Wednesday, December 12, 2012

The Myth of Expectations

Yglesias today has a post titled "
FOMC Adopts Game-Changing Conditional Inflation Targeting Rule."If you've read his site much you can probably guess the rule - as Matt puts it the Fed "has stopped screwing around and started doing real expectations-based monetary easing.".

I've had beef with Matt about this expectations business for years, and I'm glad to see that Matt is enthusiastic about this change and not saying "well, true NGDP targeting would be better."  He's recognizing that this is the idea Matt has been flogging and if it doesn't spur economic growth by easing monetary conditions, that's a bust to the idea.

The thing Matt - and many others - fail to understand about the so-called "expectations channel" is that it's something that occurs as a result of other consequences of a policy, not as something unique unto itself.  The Fed makes a policy change, the policy change makes an impact, and then there is additional impact because people's expectations about economic performance change.

The idea that economic conditions today are being impacted by expectations about Fed action in 2014 is completely unfounded.  The new Fed targeting model may well be a great idea!  It could lead to better policy!  Hooray!

What the new model doesn't do is give the Fed new policy tools.  Fed policy is the same as it was yesterday - as expansionary as possible for as far as the eye can see.  Expectations don't change conditions, conditions change expectations.  THEN expectations can theoretically have an accelerating effect.  

Saturday, June 16, 2012

A Balance Sheet Recession in a Nutshell

The Financial Times is occasionally refreshingly good.  Yesterday Martin Wolf put the essential problem of a balance sheet recession very succinctly:

[T]hose who are creditworthy do not wish to borrow; those who want to borrow are not creditworthy...
This is the problem in a balance sheet recession.  Policymakers, who overwhelmingly have banking backgrounds, want to solve these problems through the banking system - by setting interest rates and letting banks create money by lending.

However, banks cannot create net financial assets - every time a bank makes a loan, it creates an equivalent liability for each asset it creates.  So if private sector balance sheets are strained, banks don't lend, no matter what the interest rate is and no matter how much the government might want them to.

The solution to this problem is fairly simple; unfortunately ideological orthodoxy tends to assume it away.  From a different part of the same article:
Mr Osborne repeated the orthodoxies of the government’s approach to fiscal policy (it needs to be tight), monetary policy (it needs to be loose) and debt (it needs to be reduced).
The problem is, in a balance sheet recession, if fiscal policy is tight, balance sheets stay strained because no net financial assets are being transferred to the private sector, and thus no amount of "loosening" of monetary policy (which really just means low interest rates) can actually produce an expansion of private credit.

The most crucial part of the quote, though, is that bit at the end about debt needing to be reduced.  Whose debt?  For private balance sheets to "deleverage" (that is, to pay off debt) government debt must be increased.  There is no other source for the money needed to pay private debt off - that's what it means to be a monopoly issuer of a currency.

The simplest way for the UK and US to jumpstart their economies would be to target the people whose balance sheets are in the worst shape - the unemployed.  The government could hire the unemployed to perform useful work in their communities for $8/hr until such time as the private economy was ready to hire those people again.

It really is quite simple, but orthodoxy has a way of blinding people to obvious solutions that don't fit their prejudices.

Tuesday, June 12, 2012

Are Liberals Ignoring Monetary Policy?

One accusation that's been flying around a lot over at Yglesias' place is that liberals are ignoring monetary policy.  Matt makes the assertion today in a post called Job Creation is the Fed's Job.  The story, basically, is that liberals know that the Fed could easily create millions of jobs by changing its policies, but we're fixated on fiscal policy.

Of course this is not the case.  The problem is that lots of us, myself included, don't believe that the Fed can do much right now.  One thing that's been suggested is that the Fed could increase its inflation target from 2% to something higher.  I favor that but don't think it will help the current situation.  Another is that the Fed should target NGDP growth instead of inflation.  I think that's an interesting idea but don't think it will help the current situation.

Yglesias keeps hammering on two ideas to justify his fixation with monetary policy - one, that Bernanke himself says that the Fed has tools that could help the economy but isn't using them for some reason.  This isn't true - Bernanke says the Fed has things it might try if conditions warrant.  That's not the same as saying there are things that would help now that he's refusing to do.

The second idea is that there are central banks around the world that are succeeding with the monetary policy ideas he's hawking.  Matt's first obsession was Sweden - he linked to an article about Sweden setting its policy rate negative.  Unfortunately Sweden never set a negative policy rate - it was an apparent misunderstanding by a reporter that had been debunked before Yglesias ever got involved.

