It’s getting harder to be a contrarian
Back in 2009 I enjoyed playing the role of the contrarian. But these days it’s getting harder and harder to shock people with outrageous assertions, given that Fed officials are saying the same things:
DES MOINES, Iowa (Reuters) – The best way to set the stage for an eventual return to higher interest rates is, paradoxically, to keep rates low for now, a top Federal Reserve official said on Thursday.
If the Fed were to raise rates too soon, “what would happen is the economy would slow and we’d find ourselves in another tailspin,” Chicago Federal Reserve Bank President Charles Evans told the CFA Society of Iowa.
. . .
It would be a “big mistake” to withdraw the Fed’s easy-money policy too soon, he said, as some other central banks, including the Bank of Japan, have done.
That’s right. Japan’s persistent ultra-low rates mean money HAS BEEN too tight—just as Milton Friedman told us back in 1997
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1. March 2013 at 06:50
Oh! This reminds me of a Forbes from September piece I had downloaded. Glad I kept it.
Says Tim Lee:
I’ve posted it before, but in honor of yesterday’s announcement of monetary easing by the Federal Reserve, I think it’s worth repeating Milton Friedman’s analysis of the Japanese recession of the 1990s:
“”In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.
The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy.””
This quote almost perfectly mirrors the situation the United States has found itself in since 2008. Zero interest rates have fooled a lot of people, such as the Wall Street Journal editors, into thinking monetary policy is loose. But in reality, it’s been tight, as indicated by the below-target inflation rate.
Note also Friedman’s advice that Japan adopt quantitative easing “until the high powered money starts getting the economy in an expansion.” That’s the key difference between past rounds of quantitative easing””which involved fixed dollar amounts for limited periods of time””and yesterday’s open-ended commitment to buy assets until the economy recovers.
Easy money? Hm.
1. March 2013 at 07:22
How would the Fed raise rates now? What exactly would they do, in terms of OMOs?
1. March 2013 at 07:32
Wouldn’t not buying assets raise rates? And, this is just a guess don’t know if it’s right, but I think decreasing the capital reserve ratio would increase rates.
When you increase CRR, you create a captive demand, of sorts, for liquid capital – Treasuries are a good place to go. By decreasing this, as long as banks are lending (which it seems they are starting to do), one might expect banks to drop these increasing rates.
Don’t even know if that’s good theory, makes sense in my head now.
1. March 2013 at 07:33
If you’re talking about nominal interest rates, the paradoxical effect of intentional central bank interest rate changes is a direct (and pretty obvious) implication of any kind of neo-Wicksellian model, including standard new Keynesian models. It’s kind of surprising that it would even be controversial, let alone considered outrageous. (I think it’s also true of real interest rates, but this is less obvious.)
1. March 2013 at 07:37
“Japan’s persistent ultra-low rates mean money HAS BEEN too tight”
What about persistently declining interest rates in an environment of relatively stable NGDP growth?
What does that signal regarding monetary policy?
1. March 2013 at 07:38
Ashok, Good point.
Geoff, Sell bonds or raise IOR.
Andy. That’s right. I was shocked in late 2008 by the stuff I was reading, which is why I got into blogging. Why was it controversial? In early 2009 the view that the Fed could and should do more was considered a bit wacky.
I agree it applies to real rates as well.
1. March 2013 at 07:38
Geoff, Stable monetary policy (assuming NGDP growth is stable.)
1. March 2013 at 07:43
Ashok:
“Wouldn’t not buying assets raise rates? And, this is just a guess don’t know if it’s right, but I think decreasing the capital reserve ratio would increase rates.”
Not buying assets would make money tighter, wouldn’t it? If so, wouldn’t that decrease rates further?
Seems like in order to raise rates, the Fed would have to increase the extent of its OMOs.
But then what if the effect of larger reserves has a non-linear effect on the supply of bank credit issuance, such that credit significantly expands, which does not raise rates, but pulls rates down?
I think the Fed would have to increase the price inflation of consumer goods before borrowers and lenders agree to higher rates. If the Fed inflates, and it mostly affects bond prices and stock prices and other non-consumer good prices, then it’s easing will lower rates, not raise them.
1. March 2013 at 07:44
“Japan’s persistent ultra-low rates mean money HAS BEEN too tight””just as Milton Friedman told us back in 1997”
Tautology as usual. You can only designate money as “tight” after the fact. Crisis = money has been tight a couple of years earlier. Useless construct.
1. March 2013 at 07:46
Dr. Sumner:
“Geoff, Stable monetary policy (assuming NGDP growth is stable.)”
Would it be possible that interest rates are declining because of monetary policy in some way, even while NGDP growth is stable?
1. March 2013 at 07:47
Dr. Sumner:
“Geoff, Sell bonds or raise IOR.”
Wouldn’t that tighten money further, which would lead to even lower rates, since low rates are usually a signal that money has been too tight?
1. March 2013 at 07:49
Geoff:
If Fed doesn’t buy Treasuries, someone else has to buy them, for which yields may have to increase, so I thought rates would increase? It’s the equivalent of just selling bonds.
