Finance Basic To Advance Level Knowledge

One more thing about Swedish monetary policy.  I showed in a previous post that the Swedes seem to be effectively targeting the level of nominal GDP.  A nice thing about level targeting is that it has "memory," that is monetary policy does not forget past deviations from its target and works in subsequent periods to make it up.  Thus, it requires higher-than-normal catch-up growth if its targeted nominal variable it undershoots its target and vice versa.  This catch-up growth can be seen for Sweden in the figure below which shows the year-on-year growth rates of nominal GDP: The Swedes appear to be aiming for just under a 5% nominal GDP growth.  Starting in late 2008 and going into 2009, nominal spending collapses and contracts at about a 5% growth rate.  To make up for this loss in nominal spending, the Riksbank nudges up nominal GDP growth up to almost 10% in subsequent quarters.  Nominal GDP growth still remains elevated but now appears to be slo...

Neil Irwin of the Washington Post wrote just last week about how the Swedish economy is doing so much better that the U.S. economy and attributed part of that success to a more aggressive monetary policy there.  Here is Irwin: The Federal Reserve has won both plaudits and criticism for responding aggressively to the financial crisis, pumping money into the financial system in epic fashion. But by one key measure, the Swedish central bank was even more aggressive. Like the Fed, the Riksbank lowered its target short-term interest rate nearly to zero. But it also expanded the size of its balance sheet more than the Fed did relative to the size of its economy, flooding the financial system with even more cash during the height of the crisis. In summer 2009, the Riksbank had assets on its balance sheet equivalent to more than 25 percent of the nation’s gross domestic product. For the Fed, that level never got much over 15 percent. So here Irwin is implying the Fed has not bee...

Via Matt Yglesias we learn about the incredible recovery of the Swedish economy and how an aggressive monetary policy played a key role.  Specifically, the Swedish central bank expanded its balance to sheet to 25% of GDP versus the Fed's 15%, it set an explicit and clearly communicated inflation target, and charged a negative interest rate on excess reserves.  Swedish authorities also were not afraid to see their currency depreciate.  All of these steps would horrify the hard-money advocates in the United States, but I would ask to them to consider the benefits the Swedes are now enjoying: lower unemployment, higher real GDP growth, and less overall human suffering.   Just in case there are any lingering doubts about the benefits of more aggressive monetary policy, take a look a the level of nominal spending in both Sweden and the United States.  Nominal spending in both countries takes a big hit, but only in Sweden does nominal spending undergone a robu...

Here are some interesting pieces on monetary policy from past few weeks that caught my attention: 1.  Mike Konczal has been on a tear lately with his calls for more aggressive monetary policy.  Here he interviews Joe Gagnon about QE2's record and what QE3 might look like. Here he shows that FDR was actually quite astute about price level targeting during the early 1930s. 2.  Edward Harrison breaks down the differences between QE1, QE2, and Q3.  3.  The BIS annual report gets a Jiu-Jitsu takedown from Scott Sumner , Martin Wolf , and Paul Krugman . 4.  Marcus Nunes has come to the conclusion that maybe the academic Ben Bernanke was never really all that different than the central banker Ben Bernanke. 5.  The last FOMC meeting and the follow-up press conference have defeatism written all over them. Ryan Avent is disappointed and  Paul Krugman sees Fed cowardice . 6.  An excellent and thorough article on Milton Friedman's views a...

Over at Credit Writedowns , Edward Harrison discusses Richard Koo's work on balance sheet recessions.  Koo believes that monetary policy is ineffective in such settings. I disagree and have made the case before against Koo's views on balance sheet recession.  Here is the comment (with some slight edits) I left for Harrison: U.S. households during the 1920s acquired a vast amount of debt and began a deleveraging process during the Great Depression.  Consequently, there was a "balance sheet" recession in the 1930s too.  Monetary policy, however, was not impotent during this time.  At least when it was done the right way.  FDR's price level targeting from 1933-1936 sparked a robust recovery.  In my view, this experience provides a great example of why Richard Koo's balance sheet recession views are wrong .  Yes, deleveraging is a drag on the economy, but for every debtor deleveraging there is a creditor getting more payments. (And if the debt...

