This is me on CNBC being interviewed by Kelly Evans about why I think Chuck Norris should be the next Fed chairman. Enjoy.
The interview was inspired by this blog post of mine on the same topic.
This is me on CNBC being interviewed by Kelly Evans about why I think Chuck Norris should be the next Fed chairman. Enjoy.
The interview was inspired by this blog post of mine on the same topic.
Posted by Lars Christensen on August 2, 2013
I think Janet Yellen would be a pretty bad choice for new Fed chairman, but she is much preferable to Larry Summers.
So among the bookmakers’ favourites I prefer Yellen to Summers. That is easy.
However, I have another candidate. Chuck Norris! Or rather I strongly believe that monetary policy needs to be strictly rule based and if you have a rule based monetary policy who is fed chairman isn’t really important.
Under a strict monetary policy rule monetary policy will be fully “automatic” espcieally if you introduce “A Market-Driven Nominal GDP Targeting Regime”. This is of course what we call the Chuck Norris Effect – that the markets are implementing monetary policy. Or said in another way lets call the computer Milton Friedman wanted to run the fed Chuck Norris.
But there is of course no chance that we will get this kind of strict rule based monetary policy in the US. Therefore, if I was President Obama I would give Richmond fed economist Robert Hetzel a call.
Why pick Hetzel? Well because he is the best qualified for the job. It is that easy. Anybody who reads my blog should understand why I think so.
Add to that nearly 40 years expirience within the fed system and Hetzel has probably participated in more FOMC meetings as an advisor to different Richmond fed persidents over the years than any other living economist in the world (I am guessing here, but if you know anybody else with this kind of expirience please let me.)
I am of course dreaming, but I won’t pick Yellen just because I think Summers would be a bad choice.
PS Happy 101st birthday Milton Friedman. See my personal tribute to ‘Uncle Milt’ from last here.
Posted by Lars Christensen on July 31, 2013
The rally in the global stock markets has clearly run into trouble in the last couple of weeks. Particularly the Nikkei has taken a beating, but also the US stock market has been under some pressure.
If one follows the financial media on a daily basis it is very clear that there is basically only one reason being mentioned for the decline in global stock markets – the possible scaling back of the Federal Reserve’s quantitative easing.
This is three example from the past 24 hours. First CNBC:
“Stocks posted sharp declines across the board Wednesday, with the Dow ending below 15,000, following weakness in overseas markets and amid concerns over when the Fed will start tapering its bond-buying program on the heels of several mixed economic reports.”
And this is from Bloomberg:
“U.S. stocks fell, sending the Standard & Poor’s 500 Index to a one-month low, as jobs and factory data missed estimates and investors speculated whether the Federal Reserve will taper bond purchases.”
And finally Barron’s:
“Fear that the central bank may start scaling back its $85 billion in monthly bond purchases has helped trigger a sharp increase in market volatility over the last couple of weeks both here and overseas.”
I believe that what we are seeing in the financial markets right now is telling us a lot about how the monetary transmission mechanism works. Market Monetarists say that money matters and markets matter. The point is that the markets are telling us a lot about the expectations for future monetary policy. This is of course also why Scott Sumner likes to say that monetary policy works with long and variable LEADS.
Hence, what we are seeing now is that US monetary conditions are being tightened even before the fed has scaled back asset purchases. What is at work is the Chuck Norris effect. It is the threat of “tapering” that causes US stock markets to decline. Said in another way Ben Bernanke has over the past two weeks effectively tightened monetary conditions. I am not sure that that was Bernanke’s intension, but that has nonetheless been the consequence of his (badly timed) communication.
This is also telling us that Market Monetarists are right when we say that both interest rates and money supply data are unreliable indicators of monetary conditions – at least when they are used on their own. Market indicators are much better indicators of monetary conditions.
Hence, when the US stock market drops, the dollar strengthens and implied market expectations of inflation decline it is a very clear signal that US monetary conditions are becoming tighter. And this is of course exactly what have happened over the last couple of weeks – ever since Bernanke started to talk about “tapering”. The Bernanke triggered the tightening, but the markets are implementing the tigthening.
Leave it to the market to decide when the we should have “tapering”
I think it is pretty fair to say that Market Monetarists are not happy about what we are seeing playing out at the moment in the US markets or the global markets for that matter. The reason is that we are now effectively getting monetary tightening. This is certainly premature monetary tightening – unemployment is still significantly above the fed’s unofficial 6.5% “target”, inflation is well-below the fed’s other unofficial target – 2% inflation – and NGDP growth and the level NGDP is massively below where we would like to see it.
