Janet Yellen should keep off the inequality topic

Janet Yellen’s remarks were ill-judged, in my view, and invite attacks on the institution of the Fed and the independence of monetary policy. They also don’t do a great service to the cause of doing something about inequality.

1. She reveals what is in the US lexicon a political position on a politically contentious topic. Those on the right will paint her as looking like an overtly liberal appointee to a job that was supposed to be reserved for technocrats.

2. The effect of 1 is to reduce the credibility of her interventions on topics that are closer to home. If, for example, she chose to make the point that, in the face of the weakening global economy, monetary policy, with unconventional instruments strained to the maximum, could do with a helping hand from fiscal policy, this would look more like partisan harping on the part of the Democrats, and be less likely to have any effect.

3. Revealing her politics makes it more likely that the next appointee will be chosen more for political acceptability than macroeconomic and monetary expertise. If the Republicans were to win some subsequent Presidential election when the post falls free, it raises the chance of a revenge appointment – of an ideologue.  Reading this back, it sounds as though I presume that past appointments were free of politics.  Clearly not, but doing the right thing can help keep the appointment as apolitical as possible.

4. Once the appointment becomes thus more politicised, potential candidates might then seek to compete by offering cooperation, eroding the independence of monetary and financial stability from the electoral cycle.

5. The intervention could reduce the room for manoeuvre of the Fed at a time when the US economy could ill afford this. Unmasked as a liberal, other Fed counter-cyclical policies might come to be viewed as a liberal conspiracy to subvert the joyous workings of capitalism. This view has already taken hold in the extremes of US discourse, but it could gain wider acceptance. Central banks around the world, the Fed included, are already accused of overreach, intervening where they hadn’t previously, much. So this is not the time to try to appropriate the right to comment on matters of redistribution.

6. Inequality is not irrelevant to monetary policy. There are well worked through arguments about how increases in income directed towards the already well off will generate smaller in creases in spending than those directed at the poor.   (The rich already have enough, and will stash more of an increase in income.)  And changes in inequality might, using similar arguments, be thought to change the natural rate of interest, currently presumed to be very low, and restricting the Fed’s freedom of movement. But Ms Yellen’s interventions were not on these terms. And given the heated nature of political fighting in Congress, I would have thought that even broaching this aspect ought to have been done in as technical and neutral way as possible.  Instead, her remarks draw emotional connections with the topic of what constituted the founding mission of the US’s constitutional visionaries.   From the point of view of monetary policy today, it’s pretty irrelevant how much less unequal US society was 30 or 40 years ago.

7. Ms Yellen will be perceived by some to be unqualified to speak on the topic. Her citing inheritance as a force for good on inequality was pretty peculiar.  Inheritance is an opportinuty for the person who gets one, sure.  But, if it were possible to do it, and without hurting incentives, collecting inheritances and handing them out more equally as a subsidy would seem to do a better job!  If fighting inequality is a priority, and you think you have to limit your airtime carefully, and choose your interventions, would you think that a Fed chair speech is a good occasion to fight the battle? Not me.

8. At such a critical time for monetary policy, with continuous scrutiny of every Fed utterance for clues about the exit strategy from loose policy, and how and whether it would be modified to take account of the recent worsening global climate, it seems odd to consume scarce airtime by talking off topic like this. Making the same point that I directed at Andy Haldane’s speech on the economics of volunteering, I’d say it was better to keep to the more mundane task of continually refining and repeating the message about monetary instruments. After all, some will argue that this is what their tax dollars are going to the Fed for.

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The Fed dog is not being wagged by the freshwater or saltwater academic tails

This post replies to a Bloomberg View piece by Noah Smith, which I would caricature as describing the Fed’s economic analysis staff as a dog being wagged alternately by laissez faire freshwater, RBC academics and then activist, sticky-price New Keynesian thinkers.

The picture he paints is worrying, because, if, like me, you are convinced that the Fed should be actively using its instruments to smooth the business and inflation cycle, you might worry from his description of things that soon the freshwater lot will win out and the Fed will, well, give up and go home.

