until the Fed was absolutely sure the threat of rising interest rates had been crushed, and the risk of financial collapse through defaulting loans and asset depreciation had exceeded the risk of financial collapse through loss of bond valuations. AKA, liquidity crunch.
The current QEII round has directed preferential liquidity through primary dealers, thereby supporting trading activity which has buttressed bank balance sheets (in other words, infused capital) to compensate for the bad loan book.
You currently view Bernanke et. al.’s endorsement of QEII as an intellectual victory. Consider, for a moment, it simply reflects a closer alignment between the interests of large financial entities, and the broader economy."
Niklas Blanchard - Interest on reserves - "I think that Drum gets two things wrong in his analysis. The first is that interest on reserves is a very desirable policy that smooths out the Fed Funds rate fluctuations, reduces lending spreads, and reduces the opportunity costs of capital. Milton Friedman was the most famous proponent of interest on reserves, and Canada and Australia (if I’m not mistaken, working from memory) also pay interest on reserves.
When Kevin says that the IOR should be zero, what he should be saying is that the Fed Funds rate should be zero, and should have been in Sept 2008 (currently 0-.25, at the time it was 2). "
It is too little money chasing too few goods."
Ben Bernanke, please bring credit easing back! Here is what you said about it in 2002:
"If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities."
Tim Duy - Will the Fed Scale Up QE2? - "But we shouldn't kid ourselves. Flooding the market with money is dangerous business. It risks distorting prices and capital allocations. We simply don't know where the money will wash up. I know that is in vogue to believe there is a nice, obvious story that links an increase in the money supply to an increase in nominal GDP, but that only works on paper. In the real world, the paths between money and output and prices are complicated. The ultimate composition of aggregate demand matters. It matters a lot - distortions have consequences. Warsh's risks amount to a laundry list of the possible distortions that might occur as the result of ongoing quantitative easing. And he clearly takes those risks seriously.
It makes me think that I haven't been taking those risks seriously enough. But when monetary policy is the only game in town, what choice do you have? You do what you can up to a point…but then you throw it back to Congress and say "you take responsibility for the mess you created by abdicating your role in crafting long run, stabilizing macroeconomic policies." Warsh has set the stage for doing exactly that.
Of course, seriously, if we really have to throw this back to Congress, we are absolutely done for. Cooked. Toast. Somebody remember to tell the last guy to turn off the lights on his way out. Better to take our chances with the next bubble.
Bottom Line: One can tell a seemingly optimistic story - the threat of the double dip is behind us, setting the stage for a nice return to potential growth. But that story holds the dark side of persistent, pernicious low levels of labor utilization. Still, I think now the Federal Reserve would have chosen the optimistic narrative had it not been for the obvious slowdown midyear. Which suggests to me they are not eager to do more, especially if growth settles back in at trend. Reinforcing that belief is the Warsh speech, which makes a strong case that further monetary policy is increasingly ineffectual and very risky. But even more important, he makes clear a belief that only Congress and the Administration have the tools to restore growth. I imagine if that view is, or becomes, a widespread opinion among policymakers, we have seen the last gasp of quantitative easing. They have abated the financial crisis, serving as the lender of last resort, and flooded the economy with cash. They have done what they can. The rest is up to the fiscal authorities. "
Brad DeLong - Leverage as a positive good - "Once we had concluded that the Federal Reserve had the tools and the competence to absorb financial shocks, the jaws of the trap snap shut. Leverage then appears to be a positive good rather than a danger. Why? Because if the past two centuries of financial market history prove anything, it is that the markets are woefully short of patent capital willing to bear risks. The financial rich are overwhelmingly the patient risk-bearers. The financial poor are those who sought safety, or who were unwilling or unable to hold their positions and wait for fundamentals to reassert themselves. Leverage then becomes a way of taking the money of the risk-averse of whom the market has too many--for that is what low long-term returns on "safe" portfolios tell us--and putting it too work in the hands of the too-few who will use it to take the long-term risks that the market, historically, has always handsomely rewarded. And financial sophistication becomes a way of concentrating and amplifying the rewards of risk-bearing to call forth additional risk-bearing capital to bolster the numbers of the too-few."
Menzie Chinn - QE2 and currency war - "I have also been thinking about the anger with which the policymakers and economists in the rest-of-the-world (as well as certain US politicians) have greeted QE2 with. In some ways, the fact that they are angry speaks volumes about the effectiveness or ineffectiveness of QE2. (In other words, to criticize QE2 as having no effect, and then to be angry that it is being undertaken, are internally inconsistent views.)
My view is that anger at the US position is currently being driven by an understanding that QE2 has been surprisingly effective at depreciating the dollar, and that the rest-of-the-world has limited scope in countering that depreciation."
Statsguy - Fed and the support of financial system - "Finally, the one CONSISTENT principle the Fed has pursued has been to support the financial system. Period. I would challenge you to name a single decision in the last 3 years that hasn’t favored the financial system. Even QEI was not unleashed until the Fed was absolutely sure the threat of rising interest rates had been crushed, and the risk of financial collapse through defaulting loans and asset depreciation had exceeded the risk of financial collapse through loss of bond valuations. AKA, liquidity crunch.
The current QEII round has directed preferential liquidity through primary dealers, thereby supporting trading activity which has buttressed bank balance sheets (in other words, infused capital) to compensate for the bad loan book.
You currently view Bernanke et. al.’s endorsement of QEII as an intellectual victory. Consider, for a moment, it simply reflects a closer alignment between the interests of large financial entities, and the broader economy."
