Finance Basic To Advance Level Knowledge

Ben Bernanke did his first post-FOMC Q&A. Not surprisingly he got a lot of questions regarding concerns over inflation.  Unfortunately, most of these inflation questions were premised on the assumption that inflation is always a bad outcome that must be avoided at all cost.  For example, Robin Harding of the FT asked Bernanke what the Fed could do to prevent inflation expectations from increasing.  None of the reporters seemed to grasp and Bernanke failed to explain that a period of catch-up inflation--which really is just a symptom of catch-up nominal spending--could do the economy some good without jeopardizinng long-run inflation expectations.  All the Fed would need is to set an explicit level target and run with it as I explain here .  And make no mistake, the Fed has the power to make a difference.  Just look at how successful the original QE program was in the 1930s, a time of far worse economic conditions.  Allowing these reporters to fra...

Tyler Cowen brought up Gresham's Law in his NY Times column this past weekend: IS a euro held in an Irish bank in Dublin, or in a Portuguese bank in Lisbon, as sound and secure as a euro in a German bank in Berlin? That apparently simple question holds the key to understanding why the euro zone may splinter and bring a new financial crisis.  In Ireland, there has been a “ silent bank run ” on financial institutions for much of the last year. In February, for instance, Irish private sector deposits dropped at an annual rate of 9.8 percent. That’s largely because some depositors doubt the commitment of the Irish government to the euro. They fear that they will wake up one morning to frozen bank accounts, followed by the conversion of their euro deposits into a lesser-valued new Irish currency. Pre-emptively, the depositors send their money outside Ireland, where it still represents safe euros or perhaps sterling, accessible by bank transfers and A.T.M. cards.  Thi...

Ramesh Ponnuru had a thoughtful piece in the National Review where he argued that the Fed needed to do QE2.  Predictably, he was criticized for not advocating hard money, not being Austrian enough, favoring central planning, and a host of other sins.  Ponnuru patiently replies to the criticisms: Looser monetary policy hurts savers . That’s often true. But when the federal government is holding the supply of money below the demand for money balances, expanding that supply can raise the long-term return on savings by stimulating economic growth. I ignored Hayek and am unfamiliar with the Austrian School. Actually, I came to my views through Austrianism. Read Josh Hendrickson for an explanation of why the view that we have been in a monetary disequilibrium caused by excessively tight money “is consistent with Austrian business cycle theory.” Official statistics underestimate inflation. We don’t need to rely on official statistics. We can look to prices to see the ...

No, but they should be more systematic. The problem with the QEs all along is that they have been rather ad-hoc and unpredictable.  This has made them less effective and politically polarizing.  Imagine how different the Fed's monetary stimulus would have been had they adopted an explicit target, preferably a nominal GDP level target .  Such an approach would have given them the freedom to do really aggressive 'catch-up' monetary easing until nominal GDP returned to the targeted trend while at the same time ensuring long-term predictability.  It also would be viewed (correctly) as constraining the Fed's power. Instead we are stuck with the problematic QE programs that have been at best mildly effective and as result, are an easy target for critics. Thus, it is no surprise to learn from Robin Harding of the FT that the Fed is about to signal the end of monetary easing: An end to global monetary policy easing is on the horizon, with the US Federal Reserve set to sign...

Amidst all the U.S. budget talk last week, the IMF decided to weigh in by noting the U.S. lacked a "credible strategy" to handle its public debt.  Now Standard & Poor's has decided to pile it on by downgrading U.S. public debt from stable to negative.  From the FT: “We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns..." Between this and the rumors of a possible Greek debt restructuring , global markets are roiling.  If this turns ugly, then Fed should be ready to accommodate the spike in global demand for dollar-denominated money.

Desmond Lachman has a new article where does a great job comparing the current failures of ECB with those of the Fed in 2008-2009.  One comparison I would add is that the ECB's tightening of monetary policy this month over concerns about inflation is very similar to the Fed's decision not to cut the target federal funds rate in the September, 2008 FOMC meeting because of concerns about inflation. One would hope that the ECB would learn from the Fed's passive tightening of monetary policy in 2008. Here is Lachman: Mark Twain famously observed that history does not repeat itself but it does rhyme. Considering how Europe's sovereign debt crisis is playing out, one has to be struck by Mark Twain's prescience. For the Europen sovereign debt crisis bears an uncanny resemblance to the 2008-2009 U.S. financial crisis. And it gives every indication of having the potential to shock the global economy in a manner not too dissimilar from the way in which the U.S. subp...

He returns in a Bloomberg news story that calls on the Bank of England to abandon inflation targeting: The Bank of England should consider replacing its inflation-targeting regime with one focusing on nominal gross-domestic-product growth, U.S. economist Scott Sumner said.  Targeting nominal GDP growth, which is not adjusted for inflation, would clarify the bank’s mandate and lessen its reliance on unreliable price indicators, Sumner, an economics professor at Bentley University in Waltham, Massachusetts, said in a report published today[.] [...] Inflation is “measured inaccurately and doesn’t discriminate between demand versus supply shocks,” Sumner said in a telephone interview. “Inflation often changes with a lag and sometimes when you go into recession, it doesn’t change very easily, but nominal GDP growth falls very, very quickly, so it’ll give you a more timely signal stimulus is needed.” The U.K. central bank should target annual nominal GDP growth of about 4 pe...

