All posts tagged Scott Sumner

The Kuroda recovery will be about domestic demand and not about exports

There has been a lot of focus on the fact that USD/JPY has now broken above 100 and that the slide in the yen is going to have a positive impact on Japanese exports. In fact it seems like most commentators and economists think that the easing of monetary policy we have seen in Japan is about the exchange rate and the impact on Japanese “competitiveness”. I think this focus is completely wrong.

While I strongly believe that the policies being undertaken by the Bank of Japan at the moment is likely to significantly boost Japanese nominal GDP growth – and likely also real GDP in the near-term – I doubt that the main contribution to growth will come from exports. Instead I believe that we are likely to see is a boost to domestic demand and that will be the main driver of growth. Yes, we are likely to see an improvement in Japanese export growth, but it is not really the most important channel for how monetary easing works.

The weaker yen is an indicator of monetary easing – but not the main driver of growth

I think that the way we should think about the weaker yen is as a indicator for monetary easing. Hence, when we seeing the yen weakeN, Japanese stock markets rallying and inflation expectations rise at the same time then it is pretty safe to assume that monetary conditions are indeed becoming easier. Of course the first we can conclude is that this shows that there is no “liquidity trap”. The central bank can always ease monetary policy – also when interest rates are zero or close to zero. The Bank of Japan is proving that at the moment.

Two things are happening at the moment in the Japan. One, the money base is increasing dramatically. Second and maybe more important money-velocity is picking up significantly.

Velocity is of course picking up because money demand in Japan is dropping as a consequence of households, companies and institutional investors expect the value of the cash they are holding to decline as inflation is likely to pick up. The drop in the yen is a very good indicator of that.

And what do you do when you reduce the demand for money? Well, you spend it, you invest it. This is likely to be what will have happen in Japan in the coming months and quarters – private consumption growth will pick-up, business investments will go up, construction activity will accelerate. So it is no wonder that equity analysts feel more optimistic about Japanese companies’ earnings.

Hence, the Bank of Japan (and the rest of us) should celebrate the sharp drop in the yen as it is an indicator of a sharp increase in money-velocity and not because it is helping Japanese “competitiveness”.

The focus on competitiveness is completely misplaced

I have in numerous earlier posts argued that when a country is going through a “devaluation” as a consequence of monetary easing the important thing is not competitiveness, but the impact on domestic demand.

I have for example earlier demonstrated that Swedish growth outpaced Danish growth in 2009-10 not because the Swedish krona depreciated strongly against the Danish krone (which is pegged to the euro), but because the Swedish Riksbank was able to ease monetary policy, while the Danish central bank effectively tightened monetary conditions due to the Danish fixed exchange rate policy. As a consequence domestic demand did much better in Sweden in 2009-10 than in Denmark, while – surprise, surprise – Swedish and Danish exports more or less grew at the same pace in 2009-10 (See graphs below).

Similarly I have earlier shown that when Argentina gave up its currency board regime in 2002 the major boost to growth did not primarly come from exports, but rather from domestic demand. Let me repeat a quote from Mark Weisbrot’s and Luis Sandoval’s 2007-paper on “Argentina’s economic recovery”:

“However, relatively little of Argentina’s growth over the last five years (2002-2007) is a result of exports or of the favorable prices of Argentina’s exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable “commodity export boom…

During this period (The first six months following the devaluation in 2002) exports grew at a 6.7 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 28 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.0 percent annual rate.

But exports did not play a major role in the rest of the recovery after the first six months. The next phase of the recovery, from the third quarter of 2002 to the second quarter of 2004, was driven by private consumption and investment, with investment growing at a 41.1 percent annual rate during this period. Growth during the third phase of the recovery – the three years ending with the second half of this year – was also driven mainly by private consumption and investment… However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.

The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 8.2 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.

…the fastest growing sectors of the economy were construction, which increased by 162.7 percent during the recovery; transport, storage and communications (73.4 percent); manufacturing (64.4 percent); and wholesale and retail trade and repair services (62.7 percent).

The impact of this rapid and sustained growth can be seen in the labor market and in household poverty rates… Unemployment fell from 21.5 percent in the first half of 2002 to 9.6 percent for the first half of 2007. The employment-to-population ratio rose from 32.8 percent to 43.4 percent during the same period. And the household poverty rate fell from 41.4 percent in the first half of 2002 to 16.3 percent in the first half of 2007. These are very large changes in unemployment, employment, and poverty rates.”

And if we want to go further back in history we can look at what happened in the US after FDR gave up the gold standard in 1933. Here the story was the same – it was domestic demand and not net exports which was the driver of the sharp recovery in growth during 1933.

These examples in my view clearly shows that the focus on the “competitiveness channel” is completely misplaced and the ongoing pick-up in Japanese growth is likely to be mostly about domestic demand rather than about exports.

Finally if anybody still worry about “currency war” they might want to rethink how they see the impact of monetary easing. When the Bank of Japan is easing monetary policy it is likely to have a much bigger positive impact on domestic demand than on Japanese exports. In fact I would not be surprised if the Japanese trade balance will worsen as a consequence of Kuroda’s heroic efforts to get Japan out of the deflationary trap.

HT Jonathan Cast

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PS Scott Sumner also comments on Japan.

PPS An important non-competitiveness impact of the weaker yen is that it is telling consumers and investors that inflation is likely to increase. Again the important thing is the signal about monetary policy, which is rather more important than the impact on competitiveness.

