Tag: Monetary Policy

Social credit is the answer

Posted on by Brad DeLong

Why is it called: “helicopter money”? Why isn’t it called: “expansionary fiscal policy with monetary support to neutralize any potential crowding-out of private-sector spending”?

Why did Milton Friedman set it forth in his writings as one of the paradigmatic cases of expansionary monetary policy? Why did Ben Bernanke refer to it and so gain his unwanted nickname of “Helicopter Ben”?

In Milton Friedman’s case, I believe that it was a conviction that the LM curve was steep enough and the IS curve flat enough that the fiscal side was fundamentally unimportant–that about the same effects were achieved whether the extra money was introduced into the economy via being dropped from helicopters or via open-market operations. To focus on how open-market operations worked would thus confuse listeners who would then have to think through asset market-equilibrium to no substantive gain in understanding. In Friedman’s view, the entire Tobin analytical tradition, not to mention Wicksell, was largely a distracting waste of time. So why go there?

In the case of Ben Bernanke and of the rest of the participants in today’s debate, I think it is has different causes. I think it is a result of the default Washington-Consensus Great-Moderation assignment of the stabilization-policy role to independent and technocratic central banks. In that paradigm, directly-elected governments are supposed to limit their focus to the “classical” tasks of rightsizing the public sector and adopting an appropriately-prudent long-term government-spending financing plan.

To speak of “expansionary fiscal policy with monetary support to neutralize any potential crowding-out of private-sector spending” is to open a can of worms. To speak of “helicopter money” is to convey the impression that this is the central bank undertaking its proper business, but in a context in which as a result of unfortunate historical accidents of institutional development the independent central bank needs the active support of the directly-elected government. The active support of the directly-elected government is needed undertake what is, after all, a fundamentally monetary policy. And it is, in this line of thinking, a fundamentally monetary policy: Milton Friedman himself said so.

Now comes the extremely-sharp Adair Turner to try to focus the debate in a productive direction.

Many today are unwilling to advocate for more expansionary fiscal policy out of:

  1. a fear that many economies that would find their governments engaging in it lack fiscal space for it to be of much use,
  2. a fear that directly-elected governments allowed to cross the line and engage in open-ended explicitly stabilization policy will not give due weight to the objective of keeping inflation low over the long term, or
  3. a fear that central banks allowed to control fiscal-policy levers will be captured by and use their powers to then take taxpayers’ money and spend it enriching the banking sector.

So what is the solution? How can we build institutions that will:

  1. avoid the Scylla of allowing directly-elected governments that use fiscal levers in support of monetary expansion to enforce fiscal dominance and abandon prudent inflation targets, while also

  2. avoiding the Charybdis of allowing central banks that may well have been partially-captured by their banking sectors of using their powers to spend the taxpayers’ money further enriching the bankers?

The solution is obvious: Social Credit. Adopt the policies of the Social Credit Part of Alberta in the 1930s. Adopt the policies of Upton Sinclair’s campaign for Governor of California in the 1930s. Adopt the policies that are taken as a matter of course and are in the background of Robert A. Heinlein’s 1947 novel Beyond This Horizon.

Central banks should, instead of taking all the revenue from seigniorage they create and transferring it all back to the Treasury, calculate each quarter how much of the seigniorage they hold should be distributed to citizens in the form of that quarter’s helicopter drop.

I am not certain about how the legal-institutional constraints bind the BoJ, and ECB, and the BoE. I believe that the Federal Reserve could start such a policy régime today:

  1. Incorporate–for free–everybody with a Social Security number as a bank holding company.
  2. Let everybody then have their personal bank holding company join–again for free–the Federal Reserve system as a member bank.
  3. Offer every such personal bank holding company a permanent long-term open-ended infinite-duration zero-interest line-of-credit to draw on, up to some set maximum nominal amount.
  4. Raise the amount of the line-of-credit maximum every quarter by that quarter’s desired helicopter drop.

The same institutional forces that have, since the selection Paul Volcker, kept the Federal Reserve focused on avoiding an inflationary spiral would still bind. There would be no way to gimmick such a Social Credit system to turn it into a giveaway to the bankers. It would give the Federal Reserve the power to engage in the one policy that nearly all economists are confident will always have traction on nominal demand. Once the Federal Reserve was off and rolling, other central banks would, I think, quickly find mechanisms within their current institutional-legal competence to accomplish the same ends.

