All posts tagged Robert Hetzel

The ECB should give Bob Hetzel a call

The ECB is very eager to stress that the monetary transmission mechanism in some way is broken and that the policy measures needed is not quantitative easing, but measures to repair the monetary transmission mechanism.

In regard to ECB’s position I find this quote from a excellent paper – What Is a Central Bank? – by Bob Hetzel very interesting:

For example, in Japan, the argument is common that the bad debts of banks have broken the monetary transmission mechanism. The central bank can acquire assets to increase the reserves of commercial banks, but the weak capital position of banks limits their willingness to engage in additional lending. As in the real bills world, the marketplace controls the ability of the central bank to create independent changes in money that change prices.

According to the quantity theory as opposed to the real bills view, a central bank exercises its control over the public’s nominal expenditure through money (monetary base) creation. That control does not derive from the central bank’s influence over financial intermediation. A commercial bank acquires assets by making its liabilities attractive to individuals who forego consumption to hold them. In contrast, a central bank acquires assets through the ability to impose a tax (seigniorage) that comes from money creation. It imposes the tax directly on holders of cash and indirectly on holders of bank deposits to the extent that banks hold reserves against deposits.

Bob wrote the paper while he was a visiting scholar at the Bank of Japan in 2003.

It is striking how the present position of the ECB is similar to the BoJ’s position at the time Bob spend time there. Maybe the ECB should invite Bob to pay a visit?

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See also Bob’s paper Japanese Monetary Policy and Deflation.

3 Comments
by Lars Christensen on June 9, 2014  •  Permalink
Posted in Bank of Japan, ECB, Real Bills doctrine, Robert Hetzel
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Posted by Lars Christensen on June 9, 2014

https://marketmonetarist.com/2014/06/09/the-ecb-should-give-bob-hetzel-a-call/

It is time to get government out of US housing finance

Scott Sumner has a great post on the very scary state of US housing finance. This is something that many Europeans might not realise, but when it comes to housing finance the US is likely one of the most socialist countries among the developed economies of the world.

This is from the Wall Street Journal article Scott quotes in his post:

Fannie and Freddie, which remain under U.S. conservatorship, and federal agencies continue to backstop the vast majority of new mortgages being issued.

Yes, that is true – the two largest mortgage lenders in the US is effectively government owned. So to the extent that you think that there was a bubble in US property market prior to 2008 – I am not sure that there was – then you should probably forget the talk about overly easy monetary policy and instead focus on the massive US government involvement in housing finance.

Post-2008 the regulatory move has been to tighten lending standards for mortgage lenders, but now we have this (also from the WSJ article):

The Obama administration and federal regulators are reversing course on some of the biggest post crisis efforts to tighten mortgage-lending standards amid concern they could snuff out the fledgling housing rebound and dent the economic recovery.

On Tuesday, Mel Watt, the newly installed overseer of Fannie Mae and Freddie Mac said the mortgage giants should direct their focus toward making more credit available to homeowners, a U-turn from previous directives to pull back from the mortgage market.

In coming weeks, six agencies, including Mr. Watt’s, are expected to finalize new rules for mortgages that are packaged into securities by private investors. Those rules largely abandon earlier proposals requiring larger down payments on mortgages in certain types of mortgage-backed securities.

My god…it seems like the Obama administration wants a new government subsidized subprime market. Good luck with that!

The regulatory wave that have rolled over the US banking and finance industry in the past five years has not made moral hazard problems smaller, but rather the opposite and the continued massive government involvement in housing finance is seriously adding to these problems.

It is very clear that the US housing finance system over the past couple of decades has become insanely politicized. An example is Mr. Watt – the newly appointed overseer of Fannie and Freddie. Mr. Watt do not have a background in finance or in economics. Rather he is a career politician. Is a career politician really what you want if you want to avoid moral hazard? I think not.

