Tag: Liquidity Trap

Must-Read Pre-Liftoff Lollapalooza: Matthew Yglesias: This week, the US government will take action to slow the economy and prevent wage growth

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Matthew Yglesias: This week, the US government will take action to slow the economy and prevent wage growth: “Imagine President Barack Obama announced a… new tax… [to] raise the price of borrowing money…

…Republicans would, of course, denounce him. Why would the president impose a new job-killing tax at a time when the American people have been suffering from an agonizingly slow labor market recovery and years of flat wages? And then imagine the Democratic reaction when Obama explained that… his only goal with the new tax was precisely to reduce the pace of job growth. To make sure that unemployment didn’t get too low. That workers’ bargaining power didn’t become excessive…. ‘When it comes to inflation,’ the president might say, ‘it’s better safe than sorry. So here’s your new job-killing tax!’…

The Federal Reserve is going to do exactly this by raising interest rates at its meeting next week…. The Federal Reserve is structured as an independent agency precisely on the theory that for the long-term good of the economy we sometimes want the central bank to slow the pace of job creation in order to avoid inflation…. But the weird thing about this week’s push for higher interest rates is that there’s no inflation problem to solve…. There has been literally no inflation at all throughout 2015. If you ignore food and energy prices… inflation… has still been below the Fed’s 2 percent target for all of 2015. And… 2014. And… 2013. And… for about half of 2012….

The reason the Fed is now comfortable with the idea of a rate hike is that the labor market has improved considerably from where it was a few years ago…. But even though the labor market is in much better shape than it was a year or two ago, it’s honestly still not in such great shape. A broad gauge of the labor market–the share of 25- to 54-year-olds who have a job–shows that something between 2 and 5 percent of the prime age population has vanished from the workforce…. At a congressional hearing earlier this year, Fed Chair Janet Yellen was asked about the black-white unemployment gap and said basically that there’s nothing she can do about it…. It’s easy enough to see… [that] the African-American unemployment rate and the white unemployment rate move in tandem at a 2-to-1 ratio…. But as Jared Bernstein points out, this semi-fixed ratio actually means that monetary policy matters a great deal for the racial gap….

With the United States currently enjoying a lowish 5 percent unemployment rate, it’s easy for relatively privileged people to neglect the benefits of further small reductions. But for an African-American population that will enjoy a double-scale version of any drop in the unemployment rate, the stakes remain quite high. The same is true of other kinds of vulnerable populations….

Most economists think I am wrong and the Fed should raise rates. But the thinking behind this, as measured in things like the IGM Survey of prominent economists, is awfully fuzzy. Anil Kashyap of the University of Chicago says he strongly agrees with a rate hike because, ‘As Mike Mussa once famously said, ‘If not now, when?” Darrell Duffie of Standard says ‘the macro vital signs look healthy enough now.’… Many supporters haven’t articulated a rationale at all…. The relevant question is whether, under the circumstances, the risks of a little bit of inflation are really worse than the risks of sluggish job growth. This is a subject that deserves to be debated squarely…

Must-Read Pre-Liftoff Lollapalooza: Neil Irwin: Yellen Blinks on Interest Rates

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: From last September: the very sharp Neil Irwin on Yellen’s blinking:

Neil Irwin: Yellen Blinks on Interest Rates: “The cost of waiting… to ensure that the economy continues to perform the way… models predict…

… [is] low…. The challenge… is that we could well get through the end of 2015 without the open questions that triggered the September delay being resolved…. There is no assurance that these key questions… whether inflation is finally… poised to rise, and whether economic softness in… emerging markets will crimp… growth… will be resolved by December or even by the spring…. Inflation continues coming in less than forecast, and the global economy looks perilous….

As… Stanley Fischer said… if the Fed waits until it is absolutely certain it is time to raise rates, it will probably be too late…. The decision to hold off on rate increases this week suggests Ms. Yellen and the Fed want a little more evidence that the economy is on the mend, but they may find themselves back in the same spot before they know it.

But, as Stanley Fischer did not say, if the Fed raises interest rates when the odds are still only 60-40 that it should, it is not probably but definitely raising them too early.

Must-Read Pre-Liftoff Lollapalooza: Tim Duy: Makes You Wonder What The Fed Is Thinking

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: The extremely-thoughtful Tim Duy is… genuinely frightened…

Tim Duy: Makes You Wonder What The Fed Is Thinking: “My interest tonight is a pair of Wall Street Journal articles that together call into question…

…the wisdom of the Fed’s expected decision… inflation, or lack thereof, by Josh  Zumbrun… the growing consensus among economists that the Fed faces the zero bound again in less than five years…. Fed officials expect the terminal fed funds rate in the 3.3-3.8 percent range (central tendency) while the 2001-03 easing was 5.5 percentage points and the 1990-92 easing was 5.0 percentage points. You see of course how the math works….