Not sure about the CRR – was just a guess, I’m sure there are lots of non-linear actions that would make this false.
1. March 2013 at 08:07
Ashok:
“If Fed doesn’t buy Treasuries, someone else has to buy them, for which yields may have to increase, so I thought rates would increase? It’s the equivalent of just selling bonds.”
This assumes the rate of bond issuance will remain unchanged. But if the Fed stops buying bonds, the rate of bond issuance would likely change as well, so I don’t think it’s as clear cut.
1. March 2013 at 08:36
Geoff wrote:
“Wouldn’t that tighten money further, which would lead to even lower rates, since low rates are usually a signal that money has been too tight?”
Did the tighenting the occured during the Volcker era lead to persistently lower rates in the Greenspan era? This doesn’t seem controversial or difficult to grasp.
1. March 2013 at 09:43
Bernanke said the same thing in his House testimony:
“The best way to get sustainable high returns to savers is to get the economy back to running on all cylinders. It’s somewhat paradoxical, but in some ways the best way to get interest rates up is to not raise them too quickly, because by keeping rates low, now, we can help the economies get stronger, we can create more jobs, we can create more momentum in the economy, that’s the way to get a sustainable higher set of interest rates. Until we can get greater
forward momentum, we are not going to get sustainable higher returns.”
“One of the paradoxes is that the best way to get interest rates up is to have low interest rates, because that promotes a stronger growing economy and that causes interest rates to rise. In some ways the fact that interest rates have gone up a bit, and it happens on the real not the inflation side, is actually indicative of a stronger economy, which again suggests that maybe this is having some benefit.”
i.e.: QE raises interest rates.
1. March 2013 at 12:23
Obviously the long run impact being the opposite of the short run effect is too complicated for most people to understand. Why would they ever think beyond the short run?
1. March 2013 at 15:53
OhMy, Not at all–if inflation had been high then Friedman’s hypothesis would have been refuted.
Geoff, You said;
Would it be possible that interest rates are declining because of monetary policy in some way, even while NGDP growth is stable?”
No.
On your other question, yes, higher short term rates might well reduce long term rates.
Thanks NW.
1. March 2013 at 20:07
Progress, but they still insist that they are in fact running an easy money policy, and that contractionary OMOs would merely “slow” the economy.
Scott, isn’t Geoff right about rates, there could be a liquidity effect without an NGDP effect? Not the case right now, but still.
2. March 2013 at 12:27
Dr. Sumner:
“Would it be possible that interest rates are declining because of monetary policy in some way, even while NGDP growth is stable?””
“No.”
Why not?
“On your other question, yes, higher short term rates might well reduce long term rates.”
I was actually asking whether or not reducing the extent of OMOs would reduce interest rates as such, which includes short term rates, because reducing the extent of OMOs would mean tighter money, and I was under the impression that tighter money reduces rates as such, not just long term rates.
Short term rates are low now because of tight money, correct?
Michael:
“Did the tighenting the occured during the Volcker era lead to persistently lower rates in the Greenspan era? This doesn’t seem controversial or difficult to grasp.”
Why are you assuming that the argument “lower rates means money has been tight” means you can compare Greenspan era Fed to Volcker era Fed. Does the “has been tight” go back 5 years or more?
It sure is difficult to grasp, not because it’s inherently difficult though. The difficulty I think lies elsewhere…
2. March 2013 at 15:24
Saturos, One step at a time.
Geoff, Short term rates are low because money was tight in the past. Long term rates are low because money is tight right now.
2. March 2013 at 16:00
Dr. Sumner:
“Geoff, Short term rates are low because money was tight in the past. Long term rates are low because money is tight right now.”
Isn’t tight money and loose money ALWAYS historical?
Bernanke’s activity “today”, and before, is all historical. When you are saying money “is” tight, you’re talking about yesterday, the day before, the day before that, and so on.
If the Fed stopped, or reduced its OMOs, “today”, then that would become historical. Money would be in a “has been” tight situation.
Why doesn’t Fed activity today and the last few days become “historical” tightness that lowers both short and long term rates? Doesn’t MM assume that market rates “immediately” adjust to Fed policy?
7. March 2013 at 11:49
I would argue that many finance people were actually aware of tight FED policy in 2008/09 exacerbating the crisis. I just stumbled over an analyst by Dresdner Kleinwort (an investment bank) from Dec. 2008 that said the following:
“Despite central banks around the globe slashing policy rates, they fail to ‘ease’ monetary policy sufficiently to account for the unfolding dire macroeconomic realities. …Crucially for rates and curves, before the ECB can expand its balance sheet further, it would be well-advised to slash short-term rates closer to zero, and even a change in its operational target should not be excluded categorically!”
I sometimes wonder if many people close to the markets (even economists) understand your view at the level of gut instinct but when they try and write down/say why they think this way, they remain stuck in an economic framework that they learned during gold standard times.
How do you think it happens that the market prices are market monetarist in their reactions to monetary policy, but few pundits and analysts seem to espouse market monetarist views in the media? Are news organizations anti-market-monetarists?