Yglesias continues to claim that Sweden did what they did not do, and has never addressed the Economix piece to my knowledge.  And now he's got a new dead horse to flog:  Bank of Israel's alleged targeting of NGDP growth.  Evan Soltas started a rumor that Bank of Israel was NGDP targeting and that this policy had led to Israel's impressive growth path since the 2008 financial collapse.

Once again, though, Matt has simply catapulted a myth into the mainstream.  Bank of Israel is not NGDP targeting.  Sweden never had a negative policy rate.  All these little mistakes add up to a big imaginary set of data that monetarists seems to have agreed to pretend is actual data.  This is no way to discuss the finance policy of the most important nation in the world.

Proving that Bank of Israel is Using an Inflation Target

Eric, one of the more rabid market monetarist commenters at Yglesias' place, is still insisting that I prove that Bank of Israel is not using NGDP targeting.  So, here goes.

1.  Bank of Israel's published policy is a 1-3% inflation target.
2.  Bank of Israel publishes a report every quarter explaining how it arrived at its policy by targeting 1-3% inflation.
3.  Bank of Israel's policy changes are consistent with a 1-3% inflation target (their stated policy) and inconsistent with an NGDP target (their alleged secret policy that a prep student invented by writing a blog post.)  We know this because in late 2009 Bank of Israel tightened rates to curb inflation  despite the fact that NGDP growth was below the alleged target rate of 6.5%.

I really, really hope that does it.  But somehow I think that it won't.

Monday, June 11, 2012

The Bank of Israel is not using NGDP Targeting

A couple days back Scott Sumner approvingly linked to a piece by a little-known blogger named Evan Soltas in which Soltas alleged that the Bank of Israel is using NGDP targeting.

Then Matthew Yglesias approvingly linked to the Scott Sumner article, and now around the web you're seeing market monetarists in comment threads bringing up how wonderful NGDP targeting is and wouldn't it be nice if all central bankers were as smart as the ones at Bank of Israel.

Well, there's a problem.  The Bank of Israel is not using NGDP targeting.  Soltas' "evidence" that the Bank of Israel was using a 6.5% NGDP target is that Israel's NGDP growth rate has hovered around 6.5% the past few years.  Seriously, that's the evidence.  

Sumner, who despite being by all accounts a nice guy traffics in these kinds of flimsy free-associations all the time, took Soltas' post at face value, and Yglesias, who is not known for his rigor, catapulted the whole myth into what passes for the blogosphere's "mainstream."  

This is the same thing that happened with Sweden's fictional negative interest rate policy - Yglesias linked to an old article that had since been corrected and now the myth keeps popping up because Yglesias never, ever corrects anything.  

I defend Matt a lot to people who think he's a real nuisance, but this sort of thing makes it hard.  Correct the record, Matt.  Bank of Israel is not using NGDP targeting - they're using a 1-3% inflation target.  Full stop.

Thursday, June 7, 2012

The Television Addiction Situation

Once upon a time there were two children who were very smart and very obedient but whose parents had made a very serious miscalculation.  The parents had allowed the children to become addicted to television.

Every morning upon awakening the children would demand television.  They would demand to have it before breakfast, and when they were told they could not have it before breakfast, they would demand to have breakfast WITH television, and when they were told they could not have breakfast with television, they would collapse on the floor in tears and refuse to do anything at all for the rest of the day.

The parents were beset by offers from friends and neighbors to break the children of their unhealthy reliance on the glowing storybox, but the parents, being an odd sort of parents, saw in their kids' affliction an opportunity.

One morning when the children awakened they were greeted not with the normal trip to the breakfast table but to a strange room that they had never noticed in the house before.  Inside were stacks of cards, each identical to the next, with a drawing of a snake wrapped around a staff, and the signature of the mother and father in the bottom left and right corners, respectively.

The children were told that from now on in order to watch one television program each child must remit one card to either the father or the mother.  The cards were acquired by doing chores - one card for sweeping the kitchen, two for cleaning out the shed, and three for planting a berry bush or suchlike improvements to the home.

At first the children worked only for the television they wanted to watch each day, but soon Ruby, who was older, said to her little brother "Luke," for that was her brother's name, "we should spend a day doing chores so that the next day we can spend the ENTIRE DAY watching television."

The prospect of an entire day of doing nothing but watching television so inspired the little one that he did twice his normal work - though it was still a fraction of what his sister could do - and the two saved enough cards to make their dream come true.  They could hardly contain their excitement as they lay their heads down to sleep.

When they awakened they did not demand television before breakfast but ate their fill, knowing that a glorious day of television watching lay ahead of them.  After finishing their meal they sat down and watched all their favorite movies, and all the best episodes of the very funniest shows.