It is bad enough to passively allow monetary policy to tighten in an economic crisis, but to actively do so is unconscionable. Yet, as Michael T. Darda reports , that is exactly what the ECB's seems to be doing at this time (my bold): Our main concern is that it’s not just Greece. Ireland and Portugal are in very similar predicaments, while Spain’s economy, with twice the debt load of Greece, remains in deep trouble with 20% unemployment and tightening debt markets. Italy, with three times the debt load of Spain, also remains on shaky ground. If the periphery is going to survive, there has to be some path to growth/recovery. As yet, there is none. Austerity programs have dented growth and shrunk the tax base. Data for the last week show that the ECB, inexplicably, is contracting high-powered liquidity at more than a 10% year-to-year rate. Broad money across the zone is weak. Peripheral debt spreads are in the stratosphere. And funding costs are inching ever higher. To us, this is ...

This is a question that has raged in the blogosphere for some time now.  And here is an answer from Prakash Loungani et al. (2011): We provide cross-country evidence on the relative importance of cyclical and structural factors in explaining unemployment, including the sharp rise in U.S. long-term unemployment during the Great Recession of 2007-09. About 75% of the forecast error variance of unemployment is accounted for by cyclical factors-real GDP changes (Okun‘s Law), monetary and fiscal policies, and the uncertainty effects emphasized by Bloom (2009). Structural factors, which we measure using the dispersion of industry-level stock returns, account for the remaining 25 percent. For U.S. long-term unemployment the split between cyclical and structural factors is closer to 60-40, including during the Great Recession. This is a little less than Scott Sumner's 70-30 split, but is still far more weighted toward cyclical factors than Arnold Kling's Recalculation the...

Brad DeLong and Jim Grant debate whether the Fed should do QE3.  DeLong makes the case for QE3 and invokes Milton Friedman in support of his view: We have seen something like this--but worse--twice before: the Great Depression, and Japan's lost decades. A collapse in trust in the solvency of financial institutions induces the hoarding cash as part of the safe-asset tranche of portfolios. The economy's cash disappears from the transactions money stock--and so, for standard monetarist reasons, spending declines and unemployment rises... Expansionary monetary policy even at the zero lower bound via quantitative easing is what Milton Friedman recommended for the Great Depression and for Japan.  That's what Friedman would be recommending were he with us today--keep doing rounds of quantitative easing until we get the economy's transactions cash balances and the flow of spending back to normal levels. So did Milton Friedman actually recommend doing s...

According to this Bloomberg article , you are seriously discussing the adoption of an explicit inflation target.  Let me remind you that a price level target is even better since it has "memory".  Let me also remind you that during the September, 2010 FOMC meeting you folks discussed the possibility of a nominal GDP level target. There is much to like about a nominal GDP level target --it improves upon a price level target in how it handles supply shocks--and I hope you seriously consider it too.  

Raghuram Rajan has come out swinging against U.S. monetary policy.  He argues it is wrong to look to the Fed as some monetary wizard who can "revive the economy through a swish of the monetary wand."  He also believes the Fed's monetary stimulus causes more problems that it solves.  In particular, he views the Fed's low-interest rate polices causing excessive risk taking by investors and harm to savers.  On the surface his arguments are consistent with his belief that the housing and credit boom was similarly driven by monetary policy that was too easy back in the early-to-mid 2000s.  I am sympathetic to his views on the Fed's role in the housing and credit boom, but believe his current take on U.S. monetary policy is off.  Let me explain why. First, a low policy interest rate target by itself does not mean monetary policy is loose, let alone too loose.  Interest rates have to be low relative to the neutral (or the natural) interest rate to be stimul...

San Francisco Fed economist Fernanda Nechio shows us in one picture the ECB monetary policy mess: If there were any doubt that the ECB is in practice narrowly setting monetary policy for the core countries (i.e. Germany and France) this figure should remove it.  The figure should also nix any doubts as to whether what is good for the core is good for the periphery.  ECB monetary policy was too loose in the early-to-mid 2000s and now it is too tight.  If the ECB really wants to preserve the Eurozone in its current form it must confront this reality.  So far it hasn't and this is why I say the ECB is fiddling while the Eurozone is burning .

Nouriel Roubini has written a number of good pieces on the Eurozone crisis.  His latest one in the Financial Times is no different.  It provides a summary of how the Eurozone got to this point and the options left for it going foward.  Here are the options according to Roubini: (1) The euro could fall sharply in value towards – say – parity with the US dollar, to restore competitiveness to the periphery; but a sharp fall of the euro is unlikely given the trade strength of Germany and the hawkish policies of the European Central Bank . (2) The German route — reforms to increase productivity growth and keep a lid on wage growth — will not work either. In the short run such reforms actually tend to reduce growth and it took more than a decade for Germany to restore its competitiveness, a horizon that is way too long for periphery economies that need growth soon. (3) Deflation is a third option, but this is also associated with persistent recession. Argentina tried th...

