The Fed's Dark Age communications strategy

One sentence in Fed vice-chair Janet Yellen's speech caught my eye:

"Indeed, I believe that the Federal Reserve qualifies as one of the most transparent central banks in the world."

That is total bullshit. The Fed is one of the least transparent central banks in the world.

Ironically, in the excellent paragraph immediately following her bullshit sentence, Janet Yellen tells us precisely why it is a bullshit sentence:

"Moreover, clear communications play an integral role in facilitating the effectiveness of monetary policy actions. Expectations play a critical role in the decisions of forward-looking households and businesses about how much to spend, work, hire, and invest, and their decisions are more likely to be consistent with the objectives of the central bank if they are based on a solid understanding of the shocks affecting the economy and the likely monetary policy response. When financial market participants understand how a central bank is likely to react to incoming information, asset prices should adjust in ways that anticipate the central bank's expected policy actions, enhancing the monetary policy transmission mechanism and thereby supporting the central bank's attainment of its objectives. Finally, good communication can help anchor the public's long-term inflation expectations, which can, in turn, greatly improve the scope for monetary policy to counteract departures of resource utilization from its sustainable level."

The Fed is one of the least transparent central banks in the world because it is totally opaque about the only thing that really matters for monetary policy. What is the Fed's objective? What is the Fed's target? What is it trying to do? Where is it trying to go? How can we possibly know how the Fed will respond to shocks to meet its objective if we don't know what that objective is?

Go on the website of any modern central bank in any other advanced country. Or some not so advanced countries. You will find a number, right there on the home page. That number is the central bank's target. It's nearly always an inflation target, but it doesn't have to be. 2% inflation. Or 2.5% inflation. You know exactly what that central bank is trying to do. And, looking back, you will know if it has succeeded, or failed, in doing what it said it was trying to do.

[Update: Gah! I totally forgot about the Bank of Japan, which is at least as bad as the Fed. But that exception surely proves the rule!]

That's what "transparency" means, when it comes to central banking. It doesn't matter if you publish your minutes. If we knew what your objective is, and that you would get there eventually, we wouldn't really need to know the precise details about your internal bickerings about the best route to take to get there.

The Fed publishes its minutes; the Bank of Canada doesn't. The Bank of Canada publishes its target; the Fed doesn't. Because the Bank of Canada publishes its target, it doesn't need to publish its minutes. The target tells us what we need to know; the minutes don't. The Bank of Canada is transparent in the way that matters; the Fed isn't.

This is not (just) some Market Monetarist point. Any New Keynesian macroeconomist would say exactly the same thing. Expectations of what the central bank will be doing in future matter for what happens today. They matter more than what the central bank is actually doing today. Today is just one day. The future is every day after this.

And it is conditional expectations of what the central bank will be doing in future that matter today. Because we cannot predict the future. But the central bank should tell us what it would do differently if the future turns out differently to what we expect. Canadians know that if new data comes in showing inflationary pressures are higher/lower than we had expected, then the Bank of Canada will also set higher/lower interest rates than we had expected. Which means we continue to expect 2% inflation, regardless of what data come in, because we know the Bank of Canada will adjust the steering wheel conditional on that data.

That's how the Bank of Canada targets inflation. By telling us what that target is, so we expect 2% inflation. And as long as we all expect 2% inflation, it is very hard for actual inflation to differ very much from 2%.

Because Fed watchers don't know the Fed's target, they often confuse the Fed's instrument for the Fed's target. Here's an example:

"Should the Federal Reserve abandon its traditional tactic of targeting interest rates in favor of targeting a specific level of nominal gross domestic product?"

That was the opening sentence by CNBC business reporter John Carney in an article on NGDP targeting. He is confusing today's tactic with the strategic objective. It's like confusing the position of the steering wheel with the destination of the bus. "Should the bus driver abandon his traditional tactic of holding the steering wheel in favour of driving to Toronto?" It's gibberish. I don't blame John Carney for this horrible conceptual mistake. I blame the Fed.

Of course you don't expect the bus will ever get to Toronto if you think the driver's objective is to hold the steering wheel in a particular position. You expect the bus will end up in the ditch. Of course you don't expect monetary policy to work if that's how you think of monetary policy.

