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Nick: on your last point, I do not envy you...

Sure, assuming the interest rate you care about is the policy rate. If you care about the rates that matter for private borrowers -- long, risky rates -- and you think, realistically, that transmission from the former to the latter is not complete & instantaneous, then the old sloping LM curve is more realistic.

Admittedly, describing it in terms of a fixed stock of money is probably not ideal...

Nick: i'll pray for the spirit of Abba Lerner to visit you before it's too late...

Nick, let me try to defend the indefensible. Given the central bank sets the policy rate and allows the money supply to endogenously respond to money demand in the short-run (and short-run only), it seems reasonable to me have it horizontal. Especially if you have a full employment line like in the Abel-Bernanke-Rowe text! Thus, when shocks to the economy shift the full employment line or if the central sets the policy rate too low/high relative to the natural rate, eventuall it will eventually the policy rate to restore full employment and avoid excessive inflation/deflation. That is the way I did it here: http://macromarketmusings.blogspot.com/2012/02/can-raising-interest-rates-spark-robust.html

Nick: In teaching the burden of the govt. debt, would you know where I can find historical estimates of the average yield on Canadian Federal Govt. Debt?

I know of a few studies that have long time series for US debt and conclude that g > r (and g >> r if you look post-WWII.) However, I don't recall how representative that is for other countries. What do you teach the kids?

How is targeting the money supply (long term) any more feasible than targeting interest rates (long term)?

"Modern teaching of modern macroeconomics and modern monetary theory should reflect modern monetary policy -- what modern central banks actually do nowadays. That means the modern LM curve is vertical."

I'm not sure. Seems to me the inflation-targeting case can be easily represented in a conventional IS/LM set-up. All that's needed is to draw a distinction between ex ante IS/LM curves (the forecast curves that inform the central bank's decisions) and ex post IS/LM curves (the curves that actually determine where the economy is, given the decisions the central bank made before the state-of-the-world was revealed). For pedagogical purposes, this approach has the advantage of explicitly showing students the forecast-dependency of monetary policy, even where the central bank is committed to a very simple policy rule.

Same, really, for interest-rate targeting. Things become a bit hairier in a Mundell-Fleming model with uncovered interest parity, but a reasonably clever instructor can still pull it off. (I used to - at least, I think I did - and my own cleverness is low-to-moderate at best.)

Nick: Echoing what Giovanni says about ex ante and ex post, how would you teach a student how to be a central banker using IS/LM if their objective is to achieve a level of output consistent with their inflation objective and they have to respond to, say, fiscal policy shocks? Doesn't your vertical LM curve beg the question?

[Off-topic: the class on burden of the debt went well, I think!

I began by writing down my outline:

1. The national debt is not a burden because we owe it to ourselves. (simple closed economy no investment constant GDP=consumption.)
1a. Yes, but, there are exceptions. (distorting taxes, foreigners, crowding out of investment).

2. That's all wrong. It is a burden. (same simple model only with overlapping generations and 0% interest rate).
2a. Yes, but, there are exceptions. (sustainable Ponzi, government investment).

They nodded their heads, and asked very good questions, so I'm pretty sure at least most of them got it!]

Questions...good. Nodding...er...possibly good. But the real test...do they hiss in unison if you utter the phrase "Baby Boomers"?

Giovanni and Seamus are right. If the central bank had real time GDP data, with no lags, there would be no problem with drawing a vertical LM curve. But it doesn't. So it has to grab whatever data and use whatever forecasting techniques it can, to try to make the LM vertical in the right place. And all that is pushed under the rug. But that question is a really difficult question. Because it depends on the nature and timing of the data the central bank gets, the source of the shocks, etc. Drawing a horizontal LM curve is even worse, because it says the central bank ignores all data except the rate of interest on overnight lines. Plus, fiscal policy changes are normally announced well in advance, so if that is the source of the IS (and BP) curve shift, the central bank will know it in advance and be able to keep the LM curve vertical (in expectation) in that case.

JW is right too, that the rate(s) of interest that matter for the IS curve are a long way removed from the overnight rate of interest. So even if the central bank did keep the overnight rate constant, that doesn't mean a horizontal LM curve is a good model. But that too is a hard thing to model well.