Blame Bill Clinton  

In his great book The Great Recession – Market Failure or Policy Failure? Robert Hetzel spells out how  the present housing finance debacle in the US started back in the 1990s during the Clinton administration – with strong bi-partisan support I should say. (See particular 10 in Bob’s book).

Hence, the Clinton administration set ambitious goals to raise homeownership in the US in a document called “The National Homeownership Strategy: Partners in the American Dream”.

The document starts with a message from president Clinton:

“…This past year, I directed HUD Secretary Henry G. Cisneros to work with leaders in the housing industry, with nonprofit organizations, and with leaders at every level of government to develop a plan to boost homeownership in America to an all-time high by the end of this century. The National Homeownership Strategy: Partners in the American Dream outlines a substantive, detailed plan to reach this goal. This report identifies specific actions that the federal government, its partners in state and local government, the private, nonprofit community, and private industry will take to lower barriers that prevent American families from becoming homeowners. Working together, we can add as many as eight million new families to America’s homeownership rolls by the year 2000.”

Did Clinton “succeed”? You bet he did. Just take a look at this graph of the US home ownership rate (I stole it from Bob’s book):

Homeownership rate US

It is hard to avoid the conclusion that there is a clear connection between the US government’s stated goal of boosting homeownership and the actual sharp increasing in homeownership from around 1995.

Therefore, I also find it likely that the sharp increase in housing demand from the mid-1990s was a result of US government policies to subsidize housing finance rather than a result of overly easy monetary policy. There certainly also were other reasons such as demography, but direct and indirect subsidizes likely were the main culprit.

Forgetting monetary policy and increasing moral hazard

In the light of this I completely share Scott’s reaction to the latest policy actions from the Obama administration. It is particularly horrifying that the Obama administration consistently has undermined the efforts to ease US monetary policy during this crisis – among other things by appointing über hawkish Fed officials – while at the same time now is trying to “boost growth” by further increasing moral hazard problems in the US financial system. And just imagine what would have happened if Larry Summers had been appointed new Fed chairman…

That I believe once again shows how policy makers again and again prefer credit policies and quasi-fiscal policies to monetary policy. The result is that we are not really seeing any lift in nominal demand growth, but moral hazard problems continue to increase. That is the case in the US as well as in Europe. Or as Scott so clearly explains it:

“So let’s see, we have to taper QE because otherwise the economy will “overheat.” After all, unemployment has fallen to 6.3% and many of the remaining unemployed are supposedly unemployable.  And yet we need to go back to the subprime mortgage economy to juice the economy.  Is that the view of the Fed? Forget about “getting in all the cracks,” can we stop opening up new cracks as wide as the Grand Canyon?”

Get government out of housing finance and implement a rule based monetary policy

The US government involvement in housing finance has been an utter failure. It has strongly increased Too Big To Fail problems and moral hazard in the US financial system and the latest initiatives are likely to further increase the risk of a new housing crisis.

There in my view is only one solution and that is to get the US government completely out of housing finance and to significantly scale back the US government’s (and the Federal Reserve’s) involvement in the credit markets. There are no economic valid arguments for why the US tax payers should subsidize housing finance.

Obviously one can argue that such badly needed reforms in the near-term could tighten financial and credit conditions, which effectively could cause a tightening of monetary conditions (through a drop in the money-multiplier). However, this is no argument against such reforms. Rather it is yet another argument why the Fed should implement a strictly rule based monetary policy – preferably a NGDP target.

If indeed housing finance reforms where to tighten credit conditions and cause the money-multiplier to drop then this can always be counteracted by an increase in the US money base. This of course would happen quasi-automatically under a strict NGDP target.

In that sense there is also a good argument for the Fed and the US government to coordinate such reforms. The US government should reduce its role in the credit markets to a minimum, while the Fed should commit itself to maintaining nominal stability and if needed postponing tapering or even expand quantitative easing as housing finance reform is implemented.

