Any bearing on the price of gold going up 100 points in the past two weeks (as of last night), after having been slumping for the previous two weeks? Someone seems to think inflation is very likely to be a result of some recent monetary action(s).
Roddy
I have a small amount of money in a gold/silver stock as a hedge. It jumped 5% in value in the hour after Bernanke’s announcement, and it has continued to rise since. It’s up 9% since the announcement. So someone certainly thinks the currency has been devalued or inflation risk has increased.
Sam:
Money supply, as measured by M2, jumped up in 2008. Inflation declined. Draw a line from June 2008 to the present, and you can see that we remain above trend. Inflation is still declining, alas.
Play with data here:
M2 (DISCONTINUED) | FRED | St. Louis Fed,
More generally, monetarism got mugged by reality during the 1980s. First monetarists pushed M1 as a target, then M2, then M3, then Monetary Base, St. Louis, then Domestic Nonfinancial Debt. All of these seemed to be related to the economy at one time or another until they were not. Charles Goodhart, Professor Emiritous at LSE once related, “Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Goodhart's law - Wikipedia
With that in mind, let’s look at M1. We can see its explosion precisely during the time that the US entered its era of great deflation:
But check out the Monetary Base. This chart made nutty conservatives panic a couple of years ago: “Hyperinflation!” they cried. In reality, the exact opposite occurred.
St. Louis Adjusted Monetary Base (DISCONTINUED) (BASE) | FRED | St. Louis Fed
Ok, but what do the investment professionals think? The US sells both bonds and inflation adjusted bonds. A simple calculation nets out the expected inflation rate. Over the next 10 years inflation is expected to be about 2.1%. Over the next 5 years it’s expected to be 1.7%. This is lower than it was 4 years ago, before the crisis began. Inflation expectations are low: they are too low in my opinion. If they were at 5%, investment might pick up given today’s rate climate. Constantly refreshing link: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Terrific. What do you think will happen to inflation if there’s a double dip? Will we get deflation? If so, how could the US pull out of that wage/deflation spiral if they can use neither monetary nor fiscal policy? This is the sort of thinking that gave us a Great Depression. But hey, if we believe in Stone-monetarism inflation should be around the corner next year, right?
Ok, snark aside, let me note that Sam’s position is hardly unusual. And he deserves props for explaining his underlying model. It’s just that we’ve seen this movie before --during the 1930s. Andrew Mellon IIRC was the champion of Sam’s current position: they were called liquidationists. What surprised me in 2007-2010 was that there are strong political barriers to applying conventional macroeconomic policy in the aftermath of a deep financial meltdown, even with the benefits of hindsight and past experience. After a certain point, big packages become unpopular. Heck, even small packages are: witness QE2.
I wager 100 quatloos
Sam: What are the odds that core CPI inflation surpasses 7% in the next 2 years? I say, “2%”, or “De Minimus”. And the percentage odds that inflation exceeds 14% are 0.
Measure for Measure : Thanks for that yield curve link. Isn’t it rare for it to be nearly linear?
I remember about a week ago after the details of QE2 were announced, the 30 year spiked up by some huge amount - 50 basis points? More maybe? I don’t remember. So before that, it must have had a little bit of a tail on the long end.
A valid point.
Okay, a couple of things. First, I supported the first round of Quantitative Easing. In fact, I advocated for it on this board before Bernanke even did it. And I didn’t strongly object to QE2 here. I simply pointed out that the case for QE this time around wasn’t as strong. I admitted that it could do some good, but that it also carried a number of risks, and in my admittedly amateur judgment, the risk/reward tilted slightly against it. So don’t hold me out as some big opponent of Quantitative Easing.
However, I should point out that since I made the first post about potential risks including international blowback, China appears to be taking steps to counteract the Fed’s move and Germany’s central bank has issued harsh words against the U.S. If QE2 triggers a selloff of U.S. securities, or a trade war, or a fiscal response from China and Germany and others, it could be very bad. That’s one of the risks I mentioned.
