Two weeks ago I wrote a post "Monetary stimulus vs financial stability is a false trade-off".
My opening lines in that post were: "There's an idea floating around out there that I fear may be influential. And that idea is horribly wrong. Which makes it dangerous. And I want to try to kill it."
Today, the C.D. Howe Institute publishes a Commentary by Paul Masson "The dangers of an extended period of low interest rates: why the Bank of Canada should start raising them now".
That's the idea I was talking about.
If you are worried about the dangers of an extended period of low interest rates, the worst possible thing the Bank of Canada could do would be to start raising them now. Because if the Bank of Canada tightens monetary policy now, and this causes the economy to slip back into recession and disinflation, that would require an extended period of even lower interest rates in the future.
Now go read my old post. Update: and posts by Mike Konczal and Brad DeLong. Update2: and see how the Bank of Japan's looser monetary policy is raising interest rates on 10 year bonds (finally, now the bond market has woken up to the fact that monetary policy really has loosened).
Update 3: To see pictures of recent Canadian data, which illustrate my point here, see Marcus Nunes' post.
Update4: if you want a mechanical metaphor to help you understand the paradox here: the Bank of Canada is like a man balancing a pole upright in the palm of his hand. If he wants the pole to move north, he must first move his hand south, so the pole begins to lean north, so he can then move his hand north to prevent the pole falling over. Except the pole has expectations.
There's an idea floating around out there that I fear may be influential. And that idea is horribly wrong. Which makes it dangerous. And I want to try to kill it. But macro is hard. And it's not easy to explain clearly and simply.
I can only try. And I can only hope that others who are more influential than me, or can explain things better than me, will do the same.
"Sure, there's a risk that inflation is falling below target, and a risk that recovery will be delayed, and it would be nice if the Bank of Canada (or Sweden or wherever) could loosen monetary policy to prevent this happening. But monetary policy works by lowering interest rates and encouraging people to borrow more and spend more. And that creates a problem for financial stability, because some people are already borrowing too much. So there's a trade-off between monetary stimulus and financial stability, and monetary policy needs to take both objectives into account."
I made up that quote. But I don't think I made up the influential idea it expresses. And it's horribly wrong. It's almost the reverse of the truth.
1. Did a financial crisis cause a fall in expected and actual aggregate demand? (With central banks being unable or unwilling to do enough to stop it).
2. Or did a fall in expected and actual aggregate demand cause (or worsen) a financial crisis? (With central banks being unable or unwilling to do enough to stop it).
Obviously, there is a positive feedback multiplier between financial crises and expected and actual aggregate demand growth. (If central banks are unable or unwilling to prevent there being positive feedback.)
I started to write a post on this, but scrapped it, because I couldn't think of any way to provide good evidence one way or the other.
Now David Beckworth has a very important post which provides evidence for the second hypothesis. Go read it. Or simply look at the picture. US households' expected dollar income growth started to fall well before the US financial crisis.
[Update: see also Marcus Nunes' post and graph.]
The purpose of this post is simply to draw attention to David's post, and to raise a few minor points:
What a difference just a few months can make in the world of federal government finance. Apparently, weak commodity prices and a slowing economy are playing such havoc with government finances that Thursday’s federal budget will show a downward revision of economic growth forecasts as well as a shortfall in revenue that will be addressed by extra savings that will come from limiting the growth of federal discretionary spending – direct spending on programs and services as opposed to transfers.
Just a short post on one point about the recent Cyprus business. (It looks like Cyprus will impose a "one-time tax" on bank deposits rather than honour its deposit insurance.)
"Monetary policy can cause bad things to happen in financial markets, which can cause bad things to happen in the rest of the economy. Therefore NGDP targeting is wrong."
I made up that quote. But if I had to summarise M.C.K.'s long article in two short sentences, that is how I would do it.
Well, Ontario has a new finance minister – Charles Sousa – and according to the Toronto Star: “Charles Sousa, the two-term Mississauga South MPP who finished fifth in last month’s leadership race, will succeed the retiring Finance Minister Dwight Duncan at the treasury. An affable former Royal Bank executive, Sousa inherits a $11.9-billion deficit that the minority Liberals hope to eliminate by 2017-18.” As far as inheritances go, I suppose I would prefer to be on the receiving end of a few thousand acres of rolling English countryside and Downton Abby rather than an 11.9 billion dollar deficit. No doubt, the new minister has been briefed on what is coming down the pipeline. The most recent Ontario quarterly finance update provides a lot for him to chew on.
