Year: 2016

On the potential for a contractionary impact of IOR, they write:

This claim, made even by some good economists, is puzzling. Before December, the Fed paid banks one-quarter of one percent on their reserves. If the Fed had not paid interest, the return to reserves would have been zero. Accordingly, the only potential loans that would have been affected by the Fed’s payment of interest are those with risk-adjusted short-term returns between precisely zero and one-quarter percent—surely a tiny fraction of the total. In fact, over the last four years bank lending has increased at about a 5 percent annual pace (including around a 7 percent annual rate the past two years), with only residential mortgage lending lagging in the aftermath of the housing bust.

There is more here.  I cannot say I am convinced.  I would focus not on the interstices of lending, but rather on expansionary pressures from the banking system.  Without IOR, what do Fed models predict would have been the price level impact of those trillions of new reserves following 2008?  (Note that at some margin banks can just convert those new reserves into dividends, without any additional lending, if they are so satiated with trillions of unwanted liquidity. I’m not saying it would happen that way, but think of that as a limiting case.)  No, I’m not advocating hyperinflation, but less sterilization of those new reserves would have maintained aggregate demand at a higher level post-2008, boosting investment, output, and employment through a quite traditional channel, as advocated say by the market monetarists.

And note Bernanke and Kohn’s own argument, elsewhere in the post, that soaking up reserves by selling off the Fed’s portfolio may be impractical, disruptive, or too costly.  Let’s say that’s true.  By limiting its use of IOR, the Fed in essence would have made a more credible commitment that any increase in bank reserves is here to stay, rather than just sitting in a holding tank of sorts.  No?

Bernanke and Kohn also rebut the common charge that interest on reserves is a subsidy to banks.  They may be right, but they are arguing too hard for “it is not a subsidy at the current margin of further reserve extension,” and not sufficiently rebutting the possibility of an infra-marginal subsidy, initiated right after IOR.

So this is a very smart and well-argued post, as one would rationally expect, but I don’t quite think it lays one’s doubts to rest either.

I say “not that tight,” while leaving room open for the possibility that it should be looser.

What metrics might we look at?  Federal funds futures no longer expect imminent further rate hikes from the Fed.  Expected rates of price inflation have been very close to two percent.  No matter what you think about the structural component of labor supply, cyclical unemployment has recovered a great deal over the last few years.  And that is through the period of “taper talk” of almost two years ago.  Consumer spending is doing OK, not spectacular but not cut off at the knees.  And while in very recent times price expectations are headed downwards away from two percent, this seems to stem from negative real shocks, to which the Fed has responded passively (perhaps unwisely).  That’s different than the Fed tightening.  There was a quarter point rate hike from December, which is a small tightening for sure, but I don’t see much more than that.

So in sum, those data do not suggest severe monetary tightness, though again I am open to the argument that monetary policy should be looser.

By the way, I agree with Scott Sumner that we should not equate low interest rates with loose money.  Tight and loose money are multi-dimensional, cluster concepts, especially post-2008, and require reference to a variety of variables.  And if you are wondering, from this list of Lars Christensen monetary policy indicators I accept only #2, at least in a 2016 global setting where other real economies are volatile.

Given that I don’t see monetary policy as so tight right now, I suggested that if we have a recession it was likely to be a risk premium recession.  The big uptick in gold prices is consistent with this view, though hardly proof of it.

So what is the context here?  I am worried that if the United States has a recession this year (still unlikely, in my view, but maybe 20%?), that recession will be blamed on “tight money.”

To get more specific yet, I am very much a fan of the ngdp rule approach to monetary policy, but I am uncomfortable with one strand in market monetarist thought.  I worry when low ngdp growth is blamed for low growth rates of real gdp.

Ngdp is an accounting summation, so I still want to know the real cause of the slower growth in real gdp.  Let’s unpack at the most basic level whether the active cause was Fed tightening on the nominal side, or instead a negative real shock, followed perhaps by excess Fed passivity.  That is one reason why I think of it as information-destroying to cite ngdp as a cause of developments in rgdp.

More fundamentally, if a central bank is doing anything close to price inflation targeting, mentioning low ngdp and low real gdp growth rates is simply citing the same fact twice, or almost so, rather than explaining one variable with the other.  Angus once called the ngdp invocation a tautology; I’m not sure that is the right terminology, but still I wish to look for independent, non-ngdp measures of monetary policy when deciding how to allocate the blame for a recession, to real or nominal factors.

For further context, I was disquieted by some recent Lars Christensen posts on monetary policy and the American economy.  I read him as “revving up” to blame a possible recession on tight U.S. monetary policy.  I don’t think he provides much evidence that money is tight enough to cause a recession, other than citing the deterioration of some real variables.

I would encourage market monetarists to define — now — how tight or loose monetary policy really is.  Then stick with that assessment, based on whatever variables you consulted.

A year from now, I won’t count it if you say a) “well, ngdp growth is down, money was tight, therefore real gdp growth rates fell.  Tight money must have been the problem because low rates of ngdp growth are tight money.”

I would count it if you say something like b): “the dollar shock [or some other factor] was worse than the Fed had thought.  That started to push us into recession.  The Fed should have loosened, but they didn’t, and so the slide into recession continued, when the Fed could have moderated it somewhat by pursuing an ngdp target.”  (By the way, read Gavyn Davies on the strong dollar issue.  Alternatively, here is a Marcus Nunes take which I think is citing ngdp in exactly the way I am worried about.)

I also would count it if you said “I see the Fed tightening a lot right now, a recession is likely coming,” although I might dispute your evidence for that tightening.

Here is a recent Scott Sumner post, mostly about me.  It’s basically taking the other side of what I have been arguing, and I would suggest simply disaggregating the ngdp terminology into a more causal language of nominal and real shocks.  Surely there are other independent, ex ante signs for judging the tightness of monetary policy, rather than waiting for ngdp figures to come in, which again is citing a transform of the real gdp growth rate as a way of explaining real gdp.

I find these issues come up many, many times in market monetarist writings.  I think they have basically the right policy prescription, and could provide the world with billions or maybe even trillions of dollars of value, if only policymakers would listen.  But I also think they are foisting a language of causality on the business cycle problem which the rest of economic discourse does not easily absorb, and which smushes together real and nominal shocks into a lower-information accounting variable, namely ngdp, and then elevating that variable into a not entirely deserved causal role.  We ought to talk in terms of ex ante, independent measures of monetary policy looseness, not ex post measures which closely resemble indirect transforms of real gdp itself.

That, in a nutshell is why, although I usually agree with the market monetarists on policy, and their desire to lower the status of “hard money” doctrine within liberalism, and while I have long applauded and supported their efforts, I don’t call myself a market monetarist per se.

Addendum: Nick Rowe comments.  And Marcus Nunes comments.