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50 Comments
by Lars Christensen on May 10, 2013  •  Permalink
Posted in Argentina, Denmark, Haruhiko Kuroda, Liquidity trap, Sweden, Transmission mechanism
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Posted by Lars Christensen on May 10, 2013

http://marketmonetarist.com/2013/05/10/the-kuroda-recovery-will-be-about-domestic-demand-and-not-about-exports/

Monetary policy works just fine – Exhibit 14743: The case of Japanese earnings

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.

8 Comments
by Lars Christensen on May 9, 2013  •  Permalink
Posted in Bank of Japan, Chuck Norris Effect, Haruhiko Kuroda, Japan, Scott Sumner
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Posted by Lars Christensen on May 9, 2013

http://marketmonetarist.com/2013/05/09/monetary-policy-works-just-fine-exhibit-14743-the-case-of-japanese-earnings/

Depression Remedy – what we can learn from old newspaper articles

I strongly believe that we can learn a lot about the present crisis from studying economic and monetary history. Particularly the study of the Great Depression should be of interest to anybody who is interested in the causes of the present crisis and how to get us out of the crisis.

Scott Sumner would hence tell you that he has read most of what was printed in the financial section of the New York Times in early 1930s. I think Scott is right when he is telling us that we should read old newspaper articles. My favourite source for Great Depression newspaper articles is the National Library of Australia’s newspaper database Trove.

The Trove newspaper database makes it possible to follow the discussion about economic and financial matters for example during the 1930s.  It is amazing how many interesting articles one will find there. The latest piece I have found is a very good article about Irving Fisher’s Compensated dollar plan. Below I have reproduced parts of the article. You can read it all on Trove. The article appeared in The Mercury on May 18 1933. I have added my own comments.

Depression Remedy: Professor Irving Fisher’s Plan for a Compensated Currency

In “Booms and Depressions” Professor Irving Fisher of Yale University (U.S.A.). has… set out to discover the causes of depressions and their cures. He is best known internationally as the originator of a plan whose object is to keep prices stable by varying as may be required the gold content of legal tender money. In his preface he indicates that the main conclusion of his book is that depressions are for the most part preventable, and that their prevention requires a definite policy, in which the central banking system of each country must play an important role. Such knowledge as he has obtained on the subject, he declares, he has only recently acquired.

That over-production is the cause of depressions he will not have. There is no over-production, nor is there anything wrong with the mechanical means of the distribution of production, nor with the roads, the bridges, or the transport systems by land or sea. But he asks as to the other distributive mechanism – the money mechanism – is there any more reason why the money mechanism should be proof against getting out of order than a railroad or a ship canal. Profits are measured in money, and if money should become deranged, is it not at least probable that the derangement would affect all profits in one way at one time? This is what he sets out to prove.

LC: Hence, you here see that Fisher’s view is that recessions are caused by a monetary disequilibrium. This of course is exactly what Market Monetarists argue today. The problem is not some inherent instability of the market system,  but rather instability created by monetary policy failure.

Disaster of over-indebtedness

Debts are a necessary part of the establishment of business. For business to be carried out in volume as we know it today debts must be incurred. Debts may lead to over-indebtedness, which he defines as that degree of in-debtedness which multiplies unduly the chances of becoming insolvent. Pressure caused by over-indebtedness leads to distress selling, which prevents the operations of the law of supply and demand, and when a whole community is involved in distress selling the effect is to lower the general price level. It does this because the stampede liquidation involved there by actually shrinks the volume of currency, that is, deposit currency.

Three of the main factors causing depressions are in this manner shortly stated-debts, currency volume, price level. The al- teration of tho price level causes an alteration of the real measures of money-dollar in tho United States, pound in Great Britain and Australia. When the price level falls in the manner stated it reacts on the debt situation, which first caused the alteration.

“When a whole community is in a state of over-indebtedness” Professor Fisher states, “the dollar reacts in such a way that the very act of liquidation may sometimes enlarge the real debts, instead of reducing them. Nominally every liquidation must reduce debts, but really by swelling the worth of every dollar in the country it may swell the unpaid balance of every debt in the country, because the dollar which has to be paid may increase in size faster than the number of dollars in the debt decreases, and when this process starts It must go on, much after the fashion of a vicious spiral . . . downward into the trough of depression.”

So he concludes that when the expanding dollar (that is when the value of the dollar increases) grows faster than the reduction of the number of dollars of debt, liquidation docs not really liquidate, so that the depression goes right on, until there are sufficient bankruptcies to wipe out the activating cause the debts.

LC: Fisher’s comments about indebtedness seem highly relevant today. What Fisher is arguing is that deleveraging is a necessary evil if we have become over-indebted, but if the price level is allowed to contract at during the deleveraging process (the “liquidation”) then the desirable process of “liquidation” will become depressionary. This of course is the argument that Market Monetarists make today when we argue that the euro crisis is not a debt crisis, but a monetary crisis. Yes, it is necessary to reduce debt levels in parts of the euro zone but this process is unlikely to end well if monetary policy remains too tight.

Similarly Fischer’s discussion shows that the debate between one the one hand Keynesian fiscalists and the ‘Austerians’ on the other hand is a phony debate. The Austerians are of course right when they argue that if you have become overly indebted you have to reduce debts, but the Keynesians are equally right that the collapse in aggregate demand is the main cause of the present crisis. Where both sides are wrong is their common focus on fiscal policy. Irving Fisher would have told them to focus on monetary policy instead. Yes, we should reduce debt levels (if we are overly indebted), but the central bank needs to ensure nominal stability so this process does not become deflationary.

Correcting the Price Level

But Why, he asks, suffer from this dollar disease, this variation in the value of the dollar? Should gold coin become copious in the nick of time the gold inflation might counteract the credit deflation. The same result might come from paper inflation for instance, by way of financing a war. That inflation would be a matter ot exercising control of the currency. It should be equally clear, Professor Irving Fisher considers, that deflation or dollar bulging is not an “act of God.” We need not wait for a happy accident to neutralise deflation; we may frustrate, it by design. Man has, or should have, control of his own currency. If we must suffer from the debt disease, why also catch the dollar disease?

