Finance Basic To Advance Level Knowledge

Paul Krugman writes about a two-speed global economy where the emerging economies are experiencing rapid economic growth and rising inflation while the advanced economies remain in a slump. A key point he makes is that the countries still in a slump should focus on their own economic problems, not those of other countries. This especially applies to concerns about the Fed's monetary policy being exported across the globe: What about complaints from other countries that they’re suffering inflation because we’re printing too much money? (Vladimir Putin has gone so far as to accuse America of “hooliganism.”) The flip answer is, Not our problem, fellas. The more serious answer is that Russia, Brazil and China don’t have to have inflation if they don’t want it, since they always have the option of letting their currencies rise against the dollar. True, that would hurt their export interests — but economics is about hard choices, and America is under no obligation to strangle its...

The U.S. dollar vs. the Euro view circa 2005-2006:  The U.S. dollar vs. the Euro view today:  What a change in perspective.  Barry Eichengreen reminds us , however, that eventually the dollar will be one of probably two or three reserve currencies.

Dear Congressman Paul Ryan, In a recent speech you made the case for a more rules-based approach to monetary policy: The Fed’s recent departures from rules-based monetary policy have increased economic uncertainty and endangered the central bank’s independence...  Congress should end the Fed’s dual mandate and task the central bank instead with the single goal of long-run price stability. The Fed should also explicitly publish and follow a monetary rule as its means to achieve this goal.  I agree that we need a more systematic approach to monetary policy.  The ad-hoc nature of the QEs adds uncertainty and makes the Fed a political lightning rod for criticism.  Ultimately, this reduces the effectiveness of monetary policy.  So, yes, we need a predictable, rules-based approach to monetary policy.  We also need, however, an approach that responds appropriately to supply shocks.  For example, we wouldn't want the Fed to follow a rule that would call...

I made the case in an exchange last year with Paul Krugman that QE2 was not the first time quantitative easing had been tried in the United States.  Moreover, I noted that the original QE was a smashing success with nominal spending experiencing a robust recovery despite the zero bound problem.  So when was this original QE program? The answer is from 1933-1936.   I bring this up now for two reasons.  First, I just came across this short essay by Richard G. Anderson of the St. Louis Fed that confirms my view that the monetary stimulus program during this time was effectively a QE program (though he says it started in 1932).  Second, the original QE program provides a nice counterexample to the more modest accomplishments of QE2.  This QE program was put in motion by FDR telling the public he wanted to return the price level to its pre-crisis level.  In other words, FDR was signalling a price level target. Gautti Eggerton shows it was well und...

Paul Krugman appreciates my efforts against the hard money advocates.  He questions, however, my and other quasi-monetarists' belief that monetary policy can still pack a punch when short-term interest rates hit the zero bound: [T[hey want to keep that policy action narrowly technocratic, limited to open-market operations by the central bank.  As I’ve argued before, this doctrine has failed the reality test: liquidity traps are real, and blithe assertions that central banks can easily pump up demand even in the face of zero short-term rates have not proved correct. It is true that us quasi-monetarists believe that the efficacy of monetary policy is not limited by the zero bound, but we have never said the that all it takes is further open-market operations.  Rather, we have said that monetary policy can be highly effective regardless of circumstance if the following steps were taken by the Fed: (1) Set an explicit nominal GDP level target so that expectations are approp...

There is an interesting article on Bill Gross and PIMCO in The Atlantic.  It highlights PIMCO's decision to dump and then bet against U.S. treasury bonds.  According to Tyler Durden , the amounts involved are significant.  Bill Gross' explanation for these decisions is that the bond market is being artificially propped up by QE2 and once it ends so will bond prices.  These decisions have me stumped.  First, Gross' view assumes that the flow of QE2 purchases is what matters to bond prices.  There are good reasons to think, however, that it is the stock of QE2 purchases that matter.  If so, there should be no bond market correction since the Fed is not planning to sell its newly-acquired assets anytime soon. Second, given the weak economic outlook the expected short-term interest rates going forward should remain low.  That in turn should translate into low long-term bond yields.  Finally, if PIMCO's view were correct would not the bond mar...

