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If the BoC is worried about both inflation being too low and interest rates being too low why couldn't it

1) Use monetary policy to increase rate of interest (adjust balance between bonds and money to achieve this)
2) Use fiscal policy (or arrange for the govt to use fiscal policy) to increase rate of inflation (increase budget deficit in order to increase NGDP relative to RGDP)

Isn't the view that the only way to hit an inflation target is to lower interest rates based on too narrow a view of the role of fiscal policy ?

Market Fiscalist,

I don't see governments running deficits/surpluses at the whim of the central bank.

Market Fiscalist: if someone made the argument that fiscal policy should be loosened to raise equilibrium interest rates, that would at least make macroeconomic sense. Or investment subsidies, or something like that.

Why the hell can't central bankers figure this out! Would it help if I emailed your posts to the Bank of Canada? We in the maritime provinces have been suffering double digit unemployment for years!!

Nick,

Surely a larger budget deficit would increase the money supply (assuming the deficit was funded by selling bonds to the CB in exchange for new money) then this would put downward pressure on interest rates. Monetary policy (selling some of those bonds to the public) would be needed to raise interests back up again to address those fears that too low interest rates leads to too much private borrowing. I suppose if there is some "wickselian" natural rate that could be achieved when the economy is at full employment/balanced budget equilibrium then perhaps this would be higher than the rate holding at less than full employment - but in a deep recession I am not seeing how that is relevant to the discussion.

W. Peden: I am assuming co-operation between these 2 branches of economic policy.

And if the budget deficit was used to fund investment subsidies then that would work as well as anything.

"However, the Bank must also take into consideration the risk of exacerbating already-elevated household imbalances."

Isn't this the same reason that the Riksbank gave for tightening monetary policy?

And isn't this what prompted Lars Svensson to resign as Deputy Governor?

And since then hasn't Svensson argued repeatedly and quite convincingly that tightening monetary policy only makes household leverage worse, not better?

[link here NR]

[link here NR]

[link here NR]

And the best cure for a debt crisis is more debt! You see, it's a paradox (world burns).

Here look, I've made you guys a logo: http://i.imgur.com/rg50NKU.png

I agree with all this except the last three paragraphs. That's ok; it's boring to agree on everything.

One other reason the "household imbalances" line is silly: To the extent that rates on current debt respond to policy (because the debt is floating rate and/or because household expenditure responds only slowly to rate changes), the immediate effect of higher rates is to raise household debt/income ratios. Not lower them. Of course thiseaffect is even stronger to the extent that higher rates lead to slower income growth.

See for instance [link here pdf NR}

Ah I see Mark Sadowski got there before me.

I have also written about this myself: [link here pdf NR}

if someone made the argument that fiscal policy should be loosened to raise equilibrium interest rates, that would at least make macroeconomic sense.

I wish people said this more often.

If you think low interest rates are a problem -- either because you think the ZLB is a binding constraint on monetary policy, or because you think financial markets don't work well when interest rates are very low -- then logically you should be making an argument for a permanently higher level of government spending.

JW Mason,
I love your Fisher Dynamics paper and often refer to it.

Market Fiscalist: " I suppose if there is some "wickselian" natural rate that could be achieved when the economy is at full employment/balanced budget equilibrium then perhaps this would be higher than the rate holding at less than full employment - but in a deep recession I am not seeing how that is relevant to the discussion."

have a look at this old post.

the best cure for the easy money drug addicts is a german Governor of the B of Canada. Volckers would also do.

I looked at that post and agree (now) that fiscal policy that boosted AD would cause upward pressure on interest rates as business respond to the increased demand. This might alleviate the need for selling so many (or even any) bonds to the public to achieve the desired interest rate target.

My (revised) point remains though: If (rightly or wrongly) it is desired to both boost AD to a certain level and to target a specific rate of interest then this can be done via combined fiscal policy (boost AD by expanding the money supply via govt deficits) and monetary policy (control the interest rate by adjusting the holdings of the public between money and other assets).

Is strikes me that a combinations of these 2 policies allows a much great flexibility in stabilizing an economy in disequilibrium than monetary policy alone.

