Must-Read: : The Puzzling Aversion to Expansionary Fiscal Policy: ‘Low interest rates are not really low’, or something…
Tag: Liquidity Trap
Must-Read: Paul De Grauwe and Yuemei Ji: Animal Spirits and the Optimal Inflation Target
Must-Read: : Animal Spirits and the Optimal Inflation Target: “Low inflation targets can cause economies to hit the zero lower bound during deflationary periods caused by even mild shocks…
…In such circumstances, central banks lose their ability to stimulate the economy. This column assesses the risk of this happening using a model that endogenises self-perpetuating optimism and pessimism in the economy. Given agents’ intrinsic chronic pessimism during times of recession, central banks should raise their inflation targets to 3 or 4% to preserve their ability to stimulate the economy when needed.
Must-Read: Narayana Kocherlakota: Three Antidotes to the Brexit Crisis
Must-Read: Correct, IMHO, from the very sharp Narayana Kocherlakota. Now perhaps his successor Neel Kashkari and the other Reserve Bank presidents not named Charlie Evans might give him some back up?
The one thing I do not like is Narayana’s “Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system.” That sentence seems to me to misread market psychology completely. As I see it–and as the people in markets I talk to say–right now markets are fairly completely spooked by their belief that the Federal Reserve is unconcerned, and takes that lack of concern as a sign of Federal Reserve detachment from reality. Narayana’s following sentences seems to me to be highly likely to be the right take: “I’d say the markets are already pretty spooked” and “By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management”.
Let me stress that, at least from where I sit, that confidence in Federal Reserve economic management is, right now, lacking.
The people I talk to in financial markets tend to say that they believe markets took Stan Fischer on January 5 to be something of a wake-up call with respect to Fed groupthink:
Liesman: When I looked at where the market is priced, the market is priced below where the Fed median forecast is. Quite a bit. Two rate hikes really, if you count them in quarter points. Does that concern you that the market needs to catch up with where the Fed is or is it a matter of you think the Fed needs to recalibrate to where the market is?
Fischer: Well, we watch what the market thinks, but we can’t be led by what the market thinks. We’ve got to make our own analysis. We make our own analysis and our analysis says that the market is underestimating where we are going to be. You know, you can’t rule out that there is some probability they are right because there’s uncertainty. But we think that they are too low.
For eight straight years now the Federal Reserve has been more optimistic than the markets. And for eight straight years now the markets have been closer to being correct. And yet the Federal Reserve still believes that it “can’t be led by what the market thinks” and has “got to make our own analysis”? Why?
: Three Antidotes to the Brexit Crisis: “The Fed should ensure that banks have enough loss-absorbing equity capital…
…not allow them to return equity to shareholders…. The measure should apply to all banks, so markets won’t read it as a signal about individual institutions’ relative strength. Second, there’s a risk that investors’ flight to safe assets could develop into a broader credit freeze. To mitigate this, the Fed should lower its short-term interest-rate target…. Finally, the Fed should consider reviving the Term Auction Facility, which allows banks to borrow funds from the central bank with less of the stigma…. Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system. That said, as an outsider who gets much of his information from Twitter, I’d say the markets are already pretty spooked. By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management. One important lesson of the last financial crisis is that the guarantors of stability must be proactive if they want to be effective. It’s time for the Fed to put that lesson into practice.
Must-Read: Jamie Chisholm: Treasury Yields Hit Record Lows
Must-Read: May I please have a theory from the Federal Reserve–I am not asking for much: just a theory–as to why they continue to be confident that their models are a better guide to likely futures than financial markets, and as to why they continue to regard the lower tail of outcomes as something that can be handled if and when it happens rather than something they need to be desperately clawing away from as fast as they can?
: Treasury Yields Hit Record Lows: “The 10-year Treasury yield is down 7 basis points to 1.39 per cent…
…earlier touching 1.377 per cent, its most meagre offering on record. The 30-year Treasury yield also hit an all-time low of 2.14 per cent. Equivalent maturity German Bunds and UK gilts are down 3bp to minus 0.17 per cent and off 4bp to 0.80 per cent, respectively — also flirting with record lows. The Bank of England has already said it is likely to loosen policy further in coming months, and governor Mark Carney on Tuesday said banks could stop building up rainy-day funds in an attempt to support lending. Shares in real estate companies, life insurers and housebuilders are leading declines in London, following the Standard Life news. Miners are under pressure too, as the ‘risk off’ mood batters commodities, with base metals lower and Brent crude down 3.6 per cent to $48.31 a barrel.
