jamesz

Blanchard on expectations

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Matt loves to talk about multiple equilibria and how changing expectations can shift us between Pareto-ranked equilibria. It turns out he’s not the only one who thinks it’s an important matter in the current environment. Here is Olivier Blanchard discussing recent developments in the implementation of monetary policy.

In a world of multiple equilibria, announcements can matter a lot. Take for example the case of the Outright Monetary Transaction program announced by the European Central Bank.  …The announcement has succeeded, without the program actually having to be used.

From this viewpoint, the recent announcement by the Bank of Japan that it intends to double the monetary base is even more interesting. What effect it will have on inflation depends very much on how Japanese households and firms change their inflation expectations. If they revise them up, this will affect their wage and price decisions, and lead to higher inflation—which is the desired outcome in the Japanese deflation context.  But if they do not revise them, there is no reason to think that inflation will increase much.

This very much reinforces the message of people like Woodford and Sumner that the expectations channel is by far the most important one for monetary policy.

Matt Nolan

For next time someone attacks macro based on the “money multiplier”

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Via the Wonkmonk twitter, this paper from the Fed.

The effect of reserve balances in simple macroeconomic models often comes through the money multiplier, affecting the money supply and the amount of bank lending in the economy. Most models currently used for macroeconomic policy analysis, however, either exclude money or model money demand as entirely endogenous, thus precluding any causal role for reserves and money.

This makes more sense if you are willing to think of economic models not as “general models” by as models of individual tendencies – identifying specific causal mechanisms.  In this way, policy making requires “multiple models”, and trying to say something like “you entirely rely on money multipliers” really doesn’t make sense.

Matt Nolan

Two undervalued points in thinking about monetary stimulus

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Tyler Cowen does his normal thing of making a lot of very good points other people aren’t.  For me these two are key:

  1. The rate of unemployment in Japan, last I checked, was 4.1%.  Yes, they calculate it differently than we do, and yes in their heyday they had an even lower rate of unemployment.  But still, ask yourself: just how labor market slack is there going to be?
  2. An alternative is that money will boost real economic activity through a Lucas supply curve combined with a fair degree of money illusion, which is what you would expect from a longstanding deflationary environment.  Businesses will confuse nominal changes with real changes, raise output, and eventually figure out the confusion and restrict output again.  The economy does get to keep a one-time gain (probably there are positive social externalities to higher output in this setting), but it doesn’t drive an enduring recovery.

The unemployment rate issue is one I have had in the back of my mind.  My presumption has been that Japan has, in recent quarters, been facing a sharp drop in demand – and as a result they are responding to a recent shock.  The stimulus isn’t about their long-run failure to me, it is a monetary policy response to a recent shock.  I am also happy that they appear to be setting up a framework that will deal with similar shocks in the future.

There seems to be this accidental view appearing when may of us, including myself, write about monetary policy – a view where we start to undermine the medium-long term neutrality of money.

Either we need to explicitly state how there is a “multiple equilibrium argument for how the neutrality of money breaks down in this circumstance” (this would certainly take us down the rabbit hole …), or we need to assume that there has been a number of shocks that have built up upon each other.

If we assume the first we are on pretty intense and shaky ground, and need to make sure our arguments are crisp and transparent.  If we assume the second (which is the camp I am closer to when looking at NZ) then we can’t say that the central bank ex-ante failed UNLESS they could have foreseen the shocks.  If the shocks are things such as policy incompetence in Europe, and sudden large shifts in commodity prices and the exchange rate, then they are indeed unforeseeable!

Matt Nolan

The new Bank of Japan

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Look at that, the Bank of Japan has joined other central banks in announcing an explicit inflation target, and doing all they can to show their credibility for achieving it.

Good.

Some will call this a currency war, or “monetization” – but again, this is the Bank targeting a specific inflation target in a forward looking manner.  This is what they should have been doing all along – and given it is a rule, it helps set expectations and acts as a “no-monetization” condition.

Some will say this destroys central bank independence.  I would note that the purpose of independence is to sovle “time inconsistency” in central banks – rule based policy does this fine.  It would only be a problem if the Japanese government tried to force them to violate the rule.