And it would, I think, make the FOMC and its members “very popular”, as Marty Feldman playing Igor in the movie Young Frankensteinsays of the monster they are creating.

Adair Turner: Are Central Banks Really Out of Ammunition?: “The global economy faces a chronic problem of deficient nominal demand…

…But the debate about which policies could boost demand remains inadequate, evasive, and confused. In Shanghai, the G-20 foreign ministers committed to use all available tools – structural, monetary, and fiscal – to boost growth rates and prevent deflation. But many of the key players are keener to point out what they can’t do than what they can….

Central banks frequently stress the limits of their powers, and bemoan lack of government progress toward ‘structural reform’…. But while some [SR measures] might increase potential growth over the long term, almost none can make any difference in growth or inflation rates over the next 1-3 years…. Vague references to ‘structural reform’ should ideally be banned, with everyone forced to specify which particular reforms they are talking about and the timetable for any benefits that are achieved…. Central bankers are right to stress the limits of what monetary policy alone can achieve…. Negative interest rates, and… yet more quantitative easing… can make little difference to real economic consumption and investment. Negative interest rates… [may have the] the actual and perverse consequence… [of] higher lending rates….

Nominal demand will rise only if governments deploy fiscal policy to reduce taxes or increase public expenditure – thereby, in Milton Friedman’s phrase, putting new demand directly ‘into the income stream.’ But the world is full of governments that feel unable to do this. Japan’s finance ministry is convinced that it must reduce its large fiscal deficit…. Eurozone rules mean that many member countries are committed to reducing their deficits. British Chancellor of the Exchequer George Osborne is also determined to reduce, not increase, his country’s deficit. The standard official mantra has therefore become that countries that still have ‘fiscal space’ should use it. But there are no grounds for believing the most obvious candidates – such as Germany – will actually do anything….

These impasses have fueled growing fear that we are ‘out of ammunition’…. But if our problem is inadequate nominal demand, there is one policy that will always work. If governments run larger fiscal deficits and finance this not with interest-bearing debt but with central-bank money…. The option of so-called ‘helicopter money’ is therefore increasingly discussed. But the debate about it is riddled with confusions.

It is often claimed that monetizing fiscal deficits would commit central banks to keeping interest rates low forever, an approach that is bound to produce excessive inflation. It is simultaneously argued (sometimes even by the same people) that monetary financing would not stimulate demand because people will fear a future ‘inflation tax.’
Both assertions cannot be true; in reality, neither is. Very small money-financed deficits would produce only a minimal impact on nominal demand: very large ones would produce harmfully high inflation. Somewhere in the middle there is an optimal policy…. The one really important political issue is ignored: whether we can design rules and allocate institutional responsibilities to ensure that monetary financing is used only in an appropriately moderate and disciplined fashion, or whether the temptation to use it to excess will prove irresistible. If political irresponsibility is inevitable, we really are out of ammunition that we can use without blowing ourselves up. But if, as I believe, the discipline problem can be solved, we need to start formulating the right rules and distribution of responsibilities…

Note also that chapter 23, “Notes on Mercantilism, the Usury Laws, Stamped Money and Theories of Under-Consumption”, of John Maynard Keynes’s General Theory of Employment, Interest and Money can be read with great profit here…

Must-read: Adair Turner: “Are Central Banks Really Out of Ammunition?”

Posted on by Brad DeLong

Must-Read: Adair Turner: Are Central Banks Really Out of Ammunition?: “The global economy faces a chronic problem of deficient nominal demand…

…But the debate about which policies could boost demand remains inadequate, evasive, and confused. In Shanghai, the G-20 foreign ministers committed to use all available tools – structural, monetary, and fiscal – to boost growth rates and prevent deflation. But many of the key players are keener to point out what they can’t do than what they can….

Central banks frequently stress the limits of their powers, and bemoan lack of government progress toward ‘structural reform’…. But while some [SR measures] might increase potential growth over the long term, almost none can make any difference in growth or inflation rates over the next 1-3 years…. Vague references to ‘structural reform’ should ideally be banned, with everyone forced to specify which particular reforms they are talking about and the timetable for any benefits that are achieved…. Central bankers are right to stress the limits of what monetary policy alone can achieve…. Negative interest rates, and… yet more quantitative easing… can make little difference to real economic consumption and investment. Negative interest rates… [may have the] the actual and perverse consequence… [of] higher lending rates….