LC: Deflation is not a necessary outcome of the “bust”. Deflation is a result of overly tight monetary policy. Irving Fischer knew this very well. Friedman learned that from studying Fisher and Market Monetarists know that today.

The remedy, Professor Fisher declares is first a correction of the price-level by reflation and then henceforward its safe-guarding. He admits that the problem of “what price-level?” is difficult, because the matter what year may be chosen as the year whose level should be restored, it will do injustice. He proposes, therefore, as between the years from 1929 to 1932 to put the price-level part of the way back, so that the injustice would be shared by a great part of two groups, the debtors and the creditors.

…Reflation is the duty of Central Banks, he considers, through expanding thc currency and credit, and when sufficient reflation has been obtained to serve the purpose sought, the currency and credit should be so managed that the general price index after it has been raised to the height required should be maintained at that height.

LC: While Fisher focused on the price level Market Monetarists today focus on the level of nominal GDP,  but the policy message is basically the same – a monetary contraction caused the crisis so monetary policy needs to be eased to “undo” the damage done by monetary tightening. The question then is how much? What level of prices/NGDP should be targeted? This was a challenge to Fisher and that is a challenge to Market Monetarists today.

The Other Means

If, in spite of all other efforts to regulate the price level, the purchasing power of gold over goods should fall, the weight of the gold dollar or sovereign should be increased; or if the purchasing power of gold should rise, the weight of the dollar or sovereign would be correspondingly reduced. Under this plan the actual coinage of gold would be abandoned, and instead of gold I coins, gold bars would be used to redeem the gold certificates. Only gold certificates would circulate, and the price of the bars in terms of these certificates I would be varied from time to time. One advantage of the compensated gold coin plan would be that any nation could operate it alone. The inconvenience of each alteration in the gold coin’s weight causing a corresponding alteration in the foreign exchange would be, he considers, a small matter.

LC: Hence, Irving Fisher was suggesting to revalue or devalue the dollar against the price of gold to ensure a stable price level. Hence, if the price level dropped below the targeted level then the dollar would be devalued against gold, while if prices rose above the targeted level then the dollar would be revalued. The Market Monetarist proposal that central banks should use an NGDP future to conduct monetary policy is very much in the spirit of Fisher’s compensated dollar plan. Both are rule based policies that ensures nominal stability and at the same time strongly limits the central bank’s discretionary powers.

We can learn a lot from history so I encourage everybody interested in monetary history to have a look at the Trove database and similar newspaper archives and please let me know if you find something interesting that can teach us more about how to get out of the present crisis.

6 Comments
by Lars Christensen on April 28, 2013  •  Permalink
Posted in Compensated dollar plan, Irving Fisher, Scott Sumner
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Posted by Lars Christensen on April 28, 2013

http://marketmonetarist.com/2013/04/28/depression-remedy-what-we-can-learn-from-old-newspaper-articles/

Never reason from a price change – the case of commodity prices

The big story in the financial markets this week is the continued decline in commodity prices – particularly the drop in gold prices is getting a lot of attention.

The drop in commodity prices have led some people to speculate that this is an indication that the global economy is slowing. That may or may not be the case. However, as Scott Sumner like to remind us – we should never reason from a price change. 

We have to remember that the price of commodities can drop for two reasons – either demand for commodities declined (that would be an indication that the global economy is slowing) or because of a positive supply shock (that on the other hand would be good news for the global economy).

The good news graph…

Supply demand supply shock And the bad news graph…

Supply demand demand shock

This is not the place to speculate about whether we are in the “bad news” or the “good news”, but global markets are nonetheless telling us that this is not the time to panic – global stock prices have been trending upward, while commodity prices have been declining.

MSCI CRB

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David Glasner also comments on the gold price – he has more interesting things to say than I have.

9 Comments
by Lars Christensen on April 15, 2013  •  Permalink
Posted in Gold price, Scott Sumner
Tagged

Posted by Lars Christensen on April 15, 2013

http://marketmonetarist.com/2013/04/15/never-reason-from-a-price-change-the-case-of-commodity-prices/

2008 was a large negative demand shock – also in Canada

Scott Sumner has a follow-up post on Nick Rowe’s post about whether a supply shock or a demand shock caused the Canadian recession in 2008-9. Both Nick and Scott seem to think that the recession in some way was caused by a supply shock.

I must admit that I really don’t understand what Scott and Nick are saying. It is pretty clear to me that the shock in 2008-9 was negative aggregate demand shock.

Lets start with the textbook version of a negative aggregate demand (AD) shock). Here is how a negative demand shock looks in AS/AD model (the growth rate version):

Demand shock

So what happened in Canada? Here is a look at inflation measured by headline CPI and by the price deflator for final domestic sales.

CAD inflation

Both measures of inflation were running higher than the Bank of Canada’s official 2% inflation target when the crisis hit in the autumn of 2008.

However, it is pretty clear that inflation slowed sharply and dropped well-below the 2% inflation target in 2009 as the Canadian economy went into recession (real GDP contracted). It is hard to say that this is anything other than a rather large negative AD shock.

Obvioulsy inflation increased above 2% in 2011, but we all know that a major negative supply shock hit in 2011 as global oil prices spiked. In the case of Canada this in fact is both a negative supply shock and a positive demand shock (remember Canada is an oil exporter). That said, the rise in inflation was certainly not dramatic and since 2012 inflation has once again dropped well-below 2% indicating that monetary policy in Canada has become overly tight given the BoC’s 2% inflation target.

