Tag: Monetary Policy

Must-Read: Simon Wren-Lewis: Helicopter Money and Fiscal Policy

Posted on by Brad DeLong

Must-Read: What I often hear: “Expansionary fiscal policy increases the burden of the national debt. That’s the reason expansionary fiscal policy is too risky. Helicopter money–social credit–is expansionary fiscal policy. But expansionary fiscal policy is too risky. Hence helicopter money is too risky.”

Stupid or evil? Simon Wren-Lewis does some intellectual garbage collection:

Simon Wren-Lewis: Helicopter Money and Fiscal Policy: “John Kay and Joerg Bibow think additional government spending on public investment is a good idea…

…We can have endless debates about whether HM is more monetary or fiscal. While attempts to distinguish… can sometime clarify… ultimately… HM is what it is. Arguments that… use definitions to… conclude that central banks should not do HM because it’s fiscal are equally pointless. Any HM distribution mechanism needs to be set up in agreement with governments, and existing monetary policy has fiscal consequences which governments have no control over…..

At this moment in time… public investment should increase in the US, UK and Eurozone. There is absolutely no reason why that cannot be financed by issuing government debt…. HM does not stop the government doing what it wants with fiscal policy. Monetary policy adapts to whatever fiscal policy plans the government has, and it can do this because it can move faster than governments…. Kay… also suggests that HM is somehow a way of getting politicians to do fiscal stimulus by calling it something else. This seems to ignore why fiscal stimulus ended. In 2010 both Osborne and Merkel argued we had to reduce government borrowing immediately because the markets demanded it. HM… avoids the constraint that Osborne and Merkel said prevented further fiscal stimulus…. Many argue that these concerns about debt are manufactured… deficit deceit. HM, particularly in its democratic form, calls their bluff….

There is a related point in favour of HM that both Kay and Bibow miss. Independent central banks are a means of delegating macroeconomic stabilisation. Yet that delegation is crucially incomplete, because of the lower bound for nominal interest rates. While economists have generally understood that governments can in this situation come to the rescue, politicians either didn’t get the memo, or have proved that they are indeed not to be trusted with the task. HM is a much better instrument than Quantitative Easing, so why deny central banks the instrument they require to do the job they have been asked to do?

Must-read: Ryan Avent: “The Fed Ruins Summer: America’s Central Bank Picks a Poor Time to Get Hawkish”

Posted on by Brad DeLong

Must-Read: And agreement on my read of the Federal Reserve from the very sharp Ryan Avent. Nice to know that I am not crazy, or not that crazy…

Ryan Avent: The Fed Ruins Summer: America’s Central Bank Picks a Poor Time to Get Hawkish: “THE… Federal Reserve… ha[s] been desperate to hike rates, often…

…keen to begin hiking in September, but were put off when market volatility threatened to undermine the American recovery. In December they managed to get the first increase on the books, and committee members were feeling cocky as 2016 began; Stanley Fischer, the vice-chairman, proclaimed that it would be a four-hike year… and here we are in mid-May with just the one, December rise behind us. But the Fed… is ready to give higher rates another chance…. Every Fed official to wander within range of a microphone warned that more rate hikes might be coming sooner than many people anticipate. And yesterday the Fed published minutes from its April meeting which were revealing:

Most participants judged that if incoming data were consistent with economic growth picking up…then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June….

[But] worries about runaway inflation are based on a view of the relationship between inflation and unemployment that looks shakier by the day…. Global labour and product markets are glutted… a global glut of investable savings too…. The Fed does not have cause to try to push inflation down. Its preferred measure of inflation continues to run below the Fed’s 2% target, as it has for the last four years. Somehow the Fed seems not to worry about what effect that might have on its credibility. All that undershooting has depressed market-based measures of inflation expectations…. If the Fed’s goal is to hit the 2% target in expectation, or on average, or most of the time, or every once in a while, or ever again, it might consider holding off on another rate rise until the magical 2% figure is reached. You know, just to make sure it can be done.

But the single biggest, overwhelming, really important reason not to rush this is the asymmetry of risks facing the central bank. Actually, the Fed’s economic staff explains this well; from the minutes:

The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff’s assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks. In addition, while there had been recent improvements in global financial and economic conditions, downside risks to the forecast from developments abroad, though smaller, remained. Consistent with the downside risk to aggregate demand, the staff viewed the risks to its outlook for the unemployment rate as skewed to the upside.

