Fiscal Policy, and the macroeconomics of doing nothing, redux

I don't think Simon Wren-Lewis will find this an annoying argument against fiscal policy. I hope not anyway.

Let's assume that New Keynesian macroeconomics is 100% correct. What role is there for fiscal policy?

Simon agrees that in normal times there is no role for fiscal policy as a tool to control Aggregate Demand. Monetary policy can handle AD all by itself. Fiscal policy has a lot of micro jobs to do: making sure the right number of bridges get built at the right time in the right places; and making sure that the right people are taxed the right amount at the right time for allocative efficiency and equity. It would be suboptimal to distract fiscal policy from its microeconomic job and leave monetary policy less than fully employed at doing its macroeconomic job.

The New Keynesian case for fiscal policy as a tool to influence AD only applies at the Zero Lower Bound, when monetary policy is supposedly incapable of doing the job by itself. Let's concentrate on that ZLB case.

Even New Keynesian macroeconomists recognise that a commitment to future monetary policy can still be effective at the ZLB. The central bank promises that in future it will leave interest rates "too low for too long". So, why can't we say that monetary policy still works, even at the ZLB? Their reply is that such a promise might not be credible. OK. Let's grant them that assumption. Promises about future monetary policy are assumed not credible.

New Keynesian macroeconomists say that increases in government spending will increase AD when the economy is at the ZLB. That isn't quite right. In fact, it's wrong. That is not what their models actually say.

Let's take this bit slowly. First consider a permanent increase in government spending in a New Keynesian model. The result is no change in the natural rate of interest. The New Keynesian IS curve does not shift vertically up when there is a permanent increase in G. For a given time-path of Y (remember, we are asking if the IS curve shifts vertically up, not horizontally right, so this is a legitimate supposition) a permanent increase of G and a permanent decrease of C by an equal amount will leave the consumption-Euler equation still satisfied at the original time-path of real interest rates. Intuitively, a permanent increase in G means an equivalent reduction in permanent disposable income and an equivalent reduction in desired consumption. (New Keynesian macroeconomists may miss seeing this if they ask whether an increase in G shifts the IS curve right, as opposed to shifting it up. But if you put permanent income on the horizontal axis, the New Keynesian IS curve is horizontal, so it makes no sense to ask whether a permanent increase in G will shift that horizontal IS curve rightwards.)

(The only effect of a permanent increase in G in a New Keynesian model comes through the supply-side. If the government takes part of national income and spends it on (say) pyramids (which is what New Keynesian models typically assume, since G does not appear in the representative agent's utility function), then the representative agent may choose to work more hours, because he is now poorer. But this supply-side effect is not what New Keynesians need if they want to prevent deflation at the ZLB. It only makes things worse.)

OK, so what about a temporary increase in G? Won't that shift the New Keynesian IS curve upwards, and cause the natural rate of interest to increase temporarily? Yes and no. If you increase G from 200 to 300 today, and promise to reduce it from 300 to 200 tomorrow, that will increase AD today. But if you leave G at 200 today, and promise to reduce it from 200 to 100 tomorrow, that will have exactly the same effect on AD today. Today's increase in G is not what causes AD to increase. It's tomorrow's decrease in G that causes today's AD to increase.

Here's the intuition. A temporary increase in G from 200 to 300 and back to 200 is identical to a permanent increase of G from 200 to 300 plus a promise to cut G by 100 tomorrow. We have already established that a permanent increase in G does nothing. Therefore the effect of a temporary increase in G is identical to the effect of a promise to cut G in future.

A decrease in future G (once the economy has escaped the ZLB) causes an equivalent increase in future C. By consumption-smoothing, that increase in future C causes an equivalent increase in current C, for a given real interest rate between today and the future.

OK. Now let's compare monetary policy to fiscal policy at the ZLB. We can either promise to loosen future monetary policy. Or we can promise to cut future government spending. Which promise is more credible?

Hmmmmm. The answer's not so obvious, is it?

Notice something weird? I have made absolutely no change in the standard New Keynesian model. The only thing I have done is to re-frame the question. Instead of talking about the effects of a temporary increase in government spending I am talking about the effects of a promise to cut future government spending.

I have changed the definition of "doing nothing". Under the original definition, we do something now, when we increase government spending, and we do nothing in the future, when government spending just falls again, all by its little self. Under my re-definition of "doing nothing", we do nothing now, and we promise to do something in the future, when we will actively cut government spending.

Acts of commission and ommission. Trolley problems. Stuff like that. That's what we are talking about.

By changing the definition of "doing nothing" I have suddenly made both fical and monetary policy at the ZLB rely on the credibility of promises of future actions. The two policies are now on a par.

Now I'm going to go further, and change the definition of "doing nothing" with monetary policy.

Take the standard New Keynesian macro model, and bolt on a bog-standard money demand function. You can even make that money demand function perfectly interest-elastic at the ZLB, if you like.

It is well-understood by New Keynesian macroeconomists that if you add a money demand function it does nothing whatsoever to the model. The two models are observationally equivalent. For every interest rate reaction function there exists a money supply reaction function, and vice versa. But it lets me change the definition of "doing nothing".

Again, a credible promise to keep future interest rates too low for too long will increase the expected future price level. That means the future nominal demand for money will be higher too. In equilibrium, money supply equals money demand, so the expected future money supply will be higher too.

A permanent increase in the money supply today is equivalent to a promise to keep future interest rates too low for too long.

Let's see how the question looks now. The New Keynesians are asking us to believe that a promise to cut future government spending would be more credible than an actual increase in the money supply today. Really?

See how I have turned the tables, just by redefining what "doing nothing" means? All of a sudden it is fiscal policy that requires credibility of a promise of future action. Monetary policy simply requires a belief that central bank will "do nothing" in future. It won't decrease the money supply back down again.

Roosevelt was at the ZLB. He didn't promise to keep interest rates too low for too long. Roosevelt simply raised the price of gold. And it worked. Because people naturally assumed he would "do nothing" in future. By "doing nothing" they understood "not lowering the price of gold back down again". It worked because people thought of "monetary policy" as "setting the price of gold".

New Keynesian macroeconomists will be tempted to insist that monetary policy really is, is, IS, IS setting interest rates. Any monetarist could insist right back that monetary policy really is, is, IS, IS setting the money supply. And a gold bug could in turn insist that monetary policy really is, is, IS, IS setting the price of gold. That argument will get us nowhere. Nor will arguing over whether fiscal policy really is setting the level of government spending or setting the change in government spending.

