FOMC: Conspiracists to the left of them, conspiracists to the right

Paul Krugman worries that the reason why the Fed hiked by a quarter point in December 2015, and won’t immediately reverse course, is that their judgement has been impaired by talking to too many who work in banking, which industry suffers from very low interest rates.

As Paul noted in one of his earlier blogs, there are those on the right of the Fed who think that rates are so low, and quantitative easing was undertaken, as part of a liberal conspiracy to help Obama;  or, to impoverish those who live off savings.

If I was on the FOMC, I’d probably feel comfortable that there were conspiracists accusing me of having been corrupted by interest groups on opposing sides.

Addressing PK’s most recent charge, his worry seems pretty unlikely to me.  The FOMC had no problem dropping interest rates like a stone – from 5.5%, to 0.25% – when the crisis hit, and holding them there for almost seven years.  All of a sudden, because rates are put up by 25 basis points, this is evidence of a pro-bank bias?  I don’t buy it.

Concern about banks wasn’t mentioned as part of the narrative about raising rates;  so we have to believe that somehow banking contacts distorted the information about the rest of the economy in favour of their ulterior motive.  And that that survived battle with the prominent Fed staff view, delivered by Laubach and co..  And continues to survive the temptation to gossip disapprovingly about it to other private sector contacts.  Unlikely.

Even if this concern had figured materially, there would be a prima facie case for thinking it through.  Recall the UK Monetary Policy Committee’s argument for not cutting rates below 0.5% [a floor since revised down].  Lowering rates beyond some point would harm bank profits and cause them to push up lending rates, undoing much of the effect of the central bank interest rate cut.  Less finance is bank intermediated in the US, and there is a greater proportion of fixed-rate loans to the personal sector.  But the argument holds true in principle.

At the time of the December hike, I thought there was a pretty good case for it.  I doubt, however, that if the FOMC had had special foresight into the market chaos that would unfold subsequently that they would have moved then.  Which leads me to think that, other things equal, they ought to reverse course now.  And that we might conjecture that one thing that is stopping them is, not a surfeit of nice dinners with the head of bank treasury operations, but a worry about seeming to look stupid by changing course so quickly:  a worry I’d hope could be set aside when the stakes are so high.


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ICYMThem, 2 pieces for Nikkei Asian Review: on Japan; and on the market routs

In case you did not get these via Twitter, I wrote two pieces for NAR, which is an online newspaper that is owned by Nikkei the behemoth that recently swallowed the FT.

This piece is on the BoJ’s move to negative rates.

And this one is on the recent market routs, applying the Caballero and co-authors story about safe-asset flows.


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So, farewell then, Nick Macpherson. /You changed our constitution. /Even though. /As some said. /There wasn’t one. /Or that you didn’t.

Nick Macpherson, of course, isn’t dead.

But EJ Thribb of Private Eye might well have written something like that about his latest speech, of which there cannot yet remain many more in his capacity as Permanent Secretary to the Treasury, a post from which he has said he will step down in April this year.

The speech is a great read.

It opines on what economic policy can achieve, and how it should go about achieving it.  And the history of the ‘Treasury view’ about these questions.

There are two things to respond to in it.  1) Its economic substance.  2) issues thrown up by the fact that there exists such a thing as the ‘Treasury view’.

Despite being qualified only to write about 1), I’m going to confine myself to 2) and leave the rest to another day, or perhaps Ben Chu, economics editor at The Independent, whose hot-under-the-collar Tweets alerted me to some of the interesting aspects of the text.

The Treasury is full of clever economists and other talented thinkers.  So it is bound to produce views.  These views may coalesce.  And one would expect them, if they don’t, to get filtered, synthesised, so that they can be consumed effectively by their clients – the Treasury ministers.  So could there be any issues about the apparently harmless and obvious reality of a ‘Treasury view’?

Well, the speech has to be placed in the context of Nick’s previous public interventions.

Most notably, the letter he wrote summarising the Treasury view of whether it was sound to allow a hypothetical independent Scotland to participate in a currency union with the rest of the UK, without a fiscal union to back it.

At that moment, Nick was acting as an independent advisor, and emphasising the objectivity in the Treasury paper, and his summary of it, so that the rest of us could weigh what he was saying as the words of an economist, and not the words of a politician, who might have reasons to bend an economic case.   (For the record, I thought that letter, and the Treasury view it covered, spot on).