At lunchtime they ate thoughtfully and talked about their cards.  They loved television but they loved the power of the cards as well, and they didn't want to be without television the next day.  In the end it was decided that they would go to a friend's house for the afternoon, and use their cards to watch television the next day.

As time went on the children began to acquire so many cards that they could not imagine ever using them all.  It was then that things began to get complicated.

Monday, June 4, 2012

Yglesias Comment Mirroring

I've been unable to force myself to post here enough to get the blog going, so for at least a while I'm going to try cross-posting my substantive comments from Yglesias' blog.  Perhaps after a while this will get me in a good enough posting habit that I can do something a bit more reader-friendly.  For now, here goes:

Today Yglesias links to a Mike Konczal interview of former Fed staffer Joe Gagnon.


After all, right now the European Central Bank is refusing to engage in the volume of monetary activism that the European Union needs and the Fed is refusing to engage in the volume of activism that the United States needs. 

This is quite a triple bank shot, but the reasoning is more or less sound. More than anything it points up how ludicrous our self-induced paralysis is - it can't be the case that a currency war between the two most important economies in the world would maximize human welfare. There MUST be better policies available. 

As for the linked post, I appreciate learning that the Fed is currently authoritzed to buy FCR in large quantities as I wasn't sure that was the case.  

I hope that people read the full interview, especially the part where Gagnon makes it ABSOLUTELY CLEAR that the only impact of Fed asset purchases of bonds is through the interest rate channel: 

In the Treasury market, yields on three-year notes are only 0.3 percent, so the Fed must buy five-year to 30-year bonds to have any effect. With the 10-year yield at 1.5 percent, the scope for further effects is modest. Even if the Fed bought every 10-year Treasury, it would be hard to get the yield much below 1 percent, because the risks on such a bond become tremendously skewed toward future losses. 

Gagnon is exactly right - since Fed policy operates through the interest rate channel, when rates are as low as they go Fed policy doesn't do anything. The point of "unconventional" monetary policy is NOT to stimulate the economy directly but to lower long rates. Once long rates hit bottom Fed asset purchases no longer have any effect. 

So, if the Fed bought every MBS in the economy Gagnon believes we could lower the mortgage rate for prime borrowers to somewhere a shade under three percent. Would that impact lending? Of course! It would mean that people who are not creditworthy at 3.75 percent but are creditworthy at, say, 2.75 percent could get a loan. That would be stimulative.  

So, I will direct to this post anyone who accuses me in the future of saying the Fed is powerless. The Fed has the power to set interest rates, and could lower long rates a bit more by buying up mortgage backed securities. The Fed could also theoretically buy foreign currency. It has no other powers. 

For the record I don't at all share Gagnon's belief that it would be a good idea to authorize the Fed to intervene in the stock market.

Wednesday, May 23, 2012

A Place for The Yglesias Banking System Discussion

My wife's out of town so I'm hanging out a lot over at Yglesias' place discussing the banking system.  It's getting a little tedious to use the comments over there for such a long discussion, so here's a place we can discuss it.  Hopefully I can get Adam to come over here and continue our session, and perhaps some others will follow as well.

Thursday, February 9, 2012

Russ Roberts Interviews William Black

Really good interview via New Economic Perspectives.

I especially like the explanation of the type of fraud that allows banks to continue to report good earnings while they're actually going under.

Basically, as Black explains it, let's say I'm a bank that made a dumb $60m commercial real estate loan to a developer. The developer never makes any money, so he never pays back any part of the loan. Thus I, the bank, am the new owner of a $60m development that's almost certainly not worth $60m.

However, I don't want to eat the loan because it will hurt my profits and I might not get my bonus. So the next time someone darkens the door of the bank, I talk him into taking out an $80m loan to buy my worthless development for $78m and then have $2m "walking away money." Now, I've kicked the can down the road because 1) I sold the property at a profit and 2) the new owner of the development can use some part of his $2m to service the debt for a little while.

During this time, of course the bank is in even worse objective shape (since it's now loaned $80m against the same property we know wasn't even worth $60m) but I can continue to collect bonuses and possibly even stave off regulators if they don't stick their noses too far up into my business.

Friday, January 20, 2012

Unvanishing the Vanishing Dollar

Lots of good stuff going on right now making it difficult for me to blog. However, I wanted to highlight this conversation I had with the Internets about private sector savings and federal deficits.

Yglesias: ""A path to an increased national savings rate over the long-term that opens with a gigantic increase in public sector debt doesn't make any sense.""

