FOMC: Give up your obsession with interest rates…

…and start thinking strategically!

From Robert Hetzel:

To start, it is important to clear away the confusion surrounding the popular use of the term “liquidity trap” as a catchall phrase expressing the impotence of monetary policy. A liquidity trap is different from the zero-lower-bound problem, which expresses the fact that in a world of fiat money the nominal interest rate cannot fall below zero. The real interest rate (the nominal interest rate minus expected inflation) is the price that borrowers pay for transferring consumption from the future to the present. Alternatively, it is the price that lenders receive for deferring consumption from the present to the future. If individuals are sufficiently pessimistic about the future, the real interest rate could be negative. By itself, however, that fact is uninformative for policy without knowledge of the shock (monetary or real) that caused the pessimism.

The zero-lower-bound problem is different from a liquidity trap. The idea of a liquidity trap is that individuals will exchange assets with the central bank for money to an unlimited amount with no incentive to run down their increased money holdings through additional spending. As a result, the central bank loses its ability to influence the dollar expenditure of the public. Tim makes the monetarist argument that as long as the central bank buys illiquid assets, the public is left with a more liquid asset portfolio after the exchange. If the public was holding a balanced portfolio before, then it will try to run down its higher money holdings through bidding for other illiquid assets and, in the process, bid up their prices. Higher prices for illiquid assets like real estate and equities will make investment more attractive.

If the public is sufficiently pessimistic about the future so that asset prices are low and the demand for money is high, the central bank might have to create a significant amount of money to influence the expenditure of the public. The institutional fact that makes a liquidity trap an irrelevant academic construct is the unlimited ability of the central bank to create money. One can make this point in an irrefutable manner by noting that the logical conclusion to unlimited open-market purchases is that the central bank would end up with all the assets in the economy including interest-bearing government debt, and the public would hold nothing but non-interest-bearing money. Because that situation is untenable, individuals would work backward from that endpoint and begin to run down their money balances and stimulate expenditure in the current period.

What drives the conclusion that the central bank can control the dollar expenditure of the public is that the central bank can conduct monetary policy as a strategy, say, by altering the monetary base and the money stock by whatever amount necessary to maintain nominal expenditure on track. Historically, however, the FOMC has never been willing to communicate its behavior as a “policy” in the sense of systematic procedures designed to achieve an articulated, quantifiable objective (a reaction function). Instead, it communicates individual policy actions such as changes in the funds rate or, since December 2008, changes in the size and composition of its asset portfolio. Just as importantly, it explains those individual policy actions using the language of discretion.

The Board keeps ‘mum’. The Regionals play ‘tug o´war’

The Federal Reserve Board is still missing two members. At present there are five members including the Chair and Vice-Chair. They all vote, together with five of the twelve regional presidents on a rotating basis. The president of the Federal Reserve Bank of New York has a permanent vote and so does not rotate. It´s as if he were a Board Member.

At present, it´s “five against five”.

Since the start of this year, Board Members (including New York´s Dudley)have kept an eerie silence. Not so the Regional Presidents.

Among those who are “voters” this year:

Richmond´s Jeffrey Lacker:

“There is no pre-set timetable for raising rates…The FOMC’s actions genuinely will depend on the economic data available at the time.”

Atlanta´s Lockhart:

“I believe the first action to raise interest rates will in all likelihood be justified by the middle of the year.”

Chicago´s Evans:

“We shouldn’t be raising rates before 2016 if things transpire as I’m expecting.”

San Francisco´s Williams:

“I see no reason whatsoever to rush to tightening. I don’t see any upside risks to inflation.”

And among the non-voters who nevertheless participate in the discussions:

Boston´s Rosengren:

“I’m willing to be patient” with rate increases, and “if we don’t see any evidence [of rising inflation] in wage and price data for a year, then I’d wait a year before I’d be doing something.”

Philadelphia´s Plosser:

“The economy has returned to a more normal footing, and as such, I believe that monetary policy should follow suit.”

Cleveland´s Loretta Mester:

“I could imagine the interest rates going up in the first half of the year.”

St Louis´s Bullard:

“It is important to get started and to start normalizing policy… I don’t think we can any longer rationalize a zero interest rate policy.”

Minneapolis´ Kocherlakota:

“Raising the target range for the fed funds rate in 2015 would only further retard the pace of the slow recovery in inflation.”

Kansas City Esther George and Dallas´ have not made public speeches this year but we can be certain they belong to the “sooner rather than later” crowd.

Among the voting regional presidents the “score” is tied 2X2 (New York´s Dudley goes along with the Board).

Among the non-voters who participate in the meetings the “hawks” win 5X2.

The meetings will be interesting with the first this year taking place next week, with the Statement released on February 4th.

Who Can Blame Greek Voters?

A Benjamin Cole post

The unemployment in Greece is 25 percent. The Greek economy has shrunk by 29% since 2009. That is a full-blown economic depression, an outright failure of macroeconomic policy.