Robin Harding of the Financial Times (H/T Mark Thoma) says the Fed has set up a working group to improve the Fed's communications strategy, perhaps by specifying a target. I really hope they do. But that's 20 years behind the Reserve Bank of New Zealand and the Bank of Canada.

Maybe, just maybe, Janet Yellen's bullshit sentence was really aspirational. Like when you tell a kid who's covered in mud: "You are such a clean kid", in the hope of shaming the kid into having a wash. Janet Yellen has to say that, even though she knows it's false, because she's the kid's mother. But I'm the rude next door neighbour yelling "bullshit!"

(Come to think of it, didn't someone recently write a whole book on "Bullshit" saying much the same thing?)

Yes, I know this is a mostly Canadian economics blog, and I ought to be writing about the Bank of Canada. Sorry. But there's just nothing as important to say about the Bank of Canada. The only really important thing about the Bank of Canada is right there on its website for any idiot to see. You don't need me to tell you that the Bank of Canada is targeting 2% inflation.

Comments

[Frances Woolley]

Great post, Nick. I admire your restraint in saying nothing about the phrase "an integral role in facilitating the effectiveness..."

[Lorenzo from Oz]

The RBA publishes both target and minutes. The target being: the Reserve Bank's objective of achieving an inflation rate of 2–3 per cent, on average, over the cycle.

[Nick Rowe]

Frances: Thanks! But that wasn't restraint; I missed that! What a laugh! Yep.

Lorenzo: I wonder which came first: publishing the minutes or publishing the target?

I have seen a bright high school kid go on the Bank of Canada's website and learn far more about its monetary policy in one hour than the best Fed watcher will ever learn about the Fed.

[Phil Koop]

So yelling "bullshit" is now a worthwhile Canadian initiative? What happened to polite discourse? :-)

Frances: LOL!

[marcus nunes]

Nick
Wonderful post! Just yesterday I picked on this quote from Ian Shepherdson, Chief Economist at High frequenct Economics:
“This recession, followed by sluggish recovery, is not the experience of pretty much anyone today,” Mr. Shepherdson said. “So for all intents and purposes nobody in America has any experience for an economy behaving like this. Economists don’t even understand it.”

He added: “So if people don’t really understand what’s going on in the economy, how can they frame reasonable expectations of where it’s going?”
And I "completed" it with:
Ball over to you, Chairman Bernanke!

[Min]

Janet Yellin: "Indeed, I believe that the Federal Reserve qualifies as one of the most transparent central banks in the world."

Nick Rowe: "The Fed is one of the least transparent central banks in the world because it is totally opaque about the only thing that really matters for monetary policy. What is the Fed's objective? What is the Fed's target? What is it trying to do? Where is it trying to go? How can we possibly know how the Fed will respond to shocks to meet its objective if we don't know what that objective is?"

But wait! Suppose that the Fed is transparent and totally opaque about its target. How can that be? It has no well defined target. Why not? Well, maybe because of internal disagreements. And lack of leadership. (Assuming that Bernanke's hair is on fire.)

Oh, I forgot. We all know what the Fed's objective is: 2% inflation with 4% unemployment. {Operatic laugh: HA HA HA!}

[Nick Rowe]

Phil: yep. Sorry about that. This is supposed to be a family blog. But I was using the word "bullshit" in its technical sense: like when you say something that you and everybody else knows is false, and its falsity is almost common knowledge, so you don't really mean what you say. In other words, I'm fairly sure Janet Yellen didn't really mean what she said.

marcus and Min. Yep. The problem really isn't Ben Bernanke. I'm sure he understands all this better than me. It's all those idiot regional Fed people he has to try to keep in line. Like NK who did such a horrible job a year or so back in communicating his understanding of which way to turn the steering wheel. (My notorious "Oh Christ!" post.)

[Peter]

Does the central bank of Canada have a dual mandate? Do they specify the exact trade off between inflation and unemployment? Do they specify which inflation measure the 2% relates to?

[David Beckworth]

Great post Nick. Between this one and the all the Chuck Norris posts maybe the Fed will get it.

[Nick Rowe]

Peter: the mandate of the Bank of Canada is not totally dissimilar to the Fed's dual mandate. I can't remember the exact words. It's something like "price stability plus trying, to the extent that it can, to mitigate fluctuations in output". It's a slightly better-worded mandate than the Fed's, because the second part is on *mitigating fluctuations*, rather than *high* employment.