PS I hope this post clearly illustrate that Market Monetarists like Scott and myself are horrified by government involvement in such things as housing finance and that we are deeply concerned about moral hazard problems. We have in the past five years advocated monetary easing to ensure nominal stability, but we have NEVER advocated credit policies of any kind. As a higher level of nominal stability is returning particularly in the US we are likely to increasingly focus on moral hazard problem and yes in 1-2 years time we might start to sound quite hawkish in terms of the Fed’s monetary policy stance, but our views will not have changed. We continue to advocate that governments should get out of the credit markets and housing finance and that central banks should follow clear and transparent monetary policy rules to ensure nominal stability.

7 Comments
by Lars Christensen on May 16, 2014  •  Permalink
Posted in Housing finance reform, Moral Hazard, Robert Hetzel, Scott Sumner
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Posted by Lars Christensen on May 16, 2014

https://marketmonetarist.com/2014/05/16/time-to-get-government-out-of-us-housing-finance/

The Casselian-Mundelian view: An overvalued dollar caused the Great Recession

This is CNBC’s legendary Larry Kudlow in a comment to my previous post:

My friend Bob Mundell believes a massively over-valued dollar (ie, overly tight monetary policy) was proximate cause of financial freeze/meltdown.

Larry’s comment reminded me of my long held view that we have to see the Great Recession in an international perspective. Hence, even though I generally agree on the Hetzel-Sumner view of the cause – monetary tightening – of the Great Recession I think Bob Hetzel and Scott Sumner’s take on the causes of the Great Recession is too US centric. Said in another way I always wanted to stress the importance of the international monetary transmission mechanism. In that sense I am probably rather Mundellian – or what used to be called the monetary theory of the balance of payments or international monetarism.

Overall, it is my view that we should think of the global economy as operating on a dollar standard in the same way as we in the 1920s going into the Great Depression had a gold standard. Therefore, in the same way as Gustav Cassel and Ralph Hawtrey saw the Great Depression as result of gold hoarding we should think of the causes of the Great Recession as being a result of dollar hoarding.

In that sense I agree with Bob Mundell – the meltdown was caused by the sharp appreciation of the dollar in 2008 and the crisis only started to ease once the Federal Reserve started to provide dollar liquidity to the global markets going into 2009.

I have earlier written about how I believe international monetary disorder and policy mistakes turned the crisis into a global crisis. This is what I wrote on the topic back in May 2012:

In 2008 when the crisis hit we saw a massive tightening of monetary conditions in the US. The monetary contraction was a result of a sharp rise in money (dollar!) demand and as the Federal Reserve failed to increase the money supply we saw a sharp drop in money-velocity and hence in nominal (and real) GDP. Hence, in the US the drop in NGDP was not primarily driven by a contraction in the money supply, but rather by a drop in velocity.

The European story is quite different. In Europe the money demand also increased sharply, but it was not primarily the demand for euros, which increased, but rather the demand for US dollars. In fact I would argue that the monetary contraction in the US to a large extent was a result of European demand for dollars. As a result the euro zone did not see the same kind of contraction in money (euro) velocity as the US. On the other hand the money supply contracted somewhat more in the euro zone than in the US. Hence, the NGDP contraction in the US was caused by a contraction in velocity, but in the euro zone the NGDP contraction was caused by both a contraction in velocity and in the money supply, reflecting a much less aggressive response by the ECB than by the Federal Reserve.

To some extent one can say that the US economy was extraordinarily hard hit because the US dollar is the global reserve currency. As a result global demand for dollar spiked in 2008, which caused the drop in velocity (and a sharp appreciation of the dollar in late 2008).

In fact I believe that two factors are at the centre of the international transmission of the crisis in 2008-9.

First, it is key to what extent a country’s currency is considered as a safe haven or not. The dollar as the ultimate reserve currency of the world was the ultimate safe haven currency (and still is) – as gold was during the Great Depression. Few other currencies have a similar status, but the Swiss franc and the Japanese yen have a status that to some extent resembles that of the dollar. These currencies also appreciated at the onset of the crisis.

