If you were in charge of the Fed, how would you stimulate the economy?

Great Debates
21

Paul Krugman disagrees with you, as does every single other reputable Keynesian economist I can think of.

It’s easy to get a wrong impression about what some economists actually believe, if you’re not fully versed on how expectations work into the process.

You started a thread about a similar topic before, which septimus also participated in. In that thread, I tried to explain this sort of false turn into mistakenly thinking that monetary policy was out of oomph, but maybe my previous posts were unclear. You two seem to be retreading a dead end. I’ll take a different tack this time. Monetary policy is not out of oomph. Not even close. Conventional monetary policy? Sure. Since he seems to be so popular here, I’d suggest going back and reading Krugman very carefully – between the lines, as it were. Every time I’ve seen that he talks about the failure of monetary policy, he’s always talking about the failure of conventional policy. But there is always unconventional policy, most importantly changing the Fed’s target. Krugman and other smart Keynesians happily admit this.

Think about it from the banks’ perspective.

You are a major executive at Convenient Hypothetical Savings & Loan. Nominal GDP was plunging in 2008, which is the same as saying that demand was plunging. Dollars weren’t moving as fast as they had been. NGDP is the total face amount of dollars that change hands for the purchase of new goods and services. When it drops, it’s because people are holding on to their greenbacks instead of spending them, a collapse of the money supply or an increase in money demand, or both. Big trouble there.

So the Fed creates more dollars on its computers. It buys a bunch of stuff from your bank, normally safe assets like Treasuries, although they’ve bought up other stuff for this crisis, too, like mortgage-backed securities. They offer a good price for these assets on your bank’s books, so you dump the securities in favor of cold hard cash. What’s more, the Fed is actually offering to pay you extra money, a quarter of a percent, for all that cash you’re sitting on: interest on reserves. Just keep that cash in your vault (or on the Fed’s computers), and they’re happy to pay you for it. You make a small return on your idle cash reserves by doing absolutely nothing.

What would cause you to want to get rid of that cash? What would make your bank’s reserves move more quickly, along with all the other money out there? Simple. Higher NGDP expectations. (Krugman would say: higher inflation expectations. But for this specific example, it amounts to the same thing.) It’s not enough for the Fed to create money. As I wrote in the other thread: Temporary cash infusions mean nothing. I wrote that three times for emphasis. I was emphasizing that point because it’s so important. Let me emphasize it again: Temporary cash infusions mean nothing. It would help a lot of people think more clearly about money if they wrote that down on a post-it note to carry around in their wallets.

You are a bank executive. If your cash gets moving, it would be only to purchase other assets: more Treasuries from other private investors, more lending, etc. You’re looking for investments here, investments that will earn you a better yield than the quarter point paid by the Fed on your cash reserves. And you are not, under any circumstances, going to let go of that cash if you believe that your investment will be worse than holding the cash. Question: What would make your new investment worse than holding cash? Obvious answer: If monetary policy tightens even more. If you and the other banks buy assets with that extra cash, you’re in deep shit if the Fed tightens. Tighter money decreases asset prices. Banks aren’t in the business of buying high and selling low. Bad for their balance sheets. Why would the banks expect tighter money? Easy. If inflation is already running around 2% (and it is), then any extra burst of demand (like Convenient Hypothetical Savings & Loan emptying out its excess reserves) is going to create more inflationary pressure. If monetary policy tightens, they’d be caught with risky assets with dropping values instead of safe cash.

The Fed already has inflation at its 2% target. You, as a bank executive, can’t get rid of your reserves in favor of non-cash investments without taking a huge risk that you’re going to get hosed when the Fed yanks back the chain and asset prices fall. That’s why money isn’t moving. Those expectations power the whole process.

How do we get money moving? This is dirt simple. Increase NGDP expectations. (Krugman would say: increase inflation expectations.) Inflation is going to both 1) increase the nominal value of many assets that you can purchase or invest in, and 2) decrease the value of your cash holdings. The little mice of higher prices would be nibbling away at your hoard of cash reserves. You’d want to find a better use for that cash if NGDP expectations were higher. Money would move. Fiscal policy can do the exact same thing – in the right circumstances, government spending can increase the number of dollars that change hands for new goods and services and break us out of this trap – but monetary policy is the cheaper way to do it.