It's all in the framing. There is no reality in these matters. These are all social constructions of reality. We theorists shouldn't be suckered into believing that our conceptual schemes are out there in the real world. Except, the conceptual schemes of real people out there in the real world are part of the reality of that world, for a social scientist. And the Neo-Wicksellian social construction of reality, in which "monetary policy" is defined as "setting interest rates", is a damned bad reality to construct. Especially when we hit the ZLB.

Comments

[Lee Kelly]

The problem with the liquidity trap hypothesis is one absurd implication. That is, when the inter-bank lending rate falls to zero, the demand for money becomes infinite: it doesn't matter what the central bank purchases or in what quantities, people just want to hold money, money, money, and more money. In that case, presumably, nobody is buying anything, since everyone would rather just hold larger cash balances instead. Money stops being money, i.e. a medium of exchange, and the economy reverts to barter--isn't this called model breakdown or sumthin'?

[Max]

Here's something that is not a matter of framing: who takes the risk? Conventional monetary policy doesn't place the central bank's capital at risk. All the risk is private.

If private capital can't be lured into risk taking, and the central bank doesn't want to take risk, then what?

[paine]

assume the nk model is reality ?

why not assume hicks hansen is reality ?
one is closer then the other to ..real reality ??

that's like saying a ten foot bound across a twenty foot gap
over a chasm a mile deep
is better then a four foot bound
no its worse the progress is linear all the way to twenty one feet

whereas
there is no reason a priori to assume reality modeled would produce model results
closer to NK then hicks hansen

[Lord]

Could you explain once more how the permanent income assumption is compatible with recessions? Money demand recessions, that is, not real shocks. What causes the re evaluation? What would cause a subsequent re evaluation back to what it previously was? Seems like magical thinking to me.

[Kevin Donoghue]

Nick, there's food for thought here; but the first thing that occurs to me is that you are departing from your own precept: we should talk about fiscal policy rules, not one-off shifts in curves, vertical or horizontal. So the question becomes, which is better: a rule which says fiscal policy kicks in when the ZLB is binding, or a rule which says the central bank issues a promise for the future? Can we even model the latter sensibly in a DSGE framework?

[J.V. Dubois]

Kevin: As I understood it, Nick just cleverly turned the framing for debate that it differs from what it usually looks like and from how you present it here. In his example, it is suddenly no longer about fiscal policy "kicking in", but about promises in the future that fiscal policy will be cut back. And it is not about central bank promising something (interest too low) in the future (for too long), but about monetary policy "kicking in" now and then doing nothing in the future.

It is actually very elegant. CB could expand money supply (print money) by buying some assets (lets's say stocks) and by promising that it will not sell it back in the foreseeable future. That should have the same impact as government building more bridges. Only that the former is much more quicker + it has one really cool advantage. You can actually sell those stocks back once that "foreseeable" future passes and markets are again worried about overheating. Can you sell bridges back to construction companies? I don't think so, or at least not that easily.

I just have one additional comment for Nick. In many blogposts you express a belief that CB actually may not even *do* anything. That if everybody believes that CB is willing to buy stocks in a few months, then everybody will do it and bring back the economy back into equilibrium with CB not lifting a finger. Could not the same "scare them to good equilibrium" thing apply to fiscal policy? It could be something like - hey guys, if you somehow manage to trick CB board not to do their job (like hiding inflation in their closets), there is still a government around. So if we see that things go south, we promise to launch new projects, no matter how insane just, to spoil your evil plans. Did we already mentioned our plans to colonize moon if NGDP level stays so low?

[J.V. Dubois]

Sorry for spamming, but just by rereading my own comment I realized somtheing. In all honest fiscal vs monetary policy debates it comes to the main difference between the two - and that is irreversibility of fiscal policy. This is both its main advantage and simultaneously main disadvantage. The big advantage of fiscal policy is its credibility. If governments really borrows a lot of money to build those bridges, there is no way back. With CB, there is always a possibility of abandoning its promises (be it to do something or not to do something in the future). For instance, is FED really willing to keep interest rates low until 2014? Will they not revert their decision if inflation hawks in the board gain more power by backdoor politics?

Of course this disadvantage quickly becomes advantage if something really unexpected happens, or if the government really have to back up their threats and simultaneously did too much so that the cure becomes worse than the disease. I still believe that monetary policy approach is better. However there really needs to be done more to enhance its credibility. Decisions have to be backed up by rigorous analysis and facts so there is less space for politics, intuition, beliefs and ideology driving these decisions. If somebody on the board is afraid of inflation for instance, he has to have strong case for it, otherwise we entrench the defensive approach of "Hey, are you not afraid of some unknown variable just around the corner that proves all of us as incompetent jerks? Why not to wash our hands by nicely worded centralbanknewspeak that allows us to do nothing and see what happens?"

[Nick Rowe]

Lee: "Money stops being money, i.e. a medium of exchange, and the economy reverts to barter--isn't this called model breakdown or sumthin'?"

That's not quite right. People will still be using money as a medium of exchange, but the velocity of circulation will be very slow. Another way of saying this is that a large percentage of the money will be idle.

Max: central banks always hold bonds as assets, and the price of those bonds will fluctuate with interest rates. If they hold the bonds to maturity, there is no risk, except in case of default. An expansionary monetary policy will increase the size of the central bank's balance sheet, and increase the risk. I guess I don't see this as a big deal. If the government builds a bridge, it might fall down too.

paine: you always need some model when you talk about the effects of policy. I chose the NK model because: it is the "mainstream" model; it's the model that Simon Wren-Lewis likes, and this post is in response to his. But what I am arguing here is not the model, but the way policy questions are framed in that model.

Lord: I don't see any big difference between how a recession could happen with the permanent income hypothesis vs the current income hypothesis. E.g. an increase in the demand for money would do it in both. Changes in expected future growth rates of income would be one additional channel under the PIH.

Kevin: yes, I cheated on my own rule, and talked about policy actions, not policy rules!

If I had talked about policy rules instead, this post would have been too easy. Here's the optimum monetary policy rule: "whenever the economy gets hit by a real shock that would put it at the ZLB, then loosen monetary policy for several periods afterwards, by however much it takes to prevent it hitting the ZLB., so countercyclical fiscal policy is not needed". As I understand it, the case for fiscal policy is that a monetary policy rule like that might not be credible.