The policy risks are asymmetric. They can always raise rates, but the room to lower is limited by the zero bound. But that understates the asymmetry. You should also include the asymmetry of risks around the inflation forecast. The Fed has repeated under over-forecasted inflation. It seems like they should also see an asymmetry in the inflation forecast that compounds the policy response asymmetry. Asymmetries squared. Given all of these asymmetries, I would think the Fed should continue to stand pat until they understand better the inflation dynamics. The Fed thinks otherwise. Why would Federal Reserve Chair Janet Yellen allows the Fed to be pulled in such a direction? Partly to appease the Fed hawks. And then… Yellen is wedded to the theory that the sooner the Fed begins normalizing policy, the more likely the Fed can avoid a recession-inducing sharp rise in rates. She follows up this concern with: “Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.”

This is what Mark Dow calls ‘avalanche patrol’… becomes a story of a Fed caught between a world in which the policy necessary to meet their inflation target is inconsistent with financial stability…. And my sense is that Yellen feels the best way to slip through those cracks is early and gentle tightening….

The Fed likely only gets one chance to lift-off from the zero bound on a sustained basis…. They [sh]ould wait until they were absolutely sure inflation was coming. Even more so given the poor performance of their inflation forecasts. But the Fed thinks there is now more danger in waiting than moving. And so into the darkness we go.

Must-Read Pre-Liftoff Lollapalooza: Jared Bernstein: Will Inflation Really Snap Back Once “Temporary Factors” Abate?

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Even if there were no model uncertainty, the asymmetry of the situation would lead a rational optimizing policymaker to keep interest rates at zero until the need for liftoff was undeniable. With model uncertainty, a rational optimizing policymaker would keep interest rates at zero for considerably longer…

Jared Bernstein: Will Inflation Really Snap Back Once “Temporary Factors” Abate?: “I noted the Fed’s theory of the case as to why inflation isn’t accelerating…

…temporary factors, including low, low oil prices and the strong dollar, are blocking the usual signal…. [But] it’s not just that inflation isn’t picking up as output gaps close and unemployment falls. Inflation didn’t fall as much as expected when such activity gaps were much wider…. Blanchard, Cerutti, and Summers… a flat slope of the Phillips curve… ain’t exactly a new development…. The slope of the PC has been low for a decade… about 0.2, well below it’s historical levels in the 70s and 80s…. Larry Ball, in commenting on BCS, runs particularly transparent models and finds more stable, significant PC coefficients (though they are of the same magnitude as BCS)…. However, [he] do[es] not give much support to the view that the flat PC is temporarily low as a function of a few unique factors…. Inflation hawks, pull in your talons!

Must-Read Pre-Liftoff Lollapalooza: Harriett Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Why does the Fed think that it will be different, and not desperately want to lower interest rates in two years, but be scared to admit it made a mistake? Much better to wait until you are sure that you will not have to return to zero in short order. Yet, somehow, that asymmetric-risks argument does not have purchase within the Fed…

Harriett Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking: “Central banks in the eurozone, Sweden, Israel, Canada, South Korea, Australia, Chile and beyond…

…have tried to raise rates in recent years, only to reduce them again as their economies stumbled. Central-bank U-turns on rates in recent years had different causes and consequences…. The Bank of Israel, under Stanley Fischer, who is now the Fed’s vice chairman, was among the first to move. It started raising rates from 0.5% in September 2009, just as a global recovery took hold, pushing them up to 3.25% by May 2011. With Israel’s economy buffeted by Europe’s downturn and global inflation slowing, Mr. Fischer’s successor, Karnit Flug, has since pushed rates back down to 0.10%. Two central banks that haven’t raised rates since the crisis—the Fed and the Bank of England—have enjoyed stronger recoveries than others. Their patience might pay off. Their economies might now finally be healthy enough to bear higher rates…. “Tightening too early can have very large costs, as it has had in the Swedish case,” said Lars Svensson, who quit as Riksbank deputy governor in 2013 in protest at the bank’s policy decisions…

Must-Read Pre-Liftoff Lollapalooza: Robin Wigglesworth: How the US Federal Reserve Intends to Raise Rates

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Yes, the Federal Reserve has the tools it needs in order to liftoff interest rates. But how will it use its tools? How it is going to manipulate interest on reserves, the monetary base, reserve requirements, and the amount of duration risk it has taken off the private market will be very interesting to watch…

Robin Wigglesworth: How the US Federal Reserve Intends to Raise Rates: “Buckle up. On Wednesday, the Federal Reserve is expected to raise interest rates for the first time since 2006…

…and reversing the past seven years of extraordinary monetary policy looms as being an experimental, possibly bumpy lift-off. When economists talk about the Fed’s official borrowing rate, they refer to the Fed funds rate, which since late 2008 has been confined to a corridor between zero and 0.25 per cent…. The Fed funds rate sets a benchmark for the cost of credit that ripples through markets and guides borrowing costs for everyone in the US (and much further afield)….