It is therefore hardly the market’s perception of where the economy is relative to the fed’s targets that now leads markets to price in monetary tightening, but rather it is Bernanke’s message of possible “tapering” of assets purchases, which has caused the market reaction.
This I believe this very well illustrates three problems with the way the fed conducts monetary policy.
First of all, there is considerable uncertainty about what the fed is actually trying to target. We have an general idea that the fed probably in some form is following an Evans rule – wanting to continue to expand the money base at a given speed as long as US unemployment is above 6.5% and PCE core inflation is below 3%. But we are certainly not sure about that as the fed has never directly formulated its target.
Second, it is clear that the fed has a clear instrument preference - the fed is uncomfortable with conducting monetary policy by changing the growth rate of the money base and would prefer to return to a world where the primary monetary policy instrument is the fed funds target rate. This means that the fed is tempted to start “tapering” even before we are certain that the fed will succeed in hitting its target(s). Said, in another way the monetary policy instrument is both on the left hand and the right hand side of the fed’s reaction function. By the way this is exactly what Brad DeLong has suggested is the case. Brad at the same time argues that that means that the fiscal multiplier is positive. See my discussion of that here.
Third the fed’s policy remains extremely discretionary rather than being rule based. Hence, Bernanke’s sudden talk of “tapering” was a major surprise to the financial markets. This would not have been the case had the fed formulated a clear nominal target and explained its “reaction function” to markets.
Market Montarists of course has the solution to these problems. First of all the fed should clearly formulate a clear nominal target. We obviously would prefer an NGDP level target, but nearly any nominal target – inflation targeting, price level targeting or NGDP growth targeting – would be preferable to the present “target uncertainty”.
Second, the fed should leave it to the market to decide on when monetary policy should be tightened (or eased) and leave it to the market to actually implement monetary policy. In the “perfect world” the fed would target a given price for an NGDP-linked bond so the implied market expectation for future NGDP was in line with the targeted level of NGDP.
Less can, however, do it – the fed could simply leave forecasting to either the markets (policy futures and other forms of prediction markets) or it could conduct surveys of professional forecasters and make it clear that it will target these forecasts. This is Lars E. O. Svensson’s suggestion for “targeting the forecast” (with a Market Monetarist twist).
Concluding, the heightened volatility we have seen in the US stocks markets over the last two weeks is mostly the result of monetary policy failure – a failure to formulate a clear target, a failure to be clear on the policy instrument and a failure of making it clear how to implement monetary policy.
Bernanke don’t have to order the printing of more money. We don’t need more or less QE. What is needed is that Bernanke finally tells us what he is really targeting and then he should leave it to the market to implement monetary policy to hit that target.
PS I could have addressed this post to Bank of Japan and governor Kuroda as well. Kuroda is struggling with similar troubles as Bernanke. But he could start out by reading these two posts: “Mr. Kuroda please ‘peg’ inflation expectations to 2% now” and “A few words that would help Kuroda hit his target”. Kuroda should also take a look at what Marcus Nunes has to say.
Posted by Lars Christensen on June 6, 2013
The graph below shows the ratio of upward to downward revisions of equity analysts’ earnings forecasts in different countries. I stole the graph from Walter Kurtz at Sober Look. Walter himself got the data from Merrill Lynch.
Just take a look in the spike in upward earnings revisions (relative to downward revision) for Japanese companies after Haruhiko Kuroda was nominated for new Bank of Japan governor back in February and he later announced his aggressive plan for hitting the newly introduced 2% inflation target.
This is yet another very strong prove that monetary policy can be extremely powerful. The graph also shows the importance of the Chuck Norris effect – monetary policy is to a large extent about expectations or as Scott Sumner would say: Monetary Policy works with long and variable leads - or rather I believe that the leads are not very long and not very variable if the central bank gets the communication right and I believe that the BoJ is getting the communication just right so you are seeing a fairly strong and nearly imitate impact of the announced monetary easing.
PS As there tend to be a quite strong positive correlation between earning growth and nominal GDP growth I think we can safely say that the sharp increase in earnings expectations in Japan to a large extent reflects a marked upward shift in NGDP growth expectations.
Posted by Lars Christensen on May 9, 2013
This is what Bernanke could (or rather should) say about Italian events:
“Let me remind everybody that we have the instruments to shield the US economy from negative spill-over from political and financial events in Europe. We have said that we want to stabilize nominal spending in the US and if events in Europe jeopardize the fulfillment of our targets then we will increase money base growth to counteract these shocks. However, I do not expect that to be necessary as the markets should be well aware of our intentions to stabilize nominal spending and I therefore expect markets to adjust appropriately to do the job for us”
You can replace “stabilize nominal spending” with whatever nominal target you like.