The 2% inflation target is how the Bank of Canada has *interpreted* its mandate. How it has *operationalised* its mandate, if you like. It's the Bank telling us precisely what it thinks the mandate should mean.

It would be just as easy, or even easier, for the Fed to interpret its own mandate in terms of an NGDP level path target.

Yes, the BoC says 2% CPI inflation. There's a slight fuzziness in the use of core inflation as an "operational guide", as opposed to 2% total CPI inflation as the "inflation control target". But BoC watchers know more or less what that means, in practice. Because the BoC also tells us that it uses core as an indicator of underlying future inflationary pressures, and that it wants to get total CPI inflation back to the 2% target in 18 months to 2 years.

http://www.bankofcanada.ca/

Ah! Here is the preamble from the Bank of Canada Act:

"WHEREAS it is desirable to establish a central
bank in Canada to regulate credit and currency
in the best interests of the economic life of the
nation, to control and protect the external value
of the national monetary unit and to mitigate
by its influence fluctuations in the general
level of production, trade, prices and
employment, so far as may be possible within
the scope of monetary action, and generally to
promote the economic and financial welfare of Canada"

http://www.bankofcanada.ca/wp-content/uploads/2010/07/act_loi_boc_bdc.pdf

[Nick Rowe]

Wow! Check out Peter's NGDP blog everyone! Click on his name. Bookmarked.

[Bill Woolsey]

love the "are you going to continue holding the steering wheel or drive to Toronto" analogy.

I don't think it is the regional Federal Reserve Presidents that are causing the problem.

The problem is the U.S. Congress that created a mandate of maximum employment and stable prices.

Liberal members of Congress strongly oppose going for a strict inflation target because they want to Fed to respond to unemployment.

I also have my doubts about how well the change from "stable prices" to 2% inflation would go. I suspect that the Fed is dominated by people who think that 0% inflation is dangerous because of deflationary errors. But if they come out and say that, it creates political problems.

Today, the Fed just says that stable prices means low inflation. Maybe it is just me, but I think that sounds like a contradiction.

If you have only a poor understanding of monetary economics and think inflation is just something that happens, then the Fed is doing a reasonably good job of "fighting inflation" or "keeping inflation under control" when the inflation rate is 2%. This is compared with what happened in the seventies, when inflation was not controlled and took its natural path upward.

But now, the Fed says in front of God and everyone that they are trying to cause the cost of living to rise 2% each each year and erode everyones' standard of living, especially those on fixed incomes?

Instead of the Fed heroically battling inflation and keeping it under control (as opposed to letting it take off as it did in the seventies,) the Fed is trying to cause inflation.

As for "maximum" employment--what does that mean? Isn't it better to just keep that vague rather than try to explain the natural rate of unemployment? And worse, given the new Keynesian mindset, where excessively low unemployment is what causes inflation, what could be worse?

Anyway, I think that the U.S. Congress needs to come up with a new mandate--say, targeting the growth path of nominal GDP.

[Peter]

Nick, thanks for bookmarking my blog! Now I have a great reason to try to improve my blogging. But I will blog in Swedish sometimes. My plan is to try to lure in some Swedish poor sods and then implant the NGDP level targeting virus in their minds. Resistance will then be futile and they will be assimilated. :)

Anyway, BoC and Riksbanken seem more transparent than the Fed. But I think they could do better. Specifying a single inflation measure and the weighing of inflation versus unemployment would be a big step forward.

Also, the chief of Riksbanken, Ingves, had a chat today after their latest announcement. I asked him about NGDP level targeting and he answered that their inflation target had worked well so there was no reason to change. Not a very surprising answer, but still pretty cool that anyone can get their questions answered.

[David Pearson]

Nick,
Its worse than you say. The Fed, as you note, is transparent about its instruments but not its objectives. That "instrument transparency" is a relatively new phenomenon invented by Greenspan. The purpose of "instrument transparency" is to induce shadow banks and speculators (same thing) to engage maturity and liquidity transformation. For instance, the promise to telegraph rate hikes and do them in small increments is essentially a promise to cap the volatility of short term rates: a "put" on volatility, if you will. For any given free put written by the Fed, arbitrageurs will act in a manner that maximizes the value of that put. In English, this means actors will increase leverage and reduce liquidity.