Acting as a floor for now at 0.05 per cent, the overnight reverse repo programme, or Overnight RRP, is primarily aimed at money market funds, and is expected to do much of the heavy lifting. In a typical RRP the Fed’s market desk sells a Treasury bond from its portfolio to a money-market fund and agrees to buy it back the next day at a certain price, a process known as ‘repo’, short for repurchase. In practice, the central bank’s balance sheet does not shrink, but this sets a benchmark for cash interest rates paid by the Fed itself. These RRP operations will happen every business day between 12.45pm and 1.15pm in New York…. Currently the RRP programme is capped at $300bn to avoid the Fed’s operations distorting money markets, but economists expect its size to have to be expanded… to be enlarged to $750bn to $1tn, or perhaps be unlimited in size to ensure a smooth lift-off….

Some economists argue that the Fed should look for a new mechanism to set US interest rates, since the Fed funds market is so small and thinly traded nowadays. There used to be close to $350bn a day that changed hands before the crisis, but daily volumes are now roughly $50bn a day. Some are therefore urging a radical rethink. Even Simon Potter, head of the New York Fed’s markets division — and thus the man that will have to implement the central bank’s decision — hinted that this may be needed…. Fed officials are confident they have the tools to raise the Fed funds rate to roughly where they want it, and while the recent rash of market abnormalities has raised eyebrows, most expect other important interest rates to rise in conjunction. But it could still be a bumpy take-off.

Must-Read Pre-Liftoff Lollapalooza: Financial Times: The Federal Reserve May Be Jumping the Gun

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: The Financial Times editors argue that the Federal Reserve is making a mistake with tomorrow’s liftoff of interest rates.

They are right.

The only wrong thing they say that I see is their statement that “it would probably be more disruptive if the Fed sat on its hands”. The Fed is likely to have to break its policy commitments at some point because its policy commitments are dangerous and faulty. Given that, the least disruptive moment to break them is now. Breaking them later will only be more disruptive.

Financial Times: The Federal Reserve May Be Jumping the Gun: “Just because it seems inevitable does not mean it is a good idea…

…The Federal Reserve’s Open Market Committee, which on Wednesday announces its decision on interest rates, has widely telegraphed that it will raise borrowing costs for the first time since 2006 after seven years on hold. Janet Yellen, the Fed chair, has apparently overcome opposition from some more dovish members on the central bank’s governing board…. The Fed will, on balance, be moving too early…. The value of waiting outweighs that of acting now…. Year after year, the Fed… has overestimated inflationary pressure, suggesting either a miscalculation about the economy’s output capacity or something even more fundamental going wrong. While American unemployment is low… the US’s number of economically inactive people [is high]… discouraged workers who have left the labour market never to return, or they may be people who would start looking for a job if the offers were there…. With consumer price inflation having undershot its informal 2 per cent target for so long, there is a good case for remaining behind the curve until it is quite clear which way the curve is moving.

Having come this far in signalling that interest rates are about to rise, it would probably be more disruptive if the Fed sat on its hands on Wednesday than if it moved…. Yet at the very least it should do its utmost to make clear that this is not the first in a series of preordained interest rate rises. In that sense, too, it needs to make a break with historical precedent in which the first US rate rise is reliably followed by a string of further moves. If it does raise rates, the Fed should signal that it stands ready to reverse course…. The central bank should leave interest rates on hold this week.

Must-Read: Tim Duy: And That’s a Wrap

Posted on by Brad DeLong

Must-Read: The principal question the Federal Reserve should be discussing right now is: When the next adverse macro economic shock comes, the Fed needs to be in a position to cut the federal funds rate by up to 500 basis points. What should we be doing now to create an economy as fast as possible that is strong enough to allow for such a federal funds rate? Yet I am seeing no chatter around this question at all. Perhaps the silence is simply a consensus of despair?

Tim Duy: And That’s a Wrap: “The service sector number continues to bounce around a respectable range…

…A bit less so for… manufacturing…. The Fed is betting that a.) this data is noisy and b.) that the service sector is much, much more important to the economy than manufacturing and c.) some of the weakness in manufacturing will be alleviated as the oil/gas drilling and export drag soften over the next year in relative terms. Speaking of exports, the trade report came with a larger-than-expected deficit, a factor that added another hit to GDP nowcasting…. The Atlanta Federal Reserve Bank’s GDPnow indicator is currently tracking at 1.5%…. No fear, though… Janet Yellen… highlighted total real private domestic final purchases as the number to watch:

Growth this year has been held down by weak net exports…. By contrast, total real private domestic final purchases (PDFP)… has increased at an annual rate of 3 percent this year….