Niklas Blanchard - Interest on reserves - "I think that Drum gets two things wrong in his analysis. The first is that interest on reserves is a very desirable policy that smooths out the Fed Funds rate fluctuations, reduces lending spreads, and reduces the opportunity costs of capital. Milton Friedman was the most famous proponent of interest on reserves, and Canada and Australia (if I’m not mistaken, working from memory) also pay interest on reserves.
When Kevin says that the IOR should be zero, what he should be saying is that the Fed Funds rate should be zero, and should have been in Sept 2008 (currently 0-.25, at the time it was 2). "
Monday, November 15, 2010
Really good links - QE2 as a signal - Gold and monetary policy - QEII - EMH - Clearinhouse panic
Menzie Chinn - QE2 as a signal - "There is some mystery why the impact on the exchange rate has been so much more marked than that on long term rates. As several observers have observed, QE2 is fairly small in quantitative magnitude, and in terms of implied impact on duration adjusted interest rates. Theory suggests offsetting inflation and liquidity effects from open market operations, so the impact on observed nominal rates could in principle be small (and in either direction).
I think a large chunk of the impact comes from the fact that QE2 signals additional information about the willingness of the monetary authorities to undertake actions to stimulate the economy, perhaps by future injections. I will also observe that the likelihood of a sensible fiscal policy declined after the mid-term elections (that is the US will more likely undertake contractionary fiscal policy by not offsetting state spending reductions), so that from a simple Mundell-Fleming model, we should expect dollar depreciation."
Gavyn Davies - The gold price is not a very useful signal - "In the graph, which is drawn on a log scale, the gold price has risen in a virtual straight line for the whole of the past decade. There have been some periods when the gold price has fallen, but these have not lasted very long.
Over the same period, global price inflation has had periods of rising (before 2007) and falling (after 2007). Government debt ratios and budget deficits have similarly had periods of improvement and deterioration. The dollar has seen years in which its trend has been rising, and years where the reverse has been true. Global current account imbalances have widened, and then narrowed. The gold price has risen when measured in “inflationary” currencies like the dollar, and it has also risen (though by less) when measured in “deflationary” currencies like the yen. In other words, it is not at all clear what the rise in the price of gold has been warning us about.<..>
Consequently, I am genuinely unsure about what the gold market is signalling which could be useful to policy makers, unless it is just a general message that “things are worrying, so get your house in order”. That may be true, but it does not tell us what to do next."
Tyler Cowen - QEII - "I'm not sure it will work, because it won't fix the housing market, may not restore the demands for wealth-elastic goods in a sustainable manner, may not restore the normal flow of credit to small businesses, may not lower subjective estimated risk premia, and may not fix the general disconnect between expectations and reality. The effects on long-term interest rates are murky. "
Brad DeLong - EMH - "He [Summers] (and I) never were believers in the efficient markets hypothesis. How could we be? Look around: there are idiots! The market's prices are the results of a wealth-weighted voting mechanism: the more money you have, the bigger is your weight in the market's average. People who have done well in the recent past thus have more weight than people who have done badly. But those who have done well me be irrational trend-chasers who have been lucky and those who have done badly may be sober-sided fundamentalists whose time has simply not yet come. The questions of the degree to which the limited amount of risk-averse smart money can leverage itself and profit from all this noise in the market by reducing it is a fascinating and subtle one. But nobody thinks that the answer is that the noise simply does not matter, is ironed out into insignificance."
Craig Pirrong - Clearing, voting and panics - "One other historical note that illuminates another important cost of heterogeneity. In Banking Panics of the Gilded Age, Elmus Wicker shows that with one notable exception (the Panic of 1873), the New York Clearinghouse was unsuccessful in dealing with financial panics and contagion. (NYCH was a bank clearinghouse, not a derivatives clearinghouse, but there are important similarities. Most importantly, NYCH had the ability to mutualize some risks.) Wicker argues that conflicts between heterogeneous members were the main impediment in dealing with panics. Although mutualization of risks would have mitigated panic (because the banks collectively were more likely to be solvent than any individual bank), mutualization transferred wealth from the stronger banks to the weaker ones. The inability to overcome this distributive conflict stymied the ability of the NYCH to respond to crises in an effective way. Thus, not only can heterogeneity increase the likelihood of a problem at a CCP (due to its effect on the severity of moral hazard problems), it can reduce the effectiveness of a CCP in dealing with a crisis situation."
I think a large chunk of the impact comes from the fact that QE2 signals additional information about the willingness of the monetary authorities to undertake actions to stimulate the economy, perhaps by future injections. I will also observe that the likelihood of a sensible fiscal policy declined after the mid-term elections (that is the US will more likely undertake contractionary fiscal policy by not offsetting state spending reductions), so that from a simple Mundell-Fleming model, we should expect dollar depreciation."
Gavyn Davies - The gold price is not a very useful signal - "In the graph, which is drawn on a log scale, the gold price has risen in a virtual straight line for the whole of the past decade. There have been some periods when the gold price has fallen, but these have not lasted very long.
Over the same period, global price inflation has had periods of rising (before 2007) and falling (after 2007). Government debt ratios and budget deficits have similarly had periods of improvement and deterioration. The dollar has seen years in which its trend has been rising, and years where the reverse has been true. Global current account imbalances have widened, and then narrowed. The gold price has risen when measured in “inflationary” currencies like the dollar, and it has also risen (though by less) when measured in “deflationary” currencies like the yen. In other words, it is not at all clear what the rise in the price of gold has been warning us about.<..>
Consequently, I am genuinely unsure about what the gold market is signalling which could be useful to policy makers, unless it is just a general message that “things are worrying, so get your house in order”. That may be true, but it does not tell us what to do next."