This sums up our immediate problem. If I was at the Fed, I’d be helping Bernanke convince the hold-outs on the FOMC that we need a different target, most helpfully a NGDP path level target. That money in bank reserves would absolutely move, and move quickly, if expectations from the Fed were different. Monetary policy has plenty of oomph, but expectations about Fed policy have to change. The target has to change.

22

I have no idea what you’re trying to say. NGDP just mean nominal GDP. The phrase ‘NGDP expectations’ has no meaning that i’m aware of. I have an MBA in finance, have worked in the financial industry and am an active investor. Perhaps I missed the boat on this. I can’t rule that out. But taken on it’s face it seems to be a meaningless expression. Who, even among market participants, has any meaningful expectations about GDP as a whole? No one. Every business large and small cares only about one thing - is demand for MY products and services going to grow?

As for your comments about what banks want to do with their money, as a general rule, what they WANT to do is buy low and sell high, or more specifically, lend at high rates and borrow at low rates. If anything, the Fed’s operation twist has thwarted that effort by flattening the yield curve. This is part of the reason why the trillions, yes trillions, in excess reserves has not made it into the economy and why the multiplier is so low. You seem to either not understand or not grasp the importance of the multiplier effect as that is critical to this argument and you have glossed over it completely.

Finally, as to Krugman’s opinion, I don’t follow him and couldn’t possibly care less. I’m sure he is well regarded in many circles and I do tend to agree with his brand of Keynsianism, but beyond that, I don’t know and don’t care.

23

That’s not intended to be confusing. It’s just expectations about the future course of nominal GDP. What do people think that GDP, as measured, will be next month? Six months out? Next year?

Expectations of the future level of nominal GDP is the single best measure we have of expected future demand in the economy. By some definitions, NGDP is the same thing as aggregate demand. They can be seen as equivalent. These estimates are obviously not perfect, but they don’t have to be to give us a guideline.

The whole point about markets is their ability to aggregate information. The market as a whole knows things that individuals can’t possibly know.

When I’m talking about these estimates, the information used to make them comes from markets with individual people making decisions. Of course individuals don’t think about the whole thing. They think about their own little slice. But if you combine the slices into a whole, you’re going to get a picture of where people as a whole think these macroeconomic variables are headed in the next several quarters. A real bank is going to respond to real conditions on the ground as they see things happening. Hypothetical Bank and Trust is going to respond the whole thing together – it’s the collected decision-making of every individual market. Add up all the little decisions and you get the market as a whole.

I didn’t gloss over it. The money supply (after the multiplier, or whatever other definition you want to use) times the velocity of money is, by definition, nominal GDP. It’s also taken into account.

You seem to be focused on the “multiplier” as the basis of monetary policy. It isn’t, at least not by itself. There are two pieces: the supply of money, as multiplied by the banks, and also how fast that money is moving. You can’t look at the multiplier and ignore velocity. You have to put the pieces together. It’s not just how much money there is, but also how fast it’s moving.

There are lots of brilliant finance people who never seem to grasp this point, and I never can get that. I don’t know why finance educations seem to skip so merrily past the demand for money to focus exclusively on the multiplier. Banks don’t just have to lend to get money moving. They most often do, of course, but there are other options. Velocity could and would increase without lending, without any increase in the multiplier, if banks purchased other financial assets instead of lending money. Non-bank actors will also seek a safe haven and move money faster. NGDP takes into account both an increase in the multiplier and an increase in velocity. Falling NGDP with price stickiness also explains the primary problem of recessions. It’s an extremely useful measure in many contexts.

24

And how is this in any way relevant? Beyond economic predictions of recession or expansion, which are uniformly ignored anyway, this simply doesn’t factor into anyone’s decision making process. I used to work with the person in charge of market forecasting for a large manufacturer. The acronym GDP never passed his lips. What he cared about was the market expectations for our companies products. If you want to use made up terms and are willing to define them, fine. I can play along. But it seems to me that you are trying to make out ‘NGDP expectations’ as being some legitimate metric and it simply isn’t.

NGDP is just real GDP without the ‘real’. So what? The only relevance of the fed is to the ‘nominal’ portion and they have already done their best to boost inflation - which would have the incidental effect of also boosting NGDP. But NGDP isn’t the target or the issue. The issue is making people think there will be inflation to pull forward purchasing decisions. This is monetary policy 101 - or at least 301.