But I don’t see the Fed economics community like that. I’m not and never have been a Fed insider, so this reply comes with that health warning, but…

For starters I see that the activist school of thought holds sway, and has always held sway over the last 30 years, and there’s no danger of the flexible price academics taking over.  I also don’t see the Fed as a passive participant in the battle for ideas, but as an active and, along some dimensions, pioneering and decisive force.

I’d cite several bits of Fed intellectual activism.

a) the embracing of the Cowles Commission program for macro and policy modelling.  In academia, these models died off completely, living on only as fond regrets in the occasional academic blogger. But in central banks, where they were ‘perfected’, they lived on.  Even now the Board of Governors has FRB-US, which is, huge, only partially microfounded, embraces departures from rational expectations, and is used for forecasting.

b) the working out of the early pieces of wisdom about good and bad policy rules, on these pre-NK linear, rational expectations models. Taylor is credited with crystallising the ‘Taylor Rule’ (hence the name). But actually many in central bank circles credit the development of rules like this – both their good performance in models, and their similarity to actual central bank rates – to the published and unpublished work of people like Bryant, Henderson, Mckibben and others, all at the Board of Governors at the time.

c) the embellishment of, and the implications for optimal policy of the new NK models. A line of work through Blanchard-Kiyotaki, then Rotemberg-Woodford and McCallum-Nelson developed the first microfounded NK models for policy analysis. But Fed economists took these on stages further, and the major journals have many papers by Fed economists at the time, like Erceg, Henderson, Levin, Williams, Laubach, Edge, Kiley.    (Actually, on reflection, you could even interpret Woodford’s early papers on inflation stabilisation and welfare as a response to the conviction, then unfounded, that the Fed should be stabilising weighted sums of inflation and output gap deviations.  They were missions to formalise what the Fed already felt instinctively was the right thing to do.)

d) policy analysis with non-rational expectations: this was a literature begun by those outside the Fed – Bray, Sargent, Evans and Honkapohja. But several papers by Orphanides and Williams discussing the implications of non-rational expectations and less than perfect information brought this work to centre stage. Retaining the capacity to simulate the main policy model under alternatives to rational expectations could itself be seen as intellectual activism. Many central banks don’t.

e) Quantitative Easing. This was pursued vigorously, despite most knowing that the prevailing NK wisdom was that it would not work, and only later did evidence accumulate that it might work, in the sense of having material effects on yields. I count this as intellectual activism (leading clearly to policy activism).  As well as doing it, the Fed have naturally been at the frontier of trying to figure out whether it worked or not.  Other central banks have too.  But the Fed, which is distinctive in allowing staff to publish results that might be off-message in policy terms (contrast the UK where research outputs were always actively filtered) has been able to speak with some credibility.  The same intellectual actvism is evidence by the other post-crisis interventions too – like the TARP, TALF schemes, for example.  Or, of course, the decisions to bail out or not.

f) Monetary policy and robustness.  I credit the Fed with decisive contributions here too.  Particularly with work on the ‘fault’ tolerance of Taylor-like rules, (how wrong can you go if you get the model wrong) relative to pursuing what you think might be optimal policy, but might turn out not to be.  This work is surveyed in the Handbook of Monetary Economics chapter by Taylor and Williams [FRBSF President], and features original work by other Fed staff.

Debating Noah on Twitter, he countered by wondering about the vocal RBC-ers in the employ of the Federal Reserve System. If they have no effect, how come they are there? Isn’t their presence evidence of the battle of ideas in the Fed still going on? Possibly. But a few responses.

1)To an outsider at least, it seems to me that the policy debate is shaped more by those in the Board of Governors than the regional Feds. With no systematic evidence whatsoever, I assert that the RBC-ers are disproportionately located in the regions.

2)The business model behind hiring researchers encourages a policy of letting many flowers, including modern RBC, bloom. To get the benefit of the cleverest economists and their insights into policy, you have to give them a certain amount of their time to do what they want.

3)Many sticky price central bank activists have at the core of their preferred model a beating RBC heart. So RBCers have a lot to say to them that’s useful. For example, about real frictions that might exist, and the possibility of real tools used recently by the central bank, and monetary policy, to alleviate them.  Such people often view the job of monetary policy as being to try to make the economy look as much like the RBC one as possible had the frictions not got in the way.  Seen like this, it’s obvious why you need RBC people to tell you how to do monetary policy.  Also, RBCers in the Fed system, many pioneers in modern macro, are often those contributing to the debates about methodology that central banks have to care about: how to build models and solve them, and how to test them.