Tyler Cowen - QEII - "I'm not sure it will work, because it won't fix the housing market, may not restore the demands for wealth-elastic goods in a sustainable manner, may not restore the normal flow of credit to small businesses, may not lower subjective estimated risk premia, and may not fix the general disconnect between expectations and reality. The effects on long-term interest rates are murky. "
Brad DeLong - EMH - "He [Summers] (and I) never were believers in the efficient markets hypothesis. How could we be? Look around: there are idiots! The market's prices are the results of a wealth-weighted voting mechanism: the more money you have, the bigger is your weight in the market's average. People who have done well in the recent past thus have more weight than people who have done badly. But those who have done well me be irrational trend-chasers who have been lucky and those who have done badly may be sober-sided fundamentalists whose time has simply not yet come. The questions of the degree to which the limited amount of risk-averse smart money can leverage itself and profit from all this noise in the market by reducing it is a fascinating and subtle one. But nobody thinks that the answer is that the noise simply does not matter, is ironed out into insignificance."
Craig Pirrong - Clearing, voting and panics - "One other historical note that illuminates another important cost of heterogeneity. In Banking Panics of the Gilded Age, Elmus Wicker shows that with one notable exception (the Panic of 1873), the New York Clearinghouse was unsuccessful in dealing with financial panics and contagion. (NYCH was a bank clearinghouse, not a derivatives clearinghouse, but there are important similarities. Most importantly, NYCH had the ability to mutualize some risks.) Wicker argues that conflicts between heterogeneous members were the main impediment in dealing with panics. Although mutualization of risks would have mitigated panic (because the banks collectively were more likely to be solvent than any individual bank), mutualization transferred wealth from the stronger banks to the weaker ones. The inability to overcome this distributive conflict stymied the ability of the NYCH to respond to crises in an effective way. Thus, not only can heterogeneity increase the likelihood of a problem at a CCP (due to its effect on the severity of moral hazard problems), it can reduce the effectiveness of a CCP in dealing with a crisis situation."
Friday, November 12, 2010
Collapse of the Fed Funds Rate Peg and the Great Recession
The causes of the Great Repression are still a matter of active debate among economists, and Scott Sumner, in a post directed at me, says "the interest on reserve policy was a huge mistake, comparable to the 1936-37 decision to double reserve requirements in the midst of the Great Depression". Here I will attempt to show that the primary cause of the Great Recession was the collapse of fed funds rate peg after the bankruptcy of Lehman Brothers. The second most important cause of the Great Recession is related to the imperfections of interest rate targeting regime that was too closely associated with backward looking Taylor rules. And the interest on reserves program was not a cause of the Great Recession, it was one of the first "green shoots".
The collapse of fed funds rate peg is clearly visible in a chart below. This collapse was seen by markets as a regime change that led to deflationary expectations.
When the standard deviation of effective fed funds rate is so huge, volume weighted average of fed funds rate transactions is no longer a reliable indicator of fed funds rate. As October 2008 FOMC minutes put it, "In the overnight federal funds market, financial institutions became more selective about the counterparties with whom they were willing to trade." Fortunately, overnight LIBOR is an indicator of fed funds market that does not have a participation bias:
Breakdown of fed funds rate market has led to market expectations of elevated future cost of fed funds, and October 2008 FOMC minutes indicated that "the spread of term Libor rates over comparable-maturity overnight index swap (OIS) rates rose sharply from already-high levels". Here is a chart that compares three month Libor to fed funds rate target:
The inadvertent tightening of monetary policy that was caused by the breakdown of fed funds rate market was a matter of great concern for policymakers. On September 18 2008 a $180 billion monetary expansion was announced. The need for softer monetary conditions was communicated to President Bush, who understood the danger and said "If money isn't loosened up, this sucker could go down".
The key instrument that lowered the cost of fed funds was interest on reserves. Start of interest on reserves program led to the announcement of October 13, 2008, on that date the Fed promised to supply unlimited quantity of reserves until the policy objectives have been met. After the announcement overnight Libor and three month Libor rates started falling.
On October 22, overnight Libor finally fell to the rate consistent with the fed funds rate target, and on that date the Fed increased interest paid on reserves to prevent effective fed funds rate from falling further. This was a mistake for two reasons. First, the fed funds rate peg was not completely credible on that date according to three month Libor, and for this reason the expected future cost of reserves was higher than the target. Second, the fed funds rate target as set by the FOMC was too high at that time according to Svenssonian forward looking approach.
Related post: Should Fed stop paying interest on reserves?
The collapse of fed funds rate peg is clearly visible in a chart below. This collapse was seen by markets as a regime change that led to deflationary expectations.
When the standard deviation of effective fed funds rate is so huge, volume weighted average of fed funds rate transactions is no longer a reliable indicator of fed funds rate. As October 2008 FOMC minutes put it, "In the overnight federal funds market, financial institutions became more selective about the counterparties with whom they were willing to trade." Fortunately, overnight LIBOR is an indicator of fed funds market that does not have a participation bias:
Breakdown of fed funds rate market has led to market expectations of elevated future cost of fed funds, and October 2008 FOMC minutes indicated that "the spread of term Libor rates over comparable-maturity overnight index swap (OIS) rates rose sharply from already-high levels". Here is a chart that compares three month Libor to fed funds rate target:
The inadvertent tightening of monetary policy that was caused by the breakdown of fed funds rate market was a matter of great concern for policymakers. On September 18 2008 a $180 billion monetary expansion was announced. The need for softer monetary conditions was communicated to President Bush, who understood the danger and said "If money isn't loosened up, this sucker could go down".
The key instrument that lowered the cost of fed funds was interest on reserves. Start of interest on reserves program led to the announcement of October 13, 2008, on that date the Fed promised to supply unlimited quantity of reserves until the policy objectives have been met. After the announcement overnight Libor and three month Libor rates started falling.