Second, it is completely key how monetary policy responded to the change in money demand. The Fed failed to increase the money supply enough to meet the increase in the dollar demand (among other things because of the failure of the primary dealer system). On the other hand the Swiss central bank (SNB) was much more successful in responding to the sharp increase in demand for Swiss francs – lately by introducing a very effective floor for EUR/CHF at 1.20. This means that any increase in demand for Swiss francs will be met by an equally large increase in the Swiss money supply. Had the Fed implemented a similar policy and for example announced in September 2008 that it would not allow the dollar to strengthen until US NGDP had stopped contracting then the crisis would have been much smaller and would long have been over…

…I hope to have demonstrated above that the increase in dollar demand in 2008 not only hit the US economy but also led to a monetary contraction in especially Europe. Not because of an increased demand for euros, lats or rubles, but because central banks tightened monetary policy either directly or indirectly to “manage” the weakening of their currencies. Or because they could not ease monetary policy as members of the euro zone. In the case of the ECB the strict inflation targeting regime let the ECB to fail to differentiate between supply and demand shocks which undoubtedly have made things a lot worse.

So there you go – you have to see the crisis in an international monetary perspective and the Fed could have avoided the crisis if it had acted to ensure that the dollar did not become significantly “overvalued” in 2008. So yes, I am as much a Mundellian (hence a Casselian) as a Sumnerian-Hetzelian when it comes to explaining the Great Recession. A lot of my blog posts on monetary policy in small-open economies and currency competition (and why it is good) reflect these views as does my advocacy for what I have termed an Export Price Norm in commodity exporting countries. Irving Fisher’s idea of a Compensated Dollar Plan has also inspired me in this direction.

That said, the dollar should be seen as an indicator or monetary policy tightness in both the US and globally. The dollar could be a policy instrument (or rather an intermediate target), but it is not presently a policy instrument and in my view it would be catastrophic for the Fed to peg the dollar (for example to the gold price).

Unlike Bob Mundell I am very skeptical about fixed exchange rate regimes (in all its forms – including currency unions and the gold standard). However, I do think it can be useful for particularly small-open economies to use the exchange rate as a policy instrument rather than interest rates. Here I think the policies of particularly the Czech, the Swiss and the Singaporean central banks should serve as inspiration.

2 Comments
by Lars Christensen on January 19, 2014  •  Permalink
Posted in Compensated dollar plan, ECB, Export Price Norm, Federal Reserve, Gustav Cassel, Larry Kudlow, Ralph Hawtrey, Robert Hetzel, Robert Mundell, Scott Sumner, Uncategorized
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Posted by Lars Christensen on January 19, 2014

https://marketmonetarist.com/2014/01/19/the-casselian-mundelian-view-an-overvalued-dollar-caused-the-great-recession/

Firefighter Arsonists – the myth of the central bankers as ‘good’ crisis managers

The recent debate about who should be the new Federal Reserve governor has made me think about the general misperception that a good central bank governor is a good “crisis manager”.

This is for example Ezra Klein endorsing Larry Summer for new Fed chief:

“Summers knows how to manage a crisis. This White House is particularly attuned to the idea that the economy can fall apart at any moment. Summers, they think, knows what to do when that happens. He was at the center of the Clinton administration’s efforts to fight back the various emerging-markets crises of the 1990s (remember “The Committee to Save the World”?). He was core to the Obama administration’s efforts to fight the financial crisis in 2009 and 2010. Few people on earth are as experienced at dealing with financial crises — both of the domestic and international variety — as Summers.
What is wrong with this argument?

First, of all the assumption is that crisis is a result of the market economy’s inherent instability and that the regulators’ and the central bankers’ role is to somehow correct these failures. There is no doubt that central bankers like this image as saviours of the world. However, history shows that again and again we are in fact talking about firefighter arsonists – central banks again and again have caused crisis and afterwards been hailed as the firefighters who flew in and saved the world.