Max. The rate of interest (real or nominal) has the units 1/time. Central banks control their own balance sheets, which have the units $. The money supply has the units $ too. The problem is that the data on the money supply is also not real time, so it can't control it exactly. But trying to target a rate of interest leads to the Wicksellian indeterminacy problem.

Nick,

Is it a burden or a crutch? Ultimately, federal debt of any nation is a guaranteed claim against the future tax revenue of that country. The question you should be asking is why should a government should ever sell guaranteed claims against its own tax base.

Simon: Good question. I don't know the answer. It's not going to be a simple answer either, because different maturities of government debt will have different rates of interest.

This is what I teach: the rate of interest on government debt depends on the debt/GDP ratio. For low debt/GDP ratios, it's probably true that r < g. For high enough debt/GDP ratios it will eventually be true that r > g. So there is an (unknown and time-varying) maximum debt/GDP ratio such that Ponzi schemes are borderline sustainable.

David: my take on your post, on a quick re-read: You have a very short run horizontal LM, and a longer run vertical LM. The question is: which run is relevant for the ISLM (or ISLMBP) model? I just don't see the economy getting anywhere near the IS curve in 6 weeks. It takes time for firms to hire more workers and increase production. It takes time for people to learn that their income has increased, to revise their expectations of future income, and to revise their spending plans.

Giovanni @ 5:13 ;-)

Nick, glad class went well, learned something from this post.

Picking nits here, but the LM curve can't be a vertical line because that would include points far below the X-axis, which are impossible (unless we adopt something like Miles Kimball's electronic currency proposal). It might be a backwards L. I like the IS-LM model, but it turns out that what's really interesting is what happens when it can't be applied in its original form. We know that central banks still conduct monetary policy when the zero constraint binds, but it seems that what they do then is not well approximated by a target level of output that is independent of the position of the IS curve.

Nick,

"This is what I teach: the rate of interest on government debt depends on the debt/GDP ratio. For low debt/GDP ratios, it's probably true that r < g. For high enough debt/GDP ratios it will eventually be true that r > g. So there is an (unknown and time-varying) maximum debt/GDP ratio such that Ponzi schemes are borderline sustainable."

A government decides how much of its tax revenue it wants to spend on making interest payments. Tax revenue as a percent of GDP fluctuates based upon fiscal decisions. The same can be said for federal interest payments as a percentage of GDP. The amount of interest a government pays out every year is a function of interest rates as well as the term structure and payment arrangements on its debt. If a government opts to sell accrual securities, it can stretch its interest payments out by increasing the duration of the debt that it sells.

For coupon, simple interest securities increased interest rates increase annual interest expense:

Interest Expense = Average Interest Rate * Total Debt Outstanding

For accrual, compound interest securities:

Interest Expense = % of Securities Maturing * Total Debt Outstanding * ( 1 + Average Interest Rate ) ^ ( Average Duration )

Suppose a government started out issuing only one year debt. Its interest payments would be:

IE = 1 * D * ( 1 + INT ) ^ ( 1 ) - D

Suppose it then decided to restructure its debt so that only half of it came due during any year. Its new interest expense would be:

IE = 0.5 * D * ( 1 + TP * INT ) ^ ( 2 ) - D

TP would be the term premium for the longer maturity debt.

Setting the two equal to each other

1 * D * ( 1 + INT ) ^ (1) = 0.5 * D * (1 + TP * INT ) ^ ( 2 )
2 * ( 1 + INT ) = ( 1 + TP * INT ) ^ 2

TP = [ SQRT ( 2 * ( 1 + INT ) ) - 1 ] / INT

Notice that for equal value interest expense, the term premium increases with average duration and increases as short term interest rates go to zero.

Thanks Frances!

I have a hunch that Giovanni ought to come out of retirement(?)/teaching something else(?) and go back to teaching macro.

Andy: fair point. It depends I think if we have the real or nominal rate of interest on the axis. If real, it could always raise the inflation target (or tax currency) to break through the ZLB.

Kind of you to to say so, Nick. Alas, at this point I'm content just to enjoy life until my big meeting with the Dean-of-Social-Sciences-in-the-Sky.

Where are all the PK's, Neo-Wicksellians, and MMTers? Should (could?) I have made this post even more provocative?

What does the LM curve look like in a nominal Y (where Y is the path of nominal GDP rather than level) and real r world?

A 'classical' or 'monetarist' curve should be 45 degrees. If a central bank is making it vertical, arguably, it is over-reacting.