The Fed has unlimited room to raise interest rates…. It has almost no room to reduce rates…. Hiking now is a leap off a cliff in a fog; one could always wait and jump later once conditions are clearer, but having jumped blindly one cannot reverse course if the expected ledge isn’t where one thought it would be…

I Continue to Fail to Understand Why the Federal Reserve’s Read of Optimal Monetary Policy Is so Different from Mine…

Posted on by Brad DeLong

Does you think this looks like an economy where inflation is on an upward trend and interest rates are too low for macroeconomic balance?

Personal Consumption Expenditures Chain type Price Index FRED St Louis Fed Graph Personal Consumption Expenditures Excluding Food and Energy Chain Type Price Index FRED St Louis Fed

Mohamed El-Erian says, accurately, that the Federal Reserve is much more likely than not to increase interest rates in June or July: Mohamed El-Erian: Federal Reserve Is Torn: “”Moves in financial conditions as a whole are making [the Fed]…

…more confident about going forward [with interest-rate hikes,] and they were worried that the markets were underestimating the possibility of a rate hike this year and they wanted to do something about it…. In the end, what’s clear is a hike will definitely happen this year…. If the Fed unambiguously signals that it will move, you will see a stronger dollar and that… will have consequences on other markets…

Olivier Blanchard (2016), [Blanchard, Cerutti, and Summers (2015)2, Kiley (2015), IMF (2013), and Ball and Mazumder (2011) all tell us this about the Phillips Curve:

  • The best estimates of the Phillips Curve as it stood in the 1970s is that, back in the day, an unemployment rate 1%-point less than the NAIRU maintained for 1.5 years would raise the inflation rate by 1%-point, and that a 1%-point increase in inflation would raise future expected inflation by 0.8%-points.
  • The best estimates of the Phillips as it stands today is that, here and now, an unemployment rate 1%-point less than the NAIRU maintained for 5 years would raise the inflation rate by 1%-point, and that a 1%-point increase in inflation would raise future expected inflation by 0.15%-points.
Www bradford delong com 2016 01 must read olivier blanchard says that he and paul krugman differ not at all on the analytics but rather substantially html

In only 6 of the last 36 months has the PCE core inflation rate exceeded 2.0%/year. I keep calling for someone to present me with any sort of optimal-control exercise that leads to the conclusion that it is appropriate for the Federal Reserve to be raising interest rights right now.

Civilian Employment Population Ratio FRED St Louis Fed

I keep hearing nothing but crickets…

My worries are compounded by the fact that the Federal Reserve appears to be working with an outmoded and probably wrong model of how monetary policy affects the rest of the world under floating exchange rates. The standard open-economy flexible-exchange rate models I was taught at the start of the 1980s said that contractionary monetary policy at home had an expansionary impact abroad: the dominant effect was to raise the value of the home currency and thus boost foreign countries’ levels of aggregate demand through the exports channel. But [Blanchard, Ostry, Ghosh, and Chamon (2015)][6] argue, convincingly, that that is more likely than not to be wrong: when the Fed or any other sovereign reserve currency-issuer with exorbitant privilege raises dollar interest rates, that drains risk-bearing capacity out of the rest of the world economy, and the resulting increase in interest-rate spreads puts more downward pressure on investment than there is upward pressure on exports.

It looks to me as though the Fed is thinking that its desire to appease those in the banking sector and elsewhere who think, for some reason, that more “normal” and higher interest rates now are desirable is not in conflict with its duty as global monetary hegemon in a world afflicted with slack demand. But it looks more likely than not that they are in fact in conflict.

[6]: Blanchard, Jonathan D. Ostry, Atish R. Ghosh, and Marcos Chamon

Must-read: Tim Duy: Fed Watch: Fed Speak, Claims

Posted on by Brad DeLong

Must-Read: I confess I could understand FOMC participants wanting to raise interest rates right now if projected growth over 2016 was 3.5% or higher. But we have a first quarter of 0.8% and a second quarter of 2.3%: we may well not even get to 2.0% this year.

I confess I understand FOMC participants worrying about “imbalances” created by extremely-low interest rates, but:

  1. If they are worried about extremely-low real interest rates, they need to be all-in pressuring the Congress for more expansionary fiscal policy.