Just take the ECB’s actions of the last couple of years. The introduction of the so-called OMT program is often said to have ended the fire that was (is) the euro zone crisis. But why did we have a euro crisis to begin with? Well, it is pretty hard to get around fact that the ECB’s two rate hikes in 2011 played a very significant role in igniting the crisis in the first place. So is the ECB a firefighter or an arsonist?

Second, describing central bankers as crisis managers and firefighters exactly defines monetary policy as first of all a highly discretionary discipline. There are no rules to follow. A crisis suddenly erupts and the clever and imaginative crisis manager – a Larry Summers style person – flies in and saves the day. This is often done with the introduction of enormous amounts of moral hazard into the global financial system.  This has certainly been the case during the Great Recession and it was certainly also the case when Summers was on “The Committee to Save the World”.

committee-to-save-the-world-303x400

Did the “The Committee to Save the World” actually save the world or did it introduce a lot more moral hazard into the global financial system?

We don’t need crisis managers – we need strict and predictable monetary policy rules

We need to stop thinking of central bankers as crisis managers. They are not crisis managers and to the extent they try to be crisis managers they are not necessarily good crisis managers. As long as there is a monopoly on money issuance the central bank’s role is to ensure nominal stability and act of as lender of last resort. Nothing more than that.

To the extent the central bank should play a role in a crisis it should ensure nominal stability by providing an elastic supply of money. Hence, in the event of a drop in money velocity the central bank should increase the money base to stabilize nominal GDP. Second, the central bank shall act as lender-of-last resort and provide liquidity against proper collateral. Those are the core central bank tasks. Often central banks have failed on these key roles – the Fed certainly failed on that in 2008 when the Primary Dealer system broke down and the Fed effectively failed to act as a lender-of-last resort and allowed money-velocity to collapse without increasing the money base enough to offset it.

On the other hand the Fed got involved in tasks that it should never have gotten itself into – such as bank rescue and credit policies.

A stable monetary and financial system is strictly rule based. There should be very clear rules for what tasks the central bank are undertaking and how they are doing it. The central bank’s reaction function should be clearly defined. Furthermore, bank resolution, supervision and enforcement of capital requirements etc. should also be strictly rule based.

If we have a strictly rule based monetary policy and rule-based financial regulation (for example very clearly defined norms for banking resolution) then we will strongly reduce the risk of economic and financial crisis in the first place.  That would completely eliminate the argument for central banking firefighters. Public Choice theory, however, tells us that that might not be in the interest of firefighters – because why would we need firefighters if there are not fires?

Finally let me quote Robert Hetzel’s conclusion on the Asian crisis from his book on the history of the Fed (pp 215):

“…market irrationality was not the source of the financial crisis that began in 1997. The fundamental source was the moral hazard created by the investor safety net put together by the no-fail policies of governments in emerging-market economies for their financial sectors and underwritten by the IMF credit lines. The Fed response to the Asia crisis would propagate asset market volatility by exacerbating a rise in U.S. equity markets”

Hence, the firefighters created the conditions for the Asian crisis and following stock market bubble. And we should remember that today. Because central bankers over the past five years have acted as discretionary firefighters (the Larry Summers playbook) they rather than acting within a rule based monetary policy framework might instead very well have laid the foundation for the next crisis by further increasing moral hazard problems in the global financial system. Paradoxically enough central bankers have been extremely reluctant about doing what they are meant to do – ensuring nominal stability by providing an elastic money supply – but have happily ventured into credit policies and bailouts.

PS Given the discussion some might be wrongly led to conclude that I think monetary easing is the same as moral hazard. That, however, is not the case. See a discussion of that topic here. We have had too tight monetary policy in the euro zone and the US in the past five years, but far too much credit policy and too much moral hazard.