JV: "Could not the same "scare them to good equilibrium" thing apply to fiscal policy?"

I think it could. I don't see any reason in principle why it couldn't. The fiscal authorities could go Chuck Norris too.

The way out of the credible promises/reversibility dilemma is to make the promises conditional. "I will do this as much as is needed until NGDP hits my pre-announced target".

[Nick Rowe]

One minor addendum to what I said about fiscal policy. Consider 3 policies (assume that the first period is normal times, second period is the ZLB, third period and on is back to normal times):

1. "Temporary increase". G = 200, 300, 200, 200 etc.

2. "Future cut". G = 200, 200, 100, 100, etc.

3. "Preponed expenditure". G = 200, 300, 100, 200 etc.

Policies 1 and 2 will increase Y in period 2 by 100. Policy 3 will increase Y in period 2 by 200. Damn, but I do like my old "preponed government expenditure multiplier" idea. If you do want to argue for fiscal policy in a NK model, preponed is the way to go.

[BSEconomist]

The problem with all this is that the fiscal policy, or government spending, is assumed to be worthless. That's fine in context because NK assumes G to be useless, but it is not. From a strictly micro perspective, when resources are slack the opportunity cost falls and so the ideal path of G would follow a counter cyclical pattern anyway. A point you've made before. Frankly, I am much interested in these kinds of model-independent observations than in pointing out "hey monetary policy is STILL better than fiscal policy at fighting recessions".

I suppose, though, that your purpose is to rebut a specific NK claim. Fine. I haven't the slightest inclination to defend the model itself--instead I want to just note that your claim about increasing the money supply today almost certainly does not work as a matter of stimulative macro policy at the ZLB. As a matter of simple observation, we can look at the money base and bank reserves over the great recession and see quite clearly that the two move together almost perfectly. The right monetarist response IMHO is to stop this pointless argument about the ZLB and think harder, Bernanke-style, about the best ways to transmit M to the rest of the economy. Helicopter drops, sock lending facilities... Fine, but it's past time to get serious and talk about actual institutional structures to do the same thing. Ultimately, I'm with Karl Smith on these sorts of questions: printing bonds, but not retiring them by taxing, is for all intents and purposes the same thing as printing money except that the transmission mechanism to the economy is different which is to say that the money "created" when you do fiscal policy doesn't immediately get stuck on bank balance sheets. In other words, fiscal policy is just monetary policy by other means, which is why the conclusions keep looking so similar. The fact that you get bridges, also--and for cheap--that's just gravy.

Before I go, I just want to second something that J.V. Dubois is trying to say. Which is that it is not entirely clear that the CB doing nothing in the face of possibly higher inflation is at all credible--the past few years have certainly soured me on the idea that the CB would in fact act aggressively to prevent a prolonged recession in Japan, Europe and the US the story is the same--too tight money. I would only add that as a consultation for the monetarists governments keep insisting on doing the wrong things with fiscal policy--austerity is after all, all the rage. So here I give you my simple all-encompassing solution... G-T needs technocratic management just like we do for M.

[Andy Harless]

I think when you consider monetary policy, it is misleading that you view the different definitions of passivity in terms of instruments rather than targets. In the actual practice of central banks, we all know that monetary policy really is, is, IS, IS pursuing an inflation target. It makes no difference whether you pursue it using a money stock instrument or an interest rate instrument or an exchange rate instrument. Most central banks happen to use interest rate instruments, but the situation would be no different if they used money stock instruments. Just as a change in interest rates is not expected to be permanent, so a change in the money stock would not be expected to be permanent, when we know that central banks prefer a certain inflation rate. To make a commitment to make the money stock increase permanent, they need to promise to act contrary to their preferences in the future. (Of course, in FDR's case, the fact of going off the gold standard -- along with rhetoric about "reflation" and a "new deal" -- was a signal that his preferences were different from those of previous policymakers.) It's a classic time inconsistency problem, no matter what instrument you use.

Fiscal policy is another matter, I think, because it would be fairly obvious that an increase in government spending, if not offset with an increase in taxes, would not be in accordance with the long-term preferences of fiscal policymakers. The difference between fiscal and monetary policy is that, if you use fiscal policy (in the conventional way), then the promise you are making is a promise to go back to the baseline, which presumably reflected your long-run preferences, so there is no time inconsistency problem. With monetary policy, you need to promise to deviate from the baseline in the future.

Of course this would all argue for changing the way baseline preferences in monetary policy are defined -- shifting from growth rate targets to level targets and perhaps from price targets to NGDP targets -- but this isn't a Keynesian vs. Monetarist issue.

[Nick Rowe]

Andy: "I think when you consider monetary policy, it is misleading that you view the different definitions of passivity in terms of instruments rather than targets. In the actual practice of central banks, we all know that monetary policy really is, is, IS, IS pursuing an inflation target."

Good point. But I don't think it's really me who is viewing monetary policy in terms of the instrument rather than the target. I think it's those who are arguing for fiscal policy who are viewing monetary policy this way. Otherwise, if we all viewed monetary policy in terms of (say) an inflation target, then it would be trivially easy to escape the ZLB. Just increase the inflation target today. Job done. (It's the people from the concrete steppes who would start shrieking at this point! Ultimately because they can only think in terms of instruments, not targets.)

"Fiscal policy is another matter, I think, because it would be fairly obvious that an increase in government spending, if not offset with an increase in taxes, would not be in accordance with the long-term preferences of fiscal policymakers."

That's not obvious to me. For political economy/public choice reasons, it might be hard to cut G again, after you have increased it. And I think I notice a correlation between people who want to use fiscal policy to escape the ZLB and people who would like G to be bigger permanently. Am I being a little bit cynical here? I don't ever remember hearing anyone advocate a cut in future G as a way to escape the ZLB, based on good NK modelling. Instead, they talk about an increase in G, and remember to add afterwards it would be just temporary.

Ironically, if the NK model is true, the government expenditure multiplier would be bigger for a "conservative" (small g) government than for a "liberal" (big g) government. precisely because people would be more likely to see the increase in G as temporary under the former. And the preponed government expenditure multiplier is bigger still, precisely because it is conducted by a government which wants zero change in the Present Value of government spending.

(If I were being provocative here, I would say that the fiscal multiplier is much bigger for Stephen Harper than it would be if the NDP had been in power ;-) ).