End of story…
Posted by Lars Christensen on February 26, 2013
I continue to be completely puzzled that somebody would think that central banks somehow have run out of ammunition and that monetary policy is impotent. The developments in the global financial markets since August-September last year clearly tell you that monetary policy is extremely potent – also when interest rates are at the Zero Lower Bound.
Just take a look at this story from Japan today:
Japanese shares rose, with the Nikkei 225 Stock Average heading for the highest close since September 2008, as the yen fell after Bank of Japan Governor Masaaki Shirakawa said he will step down ahead of schedule.
…The Nikkei 225 gained 3 percent to 11,377.53 as of 12:38 p.m. in Tokyo, heading for the highest close since Sept. 29, 2008, two weeks after the collapse of Lehman Brothers Holdings Inc. Volume today was 48 percent above the 30-day average. The broader Topix Index advanced 2.8 percent to 966.03, with eight stocks rising for each that fell.
…The Topix has surged 34 percent since elections were announced on Nov. 14 on optimism a new government will push for aggressive stimulus. The gauge is trading at 1.14 times book value, compared with 2.1 for the Standard & Poor’s 500 Index and 1.45 for the Stoxx Europe 600 Index.
(Update: Nikkei is actually up 4%!)
And from another story:
The yen slid to its weakest level in almost three years against the dollar and euro on speculation Japan’s government will hasten the selection of a new central bank chief to take further steps to end deflation.
Japan’s currency added to yesterday’s biggest drop versus the euro in more than a week after Bank of Japan Governor Masaaki Shirakawa said he will step down on March 19, almost three weeks before his term is due to end. Demand for the 17- nation euro was supported on prospects the European Central Bank will refrain from easing monetary policy tomorrow. The Australian dollar slid after data showed the nation’s retail sales unexpectedly fell in December.
Financial markets are the best indicators of the monetary policy stance we have – a surging Japanese stock market and much weaker yen is a very strong indication that Japanese monetary conditions are getting decisively easier. Easier monetary conditions mean higher Japanese nominal GDP – just wait and see.
The market action in the Japanese markets this morning is yet another extremely clear demonstration of the Chuck Norris effect – that monetary policy does not only work through “printing money”, but also through expectations. As Scott Sumner likes to say – monetary policy works with long and variable leads. Said in another way a new Bank of Japan governor has not even been appointed but he is already easing monetary conditions in Japan as Mark Carney is in the UK.
And to all you Keynesian fiscalists out there I challenge you to find me one single example of “optimism” about “fiscal stimulus” having moved any major stock market by 4% in a day!
What we are seeing now in the US, Japan and likely soon in the UK is the kind of Rooseveltian Resolve that brought the US economy out of the Great Depression in 1933 after Roosevelt went off the gold standard and trust me – monetary policy does work! In the 1930s the “gold bloc” countries failed to understand that – today it is the ECB – but luckily for Europeans the US and Japan are leading the charge and is pulling us out of this crisis. That is what the global stock markets have been celebrating since August-September. It is really simple.
Posted by Lars Christensen on February 6, 2013
These days we are getting a proper illustration of the Chuck Norris effect – that the central bank can ease monetary policy through sheer credibility without even printing more money. In fact in the case of Mark Carney he is now easing monetary policy in the UK even before he has become Bank of England governor. That is pretty impressive, but also good news for the UK economy. It is of course the expectation that Mark Carney as coming BoE governor will be in charge of introducing some form of NGDP level targeting.
This is from Bloomberg today:
“U.K. inflation expectations rose to the highest level in 21 months amid speculation Mark Carney will expand monetary policy and spur price rises when he takes over as Bank of England governor in July.
The so-called break-even rate increased for a fifth day before Carney testifies to U.K. lawmakers this week after telling the World Economic Forum’s annual meeting in Davos, Switzerland, last month that policy in developed countries isn’t “maxed out.” Ten-year bonds fell after an industry report showed U.K. services expanded in January, undermining demand for fixed-income assets. The pound weakened against the euro.”
Market expectations of inflation in my view are one of the best measures of changes in the monetary policy stance. When inflation expectations are inching up it is a very clear indication that monetary conditions are getting easier. That is what is happening in the UK at the moment.
Central banks essentially have two monetary policy instruments. First of all they can print money – increase the money base. Second they can guide expectations. The latter is often much more important and that is exactly what we are seeing in the UK markets these days.
Effectively Mark Carney is already in charge of UK monetary policy – the only thing he has to do is hint what he would like to see happen with UK monetary policy going forward.