My contention is that a large part of the 2008 financial crisis was driven by the preceding torrid shadow bank balance sheet growth. This growth was the goal of the Fed's two main easing policy communications: "considerable period" and "measured pace". Both of these provided created puts on s.t. rate volatility and encouraged credit growth through levered speculation by shadow banks.

[Chris J]

While this is a "family" blog, BS is the correct term to use. BS is distinct from lying. (There is a wikipedia entry on it.) If it is a true statement that the minutes are public, openness is factually true but BS. BS because the minutes don't help understand what really matters according to Nick.

[Carney]

Nick,

Thanks for not blaming me. I think you are underestimating the depth of confusing about means and ends at the Fed. I've spoken with people at the FRBNY and come away with the impression that they really don't see much further than interest rates.

[Fredrik]

"Any New Keynesian macroeconomist would say exactly the same thing."

I'm not so sure. Lars Svensson has said that he prefers the FED implicit target/dual mandate policy over the RIksbank's explicit 2.0% target. And he is a very prominent New Keynesian. I think the idea is that it gives the CB freedom to fight unemployment when inflation is near the target.

[rp1]

"What is the Fed's objective?". Perception management. Print money to cover up insolvent banks. Goose the stock market. Avoid the appearance of crisis. People will be very upset if they see the frog killed, but frog legs are on the menu, so they boil the frog.

"What is the Fed's target?" You show us the hole, we'll fill it. If the hole grows, we'll fill it more. If it's a black hole, we'll put a tarp over it. But our banks are not bankrupt, no sir, so please keep paying. And we own it all. We're not bankrupt.

The Fed's mission is as old as time.

[Phil Koop]

@Chris J,

A true statement made with the intention to mislead is a "lie of the second kind." What Nick means by "bullshit" is the opposite: a statement made in the knowledge that it is false but under the assumption that everyone else also knows it to be false, thus without intention to mislead. A "public lie", if you will.

However, although I understand the concept, I am not fully persuaded that this is what Yellen has done. One could interpret the implicit contradiction of Yellen's premise by her language remarked on by Frances as a sly signalling of the pro forma nature of the statement. On the other hand, there is a much more natural interpretation ...

[jesse]

"The Bank of Canada is transparent in the way that matters"

To the credit of the Bank of Canada and Carney (and predecessors) they provide regular statements and Q&A on various issues. You'll often hear a blue note or two, if you listen in closely. A difference I see with the Fed is that it's actually a bunch of regional banks all with various opinions who tend to display them. The Bank of Canada likely has dissent too, but we're not normally privy to it.

I find it comical that people read the Fed's minutes and start reading into how many dissenters there were. Seems Kabuki to me.

PS as a Canadian I have trouble separating jingoism from reality; while the BoC looks stalwart I wouldn't want to get carried away with righteousness; Canada has high debt loads and asset bubbles that make things relatively easy, for a time.

[Phil Koop]

@David Pearson,

That is an interesting insight, and I had not previously seen matters in that light. If you are right, then one observable consequence of a switch by the Fed to any sort of targeting, whether inflation or NGDP, ought to be a change of regime in the implied volatilities of fed funds futures options and OIS options.

I am still wondering about the shadow banking issue, though, because by definition, a "shadow" bank does not draw funding directly from the fed funds or inter-bank market. How tight is the basis between fed funds and repo or CP? (I am asking, not telling; I don't know and I'm curious to hear what you have to say.)

[Gregor Bush]

Fredrik,

The impression I get is that Svensson thinks that central banks with explicit targets end up focusing too much on the current rate of (core) inflation and not enough on the forecast. He stresses that the current rate of inflation is a useful indicator only insofar as it informs your forecast of next year's inflation rate (and inflation two years out). And since inflation expectations are very well anchored in most developed market economies, deviations in output from potential should affect the central bank’s forecast of inflation much more than deviations in the current inflation rate (which is really last year’s inflation) from the stated target.

I think he would argue, for example, that despite the increase in euro zone core inflation from 1.1% to 2.0% over the last 9 months, the ECB should be easing aggressively because the forecast of 2012 and 2013 inflation is now lower than it was nine months ago. But in its interpretation of its "price stability" mandate, the ECB ends up putting far too much weight on the current rate of inflation which makes it very backward-looking (hence the July 2008 and July 2011 rate hikes).