[Lee Kelly]

Nick,

I disagree. Money demand is unquenchable in a liquidity trap. This is because, by assumption, the only opportunity cost of money is "the" interest rate. When "the" interest rate hits zero, there is no cost to holding money--people just can't get enough. According to this hypothesis, increasing the money supply is going to be about as stimulating as a shot of adrenaline to an ancient corpse.

If the public will hold larger cash balances whatever the central bank purchases, then they'll do the same regardless of who makes the purchases, because people don't care where their money comes from. However, to sell, someone else must buy, but since everyone prefers more money to anything else, it follows that nobody but the central bank is buying anything with money. Ordinary exchange among the public only occurs, if at all, by barter.

This is, of course, absurd. The problem, in my view, is that the models appealed to by proponents of the liquidity trap hypothesis only allow one alternative to holding money, i.e. bonds, and those bonds have only one interest rate. By that assumption, money is just another financial asset, or rather, the only other financial asset. Of course, since money is a generally accepted medium of exchange, the real alternatives to money are everything that can be bought. The true opportunity cost of money is whatever one most wants, and that may or may not be a financial asset.

This implicit omission of a medium of exchange just becomes more obvious when "the" interest rate falls to zero. Individuals who use these models may not be making these silly assumptions, but, logically, the models seem to.

[Gizzard]

JV

"It is actually very elegant. CB could expand money supply (print money) by buying some assets (lets's say stocks) and by promising that it will not sell it back in the foreseeable future. That should have the same impact as government building more bridges. Only that the former is much more quicker + it has one really cool advantage. You can actually sell those stocks back once that "foreseeable" future passes and markets are again worried about overheating. Can you sell bridges back to construction companies? I don't think so, or at least not that easily."

This strikes me as similar to an idea Ive had. Of course it would involve a radical change to the feds allowable purchases but it goes something like this;

Since it seems one of the problems in our asset desiring society is that too many assets right now are not as valuable as we had hoped for (as an aside, it strikes me that Nick and Mr Sumner like to think of million dollar houses and million dollar bills as rough equivalents) maybe everyone would be allowed a one time sale to the fed of their most valuable asset..... their house, their favorite stock.. whatever and get cold hard cash for it (in the case of house they could then live in it paying a negotiated rent). Once this asset is sold to the fed though, it can never again be sold again as a private asset. It changes the nature of it forever (or for a very long time). So everyone can do this once with any asset they have. Do you want to make your asset a public good? Call it voluntary socialization of assets or something. They could sell their house today for the highest recorded price of the last five years say, same with their stocks. But this would be ALL Americans who can do this.

[Sina Motamedi]

I'm missing something here.

[Sina Motamedi]

Oh yes, I see: consumption smoothing.

I don't think consumption smoothing is frictionless enough in the real world to be able to say that a promise for future decrease in G is equivalent to an increase in G right now.

That's just my gut though -- I could be wrong.

[W. Peden]

Lee Kelly,

I always took the point you make to be the real insight in Friedman's "The Quantity Theory of Money- A Restatement". One wants to avoid unrealistic assumptions which determine the output of the model.

[Steve Roth]

I really love the game-theory approach. I know. You know I know. But I'm not certain whether you know I know. But you think I'm certain that you know I know. And etc.

Here's a poser in that context:

Suppose the MMTers are right, that the only way to change the money supply (hence the price level) is through government deficits/surpluses. (I realize this is a conceptual construct/framing, but go with me.)

But the Fed doesn't know this. So of course it can't frame things that way.

And the market doesn't know this.

Or even better: the "market" knows this, even though the individuals who make up the market don't.

Deeper waters than I can plumb...

"the conceptual schemes of real people out there in the real world are part of the reality of that world, for a social scientist"

I'd kill the last phrase.

J.V. Dubois: "The big advantage of fiscal policy is its credibility. If governments really borrows a lot of money to build those bridges, there is no way back."

Love it. This is especially true of automatic stabilizers. Because unlike discretionary spending, not only do they happen, but people know they're *going* to happen. Expectations and all that.

The only way to mimic that certainty for monetary policy would be for politicians to legislate a hard-to-change monetary-policy algorithm. That is neither likely nor, IMO, desirable.

Nick: "the velocity of circulation will be very slow. Another way of saying this is that a large percentage of the money will be idle."

I think its conceptually problematic to say that these are synonymous. And the latter is prone to confusion by many. At any instant, all money is idle.

Much more useful to use the first concept, transaction volume over a period -- in absolute terms, or translated into "velocity" by comparing it to the money stock (by some measure). Or if you're talking about all transactions (as opposed to just those for newly produced goods), relative to GDP or the like.

As you've pointed out recently, transaction volume per period is what it's really all about. That's where the surplus from trade comes from.

"Idle" money is just confusing; better to ask "how much are people spending" (relative to X)?

IOW, "saving" a.k.a. not spending a.k.a. leaving money sitting idle is not the useful measure or concept. The active measure -- spending -- is.

??

[Min]

Lee Kelly: "Money stops being money, i.e. a medium of exchange, and the economy reverts to barter--isn't this called model breakdown or sumthin'?"

The Singularity. ;)

[Min]

"New Keynesian macroeconomists say that increases in government spending will increase AD when the economy is at the ZLB. That isn't quite right. In fact, it's wrong. That is not what their models actually say."

But that doesn't mean that it's wrong. :)

[Min]

"The only effect of a permanent increase in G in a New Keynesian model comes through the supply-side. If the government takes part of national income and spends it on (say) pyramids"

Wait a second! You are talking about a permanent increase in both G and T. An equal one, it sounds like.

"then the representative agent may choose to work more hours, because he is now poorer."

If the increase in G equals the increase in T, which is what you seem to be saying, why is the representative agent poorer? What goes around, comes around, as they say.

[Min]

Steve Roth: "I really love the game-theory approach. I know. You know I know. But I'm not certain whether you know I know. But you think I'm certain that you know I know."

We're a confused and confusing family. ;)

With apologies to "The Lion in Winter".

[Ralph Musgrave]

“Fiscal policy has a lot of micro jobs to do: making sure the right number of bridges get built at the right time in the right places; and making sure that the right people are taxed the right amount at the right time for allocative efficiency and equity.”

That is a very feeble argument against using fiscal for AD control purposes in “normal times”.

First, monetary policy alone is distortionary, assuming that by “monetary policy” one means interest rate adjustment. Such adjustments work only via entities that are significantly reliant on variable rate or short term loans. I.e. entities reliant on long term loans or not reliant on lending at all are no affected by short term interest rate adjustments. You might as well boost an economy only via people with red or blonde hair.