I might add that different measures of inflation expectations (both survey and market data) are telling the exact same story. Inflation and inflation expectations eased significantly in 2008-9 and once again in 2012.  

And we can tell the same story if we look at the price level. The graph below compares the two measures of prices (CPI and the final domestic demand deflator) with an 2% price path starting in Q3 2008.

Canada Price Level

Again the picture is clear. The price level – for both measures – are lower than a hypothetical 2% price level path – indicating that Mark Carney and his colleagues in the Bank of Canada have kept monetary conditions too tight over the past 4-5 years – maybe because of a preoccupation with the risk of “bubbles”. Mark Carney might be talking about NGDP level targeting, but he is certainly also speaking quite a bit about “macroprudential indicators” (modern central bank lingo for bubble risk).

Concluding, it is very clear that the Canadian economy was hit by a large negative demand shock in 2008 and initially the BoC has kept monetary policy overly tight and the recent tightening of monetary conditions certainly also looks problematic.

Once again it is monetary policy failure and it is certainly not a negative supply shock, which is to blame for the Canadian recession and sub-trend growth since 2008. Needless to say NGDP tells the exact same story. I should add that the size of this “monetary policy failure” is fairly small compared to for example for example what we have seen in the euro zone.

Reminding Scott about the Sumner Critique

Given the very clear evidence of a negative demand shock I find this comment from Scott somewhat puzzling:

Let’s suppose that the BOC had been targeting NGDP in 2008, when global trade fell off a cliff.  How would the Canadian economy have been affected?  Many would see the drop in global trade as a demand shock hitting Canada, as there would have been less demand for Canadian exports.  In fact, it would be an adverse supply shock.  Even if the BOC had been targeting NGDP, output would have probably fallen.  Factories in Ontario making transmissions for cars assembled in Ohio would have seen a drop in orders for transmissions.  That’s a real shock.  No (plausible) amount of price flexibility would move those transmissions during a recession.  If the assembly plant in Ohio stopped building cars, then they don’t want Canadian transmissions.  If the US stops building houses, then we don’t want Canadian lumber.  That’s a real shock to Canada, i.e. an AS shock.

I simply don’t understand Scott’s argument. A negative shock to exports obviously is a negative demand shock. From the perspective of nominal spending a negative shock to exports is a negative shock to money-velocity in the exact same way as a tightening of fiscal policy. Therefore, if the BoC had been targeting NGDP (it actually also goes for inflation targeting) the Sumner Critique would apply - the BoC would offset any negative shock to exports by easing monetary policy (increasing M to offset the drop in V). As a consequence domestic demand would rise and offset the drop in exports. And this obviously applies even if prices are sticky. Yes, the production of transmissions in Ontario drops, but that is offset by an increase in construction of apartments in Vancouver.

However, the point is that the BoC failed to offset the shock to exports and as a consequence prices have been growing slower than implied by BoC’s official inflation target.

There is absolutly nothing special about Canada – its monetary policy failure – the failure is just (a lot) smaller than in the euro zone or the US.

PS I could also have used the GDP deflator as well in my examples above. The story is the same. In fact it is worse! The GDP deflator dropped by more than 4% during 2009. The primary reason for the massive drop in the GDP deflator is that the price of oil measured in Canadian dollars dropped sharply in 2008-9. As drop in the oil price obviously is a negative demand shock as Canada is a oil exporter. The story in that sense is completely the same as what happened to the Russian economy in 2008-9. Had the BoC had followed a variation of an “Export Price Norm” as the Reserve Bank of Australia is doing then the negative shock would likely have been much smaller as was the case in Australia.

GDP deflator Canada

PPS JP Irving also comments on the Canadian story.

14 Comments
by Lars Christensen on March 8, 2013  •  Permalink
Posted in Bank of Canada, JPIrving, Nick Rowe, Scott Sumner, Sumner Critique
Tagged , , , , , , , ,

Posted by Lars Christensen on March 8, 2013

http://marketmonetarist.com/2013/03/08/2008-was-a-large-negative-demand-shock-also-in-canada/

I don’t care who becomes BoJ governor – I want better monetary policy rules

UPDATE: I have edited my post significantly – I misread what Scott really said. That is the result of writing blog posts very early in the morning after sleeping too little. Sorry Scott…

Scott Sumner has a blog post on who might become the next governor of Bank of Japan. Scott ends his post with the following comment:

Naturally I favor the least dovish of the three.

Note that Scott is saying “least dovish” (I missed “least” in my original post). But don’t we want a the most dovish BoJ governor? No, we want the most principled governor – or rather the governor most committed to a rule based monetary policy.

The debate over doves versus hawks is a debate among people who fundamentally think about monetary policy in a discretionary fashion. Market Monetarism is exactly the opposite. We are strongly against discretion in monetary policy (and fiscal policy for that matter).

The important thing is not who is BoJ governor – the important thing is that there are good institutions – good rules. As I have argued before – what we really want is a monetary constitution in spirit of Jim Buchanan. In that sense the BoJ governor should be replaced – as Milton Friedman suggested – by a ‘computer’ and not by the most ‘dovish’ candidate.

Market Monetarists would have been “hawks” in the 1970s in the sense that we would have argued that for example US monetary policy was far too easy and we are ‘doves’ now. But that is really a mistaken way to think about the issue. If we favour for example a 5% NGDP level target for the US today – then we would have been doves in 1974 or 1981. That would make us more or less dovish/hawkish at different times, but that debate is for people who favours discretionary monetary policies – not for Market Monetarists.

