Even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them.
–Ben Bernanke, October 15, 2002
Policy accommodation—and the expectation that it will persist—is distorting asset prices. Most of this distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand.
–Donald Kohn, March 16, 2004
Kohn’s belief that monetary policy can reinvigorate a weak economy by encouraging people to borrow and spend out of unrealised capital gains is hard to square with Bernanke’s claim that central bankers shouldn’t attempt to restrain excessive risk-taking by raising interest rates. Bernanke reconciles this apparent asymmetry by arguing that “targeted measures…such as financial regulation and supervision” can promote financial stability better than the “blunt” instrument of monetary policy. Read more
Ask most monetary policymakers how they think about their job and the conversation generally goes like this:
- There is “an equilibrium interest rate” that somehow balances out the desires of savers and borrowers
- This “equilibrium rate” can be estimated roughly in real time
- The role of the central bank is to ensure that actual interest rates align with this theoretical ideal
We don’t really buy any of these points, especially 2) — see our earlier post discussing research by BAML’s Ethan Harris and Goldman’s Jan Hatzius, among others, on the difficulty of determining the “equilibrium” rate at any point in time — so naturally we want to highlight some new papers that reinforce our monetary policy nihilism. Read more
Compare and contrast:
Some observers have been arguing that our patience should be wearing thin sooner rather than later. One argument is that policy is very accommodative by historical standards and that many of the reasons for adopting such an accommodative policy no longer pertain. Demand has strengthened substantially, and the threat of pernicious deflation has receded. A second concern is that policy accommodation—and the expectation that it will persist—is distorting asset prices. Most of this distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand… Read more
When it comes to central banking, we tend towards nihilism: the economy is far too complex for any policy rule, but also too complex to be understood by even the most intelligent, well-meaning technocrats. That presents an insurmountable problem for monetary policymakers, who are forever doomed to be fumbling about in the dark rather than smoothing out the vicissitudes of the cycle.
So we were intrigued to read a new paper by, among others, Goldman’s Jan Hatzius and BAML’s Ethan Harris, which was presented on Friday at the Chicago Booth Monetary Policy Forum, that basically agrees with our view. Read more
Eric Rosengren, the President of the Federal Reserve Bank of Boston, gave a speech in Frankfurt on Thursday arguing that the Fed’s full employment mandate gave the central bank more flexibility to be aggressive earlier, and that open-ended programmes that are tied to economic targets are more effective than purchases of predetermined size and duration.
Nothing novel there. But his speech also contained, perhaps inadvertently, some interesting arguments that the rounds of bond-buying after the acute phase of the financial crisis did little for the real economy. (We covered the tenuous relationship between asset purchase programmes and inflation here.) Read more
Housing booms are wasteful — and the subsequent busts are deeply destructive. Worse, they have become bigger and more frequent since the 1970s. An important new paper from Oscar Jorda, Moritz Schularick, and Alan Taylor places the blame on structural changes in the financial sector that exacerbate the impact of excessively loose monetary policy.
This is a continuation of earlier research on the drivers of credit booms and their impact on GDP using data from more than a dozen rich countries going back to 1870, which we covered in detail here. For those who don’t want to reread that post, the two important takeaways are, first, that the growth rate in private borrowing during an economic expansion predicts the severity of the subsequent downturn even when there is no financial crisis: Read more
Whilst strolling on a beach in southern California over the holidays, we were inspired to try our hand at songwriting. (The topic may or may not have been partly inspired by our location.) After toying around with our initial idea for a while we managed to produce a few verses and a refrain. Feel free to suggest additional lyrics in the comments. To the tune of Jingle Bells:
Rolling down the curve
With my Eurodollar strips
Making tons of money
‘til the Fed hikes 50 bps! Read more
**10.5 per cent to 17 per cent**
Click to enlarge for the Central Bank of Russia’s emergency rate hike at 1am Moscow time — surpassing both the Turkish central bank’s hike in January this year and the Bank of England’s 500bps of moves on one day in 1992. Lamontsky.* Read more
CreditSights points out today that changes in gross ECB liquidity provided to the euro area’s banking sector closely track changes in 10 year Bund yields:
A fascinating chart from Morgan Stanley’s European banking research team caught our eye. See if you can spot the odd one out (click to enlarge):
Back in 2011, inflation climbed above the Fed’s 2 per cent target, but the FOMC resisted the impulse to tighten monetary conditions. Long-run inflation expectations hadn’t risen to worrying levels, and Ben Bernanke perceived that a price spike led by oil was likely to be “transitory”.
No surprise there: he wrote the paper on this very topic. And he was proved right. Read more
The Bank of England’s latest quarterly bulletin, released on Monday, contains an interesting article on “the potential impact of higher interest rates on the household sector.”
A few interesting tidbits:
–Raising rates by 2 percentage points would redistribute income “from higher-income to lower-income households”
–But would probably lead to a reduction in spending, since 60 per cent of borrowers would spend less and only 10 per cent of savers would spend more. The BoE estimates that the net effect of a 1 percentage point increase in the Bank Rate would be a reduction “aggregate spending by around 0.5 per cent via a redistribution of income from borrowers to savers.” A 2 percentage point increase would lower spending by 1 per cent. (The total impact on spending could be a bit different, however, since monetary policy works in other ways besides redistributing income from net savers to net borrowers.)