Second, absent government interference with interest rates there would presumably be a free market interest rate which would optimise the amount of investment. Tampering with that rate is not warranted unless market failure can be demonstrated.

Third, MILLIONS OF BUREAUCRATS are involved in deciding where to “build bridges” and making ten thousand other micro fiscal decisions per day. The total number of ADDITIONAL bureaucrats needed to arrange some fiscal stimulus, for example to adjust VAT (which is what the UK has done more than once during the recession) is about a HUNDRED (at a guess). I.e. the ADDITIONAL load on the bureaucracy needed to get fiscal to have an AD adjusting effect is MINIMAL.

Fourth, fiscal works from the bottom up, i.e. it influences the behaviour of Main Street. Though of course if I was a Wall Street crook or fraudster, I’d be all in favour of monetary stimulus: e.g. using taxpayers’ money to buy a variety of assets concentrated in the hands of the rich (a policy known as QE).

[Nick Rowe]

BSEconomist: (Your comment got stuck in our spam filter, till I fished it out.)

"The right monetarist response IMHO is to stop this pointless argument about the ZLB and think harder, Bernanke-style, about the best ways to transmit M to the rest of the economy. Helicopter drops, sock lending facilities... Fine, but it's past time to get serious and talk about actual institutional structures to do the same thing."

Maybe the institutional structure is something like NGDPLP targeting. Ultimately, what we call a "social institution" is nothing more than a way of framing things. "See that guy over there? We call him the 'Prime Minister', and he and those other people say things we call 'laws'". And all of a sudden the facts change, because we call them different names and see them differently, and then people start to behave differently.

Lee (and W Peden): the way I understand "liquidity trap" is that the medium of exchange becomes a perfect substitute (over a certain range) for the sort of asset the central bank might actually buy. Maybe I'm not getting your point.

Gizzard: why can't we let the central bank decide what it wants to buy? It might end up buying some total rubbish if we were all allowed to sell it whatever we wanted to and name our price. Helicopter money would be the result, because we would all sell it our worthless garbage.

Sina: "I don't think consumption smoothing is frictionless enough in the real world to be able to say that a promise for future decrease in G is equivalent to an increase in G right now."

We could modify the NK model, and assume that half the agents are "Hand To Mouth" agents who consume their current period's income with no consumption smoothing. Not sure if it would change anything I say here.

Min: "If the increase in G equals the increase in T, which is what you seem to be saying, why is the representative agent poorer? What goes around, comes around, as they say."

Suppose (conjecture) Y stays the same, and G (and T) permanently increase. Therefore C falls permanently. The marginal rate of substitution between present and future consumption stays the same, so it's still equal to the same real rate of interest. So everything checks out on the demand-side. Now let's check the supply side. Y stays the same, so no inflationary/deflationary pressure. But what about labour supply? If Y stays the same, L must stay the same. But if L is the same and C is lower, the Marginal Rate of Substitution between consumption and leisure is out of wack. So there must be a labour supply response. People will trade off to enjoy less leisure and more consumption, now that the marginal utility of consumption is higher because consumption is lower. (If they got utility out of looking at pyramids this might not work).

Steve: "I'd kill the last phrase."

Yep. I wasn't happy with it. But didn't want to go off on a longer ramble to say what I wanted to say and have said before.

I can imagine a world in which there are no government bonds, and all government deficits are paid for in central bank money. In that world G-T=delta M, and you cannot distinguish monetary and fiscal policy. But it's not the world we live in.

[Nick Rowe]

Ralph: "First, monetary policy alone is distortionary, assuming that by “monetary policy” one means interest rate adjustment."

(Let's assume it does mean "interest rate adjustment", for the sake of this point.)

You have this totally backwards. As desired saving and desired investment change, the equilibrium rate of interest ought to change too, to keep them in balance. Just like the price of apples ought to change to keep the supply and demand for apples in balance. The whole point of monetary policy (seen here as "interest rate policy") is to adjust the rate of interest so that it keeps desired saving and desired investment always in balance. That's what prices (like the rate of interest) are supposed to do. It is fiscal policy that is interventionist. The government has desired saving and desired investment too. They need a school now. Or they don't need a school now. Fiscal policy amounts to rationing saving and investment (either government or private) by some non-price mechanism.

[Jacques René Giguère]

Nick: "Fiscal policy is building bridges"
No! Building bridges is micro. The government does it in society where we decided it is the role of government to build bridges and not the role of the Canadian Bridge Building Corporation (CBBC listed on the TSX). It is micro-turtles on the back of micro-turtles all the way down.
Fiscal policy is building preponed bridges or useless bridges or bottomless pit to put cash in the hands of people who don't have enough cash to play games with it and believe the only honest, dependable source of cash is through work and not charity hand-out or incomprehensible monetary policy mechanisms. ( The guy who dig pits have no idea of their ultimate use in the real world).
We talk of the public holding cash or bonds.
Joe the welder-on-the bridge-building crew is not Joe the owner of the bridge building company and certainly not Joe the hedge fund manager ( who may even behave differently in his personnal finances than his fund managemant.)
Joe the welder understand that working on a bridge will feed his family. He doesn't trust that bankers playing with free money will do the same.
The point is not about transmission mechanisms. It is about political credibility.
You can tell me that such-and such monetary policy rule ( inflation targeting, interest rate targeting, NGDPL targeting or age-of-the captain targeting) will provide enough GDP so that my college will be funded next year through taxes on a prosperous society. Or you can send a bunch of cash to the college treasurer. In as much as I enjoy and understand our arguments, I'll take the cash.

[Determinant]

Jacques has made a most excellent point with which I fully agree.

[Patrick]

ee cummings, high on borscht and vodka

or a lame impression of don marquis

a poet with the soul of a cockroach

[Steve Roth]

@Min: I had family t-shirts made with that quotation on it. Pity my poor children.

[Determinant]

What's with the economics haikus? And what is a noetic iv bag?

[Lord]

Hasn't the CB lost it's credibility due to the recession in the first place? Oops, nothing to worry about, we won't let it happen anymore or again, take our word on it.