On October 22, overnight Libor finally fell to the rate consistent with the fed funds rate target, and on that date the Fed increased interest paid on reserves to prevent effective fed funds rate from falling further. This was a mistake for two reasons. First, the fed funds rate peg was not completely credible on that date according to three month Libor, and for this reason the expected future cost of reserves was higher than the target. Second, the fed funds rate target as set by the FOMC was too high at that time according to Svenssonian forward looking approach.
Related post: Should Fed stop paying interest on reserves?
Wednesday, November 10, 2010
Really good links - Kocherlakota: helping the victims of real estate bubble crash - Bad loans - What would Friedman say? - Gold - Bernanke put - McLean & Nocera
Narayana Kocherlakota, President, Federal Reserve Bank of Minneapolis - Government should recreate the distribution of wealth that existed before the housing bubble crashed - "Amore feasible option might be to allocate government funds so as to re-create the distribution of wealth that existed under the bubble. By doing so, the government can also re-create the higher levels of output that existed under the bubble. This distribution of funds can work in many ways. Consider a person A who has a mortgage from bank B with principal $200,000. A’s property was worth $300,000 at the peak of the bubble and is now worth $150,000. How should the government allocate the proceeds of its new debt issue between A and B? There are many ways to proceed, but my favorite is that the government pays B $150,000 to write down the value of the mortgage to $50,000. I like this approach because A keeps her property and again has $100,000 of equity in her property. In addition, B has a (presumably viable) debt worth $50,000 from A and has received $150,000 from the government."
John Kemp - Bad loans - "But while intervention may have averted the threat of widespread suspensions and failures, the losses from imprudent lending and borrowing to acquire unproductive and permanently impaired assets remain. Someone somewhere has to shoulder them.
Like central banks around the world, the Federal Reserve has decided they should be borne by depositors, savers, pension funds and bond holders. Not in the form of suspensions, insolvencies and write-downs in the face value of accounts, but through the stealthy and gradual mechanism of negative real interest rates.
Depositors, savers and bondholders may rail against the unfairness of having their wealth confiscated via inflation, and clamor for a return to more “normal” interest rates. But the reality is that they have put their funds in institutions which have lent and lost them. By making the delinquencies and asset impairments more apparent, normal interest rates would simply accelerate those losses and make them more visible.
The money has gone. It is not only the banks and their shareholders that have lost money in the crisis. Through deposits and exposure to mortgage products, ordinary savers have lost money too. The only question is what form the losses take.
Economists remain divided about whether it is better for losses to be recognized and written down, or hidden and gradually worked off over time. But policymakers have shown an overwhelming preference for the hidden, gradual approach."
David Beckworth - Last Word on What Milton Friedman Would Say - "The only reason why Milton Friedman would be critical of QE2 is its ad-hoc nature. While Friedman would be for restoring monetary equilibrium, he would want it to be done in a predictable, rule-like manner. So far that has not happened. It is likely he would have argued the Fed should adopt an explicit nominal target and commit to doing whatever is necessary to maintain it rather than the make-it-up-as-we-go-along approach behind the QEs so far. The economy needs more certainty now and an explicit nominal target would help immensely on this front. "
Martin Wolf - Could the world go back to the gold standard? - "So why choose gold? It is, after all, an impossibly inconvenient means of exchange. But gold has a lengthy history as a widely-accepted store of value. If one is looking to reinstate a pre-modern monetary, gold is the obvious place to start.
After the experience of the last three decades the monetarism of Milton Friedman is no longer a credible alternative. It was abandoned for two simple reasons: first, it proved impossible for monetarists to agree on what money is; and, second, the relation between any given monetary aggregate and nominal income proved unstable.
Again, recent experience suggests that we can no longer be so confident that delegation to independent central banks protects against severe monetary instability. That system permitted a gigantic increase in credit, relative to gross domestic product. It is equally clear that governments do not wish to see this edifice collapse, for understandable reasons. This being so, the ultimate solution may be to increase nominal incomes, via inflation. Indeed, several economists recommend this. If that did happen, it would support those who argue for abandonment of the modern experiment with fiat money.
So would the gold standard be the answer? We would need to start by asking what a return to the “gold standard” might mean.
The most limited reform would be for the central bank to adjust interest rates in light of the gold price. But that would just be a form of price-level targeting. I can see no reason why one would want to target the gold price, rather than the price of goods and services, in aggregate. <..>
With these possibilities eliminated, the obvious form of a contemporary gold standard would be a direct link between base money and gold. Base money — the note issue, plus reserves of commercial banks at the central bank (if any such institution survives) — would be 100 per cent gold-backed. The central bank would then become a currency board in gold, with the unit of account (the dollar, say) defined in terms of a given weight of gold.
In a less rigid version of such a system, the central bank might keep an excess gold reserve, which would allow it to act as lender of last resort to the financial system in times of crisis. That is how the Bank of England behaved during the 19th century, as explained by Walter Bagehot in his classic book, Lombard Street.
So what would be the objections to such a system? There are three: difficulties with the transition; instability; and lack of credibility."
Izabella Kaminska - Bernanke put - "The Bernanke put — a.ka. that almost magical and metaphysical QE2 effect — appears to be having an impact on equity options skew already.<..>
As UBS comment:
John Kemp - Bad loans - "But while intervention may have averted the threat of widespread suspensions and failures, the losses from imprudent lending and borrowing to acquire unproductive and permanently impaired assets remain. Someone somewhere has to shoulder them.
Like central banks around the world, the Federal Reserve has decided they should be borne by depositors, savers, pension funds and bond holders. Not in the form of suspensions, insolvencies and write-downs in the face value of accounts, but through the stealthy and gradual mechanism of negative real interest rates.