  2. If they are worried about extremely-low nominal interest rates, they need to be all-in pressuring their colleagues for a higher inflation target.

It’s the absence of either of those two from the Fed hawks–and the Fed moderates–that has me greatly concerned:

Tim Duy: Fed Watch: Fed Speak, Claims: “The Fed is not likely to raise rates in June…

…But not everyone at the Fed is on board with the plan. Serial dissenter Kansas City Federal Reserve President Esther George repeated her warnings that interest rates are too low…. Boston Federal Reserve President Eric Rosengren… reiterated his warning that financial markets just don’t get it….

I would suggest that the failure of policymakers to better manage the economy at turning points is not because it is impossible, but because they have overtightened in the latter stage of the cycle, forgetting to pay attention to the lags in policy they think are so important during the early stages of the cycle….

Bottom Line: Ultimately, I suspect the FOMC will not find sufficient reason in the data before June to convince the Fed that growth is sufficiently strong to justify a hike. Hence I anticipate that they will pass on that opportunity to raise rates. Look for an opportunity in September…. I doubt, however, that most on the Fed are pleased that market participants have already priced out a June hike on the basis of the April employment report…. They do not see the outcome as already preordained.

Must-read: Tim Duy: “June Fades Away”

Posted on by Brad DeLong

Must-Read: As I have said, what I am hearing sounds more and more like a Federal Reserve that is not engaged in a technocratic optimal-control exercise, but is instead employing motivated reasoning to find an excuse to raise rates on the grounds that an economy with unemployment at the NAIRU has normalized, and a normalized economy should have normal interest rates.

As I have said, I think this is a substantial mistake–not least because the Fed needs a higher inflation rate to give it more sea room for when the next macroeconomic storm arrives:

Tim Duy: June Fades Away: “At the beginning of last week, monetary policymakers were trying to keep the dream of June alive…

…Later in the week, however, financial market participants took one look at the employment report and concluded the Fed was all bark and no bite. Markets see virtually no possibility of a Fed rate hike in June. That–a desire to keep June in play coupled with insufficient data to actually make June happen–all happened faster than I anticipated. But don’t think the Fed will go down without a fight. New York Federal Reserve President William Dudley played down the April employment numbers…. Note that unemployment is settling into a level slightly above the Fed’s estimate of the natural rate of unemployment:

NewImage

For Yellen, this should be something of a red flag. The plan was to let the economy run hot enough that unemployment sank somewhat below the natural rate, thereby more aggressively reducing underemployment…. [But] the labor participation rate rose… reveal[ing] that there is substantial excess capacity in the labor market, and consequently the Fed should not be in a rush to raise rates. Indeed, because they have underestimated the slack in the economy, they need to let the economy run hot for even longer….

Bottom Line: The Fed breathed a sigh of relief after financial markets stabilized. That opened up the possibility that June would still be on the table, leaving them the option for three rate hikes this year. I don’t think that policymakers will abandon June as easily as financial market participants. My sense is that they will remain coy, implying odds closer to 50-50. But the data are not in their favor…

Must-read: Adair Turner: “Helicopters on a Leash”

Posted on by Brad DeLong

Must-Read: Adair Turner: Helicopters on a Leash: “Opponents can counter with a ‘slippery slope’ argument…

…Only total prohibition [of helicopter money] is a defensible line against political pressure for ever-laxer rules…. In countries with a recent history of excessive monetary finance… that argument could be compelling…. The crucial issue is whether political systems can be trusted to establish and maintain appropriate discipline.

Hamada cites… Korekiyo Takahashi, who used monetary-financed fiscal expansion to pull Japan’s economy out of recession in the early 1930s. Takahashi rightly sought to tighten policy once adequate output and price growth had returned, but was assassinated by militarists…. But Hamada’s inference that this illustrates the inherent dangers of monetary finance is not credible. Continued deflation would also have destroyed Japan’s constitutional system, as it did Germany’s…. Prohibition of monetary finance cannot secure democracy or the rule of law in the face of powerful anti-democratic forces. But disciplined and moderate monetary finance, by combating deflationary dangers, might sometimes help. So, rather than prohibiting it, we should ensure its responsible use. The likely alternative is not no monetary finance, but monetary finance implemented too late and in an undisciplined fashion…

