Monetary offset in Fedspeak
From the Fed statement, emphasis added:
Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.
Translation: “We are determined to hit our growth and inflation targets. Because of fiscal retrenchment there is a danger we will fall short. Thus we will not do the taper that everyone expected, because doing so would allow fiscal policy to actually move RGDP growth and inflation away from where we want them. And that’s not acceptable. With all due respect to Congress and the President, it’s our job to control inflation and growth. We won’t taper until we can do so and still hit our targets.”
Shorter version: The fiscal multiplier is zero.
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18. September 2013 at 12:13
Translation of your translation:
“We are determined to FALL SHORT of our growth and inflation targets. Because of fiscal retrenchment there is a danger we will fall EVEN SHORTER THAN WE WOULD LIKE. Thus we will not do the taper that everyone expected, because doing so would allow fiscal policy to actually move RGDP growth and inflation away from where we want them. And that’s not acceptable. With all due respect to Congress and the President, it’s our job to control inflation and growth. We won’t taper until we can do so and still FALL SOMEWHAT SHORT of our targets.”
18. September 2013 at 12:19
I liked your other version of it as well. The fiscal multiplier as the estimate of the Central Bank’s incompetence.
18. September 2013 at 12:19
Yglesias has some positive things to say about fiscal deficits: http://www.slate.com/blogs/moneybox/2013/09/18/fed_faq_tapering_questions_and_answers.html
18. September 2013 at 12:43
Considering that the economy is not as strong as the Fed expected it to be, low employment rates and super-low inflation, plus the (probably) upcoming extra round of fiscal tightening, one would have expected the Fed to ease monetary policy.
Instead, we get the status quo (albeit expectation did change). I have this impression we are congratulating Bernanke for not pulling a 2011 ECB on the US. The bar seems quite low for monetary policy these days, in my opinion.
18. September 2013 at 12:51
Saturos,
From your link to MattY: “Public policy ought to ensure that this government debt is around in ample supply.”
I’ll go out on a limb and say this ain’t gonna be a problem in my lifetime, but Matt interprets this as ‘fiscal stimulus now’. Hmmm.
18. September 2013 at 13:00
LK,
This WAS an easing of policy,in the sense than most people expected a tighter policy (the taper).
18. September 2013 at 13:32
On Fed days, I just feel the insanity and wasted potential of Fed-ology. It’s so stupid, it hurts.
This concentration of power, that is governed by seven-to-twelve people’s judgement, has no place in a constitutional republic.
18. September 2013 at 13:57
Guys, MM could really make some gains here with a credible answer / argument:
Using NGDPLT will make tapering easier.
If it actually can make this argument, it feels like one that might appeal to people freaking that the Fed might not be able to stop.
18. September 2013 at 14:20
[…] Sumner, “Monetary offset in Fedspeak”（TheMoneyIllusion, September 18, […]
18. September 2013 at 14:29
Translation of your translation: We asked Congress for help in boosting the economy, but Republicans are not cooperating. We will not allow their attempted sabotage to succeed. Monetary policy can overcome fiscal policy, but only if absolutely necessary.
18. September 2013 at 14:35
“Monetary policy can overcome fiscal policy, but only if absolutely necessary.”
Why the “but only if absolutely necessary.”? Monetary policy can overcome fiscal policy, therefore using deficits to attempt to boost AD is not only useless, it adds to our national debt and future interest payments.
18. September 2013 at 15:02
The Chicago Plan Revisited
Jaromir Benes and Michael Kumhof
http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf“Ž
18. September 2013 at 15:04
From Benes & Kumhof – The Chicago Plan Revisited
At the height of the Great Depression a number of leading U.S. economists advanced a
proposal for monetary reform that became known as the Chicago Plan. It envisaged the
separation of the monetary and credit functions of the banking system, by requiring 100%
reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this
plan: (1) Much better control of a major source of business cycle fluctuations, sudden
increases and contractions of bank credit and of the supply of bank-created money.
(2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt.
(4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims by embedding a comprehensive and carefully calibrated
model of the banking system in a DSGE model of the U.S. economy. We find support for all
four of Fisher’s claims. Furthermore, output gains approach 10 percent, and steady state
inflation can drop to zero without posing problems for the conduct of monetary policy.