8 Comments
by Lars Christensen on August 3, 2013  •  Permalink
Posted in Federal Reserve, Larry Summers, Moral Hazard, Robert Hetzel
Tagged , , ,

Posted by Lars Christensen on August 3, 2013

https://marketmonetarist.com/2013/08/03/firefighter-arsonists-the-myth-of-the-central-bankers-as-good-crisis-managers/

My CNBC interview on why Chuck Norris should be the next Fed chairman

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.

3 Comments
by Lars Christensen on August 2, 2013  •  Permalink
Posted in Chuck Norris, Chuck Norris Effect, Kelly Evans, Robert Hetzel
Tagged , , ,

Posted by Lars Christensen on August 2, 2013

https://marketmonetarist.com/2013/08/02/my-cnbc-interview-on-why-chuck-norris-should-be-the-next-fed-chairman/

Forget about Yellen or Summers – it should be Chuck Norris or Bob Hetzel

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.

15 Comments
by Lars Christensen on July 31, 2013  •  Permalink
Posted in Chuck Norris, Chuck Norris Effect, Federal Reserve, Janet Yellen, Larry Summers, Robert Hetzel
Tagged , , , ,

Posted by Lars Christensen on July 31, 2013

https://marketmonetarist.com/2013/07/31/forget-about-yellen-or-summers-it-should-be-chuck-norris-or-bob-hetzel/

A few words that would help Kuroda hit his target

The developments in the Japanese financial markets over the past week has caused a lot of debate about the sustainability of the “Kuroda shock”. It is particularly the rise in nominal bond yields, which seems to have shaken some Japanese policy makers.

Even though the rise in nominal bond yields is a completely expected (for Market Monetarists) and welcomed (!) result of monetary easing it has nonetheless caused some to suggest that Kuroda’s monetary regime change is self-defeating.

As I have explained earlier the increase in bond yields in itself is not a threat to the recovery, but I must also admit that some Japanese policy makers (and a lot of commentators) have a hard time understanding this. It might therefore be warranted that Bank of Japan chief Kuroda puts the record straight.

He can do this by again and again repeating the following statement:

“The increase in Japanese nominal government bond yields is welcomed news as it reflects investors’ expectations for higher nominal spending growth. Furthermore, I am very happy to see that real bond yields continue to decline as markets are pricing in that we are increasingly likely to hit our 2% inflation target.

However, I am not satisfied with the speed of adjustment of market expectations to our inflation target. When we say we have a 2% inflation target investors should listen.

So while inflation expectations have increased they are still far below our 2% inflation target on all relevant time horizons. We therefore stand ready if necessary to further step up the monthly increase in the money base. We will evaluate that need based on market expectations of future inflation.

We will particularly focus on market pricing of 2year/2year and 5year/5year break-even inflation expectations. We want investors to understand that we will ensure that market pricing fully reflects our inflation target. That means 2% inflation expectations on all relevant time horizons. No less, no more.”

Anybody who have been reading my blog (and Robert Hetzel!) should understand why the reference to break-even inflation expectations is extremely important…

Mr. Kuroda, the advise is for free. Please take it.

11 Comments
by Lars Christensen on May 27, 2013  •  Permalink
Posted in Bank of Japan, Haruhiko Kuroda, Robert Hetzel
Tagged , ,

Posted by Lars Christensen on May 27, 2013

https://marketmonetarist.com/2013/05/27/a-few-words-that-would-help-kuroda-hit-his-target/

How to avoid a repeat of 1937 – lessons for both the fed and the BoJ

The Japanese stock market dropped more than 7% on Thursday and even though we are up 3% this morning there is no doubt that “something” had scared investors.

There are likely numerous reasons for the spike in risk aversion on Thursday, but one reason is probably that investors are getting concerned about the Federal Reserve and the Bank of Japan getting closer to scaling back monetary easing. That has reminded me on what happened in 1937 – when market participants panicked as they started to fear that the Federal Reserve would move prematurely towards monetary tightening – after the US economy had been in recovery since FDR took the US off the gold standard in 1933.