Though, of course I agree that an 'interest-rate-targeting' central bank does not make the LM curve horizontal, because as you consistently point out, the interest rate is not an exogenous variable but constrained by other objectives of the central bank.

What is this objective/ how should it be modelled? I will argue that the objective of a central bank is to keep the economy on a classical 45 degree LM curve, where the LM curve should be defined to mean the locus of points at which there is no excess demand for money or bonds (risk capital) relative to each other.

The short rate is then a parameter of the curve, rather than the position of the curve itself.

Neo-Wicksellian incoming!

Nick,

"But trying to target a rate of interest leads to the Wicksellian
indeterminacy problem."

I assume you are referring to price level indeterminacy. There are three responses to this:

1) It's not a problem so long as the system is meta stable by virtue of central bank interest rate policy. The only real requirement for this to be the case is that inflation expectations must not increase more than one-for-one with hikes in the policy rate (so real rates rise with nominal rates). In practise inflation expectations always *decline* with surprise policy rate hikes, so this is absolutely not a problem: real rates rise *faster* than nominal rates.

2) *Anyways*, the money demand is *tiny* compared to the impact of changes in the real rate on the balance of investment, consumption and savings. If you put money in the utility function in an empirically realistic way you see that it just doesn't matter. Matt Rognlie wrote a great post evaluating the reasonable impact of a few percent change in interest rates on our desire to hold a couple of hundred bucks in our pocket. Basically irrelevant. The impact of the real demand for money is too small to provide any credible price anchor on any reasonable time scale.

3) Even *if* there was significant utility in holding cash, it can be 100% frictionlessly and reversibly converted to interest bearing deposits. Therefore the convenience yield of cash is *always* equal to the rate on deposits despite no change in the relative value of cash and deposits. Taking that into account, it is impossible to write a model of money in which the supply of non-interest bearing money has economic significance. All you got is shoe leather, and that just isn't going to cut it.

There *is* a real quantity that matters which is the real value of all government debt and money. Presumably it is reasonable to expect the representative household to demand a higher yield (pecuniary+convenience) with increased supply relative to other assets (assuming the impact on growth of corresponding future tax increases is zero). But models that break out the quantity of the "money" portion of liabilities make little sense.

There is a really important thought experiment that every monetarist should answer for him/herself: Imagine that *all* the base was interest bearing and the CB said it would pay out 10%/year to all holders continuously and indefinitely. Would inflation rise as a result of this big expected monetary expansion? Or would nominal rates rise to 10%, resulting in a massive disequilibrium debt-deflation spiral? (Yes, it would.) How would adding a bit of non-interest bearing base fundamentally change any of this?

So what's the shape of the LM curve? Very confusing, but fortunately irrelevant. If we must teach static models then IS/MP is a decent choice.

K

Good to see a fellow Neo-Wicksellian here! I think I have some re-formulation of IS/LM that corresponds to Wicksellian schema. Perhaps I sjhould wrte it upa nd send it to Olivier Blanchard who wants to re-invent IS/LM following his IMF stint.

On your point 1, does it not actually re-inforce Nick's point? If the assumption of monetary super-neutrality is given up, a real rate targeting central bank is in theory always open to a Howitt-Wicksell collapse or explosion. History and sticky prices are pretty much the only exogenous anchors that the price level has, with the monetary regime being the central endogenous anchor.

Ritwik: "What does the LM curve look like in a nominal Y (where Y is the path of nominal GDP rather than level) and real r world?"

If we put nominal GDP on the horizontal axis, then if the BoC were targeting NGDP, the LM curve would be vertical, and it would never shift (more strictly, it would shift rightwards at a fixed 5% per year). If the BoC were targeting inflation, then it would still be vertical, but changes in AS would cause the division of PY into P and Y to change, and would cause the LM to shift right or left.

You lost me on the 45 degree stuff.

K: "1) It's not a problem so long as the system is meta stable by virtue of central bank interest rate policy."

Possibly correct. But even then, if the central bank changes the interest rate "target" in response to what happens, it's no longer a target.

2. It doesn't matter how tiny the demand for money is. It is the fact that everything else is bought and sold for the medium of exchange (plus it's the medium of account) that makes money important.