If we just want a ‘dovish’ BoJ governor then we should advocate that Prime Minister Shinzo Abe gives Zimbabwean central bank governor Gideon Gono a call. He knows all about monetary easing – and so do the central bank governors of Venezuela and Argentina. But we all know that these people are ludicrously bad central bankers.  In similar fashion Janet Yellen would not be the Market Monetarist candidate for the Federal Reserve chairman just because she tends to favour monetary easing – in fact it seems like Yellen always favours monetary easing. In fact you should be very suspicious of the views of policy makers who will always be hawks or doves.

Gideon_Gono10

The reason that Mark Carney is a good choice for new Bank of England governor is exactly that he is not ‘dovish’ or ‘hawkish’, but that he tend to stress the need for a rule based monetary policy. That said, the important thing is not Mark Carney, but rather whether the UK government is serious about introducing NGDP level targeting or not.

Monetary policy is not primarily about having the right people for the job, but rather about having the best institutions. Obviously you want to have the best people for the job, but ultimately even Scott Sumner would be a horrible Fed governor if his mandate was wrong.

If the BoJ had a rule based monetary policy and used for example NGDP futures to conduct monetary policy then it wouldn’t matter who becomes BoJ governor – because the policy would be the same no matter what. We cannot rely on central bankers to do the ‘right thing’. Central bankers only do the right thing by chance. We need to tie their hands with a monetary constitution – with strong rules.

Related posts:

Forget about “hawks” and “doves” – what we need is a “monetary constitution”
NGDP targeting is not about ”stimulus”
NGDP targeting is not a Keynesian business cycle policy
Be right for the right reasons
Monetary policy can’t fix all problems
Boettke’s important Political Economy questions for Market Monetarists
NGDP level targeting – the true Free Market alternative
Lets concentrate on the policy framework
Boettke and Smith on why we are wasting our time
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed
NGDP level targeting – the true Free Market alternative (we try again)

 

4 Comments
by Lars Christensen on February 24, 2013  •  Permalink
Posted in Argentina, Bank of Japan, Gideon Gono, James Buchanan, Japan, Mark Carney, Venezuela
Tagged , , , , , , , ,

Posted by Lars Christensen on February 24, 2013

http://marketmonetarist.com/2013/02/24/i-dont-care-who-becomes-boj-governor-i-want-better-monetary-policy-rules/

The root of most fallacies in economics: Forgetting to ask WHY prices change

Even though I am a Dane and work for a Danish bank I tend to not follow the Danish media too much – after all my field of work is international economics. But I can’t completely avoid reading Danish newspapers. My greatest frustration when I read the financial section of Danish newspapers undoubtedly is the tendency to reason from different price changes – for example changes in the price of oil or changes in bond yields – without discussing the courses of the price change.

The best example undoubtedly is changes in (mortgage) bond yields. Denmark has been a “safe haven” in the financial markets so when the euro crisis escalated in 2011 Danish bond yields dropped dramatically and short-term government bond yields even turned negative. That typically triggered the following type of headline in Danish newspapers: “Danish homeowners benefit from the euro crisis” or “The euro crisis is good news for the Danish economy”.

However, I doubt that any Danish homeowner felt especially happy about the euro crisis. Yes, bond yields did drop and that cut the interest rate payments for homeowners with floating rate mortgages. However, bond yields dropped for a reason – a sharp deterioration of the growth outlook in the euro zone due to the ECB’s two unwarranted interest rate hikes in 2011. As Denmark has a pegged exchange rate to the euro Denmark “imported” the ECB’s monetary tightening and with it also the prospects for lower growth. For the homeowner that means a higher probability of becoming unemployed and a prospect of seeing his or her property value go down as the Danish economy contracted. In that environment lower bond yields are of little consolation.

Hence, the Danish financial journalists failed to ask the crucial question why bond yields dropped. Or said in another way they failed to listen to the advice of Scott Sumner who always tells us not to reason from a price change.

This is what Scott has to say on the issue:

My suggestion is that people should never reason from a price change, but always start one step earlier—what caused the price to change.  If oil prices fall because Saudi Arabia increases production, then that is bullish news.  If oil prices fall because of falling AD in Europe, that might be expansionary for the US.  But if oil prices are falling because the euro crisis is increasing the demand for dollars and lowering AD worldwide; confirmed by falls in commodity prices, US equity prices, and TIPS spreads, then that is bearish news.

I totally agree. When we see a price change – for example oil prices or bond yields – we should ask ourselves why prices are changing if we want to know what macroeconomic impact the price change will have. It is really about figuring out whether the price change is caused by demand or supply shocks.

The euro strength is not necessarily bad news – more on the currency war that is not a war

A very good example of this general fallacy of forgetting to ask why prices are changing is the ongoing discussion of the “currency war”. From the perspective of some European policy makers – for example the French president Hollande – the Bank of Japan’s recent significant stepping up of monetary easing is bad news for the euro zone as it has led to a strengthening of the euro against most other major currencies in the world. The reasoning is that a stronger euro is hurting European “competitiveness” and hence will hurt European exports and therefore lower European growth.

This of course is a complete fallacy. Even ignoring the fact that the ECB can counteract any negative impact on European aggregate demand (the Sumner critique also applies for exports) we can see that this is a fallacy. What the “currency war worriers” fail to do is to ask why the euro is strengthening.

The euro is of course strengthening not because the ECB has tightened monetary policy but because the Bank of Japan and the Federal Reserve have stepped up monetary easing.

With the Fed and the BoJ significantly stepping up monetary easing the growth prospects for the largest and the third largest economies in the world have greatly improved. That surely is good news for European exporters. Yes, European exporters might have seen a slight erosion of their competitiveness, but I am pretty sure that they happily will accept that if they are told that Japanese and US aggregate demand – and hence imports – will accelerate strongly.