As for the future potential for inflation, I don’t think there will be much either. But that’s not because I expect robust growth and a rapid increase in velocity with no inflationary pressure - it’s because I don’t think the economy’s going to get better any time soon. So I didn’t say I believed inflation was right around the corner, I said that IF the economy started to heat up, then all the QE that’s gone on is going to become a problem, and potentially choke off the recovery. But I don’t think that’s likely, because I think the U.S. is heading into a long period of very low growth. The fundamentals are all just too bad for me to see a light at the end of the tunnel.
So if the market is predicting low inflation, there are two possibilities - one is that it sees decent economic growth coming and yet doesn’t think the QE is going to lead to inflation (because they believe Bernanke’s claim that he’s got the tools to unwind all the liquidity without harm), OR they think there won’t be inflation because the economy is going to stay in the crapper.
Which do you think is more likely?
I know you’re not asking me (as if that would be a relevant consideration anyway 
), but I think that we will chug along until we reach a tipping point. From that point forward, things will unwind very quickly - and I don’t think anyone will see it coming.
By ‘tipping point’ what I mean is that you will probably see things like the multiplier increase at a moderately increasing rate but not enough to spur any kind of radical response from the fed. Once it becomes clear what is happening, the fed will have to act very quickly.
I would like to think that they have planned for this possibility in the form of working on methods of quickly draining liquidity. That was the idea behind the reverse repo’s they were looking into earlier in the year I think. Not sure whatever happened to that program. Presumably they’ve followed through on that and if so, it’s certainly one tool they could use to that end.
Once that happens, the fed’s timing will have to be exquisite. Maybe I’m naive, but I think Uncle Ben can pull it off.
Thanks for the clarification. I didn’t pick that up. The problem is that it is likely (i.e. I predict) that QE2 will be enhanced next year. Also as it stands I see the risks as de minimus and the risks of inaction to be substantial.
Germany has whined, as has China. So what? If China decides to stop buying US bonds, that’s great – what the world needs is an appreciation of the Yuan. US interest rates have hit the lower bound, so Chinese purchases of US Bonds don’t do us any good. And if China and Germany decide to run higher budget deficits – great – it will add to world aggregate demand.
The current account surpluses of both Germany and China are too high, while the US’s trade deficit is too high. To correct that should involve a decline in the US dollar relative to those 2 countries. In other words they have to retract their export industries and stimulate domestic demand. Lots of interest groups will be unhappy. So the yelps are to be expected.
But a collapse in the dollar is one of the mechanisms for higher inflation!
How could QE2 choke off the recovery?
I think we’re in a liquidity trap, a balance sheet recession and the aftermath of a financial crisis. In a general sense, the solution is to fix the bank’s balance sheets and stimulate AD with fiscal and monetary policy. I knew the former was politically hard. Now I know the latter is as well. I’ve learned a lot about macroeconomics and political economy since July 2007.
Well the bond market is predicting an increase in the inflation rate (from 0.8 (core rate) to 1.7 (general rate, but over 5 years)), while stock market valuations don’t seem to be factoring in recession. So that means… a slow but steady recovery?
I need to think much harder about this, but if we get tight fiscal policy and mildly accomodative monetary policy, unemployment will remain high. If unemployment remains a lot above NAIRU (which it is 9.7>>5.5) then disinflation should occur, making monetary policy less effective. That scenario points to a lost decade. (Could profits hold up under those circumstances? After all, wages would be repressed.) What I need to ask myself is how this scenario can be wrong. Traditionally, US economic recovery has been grounded on an upswing in consumption and private residential construction. That seems unlikely until the banks get their books in order. In other countries experiencing financial crisis (Canada, Sweden), export-oriented growth has saved the day. But the world is in recession, and I doubt whether the BRICs are big enough to pull us out of it.
Then again, gloomy forecasts are always easy to make.
Not according to my memory. But 30 year rates are astonishingly low. It’s a great time for the US government to borrow long and invest in infrastructure projects.
This post has gone long enough. Q: What policy change could a) clean up the bank’s books, b) stimulate the economy, c) prevent future liquidity traps and d) lower the necessity of future $1.5 trillion stimulus packages? Answer to come later!
Here’s some links on historical yield curves:
It’s almost like Friedman’s basic premise was complete hogwash and based on statistical manipulation that can only be described as either idiotic or fundamentally dishonest. Maybe, just maybe, the government has no real control over the money supply, and factors other than money supply growth are the cause of inflation (which itself can be one of the greatest causes of increase in the money supply).