3. If the price of peanuts were perfectly flexible, it would also be always possible to buy or sell money for peanuts. Does that make the price of peanuts the macroeconomically significant price, in addition to the (a) rate of interest?

K:

I don't think anything in your post really is a serious challenge to MM. I remember we hashed it out in the comments earlier and my takeaway from your position was:

1. Monetary policy is really, really about interest rates.
2. Printing money is really just about pushing down interest rates (printing a nontrivial amount pushes them down to zero immediately).
3. But interest rates matter particularly because (ceteris paribus) lower rates cause private banks to create more deposits.
4. Therefore printing money / changing interest rates does feed pretty directly into the broad quantity of money.
5. Therefore a policy of "print money until your model says you'll hit your NGDP level target" works.

I don't think MM actually suffers very much if you force it to strike out all its reference to "permanent monetary injection" to "promised future interest rate path".

Nick:

3. If the price of peanuts were perfectly flexible, it would also be always possible to buy or sell money for peanuts. Does that make the price of peanuts the macroeconomically significant price, in addition to the (a) rate of interest?

In K's model, if you made the price of peanuts perfectly flexible and banks could instantly and costlessly exchange them for money then they actually could be. But that actually makes sense, because then peanuts basically are money.

Nick,

"But even then, if the central bank changes the interest rate "target" in response to what happens, it's no longer a target."

The interest rate is not the target, any more than the size of the base is the target. You should think of the CB as setting either of these two variables in order to control the NGDP level *target*. The rate (or base) is the *instrument*.

"It is the fact that everything else is bought and sold for the medium of exchange (plus it's the medium of account) that makes money important."

I don't know what this means, but I suspect that parsing it in a mutually comprehensible way is the key to a meeting of minds. At face value, it isn't even remotely true. Essentially everything is bought via commercial bank intermediated credit: credit cards, debit cards, cheques, money wires, bank drafts and money orders. Currency is an irrelevant vestigial appendage, without which I'd just use my credit card. The only thing that matters to the real economy is a huge zero sum game of commercial bank debits and credits. *And* the fact that the CB controls the interest rate on risk free loans denominated in the unit of account.

When you say that money is "important," do you mean that the quantity of money is important? The quantity of *what* exactly? Given that debits and credits are in net zero supply, you can't be referring commercial bank money. If, for example, I spend from my deposit account I decrease the quantity of deposits, but if I spend from my line of credit, I increase it. So the gross supply of deposits is determined by *relative* time preferences for consumption/investment between different agents in the economy, which has nothing to do with the price level.


"Does that make the price of peanuts the macroeconomically significant price"

What Alex Godofsky says. The supply of peanuts adjusts until the nominal price of peanuts is equal to the guaranteed exchange rate to money. The nominal price of everything else in the economy doesn't just suddenly adjust to accomodate the new exchange rate between money and peanuts. The non-peanut economy is huge and it has way to many sticky prices to adjust at all. All that happens is that the supply of peanuts [currency] adjusts and people use near substitutes like almonds [credit cards], pistachios [debit cards], and cashews [cheques], etc instead. Honestly, assuming peanut growing was impossible, what *would* happen if the central bank suddenly made peanuts convertible to and from money at the current price, just like paper currency. I don't see how it effects anything.

But I'd worry that we are going to get confused if this gets too metaphorical. Everybody has a different conception of the meaning of peanut. The only way to settle this stuff is talk about *real* - if idealized - model frameworks, and to think about the incentives and actions of agents within those models. And the framework that would be most enlightening by far, is if we agree to try to imagine what would happen if Canada (a zero reserve requirement system) withdrew currency. I say absolutely nothing.


Alex Godofsky,

Actually I only agree with 1 and 2. I think 3-5 are irrelevant as the quantity of deposits (bank debt) is a reflection of relative time preferences between different agents in the economy (see my comments to Nick above), as well as the total size of the economy, and unrelated to the price level. Inflation and the output gap, on the other hand, are directly determined via expectations of the path of the real rate relative to the natural rate. The real rate directly determines whether I choose to consume or invest now, or *try* to save and consume or invest later. That, in turn, directly impacts inflation and output (NGDP). Deposits, loans *and* the base will tend to scale with NGDP. But those are the tail, not the dog.