Instead of just looking at the euro rate European policy makers should consult more than one price (the euro rate) and look at other financial market prices – for example European stock prices. European stock prices have in fact increased significantly since August-September when the markets started to price in more aggressive monetary easing from the Fed and the BoJ. Or look at bond yields in the so-called PIIGS countries – they have dropped significantly. Both stock prices and bond yields in Europe hence are indicating that the outlook for the European economy is improving rather than deteriorating.

The oil price fallacy – growth is not bad news, but war in the Middle East is

A very common fallacy is to cry wolf when oil prices are rising – particularly in the US. The worst version of this fallacy is claiming that Federal Reserve monetary easing will be undermined by rising oil prices.

This of course is complete rubbish. If the Fed is easing monetary policy it will increase aggregate demand/NGDP and likely also NGDP in a lot of other countries in the world that directly or indirectly is shadowing Fed policy. Hence, with global NGDP rising the demand for commodities is rising – the global AD curve is shifting to the right. That is good news for growth – not bad news.

Said another way when the AD curve is shifting to the right – we are moving along the AS curve rather than moving the AS curve. That should never be a concern from a growth perspective. However, if oil prices are rising not because of the Fed or the actions of other central banks – for example because of fears of war in the Middle East then we have to be concerned from a growth perspective. This kind of thing of course is what happened in 2011 where the two major supply shocks – the Japanese tsunami and the revolutions in Northern Africa – pushed up oil prices.

At the time the ECB of course committed a fallacy by reasoning from one price change – the rise in European HICP inflation. The ECB unfortunately concluded that monetary policy was too easy as HICP inflation increased. Had the ECB instead asked why inflation was increasing then we would likely have avoided the rate hikes – and hence the escalation of the euro crisis. The AD curve (which the ECB effectively controls) had not shifted to the right in the euro area. Instead it was the AS curve that had shifted to the left. The ECB’s failure to ask why prices were rising nearly caused the collapse of the euro.

The money supply fallacy – the fallacy committed by traditional monetarists 

Traditional monetarists saw the money supply as the best and most reliable indicator of the development in prices (P) and nominal spending (PY). Market Monetarists do not disagree that there is a crucial link between money and prices/nominal spending. However, traditional monetarists tend(ed) to always see the quantity of money as being determined by the supply of money and often disregarded changes in the demand for money. That made perfectly good sense for example in the 1970s where the easy monetary policies were the main driver of the money supply in most industrialized countries, but that was not the case during the Great Moderation, where the money supply became “endogenous” due to a rule-based monetary policies or during the Great Recession where money demand spiked in particularly the US.

Hence, where traditional monetarists often fail – Allan Meltzer is probably the best example today – is that they forget to ask why the quantity of money is changing. Yes, the US money base exploded in 2008 – something that worried Meltzer a great deal – but so did the demand for base money. In fact the supply of base money failed to increase enough to counteract the explosion in demand for US money base, which effectively was a massive tightening of US monetary conditions.

So while Market Monetarists like myself certainly think money is extremely important we are skeptical about using the money supply as a singular indicator of the stance of monetary policy. Therefore, if we analyse money supply data we should constantly ask ourselves why the money supply is changing – is it really the supply of money increasing or is it the demand for money that is increasing? The best way to do that is to look at market data. If market expectations for inflation are going up, stock markets are rallying, the yield curve is steepening and global commodity prices are increasing then it is pretty reasonable to assume global monetary conditions are getting easier – whether or not the money supply is increasing or decreasing.

Finally I should say that my friends Bob Hetzel and David Laidler would object to this characterization of traditional monetarism. They would say that of course one should look at the balance between money demand and money supply to assess whether monetary conditions are easy or tight. And I would agree – traditional monetarists knew that very well, however, I would also argue that even Milton Friedman from time to time forgot it and became overly focused on money supply growth.

And finally I happily will admit committing that fallacy very often and I still remain committed to studying money supply data – after all being a Market Monetarist means that you still are 95% old-school traditional monetarist at least in my book.

PS maybe the root of all bad econometrics is the also forgetting to ask WHY prices change.

13 Comments
by Lars Christensen on February 14, 2013  •  Permalink
Posted in Bank of Japan, Currency war, David Laidler, Denmark, euro crisis, Federal Reserve, Mexico, Milton Friedman, Robert Hetzel, Scott Sumner, Sumner Critique, The Great Recession
Tagged , , , , , , , , , , , ,

Posted by Lars Christensen on February 14, 2013

http://marketmonetarist.com/2013/02/14/the-root-of-most-fallacies-in-economics-forgetting-to-ask-why-prices-change/

Don’t ever tell me again that monetary policy does not work! Chuck Norris visits Japan

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.

6 Comments
by Lars Christensen on February 6, 2013  •  Permalink
Posted in Bank of Japan, Chuck Norris Effect, Mark Carney, Scott Sumner
Tagged , , , ,

Posted by Lars Christensen on February 6, 2013

http://marketmonetarist.com/2013/02/06/dont-ever-tell-me-again-that-monetary-policy-does-not-work-chuck-norris-visits-japan/

Will anybody read this post if I put “data revisions” in the headline?

Opponents of NGDP level targeting often argue that nominal GDP is problematic as national account data often is revised and hence one would risk targeting the wrong data and that that could lead to serious policy mistakes. I in general find this argumentation flawed and find that it often based on a misunderstanding about what NGDP level targeting is about.