In the context of that previous letter written as independent advisor, Nick’s speech can’t help but be read similarly.

His comments about the rightness of the Coalition government’s approach to the crisis have the subtext: ‘I’m an independent, objective guy, and I think that what the government did to respond to the crisis was pretty much right.  I understand you wouldn’t trust George Osborne to tell it how it really was, but you can trust me.’

We are then led to wonder how independent Nick is.  I have never met or interacted with him.  Those that I know who speak of him say that he has a first-rate mind and is of unimpeachable integrity.

But not everyone can convince themself of that.  They may be led to wonder how he came to be confirmed in his position.  Was he kept there on account of his objectivity, or his preparedness to subordinate his or the ‘Treasury’ views to the political imperatives of the day?  If he or his staff wanted to dissent from the position of the Government, could they really do it?  If not, what weight can we attach to public views expressed by Macpherson or his staff?

One line in the speech that pressed Ben Chu’s buttons hardest was this one:

“It is no surprise to me that the response to the recent crisis has focused on monetary policy and the credit channel rather than on fiscal policy.”

Ben’s Tweeting responded that of course it was no surprise, since the Treasury was either instrumental in persuading the Government to this view, or was commandeered to market and implement it.

But taken at face value, the words want us to understand that the Treasury did not influence the governments on this course.  The government’s strategy was meditated by the governments alone, but their decisions weren’t a surprise, since, had Nick been involved in the thought process, this is what he and his staff would have concluded too, since that’s where the evidence points [on this I disagree, incidentally].  I am caricaturing somewhat for effect, here.

I am not against Treasury civil servants speaking out independently.  But the model of sometimes speaking out, and sometimes not, is a curious one.  Matters might be improved if it could be codified when independent views were to be offered in public.  Some of the responses to my blogs on the Macpherson indyref letter pointed out that the independence referendum was an existential issue for the UK, therefore an exception to the norm of civil service silence.  The efficacy of the Darling/Coalition fiscal consolidation is hardly in that category.

I wonder about whether it’s possible for a single person, or body of persons, to combine the role of private implementor and public commentator/critic.  Given the legislative and other care devoted to the Bank of England and now the Office for Budget Responsibility, both of which are charged with always ‘speaking out’, it seems neglectful not to attend to this other, influential body-economic lurking inside the civil service, sometimes speaking out, sometimes influencing government towards its Treasury view, sometimes not.


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On loosening by yield curve talking and cutting rates

Since Mark Carney took over the Governorship of the Bank of England in July 2013, expectations of the first hike in rates from 0.5 have been pushed further and further back.

Accommodating this – with a few hiccoughs along the way – has been the MPC’s sole tool for easing monetary policy.  Carney inherited the collective view of MPC formed under Mervyn King that the practical floor to rates was 0.5%.  So loosening then meant either more QE – which Carney was clearly able to persuade other MPC members was undesirable, or ineffective, or both – or yield curve loosening.

In February 2015, however, the Bank of England made clear that it no longer considered the floor of 0.5% to be operative.  So at that point, it obtained a new option for easing, on top of yield curve talking.  Yet since then, policy has been eased without using this extra tool.

This isn’t obviously wrong.  It’s entirely possible that the best path for rates involved keeping them just where they were, but where adjustment was purely through the timing of the first hike.

But a clear starting point for thinking about how to change the plan for rates offered by models like the Bank’s own COMPASS would be that as conditions worsen, rates are lowered – relative to the old path – for a while, and then raised again subsequently.

This latest Inflation Report could have been the point to do just that.  The forecast under the market path the BoE used involved a small overshoot of the target.  But this doesn’t rule out a cut now, and a more marked tightening path later on.  I wonder:  have these trajectories been tried out in the Bank, but ruled out?

I wonder also if the reluctance not to use anything other than yield curve tightening is the worry that if rates were cut, without a device – like an interest rate forecast – to communicate clearly how the BoE would make up for it later, they would loosen monetary conditions too drastically, or at any rate inject more uncertainty into longer rates than they wanted.  Consequently, confining themselves to the broadest of verbal hints, the MPC are thus disproportionately reluctant to breach the 0.5% that has been the floor to rates since March 2009.


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You can’t have your helicopter money cake and eat high interest rates, Adair

Prompted by Adair Turner in an exchange on Twitter, I read this paper of his delivered to the IMF.  The paper is one to set current and former central bank pulses racing.