Nominal demand will rise only if governments deploy fiscal policy to reduce taxes or increase public expenditure – thereby, in Milton Friedman’s phrase, putting new demand directly ‘into the income stream.’ But the world is full of governments that feel unable to do this. Japan’s finance ministry is convinced that it must reduce its large fiscal deficit…. Eurozone rules mean that many member countries are committed to reducing their deficits. British Chancellor of the Exchequer George Osborne is also determined to reduce, not increase, his country’s deficit. The standard official mantra has therefore become that countries that still have ‘fiscal space’ should use it. But there are no grounds for believing the most obvious candidates – such as Germany – will actually do anything….

These impasses have fueled growing fear that we are ‘out of ammunition’…. But if our problem is inadequate nominal demand, there is one policy that will always work. If governments run larger fiscal deficits and finance this not with interest-bearing debt but with central-bank money…. The option of so-called ‘helicopter money’ is therefore increasingly discussed. But the debate about it is riddled with confusions.

It is often claimed that monetizing fiscal deficits would commit central banks to keeping interest rates low forever, an approach that is bound to produce excessive inflation. It is simultaneously argued (sometimes even by the same people) that monetary financing would not stimulate demand because people will fear a future ‘inflation tax.’
Both assertions cannot be true; in reality, neither is. Very small money-financed deficits would produce only a minimal impact on nominal demand: very large ones would produce harmfully high inflation. Somewhere in the middle there is an optimal policy…. The one really important political issue is ignored: whether we can design rules and allocate institutional responsibilities to ensure that monetary financing is used only in an appropriately moderate and disciplined fashion, or whether the temptation to use it to excess will prove irresistible. If political irresponsibility is inevitable, we really are out of ammunition that we can use without blowing ourselves up. But if, as I believe, the discipline problem can be solved, we need to start formulating the right rules and distribution of responsibilities…

Must-read: John Plender: Uncertainty Principles: ‘The End of Alchemy’, by Mervyn King

Posted on by Brad DeLong

Must-Read: John Plender: : “King’s hugely ambitious aim in his book is to put an end to the alchemy…

…that has made financial crises a permanent feature of the landscape and allowed money — a public good — to become the byproduct of credit creation by private-sector banks. Above all, he argues that the crisis of 2007-09 reflected not just a failure of individuals or institutions, but a failure of the ideas that underpin current economic policymaking…. King argues that in a world of what economists now call ‘radical uncertainty’… there is simply no way of identifying the probabilities of all future events and no set of economist’s equations that describe people’s attempts to cope with that uncertainty…. In King’s terms, the coping strategy of households, businesses and investors involved adopting a narrative of stability while the level of spending ran at unsustainably high levels….

Western consumers’ urge to spend was not strong enough to offset the greater urge of northern Europeans and Asians to save, [so] global interest rates fell. Banks then satisfied investors’ desperate search for income by creating increasingly complex and risky financial products…. Bank balance sheets grew explosively…. The financial crisis changed the narrative. In King’s estimation, policymakers were right to adopt a Keynesian stimulatory response in 2008-9…. They averted a repetition of the Great Depression but, in doing so, created what King calls a paradox of policy. Interest rates today, he says, are too high to permit rapid growth of demand in the short run but too low to be consistent with a proper balance between spending and saving in the long run….

King argues that Bagehot’s famous dictum on central bank crisis management — lend freely on good collateral at penalty rates — is out of date because bank balance sheets today are much larger and have fewer liquid assets than in the 19th century. Central banks are thus condemned in a crisis to take bad collateral in the shape of risky, illiquid assets on which they will lend only a proportion of the value, known as a haircut…. King suggests this lender of last resort role should be replaced by what he calls, with a pleasing irreverence towards central banking mystique, a pawnbroker for all seasons…. Banks would decide how much of their asset base to lodge in advance at the central bank to be available for use as collateral. For each asset, the central bank would calculate a haircut…. The system would displace what King regards as a flawed risk-weighted capital regime ill-suited to addressing radical uncertainty…

Must-read: Gavyn Davies: “Splits in the Keynesian Camp: a Galilean Dialogue”

Posted on by Brad DeLong

Must-Read: Very nice. But why “Galilean”, Gavyn? I do note that in the end Gavyn’s “insider” argument boils down to “we must keep the hawks on the FOMC on board with policy”, which is a declaration that:

  1. The Obama administration has made truly serious mistakes in speed of action and in personnel in its Fed governor nominations;
  2. The Bernanke-Yellen Board of Governors has made truly serious mistakes in Fed Bank President selection; and
  3. The high priority given to keeping (nearly) the entire FOMC on board with the policy path should, perhaps, be revisited.