Your conclusion is right, but the Goodhart justification for it is weak tea.
The reason why the various monetary aggregates never worked as targets is not because they lost their statistical regularity once they were used for “control purposes”. It’s much simpler. Monetary targets have never worked. Money is tricky, and using any monetary aggregate is destined to become irregular. It’s not necessarily related to using those aggregates as a target, as you’ve demonstrated yourself with your cite from the M2. Using the M2 today for “control purposes” couldn’t destroy its current statistical regularity because it doesn’t have any useful statistical regularity to begin with. The periods of apparent regularity are, to oversimplify a bit, basically coincidence on which they attempted to build a framework. The framework failed, because the apparent statistical regularity was an illusion.
It’s like those data hounds who use past stock market data in an attempt to develop predictive correlations. Half-trained math geeks see a relationship in past figures and immediately assume a causal relationship. They make their bets, and the relationship collapses. If they were actually more well versed in statistics, they’d know that sniffling through old data sets is destined to turn up meaningless relationships. It is mathematically inevitable that strong correlations will randomly turn up. It is just as inevitable that those relationships will disappear in the future, not because using those correlations as targets destroys the statistical regularity, but because the apparent regularity was a phantom from the beginning.
The “Reverse Goodhart’s Law” from the wiki page is a classic example of post hoc justification along these lines. The correlation started to work again for a while, and instead of acknowledging that it’s just random noise, people attempted to find yet another causal justification.
I strongly disagree with the view that all that money is being checked by a dam ready to burst at a moment’s notice. I can’t see that happening in any circumstance short of a debt crisis. If you have some mechanism to explain it, I’m willing to listen to the reasoning, but so far, I’ve heard nothing that substantiates it. Everything about the economy points to a gradual change.
Near 10% unemployment, with even higher underemployment, acts as an enormous downward pressure on prices. Effective QE means an upward pressure on prices, but it still has to overcome the pressure from unemployment. The deflationary tendency will decrease as the unemployment rate drops, but it will still be strong for a long time. The Fed’s money management should work against that deflationary pressure and increase the price level, but it should be a slow process as the two forces work against each other. Another way of saying it: Prices increase when demand increases, as too many dollars chase around too few goods. But we have a general glut right now. The first thing those new dollars are going to do is buy up all those cheap idle resources, rather than bidding up the prices of already utilized goods. That means a gradual increase in prices.
There is no flash point here, no sudden change that would require quick action by the Fed.
You won’t find anyone more enthusiastic than me when it comes to bashing libertarian excesses, but this simply isn’t fair.
Originally, Friedman was dealing with long term trends with respect to money, and those trends hold. They’re solid. If everyone believed that the Fed were unable to suck those extra dollars out of the system, inflation would hit and hit hard. Now of course, anyone who cares about the data should know that money isn’t neutral in the short run, but Friedman himself dumped his own rule of constant money supply growth when the data from the 80s and 90s made it apparent that such targeting wasn’t useful. He had extreme ideological eccentricities, but he was in fact able to change his mind based on new evidence.
And most important, the “quasi-monetarist” school of constant nominal income growth is still alive and kicking, and in fact has been winning every argument recently. This is the view that takes into account changes in velocity. If the quasi-monetarists win – and the more time that passes, the less Keynesian and more quasi-monetarist I become – then Friedman’s underlying ideas will ultimately be vindicated, even if his original choice of money supply targeting was not.
This is a request to summarize a couple centuries worth of macroeconomic thought. Tough, but I will try to put it in simple terms.
First, people’s wants are essentially limitless. Second, unemployment is bad, but it is also doesn’t seem to make any logical sense. Our wants are limitless, right? (See point the first.) So if we threw all those idle workers back into jobs, then we’d have even more stuff for our limitless wants. More stuff is good. And yet those people aren’t working to give us more stuff, even though we’d all be better off if everyone had jobs and more stuff. Just doesn’t make sense. So we have to untangle another couple knots, and those are the problems of time and money. Time: Our wants are limitless, but that doesn’t mean we want everything today. We can choose the future over the present. Money: We’re not a barter economy. We can choose future consumption over present consumption by holding on to our cash instead of spending it. Instead of buying things today, we save for tomorrow.