Posted by Lars Christensen on February 5, 2013
Here is ft.com quoting John Williams president of the Federal Reserve Bank of San Francisco:
“If the Fed launched another round of quantitative easing, Mr Williams suggested that buying mortgage-backed securities rather than Treasuries would have a stronger effect on financial conditions. “There’s a lot more you can buy without interfering with market function and you maybe get a little more bang for the buck,” he said.
He added that there would also be benefits in having an open-ended programme of QE, where the ultimate amount of purchases was not fixed in advance like the $600bn “QE2” programme launched in November 2010 but rather adjusted according to economic conditions.
“The main benefit from my point of view is it will get the markets to stop focusing on the terminal date [when a programme of purchases ends] and also focusing on, ‘Oh, are they going to do QE3?’” he said. Instead, markets would adjust their expectation of Fed purchases as economic conditions changed.”
Posted by Lars Christensen on July 24, 2012
I don’t particularly feel an obligation to comment on today’s ECB monetary policy announcement and I think my regular readers have a pretty good idea about how I feel about the ECB these days. However, ECB chief Mario Draghi pulled out a traditional ECB phrase on the outlook on monetary policy that I think pretty well describes the ECB’s problem and why we are in mess we are in.
Mario Draghi said – as Trichet used to before him – that “we never pre-commit” to any particular future monetary policy action. My reply to Draghi would be isn’t that exactly your problem!?
Yesterday, I did a post on the importance of the expectational channel in monetary policy and how the Chuck Norris effect or what Matt O’Brien has called the Jedi mind trick can be a tremendous help in the conduct of monetary policy. If you have a credible target and credible reaction function the markets are likely to do most of the lifting in terms of monetary policy implementation. However, when Draghi is saying that the ECB is not pre-committed on monetary policy then he is effectively saying “We don’t want to tell you what your target is and we are not going to reveal our reaction function”. That of course means that the ECB will get no help from Chuck Norris (the markets) to implement policy.
On the other hand if Draghi had said “The ECB is pre-committed to use whatever instruments in our arsenal to achieve our nominal targets and will do unlimited amounts of buy or selling of assets to achieve these targets” then Draghi would not have to do much more. Chuck Norris would help him so he could spend more time golfing.
However, you get the feeling that the ECB on purpose wants to be ambiguous on what monetary policy action it will take and what it want to target. From a monetary policy perspective this makes no sense at all. Why would a central bank do something like that? What monetary theory is telling the ECB that it is a good idea not to pre-commit? I think the answer is nothing to do with monetary theory and everything to do with public choice theory. The special ECB lingo like “we never pre-commit” seem to be designed to ensure the legitimacy of the ECB. The lingo is simply rituals that should convince us that the ECB is a legitimate institution and it’s powers should not be questioned. See more on this topic here.
Posted by Lars Christensen on June 6, 2012
Our friend Matt O’Brien has a great new comment on the Atlantic.com. Matt is one of the most clever commentators on monetary matters in the US media.
In Matt’s new comment he set out to explain the importance of expectations in the monetary transmission mechanism.
Here is Matt:
“These aren’t the droids you’re looking for.” That’s what Obi-Wan Kenobi famously tells a trio of less-than-with-it baddies in Star Wars when — spoiler alert! — they actually were the droids they were looking for. But thanks to the Force, Kenobi convinces them otherwise. That’s a Jedi mind trick — and it’s a pretty decent model for how central banks can manipulate expectations. Thanks to the printing press, the Fed can create a self-fulfilling reality. Even with interest rates at zero.
Central banks have a strong influence on market expectations. Actually, they have as strong an influence as they want to have. Sometimes they use quantitative easing to communicate what they want. Sometimes they use their words. And that’s where monetary policy basically becomes a Jedi mind trick.
The true nature of central banking isn’t about interest rates. It’s about making and keeping promises. And that brings me to a confession. I lied earlier. Central banks don’t really buy or sell short-term bonds when they lower or raise short-term interest rates. They don’t need to. The market takes care of it. If the Fed announces a target and markets believe the Fed is serious about hitting that target, the Fed doesn’t need to do much else. Markets don’t want to bet against someone who can conjure up an infinite amount of money — so they go along with the Fed.
Don’t underestimate the power of expectations. It might sound a like a hokey religion, but it’s not. Consider Switzerland. Thanks to the euro’s endless flirtation with financial oblivion, investors have piled into the Swiss franc as a safe haven. That sounds good, but a massively overvalued currency is not good. It pushes inflation down to dangerously low levels, and makes exports uncompetitive. So the Swiss National Bank (SNB) has responded by devaluing its currency — setting a ceiling on its value at 1.2 Swiss francs to 1 euro. In other words, the SNB has promised to print money until its money is worth what it wants it to be worth. It’s quantitative easing with a target. And, as Evan Soltas pointed out, the beauty of this target is that the SNB hasn’t even had to print money lately, because markets believe it now. Markets have moved the exchange rate to where the SNB wants it.”