Actually, it’s even worse than that because the ECB tends to put more weight on the HEADLINE rate of inflation than do most central banks. They essentially behave as if their credibility in terms of keeping inflation low is always in question.

Again this is just my interpretation of Svensson - I could be way off here.

[Lars Christensen]

Weltklasse Nick! However, I think that the Ukrainian central bank is slightly less transparent than the Fed, but only slightly...

[Peter]

Sweden's central bank has a dual target. From a recent Svensson paper:

"According to the Riksbank’s booklet Monetary policy in Sweden” (2010a), and
the Sveriges Riksbank Act and its reparatory works, monetary policy shall aim to stabilise inflation around the inflation target and resource utilisation around a normal level."

[Will]

Who would ever have expected that monetary policy could be such a fun subject?!

I think that the broader problem is that people in general have no idea what central banks do, beyond very general and unhelpful formulations like, "they manage the economy." I read Bob Woodward's book about Greenspan, and one of the things I hated about it was its simplistic, heavy-handed way of explaining Federal Reserve actions. I went on one of the book-review sites to air this grievance, and found all the other reviewers saying, "this book gets into really technical economic stuff." This depressed me so much I didn't bother to post the review.

Milton Friedman tried very hard to make the subject accessible, in his PBS special. That was long ago. Something else needs to fill the void!

[Nick Rowe]

(John) Carney: welcome! Yep, I think you are right. All people look at is the Fed's interest rate target for the next few weeks. Which are its tactics, not its strategic goal. Because that is all the Fed has been communicating. And so, when the Fed hit the Zero Lower Bound, it was struck dumb. It could no longer communicate monetary easing. It was using sign language, and its hands were already on the floor. For all other central banks, the strategic target is primary, and the tactics used to try to hit that strategic target are secondary.

Bill: OK. The US does have a rather different political system.

"Anyway, I think that the U.S. Congress needs to come up with a new mandate--say, targeting the growth path of nominal GDP."

I would think a more loosely defined mandate would be better. Yes, right now, I think that an NGDP level path target would be best for the Fed. But I wouldn't want to tie its hands too tightly. You never know what the future will bring.

The bit I really like about the BoC's mandate is that it is not overly ambitious. "...to mitigate
by its influence fluctuations in the general
level of production, trade, prices and
employment, so far as may be possible within
the scope of monetary action,.."

It recognises there are limits to monetary policy.

David: very interesting point.

Fredrik, Gregor, Peter: some say that the BoC is a *strict* inflation targeter (an "inflation nutter"). But that is not really quite right. Even though output and employment fluctuations do not appear explicitly as part of the BoC's objective, the fact that it explicitly says that it wants to bring *future* inflation, at a 2-year horizon, back to target is where output and employment fluctuations are given weight. It does not try to bring inflation back to target immediately, precisely because it believes doing so would lead to greater volatility of output and employment.

[Deus-DJ]

What's all this blathering about Federal Reserve Bullshit about?

So what you're saying is that you would be OK with an INFLATION TARGET in today's deflationary environment. In other words, even if their objective is complete and utter nonsense in today's economy then you wouldn't have created this post. Ok this is *perhaps* just a quibble because that would have perhaps introduced a different sort of post from you, but the larger issue is...

the federal reserve's only policy tool is the setting of the fed funds rate...your assertion that it has some large effect on expectations...when empirically a large portion(over 90%) of business enterprises are internally financed and hence an explicit target rate of unemployment or inflation would somehow affect investment and employment...is ludicrous.
The only bullshit here is that the federal reserve has, since monetarism/new keynesiasm became the latest fad, completely abandoned targeting unemployment despite it being one of its mandates. Well, this really isn't a big deal either because they can't do much for unemployment anyway.

[Too Much Fed]

"Moreover, clear communications play an integral role in facilitating the effectiveness of monetary policy actions."

I want clear communication from the fed of whether it thinks productivity gains and other things should be evenly divided between the major economic entities. Specifically, will it allow lower and middle class workers to get their fair share of productivity gains and other things so that they can generate some real earnings growth based on their budgets (NOT CPI)?