First of all let me acknowledge that macroeconomic data in general tend to undergo numerous revisions and often the data quality is very bad. That goes for all macroeconomic data in all countries. Some have for example argued that the seasonal adjustment of macroeconomic data has gone badly wrong in many countries after 2008. Furthermore, it is certainly not a nontrivial excise to correct data for different calendar effects – for example whether Easter takes place in February or March. Therefore, macroeconomic data are potentially flawed – not only NGDP data. That said, in many countries national account numbers – including GDP data – are often revised quite dramatically.

However, what critics fail to realise is that Market Monetarists and other proponents NGDP level targeting is arguing to target the present or history level of NGDP, but rather the future NGDP level. Therefore, the real uncertainty is not data revisions but about the forecasting abilities of central banks. The same is of course the case for inflation targeting – even though it often looks like the ECB is targeting historical or present inflation the textbook version of inflation forecasting clearly states that the central bank should forecast future inflation. In that sense future NGDP is not harder to forecast than future inflation.

I believe, however, there is pretty strong evidence that central banks in general are pretty bad forecasters and the forecasts are often biased in one or the other direction. There is therefore good reason to believe that the market is better at predicting nominal variables such as NGDP and inflation than central banks. Therefore, Market Monetarists – and Bill Woolsey and Scott Sumner particular – have argued that central banks (or governments) should set up futures markets for NGDP in the same way the so-called TIPS market in the US provides a market forecast for inflation. As such a market is a real-time “forecaster” and there will be no revisions and as the market would be forecasting future NGDP level the market would also provide an implicit forecast for data revisions – unlike regular macroeconomic forecasts. By using NGDP futures to guide monetary policy the central banks would not have to rely on potentially bias in-house forecasts and there would be no major problem with potential data revisions.

Furthermore, arguing that NGDP data can be revised might point to a potential (!) problem with NGDP, but at the same time if one argues that national account data in general is unreliable then it is also a problem for an inflation targeting central bank. The reason is that most inflation targeting central banks historical have use a so-called Taylor rule (or something similar) to guide monetary policy – to see whether interest rates should be increased or lowered.

We can write a simple Taylor rule in the following way:

R=a(p-pT)+b(y-y*)

Where R is the key policy interest rate, a and b are coefficients, p is actual inflation pT is the inflation target, y is real GDP and y* is potential GDP.

Hence, it is clear that a Taylor rule based inflation target also relies on national account data – not NGDP, but RGDP. And even more important the Taylor rule dependent on an estimate of potential real GDP.

Anybody who have ever seriously worked with trying to estimate potential GDP will readily acknowledge how hard it is to estimate and there are numerous methods to estimate potential GDP and the different methods – for example production function or HP filters – that would lead to quite different results. So here we both have the problem with data revisions AND the problem with estimating potential GDP from data that might be revised.

This is particularly important right now as many economists have argued that potential GDP has dropped in the both the US and the euro zone on the back of the crisis. If that is in fact the case then for a given inflation target monetary policy will have to be tighter than if there has not been a drop in potential GDP. Whether or not that has been a case is impossible to know – we might know it in 5 or 10 years, but now it is impossible to say whether euro zone trend growth is 1.2% or 2.2%. Who knows? That is a massive challenge to inflation targeting central bankers.

Contrary to this changes in potential GDP or for that matter short-term supply shocks (for example higher oil prices) will have no impact on the conduct on monetary policy as the NGDP targeting central bank will not concern itself with the split between real GDP growth and inflation.

An example of the problems of how we measure inflation is the ECB two catastrophic interest rate hikes in 2011. The ECB twice hiked interest rates and in my view caused a massive escalation of the euro crisis. What the ECB reacted to was a fairly steep increase in headline consumer prices. However, in hindsight (and for some of us also in real-time) it is (was) pretty clear that there was not a real increase in inflationary pressures in the euro zone. The increase in headline consumer price inflation was caused by supply shocks and higher indirect taxes, which is evident from comparing the GDP deflator (which showed no signs of escalating inflationary pressures) with consumer prices inflation. Again, there would have been no mixing up of demand and supply shocks if the ECB had targeted the NGDP level instead. From that it was very clear that monetary conditions were very tight in 2011 and got even tighter as the ECB moved to hike interest rates. Had the ECB focused on the NGDP level then it would obviously have realised that what was needed was monetary easing and not monetary tightening and had the ECB acted on that then the euro crisis likely would already have been over.

It should also be noted that even though NGDP numbers tend to be revised that does not mean that the quality of the numbers as such are worse than inflation data. In fact inflation data are often of a very dubious character. An example is the changes in the measurement of consumers prices in the US after the so-called Boskin report came out in 1996. The report concluded that US inflation data overestimated inflation by more than 1% – and therefore equally underestimated real GDP growth. Try to plug that into the Taylor rule above. That means that p is lower and y* is higher – both would lead to the conclusion that interest rates should be lowered. Some have claimed that the revisions made to the measurement of consumer prices in the US caused the Federal Reserve to pursue an overly easy monetary stance in the end of the 1990s, which caused the dot-com bubble. I have some sympathy for this view and at least I know that had the Fed been following a strict NGDP level targeting regime at the end of the 1990s then it would have tighten monetary faster and more aggressively than it did in particularly 1999-2000 as the Fed would have disregarded the split between prices and real GDP and instead focused on the escalation of NGDP growth.

Concluding, yes national account numbers – including NGDP numbers – are often revised and that creates some challenges for NGDP targeting. However, the important point is that present and historical data is not important, but rather the expectation of the future NGDP, which an NGDP futures market (or a bookmaker for that matter) could provide a good forecast of (including possible data revisions). Contrary to this inflation targeting central banks also face challenges of data revisions and particularly a challenge to separate demand shocks from supply shocks and estimating potential GDP.
Therefore, any critique of NGDP targeting based on the “data revision”-argument is equally valid – or even more so – in the case of inflation targeting. Hence, worries about data quality is not an argument against NGDP targeting, but rather an argument for scrapping inflation targeting – the ECB with its unfortunate actions proved that in both 2008 and 2011.