Depositors, savers and bondholders may rail against the unfairness of having their wealth confiscated via inflation, and clamor for a return to more “normal” interest rates. But the reality is that they have put their funds in institutions which have lent and lost them. By making the delinquencies and asset impairments more apparent, normal interest rates would simply accelerate those losses and make them more visible.
The money has gone. It is not only the banks and their shareholders that have lost money in the crisis. Through deposits and exposure to mortgage products, ordinary savers have lost money too. The only question is what form the losses take.
Economists remain divided about whether it is better for losses to be recognized and written down, or hidden and gradually worked off over time. But policymakers have shown an overwhelming preference for the hidden, gradual approach."
David Beckworth - Last Word on What Milton Friedman Would Say - "The only reason why Milton Friedman would be critical of QE2 is its ad-hoc nature. While Friedman would be for restoring monetary equilibrium, he would want it to be done in a predictable, rule-like manner. So far that has not happened. It is likely he would have argued the Fed should adopt an explicit nominal target and commit to doing whatever is necessary to maintain it rather than the make-it-up-as-we-go-along approach behind the QEs so far. The economy needs more certainty now and an explicit nominal target would help immensely on this front. "
Martin Wolf - Could the world go back to the gold standard? - "So why choose gold? It is, after all, an impossibly inconvenient means of exchange. But gold has a lengthy history as a widely-accepted store of value. If one is looking to reinstate a pre-modern monetary, gold is the obvious place to start.
After the experience of the last three decades the monetarism of Milton Friedman is no longer a credible alternative. It was abandoned for two simple reasons: first, it proved impossible for monetarists to agree on what money is; and, second, the relation between any given monetary aggregate and nominal income proved unstable.
Again, recent experience suggests that we can no longer be so confident that delegation to independent central banks protects against severe monetary instability. That system permitted a gigantic increase in credit, relative to gross domestic product. It is equally clear that governments do not wish to see this edifice collapse, for understandable reasons. This being so, the ultimate solution may be to increase nominal incomes, via inflation. Indeed, several economists recommend this. If that did happen, it would support those who argue for abandonment of the modern experiment with fiat money.
So would the gold standard be the answer? We would need to start by asking what a return to the “gold standard” might mean.
The most limited reform would be for the central bank to adjust interest rates in light of the gold price. But that would just be a form of price-level targeting. I can see no reason why one would want to target the gold price, rather than the price of goods and services, in aggregate. <..>
With these possibilities eliminated, the obvious form of a contemporary gold standard would be a direct link between base money and gold. Base money — the note issue, plus reserves of commercial banks at the central bank (if any such institution survives) — would be 100 per cent gold-backed. The central bank would then become a currency board in gold, with the unit of account (the dollar, say) defined in terms of a given weight of gold.
In a less rigid version of such a system, the central bank might keep an excess gold reserve, which would allow it to act as lender of last resort to the financial system in times of crisis. That is how the Bank of England behaved during the 19th century, as explained by Walter Bagehot in his classic book, Lombard Street.
So what would be the objections to such a system? There are three: difficulties with the transition; instability; and lack of credibility."
Izabella Kaminska - Bernanke put - "The Bernanke put — a.ka. that almost magical and metaphysical QE2 effect — appears to be having an impact on equity options skew already.<..>
As UBS comment:
"As we mentioned in our report out earlier this week, These Go to 11, many investors have interpreted a more engaged Fed as providing put protection under the equity market, decreasing the potential for adverse outcomes.
This dynamic can be observed most directly by looking at the option market’s implied volatility skew, which measures the difference between the cost of puts and calls. As illustrated below, this declined significantly following the Fed’s hint at additional QE on September 21. Why buy downside protection when the Fed has done it for you?"<..>But there is another point that Curnutt makes, which is that the Fed may be unwittingly displacing all that volatility elsewhere:
"…it looks like there’s a divergence between currency and equity volatility. The Fed may be compressing equity volatility but it’s incentivising currency volatility in its place.""Eric Falkenstein - Book review - All the Devil's are Here, by Bethany McLean and Joe Nocera
Sunday, November 7, 2010
Really good links - Kocherlakota and bubbles - Capping the climate change - Bernanke and stock market - Basel 3
Narayana Kocherlakota, President, Federal Reserve Bank of Minneapolis - Housing bubbles, credit bubbles and government bond bubbles - "Insufficiently stringent bank regulation may have relatively little impact on bank profits, but nonetheless lead scarce factors (finance talent, land) to be overvalued. <..>
There has been a great deal of discussion about how monetary policy should respond to bubbles. I will have nothing to say on this issue. In the United States, monetary policy generally takes the form of open market operations. In an open market operation, the Federal Reserve exchanges some govenment liabilities (reserves) for other government liabilities (Treasuries or securities issued by govenment-sponsored enteprises) of equal market value. In this way, the Federal Reserve can influence the composition of outstanding government liabilities, but not the total value of outstanding government liabilities. (The latter is shaped by Congress.)
As we will see, in the rational bubble framework, the time path of the total value of government liabilities matters a great deal for economic outcomes. However, the composition of those liabilities is, at a minimum, less essential. Hence, I abstract from the latter consideration entirely–and, in doing so, I abstract from monetary policy. <..>
Because of the government’s ability to tax, public sector bubbles may be more stable than private sector bubbles."
Andrew Restuccia - Thomas Crocker - Newly released paper details origins of cap-and-trade - Inventor now believes it's the wrong approach to climate change - "Cap-and-trade, which Crocker said is not “inappropriate by any means” to reduce greenhouse gas emissions, works better for traditional pollutants like sulfur dioxide, because “incremental emissions of SO2 do a great deal of damage.”