O/T: I'm asking all my favorite econ bloggers about this: George Selgin thinks this new popular video:

https://www.youtube.com/watch?v=iFDe5kUUyT0

is tin foil hat material:

http://marketmonetarist.com/2013/10/19/more-silliness-from-the-tin-foil-hat-austrians/#comment-28467

Your take? (A minute or two of viewing should be sufficient)

Nick,

I'm not sure I understand your first point. Surely, the issue they are concerned with is that some people might borrow more, not everyone. The others may be accumulating financial assets. So you don't get any increase in net debt, but you do get an increase in gross debt. People might be spending $100 more on average and earning $100 more, but some of them might be spending $50 more and some spending $150 more.

Nick,
Have you seen Svensson's criticism of Riksbank “leaning against the wind” policy (ie. perusing tighter than is necessary to hit its inflation target in order to restrain the household debt to income ratio)? Svensson shows what should be obvious: that tight money raises the household debt/income ratio instead of lowering it – a problem that gets compounded over time because the Riksbank has effectively put the household debt/income ratio into its reaction function with the wrong sign. In a related VoXEU note he actually praises the BoC for not following the Riksbank over the past 15 years. But over the past two years the BoC is quite clearly following in teh Riksbank's footsteps (and the result has been a widening output gap and below target inflation):

http://www.google.ca/url?sa=t&rct=j&q=&esrc=s&frm=1&source=web&cd=1&cad=rja&ved=0CC0QFjAA&url=http%3A%2F%2Flarseosvensson.se%2Ffiles%2Fpapers%2FLeaning-against-the-wind-leads-to-higher-household-debt-to-gdp-ratio.pdf&ei=wINqUvS4EvKkyAHKo4HQDQ&usg=AFQjCNG5O9OXNC12_sFhXm0tTLg4ErJuVQ&sig2=E9OemY7DgR_SSDKrWFtpog

Didn't you listen to Poloz's press conference? All the central bank needs to do is just hide under a great big pile of coats and wait for "Mother Nature" to make everything all right again.

Gregor: stupidly (because I was over-excited) I forgot about Svensson when I wrote this post. Mark Sadowski and JW Mason reminded me above.

Nick Edmonds: " People might be spending $100 more on average and earning $100 more, but some of them might be spending $50 more and some spending $150 more."

But it might be the ones who are already in debt who are increasing their spending by less than their income, and the ones who are already in credit who are increasing their spending by more than their income. And in the 1982 recession, IIRC, it was precisely the increased unemployment that was empirically the biggest factor in people defaulting on their mortgages. The "best" way to increase defaults would be to try for a repeat of 1982 or (God forbid) the 1930's.

Good paper JW. One tiny picky disagreement. I think your footnote 10 is wrong. Since this is arithmetic, it would make no difference if we did everything in real terms, using (r-g) as the single explanatory variable, instead of the trio p, i, and g. We do not need to assume the Fisher *theory* of the relation between r, i, and p. We just need the Fisher *identity*. We can restate your conclusion as "(r-g) was bigger post 1980 than pre-1980, and would "explain" most of the cumulative rise in b."

Because (1+i)/(1+g+p) = 1/(1+g-r) (in continuous time)

Or maybe I misunderstood.

I agree it might go that way. But presumably the BoC's concern is that it will go the other way. I guess what generally happens is a small number of people borrow a large sum and most people save a little (which for those already in debt means reducing that debt), so it's a net effect.

And I also agree that deflationary policy is not necessarily the best way to deal with excessive debt levels.

Nick you write:

"And by saying it is less likely to cut interest rates should the need arise, because of fear of "exacerbating already-elevated household imbalances" the Bank of Canada is changing people's beliefs, increasing people's fear of continuing recession, and prolonging the duration of low equilibrium interest rates."

That's a great assessment for the people of Canada. In the US what you'll get is:

1. Blank stares

2. A rousing chorus of "End the Fed! End the Fed!"

Think of the trial scene in Idiocracy.

the best cure for the easy money drug addicts is a german Governor of the B of Canada. Volckers would also do.