[Scott Sumner]

Great post. Regarding your discussion with Andy, I think there's an interesting reason why it's so hard to plausibly model the political economy of these various choices. It seems to me that the attitude of policymakers (in America at least) is partly due to ignorance. It seems like the people in the Bush administration, the Obama administration, and Congress, really did not understand that the Fed could do something at the zero bound. Both administrations made an effort to boost AD via fiscal policy. If they realized that a different monetary regime could prevent disastrous NGDP collapses, it's hard for me to believe that they wouldn't be more proactive in pressuring the Fed, appointing officials to the Fed, trying to change its mandate, etc. They act like they really believe in Keynesian economics circa 1938. So any game theory model of the interaction of fiscal and monetary policy will be highly unstable, and contingent on whether this ignorance will continue. We're leaving $100 bills on the sidewalk out of ignorance, that's hard to model.

[Patrick]

Determinant: it's an ad-hominem attack and it bugged me. It's no secret Nick is right of center, but it does not follow that all small-c conservatives are by definition intellectually and morally corrupt plutocrats. Obvious NIck doesn't need defending (he can do that for himself), but the incivility masked as vaguely clever verse pissed me off.

no·et·ic
adjective
1. of or pertaining to the mind.
2. originating in or apprehended by the reason.

So noetic IV (eye-vee) bag would be understanding (in the old fashioned sense) received via those who sustain you (implying, a sort of intellectual corruption). It's intended as an insult. Google "archy and mehitabel" and you'll get the gist of my reply.

[Determinant]

I didn't know that was a word, and I pride myself on being literate.

Yeah, I know Nick is right of centre, that's why I hang around here. Somebody has represent the Left. ;)

[W. Peden]

Nick,

"the way I understand "liquidity trap" is that the medium of exchange becomes a perfect substitute (over a certain range) for the sort of asset the central bank might actually buy."

Then (1) there is no single thing that is the "liquidity trap", because central banks can buy a variety of assets and different central banks will likely face different restrictions, and (2) at the aggregate level, there are no substitutes for the medium of exchange that are not also media of exchange e.g. sight deposits. From an individual POV, a perfectly safe bond with an interest rate of almost zero is a near-perfect money substitute since it can be sold for the medium of exchange as needed. At the aggregate level, it's nothing like a substitute, any more than a box of matches is a substitute for an aircraft carrier. An increase in the media of exchange by the central bank always constitutes a qualitative change in the composition of the assets of the non-CB public at ANY interest rate.

[Ralph Musgrave]

Nick,

Recessions (in the simple case of closed economies) are caused by a drop in consumer spending or business investment (assuming government net spending is constant). To the extent that a fall in consumer spending is the culprit, cutting interest rates so as to encourage more investment is clearly inappropriate.

As to a drop in business investment, this could be entirely RATIONAL, e.g. a valid expectation by business that economic growth in future will be lower. In that case, encouraging investment is again inappropriate.

Alternatively, the expectation could be IRRATIONAL, in which case encouraging investment WOULD be logical. But this assumes that governments have superior judgement as to the prospects for future growth as compared to the business community, which is a questionable idea. Any evidence to support that idea?

To summarise, the only justification for having government encourage investment is based on a “questionable” premise. So why not do stimulus the fiscal way? If businesses subsequently find they’ve invested too little, THERE IS ABSOLUTELY NOTHING TO STOP THEM using the cash flow they get from increased consumer demand to fund more investment. In contrast, if low consumer demand is the culprit, low interest rates won’t help much (e.g. there is no relationship between central bank base rates and the rates charged by credit card operators). Indeed we have record low interest rates right now, and consumers are reluctant to borrow because they’ve just had their fingers burned in the credit crunch.

You also claim that “Fiscal policy amounts to rationing saving and investment (either government or private) by some non-price mechanism.” Why so? Fiscal stimulus is only applied (or SHOULD only be applied) when the economy has some slack, i.e. when building a “new school” will tend NOT TO RATION other forms of spending.

[D R]

"(The only effect of a permanent increase in G in a New Keynesian model comes through the supply-side. If the government takes part of national income and spends it on (say) pyramids (which is what New Keynesian models typically assume, since G does not appear in the representative agent's utility function), then the representative agent may choose to work more hours, because he is now poorer. But this supply-side effect is not what New Keynesians need if they want to prevent deflation at the ZLB. It only makes things worse.)"

So, the income from pyramid-building simply disappears?

[D R]

AH.

"Suppose (conjecture) Y stays the same, and G (and T) permanently increase..."

Yes, so if the fiscal multiplier is zero, then the fiscal multiplier is zero?

[nemi]

D R: That is usually the case.
Nick: Are you, once again, assuming your result rather than deriving it – or is this what the New Keynesian model assumes?

If this is what the New Keynesian model assumes, it does not sound very Keynesian.

I would not be surprised if it were, the so called microfoundations of modern macro are so ridiculous that I only worked through it once – to never return.

If I made a Keynesian model of pyramid building, I would assume that you taxed the people currently working – and thereby decreasing their salaries (and possibly effort, but lets disregard this for the moment). The tax revenues would be spent on hiring unemployed to build the pyramid. Total output would be close to 110.

I.e. start with a workforce of 10 people (W=10), G=0, Y=100, C=100, C/W=10.
Tax and spend so that W=11, G=10, Y=110, C=100, C/W=9.
Furthermore, it is not clear why the pyramid building would cause inflation.

However, the things above would of course not be possible if you only had one representative individual in the model.

[Nick Rowe]

DR and Nemi: No, I am NOT *assuming* that Y is constant (in the face of a permanent increase in G). It's a *conjecture* that I go back and check. In the long run, Y in the NK model *is* pinned down by the LR Phillips Curve, which is (almost) vertical. (In other words, Y in the NK model is determined by the supply-side. Everything on the demand-side "scales", so that, even if r is fixed, the demand side cannot determine long run Y in the NK model. Imagine a horizontal IS curve, and you get the basic picture.

The income from pyramid building is taxed back and spent on pyramid building (for permanent change in pyramid building).

[Nick Rowe]

paine: given your comments here, and your worse comments (with a fixation on a part of my anatomy) elsewhere on the net, you are no longer welcome on this blog.

Thanks for your support Patrick.

[Nick Rowe]

DR and nemi (and everyone else too, because most people may not know this).

Forget G and NX, to keep it simple.

An old Keynesian IS curve looks like this: Y=C(Y,r). We can solve it for Y as a function of r. It slopes down. Given r, Y is determined. In this sort of model we can ask whether an increase in G causes the IS curve to shift right, or shift up. It's the same thing, if the curve slopes down.