OK, and . . . ?

Again, what is your point. I’m well aware of what velocity is. What I don’t see is your point.

Your definition of velocity is completely wrong so let me fix that for you.

** At this point, I don’t even know what we’re discussing anymore. Please clearly and SUCCINCTLY state your thesis so I can at least determine if I’m interested in continuing.**

25

I’m going to do some mathematical manipulation here. I think you will be able to follow it. Velocity is defined, exactly as they say, by the ratio of NGDP to some measure of the money supply. Your cite is right. Unfortunately, you have shown that you do not understand it.

V = NGDP/M

MV = NGDP

What I did was multiply both sides by M, the money supply. A tiny bit of algebra there. Now what did I say about velocity that was, to use your words, “completely wrong”? Let me quote myself.

The money supply times the velocity of money is NGDP. It’s the very same thing. (Literally the only difference is that I didn’t explicitly restrict myself to the M1 or M2.) You have so little experience with this equation that you didn’t recognize it when I used one single algebraic manipulation, a manipulation that can be seen in any intro or intermediate macro textbook I’ve ever read.

Look, dzero, this is the single most important identity in monetary economics. Milton Friedman called it the E = mc[sup]2[/sup] of money. The version I used is called the equation of exchange: MV = PY = NGDP. The idea is probably more than two centuries old, with the algebraic form going back to Irving Fisher, the first great American economist whose debt-deflation idea can still provide some insight into our current problems. I’d be happy to rephrase my points to make them more clear, but only if I think the other party is going to get something out of it. It’s obvious you’re not stupid, and it’s just as obvious that you don’t (yet) understand this. You’re not alone. Lots of brilliant finance guys are in the same position. So it’s up to you. It’s not worth my while to do this for someone who links to definitions that support what I’m saying while embarrassingly claiming that I’m “completely wrong”. That would be just a ridiculous waste of time on my part.

If you’d like to start over, though, I can try to rephrase from the beginning. (Or if there’s anyone else out there interested.) I’ll cheerfully admit that I’m not the best writer. If I’ve been as clear as mud so far, that’s entirely my fault.

My thesis is that the Fed should target NGDP growth of 4 to 5% every year, compensating when they get off track so that they stay on the same long-term trend line. Much much better than an inflation target, for macroeconomic reasons. That’s the basics. It goes from there.

26

When I said you didn’t understand velocity, I was referring to your statements that manipulating investment assets would somehow increase velocity. IT DOESN’T. The reason is because you have misunderstood what “investment” means in the context of GDP.

But since the quoted part is all that I care about, I’ll proceed from there.

As I have already stated, the fed has done everything possible to stimulate inflation. This would have the effect of satisfying your desire for an increase in NGDP.

However, the reason behind this is to pull forward future purchasing decisions. So this is not a goal of the fed per se but merely a means to an end.

The fed does target LONG TERM inflation at 2% roughly, but this is only due to systemic inefficiencies. To target a 0% inflation rate simply isn’t possible without artificially creating a recession and/or deflation.

But putting all of that aside, your thesis makes no sense to me. Other than the goals and methods I have already outlined, what is the purpose of targeting nominal GDP? Real GDP is what makes an actual difference. The rest is just window dressing.

27

Recently the FRB took the (unprecedented?) step of promising to keep interest rates low for the next several years. Should that have helped? Did it? (I’m not asking rhetorical questions; I’m sincerely curious.)

Can we agree that spending money improving America’s capital (technology, infrastructure, etc.) is the overriding goal? Call me a Soviet-style central planner if you wish, but I don’t agree that government spending is always bad, nor that private spending is always good. It is the government which is best placed to improve roads, bridges, levees, etc. and there’s wide agreement that America’s infrastructure needs investment. Private money invested without restriction in today’s environment is likely to seek better opportunities overseas. (Stated differently, it is wrong to suppose that that which is best for Wall Street is also best for America’s Main Street.)

28

The benefit of low interest rates is that it makes more projects competitive since the funding costs are lower.

Say you have a project that will generate an 8% return. If your cost of funds are not substantially below 8%, you won’t pursue that project. If the cost is much lower, you will.