So, with interest rates pressed against the zero bound, and quantitative easing purchases having swelled the Fed balance sheet, both expressing the prevailing view that the Fed should strain as hard as it can to achieve its dual mandate (the employment goal of which would make little sense to the Freshwater lot), I don’t expect a retreat any time soon.  That is, not until the data warrant it and the activist controllers at the Fed see their job as done.

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Don’t call the helicopters yet!

This prompted by twitter commentary on Buiter’s recent paper explaining why helicopter drops will always work and stimulate the economy;  a formal paper echoing the call for money printing by Mark Blyth and Eric Lonergan in Foreign Affairs.

Buiter’s paper conducts surgery on the modern monetary DSGE model.  The surgery appears to make the model more realistic.  In the original, it’s assumed that somewhere off in the infinite recesses of time, the government will pay back all outstanding bonds it has issued, but will also redeem money it printed for real consumption goods too.  In this way it’s policies are set to satisfy the public sector intertemporal budget constraint.  Buiter says:  no one seriously believes the money is going to be ‘redeemed’.  So let’s remove that assumption.  His model retains the rest of the original machinery, notably, the ASSUMPTION that for some reason unspecified, holders attach a non-pecuniary benefit to holding money.

In the old model, if the helicopters rained down government bonds on the populus, said populus would think:  ‘hang on, these are not net wealth to me [HT Barro], because sooner or later they are going to be paid back out of my taxes.  Similarly, in the old model, if the helicopters rained down money, people would say ‘the government is going to have to pay for this gift when it redeems the money from whoever has it, and I will be taxed for it’.  In the new model, Buiter makes money net wealth in a way that it wasn’t previously.

Actually, that wasn’t the whole story.  In the old model, what people would say when money rained down on them would depend on whether we were at the zero bound or not.  If we were, at that point it would be the case that people already had sufficient money that the non-pecuniary like they had for it would have been exhausted.  This benefit is assumed to capture money’s function as a convenient medium of exchange. And the idea is that beyond some point, it’s useless to keep your wealth in money [perhaps even costly].  Once that benefit disappears, interest rates have to be zero:  this measures the opportunity cost of holding money, which has to be equal to its benefit.  If you are still with me, this means that whether money has any effect or not will hinge on whether at the zero bound people view it as net wealth.  And if they don’t, because it is to be redeemed, they won’t spend as though it were.  This is how Buiter gets his stimulatory effect.

This sounds like a triumph.  A more realistic model, showing how helicopter drops can stimulate?  Not so fast.  Forget the real world for a moment.  In the model world, we have just assumed that people value money for its own sake [to capture a parable about how they would value its convenience].  And as modellers, this seems ok either because we feel, or from other work we can derive, that this convenience value will emerge attached to an asset that is redeemed.  Once we take away the redemption assumption, it begs the question why the convenience value as a medium of exchange is there.  After all, the real story of paper money was that it was once redeemable, and that was why it became an acceptable medium of exchange.  So, as modellers, we ought to feel very uncomfortable about Buiter playing fast and loose with the government’s intertemporal budget constraint.  [Actually, some modellers, the 'new monetarists' like Williamson, Wright, Lagos, Kiyotaki, go ballistic about this mainstream model of money for the simple assumption of convenience value regardless of whether money is in the government budget constraint or not].

You might say:  but what about the real world?  Surely no-one thinks money is going to be redeemed do they?  Surely despite this they will always place a convenience value on holding money?  Well, maybe, or maybe not.  Maybe once helicopters rain down money, people will think that the UK or US governments will get a taste for it, will think that we have become ‘like Zimbabwe’ and run for gold, or other metals, or even, as in revolutionary France as their currency got debased, wine and cheese.  What about the law of legal tender?  Someone once said to me in the Bank of England that the reason why money has value is because of the law of legal tender.  [Which stipulates that a debt is to be considered closed if settled with, legal tender].  This has a grain of truth in it, but a lot of falsehood.  The law of legal tender, and the widespread use and acceptance of pound coins [first draft wrote pound notes, revealing my age] are symbiotic facets of our monetary system, and the former doesn’t solely determine the latter.  I’ve no doubt that if the government started debasing the currency, dollarisation would ensue here as fast as could be, and the law of legal tender would not matter at all.