Also, “we have already allowed for these asymmetrical risks by holding interest rates below those suggested by the Taylor Rule for a long time” is simply incoherent: sunk costs do not matter for future actions.

The dialogue:

Gavyn Davies: Splits in the Keynesian Camp: a Galilean Dialogue: “As Paul Krugman pointed out a year ago…

…a sharp difference of views about US monetary policy has developed between two camps of Keynesians who normally agree about almost everything. What makes this interesting is that, in this division of opinion, the fault line often seems to be determined by the professional location of the economists concerned. Those outside the Federal Reserve (eg Lawrence Summers, Paul Krugman, Brad DeLong) tend to adopt a strongly dovish view, while those inside the central bank (eg Janet Yellen, Stanley Fischer, William Dudley, John Williams) have lately taken a more hawkish line about the need to ‘normalise’ the level of interest rates [1]. My colleague David Blake suggested that this blog should carry a Galilean ‘Dialogue’ between representatives of the two camps. Galileo is unavailable this week, but here goes”

Fed Insider: The US has now reached full employment and the labour market remains firm. The Phillips Curve still exists, so wage inflation is headed higher. Core inflation is not far below the Fed’s 2 per cent target. While the economy is therefore close to normal, interest rates are far below normal, so there should be a predisposition to tighten monetary conditions gradually from here. That would still leave monetary policy far more accommodative than normal for a long period of time.

Fed Outsider: I am not so sure about the Phillips Curve. It seems much flatter than it was in earlier decades. But in any case you do not seem to have noticed that the economy is slowing down. This is probably because of the increase in the dollar, which has tightened monetary conditions much more than the Fed intended. The Fed should not make this slowdown worse by raising domestic interest rates as well.

Insider: I concede that the economy has slowed, and I am worried about the tightening in financial conditions caused by the dollar. But I think that this will prove temporary. The dollar effect will not get much worse from here, and the economy has also been affected by inventory shedding and the drop in shale oil investment. As these effects subside, GDP growth will return to above 2 per cent. The pace of employment growth may slow, but remember that payrolls need to grow by under 100,000 per month to keep unemployment constant at the natural rate. Some slowdown is not only inevitable, it is desirable.

Outsider: I do not know how you can be so confident that growth will recover. All your forecasts for growth in recent years have proven far too optimistic. You should be worried that the economy is stuck in a secular stagnation trap. The equilibrium real interest rate is lower than the actual rate of interest. To emerge from secular stagnation, the Fed should be cutting interest rates, not raising them.

Insider: The case for secular stagnation is a bit extreme. Economies tend to return to equilibrium after shocks. The US has been held back by a series of major headwinds since 2009, but these are now abating. Fiscal policy is easing, the euro shock is healing and deleveraging is ending. As these headwinds abate, the equilibrium real rate of interest will return to its normal level around 1.5 per cent, so the nominal Fed funds rate should be 3.5 per cent. It is right to warn people now that this is likely to happen.

Outsider: The hawkish forward guidance shown in your ‘dot plot’ will slow demand growth further. It is unnecessary – in fact, outright damaging. I am pleased that you are rethinking the presentation of the dots. But, more important, the economic recovery is already long in the tooth. There is a 60 percent chance of a recession within 2 years. In a normal recession, the Fed has to cut interest rates by 4 percentage points. Because of the zero lower bound, it will not be able to do so in the next recession, so it needs to avoid a recession at all costs.

Insider: Oh dear. Recoveries do not die of old age, as Glenn Rudebusch at the San Francisco Fed has just conclusively proved. Expansions, like Peter Pan, do not grow old. Provided that we avoid a build up of inflation pressures, or excessive risk taking in markets, there is no reason to believe that this recovery will spontaneously run out of steam. It is much more likely to persist.

Outsider: Maybe, but have you ever considered the possibility that you might be wrong? The future path of the equilibrium interest rate is subject to huge uncertainty, as your own estimations demonstrate. If you kill this recovery, it will subsequently be impossible to use monetary policy to get out of recession. If, on the other hand, you allow inflation to rise, you can easily bring it back under control, simply by raising interest rates. So the risks are not symmetrical.

Insider: Well, we have already allowed for these asymmetrical risks by holding interest rates below those suggested by the Taylor Rule for a long time. And anyway I do not agree with you about inflation risks. If we allow inflation to become embedded in the system, we will then have to raise interest rates abruptly. That is the most likely way that this recovery can end in a severe recession.