That sent everyone to FRED (the code is LB0000031Q020SBEA)…. When they search through the data for the happy numbers, you know they are looking to hike. Indeed, the clear takeaway from Yellen’s speech was that a rate hike was coming….

We are now well beyond the issue of the first rate hike. The new questions are how gradual will ‘gradual’ be and when will the Fed begin widening down the balance sheet…. Federal Reserve Governor Lyle Brainard argued to hold the balance sheet at current levels until interest rates are sufficient to provide a cushion for the next recession…. Brainard knows she has lost the battle to forestall the first rate hike further and has now chosen to stake out a position on one of the next big issues…. The pace of subsequent tightening, the normalization–or not–of the balance sheet, and the countdown to the next easing are all issues now on the table.

Must-Read: Larry Summers: Central Bankers Do Not Have as Many Tools as They Think

Posted on by Brad DeLong

Must-Read: As John Maynard Keynes famously wrote, a government dedicated to producing a high-pressure economy is needed to enable entrepreneurship, enterprise, and growth. A government that does not only fail to work to generate high-pressure now, but also lacks a plan for fighting the next recession, is a government that drives the Confidence Fairy far away indeed:

Lawrence Summers: Central Bankers do Not Have as Many Tools as They Think: “It is agreed that the ‘neutral’ interest rate…

…has declined substantially and is likely to be lower in the future than in the past throughout the industrial world because of a growing relative abundance of savings relative to investment…. Neutral real interest rates may well rise over the next few years…. This is what many expect…. [But a] number of considerations make me doubt the US economy’s capacity to absorb significant increases in real rates over the next few years… leav[ing] me far from confident that there is substantial scope for tightening in the US and there is probably even less scope in other parts of the industrialised world. The fact that central banks in countries, including Europe, Sweden and Israel, where rates were zero found themselves reversing course after raising rates adds to the cause for concern.

But there is a more profound worry…. Once a recovery is mature the odds of it ending within two years are about half…. When recession comes it is necessary to cut rates more than 300 basis points. I agree with the market that the odds are the Fed will not be able to raise rates 100 basis points a year without threatening to undermine recovery…. [Thus] the chances are very high that recession will come before there is room to cut rates enough to offset it. The knowledge that this is the case must surely reduce confidence….

The unresolved question that will hang over the economy is how policy can delay and ultimately contain the next recession. It demands urgent attention from fiscal as well as monetary policymakers.

The Keynes quote, from the General Theory:

If effective demand is deficient… the individual enterpriser who seeks to bring… resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros…. Hitherto the increment to the world’s wealth has fallen short of the aggregate of positive individual savings; and the different eras been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual goo fortune. But if effective demand is adequate, average skill and average good fortune will be enough….

It is certain that the world will not much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated… with present-day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease while preserving efficiency and freedom…

Must-Read: Paul Krugman: The Not-So-Bad Economy

Posted on by Brad DeLong

**Must-Read: Mark Thoma sends us to Paul Krugman on the Fed’s forthcoming likely policy mistake with respect to this month’s interest-rate liftoff. My take: there is one chance in two that in June of 2018 the Federal Reserve will be wishing it had not raised interest rates in December 2015–it is, of course, unable to effectively catch up in policy terms:

Paul Krugman: The Not-So-Bad Economy: “I believe that the Fed is making a mistake…

…But the fact that hiking rates is even halfway defensible is a sign that the U.S. economy isn’t doing too badly. So what did we do right?… The Fed and the White House have mostly worried about the right things. (Congress, not so much.) Their actions fell far short of what should have been done…. But at least they avoided taking destructive steps to fight phantoms…. Meanwhile, on the other side of the Atlantic, the European Central Bank gave in to inflation panic, raising interest rates twice in 2011–and in so doing helped push the euro area into a double-dip recession….

Unfortunately, the U.S. ended up doing a fair bit of austerity too, partly driven by conservative state governments, partly imposed by Republicans in Congress via blackmail over the federal debt ceiling. But the Obama administration at least tried to limit the damage.
The result of these not-so-bad policies is today’s not-so-bad economy…. Things could be worse.

And they may indeed get worse, which is why the Fed’s likely rate hike will be a mistake…. I’m not sure why this [asymmetric risks] argument, which a number of economists are making, isn’t getting much traction at the Fed. I suspect, however, that officials have been worn down by incessant criticism of their policies, and want to throw the critics a bone. But those critics have been wrong every step of the way. Why start taking them seriously now?