And Greek citizens cannot vote for a growth-oriented monetary policy. Greek monetary policy is determined by Teutonic ideologues at the European Central Bank, the same insensate gnomes who have brought Europe to a seemingly permanent deflation and recession outlook.

And so Greek voters, looking at the wreckage that is the economy of the archipelago, voted in the left-wing Syriza Party in the just-concluded national elections.

I don’t blame the Greek voters. I am only surprised they did not eye China, and decide that communism and central planning work even better.

The Wrong Choice

Of course, Greek voters are making a mistake.

What they need is cheaper drachma and structural reforms, and meaningful tax collection. But what the man or woman on the Athens street sees is a daily business and economic catastrophe that coincides with austerity.

And they read about a huge unsustainable national debt load somehow arranged by one ruling class after another, in deference to Euro-bankers. Yet they read that when banks fail, the voters and taxpayers bail them out. Now, when a nation fails, the bankers only want their pound of flesh. Evidently, at any cost to Greek citizens.

Right in One Regard

Of course, Greece should have never incurred debts in any currency but the drachma, and should have never given up their own central bank, and they should have First World tax collections and controlled government spending.

But, at this point, if Greek voters decide to declare national bankruptcy, and stiff Greek bondholders, who can blame them?

They have been put into a tightening economic noose by the ECB for six years, and appear headed for the financial gallows. If anything, Greek voters have shown tolerance, and have not (in large) adopted the hate parties so common in the Great Depression, though the appearance in the last Greek election of the extreme-right, Nazi-inspired Golden Dawn is worrisome. Nevertheless, all citizens of the free world can salute the bulk of our Greek brethren for avoiding hate politics.

And again, we have a reminder: Tight money does not lessen structural impediments in any modern democratic economy. When the ECB suffocates Europe, it births only recession.

All pain, but no gain.

Three (interrelated) quotes spanning six decades

Granted that the final result will be capable of being expressed in the form of a system of simultaneous equations applying to the economy as a whole, it does not follow that the best way to get to that final result is by seeking to set such a system down now. As I am sure those who have tried to do so will agree we now know so little about the dynamic mechanisms at work that there is enormous arbitrariness in any system set down. Limitations of resources – mental, computational, and statistical – enforce a model that, although complicated enough for our capacities, is yet enormously simple relative to the present state of understanding of the world we seek to explain.

Until we can develop a simpler picture of the world, by an understanding of interrelations within sections of the economy, the construction of a model for the economy as a whole is bound to be almost a complete groping in the dark. The probability that such a process will yield a meaningful result seems to me almost negligible.

Milton Friedman (1951)

One view, prevalent among mathematical theorists of general equilibrium, is that traditional macroeconomic theory suffers from its lack of firm microeconomic foundations. The behavioral relations of macro models, it is said, are not rigorously derived from optimization by individual agents and from the clearing of markets in which optimizing agents participate. In short, macro models do not look like general equilibrium models.

Of course, it is hard to make them look like general equilibrium models without emptying macro models of the aggregative simplicity, institutional content, and definiteness of conclusion which are their raison d’étre. It is possible to give macro relations the veneer of rigorous derivation from utility or profit maximization by assuming the aggregate of firms to behave if they were one firm. Since the procedure involves a dubious assumption of aggregation, it is not clear it is as much an improvement of the rigor and robustness as a gratification of the trained consciences of the theorists.

James Tobin (1978)

In this paper I argue that the current core of macroeconomics – by which I mainly mean the so-called dynamic stochastic general equilibrium approach – has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in “fine-tuning” mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in “broad-exploration” mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.

Ricardo Caballero (2010)

In essence:



Playing “holier than thou” is typical of past sinners

Very interesting interview on Spiegel:

SPIEGEL ONLINE: If there was a list of the worst global bankruptcies in history, where would Germany rank?

Ritschl: Germany is king when it comes to debt. Calculated based on the amount of losses compared to economic performance, Germany was the biggest debt transgressor of the 20th century.


SPIEGEL ONLINE: You’re saying that Germany should back down?

Ritschl: In the 20th century, Germany started two world wars, the second of which was conducted as a war of annihilation and extermination, and subsequently its enemies waived its reparations payments completely or to a considerable extent. No one in Greece has forgotten that Germany owes its economic prosperity to the grace of other nations.

SPIEGEL ONLINE: What do you mean by that?

Ritschl: The Greeks are very well aware of the antagonistic articles in the German media. If the mood in the country turns, old claims for reparations could be raised, from other European nations as well. And if Germany ever had to honor them, we would all be taken the cleaners. Compared with that, we can be grateful that Greece is being indulgently reorganized at our expense. If we follow public opinion here with its cheap propaganda and not wanting to pay, then eventually the old bills will be presented again.

Not at this time=Never ever!