Outsider: Inflation cannot rise permanently unless inflation expectations rise as well. In case you have not noticed, inflation expectations have been falling and are now out of line with your 2 per cent inflation target. This is dangerous because real (inflation adjusted) interest rates are actually rising when they should be falling.

Insider: I used to worry a lot about the inflation expectations built into the bond market, but I now think that these are affected by market imperfections that should be downplayed. Inflation expectations in the household and corporate sectors are still broadly in line with the Fed target. And, anyway, I am increasingly concerned that inflation could rise because productivity growth is now so low. With the economy at full employment, inflation pressures could be building, even with GDP growth still very subdued.

Outsider: I am also very worried about the slowdown in productivity growth. But I think this could be happening because you have allowed the actual GDP growth rate to be so low for so long. Because of hysteresis, you may be making things progressively worse. You may have permanently shifted the equilibrium of the economy in a bad direction.

Insider: I am not so sure about this hysteresis stuff. I would not rule it out entirely. But you cannot rely on the Fed to solve all of our economic problems. At the moment, the Fed’s main priority is to return monetary policy to normal, and I am determined to continue this process unless something really bad happens to the economy.

Outsider: In that case, something bad is quite likely to happen. It seems that it will take a disaster to shake your orthodoxy. Do you really want to be responsible for making a historic economic mistake?

Insider: It is easy for you on the outside to make dramatic points like that. If you had been entrusted with the responsibility of office, you would be more circumspect. Although we went to the same graduate school, we are now in different positions. The hawks on the FOMC need to be kept on board with the majority. And I do not want to inflame the Fed’s Republican critics in Congress by appearing soft on inflation. That means I sometimes have to make difficult compromises that you do not have to make.

Outsider: The hawks are giving too much weight to the health of the banks. You should be worrying more about Main Street, and less about Wall Street.

Must-read: Paul Krugman: “Living with Monetary Impotence”

Posted on by Brad DeLong

Must-Read: [And no sooner do I write:]

There are three possible positions for us to take now:

  1. In a liquidity trap, monetary policy is not or will rarely be sufficient to have any substantial effect—active fiscal expansionary support on a large scale is essential for good macroeconomic policy.
  2. In a liquidity trap, monetary policy can have substantial effects, but only if the central bank and government are willing to talk the talk by aggressive and consistent promises of inflation—backed up, if necessary, by régime change.
  3. We are barking up the wrong tree: there is something we have missed, and the models that we think are good first-order approximations to reality are not, in fact, so.

I still favor a mixture of (2) and (1), with (2) still having the heavier weight in it. Larry Summers is, I think, all the way at (1) now…

But Paul Krugman goes full (1) as well:

Paul Krugman: Living with Monetary Impotence: “Check our low, low rates…

… Fiscal policy has been effective but procyclical…. Monetary policy has been countercyclical but ineffective…. Lender of last resort matters…. Otherwise, not so much…. Open market vs. open mouth operations…. String theory is hard to explain…. Surprise implication: stagnation is contagious.

Quantitative easing: Walking the walk without talking the talk?

Posted on by Brad DeLong

The extremely sharp Joe Gagnon is approaching the edge of shrillness: He seeks to praise the Bank of Japan for what it has done, and yet stress and stress again that what it has done is far too little than it should and needs to do:

Joe Gagnon: The Bank of Japan Is Moving Too Slowly in the Right Direction: “Bank of Japan Governor Haruhiko Kuroda’s bold program…

…has made enormous progress, but it has fallen well short of its goal of 2 percent inflation within two years. Now is the time for a final big push… The government of Prime Minister Shinzo Abe could help by raising the salaries of public workers and taking other measures to increase wages…. But the BOJ should not make inaction by the government an excuse for its own passivity…. The BOJ needs to make a convincingly bold move now… lowering its deposit rate to -0.75 percent… step up purchases of equities to 50 trillion yen…. The paradox of quantitative easing… is that central banks that were slowest to engage in it at first (the BOJ and the European Central Bank) are being forced to do more of it later…. If the BOJ does not move boldly now, it will have to do even more later.