Must-Read: Timothy B. Lee: Brexit Isn’t the Most Serious Threat to the EU — the Euro Is
Must-Read: : Brexit Isn’t the Most Serious Threat to the EU — the Euro Is: “David Beckworth makes the case that the economic woes of eurozone countries like Spain and Greece…
…can ultimately be traced back to the euro itself… other problems… made worse by the ECB’s tight-money policies…. Without reforms, eurozone countries could continue suffering from slow growth and abnormally severe recessions for decades to come. That, in turn, will fuel public resentment against the EU and increase the danger that other countries will follow the UK’s lead. And the euro isn’t just a mistake–it’s a mistake that’s going to be hard to fix. Any country that tries to leave the euro risks triggering a financial crisis. And while deeper economic integration could help to mitigate the euro’s problems, the political obstacles could be insurmountable. Brexit wasn’t great news for the future of the EU. But the common currency is likely to create much bigger headaches for European leaders in the years to come.
Must-Read: Steve Cecchetti and Kermit Schoenholtz: A Primer on Helicopter Money
Must-Read: Ummm… But aren’t the objections to expansionary fiscal policy today all that they involve governments taking on interest rate risk–that that is not a risk governments today ought to bear? And so isn’t the fact that helicopter money extinguishes that risk and is a more stable fiscal policy than bond-financed spending the entire point?
So I don’t understand…
: A Primer on Helicopter Money: “Helicopter money is not monetary policy…
…It is a fiscal policy carried out with the cooperation of the central bank…. If the yield curve still has any upward slope, issuing reserves rather than long-term bonds to finance fiscal expenditure will appear cheaper in terms of current debt service. However, this apparent saving is an illusion because it ignores interest rate risk…. Helicopter money may strain the relationship between the fiscal and monetary authority… creating a situation commonly known as ‘fiscal dominance.’… A central bank does not face rollover risk, so a fiscal expansion financed by central bank money is more stable than one financed by bond issuance…. But is rollover risk really a concern for the government of most advanced economies? We doubt it….
Helicopter money today is… expansionary fiscal policy financed by central bank money. And, if interest rates have fallen to the ELB, it is neither more nor less powerful than any bond-financed cut in taxes or increase in government spending in combination with QE.
Must-Read: Ryan Avent: Expect the Worst
Must-Read: the sharp Ryan Avent, I think, nails it:
: Expect the Worst: “It wouldn’t make sense for the Fed to target real GDP growth, but then, the Fed is not really in that business…
…The Fed is also unable to control the long-run real interest rate, which is a function of global saving and investment. What’s more, it does seem clear that the global real interest rate has settled down to a level of approximately zero. But does it follow that the Fed should then either 1) set a high nominal interest rate in order to achieve higher inflation, or 2) keep its interest rate low and accept low inflation? I don’t believe so…. It is not the case that the Fed is choosing low rates and inflation expectations are therefore converging toward a low level…. The Fed has been targeting very low inflation, and falling inflation expectations imply much lower interest rates in future. This dynamic is there back in 2013. In its projections the Fed indicates that rates will rise steadily, even as it projects that inflation will be extraordinarily low, just over 1% in 2013, converging, finally, toward 2% by the end of 2015. Essentially every set of Fed projections since then has shown the same thing. It allowed its QE programmes to end despite too-low inflation, and it raise its interest rate in December despite too-low inflation. The Fed has signalled very strongly that markets should expect inflation to remain at very low levels, indeed, below target. It would be shocking if inflation expectations hadn’t trended inevitably downward….
