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.