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Monetary policy has been reactive to the credit crisis, locally and globally. This is understandable, given the incremental nature of monetary policy tactics, its dependence on dynamic feedback, the evolution of the actual credit crisis, and the extraordinary staging of conventional, quantitative, and qualitative easing strategies.

Monetary policy is also inherently covert at a global coordination level. We hear the announcement of Fed currency swaps as a surprise. We see the cascading of various policy rate cuts and wonder whose being talking with whom before the fact.

Given the problems with the zero bound for monetary policy, fiscal policy is the logical hand off point in the relay race. Therefore, fiscal policy is in a better position to be strategic and anticipatory, as opposed to monetary policy, which must be reactive and incremental.

So, given the anticipatory advantage of fiscal policy, it can more or less ignore exactly where monetary policy is when in the late stages of a zero bound destination.

I think that’s why there’s an apparent coordination lapse at this stage.

Another advantage is that anticipatory fiscal strategy is more amenable to global coordination, or at least global communication and discussion around the necessity for longer term fiscal programs.

My impression of the Canadian budget is that it is very anticipatory in this sense, even though monetary policy has not yet run through the full extent of its late stages.

That was quick, JKH!

I hear mostly 4 in your comment. But for the last 15 or 20 years, all or nearly all countries have been using monetary rather than fiscal policy, and one of the main reasons is because it's quicker to change. All those things you say about monetary policy being reactive and incremental I would say apply more to fiscal policy, simply because it takes time to get stuff through Parliament, and more time to get the cliched shovels in the ground. Over the last 15 or 20 years, it has been monetary policy which is strategic and anticipatory, not fiscal.

And if we needed international coordination, it's so much easier with the tight club of central bankers meeting quietly, and deciding things behind the scenes.


But my point is that in the last 18 months, monetary policy has been far more reactive than strategic. Just look at how the Fed has had to improvise beyond the issue of the fed funds rate alone.

JKH: OK, I can understand central banks being slower on unorthodox monetary policy, where it's all new, but why should they be slow on orthodox monetary policy? And the Fed is not the puzzle, since it cut to zero before the fiscal expansion started. Why are other central banks going to wait until after the fiscal expansion before cutting to zero? And that's if they even plan to cut to zero.

Nick - given the pitfalls of zero interest rates, is there any logic to putting a non-zero floor on interest rates (something like 1%), and switching to fiscal policy if it isn't enough?

Patrick: What pitfalls? I can see a 0.25% floor, in Canada for example, just because you might want to keep the traditional 50 basis point spread between interest on reserves and the bank rate, with the overnight rate target in the middle of the band, at 0.25%. Maybe. But I can't think of any reason not to go down to 0.25% (unless you don't think that more aggregate demand is needed, but then why fiscal policy).

The more I think about it, the more I am leaning towards some version of 6; ROTW wants to keep the US dollar low (or at least prevent it rising further). They want the US to reduce its trade deficit?

If we take the US vs the ROTW as the model, wouldn't ROTW want a high US dollar so that ROTW can export goods to the US because the US is the largest global consumer.

Mark: yes, but the US having run a balance of trade deficit for many years has built up a large foreign debt to the ROTW. Some argue that this large US debt is part of the problem that caused the financial crisis. If the US is going to reduce its foreign debt, it must now run a balance of trade surpulus, which requires a lower US dollar exchange rate. But my explanation does assume that ROTW either sees itself as responsible for helping the US achieve a balance of trade surplus, or has been pressured by the US into accepting this responsibility.

Eventually, of course, the US must run a trade surplus. The question is whether it should start along that road now (which requires my 6), or else wait for recovery from the financial crisis.

Looking at what happened in Canada, I'd vote for the pandering explanation, i.e. the decision was made for political rather than economic reasons.

If I was feeling charitable, I'd add that maybe the purpose was to reassure the population that something was being done, and spending lots of money is more impressive than lowering an interest rate.

Indeed. I think most average Joes underestimate the effect of lowering the interest rate.


1) A stimulating list of alternative explanations. One problem, though, emerges with your endorsing no. 6: if the $US depreciates, then the ROTW --- which means, I imagine, overwhelmingly the EU, Japan, and China --- will find that its large capital investments in the US will depreciate in lock-step . . . at any rate, in terms of their own currencies (euros, yen, yuan). Do you really think the central banks and big financial institutions in those regions or countries really want this?


2) So far, of course, for reasons having nothing to do with relative interest rate differentials, the $US has appreciated noticeably against the yen and the euro since last summer . . . by which time it had been rising for a year or so against them anyway.Yet Chinese and Eurozone and even British short-term benchmark interest rates are markedly higher than in the US right now.

Which means, obviously, there are other motives for capital from abroad to continue flowing into the USA. Such as:

* A safe-haven refuge . . . habitually, the USA always a recipient in troubled times around the world.