“Whereas with respect to greenhouse gases,” he continued, “the marginal damages of an additional bit of greenhouse gas is not going to do much harm.”
Because each additional increment of SO2 that is emitted into the atmosphere is so detrimental to the environment, a proper policy must give certainty with respect to quantity, Crocker said. Cap-and-trade puts a hard cap on emissions and therefore controls emissions quantity. A carbon tax, on the other hand, provides certainty with respect to pricing — it imposes a certain cost on carbon — but does not set a limit on how much carbon can be emitted across the economy.
Greenhouse gases, Crocker argued, are not as incrementally dangerous as SO2 and other pollutants. Therefore, price certainty, delivered through a carbon tax, is more important."
Scott Sumner - Dating game (Bernanke and stock market) - "If I had some literary talent, I’d try a dating analogy for the game that Bernanke and the stock market are playing. Bernanke sends out some sweet talk, the stock market responds with enthusiasm. That emboldens Bernanke (a rather shy guy) to send out a bit more sweet talk, with the confidence his ‘policy tools’ are not viewed as being impotent. I think you can see why I’ll stay away from literature, I couldn’t even write trashy romances. <..>
The way the stock market responded to rather vague and unimpressive rumors of monetary ease, suggests to me that credibility is the last thing Bernanke needs to worry about. The stock market seems like a lonely girl who laps up anything she hears from a sweet-talking guy with a very big wallet in his back pocket. A cheap date.
What do you guys think? Is Krugman right, or is it easy for the Fed to impress the markets? No need to even mention marriage (i.e. higher inflation targets), just give her a wink and a nod, and promise you’ll spend $600b on the date."
Pablo Triana - Basel III - "By keeping total capital requirements almost intact, demanding that the core equity component of those requirements be substantially raised, and insufficiently modifying the mechanisms through which asset risks are measured, the new Basel III regulatory regime still allows for the possibility of a banking blow-up while making it harder for banks to produce juicy returns.
While banks can still sink abruptly, the journey enjoyed before that happens might be less glamorous than was the case previously (due to the lower return on earnings implied by the harsher equity demands). In fact, Basel III could well result in a perverse combination of higher risks and lower returns."
Nick Rowe - Monetary policy and Daylight Savings Time
There has been a great deal of discussion about how monetary policy should respond to bubbles. I will have nothing to say on this issue. In the United States, monetary policy generally takes the form of open market operations. In an open market operation, the Federal Reserve exchanges some govenment liabilities (reserves) for other government liabilities (Treasuries or securities issued by govenment-sponsored enteprises) of equal market value. In this way, the Federal Reserve can influence the composition of outstanding government liabilities, but not the total value of outstanding government liabilities. (The latter is shaped by Congress.)
As we will see, in the rational bubble framework, the time path of the total value of government liabilities matters a great deal for economic outcomes. However, the composition of those liabilities is, at a minimum, less essential. Hence, I abstract from the latter consideration entirely–and, in doing so, I abstract from monetary policy. <..>
Because of the government’s ability to tax, public sector bubbles may be more stable than private sector bubbles."
Andrew Restuccia - Thomas Crocker - Newly released paper details origins of cap-and-trade - Inventor now believes it's the wrong approach to climate change - "Cap-and-trade, which Crocker said is not “inappropriate by any means” to reduce greenhouse gas emissions, works better for traditional pollutants like sulfur dioxide, because “incremental emissions of SO2 do a great deal of damage.”
“Whereas with respect to greenhouse gases,” he continued, “the marginal damages of an additional bit of greenhouse gas is not going to do much harm.”
Because each additional increment of SO2 that is emitted into the atmosphere is so detrimental to the environment, a proper policy must give certainty with respect to quantity, Crocker said. Cap-and-trade puts a hard cap on emissions and therefore controls emissions quantity. A carbon tax, on the other hand, provides certainty with respect to pricing — it imposes a certain cost on carbon — but does not set a limit on how much carbon can be emitted across the economy.
Greenhouse gases, Crocker argued, are not as incrementally dangerous as SO2 and other pollutants. Therefore, price certainty, delivered through a carbon tax, is more important."
Scott Sumner - Dating game (Bernanke and stock market) - "If I had some literary talent, I’d try a dating analogy for the game that Bernanke and the stock market are playing. Bernanke sends out some sweet talk, the stock market responds with enthusiasm. That emboldens Bernanke (a rather shy guy) to send out a bit more sweet talk, with the confidence his ‘policy tools’ are not viewed as being impotent. I think you can see why I’ll stay away from literature, I couldn’t even write trashy romances. <..>
The way the stock market responded to rather vague and unimpressive rumors of monetary ease, suggests to me that credibility is the last thing Bernanke needs to worry about. The stock market seems like a lonely girl who laps up anything she hears from a sweet-talking guy with a very big wallet in his back pocket. A cheap date.
What do you guys think? Is Krugman right, or is it easy for the Fed to impress the markets? No need to even mention marriage (i.e. higher inflation targets), just give her a wink and a nod, and promise you’ll spend $600b on the date."
Pablo Triana - Basel III - "By keeping total capital requirements almost intact, demanding that the core equity component of those requirements be substantially raised, and insufficiently modifying the mechanisms through which asset risks are measured, the new Basel III regulatory regime still allows for the possibility of a banking blow-up while making it harder for banks to produce juicy returns.
While banks can still sink abruptly, the journey enjoyed before that happens might be less glamorous than was the case previously (due to the lower return on earnings implied by the harsher equity demands). In fact, Basel III could well result in a perverse combination of higher risks and lower returns."