The Problem: If everyone collectively chooses the future over the present, then we have idle resources right now, in the present. Workers get fired, capital equipment rusts. And that present economic damage destroys our future ability to have a better economy with more stuff. We attempt to be responsible by saving, and that very responsibility destroys our ability to save. We perversely damage ourselves with an attempt to be good. What’s worse: by saving money, we increase the value of the money (more money demand increases the “price”, causing deflation). This increase in the value of money makes people even more likely to hoard their cash, since their cash is becoming more valuable with no effort. It is a hideous self-reinforcing cycle.
The QE Solution: Print more money. Make money less valuable, so it moves around more quickly. As it moves around, it will gobble up idle resources. Idle factories will hum with activity. People will go back to work.
And yes, it will work. It won’t be perfect, but it’s a step in the right direction. The problem with the Fed’s QE is not that they did it, but that they didn’t go far enough. They’re a day late and a dollar short. Or more precisely, they are several hundred days late and a few trillion dollars short. Of course, there are people who disagree. Why do they disagree? Because macroeconomics is hard. I mean, I doubt it’s as tough as quantum mechanics, but it’s extremely counter-intuitive. Every single one of the steps I outlined above is attested to with copious evidence, but history is also full of examples of irresponsible countries debasing their currency, like the Weimar Republic or modern Zimbabwe. People who scream of the dangers of hyperinflation know the example of 1920s Germany with their wheelbarrows full of bills, but they don’t know or understand the example of 1930s France or modern Japan.
They’ve got half a picture, and hyperinflation is a very compelling picture. It’s like knowing the dangers of fire, with no knowledge of what hypothermia is. That’s why they scream themselves hoarse about dollar collapse, even as we were suffering disinflation.
Cool. There was something I wanted to respond to in the first section and that just happens to tie into my response to the second section.
I suspect that there are some meaningful correlations between very broad measures of the money supply and the business cycle simply because more economic activity requires more money in order to facilitate the additional transactions. I think the problem is that the money supply is reactive rather than predictive (except of course when manipulated by the fed - and even then, it’s not something you can always count on). I have no basis for this but I would suspect that it lags the business cycle so much that it probably approaches being counter-cyclical - much like employment statistics. Employment always peaks after the peak of the business cycle. However it’s probably not a testable hypothesis since the fed is so active in managing the money supply.
The point I want to make though is that money creation is no longer a function purely of the fractional reserve banking system. You have so many other players, the “shadow banking system” if you will permit, that new money can be created at an accelerated rate. Witness the growth of CDS’s and other derivatives. Although presumably entities such as AIG will now be held to reserve requirements similar to other financial institutions, new instruments are always coming into existence and can add to the money supply as effectively as bank lending. What’s worse, much of this money creation is not tracked. Although it’s not really on point, take dark pools as an example. Large institutional traders and hedge funds can move literally millions of shares of stock on these private exchanges with virtually no reporting of their activities. And the prices negotiated, if they are substantially greater or less than the market price are sure to move the market.
So there are mechanisms already in place and new ones being invented every year that facilitate the shadow banking system and make it in many ways preferable to standard banking, brokerage, insurance, etc operations.
However I think you may have assumed I meant something more dramatic than I did. The reason the fed’s timing has to be exquisite is that there is such a long time delay between FOMC operations and those operations having an effect. And that delay is just as insidious on the prediction side as it is the implementation side. By the time a trend becomes clear, it is already well under way. That means that it not only has to be properly anticipated, but the response has to be properly measured as well. It’s not enough that you hit the target but that you hit it with the right type of round.
Having said all of that though I would emphasize that it is simply speculation on my part. I have nothing to base this analysis on except my ongoing attempt to make sense of how the markets operate. I do have a background in finance but these ideas are the result of trying to synthesis the disparate pieces of financial information flying at one every day.
This is an excellent point, and it’s yet another reason why the classical monetarist ideal of targeting the money supply is useless.
I agree fully with the problem on the prediction side, and disagree just as fully on the implementation side. The problem with the Fed’s actions taking effect is almost entirely on the prediction side.