Must-read: John Maynard Keynes (1923): “A Tract on Monetary Reform”

Posted on by Brad DeLong

Must-Read: John Maynard Keynes (1923): A Tract on Monetary Reform: “One is often warned that a scientific treatment of currency questions…

…is possible because the banking world is intellectually incapable of understanding its own problems…. I do not believe it…. If the new ideas… are sound and right, I do not doubt that sooner or later they will prevail. I dedicate this book, humbly and without permission, to the Governors and Court of the Bank of England, who now and for there future has a much more difficult and anxious task entrusted to them than in former days…

[…]

It is not safe or fair to combine the social organization developed during the nineteenth century (and still retained) with a laisser-faire policy towards the value of money…. we must make it a prime object of deliberate State policy that the standard of value… be kept stale… adjusting in other ways the redistribution of the national wealth if… inheritance and… accumulation have drained too great a proportion… into the spending control of the inactive….

We see… rising prices and falling prices each have their characteristic disadvantage…. Inflation… means Injustice to individuals… particularly to investors: and is therefore unfavorable to saving [and investment in capital]…. Deflation… is… disastrous to employment…. Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier.

But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient–perhaps cannot survive–without one.

?For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision…

On the definition of a “liquidity trap”

Posted on by Brad DeLong

I am going to split hairs with Robert Waldmann here…

Robert writes:

Robert Waldmann: The USA is not in a liquidity trap any more: “The output gap can be [estimated] by attempting to measure slack directly…

…The ratio of employment to prime age (25-54) population… is very low…. The ratio of vacant jobs to employment is very high, the quit rate is normal and real wages have begun to grow. The pattern is very confusing… it is possible for the same person to reach very different conclusions on different days….

[But] we [do not] need to estimate the output gap to predict the Fed’s response to fiscal stimulus…. The Fed Open Market Committee (FOMC) has… made it very clear that they are considering further rate increases. It could not be more clear that markedly reduced unemployment will convince them to raise interest rates. The US economy is not at the zero lower bound anymore. This just means that the FOMC no longer wishes it could achieve a negative federal funds rate…. This is a statement about what the FOMC will do not what it should do…

Let me disagree with Robert.

Whether or not the short-term safe nominal interest rate that the central bank controls is zero or not, an economy is in a liquidity trap when:

  • even a zero interest rate is not sufficient to raise planned expenditure to the level of full-employment output.

The central bank could be pegging the Fed Funds rate at 5%, and the economy would still be in a liquidity trap if even a 0% rate was insufficient to restore full employment.

Now there is disagreement about whether the U.S. economy is in a liquidity trap right now. The Federal Reserve doesn’t think so: the Federal Reserve thinks the current short-term safe nominal Wicksellian neutral interest rate is 0.25%. But I think that the Federal Reserve is wrong. And if the Federal Reserve is wrong–if the short-term safe nominal Wicksellian neutral interest rate is still less than zero–the economy is still in a liquidity trap, even though the Federal Reserve does not think that it is.

This bears on the question of whether expansionary fiscal policy is a good thing or not. If indeed the economy still is in a liquidity trap, the Federal Reserve will learn–in which case expansionary fiscal policy now will be beneficial, as it will save them from the consequences of their current mistakes as they learn and adjust. If the economy is not in a liquidity trap, expansionary fiscal policy will still raise the neutral interest rate–and so provide the Federal Reserve with more sea-room and a much better chance of avoiding another zero lower-bound catastrophe when the next adverse macroeconomic shock hits.

To say: “Because the Fed has raised the Fed Funds rate above zero, we are no longer in a liquidity trap, and expansionary fiscal policy no longer has a point” is, I think, to fundamentally mis-analyze the situation…

Must-read: George W. Evans and Bruce McGough: Interest Rate Pegs in New Keynesian Models

Posted on by Brad DeLong

Must-Read: Barrel. Fish. Gun:

George W. Evans and Bruce McGough: Interest Rate Pegs in New Keynesian Models: “John Cochrane asks: Do higher interest rates raise or lower inflation?’…

…We find that pegging the interest rate at a higher level will induce instability and most likely lead to falling inflation and output over time. Eventually, this will precipitate a change of policy…