It’s a measure of how far the crisis has led some to think the previously unthinkable that a name mentioned as a candidate for the Governorship of the Bank of England is now writing forcefully about the advantages of helicopter money.  Even pushing it as an option to be preferred over debt financed fiscal policy and forward guidance.

The exchange with Adair was prompted by him pointing out that helicopter money was a less dangerous option for the economy than negative interest rates.  To my mind, this does not make sense.

Helicopter money leads to an increase in the supply of money and liquidity, and this will depress the price of money/liquidity, lowering the interest rate, in other words.  Put differently, the discount at which securities trade below face value will include compensation for the absence of liquidity, or moneyness.  But as money and liquidity become more abundant, money-like assets command less of a premium, and the compensation for its absence falls, raising the price towards the face value of the security, or, equivalently, lowering the interest rate.

Before the crisis, I would have doubted that rates would be pushed negative, even by large-scale helicopter drops.  But with Denmark, Sweden, Switzerland, the ECB and now Japan setting negative rates without dire consequences, I would not bet against it.  That detail aside, the main point is that you can’t control both the quantity and price of money at the same time, which is what Adair claims.

Actually, as put, what I have qwritten above is not quite right.  And in his paper, Adair notes that the central bank can require banks to hold reserves, and charge whatever negative rates it liked on those reserves.   However, this is just a tax, one that takes banks off their central bank reserve demand curve.  And one that won’t inhibit the injection of money through the helicopter drop from affecting the interest rates on all other assets, along the spectrum of liquidity from very close substitutes to central bank money, to more distant ones.

It will be those interest rates which will, subsequently, most meaningfully express monetary policy, and, since those are not monopoly-supplied by the central bank, the authorities have to live with agents being ON their demand curves for those assets, and, having affected the relative quantities through the helicopter drop, will have to live with the interest rates that emerge afterwards.

In that sense, central banks can’t control the supply and price of money/liquidity at the same time.  And this is the only sense that is of material consequence, particularly for the question that worries Adair, namely, the effect of low rates of borrowing on spending, borrowing and leverage.

The tax isn’t irrelevant, but it is best understood as part of fiscal policy.  It’s no more an indicator of monetary policy than if we were to hear that the central bank required bank CEOs to deliver trays of cupcakes to Mark Carney every morning.

To carry out this thought experiment, I have – without mentioning it explicitly above – had to imagine that the BoE stops paying interest on reserves.  Without reverting to the old monetary policy implementation framework, helicopter money will simply increase the quantity of reserves out there – either directly, or indirectly – on which the central bank has to pay interest, in the form of more interest bearing reserves, leading to an explosion in liquidity.  Adair explains this himself in his paper, and MPC members Carney and Vlieghe have both talked about these consequences too, the former at Treasury Committee, and the latter during a Q and A after his first public speech as MPC member.

Abandoning interest rates on reserves is not a material reason to refuse to contemplate helicopter money, in my view.  But that is probably worth a post on its own, so I will not go into it further here.



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Krugman scolds the Fed. Unfairly.

So the Fed did not predict the panic in global stock markets.

So what?  Who could have?  It wasn’t a mistake not to have.

Krugman doesn’t scold them for this, but he does scold them for not postponing a hike on account of the asymmetric risks posed by stock market volatility.  The asymmetry being on account of the zero bound, which leaves them unable to stimulate if markets crash, but able to hike quickly if they boom.

But I don’t think that the hike in and of itself shows that they failed to take account of this risk.

Think of a standard New Keynesian model projecting the awful shocks of the financial crisis, instructing the Fed to lower rates down to the zero bound, purchases assets [ok, I’m stretching the thought experiment here, but bear with me].   Eventually, once the effects of the shocks wear off, the model will be signalling that rates should be normalised.

The trajectory for rates will look different because of the asymmetry imposed by the zero lower bound [and the inability of asset purchases to make up for it].  From memory, it would involve a sharper cut on the way to the zero floor, and then a more protracted period of low rates [Woodford’s ‘lower for longer’].

But, at some points interest rates would rise.  So the Fed might be judged simply to have followed through on its asymmetry-inclusive path.

Or, we could think of them responding to positive news relative to the previous plan, which, again, zero bound included, would warrant a hike at some point, and this time earlier than before.