5 Comments
by Lars Christensen on January 9, 2013  •  Permalink
Posted in Bill Woolsey, ECB, Federal Reserve, Scott Sumner
Tagged , , , , ,

Posted by Lars Christensen on January 9, 2013

http://marketmonetarist.com/2013/01/09/will-anybody-read-this-post-if-i-put-data-revisions-in-the-headline/

The trillion dollar coin is an utterly idiotic idea

Following US political debate these days is like following a bad parody of a third world banana republic and even though I the deepest respect for Americans and US in general I must say it is hard not to agree with those Europeans that shake their heads these days and say “they are stupid those Americans”. Well, it is not the Americans – it is their politicians and you could say a similar thing about Europe.

The latest banana republic gimmick is the suggestion that the US Treasury should use a legal loophole to print a trillion dollar coin in the event that the US congressional majority – that’s the Republicans – would refuse to increase the so-called debt celling.

The idea in my view is completely ludicrous and it is incredible that anybody seriously would even contemplate such an idea. Anyway, is Nobel Prize winning economist Paul Krugman:

“It’s easy to make sententious remarks to the effect that we shouldn’t look for gimmicks, we should sit down like serious people and deal with our problems realistically. That may sound reasonable — if you’ve been living in a cave for the past four years.Given the realities of our political situation, and in particular the mixture of ruthlessness and craziness that now characterizes House Republicans, it’s just ridiculous — far more ridiculous than the notion of the coin.

So if the 14th amendment solution — simply declaring that the debt ceiling is unconstitutional — isn’t workable, go with the coin.”

Nobel Prize or not Krugman is wrong – as he so often is.

First, of all there is no reason to think that the US government would have to default on it’s public debt just because the debt ceiling is not increased. The monthly debt servicing costs in the US is significantly smaller than the US government’s total monthly tax revenues. It might be that the US Treasury would have to stop paying out salaries to US Congressmen and stop buying new military hardware for a while – neither would be a major lose – but the tax revenues would easily cover  the debt servicing costs. That of course do not mean that I suggest that the debt ceiling should not be increased – that is US party political shenanigans that I simply don’t even want to comment on. However, it is wrong to suggest that the US government would automatically default if the debt ceiling is not increased.

Lars, wouldn’t a 1 trillion dollar coin be monetary easing? So it most be good?

What I really want to discuss is the Market Monetarist perspective on this discussion. Yes, Market Monetarists have for the past four years argued that US monetary policy has been overly tight and the reason the US recovery has been so relatively weak is the that Federal Reserve has had too tight monetary policy. That has led Market Monetarists like myself and other to call for monetary easing from the Federal Reserve.

However, at the core of Market Monetarist thinking is not the call for monetary easing and no Market Monetarist has ever said that monetary easing is the cure of all evils. Rather at the centre of Market Monetarist thinking is the call for a rule based monetary policy. An easing of monetary policy based on a trillion dollar coin is probably the most discretionary and least rule based monetary (and fiscal) idea anybody have come up with over the past four years.

Yes, Market Monetarists are certainly skeptical about central bankers ability to conduct monetary policy in a proper fashion, but that certainly do not mean that we think US politicians and bureaucrats in the US Treasury would do a better job. Far from it!

I would even go further – I don’t necessarily think that the US economy needs more quantitative easing IF the Federal Reserve started conducting monetary policy based on a transparent monetary rule like NGDP level targeting. Furthermore, if I would have to chose between an NGDP level target or a massive ramping up of quantitative easing within a discretionary framework then there is no doubt that I would choose the rule based framework. Market Monetarists are not the monetary version of discretionary Krugmanian fiscal policy.

Concluding, the trillion dollar coin idea is stupid. It is stupid because it banana republic “economic” policy based on the worst political motives without any foundation in the rule of law and a general rules based framework.

The fact is that the US government faces serious fiscal challenges. The US public debt level needs to be reduced and even if the Federal Reserve pushed back NGDP to its pre-crisis trend level I believe there would be a significant need for fiscal consolidation. There is no getting around it – debt ceiling or not, trillion dollar coin or not – fiscal policy will have to be tightened sooner or later. And if you need idea about what to cut I have some ideas about that as well (see here).

It is simple mamanomics – you can’t continue spending more money than you have. It might be that certain US policy makers would be happy if their mom raised their weekly allowances, but would they also be happy if their mom prostituted herself to do that?

PS there is no party politics in what I am saying – I have the same lack of respect for both main political parties in the US as do most Americans.

PPS Scott Sumner and Tyler Cowen also comment on the trillion dollar coin – for some reason the two gentlemen are slightly more diplomatic than I am. Josh Hendrickson, however, is as clear on the issue as I am – Josh has two posts on the trillion dollar coin. See here and here.

PPPS If you think there is a lot of James Buchanan and Friedrich Hayek in this post then I have achieved what I want to achieve. After all Friedman and Schwartz’s “Monetary History” is not the only book I read.

Update: Both Steve Horwitz and George Selgin comment on the trillion dollar coin – not surprisingly I have no reason to disagree with the two gentlemen.

18 Comments
by Lars Christensen on January 8, 2013  •  Permalink
Posted in Debt ceiling, Fiscal cliff, Fiscal policy
Tagged , , , , ,

Posted by Lars Christensen on January 8, 2013

http://marketmonetarist.com/2013/01/08/the-trillion-dollar-coin-is-an-utterly-idiotic-idea/

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