–On the whole, though, UK households are (slightly) less sensitive to increases in interest rates than they were a few years ago Read more
Back in April, Paul Krugman wrote that Swedish post-crisis central banking has been “sadomonetarism in action.” (They had the audacity to modestly raise short-term interest rates in 2010-2011.) The criticism may lead to additional parliamentary oversight of the Riksbank.
So we recommend you read an important new speech from deputy governor Per Jansson that dispels many of the myths surrounding Swedish monetary policy. He makes two basic arguments: Read more
Policy should not respond to changes in asset prices, except insofar as they signal changes in expected inflation.
–Monetary Policy and Asset Price Volatility, by Ben Bernanke and Mark Gertler (1999)
That thesis became conventional wisdom in the years leading up to the recent financial crisis. Central bankers came to think it would be presumptuous for them to act as if they knew more than the collective wisdom of the markets. Even if they could spot trouble in advance, the consensus was that there was no way to temper excesses in the financial system without tanking the economy in the process. Better to stick to the (seemingly) simpler task of inflation targeting. Read more
Nonsense is a rude word. But there isn’t a milder way of describing the Bank of England’s estimates of UK labour market slack.
For three inflation reports in a row, the BoE has published a chart (below) showing its model of labour market slack with accompanying text highlighting its great importance in the monetary policy decision. “One of the key determinants of inflationary pressures in the economy is spare capacity or slack – that is the balance between demand and supply,” the November inflation report states. Read more
Sweden’s Riksbank cut its key interest rate to zero last week because inflation was too low. The Riksbank has been noted – and criticised – for raising rates in 2011 to tackle a credit and housing bubble. Peter Doyle, an economist and former mission chief for Sweden for the IMF, argues that the recent experience of the world’s oldest central bank has more to teach policymakers.
One view of the Swedish Riksbank’s cutting its repo rate to zero is that this is a defeat for the use of monetary instruments to lean against financial fragilities. That conclusion is premature. It misses three more important implications for other monetary policymakers. Read more
(The chart frames the upper and lower forecasts of the central tendency, which removes the highest three and lowest three forecasts of the FOMC as a whole. The red line is the midpoint between the two.)
Starting in 2009, the midpoint of the central tendency projections for the long-run unemployment rate climbed from 4.9 per cent to 5.6 per cent during the next three years. Read more
One private equity chief went so far as to publicly thank Ben S. Bernanke, the Federal Reserve chairman until last month, whose program of extraordinary economic stimulus has helped push stocks higher, feeding the private equity machine.
“Thank you, Ben Bernanke. I saw him last Thursday, and I thanked him,” Mr. Schwarzman of Blackstone said during a conference in December. “The opportunity for us to be able to attract funds is very, very high.” Read more
What happens when you raise rates by 2.5 percentage points, within a period of six months, for an economy that might only grow 0.2 per cent this year?
We’re not sure. Read more
The transition to a new normal monetary policy, by David Miles, Monetary Policy Committee member, click to read in full
We’re coming to the end of a… multidirectional week for EM rates and currencies. BNP Paribas’ strategist here also pokes the media in the eye for “vying to produce the most bearish story on emerging markets…”
So we should note this dose of bullishness from the French bank: Read more
First, rewrite history (as Aufhebung). Read more
Who thinks UK base rates will go higher this year? We ask because Economics Editor Chris Giles made precisely that bold prediction in the FT’s collection of holiday prophesy.
Will the Bank of England raise interest rates in 2014?
Yes. It is fashionable to think this is an absurd question to which the answer is obviously no. But not for the first time, fashion sucks. The British economy is growing at an annualised rate of more than 3 per cent, unemployment is rapidly falling towards the Bank of England’s 7 per cent threshold when it considers rate rises and inflation has been above the central bank’s 2 per cent target for all of the past four years. The reason the BoE would keep rates on hold at 0.5 per cent amid a fast expansion is a rapid improvement in productivity, allowing recovery to coexist with an absence of inflationary pressure.
FT Alphaville is a little bit late to this appreciation of the outgoing Bank of Israel governor (and former deputy IMF managing director), penned by Peter Doyle — also formerly of the IMF.
But we think it should be read far and wide. (Click for the full doc) Read more
Some prominent Fed Reserve Board staffers recently put out two weighty papers in advance of the 4th Jacques Polak Annual Research Conference which is hosted by the IMF starting on Thursday (today).
Paul flicked one paper up yesterday — The Federal Reserve’s Framework for Monetary Policy –Recent Changes and New Questions — and the second — Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy — is here. Read more
You’ve seen those who were (ahem) surprised by the US central bank’s decision not to start tapering this month… now read the words of one who got it right: BNP Paribas’ Julia Coronado, the bank’s chief North America economist and ex-forecaster at the Fed.
And interestingly, BNP think even December is in doubt: Read more
Barclays asks clients what they think every few months and the latest batch of answers from 799
dart throwing interns global investors show that they are ready, set and already yawning over the prospects for tapering by the Fed this week.
In the UK, however, who knows? Consensus came there none. Read more
The Fed is his to lose, so here’s a useful service by Barclays rates analysts — quotes from Larry Summers on monetary policy, all the way from December 1986 to August 2013, all in one place. Click to enlarge.
First — GDP or unemployment as the slack indicator in forward guidance about low rates?
More on why the Bank of England chose unemployment (the 7 per cent threshold, not seen being reached until 2016), from the July/August minutes of the MPC: Read more
FT Alphaville presents a guest post by Stephanie Kelton, chair of the Department of Economics at the University of Missouri, Kansas City. She is also editor-in-chief of New Economic Perspectives. She tweets under @deficitowl.
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