The important thing is long term expectations. The Fed can print a trillion bucks today to very little effect if everyone thinks they will destroy that trillion tomorrow. And in fact, that is almost exactly what happened with the first QE. It’s like a genie putting a trillion dollar bill in your pocket, telling you that the bill will disappear the moment before you try to spend it. It won’t change your buying behavior at all, because you can’t rely on it. This is also the main problem with QE2. It’s this lack of trust in the Fed that is undermining their own mission. If Bernanke held a press conference tomorrow and announced an explicit long term nominal income path target – and then said that they’ll do absolutely everything within their power to hit their target – then the effect of reducing that uncertainty would be felt immediately.
People would respond not just to the open market desk’s day-to-day operations, but more importantly to the predictability and reliability of their long term target. It’s okay to miss your target today if everyone in the world is totally certain that you’re going to compensate tomorrow to improve your aim. Although inflationary pressure might creep up faster than expected, a reliable long term target would mean that everyone would know, in advance, how the Fed would respond. And they would shift their behavior according to those expectations, not having to wait for the next FOMC meeting. They would already know what the decision would be.
I think that’s a great post.
However, I would like some clarification on this:
Isn’t this the conclusion that the classical Keynesians got in trouble over with respect to stagflation in the 1970’s? You’re not supposed to get inflation while simultaneously having high unemployment and low economic growth. But we did. This failure to explain stagflation struck a blow to Keynesian economics that I don’t think it’s really recovered from. The New Keynesians have tried to find a balance by resorting to models of wage stickiness and microeconomic theories and all that, but it doesn’t seem to me that a real, comprehensive and consistent model that explains this has been developed. Rather, it seems to me that the New Keynesians are simply pointing at a grab-bag of ideas as possible explanations and then reverting back to the same old models that ran into trouble in the 70’s. Am I wrong about that?
It seems to me that the downward pressure on prices must result from a change in employment, not the absolute level. Canada maintained structural unemployment two percentage points higher than the U.S. for the period from the 1970’s to the 1990’s, and we didn’t have deflationary pressure. The EU zone has maintained higher unemployment than the U.S. without deflationary pressure. At some point, once the unemployment becomes structural and the new reality baked into economy, the downward price pressure must diminish, no? If so, do we have models that describe the process of downward pressure on prices easing even though unemployment remains high?
How long? And how do we know this? What historical data do we have that gives us enough information to make that determination? Stagflation caught economists napping in the 1970’s.
Are we so sure that Lucas was wrong about rational expectations that we believe the market won’t notice the obvious temporary nature of the QE? What if the money isn’t circulating precisely because people believe that the rug will be yanked out from under them the minute they start spending in earnest? Friedman’s Permanent Income Hypothesis would also suggest that when people can see that the money supply is being artificially increased (or that fiscal stimulus is obviously temporary) that they’ll act to counteract those attempts at macro manipulation.
For bubbles to develop, people have to believe that they aren’t in a bubble. Greenspan himself justified artificially low interest rates because he felt that technology had created a permanent productivity boom. People thought real estate prices were increasing for solid fundamental reasons for quite a long time before the bubble started to be apparent.
As a thought exercise, what if Greenspan had announced on the internet in 2001, “Hey everyone, I’m going to hold interest rates a point or two below where they should be, simply to help GDP growth. At some point, this will have to change. Now, run out and buy those 40 year floating rate mortgages!” would his low interest rate policy have had the same effect?
When Bernanke says, “Hey, I’m expanding the money supply. But don’t worry - I’ve got a plan to yank all that liquidity right back out again as soon as you people start moving it around”, what effect does that have on the efficacy of QE?
Finally, what does QE really do in a global economy with floating exchange rates? Do we really understand that? Is there not a risk that all this liquidity will wind up triggering asset bubbles in other countries rather than doing any good here, just as the excess liquidity from China helped kick off the asset bubble in the U.S. the last time around?
I assume this went without saying and I don’t want to seem snarky, but you all do realize that the fed putting new money into the economy is only the first step in a long series of steps that results in more money floating around - right?
The money multiplier is not instantaneous. You can see that just by comparing the theoretical to observed values. Theoretically, the multiplier is the inverse of the reserve ratio (inverse of 10-15% = 1/.1 for simplicity or 10), but the observed multiplier effect over the course of a year is from 2-3 at least over the past 25 years or so.