The problem is the statistical distributions of returns. Think of a bell curve. You have many potential opportunities that have just an average return but many fewer than have returns that are 1,2 or 3 standard deviations from the mean. This is where low interest rates help. It lets you dip into the mediocre types of returns but still make a profit.

As to infrastructure and other govt spending, low borrowing costs make it much cheaper to fund our deficit and therefore helps make these things possible. But we have achieved these low rates by flooding the financial markets with liquidity. Under normal circumstances (but not now) that would stimulate rampant inflation. It hasn’t yet for a variety of reasons that i can go into if you like.

29

The purpose of targeting NGDP is that different amounts of inflation are best for different times during the business cycle. When unemployment is low there is no need for inflation and it should be low, when unemployment is high then inflation should be raised to stimulate the economy and lower unemployment. What NGDP targeting does is to provide clarity about fed policy in both situations. When RGDP is growing and unemployment is low, targeting NGDP keeps inflation low. The RGDP is stagnating and unemployment is high targeting NGDP ups inflation and helps to lower unemployment. this one policy fulfills both sides of the dual mandate and helps smooth the business cycle which is the goal of all monetary policy.

30

Why do you assume inflation is necessary to stimulate growth or employment. That can sometimes be a side effect but is not in any way inevitable.

31

Inflation causes real wages to go down and aggregate demand to go up. Both of these help alleviate unemployment.

32

That wasn’t the question.

33

You’re not actually suggesting Hellestal made up the term “NGDP expectation,” are you? That’s… er, wrong. It’s a term that has been used in economics for longer than I’ve been alive, and I’m, sadly, no spring chicken.

34

Monetary policy depends largely on expectations.

Do the markets really believe that the Fed would keep their promise of near zero rates even if core inflation rose past 4%, trending upward in a hurry with interest rates still near zero? No. Absolutely not. If they were such great suckers, then it actually would be great for the economy. It would spur recovery as money demand plummeted – which would lead to the inevitable double-cross from the Fed, an increase in rates to disabuse them of their foolish gullibility.

The announcement did good to the extent that it convinced everybody that they’re not willing to surrender to the deflationistas just yet. But it didn’t set expectations for the future, because no one can take a literal reading of their promise seriously.

That’s why I beat the drum about changing the target. It would be a permanent, and believable, change in course.

Good infrastructure spending is good. Bridges falling down is bad. Some bridges have actually, literally fallen down. Obviously, we need more infrastructure spending.

But that would be true regardless of the business cycle. The OP asked about stimulus, which is to say, the thing we need to do right now. Even the best construction projects take some time to implement, whereas the Fed could change expectations immediately – and therefore start to influence market behavior immediately – with one persuasive press conference. The process would get underway with no delay. Me? I’m all for good investment in public goods. But I still think that’s a needless distraction to the stimulus question. If people hadn’t been so distracted by conventional policy, we would’ve been more willing to implement unconventional policy and the duration and severity of this downturn would have been significantly less.

The aggregate supply curve is not perfectly elastic. It slopes up a bit. It gets its shape because of sticky prices. Money is neutral in the long run, but sticky prices mean that nominal measures are absolutely essential in the short run. Money is not neutral in the short run.

An upward sloping supply curve means that some inflation is, in fact, inevitable with more demand-based economic growth. This is just basic supply and demand.

Your criticism was not that I “didn’t understand velocity”.

What you actually said was, and I quote: “Your definition of velocity is completely wrong so let me fix that for you.” You then cited a definition of velocity from the Fed which was mathematically equivalent to my definition.

Right. Well. I’m not the world’s clearest writer, so feel free to ignore this advice, but if your intent is not actually to criticize my definition of velocity, then maybe it would be best not to quote my offered definition of velocity, say “your definition is completely wrong”, and then cite a mathematically equivalent definition to mine, thus strongly suggesting that you haven’t seen this algebraic manipulation before. You now say that your real purpose – which you have now further elaborated on – was not to criticize my definition at all, but rather to criticize an entirely different point which you, incidentally, completely failed to mention the first time.