I wrote this post. Then I realised it was wrong. I really wish my math were better. So I'm turning it into a sort of bleg. I should have written the technology in implicit form as F(C,I,K,L)=0 rather than H(C,I)=F(K,L). Because the way I wrote it makes Pk depend only on I/C, when it should also depend on K/L as well. I can't think of any plausible underlying story that would make H(C,I)=F(K,L) legitimate and reasonably general. But F(C,I,K,L)=0 is ugly and unintuitive and unteachable, even though it works fine theoretically, and is just a little bit more complicated.
Maybe someone has some ideas?
Here's what I originally wrote:
I'm using this fable to try to clarify my thoughts.
Suppose, just suppose, that Nortel shares had sticky prices. Rather than adjusting almost instantly to ensure market-clearing equilibrium, the price of Nortel shares adjusted slowly over time in response to excess demand or supply of Nortel shares.
That would mean that uninformed traders, who knew only the past history of Nortel share prices, could forecast the price of Nortel shares. Not perfectly, but it wouldn't be an unforecastable random walk. If the price of Nortel shares increased today, it would probably increase tomorrow too. If the price of Nortel shares decreased today, it would probably decrease tomorrow too. The sort of naive extrapolative expectations that create bubbles would then become rational.
The Parliamentary Budget Office's most recent release "The Fiscal Impact of Federal Personnel Expenses: Trends and Developments" provides some interesting statistics on the amounts of employee compensation paid by Canada’s federal government. According to the report: “in 2011-12, Canada’s federal personnel expenses were $43.8 B, or 2.55 per cent of GDP. These expenses supported a workforce of 375,500 employees and provided approximately $114,100 on average in total compensation per employee.” Media reports attributed to the President of the Treasury Board claiming that these average compensation amounts were inaccurate and that actual compensation was lower (Tony Clement said the average compensation was closer to $95,000) were rebutted by the PBO with an information update. As entertaining as all this was, the fact is that any discussion of public employee compensation in Canada should cover more than just the federal government and that it might be more appropriate to compare us to where we stand relative to other countries.
Well, it has been an exciting couple of days in Canada on the policy side given the juxtaposition of the following news: 1) the federal by-election results suggest a more competitive political environment for the federal Conservatives in the stronghold of Alberta 2) the world-class City of Toronto is deposing its Mayor over a conflict of interest involving a high-school football team 3) the federal government is raising the limit on tax-free savings account contributions by 500 dollars and 4) Mark Carney is heading off to the Bank of England. What’s the connection?
The provincial premiers are meeting on the economy in Halifax today and tomorrow and Prime Minister Harper will not be joining them. Several of them have offered up expressions of surprise and disappointment and have lamented the absence of the Prime Minister. The operatic drama that often characterizes exchanges at federal-provincial meetings has been absent the last few years given that one of the chief actors refuses to come. I suppose the premiers are unwilling to replicate the Clint Eastwood approach to political discourse and simply address an empty chair.
The title says it all. There's not much to add. "Bond vigilante attack" is just another name for "bursting the bond bubble". And loosening monetary policy would do that.
Paul Krugman is right if he is talking about a small attack by the bond vigilantes. It's a good thing, because it increases Aggregate Demand, which is what the US economy needs.
But too much of a good thing will be a bad thing.
A large attack by the bond vigilantes would be a bad thing, because it would increase Aggregate Demand too much. That would force the Fed to increase interest rates a lot, and that would force the US government to raise taxes and/or cut spending to cover the increased costs of servicing the debt.
The 2012 Federal Fiscal Reference tables are out and the information on provincial net debt is interesting especially when the growth of net debt is considered.
This is a Sunday morning [evening - I hesitated] post, about some ideas I'm playing around with, trying to get my head straight. I'm just throwing it out there, and wondering if it has enough empirical "oomph" to fly. I don't think there's anything original here. "It's all in Menger". But Menger didn't draw a pretty picture.
Four years ago (and again two years ago) I argued it might be good policy for central banks to (conditionally) trash their own balance sheets. Now this idea is in the news. See Ralph Musgrave for links.
The recent blogosphere debate over whether money is or is not a bubble must have sounded like angels on pins to people who aren't monetary economists. But as JP Koning notes, it's what's at the root of those very policy-relevant questions. Does it matter if central banks trash their balance sheets by buying worthless junk? Might it even be a good policy, in some cases, for central banks to burn the bonds they own?
My views on this question have evolved a bit over the years. From reading other bloggers' posts, from comments here, and from thinking about it.
Here's a parable. Just in case it's not obvious, imagine I am a central bank, issuing currency, and targeting 2% inflation, so my currency pays a real rate of interest of minus 2% on average.