So yes, the fed can put $600B into the economy, but if the multiplier is operating at levels approaching what we’ve seen historically rather than the abysmal .8 to .9 we’ve been seeing, then each new dollar generates $1.00 x .9 (1 - reserve ratio). And that new 90 cents generates 81 new cents ($0.90 x .9) . . . and so on ad infinitum.
By definition, this process takes time.
for Sam Stone: I hate dissecting posts (call me lazy), and I don’t want to attempt to defend Hell’s thesis, so I just respond generally.
The idea behind QE2 is embodied in the securities that are being targeted - 2-10 year treasuries. This has the effect of increasing the prices of these securities and therefore decreasing the yield to maturity. Normally you would expect any such action as the injection of $600B to bring out the bond vigilantes at all points along the yield curve - at least for anything past a year or 2. But in this case, the focused attack on these maturities probably overwhelms any other factors.
However you did see the yield on the 30yr nearly jump off the coupon when this was announced. That’s the result you would expect for everything, but that’s not what has happened.
Aside from lowering the yields on these maturities, a second purpose is to deliberately stoke fears of inflation. If people think their dollars will be worth less, they will have a bias to present consumption. Part of the reason this recovery is so sluggish is the fact that the savings rate went from maybe 2-3% to something approaching 8% at the height of the crisis. Those numbers might be off a bit but that doesn’t really matter, the point is that we went from a nation of spendthrifts to misers virtually overnight. The savings rate has gone back down as things have gotten better and I don’t know what it is now but I’m fairly sure it is nothing close to the pre-collapse lows.
So while having a moderately high savings rate is generally a good thing, it’s a very bad thing right now - hence this seemingly bizarre action by the fed to encourage spending.
The third purpose I can think of is to force investors into riskier assets. If you know that your 10year note is going to have a negative yield after (expected) inflation, you’re going to run away from such investments as fast as your little capitalist piggie legs can carry you. But since putting the money into short term assets like money markets or bank accounts is an even stupider move, you will look for other places to invest. That usually means corporate paper.
The influx of buyers to the corporate paper market now forces down yields there as well. With lower rates and more plentiful capital, businesses can borrow more easily and therefore spend more readily.
Yes, it is. And it’s the difference between short and long term thinking, and deflation and inflation.
Those Keynesians were attempting to use political spending to balance out the business cycle, but that sort of fiscal stimulus can’t be fine-tuned. It comes with significant lags. By the time they got the spending projects out, the economic problem was over. The output gap was already closing, and so the spending, unable to close a gap that was already closed, contributed instead to inflationary pressure. The first time you do this, short term, it’s okay. But what happens when you have a severe monetary shock (e.g. Nixon axing Bretton Woods) at the same time that your fiscal policy is seriously lagging? That’s when you have problems. You will be destined to overshoot, and not just in a normal time which might be manageable, but only after inflation expectations became totally untethered by the massive money shock.
That was, in fact, one of the chief monetarist criticisms: New money does not come with the same uncertainty, nor with the same lags, as govt spending. With the right monetary policy, you can keep it in the short run.
I’m not assuming different countries should necessarily have the same NAIRU.
If you spend a long enough time with high unemployment, your NAIRU is going to rise. But it’s not going to rise overnight. Without a massive shock, it takes some doing for people to readjust their inflation expectations, and deflation is not going to speed this process because it’s self-reinforcing. Japan has an extremely low NAIRU, which to this day hasn’t risen to accommodate their current level of unemployment. Despite having low unemployment rates compared to the west, they are still managing to experience intense deflationary pressure.
All of this is to say that the Phillips Curve holds in the short run, and the short run can be uncomfortably long when deflationary expectations have taken hold.
And the Great Depression caught economists flat-footed in the 30s. 'Tis a good thing to be educable.
For “how long”, the answer is: A decade, or possibly more. For evidence, you need only look at any period of deflation that corresponds with a deliberate tight money policy (defined either as a deliberate contraction of the money supply, or perhaps better, a drop in NGDP). These are, yes, a lot more rare than the typical currency crisis, but they have the compensatory benefit of lasting freakin forever, so the short gasps of monetary expansion stick out. Look at the Great Depression, or the Long Depression (Friedman covers both in his and Schwartz’s Monetary History: they call the 19th century deflation problems “The Disturbed Years”.) Look, too, at modern Japan and their listless flirtation with expanding the base, and look even at our current predicament. They all follow the same pattern.