K:

Actually I only agree with 1 and 2. I think 3-5 are irrelevant as the quantity of deposits (bank debt) is a reflection of relative time preferences between different agents in the economy (see my comments to Nick above), as well as the total size of the economy, and unrelated to the price level. Inflation and the output gap, on the other hand, are directly determined via expectations of the path of the real rate relative to the natural rate. The real rate directly determines whether I choose to consume or invest now, or *try* to save and consume or invest later. That, in turn, directly impacts inflation and output (NGDP). Deposits, loans *and* the base will tend to scale with NGDP. But those are the tail, not the dog.

Fine, though I think you should agree with 5 as well. As I see it MM has two important policy conclusions: primarily NGDPLT (which you seem to agree with) and secondarily the use of OMOs as the policy instrument. In your model "permanent increase in the money supply" is identical to a commitment to hold rates at zero for some period*. So that instrument should actually work (in your model), though it might be somewhat cruder in practice.

*ish.

K

A little strange to see you arguing in such explicit Woodford-ian terms. The Neo-Wicksellian propensity is fine, the Walrasian reduction of savings/investment dynamics purely to consumption choices is somewhat odd. I'd have thought you'd infuse the financial/banking system with more autonomy, make the classical Wicksellian distinction between non-consumption and financing and see the dog and tail wagging each other alternately.

But I suppose you were arguing within the constraint of pure first-cut theory?

I propose that we rename this Neo-Wicksellian moniker to Neo-Hawtreyan. Especially after the recent exposition from David Glasner, invoking John Hicks, on 'A century of the bank rate'. Maybe the market monetarists will not be so comfortable citing the fallibility of interest rates as indicators (and channels) of the monetary stance then. :)

Alex,


"I don't think MM actually suffers very much if you force it to strike out all its reference to "permanent monetary injection" to "promised future interest rate path"."

Sounds like basically the NK model *except* that the CB seems to have some special powers over inflation expectations over and above what can be achieved via credible commitment to future use of the instruments at its disposal. Maybe there are multistable inflation expectations eagerly awaiting coordination from Ben Bernanke. I think that's hope and prayer, and highly unlikely to be consistent with empirical research on actual price setting. Personally I think inflation expectations are quite robust and you have to whack them really hard with real rate changes to move them. Singing at the right pitch wont cut it.

"Therefore a policy of "print money until your model says you'll hit your NGDP level target" works."

Except for the part about printing money. The point is to commit to hold the policy rate at zero until you hit a target. The way I see it, printing money does nothing to help with that commitment. Targeted asset purchases (especially high beta) may work, but it's totally wrong to call that "printing money," since anybody (e.g. treasury) could just as well do it by swapping t-bills for the assets (no money creation involved). If you want to claim that a stimulus works via targeted asset purchases, you can't claim it has anything to do with the medium of exchange in any way whatsoever. Instead, it's about risk transfer, which is a perfectly sensible argument.

Ritwik,

"But I suppose you were arguing within the constraint of pure first-cut theory?"

Yes. This conversation is about the quantity of money. Banking, on the other hand, is about credit (default risk) and bank runs from ALM mismatch (liquidity risk). Modelling that stuff is really important, but in my view it doesn't have anything to with M or the LM curve.

K

Sure, but I wasn't referring to banking itself per se.

I have this 4 interest rate model in my head. The 4 interest rates are : r (market cost of risk capital), r* ('neutral' cost of risk capital), m (market cost of 'money'), m* ('neutral' cost of 'money').

Modern central banks, in normal times, set m, hoping to clear m*.

1. Hawtrey argued this is enough because in his view the macroeconomically relevant decisions follow from m.

2. Woodford argues this is enough because making m clear m* is perforce by assumption of financial equilibrium equal to making r clear r*.

3. Keynes agreed with Hawtrey in allowing for full CB control over m but argued implicitly in terms of r vs r* (atleast in the Treatise) and tried to show how the relationship between r and m might come unhinged.

4.Wicksell lived at a time when central banks did not control m* but showed the process of how m may diverge from m* through autonomous actions of the banking/financial system, even in a purely loanable funds framework. Transcribed into a Keynesian framework for long rates, this shows how the autonomy of the financial system may make r and r* diverge, even if the CB manages to make m clear m*.