Those of us who are, like me, broadly in Joe Gagnon’s camp are now having to grapple with an unexpected intellectual shock. When 2010 came around and when the “Recovery Summers” and “V-Shaped Recoveries” that had been confidently predicted by others refused to arrive, we once again reached back to the 1930s. We remembered the reflationary policies of Neville Chamberlain, Franklin Delano Roosevelt, Takahashi Korekiyo, and Hjalmar Horace Greeley Schacht gave us considerable confidence that quantitative easing supported by promises that reflation was the goal of policy would be effective. They had been ineffective in the major catastrophe of the Great Depression. They should, we thought, also be effective in the less-major catastrophe that we started by calling the “Great Recession”, but should now have shifted to calling the “Lesser Depression”, and in all likelihood will soon be calling the “Longer Depression”.

Narayana Kocherlakota’s view, if I grasp it correctly, is that in the United States the Federal Reserve has walked the quantitative-easing walk but not talked the quantitative-easing talk. Increases in interest rates to start the normalization process have always been promised a couple of years in the future. Federal Reserve policymakers have avoided even casual flirtation with the ideas of seeking a reversal of any of the fall of nominal GDP or the price level vis-a-vis its pre-2008 trend. Federal Reserve policymakers have consistently adopted a rhetorical posture that tells observers that an overshoot of inflation above 2%/year on the PCE would be cause for action, while an undershoot is… well, as often as not, cause for wait-and-see because the situation will probably normalize to 2%/year on its own.

By contrast, Neville Chamberlain was very clear that it was the policy of H.M. Government to raise the price level in order to raise the nominal tax take in order to support the burden of amortizing Britain’s WWI debt. Franklin Delano Roosevelt was not at all clear about what he was doing in total, but he was very clear that raising commodity prices so that American producers could earn more money was a key piece of it. Takahashi Korekiyo. And all had supportive rather than austere and oppositional fiscal authorities behind them.

But, we thought, monetary policy has really powerful tools expectations-management and asset-supply management tools at its disposal. They should be able to make not just a difference but a big difference. And yet…

There are three possible positions for us to take now:

  1. In a liquidity trap, monetary policy is not or will rarely be sufficient to have any substantial effect—active fiscal expansionary support on a large scale is essential for good macroeconomic policy.
  2. In a liquidity trap, monetary policy can have substantial effects, but only if the central bank and government are willing to talk the talk by aggressive and consistent promises of inflation—backed up, if necessary, by régime change.
  3. We are barking up the wrong tree: there is something we have missed, and the models that we think are good first-order approximations to reality are not, in fact, so.

I still favor a mixture of (2) and (1), with (2) still having the heavier weight in it. Larry Summers is, I think, all the way at (1) now. But the failure of the Abenomics situation to have developed fully to Japan’s advantage as I had expected makes me wonder: under what circumstances should I being opening my mind to and placing positive probability on (3)?

(AP Photo/Koji Sasahara)

Must-read: Joe Gagnon: “The Bank of Japan Is Moving Too Slowly in the Right Direction”

Posted on by Brad DeLong

Must-Read: Joe Gagnon: The Bank of Japan Is Moving Too Slowly in the Right Direction: “Bank of Japan Governor Haruhiko Kuroda’s bold program…

…has made enormous progress, but it has fallen well short of its goal of 2 percent inflation within two years. Now is the time for a final big push…. On January 29, the Bank of Japan (BOJ) announced a complicated program to pay different rates of interest on tranches of deposits that banks hold with the BOJ…. Financial markets quickly reacted positively: Real bond yields fell, the yen fell, and stock prices rose. But much of these gains were erased in subsequent days, probably because markets came to believe the effects of the new policy would be small…. Ten-year inflation compensation is now only 0.5 percent, a clear message that markets expect the BOJ to fail to deliver 2 percent inflation….

A shift from 0.1 to -0.1 percent on a small fraction of BOJ deposits is a tiny move…. The BOJ should move to -0.75 percent on future increases in deposits, while paying 0 percent on the current stock of deposits. The BOJ’s program of asset purchases since 2013 moved the best measure of core inflation (consumer prices excluding energy and fresh food) from nearly -1 percent to more than 1 percent. This is about two-thirds of the way to its goal…. But the BOJ cannot afford to make only tiny adjustments to its policies at this time…. The government of Prime Minister Shinzo Abe could help by raising the salaries of public workers and taking other measures to increase wages recently recommended by Olivier Blanchard and Adam Posen in the Nikkei Asian Review. But the BOJ should not make inaction by the government an excuse for its own passivity…. The BOJ needs to make a convincingly bold move now… lowering its deposit rate to -0.75 percent… step up purchases of equities to 50 trillion yen….