A huge money shock (Nixon!) is going to loosen people’s mental attachments to current price levels, right quick. It doesn’t work the same way with prices going down, precisely because prices are resistant to going down. A big financial-crisis-deflationary-shock is built to last. People hate it when their wages drop, and that’s going to keep the deflationary pressure intense, potentially for ten years or more. So yes, the US NAIRU will be going up. But not very quickly. This will be a slow bleed.
Nothing I’ve written is contrary to Ratex. Look above at my response to dzero about the genie and the trillion dollar bill.
Where Lucas goes wrong is in being a little too Goodhart himself and assuming that all aggregates lose their information because of rational expectations. He seems to think it’s always like gaming a risk model, where knowing the parameters of the model allows you to work around it. Ratex explains stagflation, but it isn’t inconsistent with other macro theories. Economists have worked Ratex right into New Keynesianism itself, basically because some parameters can’t be wished away. The fact that some prices are fluid (stocks, exchange rates) and some are not (wages) is something that can’t be dodged. It can’t be gamed. You have to accept that psychological oddity as the way of the world, and compensate for it. What I’m arguing is at core a New Keynesian model, without the spending part of it. Ratex is right there in it, explaining stimulus and stagflation together.
That means expectations can be managed. And the key to managing them is doing what you say you’re going to do. Tell the plain truth about your intentions and follow through. That’s all it takes. Bernanke’s promise, which he’s now apparently making good on, means pushing inflation back to 2% before pulling the plug. That’s not even proper inflation. That’s just reflation.
This is again related to my response to dzero. If expectations change, then the effects will change.
Of course, given the bubble mentality, it’s hard to say how much more careful people would have been, even if the message of higher future rates had been conveyed into their brains with a high powered drill. Still, some would have been more cautious.
This is one of many possible results. And?
We can’t police other nations’ banks. We can’t clean out their corruption, can’t give them fair elections, can’t reduce their onerous regulations, can’t tell them how to live their lives. We have enough trouble governing ourselves, let alone other countries. So, yes, they could indeed have a bubble, and one of the many causes of such a bubble could be too much foreign investment from the weak USD. Or they could have a bubble from their own inept domestic currency manipulations (as China is possibly doing), and then hypocritically complain when another country starts massaging its own currency. Or, possibly, the increase in American demand from a successful bout of QE will spur more growth overseas, as the Chinese vice-minister of finance correctly suggested is likely to happen. Or, possibly, more funds floating in the foreign exchange markets could be used to quicken other countries’ domestic development, allowing them time to build up their own domestic demand to bring themselves into the developed world. Hell, lots of ways this could play out. Are there dangers for other countries? Possibly. Are there dangers of inaction? Definitely. It is of course true that other countries will have to react to what we do, but that would be so no matter what we do. And yes, they might make a mistake in those reactions.
Which is to say: situation normal.
What would be absurd is to pretend we can make everything better for others without first trying to fix our own problems. A stronger US will (eventually) make other countries better off, but we can’t hold their hands through the whole process. They’re big boys and girls, and they have to figure this money thing out for themselves. It would be right depressing if some countries couldn’t juggle the transition, but we can’t let their clumsiness dictate our own affairs. This is just printing bucks, not anything along the lines of a real moral dilemma with legitimate dangers. We’re not offering up the blood of hundreds of thousands of innocent foreigners for our own peace-of-mind, which is a genuine not-to-be-ignored possibility one would have to honestly face when one advocated for a serious international incident such as military invasion. This is not that. This isn’t even a beggar-thy-neighbor policy, as we can fairly accuse China of doing, deliberately reducing domestic demand to favor their exports. US demand should be headed up, not down, which will in the end turn out good for everyone. This is just a bit of greenback printing to get the money flowing again, and other countries should be able to deal with that.
Sure, the money multiplier takes time. But that’s not the most important part of this process.