I believe that in the years preceding the crisis, we were living in a world which had m > m* but r < r* . The risk premium in the market, driven by the financial system, was far too low and completely out of sync with the background risk premium of savers and investors. Call this the 'global loans glut', as Hyun Song Shin calls it. The extraordinary returns being made for investing at m (say, money market deposits) as well as the broken feedback from r and r* ensured that the standard mechanisms that would drive m* above m in an expanding economy were lacking. So r* rose, but m* stayed put. And when it all snapped, r* and m* both came crashing down, and we entered a slowdown (m>m*, r>r*) and since then, central banks have tried everything, pushing m down hoping that r will follow, trying to massage r down through portfolio balance effects, and with Japan, finally, trying to force r below r*, m and m* be damned.

When I say financial disequilibrium, Wicksell style, I basically refer to the idea that the market risk premium (r-m) may

1. become unhinged from the background risk premium (r*-m*) of the full-employment savings/investment balance.
2. change in response to central bank actions on the short rate (m).

Infusing the financial/banking system with autonomy will allow for these contingencies, which I see as fundamentally relevant to the macroeconomy, even in an IS/LM framework. With or without ALM mismatches or bank runs.

K:

Except for the part about printing money. The point is to commit to hold the policy rate at zero until you hit a target. The way I see it, printing money does nothing to help with that commitment. Targeted asset purchases (especially high beta) may work, but it's totally wrong to call that "printing money," since anybody (e.g. treasury) could just as well do it by swapping t-bills for the assets (no money creation involved). If you want to claim that a stimulus works via targeted asset purchases, you can't claim it has anything to do with the medium of exchange in any way whatsoever. Instead, it's about risk transfer, which is a perfectly sensible argument.

Your own claim (in prior threads) is that creating any nontrivial quantity of ERs instantly forces rates to zero. Thus a permanent monetary injection (printing money) would be a commitment to hold rates at zero until almost all of those ERs are converted to RRs (ultimately via creation of deposits) and/or the price level adjusts so much that that quantity of ERs becomes trivial.

Do you disagree?

"Do you disagree?"

Yes!

If there was *any* relationship between the quantity of money and the time of the commitment, the US would currently be committed to keeping the policy rate at zero until a tripling (or so) in NGDP had occurred. In fact, assuming they have to unwind QE before they hike (IOR=0), they will probably have to unwind 90% of it before the first rate hike. I.e. there is *nothing* permanent or credible about any of this, and no sense in which the quantity commits them to hiking sooner or later. No matter what, they'll have to sell essentially all of the assets OR just keep a floor system and raise IOR to whatever they want the policy rate to be. Either way, the balance sheet has no impact on timing of the exit from the ZLB.

Alex,

To be clearer. "We are doing QE until condition X" doesn't commit them any more than just saying "we wont hike until condition X," because QE is obviously easy to unwind. (Otherwise they wouldn't have expanded the balance sheet by a factor of three or whatever).

I'm all for the commitment, but QE doesn't affect the commitment one way or the other. It's a null action.

So it was wrong to say that I disagree with your statement. My assertion is that the expansion is obviously not credibly permanent. It isn't even intended to be permanent.

Which leaves the question of whether a more reasonable 5% per year permanent expansion could be credible? (The Friedman k% rule.) The answer is still no. The commitment is "we will keep the policy rate at zero until NGDP is on target." Unfortunately, at the moment that we reach that target, we have no idea what the demand for base money will be because it's totally unpredictable (see failures of the k% rule in the '80s). If we expand at 5% the money supply could, for example, be too low at some point in the near future in which case the short rate will explode and banks will fail. Or maybe the money supply will be too high at the point when we reach our NGDP target and we will be unable to hike without breaking our commitment to make the monetary expansion *permanent*. You just have no idea what the right rate of monetary expansion is that will be consistent with your desired short rate commitment. It just doesn't work, any way you look at it.

Nick

Is my mega comment in your spam filter? It showed for a while but now it doesn't.

Ritwik: Yep. I fished it out.

K:

To be clearer. "We are doing QE until condition X" doesn't commit them any more than just saying "we wont hike until condition X," because QE is obviously easy to unwind. (Otherwise they wouldn't have expanded the balance sheet by a factor of three or whatever).

I'm all for the commitment, but QE doesn't affect the commitment one way or the other. It's a null action.

So it was wrong to say that I disagree with your statement. My assertion is that the expansion is obviously not credibly permanent. It isn't even intended to be permanent.