New Zealander’s will complain about the dollar.  Remember here that the BOJ has commited to inflation of 2%pa (where previously it was expected to, on average, be lower).  The return on holding a Yen has become more negative per year … and so the asset price of the Yen much fall.  This is what has happened, however the price inflation will ensure that the real exchange rate trends back to its true level.  Remember, the exchange rate is a price, and we need to think about the primitive causes of any issue in order to figure out if there is one.  The BOJ actually doing normal monetary policy isn’t negative for NZ – although it will sting the bottom line of people trying to sell to Japan in the near term (hola Rio Tinto).

Posts:  Money Illusion, Market Monetarist. (Where is the rest of the blogsphere, a credible commitment by the BOJ is actually a massive event … I haven’t seen much in the way of posts yet though.

Matt Nolan

Bernanke rules out currency wars

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As we said in the title, Ben Bernanke has ruled out that monetary policy in developed nations is akin to a “currency war”:

The lessons for the present are clear. Today most advanced industrial economies remain, to varying extents, in the grip of slow recoveries from the Great Recession. With inflation generally contained, central banks in these countries are providing accommodative monetary policies to support growth. Do these policies constitute competitive devaluations? To the contrary, because monetary policy is accommodative in the great majority of advanced industrial economies, one would not expect large and persistent changes in the configuration of exchange rates among these countries. The benefits of monetary accommodation in the advanced economies are not created in any significant way by changes in exchange rates; they come instead from the support for domestic aggregate demand in each country or region. Moreover, because stronger growth in each economy confers beneficial spillovers to trading partners, these policies are not “beggar-thy-neighbor” but rather are positive-sum, “enrich-thy-neighbor” actions.

I’ve heard this point a few times in the past (here, here, here, here, here, here) … and those are just the links on this blog ;).  You’ll also note that the third one quotes Bernanke … so hearing him say this is hardly surprising.

Matt Nolan

Keeping it all together on bond sales

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Hey all, I’ve been away – and I still am.  I’ll be back next week.  However, I have to write on this.  Over on Rates Blog, Bernard Hickey stated the following:

The most interesting revelation from today’s Monetary Policy Statement was Graeme Wheeler’s comment that he knew other central banks were buying New Zealand government bonds as part of their Reserve buying programmes.

This is how printed money is lifting our currency to over-valued levels.

Ok, now I don’t know what the RBNZ has been saying – I don’t go to their media lock-up.  But lets think through this a bit.

“Bond buying” will push up the currency if there is some sort of financial flow – such as the government increasing borrowing (and it being funded from overseas) or bond holders in NZ selling bonds to overseas buyers.  From what is indicated, it seems like we’ve had a bit of both.  So the government is borrowing to pay for a bunch of stuff, and this is increasing the current account deficit.  We need a corresponding lift in the capital account surplus to pay for it – hence we have this financial inflow.  People are willing to lend to us incredibly cheaply so this is pretty nice of them.

The two complaints I’m hearing are:

  1. It pushes up the dollar:  Investment+consumption > savings, so yes this pushes up the dollar.  The question is why the interest rate and exchange rates that puts us in our current “balance” seem so high relative to other countries.  Is it because our growth prospects are better?  If so this is good.  Is it because of some structural issues in our economy?  If so this could be bad.  Is it because, as the RBNZ seems to believe, there is a bubble in the dollar/bond markets – if so we have people overpaying New Zealander’s to buy bonds that will decline in price … interesting.
  2. Why don’t we print/pay for it domestically:  This is part of the “QE for NZ” crew view, and it is inappropriate.  Keep the ideas together here, what are we trying to “solve” by getting the central bank to buy government bonds?  Are we trying to loosen monetary conditions … if so cut interest rates, as QE is really a form of this.  Are we trying to reduce foriegn lending … if so we need to reduce domestic borrowing, we are a small open economy and so we pay the world interest rate to borrow as much as we want (in a sense).  If monetary conditions are appropriate, then QE will just be inflationary, and it does nothing about the inherent “savings-investment imbalance” that people are concerned about when they discuss people lending to NZers.