And, "Expectations play a critical role in the decisions of forward-looking households and businesses about how much to spend, work, hire, and invest, ..."

It is called budgeting. Not a complete picture but ... What are "wages", prices, and interest rates now vs. assumed "wages", assumed prices, and assumed interest rates in the future? What happens if an entity goes into currency denominated debt, and the assumptions (including the central bank's) prove to be false (reality sets in)?

And, "and their decisions are more likely to be consistent with the objectives of the central bank if they are based on a solid understanding of the shocks affecting the economy and the likely monetary policy response."

I've read bernanke's deflation speech. He (and I assume the rest of the fed along with almost every other economist) doesn't believe in true aggregate supply shocks. So if one happens, why should I believe the monetary response will be correct? In other words, not every instance of price deflation or negative real GDP is an aggregate demand shock.

And, "When financial market participants understand how a central bank is likely to react to incoming information, asset prices should adjust in ways that anticipate the central bank's expected policy actions, enhancing the monetary policy transmission mechanism and thereby supporting the central bank's attainment of its objectives."

After many years of asset price manipulation (especially the last 10 years or so) to the benefit of the rich, I've stopped using many asset classes as a guide to the economy. I know more than one person (me partially included) that has basically stopped investing in stocks because they think the stock market is rigged. I tend to agree especially in regards to the fed and their favored entities.

Lastly, replace "financial market participants" with mostly the rich and rich entities.

[Too Much Fed]

bill woolsey said: "This is compared with what happened in the seventies, when inflation was not controlled and took its natural path upward."

It seems to me price inflation can have a natural path upward, but it does not have to. It depends on the circumstances.

And, "But now, the Fed says in front of God and everyone that they are trying to cause the cost of living to rise 2% each each year and erode everyones' standard of living, especially those on fixed incomes?"

I don't think people would mind the cost of living rising 2% per year if:

1) the cost of living is measured accurately

2) the overnight risk-free rate for people is above 2% and hourly wages are above 2%

[Too Much Fed]

Nick probably won't believe me, but I'm going to keep trying. I believe that if more and more currency denominated debt is not producing price inflation or is being used to prevent price deflation then there is an "imbalance" building up somewhere in the economy.

[Nick Rowe]

Deus-DJ: your comment is very unclear. It also has many things I (and most economists) would disagree with. I am not going to take the hours needed to unpack it all. I will just respond to one point.

"the federal reserve's only policy tool is the setting of the fed funds rate...your assertion that it has some large effect on expectations...when empirically a large portion(over 90%) of business enterprises are internally financed and hence an explicit target rate of unemployment or inflation would somehow affect investment and employment...is ludicrous."

Imagine a simple world in which a single bank offers to borrow or lend to everyone, and everyone is identical. At a high rate of interest everyone will want to lend to the bank, spend less than their income, so income (and/or prices) will decline. At a low rate of interest everyone will want to borrow from the bank, spend more than their income, so income (and/or prices) will rise. In equilibrium, nobody will want to either borrow or lend to the bank.

In other words, I can imagine a world in which the interest rate set by the bank is a very powerful instrument, and yet in equilibrium 100% of every individual's investment is internally financed.

So the fact that most business investment is internally financed does not tell us what you think it tells us.

TMF: Ditto. I'm going to respond to one point only.

"I've read bernanke's deflation speech. He (and I assume the rest of the fed along with almost every other economist) doesn't believe in true aggregate supply shocks. So if one happens, why should I believe the monetary response will be correct? In other words, not every instance of price deflation or negative real GDP is an aggregate demand shock."

No economist I know of believes that aggregate supply shocks never happen. If there were a bad aggregate supply shock, the result would *not* be deflation and reduced real GDP. It would be *inflation* and reduced real GDP. Draw a supply and demand curve. This is economics 1000.

Raise your game, you two. Get a first year economics textbook and read it. And TMF: keep it to just one comment please.

[Peter]

I made a post with some more details about my goal transparency argument.

http://blog.ngdp.info/2011/10/central-bank-transparency.html

[David Pearson]

Phil Koop,
Repo's and ABCP were tightly aligned with the FFR given their maturity and abundant liquidity. Gary Gorton describes how the 2007/2008 crisis as a classic bank run, except this time on the (uninsured) repo liabilities of shadow banks. The crisis was one of "safe" (AAA-rated) assets held by maturity transformers, not risky ones. The current EU crisis shares that attribute.