This leads me to be strongly against helicopter drops of money.  I don’t buy the model-based explanation, because Buiter’s removal of the ‘redeemability’ characteristic of money leaves the model begging too many questions about why money is valued at all.  And I think the doubts we can tell about such a model connect to practical concerns we might have about the real world, that such drops would completely undermine the monetary system, not save it.

This tale has a cross-over with the early part of the story of quantitative easing in the UK, in which I was a junior civil servant writing confusing memos not that dissimilar to this blog post.  It became clear to me and others that most if not all of those who were deciding at that time didn’t know about the redeemability assumption explicit in the models.  (I’d gone a large part of my time at the Bank not grasping it myself, and had to be talked through it by cleverer colleagues).  They scoffed at it when it was spelled out to them.  Their view was:  well, the real world isn’t like that, so pumping all this money out there via QE will work.  This is why the early communication on QE, and even now the educational material the BoE produces on the topic, stressed the monetary ‘injection’, and why there was no sweating about what assets to buy or that the MPC itself should decide this.  If the only point was to get money out there, buying the assets was just a detail that functionaries in the BoE could carry out, not a policy decision.  Only later, as evidence mounted that money expansion was immaterial, and buying duration in gilts was highly material, did the language, and eventually the policy behind QE, change.

Once again you might interject and say:  Tony, they were right, redeemability was false, wasn’t it?  Well, who knows.  But whether they really understood this or not, the BoE ditched redeemability in their hearts, but still kept on working with a model that had it, but yet had to be then doctored with judgement to superimpose a stimulus they thought money would give that wasn’t there in the model itself.  (There was none of the internal consistency, however questionable, of Buiter’s paper).  So their forecasts were based on a  fundamental, technical hotch-potch, assuming as it did that the stimulus would work through just like any other, when interest rates were away from the zero bound.  But actually, in truth, the BoE were flying completely blind, and all the paraphanalia and whizz-banginess of the DSGE based forecast, which might have comforted some, was [actually, still is], on this account, something of a smoke and mirrors show.

 

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The Kingston University Heterodox Economics Business Model

Kingston University Economics Department have been hiring.  And it made me wonder about the business model of their department.  The hiring is prompted by the recruitment of the author of international bestseller ‘Debunking Economics’ by Steve Keen.  The ads made a clear pitch for someone who is doing research in and is inclined towards heterodox economics.

This is a brave move.  Because in the short-term, it is going to mean less funding for research.  For two reasons.  First, if Kingston University gets any ESRC [Economics and Social Research Council] money for this purpose at all, they will get less of it at the next Research Excellence Framework exercise in 2021.  As this is largely determined by the success of academics at publishing.  And recruiting heterodox economists like Steve and others like him will mean fewer publications in top ranked journals.  As Steve accepts, for good or ill, these journals don’t currently publish heterodox papers, as Steve would define them.  Their editors and referees would, I guess, view what he and his peers do as, at best, provocative question-posing, but a waste of time as far as substantive research goes.

Second, I’ll forecast that the tilt towards heterodox staff will mean less money raised through direct research grants (eg through the ESRC ).  This money will follow those who have track-records in delivering what the profession (rightly or wrongly) currently deems to be top ranked journals.  It’s possible that the department’s submission to (Kingston’s submission to) the REF will be looked at differently.  ESRC exercise judgement in ‘marking’ publications of the academic team in an institution.  And it’s possible that there is money out there earmarked for those wishing to take a tilt at the econ mainstream.  But in conversation over Twitter, Steve seemed to accept these forecasts of mine as I put them to him.

So, less money from these sources for research ought to mean less time for research, right?  Wrong, seemingly.  Steve thought there would be ‘more’ time.   This is pretty puzzling.  Less money from these two funding sources for research time means more dependence on money brought in through fee income by student numbers.  Steve described that Kingston’s National Student Survey scores were rising, and that their positioning as a heterodox department would help those rankings rise even more.  But how will this free up more time per academic staff member for research?  If the NSS improvements drive up student numbers and fees stay the same, then unless the academic staff/student-contact-hour ratio falls, there will be no more time for research.  Perhaps they are counting on increasing fees to pay for extra academic staff amongst which to divide their existing teaching load.