This is true, but is also something that the MMs have been saying since the beginning. In fact one of the points Scott Sumner has been making for years is that a credible policy of returning NGDP to the pre-recession path would require negative QE, and probably lots of it. And of course in the context of an ongoing attempt by a central bank to hit a target there are no "permanent" actions, regarding the money supply or the interest rate. The real weight comes from the fact that you have a level target. Even so, both in the MM model and in your model the following central bank policy really does work:

"When NGDP is below our LT, we will exchange non-interest-bearing reserves for Treasury bonds until NGDP returns to our LT. When NGDP is above our LT, we will do the reverse until NGDP returns to our LT."

(insert caveats about bond purchases being of sufficient size, etc.)

And if we take the above policy and augment it by targeting the forecast it still works in both models.

K,

Just to add to your credible committment argument. The only entity capable of making and acting on a credible long term commitment is the legal authority (federal government). Most governments are structured that way - laws once enacted are difficult to repeal or amend.

Can Ben Bernanke make the committment that under his helm AND under the next two or three federal chairmanships, quantitative easing will be pursued?

Interesting thought experiment:

Suppose that representation on the federal open market committee expanded for population growth similar to the way government representation expands - state induction generates two additional Senators, population growth adds / subtracts House members. The FOMC was established in 1933 (Glass Steagal Act) and FOMC governors were given voting rights in 1935.

In 1935 there were twelve voting positions (seven federal reserve board members and five presidents of regional federal reserve banks). That number has been unchanged.

In the meantime the U. S. population has tripled.

Would the committment of an enterprise whose membership is aligned with a representative democracy be considered a more credible committment?

Alex,

"When NGDP is below our LT, we will exchange non-interest-bearing reserves for Treasury bonds until NGDP returns to our LT.

"Exchange" at what pace?

"When NGDP is above our LT, we will do the reverse until NGDP returns to our LT."

You can't do that without watching the short rate. Before you get to your target you may have caused a shortage in the funds market and banks will be going bankrupt. The only way to avoid that is to watch the interbank rate. I.e. you end up with a *rate* in your rule. And meanwhile nobody gives a crap about the quantity. So just use the rate.

"And if we take the above policy and augment it by targeting the forecast it still works in both models."

Your policy is not even remotely well defined. My policy is: "keep the short rate at zero until target X is achieved." I challenge you to state your quantity policy in equally clear, unequivocal terms. Also, I challenge you to write it in such a way as not be full of totally irrelevant numbers. Then, write a rule for the quantity once you are away from the ZLB (no reference to interest rates allowed).

Are you defining money supply as monetary base?

K:

"Exchange" at what pace?

That was my handwaved caveat. I know that there are some states of the world and choices of ongoing QE amount that result it the level target never being reached; I'm assuming there is someone at the Fed who can figure out if that's the case and bump up the pace, as you put it. An alternative policy (unrealistic yet pleasing to my computer scientist sensibilities) would be to make the pace exponential, doubling every month.

You can't do that without watching the short rate. Before you get to your target you may have caused a shortage in the funds market and banks will be going bankrupt.

Yes, the extremely simplistic and naive version of the policy potentially achieves its NGDP reductions through total collapse of the financial system. That's a practical critique, not a theoretical one, and I don't think the practical implementations actually advocated by MMs actually suffer from it.

The only way to avoid that is to watch the interbank rate. I.e. you end up with a *rate* in your rule. And meanwhile nobody gives a crap about the quantity. So just use the rate.

I know that in your model the whole monetary injection thing works purely through its manipulation of interest rates. I believe I've stated that several times. I've also stated that in your model a policy that uses OMOs as the instrument is certainly less elegant than one that uses interest rates directly. The point is that OMOs still work.

And they don't just work in theory, they work in practice so long as the central bank targets the forecast (another thing MM has argued for since the beginning). In your model a central bank that targets the forecast will internally just have a surjection from monetary base paths to interest rate paths and use that as the first step of its forecast.

Alex,

Looks like we're doing circles, or I'm not understanding you. Thx!

K,

Or vice versa. Sorry if I'm just not getting something.

Nick, Sounds like a zero fiscal multiplier. Andy's comment is excellent.

Got any graphs? I'm most interested in case(s) where the IS - LM curves intersect below zero?

Scott: Yep. All I am doing here is translating what you say into ISLM language.

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