Canada exports Central Bank Governors. We don't import them.

The sentence in which you mentioned low interest rates being the equilibrium of few wanting to invest and many wanting to save, caused a sudden click for me, even after reading _The Money Illusion_ for a year. I really wish someone would collect all the simple ideas like this in a list somewhere.

I would feel worse about failing to understand this for so long if the point were not also apparently eluding the governors of central banks.

Tom B: "Think of the trial scene in Idiocracy."

A lovely movie. Very subversive. I'm not sure the average Canadian would get it any quicker though.

Eliezer: It's a tricky point. It eluded me too. I'm still not 100% clear on it. But that lack of clarity just goes to show how "interest rate control" is such a screwed up way of doing monetary policy.

Sometimes in life, it is not about the fine points. For the Fed, and the Bank of Canada, they are at the moment of truth. No one believes they have the resolve to secure robust real growth.

They have print, baby, print, until the plates are melting and the roof is on fire. They need to see four or five years of robust growth, and then maybe talk about "fighting inflation."

BTW, as the North American economy is so much less inflation-prone than the 1970s, I think we would only see moderate inflation, even after five years of strong growth....

I like on the Sumner blog where you brought the broomstick metaphor. It's the classic inverted pendulum physics problem! (http://en.wikipedia.org/wiki/Inverted_pendulum) That picture of the wine glass on wikipedia also kinda conveys the risks of monetary policy where the glass falling to one side or the other would represent hyperinflation or a deflation spiral.

You could say that currently what central banks are doing is moving the base of the stick towards low rates but not enough to get the top of the stick to lean towards higher rates.

"If you cut interest rates for one individual that individual will respond by borrowing more and spending more."

I don't believe that has to be true. Cut Warren Buffett's interest rate. I doubt that he will borrow more or spend his savings on goods/services.

"But that is not how monetary policy works for an economy as a whole. Because one person's spending is another person's income. So if people spend $100 more per month then people earn $100 more income per month, so they don't need to borrow anything more in order to spend more."

Let's assume a 2 person economy. MV = PY. M = 5,000, V = 2, P = 100, and Y = 100. If V stays the same or goes down, won't M need to rise for NGDP to rise?

Mark- Thanks!

Nick- Yes, formally you could do it all in real terms. But in terms of telling a useful historical story, it's nice to distinguish between changes in interest rates that are due to changes in nominal rates and changes that are due to inflation.

Benjamin: "BTW, as the North American economy is so much less inflation-prone than the 1970s, "

I think there's some truth in that; it's also much less disinflation-prone, but I wish I understood it better.

Benoit: yep. I only found out afterwards it's a classic physics problem. But you might enjoy my old post here where I talk about the double inverted pendulum problem. There's a great video. The metaphor's still not perfect, because pendulums don't have expectations, but it gets the flavour of the problem.

TMF: MV=PY. Yes, if V goes down, you need M to go up even more, to get PY to rise. But V also depends negatively on expected growth in PY.

JW: Ah! OK.

"But V also depends negatively on expected growth in PY."

So you are saying if expected growth in PY goes up, then V goes down?

Nick,

"The best way to raise interest rates is to say you will cut interest rates if the economy doesn't recover quicker. The best way to lower interest rates is to say you are scared to cut interest rates."

What is the best way to set an interest rate that is appealing to both private borrower and private lender?

I don't see anything at odds with the BoC statement. Perhaps this translation is more accurate..........

"We would maybe like to cut interest rates to prevent inflation staying below target, but we are scared of doing this because there is a housing bubble. We are also scared of inflicting impinging on our chartered banks licence to make money. Acknowledging the bubble might pop it and we would rather not get blamed for doing that, even though it is inevitable. Seeing that a better way to address this would be to require a much higher premium for mortgage insurance. Unfortunately we do not have the means to convey this reality to CMHC. In fact, other than press releases, we have no contact with the outside world. Please if you are reading this, tell Marc Carney, whom escaped, to send for help........ perhaps Dean Baker..."

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