Hard money advocates have been taking a beating in the blogosphere over the past few days, complements of Matthew Yglesisas , Paul Krugman ,  Mike Konczal , and Ryan Avent .  These critics make some good points about the hard money view.  Here is Avent's critique: The hard money approach is atrocious economics. I don't think it's outlandish (or even particularly controversial) to say that the biggest difference in the outcome of the Great Recession and the Great Depression was the change in central bank approach to policy. An economic catastrophe was averted. What's more, hard money is a great force for illiberalism. Sour labour market conditions fuel anger at the institutions of capitalism and free markets. And when countries are denied the use of normal countercyclical policies, they quickly reach for illiberal alternatives like tariff barriers. These points are often overlooked by hard money supporters.  There is, however, an even bigger problem for them....

One of the arguments I have made over the years on this blog is that the Fed is a monetary superpower.  It manages the world's main reserve currency and many emerging markets are formally or informally pegged to dollar. Thus, its monetary policy gets exported to much of the emerging world. This means that the other two monetary powers, the ECB and Japan, have to be mindful of U.S. monetary policy lest their currencies becomes too expensive relative to the dollar and all the other currencies pegged to the dollar.  Thus, we have seen these two countries move their policy rates in line with what the Fed does usually with a lag.   The recent interest rate hike by the ECB in the absence of a similar move by the Fed goes against this pattern.  Does it mean the ECB is finally breaking free of the Fed's orbit of influence?  It could be, but I doubt it.  The ECB raised its policy rate in April and was talking up further rate hikes thro...

Robin Hanson of the FT speaks to the Fed's communication problem: [E]ven if the press conferences do improve how the Fed communicates, and dampen the volatility of market responses, the real problem is what the Fed communicates. The Fed still does not communicate two things: (1) a clear numerical objective for policy; and (2) any idea of the monetary policy path it expects to use to get to its objective. Hanson notes that the reason for this lack of clarity is the Fed's dual mandate.  He cites research by Nicholas Herro and James Murray that shows the uncertainty created by this lack of clarity is costly to the economy.  If only there were a way to narrow the Fed's mandate that so that there would be increased clarity and improved macroeconomic stability.  Oh wait, there is a way .

The Kauffman Economic Outlook , a survey of economics bloggers, is out for Q2.  The survey had two interesting questions on the Fed, one of which I submitted.  Thanks to Tim Kane for including it in the survey.  Here is the question and the results: I am not entirely surprised by these results.  Most popular accounts and thus the emerging narrative about this experience either downplay or ignore the studies that have shown the monetary policy was a major contributor.  I won't rehash them here, but will note that I am editing a book that does shift the focus back to the role the Fed played in the boom and the bust. Stay tuned for more news on the book. I was very surprised to see the responses to the second Fed question.  It was submitted by Bryan Caplan and Steve Miller: Wow.  Only 16% of the economic bloggers believe the Fed has had a net negative effect while 40% think the Fed has been good on balance.  This is surprising. These folks need t...

Over at The Economist there is an interesting debate taking place between Brad DeLong and Bennet McCallum.  They are responding to the following statement: this house believes that a 2% inflation target is too low .  The idea behind this statement is that with a higher inflation rate the targeted short-term nominal interest rate would be higher and thus less likely to hit the 0% bound.  Brad DeLong endorses this view.  He sees the 0% bound as a real constraint on monetary policy and wants to avoid it.  Bennet McCallum challenges it.  He argues that monetary policy is not powerless at the 0% bound and there are real costs with going to a higher inflation target. A key issue to resolving this debate  is how binding the 0% bound is for monetary policy.  My own view is that it is not truly a binding constraint, but only a self-imposed one because of the way monetary policy is normally conducted.  Conventional monetary policy targets a short-t...

Greg Mankiw recently referred to a paper where he assess which inflation rate should be targeted by the central bank.  Here is his conclusion: [A]central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.  There are several good reasons laid out in the paper for targeting nominal wages.  Here I like to point out that stabilizing nominal wages is similar to stabilizing nominal income per capita.  It is not too much of a stretch to go from this to a nominal income or nominal GDP target.  In fact, Greg Mankiw and Robert Hall have a 1994 paper that sings the praises of a nominal GDP target, especially one that that targets the the consensus forecast of the nominal GDP level.  So where does Greg Mankiw stand today on nominal GDP level targeting?  If he still supports it, does he see the need to return nominal GDP back to its pre-crisis trend or at leas...