The paradox of quantitative easing in the past seven years is that central banks that were slowest to engage in it at first (the BOJ and the European Central Bank) are being forced to do more of it later than those central banks that embraced it earlier (the Bank of England and the Federal Reserve). If the BOJ does not move boldly now, it will have to do even more later.

Must-read: Narayana Kocherlakota: “What We’ve Learned About Unconventional Monetary Policy”

Posted on by Brad DeLong

Must-Read: Narayana Kocherlakota has been on quite a roll recently:

Narayana Kocherlakota: What We’ve Learned About Unconventional Monetary Policy: “Lesson 1: Even over relatively long periods of time…

…unconventional monetary policy tools don’t have extreme downside risks…. Lesson 2: Central banks are able to guide inflation close to its desired level using unconventional tools…. One could certainly ask: why was the FOMC consistently aiming for such a low inflation rate in this time frame, given that they expected such a high unemployment rate? (I have posed that question here.) But let’s leave that question aside. Throughout much of the 2008-10 period, many observers outside of the Fed expressed strong concerns about the risk of unduly high or unduly low inflation. Given that level of background uncertainty, I would say that the FOMC did a very good job at using unconventional tools to achieve what policymakers wanted in terms of inflation outcomes. Lesson 3: Hitting inflation objectives does not translate into hitting growth objectives…

Plus:

Narayana Kocherlakota: Interest Rate Increases Are Hard to Undo?: “Yellen made the following statement…

I do not expect that the FOMC [Federal Open Market Committee] is going to be soon in the situation where it is necessary to cut rates….

I argue that her statement suggests that the FOMC’s policy moves will be inappropriately insensitive to adverse information about the evolution of the economy…. There’s some set of economic conditions for which a range of a quarter to half a percent for the target range for the fed funds rate is appropriate. Under an appropriately data-sensitive approach… the FOMC should slightly lower the fed funds rate target range if it confronts a slightly worse set of economic conditions [than that]…. If a move of zero is highly likely, surely a downward move of a quarter percent point should be more than a little possible? But Chair Yellen’s statement suggests that this isn’t the way that the FOMC is thinking about the situation…. She seems to be saying that it will take a pretty bad turn of events for the FOMC to be willing to reverse its December move.  Such an approach means that the FOMC’s December has created a new higher floor….

The FOMC could be a lot more data-sensitive than I’ve described when it considers interest rate cuts. Failing that, the other response is to realize that any future rate increase will push upwards on the new soft floor.  That realization should make the FOMC very cautious about undertaking any future rate increase.

And:

Narayana Kocherlakota: Negative Rates: A Gigantic Fiscal Policy Failure: “Since October 2015, I’ve argued that the Federal Open Market Committee (FOMC)…

…should reduce the target range for the fed funds rate below zero. Such a move would be appropriate for three reasons:

  • It would facilitate a more rapid return of inflation to target.
  • It would help reduce labor market slack more rapidly.
  • It would slow and hopefully reverse the ongoing and dangerous slide in inflation expectations. 

So, going negative is daring but appropriate monetary policy. But it is a sign of a terrible policy failure by fiscal policymakers.

The reason that the FOMC has to go negative is because the natural real rate of interest r* (defined to be the real interest rate consistent with the FOMC’s mandated inflation and employment goals) is so low.   The low natural real interest rate is a signal that households and businesses around the world desperately want to buy and hold debt issued by the US government. (Yes, there is already a lot of that debt out there – but its high price is a clear signal that still more should be issued.)  The US government should be issuing that debt that the public wants so desperately and using the proceeds to undertake investments of social value.

But maybe there are no such investments?  That’s a tough argument to sustain quantitatively.  The current market real interest rate – which I would argue is actually above the natural real rate r* – is about 1% out to thirty years.  This low natural real rate represents an incredible opportunity for the US. We can afford to do more to ensure that all of our cities have safe water for our children to drink.  We can afford to do more to ensure that our nuclear power plants won’t spring leaks.  We can afford to do more to ensure that our bridges won’t collapse under commuters.

These opportunities barely scratch the surface.  With a 30-year r* below 1%, our government can afford to make progress on a myriad of social problems.  It is choosing not to. 

If the government issued more debt and undertook these opportunities, it would push up r*.  That would make life easier for monetary policymakers, because they could achieve their mandated objectives with higher nominal interest rates. But, more importantly, the change in fiscal policy would make life a lot better for all of us. 

I don’t think that Chair Yellen will say the above in her Humphrey-Hawkins testimony tomorrow – but I also think that it would be great if she did.