Is there a route out?… Where in the past the Fed has promised to raise rates even as inflation stays low, it could instead promise to keep them low no matter what, even if, and indeed until, inflation rises above the target. If the Fed wants higher nominal rates in a world of low real rates, it must cultivate higher inflation…. The Fed can choose whether nominal rates get stuck near zero or rise to a higher, safer level. Right now, unfortunately, it is steering the American economy firmly into a low-rate rut.
Must-Read: Paul Krugman: A Question For the Fed
Must-Read: As I was just saying yesterday: Take the rate of profit–typically 6% to 7% per year–on the operating companies that make up the stock market. Subtract the risk premium–typically 4%. Add on the expected inflation rate–2.5% on the CPI basis. Get 4.5% to 5.5%. That is what the nominal interest rate on Treasury bills is likely to be in normal times toward the end of a healthy expansion. That provides a healthy amount of room for the Federal Reserve to cut interest rates to encourage spending and support the economy when a recession comes. But note that 5% of sea-room to cut interest rates when necessary was not nearly enough back in 2007-2010.
Now suppose that we are entering an age of secular stagnation. It will have a higher risk premium–say 5-6%. Slower growth will have an impact on the rate of profit for operating companies–knock, say, 1-2% off their typical value. Go through the math, and we get a likely nominal interest rate on Treasury in normal times toward the end of a healthy expansion of roughly 1-3%, not 5%.
The dot-plots tell us that the FOMC now thinks that it is headed for a 3% Treasury Bill rate–at the upper end of this range, but still very far from a 5% rate. And if we do live in a semi-permanent age of secular stagnation, this will not be a temporary inconvenience but, rather, a permanent structural fact.
That means that if the FOMC keeps its current inflation target then it will have only 3% of sea-room when the next big recession comes, whether next year, next decade, or a quarter century from now.
That means that if the FOMC keeps attempting to raise interest rates back to a 5% normal–or even, unless it is lucky, to a 3% normal–it will find itself continually undershooting its inflation target, and continually promising that rates will go up more real soon now as soon as the current idiosyncratic fit of sub-2% inflation passes.
I do not know anybody seriously thinking about all this who thinks that 3% of sea-room is sufficient in a world in which shocks as big as 2007-2010 are a thing. And I do not know anybody seriously thinking about all this who thinks that pressing for a premature “normalization” of interest rates is a good idea: It will deanchor inflationary expectations on the downside, and with rational market inflation expectations 1-2% below the “target” that means an equilibrium late-expansion Treasury Bill rate of not 1 to 3% but rather -1 to 2%.
Therefore either (a) the Federal Reserve really should raise its inflation target, or (b) the Federal Reserve should right now be screaming to high heaven about how it is the necessary and proper task of the rest of the government to do something, something big, something now to resolve our secular stagnation problem. And under no circumstances should the Fed be (c) pushing for probably premature “normalization” of interest rates.
Of course, the Fed could and should be doing both (a) and (b). But it seems to be doing neither–it seems to be doing (c).
Perhaps Janet’s thoughts on secular stagnation are part of process of trying to assemble an FOMC coalition to… do something… or at least beg others to do something…
But this intellect, at least, is pretty pessimistc.
: A Question For the Fed: “There is a near-consensus at the FOMC that rates must eventually move up…
….But… exactly?… Which component of aggregate demand do we believe will continue to strengthen in a way that will require monetary tightening to avoid an overheating economy? Here’s a look at two obvious candidates… as shares of potential GDP… deviations from the 1990-2007…. Nonresidential investment has basically recovered from the recession-induced slump. Residential investment is still a bit low by historical standards, but not as much as you might think…. So I don’t see an obvious reason to believe that current rates are too low. Yes, they’re near zero–but that in itself doesn’t mean too low. Like others, notably Larry Summers, I think the Fed is trying to return to a normality that is no longer normal.
Must-Read: Matthew Yglesias: Financial markets are begging the US, Europe, and Japan to run bigger deficits
Must-Read: : Financial markets are begging the US, Europe, and Japan to run bigger deficits: “The international financial community wants to lend money this cheaply…
… [so] governments should borrow money and put it to good use. Ideally that would mean spending it on infrastructure projects that are large, expensive, and useful–the kind of thing that will pay dividends for decades to come…. But if you don’t believe there are any useful projects or if your country’s political system is simply too gridlocked to find them, there are easy alternatives. Do a broad-based tax cut…. The opportunity to borrow this cheaply (probably) won’t last forever, and countries that boost their deficits will (probably) have to reverse course, but while it lasts everyone could be enjoying a better life instead of pointless austerity.