Steve Keen also mentioned, plausibly, that they were hoping to pick up students disaffected with the hegemony of (what he calls) ‘mainstream’ economics in the curriculum offered by other departments.  This argument has something going for it, because you can see that Manchester’s ‘Post Crash Economics Society’ has made quite some headway publicising its discontent with Manchester’s offering.

But how many students are there in this category who will go to Kingston?  Somewhat depressingly, I’ve always found most students in my subject that I’ve encountered, pretty much ever since I did my own undergraduate degree back in the late 1980s, as unswervingly focused on their ‘bottom line’.  Economics is studied by most as a route into government, academia, finance, management consulting.  And rightly or wrongly, I forecast that the vast majority will calculate that their prospects of breaking into these fields are much better if they get good degrees at departments that, as Steve would see it, ‘conform to the status quo’.   One response to this was that in fact the finance profession were chomping at the bit for more heterodox economists to hire.  Despite the intervention of a couple of offensive cyberhets [adapting cybernat terminology here], and an interesting survey of attitudes of hirers by the CFA, I personally doubt that there are enough radical hirers out there to offer a home to Kingston’s students.  Although I have to confess it’s based on the entirely unscientific approach of wondering what anyone I have ever met in finance or Government would actually say about this.

Anyway, capturing disaffected students won’t solve the research problem either, unless by giving them something different they can be satisfied with lower staff/student ratios.  And less time for research would presumably mean….   less contact with the frontier of heterodox economics.  [Although you'll guess that I would think this not such a bad thing].

Steve conceded that KU were taking a risk.  But if no-one ever tried to challenge the status-quo, it would never change.  After all, the Cowles-Commission lot once ruled academia as well as policymaking institutions, and the microfoundations and VAR pioneers were once isolated and considered the fruitcakes.

Although I think Steve’s approach to economics is completely misguided, you have to admire the nobility of this gambit by him and his department.  The money foregone by them in the meantime is a considerable externality to the rest of the discipline.  Perhaps even all disciplines.  Subsidised, test challenges like this help ward off capture by vested academic-political interests and keep the playing field leveller, so ideas can fight it out on the right terms.

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Inequality: is it defensible to nurture equality within a nation, ignoring inequality across nations?

John Cochrane’s remarks about greatly falling inequality across nations dwarfing the detail of slight increases in inequality within some Western capitalist economies are a pretty powerful objection Piketty’s call for redistributive taxes to hit the richest percentiles.  Much how cross-nation inequality has fallen, as Cochrane points out, the poor in the US should be paying Piketty taxes to those further down the global distribution of good fortune.

These remarks set me thinking about whether one could justify redistributing within a nation anyway, ignoring global redistributive priorities.  There are some lines of defence, I think, though none of them feel that comfortable.

1.  Tax avoidance might soar if we levied Piketty taxes on our rich tax-base to hand out to the poor, perhaps even unhinging acceptance of the purpose of taxing for providing local public goods.  Example of the reverse:  the experiments in Brazil with localising and hypothecating taxes at the state level, to improve tax collection.

2.  If we thought the money would be wasted abroad, that’s a reason not to tax and hand it over.  Enter the debates between Easterly, Sachs and the mediators, Banerjee and Dufflo, who debate the efficacy of foreign aid.  There are many reasons why it could be wasted.  It might get stolen.  Even if there was no tax avoidance at home it could be costly to extract the money.  Or there might be insufficient capacity to absorb it productively at the receiving end.

3.  Related to 1, and recalling the Rawlesian social contract argument for redistribution to make up for luck at birth, we could perhaps argue that those not born in our society are not signatories to this contract.  I say related, because this is really a proposal for trying to explain and justify why people might refuse to pay Piketty taxes to the global poor.  This isn’t an argument about race or nationhood.  It could be founded on the forecast that the more widely and distantly the boundary gets drawn around possible signatories to the contract, the less sure one can be that people will keep to it, therefore the less to be gained by going along with it.