Narayana Kocherlakota: Dovish Actions Require Dovish Talk (To Be Effective): “The Federal Open Market Committee (FOMC) has bought a lot of assets and kept interest rates extraordinarily low…

…Yet all of this stimulus has accomplished surprisingly little (for example, inflation and inflation expectations remain below target and are expected to do so for years to come)…. Over the past seven years, the FOMC’s has consistently talked hawkish while acting dovish. This communications approach has weakened the effectiveness of policy choices, probably in a significant way…. In December 2008, the FOMC lowered the fed funds rate target range to 0 to a quarter percent. It did not raise the target range until December 2015, when the unemployment rate had fallen back down to 5%.   But – with the benefit of hindsight – a shocking amount of this eight years’ worth of unprecedented stimulus was wasted, because it was largely unanticipated by financial markets…

Must-read: David Glasner: “Competitive Devaluation Plus Monetary Expansion Does Create a Free Lunch”

Posted on by Brad DeLong

Must-Read: The very sharp David Glasner says–correctly–that currency war is different from war-war. War war is a negative sum game. Currency war is a positive-sum game:

David Glasner: Competitive Devaluation Plus Monetary Expansion Does Create a Free Lunch: “Hawtrey explained why competitive devaluation in the 1930s was–and in my view still is–not a problem…

…Because the value of gold was not stable after Britain left the gold standard and depreciated its currency, the deflationary effect in other countries was mistakenly attributed to the British depreciation. But Hawtrey points out that this reasoning was backwards. The fall in prices in the rest of the world was caused by deflationary measures that were increasing the demand for gold and causing prices in terms of gold to continue to fall, as they had been since 1929. It was the fall in prices in terms of gold that was causing the pound to depreciate, not the other way around….

Depreciating your currency cushions the fall in nominal income and aggregate demand. If aggregate demand is kept stable, then the increased output, income, and employment associated with a falling exchange rate will spill over into a demand for the exports of other countries and an increase in the home demand for exportable home products. So it’s a win-win situation.

However, the Fed has permitted passive monetary tightening over the last eighteen months, and in December 2015 embarked on active monetary tightening…. Passive tightening has reduced US demand for imports and for US exportable products, so passive tightening has negative indirect effects on aggregate demand in the rest of the world…

Must-read: Tim Duy: “FOMC Minutes and More”

Posted on by Brad DeLong

Must-Read: But being “behind the cycle” is good, no? On a lee shore you need more sea room, lest the wind strengthen, no?

Tim Duy: FOMC Minutes and More: “The Fed may be turning toward my long-favored policy position…

…the best chance they have of lifting off from the zero bound is letting the economy run hot enough that inflation becomes a genuine concern. That means following the cycle, not trying to lead it. And I would argue that if the recession scare is just that, a scare, they are almost certainly going to fall behind the curve. The unemployment rate is below 5 percent and wage pressures are rising. The economy is already closing in on full-employment. If we don’t have a recession, then how much further along will the economy be by the time the Fed deems they are sufficiently confident in the economy that they can resume raising rates? And note the importance of clearly progress on inflation….

Bullard noted that the FOMC has repeatedly stated in official communication and public commentary that future monetary policy adjustments are data dependent. He then addressed the possibility that the financial markets may not believe this since the SEP may be unintentionally communicating a version of the 2004-2006 normalization cycle, which appeared to be mechanical…. You might forgive market participants for believing that the SEP infers some calendar-based guidance when Federal Reserve Vice Chair Stanley Fischer says things like:

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. 

Saying the markets are wrong implies that the policy direction is fairly rigid. In any event, I am not confident there is yet much support for Bullard’s position…. Bullard has also gone full-dove. He remembered that he thought inflation expectations were supposed to be important, and the decline in 5-year, 5-year forward expectations has him spooked. And he thinks that the excess air has been released from financial markets, so his fears of asset bubbles has eased. Hence, the Fed can easily pause now….

Bottom Line: The Fed is on hold, stuck in risk management mode until the skies clear. If you are in the ‘recession’ camp, the path forward is obvious. The Fed cuts back to zero, drags its heals on more QE, and fumbles around as they try to figure out if negative rates are a good or bad thing. Not pretty. But if you are in the ‘no recession’ camp, it’s worth thinking about the implications of a Fed pause now on the pace of hikes later. Being on hold now raises the risk that by the time the Fed moves again, they will be behind the cycle.