A New Keynesian IS curve looks like this: C(t)/C(t+1) = Y(t)/Y(t+1) = -alpha(r-rho) where alpha and rho are parameters. We cannot solve it for Y(t) as a function of r. We need to know what Y(t+1) is. For an time path of Y that satisfies the NK IS equation, there is an infinite number of other time paths that also satisfy that IS for exactly the same r. Just increase all Y by the same proportion, and you have another equilibrium. Y is indeterminate. Or, rather, it cannot be determined from the IS curve alone. Everything scales up (or down) in proportion. You need to use the AS curve to pin down some long run level of Y. It simply does not make sense to ask whether a permanent increase in G causes the IS curve to shift right permanently. The long run IS curve is horizontal. You can only ask whether it causes the IS curve to shift vertically up. And it doesn't.

[D R]

Sorry, I don't see how this makes any sense.

Just take the "old Keynesian" case for the moment. If Y=C(Y,r), then an increase in G... is impossible. All output is consumption, so how can any output be not-consumption? Do you mean Y=C(Y,r)+G?

[D R]

Going back and checking merely implies that the assumption is a valid one to make-- i.e., that it doesn't obviously contradict what you have assumed elsewhere. That doesn't mean you aren't making the assumption, as there may be any number of alternative assumption which also do not obviously contradict what you have assumed elsewhere.

[D R]

This is ridiculous.

Rowe:
"If Y stays the same, L must stay the same. But if L is the same... People will trade off to enjoy less leisure"

So... L rises, and therefore Y rises?

[Ralph Musgrave]

Lee Kelly, You are quite right on the liquidity trap: it’s nonsense on stilts – at least if you go by the Palgrave Dictionary of Economics definition of the term or the Wiki definition. I did a post on my blog on this two years ago:

http://ralphanomics.blogspot.com/2009/12/liquidity-trap-is-bunk-crp-and-drivel.html

Scott Sumner also threw cold water over the liquidity trap here:

http://www.themoneyillusion.com/?p=7960&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Themoneyillusion+%28TheMoneyIllusion%29

The very idea of a liquidity trap could only arise in the mind of those who think monetary policy is some sort of panacea. They observe that in some situations monetary policy does not work, which causes them to claim that that must be the end of the world. It’s a bit like arguing that applying leeches to the skin of someone with a disease does not work, therefor the disease must be a serious one.

[J.V. Dubois]

Ralph: I don't know if we red the same article (the one by Scott Sumner). What he basically says is that liquidity trap is "real" only from the instrument point of view. There are ways to conduct monetary policy that can ignore this artificial constraint, his example was devaluation of dollar during Great Depression and he argues that NDGPLP targeting by creating a new instrument for monetary policy (operations in subsidized NGDP futures market) can work in our current situation.

That argument is miles away from comparing monetary policy to applying leeches or whatever you used to show how monetary policy as a whole is ineffective and stupid. I seriously doubt that Scott would support such a view.

[Nick Rowe]

DR: to see the effect of G on the Old Keynesian IS curve, then sure, take, Y=C+G, where C=a+bY-cr, solve for Y as a function of G and r, and see the effect of G on Y holding r constant, or the effect of G on r holding Y constant.

Now try and do the same thing, for a permanent increase in G, with the New Keynesian IS curve: Y(t)=C(t)+G(t) where C(t)/C(t+1)=a(p-r(t)).

See the problem?

[K]

JV Dubois: "he argues that NDGPLP targeting by creating a new instrument for monetary policy (operations in subsidized NGDP futures market) can work in our current situation"

If only that were true, I suspect we'd be miles closer to some kind of consensus between Scott and the mainstream.

Scott claims we can do everything we need with the instruments we have. Rates, to him, are a framing problem. What we need is a commitment to raise the money supply and cause inflation, via a change to NGDP *targeting*, with or without a futures market. The Fed has to actually want inflation and clearly say it wants it and it will happen. While the New Keynesians clearly agree that communicating the contingent path of inflation is a critical part of the Fed's arsenal, their framework doesn't permit a control mechanism that works *over and above* a complete elaboration by the Fed of the contingent path of the short rate. Scott thinks we can escape the liquidity trap through expectations of the path of the money supply through some kind of mechanism that is exogenous to the short rate mechanism, but without resorting to new instruments.

[D R]

Nick,

What do you mean by

"If Y stays the same, L must stay the same. But if L is the same... People will trade off to enjoy less leisure"

Does that not imply that your "conjecture" that Y stays the same is incorrect?

[J.V. Dubois]

K: that is not how I understood him. I think that what he means could be expressed (very crudely) like this: old way of focusing monetary policy on current inflation (core or not) is worse than claiming that we will keep interest rates too low for too long that is in turn inferior to level path inflation targeting that is inferior to NGDP level path targeting. And the liquidity trap exists only for the first (or maybe even second) case, and the reason is expectations. In my eyes, CB is behaving like a madman. They basically say - Ok, we are going to expand the money supply today, but dare you use it in actual economy so that we close the output gap too fast (inflation above 2%), we will make you suffer for that. That is what he was saying. QE *was* effective, it increased the inflation expectations, but its effect ended where it clashed with FED policy of 2% ceiling.

FED has too much credibility for inflation stabilization, that in our situation means that it has no credibility for returning NGDP on the pre-recession path quick enough. It was actually FED that brought this recession on us. By not loosening monetary policy in June 2008 FED basically forced a fall in nominal GDP by 10% (from 5% growth from year before to 5% drop). Central bankers would love to pass the responsibility to Obama's insufficient stimulus using liquidity trap as an excuse. But the bitter truth is, that they actually had the tools to both - spot and prevent this slump. They even had a chairman that understood this and that made his fame on analyzing exactly such tools, but he lacked the courage to implement it. I am strongly convinced that if somebody updates "The Monetary History of the United States, 1961 - 20??" that will be the explanation of why millions had to suffer for so long. How long it will be yet remains to be seen.

[Andy Harless]

(I thought I posted another comment, but it doesn't seem to be here.)

[David]

"Everyone knows Nick is right of center."

I didn't know this. How are people defining "center" around here? lol

Nick: Excellent post, as usual. I've forwarded it to JB.

[Nick Rowe]

Andy: I just checked the spam filter, but can't find it. Did you fill in the anti-spam letter thingy before posting your comment? Sometimes I forget. Sorry we missed seeing your comment.

David: thanks!