Ramesh Ponnuru schools Niall Ferguson on the basics: In Newsweek the pundit claims that “double-digit inflation is back”: “The way inflation is calculated by the Bureau of Labor Statistics has been ‘improved’ 24 times since 1978. If the old methods were still used, the CPI would actually be 10 percent.” If Ferguson is right about inflation, it leaves two possibilities. Either our statistics on the size of the economy in current-dollar terms–which ought to be easier to compile than any numbers on inflation–are hopelessly flawed. Or the real (that is, inflation-adjusted) size of the economy is shrinking rapidly. Instead of 1.8 percent real growth, in the last few months we’ve been going through something more like 7 percent real shrinkage. (Nominal growth, remember, has to equal inflation plus real growth.) Is that even remotely plausible? Does Ferguson believe this rate of shrinkage is compatible with even the modest job increases we’ve seen? Or does he doubt the unemplo...

Matt Rognlie takes to task Tyler Cowen for claiming there is no liquidity trap. He makes his case for the liquidity trap and then closes with this statement: This doesn’t mean that all hope is lost: the Fed can still make a difference by shaping expectations of the future  trajectory of nominal interest rates, or by making unconventional bond purchases so large that they trigger portfolio balance effects and drive down interest rates on longer-maturity assets ...Just don’t go around claiming that 0% isn’t a barrier—because sadly, it is. Ironically, the above bold phrase is exactly why in most circumstances there is no liquidity trap at the 0% barrier.  To see this, first recall that a liquidity trap is a situation in which the demand for money is perfectly elastic.  That is, no matter what the central bank does it cannot cause money demand to budge.  Monetary policy, therefore, is unable to address the problems created from excess money demand in a liq...

Maybe this is why the ECB decided to hold off on the interest rate hike: The debt crisis in Greece has taken on a dramatic new twist. Sources with information about the government's actions have informed SPIEGEL ONLINE that Athens is considering withdrawing from the euro zone. The common currency area's finance ministers and representatives of the European Commission are holding a secret crisis meeting in Luxembourg on Friday night. This from Der Spiegel online (HT Ryan Avent ).  Come next Monday morning will the Eurozone be the same? 

Commodity prices took a beating today.  This Bloomberg headline sums it up well: Commodities Sink Most Since 2008 as Stocks Fall .  But how can this be? We have been told repeatedly that the surging commodity prices are because of the Fed's loose monetary policy.  But U.S. monetary policy did not suddenly tighten.  So what caused the drop in commodity prices?  For those of us who have been arguing U.S. monetary policy has not been driving commodity prices, the answer is implied by this figure: Sources:  NBEPA  ,  Moody's FreeLunch.com This figure indicates that the rapid growth of emerging economies is probably the real reason for  the rapid changes in commodity prices over the past few years.  This view is further borne out by evidence from the San Francisco Fed , Chicago Fed , and Marcus Nunes .  The reason, then, for today's fall in commodity prices appears to be the buildup of bad economic news that suggests the world economy...

The ECB decided today to hold back from another interest rate hike. It seems the ECB has finally figured out that the series of interest rate hikes it intended to do this year probably would have caused the Eurozone some harm. Specifically, the ECB's proposed tightening would have required more painful deflation in the Eurozone periphery to bring about the real depreciation that part of the currency union sorely needs . That much the ECB seems to understand.  What they don't seem to understand or don't want to understand is that the periphery's real depreciation could also occur through higher inflation in the core.  That, however, would require the ECB to ease and allow more inflation in Germany, an unlikely event.  The ECB also hasn't seemed to figure out that being passive is effectively keeping monetary policy tight.  Nominal GDP remains well below trend, the Euro is surging, and the ECB balance sheet is slowing shrinking.  Michael T. Darda appropriately c...

Current dollar spending per person in the United States is still below its pre-crisis peak.  In 2008:Q2 domestic spending per capita was $50,081.  In 2011:Q1 it reached 49,808.  So 11 quarters later, the U.S. economy has yet to even return to its pre-crisis peak, let alone get anywhere near a reasonable pre-crisis trend. Time to adopt a nominal GDP level target . Source: Fred Data

Matt Rognlie says no .  Nick Rowe says yes and I agree. Nick Rowe argues  MV=PY (where (M = money supply, V = velocity, PY = nominal GDP) is useful because it highlights the fact that money is special: it is the only asset on every other market (i.e. it is the medium of exchange) and thus is the only one that can affect every other market.  Money, therefore, is what makes it possible to have economy-wide recessions.  Even in the recent recession where the financial crisis increased the demand for safe assets, it was not the elevated demand for safe assets itself that caused the recession but the fact that this demand for safe assets was met, in part, by going after the safe asset money. I view the equation of exchange as useful because it provides a summary measure of what is causing swings in nominal spending and the role, if any, monetary policy is playing in those swings.  For example, the equation of exchange in its expanded f...