The ultimate sign of recovery – no reason to freak out about higher bond yields

This is from

U.S. Treasurys prices eased for a second day after jobless claims data suggested solid improvement in the labor market, while stocks’ gains undermined the appeal of lower-risk government debt.

The Treasury Department auctioned $13 billion of reopened 30-year bonds on Thursday at a high yield of 3.248 percent. The bid-to-cover ratio, an indicator of demand, was 2.43, the lowest level since August.

In the when-issued market, considered a proxy for where the bonds will price at auction, 30-year bonds were yielding about 3.24 percent. The auction followed solid demand in the sales of $21 billion of reopened 10-year notes on Wednesday and $32 billion of three-year notes on Tuesday.

US bond yields continue to inch higher. To me that is the ultimate sign that easier monetary conditions is pushing up nominal GDP (and very likely also real GDP).

But I am afraid that we will soon hear somebody warn us that higher bond yields will kill the recovery. But we of course know that when bond yields and equity prices are rising in parallel then it is normally a very good sign of higher aggregate demand and that is of course exactly what we need.

So if we avoid the biggest fallacy in economics and ask why bond yields are rising then we should find a lot of comfort in the fact that US stock prices are rising as well.

And finally there is some Keynesians out there that can explain to me why global stock prices continue to inch up, bond yields are rising and the US consumer seems completely unaffected despite of the fiscal cliff (I told you so!) and the sequester. Market Monetarists of course have an answer – it is monetary policy dominance – monetary policy can always offset any impact on aggregate demand from a fiscal shock. It is very simple – and is the positive spin on the Sumner Critique. (Here is a model textbook Keynesian should be able to understand).

PS yes you got it right – I am very optimistic both on the markets and on the recovery at least in the US (I have been optimistic for a while – see here and here). My only two fears are that the ECB once again will do something stupid or that we will have a repeat of the mistakes of 19367-37 – premature monetary tightening from the fed. Italian politics is, however, not keeping me awake at night.

Update: I wrote above my worry was the ECB. I should have said the EU/IMF. The terms for the EU/IMF bail out of Cyprus scare me quite a bit. So much for the rule of law…

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  1. Thanks for sharing the optimism. I’m trying to anchor my expectations to the floor for UK budget day to avoid crushing disappointment.

    I am still waiting to read the headline “Global Stocks Slump as Weak Yen Sucks Demand out of World Economy”. Why is nobody printing that, I wonder? Instead I keep seeing the opposite: it’s when the yen rises that world equities have a bad day!

    • Well my friend – we have to be optimistic. The tories are under pressures from both the libdems and UKIP to move in the right direction.

      • I just saw the FT piece, NGDP ruled out by Harrison. Now my expectations could not be much lower. Game over.

  2. troopa

     /  March 15, 2013

    I was reding this on Bloomberg a few days back, ; and immediately thought “Sumner critique”! :D

  3. Anders

     /  March 15, 2013

    “[how do Keynesians explain that] global stock prices continue to inch up, bond yields are rising and the US consumer seems completely unaffected despite of the fiscal cliff…and the sequester[?]”

    Jobless claims – a notoriously lagging indicator – data from February is hardly convincing given the fiscal shock began in January.

    As for strong performance in the stock market and the bond market, I don’t know of any new Keynesian or post-Keynesian prediction which would invalidated by these.

    • Anders,

      Thanks for the comments.

      I am not saying anything about the labour market data. I am talking about the markets. The markets seem to be completely relaxed about the fiscal issue – and rightly so.

      You should note that I never NEW keynesian. I said Keynesian. Fundamentally I don’t think there is much keynesian about NEW keynesian models.

      In fact my view that we have monetary dominance is a standard result in New Keynesian model. The budget multiplier is zero in a standard NK model with an inflation targeting central bank.

      I have written numerous posts on that issue. But see here:

      and here:

      • Anders

         /  March 15, 2013

        Lars – what I didn’t understand was which Keynesians you believed the data provided a challenge to. I guess it’s not New Keynesians, as their models are consistent with monetary dominance. But which Keynesians do predict weak markets – are you talking about Krugman?

        The question I’m more interested in is your monetary dominance idea, which strikes me from your links as a very elegant statement of market monetarist ideas. I do respectfully think it is misguided, which is why I made the comment below: tight monetary policy may dominate loose fiscal policy in many cases but the opposite seems to fall foul of Keynes’ “trying to get fat by buying a larger belt” argument.

  4. Anders

     /  March 15, 2013

    If monetary policy dominance were true – if ie monetary policy really could ALWAYS offset ANY impact on aggregate demand from a fiscal shock – then presumably the UK govt could double all tax rates overnight, provided the BoE bought back all outstanding gilts; the non-bank private sector would happily worsen its balance sheet by borrowing to supplement its much-reduced disposable income in order to maintain its nominal spending.

    Do you really think that households care so little about their balance sheets as this?

  5. AB

     /  March 15, 2013

    I am new to the site so please excuse my ignorance of your views/models.

    You write “But we of course know that when bond yields and equity prices are rising in parallel then it is normally a very good sign of higher aggregate demand and that is of course exactly what we need.” Do I read that as causality runs from lower rates >> higher aggregate demand >> higher asset prices? How does that square with Bernanke’s wealth effect which seems to imply that lower rates >> higher asset prices >> higher aggregate demand? How sensitive are the long-run positive and negative effects of monetary policy to the valuation of asset prices and debt levels?


    • AB,

      What I am claiming here is that monetary policy has been eased. That is pushing up expectations of higher growth in nominal GDP (and likely also real GDP).

      The expectation of higher NGDP is pushing up both yiels and stock prices.

      But my main point is to understand that higher bond yields is NOT negative for growth. Rather the causality runs in the other direction – expectations of higher NGDP growth pushes up bond yields.

      And welcome to the blog.

    • troopa

       /  March 15, 2013

      yields on longer term debt respond positively to a positive outlook for NGDP. Idea of QE is not to lower the yields but for yields to rise because expected NGDP is rising. since MV=PY, PY being NGDP, you can see how monetary policy can affect NGDP, and you dont even have to think in terms of short term interest rate central bank sets (especially now when most of the developed world is on zero lower bound)


  6. Anders,

    Lot of Keynesians have been warning that fiscal tightening in the US would be disastrous and been calling for fiscal stimulus – including Krugman.

    It is okay that you think mine – and New Keynesians’ – monetary dominance idea is “misguided”, but in what model set-up would we get anything other than monetary dominance. Brad Delong has some suggestions, but that is mostly to do with central bank preferences for certain policies, but other than that I don’t know of any consistent macroeconomic modelling that is able to show anything else than monetary dominance. Obviously if we assume that we are not “allowed” or willing to use the money base as a policy instrument or assume fixed exchange rate then fiscal policy can have an impact on aggregate demand. I would also admit that under certain forms of interest rates smoothing fiscal policy might have an (very weak) impact in NK models.

  7. Ravi

     /  March 16, 2013

    Lars, would it be correct to say that you are optimistic in the short-term? You’ve expressed pessimism about the long-term sustainability of the EZ in its current form. I assume that break-up will involve some painful adjustments, though it may eventually lead to better monetary policy and economic outcomes.

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