DR: there's the effect of G on AD, and the effect of G on AS. A permanent increase in G may cause AS to increase, that's what I was talking about there. But as I said in the post, that isn't the effect the NKs are looking for at the ZLB. An increase in AS would only make matters worse, at the ZLB, because it causes inflation to fall, and real interest rates to rise.

[J. V. Dubois]

Nick (or anyone else): I have a question for you that has been bugging me lately. If we assume that increase in price level is caused by aggregate demand being greater then an aggregate supply, how can it be that we have insufficient aggregate demand if we actually have a positive inflation? I am aware of the argument with downward nominal wage rigidity and that small increases in inflation can happen even with deficient AD. But is this really all there is? Is there any research on this that can show how large is this effect, meaning how high should the inflation be to cope with this?

[primedprimate]

On a side note, just to make sure I am getting some of the 'cynical' game theoretic implications right:

Suppose (for argument's sake) that the independent central bank primarily represents a certain segment of population (group 1) that is extremely worried about the distributional impact of inflation (especially since capital gains are taxed in nominal terms). Such a central bank would prefer to use an upper-limit inflation target rather than a nominal GDP target (anything more explicit would threaten the very institution). Rather than stabilize AD, such a central bank would stabilize inflation (or prices).

Suppose the fiscal authority knows that the central bank works in such a way. The fiscal authority could threaten to use expansionary fiscal policy in a recession (part of which is justified anyway due to micro reasons such as insurance and opportunity costs). Fiscal policy also has a strong distributional impact. If the distributional consequences of fiscal policy make group 1 worse off than if the central bank allowed inflation, perhaps the central bank would preempt the fiscal authority and allow some inflation for macro-adjustment. The fiscal authority would never have to engage in any actual macro-adjustment, except perhaps for micro reasons or to establish credibility with the central bank.

And of course that brings us one level down - if people actually expect inflation there may be no need for any actual expnasion by monetary authorities unless perhaps to build credibility.

[D R]

... and the supply response is somehow greater than the demand response even though hours increase? I don't understand. You are saying that in response to the increase in G (adding to AD), consumption falls by the same amount, but then rises as hours increase. So long as the overall effect is an increase in hours worked, then this implies a positive multiplier.

[Nick Rowe]

JV: that question has been bugging me (and other macroeconomists) for decades. It's usually called "inflation inertia". It's not just the price level that is sticky and doesn't want to change; it's the rate of inflation that is sticky and doesn't want to change.

Possible explanations:

1. Expectations of inflation very slow to adjust. Firms keep on raising prices, even in the face of excess supply, because they expect other firms to keep on raising prices, so think they still need to raise their prices a bit, just less than other firms are raising theirs. Greg Mankiw has a recent variant on this, where firms are just very slow to update their information on prices ("sticky information", IIRC).

2. Overlapping price setting plus real rigidity. This is a bit hard to explain clearly in a short comment. Firms change their prices every n periods, with 1/n of the firms changing each period. (This Taylor assumption is a bit different from the Calvo assumption assumed for mathematical tractability in most NK models, because Calvo assumes it's random). Add in some real rigidity (firms don't want to change their relative prices much) and you can generate some inflation inertia.

But, I am still surprised at how little inflation has slowed in several countries recently. Maybe there's a bit of absolute downward nominal rigidity in there too.

It would take me a full post and a lot more thought to give you a clear and satisfactory reply.

I did a post on "Calvo vs Taylor" price setting once, but can't find it.

[Nick Rowe]

DR: There is NO AD response (to a permanent increase in G) in an NK model. The (horizontal) IS curve doesn't shift. There is only an AS response. If you forced people to work 2 hours a day building useless pyramids, and counted those pyramids as part of GDP, then GDP would (probably) increase even in a classical model (where Y is supply-determined). People will work more hours per day, though (probably) less than 2 more hours per day.

[Nick Rowe]

primed: Dunno. What you say doesn't sound wildly wrong to me. But games between fiscal and monetary authorities can have loads of different equilibria, depending on who moves last, and who can pre-commit.

DR: I should have asked you this much earlier: what is your prior knowledge of OK and NK macro (so I know where you are coming from)?

[Jon]

My peeve in his post was this line, "If the argument assumes that, despite the zero bound, monetary policy can do all that is required, then this should be said so explicitly, because it is somewhat counterfactual."

Lets forget about the weasel word: "somewhat". What I see is that the market moves in response to signals from the Fed about what will happen later. What I see is that the market moves in response to QE announcements (both directions). What I see is that the Fed is hitting its inflation target.

It seems really obnoxious of him to be so self-confident about the ZLB issue so as to be pissed when people don't kiss his feet about it before proceeding.

It would be tempting to go so far as to say that any argument dependent on the ZLB being reached or a liquidity-trap is the counterfactual. We've never seen such a point reached (at least not in the expectations driven world in which we live).

[J.V. Dubois]

Nick: Thanks for explanation and tips for further study. I would love to see some blog on this topic from you in the future. Anyways if there really is general rate-of-inflation inertia not only the one based on nominal rigidities, then it seems to be yet another point for NGDP targeting. If people and firm really can get used to any level of inflation and stick to it, then meeting this fixed inflation expectations by CB will not help solve nominal shocks on economy. A discretionary and not completely predictable monetary policy (in terms of inflation being allowed in a larger interval), can be a boon as it will still retain its power to systematically nudge the economy into a good equilibrium.

[Tim]

I know what I am going to say is completely out of left field but for some reason I have convinced myself in the past few hours that given what is happening with the Swiss National Bank and the BoJ that Bank of Canada intervention in the exchange rate is far more likely to happen than anyone thinks. It would be a black swan event but is there anything in Carney's or Flaherty's background to assume that they would oppose it under all circumstances.

I came to this conclusion after having a discussion with someone in the US over who would intervene in EUR/CHR rate on behalf of the SNB during North American trading hours. They thought that politically the Fed would not want to touch the issue to which I responded why wouldn't the SNB call on the friendly folks at the Bank of Canada in Ottawa to help them out. As I saw I can't see any politcal and ideological reason why Flaherty or Carney wouldn't help the Swiss which got me thinking further as to how truely committed are they to Canada's current non intervention policy.

[Nick Rowe]

Tim: that does sound a little out on left field to me ;-).

Why would the Bank of Canada need to do this? I can only see the Bank of Canada intervening in forex markets in two circumstances: some sort of lack of liquidity/market disruption/extreme volatility in forex markets; if it felt that it were totally unable to loosen (or tighten?) monetary policy by other means.