I cannot be “completely wrong” about a definition that was, in fact, correct. And guess what? Your next offered criticism makes sense. It doesn’t address my point in the slightest. I am not “wrong” about what I was saying, because you still haven’t understood it. But your next criticism makes sense on its own terms. I see where you’re coming from. My point is simply that these things can be hard to explain. It doesn’t make them any easier to explain when you run around claiming that things are 100% incorrect, when anyone who can multiply M by both sides of the equation can see that’s not right.

Your giddy eagerness to jump to the wrong conclusion is not a sign that I made a mistake.

This thread would be a lot less bumpy for you if you’d give me the slightest benefit of the doubt whenever you have an issue, instead of your current habit of automatically choosing the least charitable interpretation that pops into your head and attributing that to me. You’ve already admitted that there could be some things you maybe missed the boat about. Well, I’m telling you that I’m on that very boat and I’m trying to get you a ticket. So let me start by telling you that… you are right! Not about my being wrong, no, but about another thing.

You are right that a bank rebalancing its portfolio does not, by itself, do anything for GDP. Yes! Obviously! You are correct on this point! Now take the next bloody step. If you step from the small picture of focusing on a single bank, and think instead about the inevitable string of transactions that must occur, the entire process should click for you. Think macro, not micro. Think big picture.

Convenient Hypothetical Savings & Loan expects higher inflation. They want to lighten up their heavy cash load of excess reserves because they’re going to take a loss on all that cash. Forget loans for now. They rebalance, looking for assets with higher returns than dusty green bills, maybe some securities. How? By trying to find a seller. This is the first domino. Yes, nothing has happened for NGDP yet. You’re correct about that. So what? I expected you to see the next domino, too. Don’t switch off your mind, don’t quit your analysis early and then hastily cast aspersions about other people’s knowledge. Keep following the fucking money. The money doesn’t cease to be relevant to the economy, as a whole, just because it left one single bank’s books.

They have to find a seller. How? They’re not going to threaten bodily harm until they close the deal. They’ve got to pay up. They’ve got to make a deal good enough that the seller will accept it. They’ve got to bid up the prices of those assets to convince the seller to sell. Higher inflation expectations means higher prices for certain assets. This can have profound ripple effects. You should know this perfectly well, you’re just not yet following through the full implications of your knowledge. Your knowledge is useless until you start actually applying it to think about these things.

Let us leave Convenient Hypothetical Bank. Follow the money. We’re going into the psychology of the Second Domino who sold that security for cash. Get into this person’s head. Why is the Second Domino selling? That’s easy, given just a moment of thought. They’d rather have cash instead of the security because the asset price is now high enough that they feel nice and profitable cashing out and spending the money on something. This doesn’t actually have to be the Second Domino, of course. Maybe the Second Domino re-adjusts their portfolio by selling to the Third, who re-adjusts selling to the Fourth, who re-adjusts selling to the Fifth, etc. Eventually, though, the process has to end. Where does it end? None of these are stupid people. All of them realize that inflation expectations are higher. All of them want to get out of cash as a store of value. Given inflation, just about anything on the planet would be a better store of value. All of them are bidding up asset prices in search of safety. And eventually asset prices will get high enough that someone cashes out to buy new stuff.

That’s an increase in velocity, and also an increase in NGDP. It’s often called the “hot potato effect”, and it can lead to more consumption. It’s called this regardless of whether you have ever heard of it. It is an important effect regardless of whether you have ever heard of it. Higher inflation expectations will lead to higher velocity of money as banks and other institutions rebalance their portfolios. It’s not just banks sitting on big cash piles. Corporations are also sitting on buckets of dough.

I don’t know how good your theoretical finance skills are – maybe you’re a more practical finance person – but that’s not the only potential effect from higher asset prices. You’ve also got stuff like Tobin’s q where higher asset prices from the hot potato encourage more investment, too. Apple Corporation doesn’t need to borrow money to invest. They have plenty of their own, and they’re more likely to use it if there’s a small penalty to holding cash or close-cash substitutes. None of this process I’ve outlined here has to involve the money multiplier at all. Cash can move through the economy precisely because people expect higher prices. Velocity can increase with no change in the money supply. And guess what? MV = NGDP. You can see the effect of higher velocity with nominal GDP, even if the money supply stays the same. If banks start lending, pumping up the multiplier for new investment projects? That will also increase NGDP. That’s why it is so useful for analyzing money. NGDP takes into account both how much money there is, and how fast it’s moving. I can tell you a surprising amazing amount of information about the economy knowing those two things together, and even more importantly, knowing what NGDP is expected in the future.