4.  The arguments I made in my last post about the nature of the cooperative effort involved in producing the super-success of the super-successful might simply not apply:  for example, a country that did not trade freely, or sponsored theft of intellectual property, or waged war of one kind or another, might be said not to have helped the super-succesful, but hindered them, so they had no entitlement to what they had made.

This blog expands on my twitter feed on the topic, and that prompted some interesting tweets in response from Stuart Ingham at Oxford.  [Check the feed scroll to the right of this page, or my feed on twitter, if you're interested.].  Here endeth the amateur political economy for the day.

 

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A rider to Noah Smith’s riposte to John Cochrane’s diatribe on inequality

This follows Noah Smith’s recent Bloomberg view piece replying to John Cochrane.  I won’t restate all the good points John makes, which are recounted carefully in Noah’s post.  Instead I’ll list some other counters.  If you have read Noah’s article, you’ll have to suffer that the writing will seem more like a fire safety instruction list by comparison with his prose.

1.  Success involves a large slice of luck, even given initial endowments of talent and capacity, which often masquerades as skill which should get its just reward, and sets off path dependence.  Of course, those endowments are themselves luck from the point of view of the individual.  Read the biography of Bill Gates.  For sure he seems to have been extraordinarily talented and hard-working.  But he also got unusual access to computing resources in California at a time when an explosion of computing activity was taking place there.

2.  Extreme inequality is self-propagating, allowing the rich and often fortunate to buy better formal and informal education for their offspring.  This, as well as flouting the sense of justice of many (at least me), also distorts the allocation of talent next period, which is inefficient, and will depress investment in human capital by those who would normally benefit from it.

3.  Cochrane asserts, without evidence, that public good provision – eg education – is problematic to the point of it being better to cease.  I am going to assert the opposite, with the most informal wave at ‘evidence':  That public education has been socially transformational in capitalist democracies.  Extreme inequality is corrosive of this public good.  Redistributing away from the very rich I assert may be extremely beneficial, and I would suspect would have little cost.

4.  Little cost?  Why?  Well, are those with £10bn really in it for the 11th?  If not, let’s take most of it from them.

5.  Super-success is a cooperative effort.  The super-successful profit from the collaboration, acquiescence and cooperation of the rest of us.  (Didn’t Obama state something similar ‘you didn’t build that’?)  Redistributive tax to curtail inequality is, a reciprocal act that returns the cooperative favour.  Super-capitalist success rests on a myriad of powerfully productive public goods whose output is a system of imperfect but productive property rights, and the coordination on a decision not to overwhelm the limited resources we put aside to protect them.  (Another example to flout Cochrane’s pessimism about the possibility of putting public funds to good public good provision, incidentally).  Reading back this paragraph, I see it’s intimately bound up with Cochrane’s assumption that the poor wont’ rise up to take the riches of the rich (poo-pooed by Noah).  So what if they will or won’t?  The point is there is a contract of sorts, the ability to produce vast personal wealth being one fruit of it.

6.  I’m personally swayed by Rawlesian arguments that society’s rule should insure against the lottery of birth and early development.  This legitimizes redistribution, using the fruits of the super-successful to compensate those less fortunate.  This isn’t really a counter of the right order to Cochrane, [as Nozick said:  so what if you like Rawls?  Maybe I don't] but it’s one many share.

7.  Cochrane’s basic argument, distilled by an email a friend sent me, is:  ‘if we are worried that inequality causes cronyism, let’s fix cronyism’.  Easier said than done, unless you want to dismantle all public goods.  And to some extent self-contradictory. Who’s going to fix cronyism?  Probably a lot of cronyism-fixing government employees and legislators, that’s who.

8.  Not a counter to Cochrane, who doesn’t rely on this argument, but nevertheless it is worth stating:  that many object to redistribution on grounds of natural rights, that people are not means to ends, but ends themselves.  This natural rights framework often fails (conscription for war, retaining the monopoly of violence with the state and restricting this and other individual freedoms so that society works…).  So that 11th billion dollars, in my view, is there for the taking.