Going into 1937 both US government officials and the Fed officials started to voice concerns about inflationary pressures, which clearly sent a signal to market participants that monetary policy was about to be tightened. That caused the US stock market to slump and sent the US economy back into recession – the famous Recession in the Depression.

At the core of this policy mistake was the fact that the fed had never clearly defined and articulated a clear monetary policy target after going off the gold standard in 1933. The situation in many ways is similar today.

Market participants in general know that the fed is likely to scale back monetary easing when the US economy “improves”, but there is considerable uncertainties about what that means and the fed still has not clearly articulated its target(s). Furthermore, the fed continues to be very unclear about its monetary policy instruments. Hence, the fed still considers the fed fund target rate as its primary monetary policy instrument while at the same time doing quantitative easing.

These uncertainties in my view certainly make for a much less smooth ‘transition’ in monetary policy conditions in the US. Therefore, instead of focusing on when to scale back “QE” the fed should focus 100% on explaining its target so nobody is in doubt about what the fed really is targeting. Furthermore, the fed needs to stop thinking and communicating about monetary policy in terms of interest rates. The money base and not the interest rate is the key monetary policy instrument in the US and it is about time that the fed acknowledges this.

How about trying the “perfect world”

The best way of getting rid of these monetary policy uncertainties is for the fed to first of all give an explicit nominal target. Preferably the fed should simply state that it will conduct monetary policy in a way to increase nominal GDP by 15% in the coming two years and thereafter target 5% annual NGDP growth (level targeting).

Second, the fed then should become completely clear about its monetary policy. The best thing would be a futures based NGDP targeting. See here for a description about how that would work. Alternatively the fed should clearly spell out a ‘reaction function’ and clearly describe its monetary policy instrument – what assets will the fed buy to expand or contract the money base? It is really simple, but so far the fed has totally failed to do so.

Japanese monetary policy has become a lot clearer after Haruhiko Kuroda has become Bank of Japan chief, but even the BoJ needs to work on its communication policy. Why is the BoJ not just announcing that since it now officially has a 2% inflation target it will ‘peg’ the market expectations for example for 2-year or 5 year (or both) inflation at 2% – and hence simply announce a commitment to sell or buy inflation-linked bonds so the implicit breakeven inflation is 2% on all time horizons at any period in time. This is of course a set-up Bob Hetzel long ago suggested for the fed. Maybe it is time the BoJ invited Bob back to for a visit in Japan?

If the fed and the BoJ in this fashion could greatly increased monetary policy transparency the markets would not be left guessing about what they central banks are targeting or about whether there will be a sudden redrawl of monetary policy accommodation.  Thereby it could be ensured that the scaling back of monetary easing will happen in a disorderly fashion. There is not reason why we need repeating the mistakes of 1937.

—-

Both David Glasner and Marcus Nunes have related posts.

See also here if you want to read what I wrote about the Japanese “jitters” yesterday in my day-job.

4 Comments
by Lars Christensen on May 24, 2013  •  Permalink
Posted in Bank of Japan, Federal Reserve, Robert Hetzel, The Great Depression
Tagged , , , , ,

Posted by Lars Christensen on May 24, 2013

https://marketmonetarist.com/2013/05/24/how-to-avoid-a-repeat-of-1937-lessons-for-both-the-fed-and-the-boj/

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

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

Mathilde, Mathias and Carney – family life and blogging

Thursday was a very interesting day for me. You might think it was so because Mark Carney – the next Bank of England governor – was testifying in the British parliament. But frankly speaking even though Carney said some interesting things I have to disappoint you dear Mark – I wasn’t really listening. I had more important things to do.

What can be more important that than? Well, as Bob Hetzel expressed it – the Christensen household grew by 33% on Thursday as my wife gave birth to a beautiful Daughter – Mathilde. Her soon to be three year old brother Mathias is very proud – and his parents are very prod and happy as well.