I don’t particularly care about the money multiplier, as least not by itself, because loans are simply one form of money movement, and as Measure for Measure already noted in his own post, relying on any aggregate money measure tends to be unreliable. You’ve already pointed out that people create new forms of money that are hard to track, and that means that the multiplier for your chosen form of money tends to wax and wane in significance in seemingly random ways, as people choose different forms of money to suit their purposes as the situation changes. To say it again: The money supply, and thus any given multiplier, is simply not unreliable. What I care about, instead, is all kinds of money movement, whether from loans or not, which is to say that I care about total nominal income (nominal GDP): the total value of the economy, in terms of the numbers on the bills that actually change hands.
There is no need to wait on making the new money available for loans for the effect to start taking place. Nominal income expectations can increase immediately, just based on fluid markets like stocks and exchange rates. US exports were in a sweet spot just on the expectation of Fed action, before the FOMC ever met. Bernanke said a few nice words, and recovery became a little more swift. No waiting there. What’s more, nominal income is also a helluva lot easier to measure than the tricksome money supply. The Fed actually has an extraordinary amount of control over nominal GDP expectations, and that’s true even before the open market desk has made a single trade.
It’s not just the new money that has to bounce around. The old money can pick up some velocity as well, without the wait.
You’re missing the point. Your contention is that there is no lag on the implementation side. By your own admission, there has to be - unless it is your contention that in the shadow system things happen instantaneously which, not to be rude, is ridiculous.
You’re missing the point. I brought up Forex and the stock market as examples of immediate policy implementation, and you keep talking about banking. Well, I don’t care about the lag in banking. It could take the banking system, whether traditional or shadow, a month to get round to doing their thing. It could take them six months. Hell, it could take them a year or more to react, and it wouldn’t make the slightest bit of difference to the effects I’m talking about, as long as people were fully confident in their expectations.
Maybe this would be better illustrated with a non-bank example. Let’s say I invent the new Hellalchemist 3000: Converts Lead to Gold in No Time Flat! But I don’t build it. I simply design the thing and send the plans to MIT to confirm it works. And the technologists there, after squinting at the design schematics and grunting to themselves for a few weeks, confirm that my machine would work exactly as I say, allowing gold production to expand however fast we want. Maybe it would take a month to build the machine. Maybe it would take six months. Maybe it would take a year or more to get the thing going. But you know what? The gold market collapses today. Gold miners aren’t sacked a year from now, when the machine is built. They’re sacked the moment it’s confirmed that the machine would work. Implementation begins immediately, even if it takes a while for the process to finish.
To return to the Forex example: People overseas don’t need to wait for the banking system. The USD drops in value immediately after Bee-Bee opens his mouth. US exports become more competitive immediately. US businesses who see a surge in orders from overseas start hiring workers immediately. They don’t tell their customers: “Well, sure, I’d like to be able to fill your order, but I’m going to have to wait a few months for the banking system to do whatever it does.” There’s no need for that. Forex responds not just to the present money supply, but to future expectations. Now of course, the banks need to do their part to complete the process. But implementation of Fed policy begins with zero lag, because implementation begins with shaping expectations. If expectations are properly managed, then people will be confident about future bank activities, and they won’t wait to act on that confidence. The markets will respond, and the steps to recovery will start immediately.
This is why I keep hammering the point of an explicit target (ideally, a long term nominal income path). If the Fed were operating under a clear rule, rather than under their current technocratic discretion, the markets wouldn’t even have to wait for a press release. Confidence would be built automatically, as the Fed could be fully relied upon to respond in completely predictable ways to any given situation.
I’m sorry to be rude, but I don’t think you understand how the money multiplier works. If you did, you would realize that while it does depend on lenders of all stripes “responding” as you put it, that is just the basis of the process. It is far from being a description of how the process works.
At present, lenders are not lending to the degree that would be beneficial - as is indicated by the .8 -.9 multiplier I mentioned above. This is an extremely important factor and one which you continue to ignore apparently because YOU believe it is irrelevant. Well, since it is the BASIS of monetary theory, guess what, you would be WRONG.
Your point about the market responding to news and discounting it today is irrelevant to the issue of how precise the fed’s timing needs to be. This was the bone of contention and you continue to try to change the subject. Well, you’re welcome to keep trying and I’m sure you won’t mind if I continue to ignore your attempts.