Finance Basic To Advance Level Knowledge

When I started blogging in 2007 my writing focused on the Federal Reserve's failure to properly handle the productivity boom of 2001-2004 and how this failure contributed to the global housing boom.  This productivity boom--spawned by the opening up of Asia and the ongoing technological gains--increased economic capacity, put downward pressure on inflation, and implied a higher natural interest rate.  The Fed, however, responded to the fist two developments as if they were signalling falling aggregate demand rather than rapid increases in aggregate supply.  The Fed did this by failing to raise the federal funds rate when the natural interest rate rose and then kept it well below the natural rate level for several years.  Given the Fed's monetary superpower status , this sustained easing created a global liquidity boom  that was a key force behind the "global saving glut" .  This view was what initially drove most of my blogging.  By late 2008 my f...

Martin Wolf says its time to unload both barrels of the gun and resort to true helicopter drop-types stimulus.  He has the right idea, but it could be better implemented through an explicit price level or nominal GDP level target.  Doing so is important because as Josh Hendrickson notes no one at the Fed or the ECB knows exactly how much to print. What the central banks can do, though, is properly shape expectations about future nominal spending and price growth.  Doing so would cause the markets themselves to do much of the heavy lifting (through expectation-induced portfolio rebalancings) and in the process ensure the Fed's goals are realized. Josh Hendrickson sums it up this point nicely: The Federal Reserve’s focus on the size of its asset purchases represents a grave mistake. There is no model that tells us the precise size increase in the central bank balance sheet will get us to a desired level of nominal income. Those who continue to claim that the ma...

Following a speech on Wednesday, Fed Chairman Ben Bernanke had this to say in a Q&A: "If inflation itself falls too low or inflation expectations fall too low, that would be something we'd have to respond to because we don't want deflation[.]" At first glance this statement seems reasonable, but upon further reflection there is something troubling about it.  It is the monetary policy equivalent of locking the barn door after the horse is already out.  Bernanke is saying here the Fed will respond after inflation falls too low.  Why not lock the barn door up front by explicitly targeting inflation expectations so that the public's expectations about future spending and price growth are anchored and not likely fall in the first place?   If this were the way monetary policy were conducted the Fed would be a little more concerned right now about the now 6-month downward trend in inflation expectations.   If there is one lesson the Fed sho...

Scott Sumner once compared arm wrestling with his daughter to the relationship between monetary and fiscal policy.  Scott explained that no matter how hard his daughter tried to win the arm-wrestling contest he would always apply just enough pressure to offset her efforts and keep her in check.  Likewise, no matter how hard fiscal policy may attempt to stimulate aggregate spending the Fed has the ability to offset such actions and place aggregate demand where it so chooses.  In other words, the size of the fiscal multiplier ultimately depends on the stance of monetary policy. Recent studies by Eric Leeper, Nora Traum and Todd Walker , Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo , and Michael Woodford all lend support to this understanding.  They show using formal models that in a world where nominal and real rigidities exist the impact of fiscal policy on economic activity is muted when the central bank follows something like a Taylor Rule. 1 ...

Stephen Colbert invokes his inner Keynesian spirit to propose a plan to end the Eurozone crisis and and revive the U.S. economy at the same time. The Colbert Report Get More: Colbert Report Full Episodes , Political Humor & Satire Blog , Video Archive

The latest initiative to save the Eurozone is the " Geithner Plan ." It would have the Eurozone leverage up the EU's €440 billion bailout fund to €1 trillion by making it act as an insurance fund for investors buying up debt of the troubled Eurozone countries.  Though big, this plan would only address the current debt problems.  It would not solve the large real exchange rate misalignment--30% according to Ambrose Evans-Pritchard--between the core countries and the the troubled periphery. The ECB, on the other hand, could address fix this problem. Here is how.  If the ECB were to sufficiently ease monetary policy, it would cause inflation to rise more in those parts of the Eurozone where there is less excess capacity and nominal spending is more robust.  Currently, that would be the core countries, particularly Germany.  Consequently, the price level would increase more in Germany than in the troubled countries on the Eurozone periphery.  Goods...

What explains the big sell off in markets today? As Ezra Klein notes , many observers are attributing it to the FOMC saying it sees "significant downside risk" to the economy.  Felix Salmon, however, objects to this line of reasoning: It’s silly to think that the decline in stock-market prices was a rational reaction to the FOMC statement. If the FOMC is more pessimistic than the market expected, that’s normally a good sign for markets, since it implies that monetary policy will remain looser for longer. The market cares about the Fed because the Fed controls monetary policy. And so Fed forecasts are important because they help drive that policy. No one revised down their growth expectations as a result of the FOMC statement. Actually Felix, the decline in equity markets, the drop in treasury yields, and fall in expected inflation all indicate the public has revised down its growth expectations and the most likely reason is Fed policy.  Over the past three y...