So why do I tell you that? Should blogs be personal? No not necessarily, but the great thing about both writing and reading blogs is that they are written in a personal way with few disclaimers and that is why blogs are here to stay. And that is what I really want to reflect a bit on.

First, all when I write a blog post I do it at odd times when I can sneak in 5 or 30 minutes to do it. It is typically late at night when the rest of the family is sleeping or early in the morning – or when I am traveling, which I do quite a bit. That means that I rarely think about the structure in my posts. I just write. It is just about getting things off my chest or rather get out stuff that is in my head. Having been thinking about monetary policy issues a lot for more than two decades have led to a certain “overload” and I need to empty my head a bit. And yes, I desperately want people to read what I write and I want them to like what I write. But it is actually more about expressing my views than anything else. I think that is the case for most people writing blogs – whether it is about monetary policy or wine.

Obviously it makes it much easier to write blog posts when you don’t think much about the structure of the posts and write what you think rather than what you think people would like you to write. And editing? Forget about it – yes, I do read through my post, but frankly speaking you will have to live with my typos. The important thing is the message. It should be noted that I have people that are so very kind to help me editing in the sense that they will send me corrections to my text. That I always gladly welcome and I do try to correct my typos when I have time. So you are always welcome to drop me a mail about anything in that regard (lacsen@gmail.com).

I enjoy my blogging tremendously and it has brought me into contact with extremely interesting people from all over the world – particularly in Northern America. Another very enjoyable thing about blogging is that it is completely unpretentious and there is certainly nothing snobbish about it. I have many commentators who are completely normally people – “Amateur economists” who are interested just interested in understand the world they live in. I love that. As I have said many times “Economics is not an education. Economics is a state of mind”

But I must admit my favourite readers likely are the many economics students and PhD students that follow and comment on my blog. I love when I get mails from you guys about that world and what to make of it. You are all a great inspiration.

The worst temptation in blogging is to become a “blogging asshole”. Any blogger will tell you that they every single day will check out how many visitors their blog have had on a given day. I certainly do that – and I am surely more happy on days when a lot of people have visits my blog. I have noticed that I can maximize the number of visitors to my blog and the easiest way to do that is to become a “blogging asshole”. So what is a blogging asshole. To me it is somebody who first of all is hostile to other bloggers. Somebody who in more or less nasty ways attack the views of other bloggers and commentators. In fact I think that if I did a “I hate Paul Krugman” post every week it would do a lot to boost the number of visitors on my blog, but it would also generate traffic that I would consider as unwelcomed. I love debates about monetary policy issues, but I mostly just want people to get the message. I am no saint. I have been an blogging asshole from time to time when you thing has upset me. Here is an example.

I believe that blogging has become increasing influential and will continue to play an important role in public debate and that is especially the case in the area of economic policy. The case of NGDP level targeting is obviously a very good example. As a central bank governor from a not to be disclosed European country said to me recently “Lars, you must be happy these days. Everybody is talking about NGDP targeting”.

But blogging is not scientific research and we should not forget about the importance of scientific research. That said the two things do certainly not rule out each other. As my readers know I like to share research I have read (or plan to read). Here is the latest example.

Anyway, time to go with my son Mathias to pick up my beloved wife Hanne and our daughter Mathilde.

PS Mark Carney, just relax I did find time to read your comments in the British parliament. I was slightly disappoint that we did not have a more clear endorsement of NGDP level targeting, but I certainly understand the politics of this issue so I also understand that we might be much closer to NGDP level targeting in the UK than Carney’s testimony could lead one to conclude.

8 Comments
by Lars Christensen on February 9, 2013  •  Permalink
Posted in Bank of England, Mark Carney, Robert Hetzel
Tagged , , , , , ,

Posted by Lars Christensen on February 9, 2013

https://marketmonetarist.com/2013/02/09/mathilde-mathias-and-carney-family-life-and-blogging/

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