To be expected:

Bundesbank President Jens Weidmann and Executive Board member Sabine Lautenschlaeger were against implementing QE now, according to euro-area central-bank officials. Klaas Knot of the Netherlands, Ewald Nowotny of Austria and Estonia’s Ardo Hansson also expressed reservations against starting the program at this time, the people said, asking not to be identified because the deliberations were private.

I can understand the “northern”, but what the heck is little Estonia, who came into the club only recently (January 11), playing “holier than thou”. In particular, since joining up, its inflation has “dived” while aggregate nominal spending has “jived”.




Monetizing Tax Revenues: A New Calling For Central Banks?

A Benjamin Cole post

The Swiss National Bank gave up trying to peg the Swiss franc to the Euro, and let the Swiss currency shoot to the moon. Some bankers were squeamish about a large SNB balance sheet, which the bank was garnering by printing Swiss francs and buying non-Swiss bonds.

In the U.S. also, there are pundits sweating about the large U.S. Federal Reserve balance sheet, though why remains inexplicable.

Still, there is another way, if we borrow a page from David Beckworth, market monetarist blogger, and economics professor at Western Kentucky University.

Beckworth has mulled simply sending QE-financed money to people who pay income taxes—a helicopter drop—although a tax cut amounts to much the same thing. (Tax cuts may even garner right-wing backing).

QE-financed tax cuts strike me as the best way to deploy QE, and the best way for the SNB to lower the exchange rate of their currency, if that is what they really think they should do.

Tax Holiday

Suppose the Swiss national government simply declared a tax holiday, and that the “lost” revenues would be made up by having the SNB print up (digitize) the money and toss the new booty into Swiss national government coffers?

For the Swiss economy, such a tax break would be a huge shot in the arm, to say the least. Taxpayers would actually get to benefit from their overpriced currency.

That started, the SNB should provide guidance, as in: “We will keep printing up tax revenues until we see the Swiss franc fall 30% against the Euro. Only then will we stop our QE-tax program, though we may taper slowly to make sure the Swiss franc does not rise again.”

Seems to me this would work.

Indeed, a version of this plan seems like a good idea in the United States as well. In times of economic weakness, eliminate Social Security and Medicare taxes (called FICA taxes, they are a 15.2% levy on wages) and simply have the Fed print the money and compensate the Social Security and Medicare trust funds for lost revenue.

Again, the Fed could provide guidance, as in, “We will keep pouring money into the Social Security and Medicare trust funds until nominal GDP grows at 6% or more for eight straight quarters.”

My guess is the U.S., with lowered business costs from the FICA cuts, would experience the Mother of all Recoveries, and not much inflation either.


Set aside disagreements for a moment, and grant that variations of the Beckworth idea—helicopter drops or tax cuts married to QE—are “right.” That they would work.

Then consider if our governments, laws and regulations are set up to accomplish such a plan. Could the Fed do it? Would the Fed marry QE to tax cuts? Can the SNB do it, or the ECB? (The SNB, operating within the already confused Swiss national government, strikes me a hydra-headed monster, partly reporting to cantons, or canton banks, and then to shareholders too. This is a central bank?)

We may have the wrong institutional structures in place (especially the Swiss).

Like insisting on a horse cavalry heading into WWI.

“Incestuous mafias”

In “Insiders, outsiders and monetary policy”, Krugman “sets the scene”:

I ran into Olivier Blanchard over breakfast the other day. This isn’t as prosaic as it sounds, because we were both in Hong Kong. On the other hand, that in turn isn’t as much of a coincidence as it might seem, because there was a big financial conference here, and the set of economists who get invited to such things isn’t that extensive. More broadly, many of the people who either make monetary policy or comment on it from fairly influential perches are members of what you might call the 1970s Cambridge mafia. Olivier, Ben Bernanke, Ken Rogoff, Mario Draghi, and your truly all overlapped at MIT in the mid-70s; Larry Summers was at Harvard at the same time, taking courses at MIT; just about everyone was Stan Fischer’s student.

He says he´s not being pretentious:

I mention this not to claim membership of an exclusive club, but by way of noting that most of this group shares fairly similar views about how policy works.

The pretense, in fact, is so big that he misses the wider implication, which is that they are collectively responsible for the monetary policy that gave us the “long depression”!

Mafias are never good. As Krugman himself recognizes, they tend to be “incestuous”!

Incestuous MP

Germany´s reluctance…

Shortly before the “curtain opened”:

Although some eurozone countries are critical of ECB concessions to Berlin, in Germany itself there is still strong opposition to the very idea of QE. Speaking in front of Mr Draghi and hundreds of other guests at a finance industry reception on Monday, Ms Merkel warned against using monetary policy to let governments in vulnerable economies off the hook over reforms.

She said: “One must prevent the dealings of the ECB from easing the pressure for improvements in competitiveness.

In fact she wants to “keep them thirsty”:


And when the “curtain finally opened”:

Twenty percent of the additional purchases will be subject to risk-sharing arrangements, designed to limit the amount of risk the ECB takes on to its balance books. The majority of risk will remain with euro zone national central banks.