Inflation expectations are important. NGDP expectations are important. A lack of familiarity with one of these terms is not at all a sign that they aren’t important.

Maybe that’s a lot to chew on, so I’ll leave it there for the moment.

35

I’ve found that the more a person has to write in order to make their point, the less they actually know. This particularly true on internet forums. You’re a wonderful example of this principle. It can generally be paraphrased as ‘If You Can’t Dazzle Them With Footwork, Baffle Them With Bullshit.’

Really? That’s true in some contexts but not others and I’m hardly convinced that you can tell the difference. Maybe you could engender some credulity on my part by explaining what else it depends on. Money perhaps?

Obviously you know nothing about the fed. If you did, you would know that they are renown for telegraphing, well in advance, their every move. And because they do this so consistently, yes, people DO IN FACT BELIEVE THEM. This is not to say that were conditions to change dramatically that their position would not change. Only a fool would believe that.

Obviously this isn’t true. As I have pointed out repeatedly, the fed has done everything possible to create inflation. Actions, as you know, speak louder than words, and yet, the market sees where all of the money created ab nihilo and is therefore unimpressed.

And how is this in any way relevant. Don’t you even know which indicators the fed uses?

Again, irrelevant. But nice try at attempting to appear erudite.

You’re right, you’re not the world’s clearest writer.

Your penchant for using made-up metrics and inability to explain your position clearly and cogently make it impossible for me to give you the benefit of any doubt – however small such doubt may be in your case.

I only said that to be charitable. As you can see, I’ve recognized the error of my ways.

It’s still not investment in the sense required for calculating GDP. You could have simply googled “GDP investment” but since that was apparently too difficult for you, http://en.wikipedia.org/wiki/Gross_private_domestic_investmentallow me to assist.

The ONLY way it would count as investment – on ANY level, micro or macro – is if you meant for the money to be lent. However in that case, you should have said precisely that rather than expecting your reader to make some contorted leap of faith. And even here I’m giving you unwarranted benefit of the doubt since the act of lending would still be irrelevant unless the money so lent were put to one of the 3 uses noted above.

Oops. I think my mind just switched off there for a moment, but I’m back now.

Oh, I’m following. Unfortunately, THAT is the problem.

Words cannot express how completely bogus your “logic” is.

My financial skills are obviously infinitely better than yours.

This is the other technique people who don’t know what they’re talking about like to use. Pretend to be responding to a technical issue and introduce what little technical knowledge one has whether it’s relevant or not in an attempt to obfuscate.

You clearly implied that shuffling bank “investments” around would increase velocity. If you would now like to deny that . . . fine. I accept your apology.

NGDPE is a bogus term that doesn’t exist except in your mind. Oh, and about a hundred hits on Google, all in blog postings. Clearly my first choice as a source of accurate and persuasive information.

Really, it feels more like cotton candy – or maybe Chinese food.

36

A search for the literal string “nominal GDP expectations” results in about 7400 results. “Expectations of nominal GDP” 8190.

“Nominal GDP forecast” results in over a million.
Just sayin’.
.

37

I guess you must be using a different google than I am.
http://img571.imageshack.us/img571/3698/captureqfk.jpg

Uploaded with ImageShack.us

38

Okay, this is for everyone else still reading the thread, all two of you.

Watching the European clusterfuck has led to many painful lessons for the world about why so many financiers are so completely at a loss when it comes to admitting that they don’t know everything.

Think about the position they’re in. They are obviously intelligent, well-educated, highly-skilled, highly-trained people. Yet they get things wrong. And when it’s pointed out that they’ve gotten a few things wrong, instead of accepting that new knowledge and going, “Shucks! Sure enough, I missed something!”, they tend to react with hostility. Their status is being threatened. All of that brain power, instead of being devoted to getting things right, becomes devoted to ass-covering and casting aspersions about the people who are actually capable of pointing out the mistakes. They go ad hominem because they’ve lost on the logic. It’s a lot easier on the ego to believe that education, training, experience, and intelligence makes us immune to mistakes. (Never mind that some of the critics just happen to be plenty educated and intelligent themselves.) Much more gratifying, in the short run, to get angry and try to shift the issue.