Nick Rowe - Monetary policy and Daylight Savings Time
Thursday, November 4, 2010
Really good links - QE2 - Scott Sumner - Milton Friedman - Voter turnout - Plain English FOMC
Brad DeLong - QE2 - "The five-year note carries an interest rate of 1.17% per year. The Federal Reserve is thus changing the supply of assets by taking onto its own balance sheet... wait for it... wait for it... duration risk that the market is currently willing to pay $7 billion a year to avoid.
To take $7 billion a year of duration risk off of the private sector's books in a global economy that still has more than $60 trillion of financial assets is a change in "credit conditions" equivalent to what would be achieved in normal times by a coordinated one basis point reduction in short-term interest rates by the world's central bankers."
Scott Sumner - QE2 - Will it work? - "In the end, the market movements over the last few weeks seem to be telling us that QE2 is likely to provide a modest boost to the economy, and that a double dip recession is less likely than in August. But overall the future still looks bleak. The Fed’s action fell pitifully short of what was needed. At a minimum, I would have liked to have seen enough stimulus to raise 5 year TIPS spreads to 2.0%, instead they merely rose from 1.61% to 1.65%. We didn’t need more QE, but rather the three-pronged attack I suggested earlier (including lower IOR and level targeting.)
Of course markets are often wrong, and the economy may do better than expected or worse than expected. But for those of us who favor a Svenssonian policy of targeting the forecast, the verdict is already in; the policy is better than nothing, but not nearly enough. My hunch is that unemployment will remain high for quite some time, and the Fed will be forced to do even more in 2011."
David Beckworth - A Reply to Those Who Claim We Misreprensented Milton Friedman - "The growth rates of the monetary aggregates have been anything but stable. In fact, M3 and MZM--arguably better measures of money during this crisis than M2--have had a recent run of negative growth. While M2 has had positive growth, it too appears below trend. All of them have seen plunges in their growth rates. Would Milton Friedman really look at this graph and conclude there has been monetary stability?
With that said, one should note that in this 2003 WSJ article Milton Friedman appears to have moved beyond aiming to just stabilize the growth of the money supply. For in this piece he praises the Fed for adjusting M2 in response to a M2 "velocity bubble" in the 1990s. Friedman is endorsing the Fed's actions at this time to offset money demand shocks. Thus, in this article he is implicitly calling for the Fed to stabilize the MV part of the equation of exchange (i.e. MV=PY). "
David Myatt (via jeff) - Rational voter turnout - "If each voter is willing to participate in exchange for a 1-in-2,500 chance of influencing the outcome of the election, then turnout will exceed 50%. "
Update: FOMC statement in plain English
To take $7 billion a year of duration risk off of the private sector's books in a global economy that still has more than $60 trillion of financial assets is a change in "credit conditions" equivalent to what would be achieved in normal times by a coordinated one basis point reduction in short-term interest rates by the world's central bankers."
Scott Sumner - QE2 - Will it work? - "In the end, the market movements over the last few weeks seem to be telling us that QE2 is likely to provide a modest boost to the economy, and that a double dip recession is less likely than in August. But overall the future still looks bleak. The Fed’s action fell pitifully short of what was needed. At a minimum, I would have liked to have seen enough stimulus to raise 5 year TIPS spreads to 2.0%, instead they merely rose from 1.61% to 1.65%. We didn’t need more QE, but rather the three-pronged attack I suggested earlier (including lower IOR and level targeting.)
Of course markets are often wrong, and the economy may do better than expected or worse than expected. But for those of us who favor a Svenssonian policy of targeting the forecast, the verdict is already in; the policy is better than nothing, but not nearly enough. My hunch is that unemployment will remain high for quite some time, and the Fed will be forced to do even more in 2011."
David Beckworth - A Reply to Those Who Claim We Misreprensented Milton Friedman - "The growth rates of the monetary aggregates have been anything but stable. In fact, M3 and MZM--arguably better measures of money during this crisis than M2--have had a recent run of negative growth. While M2 has had positive growth, it too appears below trend. All of them have seen plunges in their growth rates. Would Milton Friedman really look at this graph and conclude there has been monetary stability?
With that said, one should note that in this 2003 WSJ article Milton Friedman appears to have moved beyond aiming to just stabilize the growth of the money supply. For in this piece he praises the Fed for adjusting M2 in response to a M2 "velocity bubble" in the 1990s. Friedman is endorsing the Fed's actions at this time to offset money demand shocks. Thus, in this article he is implicitly calling for the Fed to stabilize the MV part of the equation of exchange (i.e. MV=PY). "
David Myatt (via jeff) - Rational voter turnout - "If each voter is willing to participate in exchange for a 1-in-2,500 chance of influencing the outcome of the election, then turnout will exceed 50%. "
Update: FOMC statement in plain English
Monday, November 1, 2010
Really good links - Successful QE - What would Milton Friedman say? - QE for bankers - University macroeconomics
David Beckworth - Successful QE in 1934 - "QE has been done before in the United States and it worked incredibly well. It was initiated in early 1934 when FDR and his treasury officials decided to (1) devalue the value of the dollar relative to gold and (2) quit sterilizing gold inflows. <..>
But that is exactly what was needed, a big permanent shock to inflation expectations that served to stop the deflationary spiral, end the liquidity trap, and allow a recovery in aggregate demand. Now this policy move was backed up with significant and permanent increases in the monetary base over time: it went from about $8 billion right before the policy change to about $24 billion by the end of the 1930s."
Bill Woolsey - What would Milton Friedman say? - "Friedman believed correctly that money expenditures (nominal income) depends entirely on monetary factors. In the long run, unemployment and ouput depend on suppply side factors. And so, monetary factors only determine money prices and wages in the long run. However, short run fluctuations in money expenditures lead to undesirable fluctuations in real output in the short run.