So my argument is that crisis causality flowed from Fed "instrument transparency" communications; to shadow bank maturity transformation with safe assets; to demand for AAA-rated paper; to ramped-up issuance of subprime paper (roughly 80% of subprime issuance was AAA); to lower underwriting standards; to rising housing demand and prices; to a run once prices plateaued and AAA-rated paper was downgraded.

[Deus-DJ]

"Imagine a simple world in which a single bank offers to borrow or lend to everyone, and everyone is identical. At a high rate of interest everyone will want to lend to the bank, spend less than their income, so income (and/or prices) will decline. At a low rate of interest everyone will want to borrow from the bank, spend more than their income, so income (and/or prices) will rise. In equilibrium, nobody will want to either borrow or lend to the bank."

There is no such thing as equilibrium.

I'm not even going to delve into the loanable funds market you're bringing up as determining investment, which is nonsense. Anyway, all you've managed to say here is that it changes the MPC. Furthermore, you're only referring here to current interest rates and not expected. Even with high(er) interest rates the MPC among lower to middle income consumers doesn't change much. So expected rates would of course also have no effect.

So we have: 1)the rate of interest is the only policy tool available to the fed. 2)The rate of interest has little determination on investment, which determines output and employment 3)Has little effect on MPC, meaning it has little effect on output and employment. So expectations of what the Fed's goal in this sense has little to no meaning whatsoever. In fact, QE/QEII were deliberate policy goals to spur exactly the kind of thing you wanted, in other words they pumped "expectations" even if qe/qeII were nothing more than asset swaps. yet it did absolutely nothing to increase investment and employment. All it did do is bring a rush of money into commodities and other asset classes, increasing their prices and thereby increasing food and oil prices for the average consumer worldwide. If this is your idea of the federal reserve doing good then I wonder what bad policy would be.

[Deus-DJ]

I reject neoclassical economics as fundamentally flawed in (almost)every conceivable way imaginable and hence totally useless. Asking me to learn first year economics is a joke, as it simply indoctrinates students to learn a model of the world that doesn't really exist. Even your market monetarist stance only differs in degree, and not in kind, from other neoclassical models. Your continued use of IS-LM in conducting analysis and frequent use of the word equilibrium shows your and the mainstreams unwillingness to admit you're wrong.

How do you justify equilibrium analysis other than that's what everyone else has done since you started learning economics?

[Gregor Bush]

Deus-DJ,

Wow, it must be nice to know so much macro without ever studying NC of NK economics. Think of all the time you saved!

I'm curious though, in your model does the Fed have the power to raise the price level? Because if it does, it surely must have the power to raise nominal aggregate expenditure and nominal wages, no?
And if the Fed took action intended to raise the price level now with the unemployment rate at 9%, would the impact on real output (and therefore employment) be the same as it would be if the unemployment rate were 5%? And if the Fed announced it intention to raise the price level would agents in the economy not begin to alter their behavior - to expect a higher future price level and all that a higher price level implies?

And if the Fed is powerless to raise the price level, why wouldn't it buy up the entire stock of US Treasuries and retire them, wiping out the US debt burden completely? As Nic asked in an earlier post, if the central bank can't raise the price level, why do we pay taxes?

Finally, when FDR took the US off the gold standard in March of 1933, did that stimulate output and employment?

Thanks. I'm curious as to how your macro model works.

[Deus-DJ]

The reason we have US treasuries is because banks and other financial institutions demand them. They want safe, interest bearing assets. Treasuries do not fund the government, we have a sovereign non-convertible debt. But if the fed wanted to buy up all of the US treasuries, they certainly could do that if they wanted. But then banks would be stuck with a bunch of non-interest bearing reserves sitting at the Fed, and they would complain. Furthermore, many people within government don't even know how our own institutional arrangements work because they believe in the orthodox economics they've been taught...meaning of course that even if the Fed wanted to buy up all of our securities it would be politically impossible. As to why we have reserves when a bank doesn't necessarily need them to make loans, that's a different question.