They forget the first rule of holes: When you’re in a hole, stop digging. My hope before was to maybe shed a little light on the situation for people, and I sincerely hope that still happens, but the most likely run of this thread is more ad hominem distractions. But this is an important topic, so I’m going to stay with this one. I want the two other people still reading to really, really get this one right. It is extremely important.

He’s still not convinced I “can tell the difference”. I’ve given every benefit of the doubt to dzero’s ability to understand everything I’ve said. I’m cool like that. Obviously, that’s not a favor that is going to be returned. Well, fine. That’s just going to make the discussion even bumpier, but whatever.

So here’s the difference expectations can make. It’s a foreign example because it makes the underlying principle easier to illustrate.

The Swiss had a problem with their currency becoming too strong, as people were fleeing euros for francs. In June 2009, a euro had been worth more than 1.5 francs. In June 2010, a euro was only worth about 1.4 francs. For a time in August 2011, the franc had strengthened so much that a euro was only worth 1.05 francs. They had to stop that. So the Swiss monetary authority made an announcement: They would not allow the value of the franc to strengthen to under 1.20 euros.

This was their announcement: They were prepared to do whatever it took, to buy as many euros as necessary to weaken the franc. What happened? See for yourself the chart from September 6th. Since that time, the franc has actually become even weaker than 1.2 for some spells, but it’s never become any stronger.

What happened? What caused the instantaneous movement?

If I was holding 1.05 francs before the announcement was made, I could’ve exchange them for one euro. After the announcement, the franc immediately weakened and I would’ve needed to cough up 1.20 francs in order to get one euro. The Swiss National Bank didn’t need to do anything except make a policy announcement! Let’s say the market is filled with ignorant doofuses who don’t realize how important the announcement was. But there is one, and only one, clever person. The doofuses are all willing to buy euros at 1.05 francs. The National Bank says it’s willing to do what it takes to get that back up to 1.20. So the one clever person buys euros from the doofuses. He pays 1.05 francs for these euros. He then immediately sells those euros to the central bank for 1.20 francs. Buy at 1.05, sell at 1.20. An instant profit of 0.15 francs with arbitrage between the doofuses and the central bank.

But the world is not filled with doofus investors. The world is filled with smart finance people like dzero. They’re not going to sell at 1.05 if the bank is going to buy at 1.20. They refuse! And that’s why the exchange rate changes instantly, based on the expectation of what the Swiss National Bank would do, without them actually having done anything but make a press conference.

The US could have a similar change in monetary policy by changing expectations and expectations only. Of course, money would obviously, eventually be involved. But the process starts with expectations. If you manage to completely change expectations, then sometimes, sometimes it’s not even necessary to take any action with money at all. The markets will sometimes take all the action all by themselves, based on what they anticipate that you’ll do.

This is self-evidently wrong.

The Fed has done everything possible… to create 2% inflation, which is their implicit target. And they succeeded! We got back up to 2% inflation. In fact, headline inflation is even higher than that at the moment.

What they haven’t done is “anything possible” to get to 4% inflation or 6% inflation, or 100% inflation, and that’s because they don’t want 4%, or 6%, or 100% inflation. They could do that, if they wished (barring political/legal complications). They could expand their balance sheet even more, and instead of paying a quarter point interest on excess reserves, they could enforce a quarter point penalty. They absolutely have the power to increase inflation even more if they wished to do so. They don’t wish to do so. The Fed isn’t doing “everything possible” to get even higher inflation, because they think inflation is just about high enough for the time being.

Which I’ve admitted.

And what about the person who claimed my definition of velocity was “completely wrong”, when it was in fact completely right. That’s not good writing, either.

Stones and glass houses, the colors of kettles and pots, physicians also in need of healing, and so on.

Here are my actual words, a little later in that somewhat long explanation: “It’s often called the “hot potato effect”, and it can lead to more consumption.”

That particular part of the process would lead to more consumption, as counted in GDP, not more investment. This is why I wrote “consumption” there. Because rebalancing portfolios can lead, in that manner, to more consumption.

This is just getting embarrassing. If dzero has no personal capacity for embarrassment, that’s okay, because I’m feeling embarrassed vicariously on his behalf.