There are a few Fed speeches [I recollect Evans and Williams at least worrying about asymmetry] that cover the issue too, so this is more circumstantial evidence on which to acquit the Fed.

[Added later..]

Taking the argument to the extreme;  for a hike always to be wrong in the face of the zero bound implies that rates have to stay where they are forever.  Which is clearly not right.  So there is some prior forecast, or some incremental news that would have justified a hike, in the face of potential market volatility and the zero bound.  It’s just a question of whether that hurdle was cleared in this case or not.

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John Taylor on auditing all the world’s Feds.

This paper explains John Taylor’s view that if only central banks committed to monetary policy rules, international monetary disorder, and indeed large-scale capital flows, would be eradicated.

It’s an extension of his earlier argument that the US’ financial crisis and recession was caused, predominantly, by a departure from the Taylor Rule for monetary policy, and by fiscal uncertainty.

I didn’t find the earlier arguments convincing, and this one doesn’t persuade me either, for related reasons.

This new contribution repeats a problem with the original one, the contention that monetary policy was too loose in the early 2000s.  This was dealt with convincingly by  Bernanke in 2010.  The Fed set rates pretty close to a ‘forward-looking’ Taylor rule in which one inserts not current, but forecast inflation.  Very low rates back then was to head off forecast deflation.

The proposal amounts to assuming away one aspect of the problem.  If authorities could just stop engaging in competitive, beggar-thy-neighbour monetary policy stimulus, then there would be no competitive, beggar-thy-neighbour monetary policy stimulus.  In the real world, such problems exist because national objectives diverge, and there is frequently and incentive to depart from cross-country commitments.  All international monetary and economic agreements reveal how this story goes.

In one version of the argument Taylor seems to think it realistic that central banks would never need to respond to exchange rate movements.  He has in mind a model economy in which all central banks are simply following through systematic monetary policy, in turn derived from first principles using statements about central bank objectives.  For Taylor, the financial crisis does not seem to have caused him to question the models that decades ago helped fashion the Taylor rule as a useful tool for monetary policy.  For many others in the profession, the initial absence of finance from those macro models looks to have been a mistake, and we seem further than ever from a position where we could possibly agree to a formally and transparently stated monetary policy rule.  For the same reason a commitment of this sorts would be nonsensical [and as a corollary not credible] for the Fed, it would be nonsensical for all world central banks.

For the foreseeable future, central banks are going to have relatively vague mandates, translated into broad statements of intent, and leaving them always pondering the causes of exchange rate movements and whether they warrant a response.  And all with good reason related to the incompleteness of our models and knowledge.

Taylor globalises a thesis that he first applied to the US, which is that the financial crisis has a predominantly monetary cause, from which it is natural that he then concludes, in my view incorrectly, that it can have a predominantly monetary solution.

In the US, there are a long list of non-monetary causes suggested.  A failure of risk management in systemically important banks and shadow banks;  political interference in the government agencies tilting lending towards sub-prime;  a failure to regulate;  over-optimistic expectations about the correlatedness or otherwise of exposures by banks and non-banks;  over-optimism about future long run growth;  the possibility of runs on perfectly healthy institutions/markets/asset classes.

Correspondingly, there are a long list of non-monetary agents that may have contributed to the globalisation of the crisis.  Most prominent are the ‘imbalances’ and capital flows ‘uphill’ into the UK/US/non-Teutonic-Eurozone caused by some combination of incorrect expectations about relative long run growth prospects, incorrect perceptions of relative risk, and a demand for safety [as, for example, articulated in Caballero-Farhi] away from the vagaries of  property-rights disorder in China and the other emerging markets.  These causes are ‘real’, ie they can be thought of in non-monetary economies, and are frequently described as such using a basic modelling philosophy that is common to the tradition in which the benefits of Taylor rules were worked out [though in that case of course the models were monetary sticky price models].

In his ‘Taylor rules for the whole world’ solution, Taylor does not grapple with the long literatures on sudden stops, or the newer literatures on how financial fluctuations, with rational and irrational causes, can amplify business cycles, and might have solutions in the form of taxes on capital flows of one sort or another.

The work of Taylor, Henderson and Mckibben on monetary policy rules is rightly praised for having transformed how we think about what central banks do.  But it doesn’t provide a clue to how to avoid another convulsion in global finance, nor a template for a new international monetary system.


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