Taxes regulate aggregate demand in today's sovereign, non-convertible currency. They also give value to the currency we use, as we need it to pay our taxes. If there were no taxes whole cities or states could decide to adopt a different currency if they wanted to. Granted there are may other reasons why we hold onto money now in addition to taxes, but taxes gives it its base stability. That's why we pay them, even if people in the government or academia don't know it.

This is Post-Keynesian economics/MMT. Unlike neoclassicals(ok i'll be more specific, unlike new classicals, quasi-monetarists, or new keynesians) we look at institutional arrangements in determining how we model the economy. Anyway I'm just a newbie here, you'd need someone like Fred Lee or Steve Keen to come here and totally destroy your worldview if that's what you're looking for.

[Deus-DJ]

Here, chew on this and see if you can spit it out.

http://cas.umkc.edu/econ/economics/faculty/lee/courses/602/readings/history1.pdf

[Too Much Fed]

"TMF: Ditto. I'm going to respond to one point only.

"I've read bernanke's deflation speech. He (and I assume the rest of the fed along with almost every other economist) doesn't believe in true aggregate supply shocks. So if one happens, why should I believe the monetary response will be correct? In other words, not every instance of price deflation or negative real GDP is an aggregate demand shock."

No economist I know of believes that aggregate supply shocks never happen. If there were a bad aggregate supply shock, the result would *not* be deflation and reduced real GDP. It would be *inflation* and reduced real GDP. Draw a supply and demand curve. This is economics 1000.

Raise your game, you two. Get a first year economics textbook and read it. And TMF: keep it to just one comment please."

Well, that is partially my fault and partially Nick's fault. Replace "true aggregate supply shock" with "true POSITIVE aggregate supply shock". I thought it would be obvious from the context. Apparently not.

http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm

Deflation: Making Sure "It" Doesn't Happen Here

"The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.1. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress."

And footnote 1, "1. Conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. I don't know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession. Return to text"

I'm going to guess Nick agrees with bernanke on that. There is no concept there of how an economic boom can later be an economic bust. In other words, if a true positive aggregate supply (AS) shock is not handled correctly, can it later in the future show up as what appears to be an aggregate demand (AD) shock?

As far as raising games, I'd like Nick to discard the assumption that real AD is unlimited. That means the possibility exists that real AS can get to the same level or above AD. If that happened:

1) What would that economy look like?
2) Would lowering real and/or nominal wages actually make that economy worse?

[Nick Rowe]

TMF: "Well, that is partially my fault and partially Nick's fault. Replace "true aggregate supply shock" with "true POSITIVE aggregate supply shock". I thought it would be obvious from the context. Apparently not."

You *totally* missed my point. With supply shocks, prices and output move in *opposite* directions to each other.

From now on, one comment only on my posts here.

[Nick Rowe]

Deus-DJ: I have read, and continue to read, a lot of heterodox economics. Including MMT. I was reading something by Steve Keen only yesterday. Because I have done so, I can agree or disagree with them from some at least minimally informed perspective.

I suggest you learn at least the very basics of the economics you say you disagree with.

If you don't, all you are doing is trolling.

[Lorenzo from Oz]

Nick: Public targeting started in 1993, have no idea when publishing the minutes started. The reason why a clear public targeted was adopted is expressed rather nicely here:
In the early 1990s, the Reserve Bank did not enjoy the largely uncritical press it receives today.
The conduct of monetary policy in the 80s was fundamentally incoherent, unsuccessfully pursuing multiple objectives and shrouded in a veil of secrecy.
Without a policy commitment to price stability, the Australian economy lacked a nominal anchor. Any of that sound familiar?

[Nick Rowe]

Lorenzo: good find! You blogged about this, IIRC?

Yes, it sounds very familiar.

[Too Much Fed]

"You *totally* missed my point. With supply shocks, prices and output move in *opposite* directions to each other."

No, I didn't. Under *certain* circumstances, a positive supply shock in the past not handled correctly could lead to lower prices and lower output.

[Lorenzo from Oz]

Nick: not directly on the Reserve Bank switch: I have both written and blogged about the general shift in Oz public policy. But I am working on a post entitled "How stupid can a Central Bank be?" which was originally inspired by this post and some of the knock-on posts by others your post inspired.

[Gregory Sokoloff]

Superb! An Indignant Canadian Initiative beats a Worthwhile one most days of the week.