Must-Read: Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities
Must-Read: Larry Summers is right.
If the Phillips Curve today still had the short-run slope in the gearing of expected inflation to recent past inflation that it appeared to have at the start of the 1980s, there might–but only might–be a case for the Federal Reserve’s current policy.
There is no reason for internal comity between the Board of Governors and the regional bank presidents to be a concern: Bernanke and Yellen have now had three full regional bank-appointment cycles to get bank presidents who are on the same page as the Board of Governors. The Federal Reserve always has and is understood to have the freedom to raise interest rates to maintain price stability when incoming data suggests that it is threatened: there is no need for talk to highball the chances of future rate increases when the current data flow does not suggest it will be needed. Thus I see no reasons at all to support a Fed policy posture other than that one that Larry Summers recommends: “signal[ling] its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks…”
: Fed’s Current Strategy Ill Adapted to the Realities: “The current hawkish inclination of the Fed, with its chronic hope and belief that conditions will soon permit interest rate increases, is misguided…
…The greater danger is of too little rather than too much demand. A new Fed paradigm is therefore in order…. I would guess that from here the annual probability of recession is 25-30 percent. This seems to me the only way to interpret the yield curve. Markets anticipate only about 65 basis point of increase in short rates over the next 3 years. Whereas the Fed dots suggest that rates will normalize at 3.3 points, the market thinks that even 5 years from now they will be about 1.25 percent. Markets are thinking that recession will come at some point and when it does rates will go to near zero…. This implies that if the Fed is serious… about having a symmetric 2 percent inflation target then its near-term target should be in excess of 2 percent. Prior to the next recession–which will presumably be deflationary–the Fed should want inflation to be above its long term target…. The Fed’s dots forecasts refer to a modal scenario of continued recovery… [with] inflation rising to 2 percent only in 2018. Why shouldn’t they prefer a path with more demand, inflation at target sooner, more stimulus as recession insurance, and a small margin of extra inflation as a buffer against the next recession?….
The logic that led to the adoption of the 2 percent inflation target years ago suggests that it is too low now…. The case for a positive inflation target balances the benefits of stable money with the output cost of lowering inflation and two ways that positive inflation is helpful—the periodic need to have negative real rates, and inflation’s role in facilitating downward adjustment in real wages given nominal rigidities. All of the factors pointing towards a higher inflation target have gained force in recent years…. Experience has proven that Yellen was correct to be skeptical of the idea very low inflation rates would improve productivity. And it is plausible that the error in price indices has increased with the introduction of new categories of innovative and often free products…. If a two percent inflation target reflected a proper balance when it first came into vogue decades ago, a higher target is probably appropriate today….
Long term inflation expectations are depressed and declining…. The Fed has in the past counterbalanced declines in market inflation expectation measures by pointing to the relative stability in surveys-based measures. This argument is much harder to make now that consumer expectations of inflation have broken decisively below their all-time lows even as gas prices have been rising…. The Fed’s summary employment conditions index has been flashing yellow since the beginning of the year. Declines in this measure have presaged recession half of the time and uniformly been followed by rate reductions rather than rate increases….
The right concern for the Fed now should be to signal its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks. This is not the Fed’s policy posture. Watching the Fed over the last year there is a Groundhog Day aspect. One senses they really want to raise rates and achieve a more ‘normal’ stance. But at the same time they do not want to tighten when the economy may be slowing or create financial turmoil. So they keep holding out the prospect of future rate increases and then find themselves unable to deliver. But they always revert to holding out the prospect of rate increases soon, partly for internal comity and partly to preserve optionality. Over the last 12 months nominal GDP has risen at a rate of only 3.3 percent. We hardly seem in danger of demand running away. Today we learned that Germany has followed Japan into negative 10 year rates. We are only one recession away from joining the club…