This is essentially the Star Wars version of the Chuck Norris effect as formulated by Nick Rowe and myself. The Chuck Norris effect of monetary policy: You don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target.
It is pretty simple. It is all about credibility. A central bank has all the powers in the world to increase inflation and nominal GDP (remember MV=PY!) and if the central bank clearly demonstrates that it will use this power to ensure for example a stable growth path for the NGDP level then it might not have to do any (additional) money printing to achieve this. The market will simply do all the lifting.
Imagine that a central bank has a NGDP level target and a shock to velocity or the money supply hits (for example due to banking crisis) then the expectation for future NGDP (initially) drops below the target level. If the central bank’s NGDP target is credible then market participants, however, will know that the central bank will react by increasing the money base until it achieves it’s target. There will be no limits to the potential money printing the central bank will do.
If the market participants expect more money printing then the country’s currency will obviously weaken and stock prices will increase. Bond yields will increase as inflation expectations increase. As inflation and growth expectations increase corporations and household will decrease their cash holdings – they will invest and consume more. The this essentially the Market Monetarist description of the monetary transmission mechanism under a fully credible monetary nominal target (See for example my earlier posts here and here).
This also explains why Scott Sumner always says that monetary policy works with long and variable leads. As I have argued before this of course only is right if the monetary policy is credible. If the monetary target is 100% credible then monetary policy basically becomes endogenous. The market reacts to information that the economy is off target. However, if the target is not credible then the central bank has to do most of the lifting itself. In that situation monetary policy will work with long and variable lags (as suggested by Milton Friedman). See my discussion of lag and leads in monetary policy here.
During the Great Moderation monetary policy in the euro zone and the US was generally credible and monetary policy therefore was basically endogenous. In that world any shock to the money supply will basically be automatically counteracted by the markets. The money supply growth and velocity tended to move in opposite directions to ensure the NGDP level target (See more on that here). In a world where the central bank is able to apply the Jedi mind trick the central bankers can use most of their time golfing. Only central bankers with no credibility have to work hard micromanaging things.
“I FIND YOUR LACK OF A TARGET DISTURBING”
So the reason European central bankers are so busy these days is that the ECB is no longer a credible. If you want to test me – just have a look at market inflation expectations. Inflation expectations in the euro zone have basically been declining for more than a year and is now well below the ECB’s official inflation target of 2%. If the ECB had an credible inflation target of 2% do you then think that 10-year German bond yields would be approaching 1%? Obviously the ECB could solve it’s credibility problem extremely easy and with the help of a bit Jedi mind tricks and Chuck Norris inflation expectations could be pegged at close to 2% and the euro crisis would soon be over – and it could do more than that with a NGDP level target.
Until recently it looked like Ben Bernanke and the Fed had nailed it (See here – once I believed that Bernanke did nail it). Despite an escalating euro crisis the US stock market was holding up quite well, the dollar did not strengthen against the euro and inflation expectations was not declining – clear indications that the Fed was not “importing” monetary tightening from Europe. The markets clearly was of the view that if the euro zone crisis escalated the Fed would just step up quantitative ease (QE3). However, the Fed’s credibility once again seems to be under pressures. US stock markets have taken a beating, US inflation expectations have dropped sharply and the dollar has strengthened. It seems like Ben Bernanke is no Chuck Norris and he does not seem to master the Jedi mind trick anymore. So why is that?
Matt has the answer:
“I’ve seen a lot of strange stuff, but nothing quite as strange as the Fed’s reluctance to declare a target recently. Rather than announce a target, the Fed announces how much quantitative easing it will do. This is planning for failure. Quantitative easing without a target is more quantitative and less easing. Without an open-ended commitment that shocks expectations, the Fed has to buy more bonds to get less of a result. It’s the opposite of what the SNB has done.
Many economists have labored to bring us this knowledge — including a professor named Ben Bernanke — and yet the Fed mostly ignores it. I say mostly, because the Fed has said that it expects to keep short-term interest rates near zero through late 2014. But this sounds more radical than it is in reality. It’s not a credible promise because it’s not even a promise. It’s what the Fed expects will happen. So what would be a good way to shift expectations? Let’s start with what isn’t a good way.”
I agree – the Fed needs to formulate a clear nominal target andit needs to formulate a clear reaction function. How hard can it be? Sometimes I feel that central bankers like to work long hours and want to micromanage things.
Posted by Lars Christensen on June 5, 2012