* A belief --- underscored by the recent IMF projections about economic growth over the next year or so --- that the US economy will weather the recessionary problems better than the EU countries, Japan, or China.

* And maybe --- hard to know here, speculation alone possible --- a widespread belief in the ROTW opposite of yours that the $US will not depreciate, but either stay roughly at its current relative high levels or even appreciate. That, in turn, would underscore either the stability or profitability of their investments.


3) Whether, of course, American policymakers would be happy with a relatively high exchange rate is an entirely different matter. We can't rule out the possibilities that the Chinese CP will seek to find ways to export their way out of a serious decline in their GDP rate of growth . . . amid growing social conflict and turmoil. In that case, Congress would probably demand some kind of trade-restrictions --- not a pleasant prospect, right?


Michael Gordon, AKA, the buggy professor

PS: I just found your web site after Mark Thoma linked to it. Very stimulating commentaries: thank you.


I'm surprised at your question in item 2 above. What are the costs? Just look at our experience with orthodox monetary policy following the tech bubble collapse. We held rates at 1% for two years. The impact of this artificial credit pricing was unprecedented (in peacetime) growth in total credit to GDP, which of course led to today's problems. What were the costs indeed.

Most respond to the above argument with, "well, now there's no danger of another lending bubble, so even if it was the wrong thing to do then, its the right thing now." True enough in the sense that a credit bubble is unlikely now. False in the sense that the problem with low policy rates is not setting them, but removing them. What will happen to our economy three years from now when it starts to grow? If the the Fed removes reserves too quickly, then presto! We have a 1937-like mini-depression. If it removes too slowly, inflation rears its head, and the policy rates needed to control it are even higher.

So there are plenty of costs. To think otherwise is to blind yourself to the consequences of policy action.


BTW, one could argue that not even Japan today will fit the "Lost Decade" analogy. Its economy is deteriorating at a much more rapid pace than at any point during its "stagnation" period. Moreover, government debt to GDP is already high, and its difficult for them to carry off the same level of increase in fiscal stimulus. So one could argue Japan is finally, two decades after its stock bubble burst, headed for a hard landing.

David: I would say I disagree with you *from the perspective of positive political economy* to explain why current policy is as it is. It sure sounds to me like governments and central banks are doing everything (else) they can to raise asset prices, and I don't hear anyone (in government or central banks) making your sort of argument. But from a normative perspective, about what policy ought to be, I am less sure. If we work through the consequences of your views, we come to the conclusion that the natural rate of interest needs to be raised, and raised permanently (by some means, such as permanently discouraging global savings). Because what you are in effect saying is that if real interest rates stay too low, in absolute terms, we get a bubble. And I would reply that if if real rates stay above the natural rate we get into a deflationary spiral. So the only way we can both be right is if the best policy is to raise the natural rate, and permanently. Hmmmm. I feel another post welling up inside me.........

Michael: Thanks! Good to see you have found your way here.

1. Hmmm. Yes, maybe. But the value of one's overseas investments are irrelevant until one withdraws them. And the only way to "withdraw" overseas investments is to run a trade deficit, which means your currency appreciates, and the value of your overseas investments goes down anyway. Unless it's all in the timing, and smoothing, so you don't withdraw them all at once, at 'fire-sale' prices. Dunno. Interesting point. But it would only work for countries which have lent big to the US.

2. Yes, there must be some other (big) motive behind the US appreciation. My guess would be that US bonds are just so much more liquid, with very thick markets, and this is a liquidity crisis. (Plus the US has no "original sin", and the Fed can always print money to buy back US bonds in the event of a run, so there is zero rollover risk. See my post a week or two back on Canada and the Eurozone.) But all this would be hidden in the "ceteris paribus" clause of my 6 argument.

3. Your 3 sounds like a more plausible variant of my 6. It's not that the US has said: "keep your interest rates up!". Rather (what I interpret you to be saying) is that ROTW knows that if it cuts to zero, and the US$ appreciates further, US demand for protectionism will be even stronger. I rather like that story. It has a ring of plausibility, plus it makes sense in the economics.

David: Your 11.31 comment came in while I was writing my last one. I think it just confirms me in my view though.

Who actually moves first,(credit, equity, commodity) markets or central banks? It seems to me that central bankers are the last people to figure anything out. Traders know.

If any of the three rally dramatically, raise rates.

As for fiscal stimulus, if spending on infrastructure is considered stimulus, then it should be used every budget cycle.

beezer: I would say (credit, equity, stock, forex) markets move first, followed by central banks, followed by a horse-race between labour/output markets and government fiscal policy. It's hard to start and stop infrastructure spending quickly. While we are waiting for it to start, why not cut to zero now?

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