“Too difficult” to google? Oh man. I actually have this stuff memorized (which others who know me on the SDMB would not find surprising). Not only does dzero not know this, he didn’t even actually bother to read his own links. See below:

This is wrong. It is not incorrect. I won’t call it “completely wrong”, 'cause I’m such a nice guy, but it is still not correct.

Investment, in macroeconomic terms, means the purchase of new capital goods. In economic terms, it doesn’t matter how the new capital goods are financed. These goods could be financed with equity instead of lending, and it still counts as investment. It could be financed with cash, and it still counts as investment. Macroeconomic investment is the purchase of new capital goods, regardless of how that purchase is financed. That is the definition used in economics, which is to say, for GDP calculations. I can also cite any number of textbooks by reputable economists. They will all say the same thing.

Now, obviously dzero is relying on the definition used in finance:

And once again we hit the problem: If dzero hasn’t heard of an alternative definition, then that alternative doesn’t exist except in the other person’s “mind”. He’s so educated, he must know everything, except for all the mistakes he makes. I said this stuff is hard to talk about, and it is! I asked him to give me the benefit of the doubt. He didn’t. And now he’s made yet another ridiculous mistake. He keeps digging himself deeper. This isn’t a mistake based on lack of knowledge, education, or skills. It’s a mistake that can only be made because a person is knowledgeable, experienced, and skilled, and then proceeds to believe that all those skills and experience mean an imperviousness to mistakes. As a matter of fact, GDP calculations are done according to the definition I’ve been using. GDP calculations are not done with the finaciers’ definition of “investment”.

Again, this is partly my fault for being a bad writer. I knew that financiers use a different definition from economists. I knew that, but I didn’t think to explain that more clearly. Although really, seeing the quote above, I’m not sure it would’ve helped. He thought he already knew the “macro” definition. He linked to a cite about GDP calculations, and he didn’t bother to read it. Perhaps it was “too difficult” for him to read, as he tried to say about me? No! Of course not! It’s obviously not too difficult for him. He’s obviously not stupid. He just thought he already knew the answer. And if you already know something, then there’s no purpose of listening to anyone else, right? If you’re already knowledgeable, then there’s no way you can make any mistakes!

I’ve said before that finance guys tend to make all sorts of mistakes. Why? They think they already know it all. I mean, just look at this:

That really stands on its own. This is not a discussion where he thinks he might possibly… gasp learn something. This whole thing is obviously just an ego work-out for him.

Look at this chart. It gives a read-out for GDP. There is no N, and no R. It just lists GDP. So which is it? (Look at this chart for a hint.)

Look at this chart. It gives a read-out for interest rates. There is no N, and no R. It just gives the interest rate. So which is it?

GDP expectations gets more than 30,000 hits, even in quotes. Many of them are talking real production, yes, but GDP expectations is a real term that gets used. The top result that I see is from the Wall Street Journal. I didn’t make up the term GDP expectations. You can find it in publications like the Wall Street Journal. I’m personally specifying nominal myself in order to make a specific point that you are evidently not interested in hearing. If putting the word nominal in throws you for a loop, then I would suggest you look back at those GDP charts, and think about interest rates, because nominal readings are quite often (though not always) the standard interpretations. I would be happy to use the simple term “GDP expectations” from now on, like the WSJ does. (I would still, of course, be referring to nominal GDP when I do so, since regarding GDP as NGDP is actually standard procedure for the Federal Reserve, as their own FRED charts show.)

There are, in fact, smart finance people who understand this stuff. But I’m starting to see why there aren’t so many of them.

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[MODERATING]
Attacking arguments is fine. You are beginning to attack the other poster, which is not fine. Stop now.

Furthermore, I’m not sure what you’re doing withe the quote function and your message is really, really messed up and so it might be a mistake, but please take care in quoting other people’s text. The only allowable alteration you may make to another person’s writing within quote tags is omitting text for brevity, which should be marked with ellipses or appropriate notes. Please don’t mess around with color with other people’s writing.

Thanks,

RickJay
Moderator

40

Nope, I still get 4700 hits.

(My apologies, by the way–I mistyped above and it came out “7400.”)

Maybe my Google has more interwebs than yours.

I’m not going to bother with a screenshot, because they’re ever so easy to fake.