 

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What the left hand buyeth, the right hand issueth

Roger Farmer has a great post showing how the maturity composition of outstanding US debt lengthened as the Fed embarked on its program of buying long dated securities.    As Summers reportedly put it, while the Fed was engaged in quantitative easing, the Treasury was doing ‘quantitative contraction’.  And surely the two arms of government should be better coordinated than that.

A few points.

The first thing to note is that what we saw doesn’t necessarily imply that the US Treasury was shifting its behaviour in order to scupper what the Fed was doing.  Its mandate to get value for money when selling debt could well imply a maturity composition of issuance that means the proportion of long-term debt brought to market rises as the term premium falls (the relative price of long-term bonds to short-term bonds rises).  So it’s conceivable that that issuance pattern amounts to running on autopilot.  In order for us to substantiate that the Treasury obstructed the Fed actively, we’d have to detect a shift in the historical relationship between the term premium and the composition of issuance.

In the UK, the Debt Management Office, an agency of the UK Treasury, and separate from the Bank of England since 1997, undertook not to change the pattern of issuance away from what would have been the case in the absence of QE.  One might have hoped for this strict form of cooperation in the States too, if you were a QE supporter.  But doing that would involve a shift in behaviour, forgoing ‘value for money’ considerations in debt sales that would lead to maturities being sold into parts of the curve where demand was strongest.  The DMO/BoE might have expected QE to reduce the term premium (especially once purchases were shifted away from the essentially neutral maturity composition of early rounds) and this would normally prompt the issuer to take advantage.  It will be interesting to see whether the DMO can be judged to have kept to this promise.  With such an extended program of purchases, I don’t see how such a promise could be evaluated.  How would the DMO or any similar agency know what it would do such a long time ahead?

Regardless, it’s also conceivable that Fed plans were not thwarted in their attempt to achieve a certain amount of stimulus through quantitative easing.  If the Fed understood the unchanging or even changing maturity reaction function of the Treasury, their purchases from the open market could be calibrated accordingly.  So long as we suppose that there are no costs associated with tilting the Fed balance sheet to compensate for the extra Treasury twisting, the Fed could do whatever was necessary to achieve its goals.

Note that some like Vissing-Jorgensen and Krishnamurthy question whether lowering the term premium through QE is a good thing at all.  They document that private yields were not materially lowered by QE.  And describe how purchases of long-term debt imposed costs by depriving the markets of a safe store of value with duration.  For these authors, even if the Treasury had been trying to frustrate the Fed, they would surely be saying ‘two thumbs way up’, since the policy would have relieved society of a costly shortage.

Some might balk at calls for coordination between the two arms of government for fear that it corrodes the independence of the central bank in its conduct of monetary policy.  These calls are not entirely vacuous, since histories of the Fed in the 1960s and 1970s seem to conclude that the Fed regularly subordinated itself.  But here what is being asked for – regardless of its rights and wrongs – is for the Treasury to subordinate itself to the Fed.  The reverse of what is usually feared.  If that were achieved (presuming it hasn’t been already) it does not follow that the Fed would have to reciprocate in some other way.

‘Monetarists’ of sorts may scoff at all this debate, arguing that this is all of second-order importance.  What matters, they might say, is how much the balance sheet expanded in line with the corresponding creation of central bank reserves.   For them, the composition is just a detail.   Of course, concerning oneself solely with total issuance and total purchases leads to a related question about co-ordination, even subterfuge, and one that certain political factions have pushed, namely, whether the Treasury’s total issuance rose because of QE, or vice versa.   However, I personally lean towards the view espoused by Woodford and others in several papers, which is that the monetary expansion part of QE is essentially redundant, no different in effect from forward guidance, and that the only independent stimulus is to be got by the twisting of maturities, or the risk transfer from private to public.  Under this view, the effects seen of quantitative easing could have been got by the Treasury issuing very short-term debt in order to take back longer term debt.

What this debate and the ambiguities in resolving it make clear is that some institutional refinement is in order.  Appropriate coordination needs to be hard-wired into the debt management function and into monetary policy, not currently in place in either the US or the UK.  My involvement in QE on the inside at the Bank of England convinced me that all parties were determined to do the right thing.  But that British kind of solution to this new (or is it old) problem is probably not the best one, because it allows composition or quantity conspiracy-theorising to live on.

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