He found that the conglomerations of assets that make up M2 was more or less proportional to money expeditures. In other M2 velocity is was pretty much constant. The implication was that if the Fed could vary the monetary base in such a way that the M2 combination of assets stated on a 3% growth path, then money expenditures would stay on that same growth path. The price level would be stable, wages and other incomes would grow about 3%, and fluctuations in supply side factors would result in fluctuations in output and also the price level and inflation as the price level moves.
But it turned out that the M2 measure of the money supply stopped tracking money expenditures. M2 velocity changed.
Before he died, Friedman noticed that like everyone else. There was never any reason why that combination of assets should necessarily track money expenditures. When they stopped, Friedman began to change his mind.
However, he always maintained that money expenditures depend on monetary factors, that interest rates don't tell us much about those factors, and that stable growth in money expenditures are important in both the short run and long run."
Karl Smith - QE explained for bankers - "However, the Fed’s strategy can be summed up succinctly for bankers: get out of long dated nominal Treasuries. In the short run we are pushing down yields, so we are lowering the return you can lock in. In the long run yields are going to pop up so you are going to take capital losses.
Ergo: find some other place to put your money."
Nick Rowe - University macroeconomics and Barro-Grossman supply-side multiplier - "The supply of seats is determined by the individual department. But the demand for seats is determined centrally, by Admissions. Admissions is ordered to bring in as many students as are needed to pay the profs' salaries. But each individual prof and department wants to reduce the number of bums on seats in his course and his department.
The result is a classic case of chronic excess demand for seats. Just like in the old Soviet Union. Capitalist economies have chronic excess supply. Communist economies have chronic excess demand. My job as associate dean (because I made it my job) was to persuade, cajole, bribe, threaten, or bully departments into putting on enough seats for the bums that needed or wanted to sit in them. I was what the Russians used to call "the pusher". <..>
You get hoarding. Students grab a seat in any course that's open, even if they think they will probably not want it, just in case they do want it and can't find a seat.
What's worse is that you get Clowerian spillovers. Walras' Law is totally false. The sum of the excess demand for seats can add up to anything whatsoever, because the student who can't get a seat in course A, will try to get a seat in course B instead, and if he can't will try for course C,...then maybe try course A again, and so on. So the central planner (that was me) trying to find out how many extra seats in which courses are really needed, hasn't got any idea. A notional excess demand for one seat in one course can create an effective excess demand for hundreds of seats all over the university. I am one of the very few economists who has actually seen the Barro Grossman supply-side multiplier at work, in real time. Create a couple more seats in one course, and seats suddenly start appearing in other courses all over the university."
But that is exactly what was needed, a big permanent shock to inflation expectations that served to stop the deflationary spiral, end the liquidity trap, and allow a recovery in aggregate demand. Now this policy move was backed up with significant and permanent increases in the monetary base over time: it went from about $8 billion right before the policy change to about $24 billion by the end of the 1930s."
Bill Woolsey - What would Milton Friedman say? - "Friedman believed correctly that money expenditures (nominal income) depends entirely on monetary factors. In the long run, unemployment and ouput depend on suppply side factors. And so, monetary factors only determine money prices and wages in the long run. However, short run fluctuations in money expenditures lead to undesirable fluctuations in real output in the short run.
He found that the conglomerations of assets that make up M2 was more or less proportional to money expeditures. In other M2 velocity is was pretty much constant. The implication was that if the Fed could vary the monetary base in such a way that the M2 combination of assets stated on a 3% growth path, then money expenditures would stay on that same growth path. The price level would be stable, wages and other incomes would grow about 3%, and fluctuations in supply side factors would result in fluctuations in output and also the price level and inflation as the price level moves.
But it turned out that the M2 measure of the money supply stopped tracking money expenditures. M2 velocity changed.
Before he died, Friedman noticed that like everyone else. There was never any reason why that combination of assets should necessarily track money expenditures. When they stopped, Friedman began to change his mind.
However, he always maintained that money expenditures depend on monetary factors, that interest rates don't tell us much about those factors, and that stable growth in money expenditures are important in both the short run and long run."
Karl Smith - QE explained for bankers - "However, the Fed’s strategy can be summed up succinctly for bankers: get out of long dated nominal Treasuries. In the short run we are pushing down yields, so we are lowering the return you can lock in. In the long run yields are going to pop up so you are going to take capital losses.
Ergo: find some other place to put your money."
Nick Rowe - University macroeconomics and Barro-Grossman supply-side multiplier - "The supply of seats is determined by the individual department. But the demand for seats is determined centrally, by Admissions. Admissions is ordered to bring in as many students as are needed to pay the profs' salaries. But each individual prof and department wants to reduce the number of bums on seats in his course and his department.
The result is a classic case of chronic excess demand for seats. Just like in the old Soviet Union. Capitalist economies have chronic excess supply. Communist economies have chronic excess demand. My job as associate dean (because I made it my job) was to persuade, cajole, bribe, threaten, or bully departments into putting on enough seats for the bums that needed or wanted to sit in them. I was what the Russians used to call "the pusher". <..>
You get hoarding. Students grab a seat in any course that's open, even if they think they will probably not want it, just in case they do want it and can't find a seat.
What's worse is that you get Clowerian spillovers. Walras' Law is totally false. The sum of the excess demand for seats can add up to anything whatsoever, because the student who can't get a seat in course A, will try to get a seat in course B instead, and if he can't will try for course C,...then maybe try course A again, and so on. So the central planner (that was me) trying to find out how many extra seats in which courses are really needed, hasn't got any idea. A notional excess demand for one seat in one course can create an effective excess demand for hundreds of seats all over the university. I am one of the very few economists who has actually seen the Barro Grossman supply-side multiplier at work, in real time. Create a couple more seats in one course, and seats suddenly start appearing in other courses all over the university."
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