So the European Central Bank (ECB) has decided to follow through on its plans to tighten monetary policy this year. The ECB will begin by raising its benchmark interest rate next month.  This is unbelievable. The Eurozone is under severe pressure that could ultimately lead to its breakup and yet the primary concern at the ECB is tightening monetary policy according to schedule.  If followed through, the consequences of this are not only bad for the Eurozone, but for the rest of the global economy too.  The slow-motion bank run now taking place in the Eurozone could easily turn into another severe global financial crisis.   So why then is the ECB pushing so hard for monetary policy tightening?  From the New York Times we learn the answer: With Germany, the euro zone’s largest economy, growing so quickly that some economists fear overheating, the E.C.B. has been trying to nudge interest rates back to levels that would be normal in an upturn. Silly me, I...

Mark Thoma cues us in on the hot issues to look for in Ben Bernanke's speech today.  Here are ten questions Bernanke will not answer in that speech, but I wish he would consider:  Does the recent decline in the Treasury break-even inflation expectations raise concerns for the Fed? On a per capita basis, domestic nominal spending is still below its pre-crisis peak level.  Should the Fed be concerned about this?   In past speeches you and other Fed officials have mentioned the Fed could raise the interest payment on excess reserves (IOR) as a way to prevent the large stock of excess reserves from being invested in higher yielding loans or securities.  In other words, you and other Fed officials have claimed the Fed can effectively tighten monetary policy by raising IOR. By that same reasoning, wouldn't that mean the Fed could lower the IOR to loosen monetary policy and thus, by implementing IOR in the first place in late 2008 the Fed effectively tighten...

Nick Rowe reminds us that if a central bank is doing a good job in terms of hitting its nominal target, then both the indicator variables and the monetary policy instrument it uses should not be correlated with the target. For example, say the central bank were targeting a nominal GDP growth of about 5% a year and adjusted the stance of monetary policy to offset velocity shocks so that the 5% target was hit on average.  Though the stance of monetary policy would be systematically related to the velocity shocks it would not be correlated with nominal GDP growth. An observer, not knowing any better, might study the empirical relationship between the stance of monetary policy and nominal GDP growth and conclude monetary policy is ineffective with regards to nominal spending when in fact it is very effective.   This insight is important for several reasons. First, it helps shed light on why it monetary policy shocks  in empirical studies appear to have less o...

Robert Lucas has been taking some heat around the blogosphere for a lecture he gave at the University of Washington.  Scott Sumner responds: In a recent talk , Robert Lucas argued that a decline in “spending” (i.e. NGDP) produced the severe contractions of 1929-33 and 2008-09.  He argued that the slow recoveries were caused by adverse supply-side polices.  This is not “classical” or RBC economics, it’s AS/AD.   I think he’s right about the the Great Depression and the recent contraction, but only about 30% right about the current recovery (I attribute 70% of the slow recovery to lack of NGDP growth.)  Oddly, Paul Krugman and Matt Yglesias  seem to think that Lucas denies that demand shocks cause recessions–which is clearly not Lucas’s view. Let me add to this discussion by noting that recently I met Robert Lucas at a conference.  We started talking and, among other things, he expressed his support for nominal GDP targeting because it woul...

George Selgin is now blogging .  It is about time.  He is the individual who introduced me to nominal GDP targeting, the monetary disequilibrium view of recessions, benign vs. malign deflation, and other interesting ideas. I was fortunate to have him as a professor and now the rest of world can have access to him too.   To get a taste of the Selgian view of the world, here is a recent article of his evaluating the Fed's performance and here is an older monograph where he promotes his Productivity Norm Rule for monetary policy. 

Gautti Eggertson has an interesting post where he compares current economic conditions to those that prevailed leading up to the recession of 1937-1938. Here is his description of developments in 1937: (1) Signs indicate that the recession is finally over. (2) Short-term interest rates have been close to zero for years but are now expected to rise. (3) Some are concerned about excessive inflation. (4) Inflation concerns are partly driven by a large expansion in the monetary base in recent years and by banks’ massive holding of excess reserves. (5) Furthermore, some are worried that the recent rally in commodity prices threatens to ignite an inflation spiral. The Federal Reserve responded at this time by tightening monetary policy.  Fiscal policy also was tightened. These policy moves turned what had been a robust recovery between 1933 and 1936 into the second recession of the Great Depression. As a result, a full economic recovery was postponed sev...