I have a new article up at National Review Online where I argue that the best way for Congress to narrow the Fed's mandate is through nominal GDP level targeting.  One point mentioned in the piece is that because a nominal GDP target ignores aggregate supply shocks it dominates an inflation target.  This applies equally well to a price level target.  Another way of thinking about this is that movement in the price level is a symptom of all underlying shocks, whereas movement in nominal spending is an underlying shock itself (i.e. an aggregate demand shock).  The Fed will be far more effective if responds directly to the underlying shock over which it has influence--the aggregate demand shock--than responding indirectly to an imprecise symptom of that shock. The importance of nominal spending shocks can be seen in the three figures below.  The first  figure shows the growth rates  of nominal GDP with the blue line, real GDP with the red line, and the ...

The ECB decided to raise interest rates today, despite the strain it is going to put on the Eurozone.  Michael T. Darda explains in the WSJ what this could mean for the currency union: If the ECB starts to tighten policy as expected, it could be a "lights out" situation for the beleaguered European periphery and a potential threat to the euro zone itself. In more blunt terms, this move may have begun the countdown to the Eurozone breakup.  It is hard to see how else this can turn out.  The Germans--the folks who really call the shots in Europe--are reluctant to see the needed debt restructuring in the periphery and are equally reluctant to provide bailouts large enough to fix the problem. So far the Germans have been kicking the can down the road on these issues. With ECB monetary policy now tightening they will soon run out of road to kick the can down. Maybe the breakup was inevitable from the start and this is just hastening that outcome.  After all, the Eurozo...

Ramesh Ponnuru is a breath of fresh air.  Unlike many conservative commentators who get lulled in by the siren song of hard money, Ponnuru takes an informed and nuanced approach to monetary policy. He understands that currently there is an excess demand for safe, liquid assets that is preventing a robust recovery. He believes the Fed should be addressing this problem.  In his latest National Review article , he once again makes this case.  Here are some excerpts: More important — and more disturbing — is that it is not at all clear that we have learned from the mistakes of the 1930s. Those central bankers believed that money was easy because interest rates were low and the monetary base (the supply of money under the Fed’s control) had expanded. They worried that further easing would reduce confidence in the dollar. British economist R. G. Hawtrey, writing in the late 1930s, described the climate of opinion in his country at the start of the decade: “Fantastic fears of in...

That is what Noah Smith finds when he graphs TFP by durable and nondurable sectors.   Here is the stunning figure he provides:  Here is Smith: From this graph, it definitely looks like something big did happen to technological progress. But it looks like it happened not in 1973, as Cowen claims, but a decade earlier. In the 15 years to 1963, the two sectors progressed pretty much in tandem. But sometime in the early- to mid-60s, they diverged wildly, with nondurables TFP rising anemically through the late 70s and then basically flatlining until now. Durables TFP looks to have suffered its own very minor slowdown in the mid-70s (which is probably the reason why overall TFP looks like it took a turn around that time), but then exploded with unprecedented vigor after '93. Smith is responding to an earlier  post  of  mine that Tyler Cowen  linked  to yesterday.  In that post I showed using John Fernald's data  that the TFP growth ra...

Paul Krugman has a post explaining the monetary policy transmission channels for QE2. His explanation is that there was a rise in wealth effect-driven consumption spending via the rising stock market and a rise in foreign spending on the U.S. economy via the depreciated dollar.  While true, there is a far richer story to tell with the portfolio rebalancing channel of monetary policy. Here is how I described it before: Currently, short-term Treasury debt like T-bills are near-perfect substitutes for bank reserves because both earn close to zero percent and have similar liquidity.  In order for the Fed to get investors to spend some of their money holdings it must first cause a meaningful change in their portfolio of assets.  Swapping T-bills for bank reserves will not do it because they are practically the same now. In order to get traction, the Fed needs to swap assets that are not perfect substitutes.  In this case, the Fed has decided to buy less-li...

In my previous post I argued the ECB could help the Eurozone not just by refraining from interest rate hikes, but by easing monetary policy.  I said doing so would lead to a real appreciation in the core economies of Germany and France and a much needed real depreciation in the periphery.  This would not solve the periphery's problems, but it would make them more manageable.  This is an argument I fist heard from Ryan Avent and I find it compelling.  Let me explain it in more depth. If the ECB were to ease monetary policy, it would cause inflation to rise more in those parts of the Eurozone where there is less excess capacity.  Currently, there is less economic slack in the core countries, especially Germany.  The price level, therefore, would increase more in Germany than in the troubled periphery.  Good and services from the periphery would then be relatively cheaper.  Thus, even though the exchange rate among them would not change, th...

Jürgen Stark is a member of the executive board of the European Central Bank.  He has a piece in the Financial Times that makes me wonder if the ECB really understands what it is doing.  Stark goes after commentators who question whether the ECB's monetary policy has been appropriate for the Eurozone.  He may be responding to folks like Ryan Avent , Kantoos , and myself who have argued that easier monetary policy would be in the best interest of preserving the Eurozone.  Doing so would cause a real appreciation for Germany and France while allowing a much needed real deprecation for the Eurozone periphery.  Unfortunately, he misses this important point and makes some rather astounding claims.  This one in particular was amazing: My first reason for rejecting the commentators’ view is that in a monetary union, when setting interest rates, the central bank cannot do any better than take an area-wide perspective. This applies to any central bank...