ApeMan: Actually, it does! I don't favor a cut in the capital gains rate for fairness reasons, but in fact public sector deficits are the ONLY source of net financial savings by the private sector.

Private sector saving equals, to the penny, public sector deficit. The only source for net financial saving is money creation by the currency issuer.

This is the piece of information that is preventing you from understanding economics, Matt. You MUST think about it and try to understand it. If you don't the confusion you sow will continue to offset the good work you do. It's really critical.

This is why it's misleading to think of deficit spending as "borrowing." It isn't - not really. It's the creation of net financial assets.

Here's a simple way to think about it in lay terms. The federal government creates a certain number of dollars in a given year. Some of those dollars are accumulated by foreigners - that's the trade deficit. Thus for savings by Americans just to get to zero, the government has to create dollars (deficit spend) equal to the level of the trade deficit. For Americans to actually accumulate net dollars (save money) the government must create a number of dollars GREATER THAN the level of the trade deficit.

The government does not, of course, borrow these dollars from anyone. It just creates them. If it creates fewer net dollars than are sent overseas, Americans wind up with less savings. If it creates more than are sent overseas, Americans wind up with more savings. It's so simple, as I think Galbraith wrote, that the mind recoils from it.

Steve: I don't understand, ApeMan. I thought money is created by people and corporations who borrow from banks.

ApeMan: Money is indeed created by bank loans. However, when a bank loan creates money it also creates a corresponding private sector liability (the note itself), so the total operation nets to zero. Total private savings are unaffected.

When the currency issuer creates a dollar, no corresponding private sector liability is created, so the total operation has a net positive impact on private sector savings.

This sounds complicated but in fact it's quite simple - when you borrow money from your bank, you wind up with two accounts, a deposit account (positive) and a loan account (negative). When you get a check from the federal government, you wind up with one account, a deposit account (positive.)

The government's account with the Fed is debited, of course, but the government's account with the Fed is purely notional - the federal government doesn't have "savings."

In a way it's actually easier to understand if you look at the way it used to work. Banks used to create their own money, such that when you took money out of your bank it would say "Bank of America Note" on it instead of "Federal Reserve Note." Banks had various agreements about honoring each other's notes.

Eventually everything was standardized when the Fed declared that notes issued by legitimate banks would clear "at par" with federal reserve notes, at which point there was no longer any need for individual banks to issue their own notes. That's why now we just use nothing but federal reserve notes.

The only downside is that it's harder to demonstrate conceptually that some money is "bank money" and some money is "state money" since now it all looks and acts the same, regardless of where it originated.

The one key is: bank reserves - and thus savings - are still always state money. That's why deficits are the norm for modern governments. It's a feature of the system, not a bug, and present deficits do not necessitate future tax increases. It's a misconception.

LD: Why would 'net private sector savings' be zero?

ApeMan: Imagine I'm the currency issuer. I issue $100 in notes. Now people have $100 in savings. Then at the end of the quarter I tax them back again. Now people have $0 in savings.

LD: That would only be if the tax equaled the entire money supply, but maybe I'm not understanding your argument.

ApeMan: No, the money supply is the total amount of money in existence, not the NET money in existence. Savings is net money. The private sector can't create savings by borrowing, obviously.

To extend the example, I'm the currency issuer and I issue $100 of state money. Bank A now has $100 of reserves and a deposit account in the amount of $100. Now Bank A makes loans in the amount of $100, so now Bank A still has $100 of reserves but it has $200 in deposits ($100 in bank money, $100 in state money) and $100 in loans.

The total NET savings in the economy is still $100, no matter how much money Bank A creates by lending.

LD: If I might adjust your example?

Currency issuer issues $1000 at $100 each to 10 banks.

Banks loan out with 10% reserve, implying a total money supply of $9000. Let's say the banks make 5%, for a total profit of $450.

On tax day, Gov'mint takes 10%, $45, and spends $45.

First, you assume money supply=tax rate or government expenditure. Second, even if the net savings is '$100', or $1000 in my scenario, this is not dramatically affected by the tax imposition such that "money injected into the economy by the federal treasury would be taxed back out again"

ApeMan: Right but you're confusing yourself by equating "savings" with "money." Savings is NET money, not total money. Total money is only slightly affected by taxation because most money is bank money. But ALL net money is state money.

The easiest way to see it is to look at the POV of the customer of the bank. He can take out loans in any amount the bank will allow, but his net position will still be zero unless and until he gets a check from some outside entity. if you aggregate the entire private sector together, obviously the only remaining outside entity is the currency issuer.