18. September 2013 at 16:29
Something does not click here…if QE works and the economy has been at or near ZLB, then one should expect higher interest rates.
Also, seems to me bondsellers (to the Fed) now have immediate claim on output (they can buy stuff) and so this is good for AD. This is not explained. Bondsellers can also invest in stocks or property, also good. The only dead spot is if bondsellers put he money into banks and banks sit on it to collect IOER. So do more QE.
I think the Fed explanation of QE is weak and thus not convincing and lacks guidance.
18. September 2013 at 17:06
Scott,
Questions: is the fiscal multiplier zero, in your view, because the Fed will always offset it? Does the Fed have a choice as to whether to offset fiscal policy changes or not?
18. September 2013 at 17:54
Why rates go up when Fed balance sheet expansion slows? Pretty simple. If QE is slower than NGDP, then rates go up.
http://research.stlouisfed.org/fred2/graph/?g=mxp
18. September 2013 at 17:55
Maybe important. According to Bloomberg, Bernanke said today a “floor” on inflation was a worthy consideration and maybe should be made part of guidance.
The problem as I see it…any floor below 2 percent is risky, one stumble away from ZLB…so the floor and the target and the ceiling all fall at 2 percent…deuces wild!
18. September 2013 at 18:02
Michael, Yes, even better.
Saturos, Most of that Yglesias post was quite good.
LK, Very good point.
Morgan, Good point.
Greg, No, the Fed will not always offset fiscal policy. Look at WWII.
Benjamin, Interesting, but the key question is what happens if inflation falls through the floor? Level targeting?
18. September 2013 at 18:31
Scott,
“No, the Fed will not always offset fiscal policy. Look at WWII.” In other words, the fiscal multiplier is only zero if the Fed decides to make it zero. This proposition is quite different than simply saying “the fiscal multiplier is zero.”
Why not coordinate monetary and fiscal policy?
18. September 2013 at 18:44
“even if the interest rate channel is less powerful right now than it was before the crisis, asset purchases still work to support economic growth through other channels, including by boosting stock prices and house values. The resulting improvement in rich people’s wealth supports greater consumption spending.”
‘Janet Yellen’
http://www.federalreserve.gov/newsevents/speech/yellen20130302a.htm
18. September 2013 at 18:56
Philippe,
Yellen’s speech actually reads:
“The resulting improvement in household wealth supports greater consumption spending.”
This is not the first time I’ve noticed you lying, propagandizing or libeling here, or elsewhere.
18. September 2013 at 19:21
Obviously Yellen wouldn’t say ‘rich people’ in a speech, would she.
Goddamit you’re thick.
18. September 2013 at 19:29
btw the Fed refers to hedge funds as ‘households’.
18. September 2013 at 19:33
What’s the point of polluting comment threads with stuff like that? Is supposed to be funny?
18. September 2013 at 20:03
I’m working my way through your “Quick Intro to My Views” posts. I can’t remember if you said you are going to try to publish a book on based on those posts? Are you working on one?
I don’t know if I will be able to get to a real in-depth level of understanding or measure of confidence of your views from these posts alone, given my limited economic educational background. A real help would be if you always defined every acronym and variable in each and every post. I am always going to Google search to remind myself what a letter or acronym stands for. Anyone taking or teaching econ classes will not need this, but I sure do. I’d like to see more examples of the same principals, the same story told three or four different ways. Something like Adam Smith repeating arguments for free trade several times in a row using different assumptions of relative advantages. You believe all recessions/depression are due to too tight money. A few different examples running from 1800’s panics to the present time with different initial triggers would help illustrate that view. But that would require a book level treatment.
18. September 2013 at 20:29
Yellen becomes Fed Chair…
I really think her biggest gnarly question is to “how to end the taper” and her best answer is we are moving to a new target… NGDPLT.
The regime change isn’t just a new policy, its a new policy that has specific rational answer to a question everyone else is now struggling with.
What MM econos should be doing is the mechanization of the policy rule into A/B choices.
Example: we set a 2% make up, and each month the level grows at annual 4.5% , and the Fed will now hit that target FAST, bc hitting it FAST, means the SOONER we hit it, the faster QE ends, and faster rates gets raised.
It’s the rip off the band-aid story. Conservatives like to rip off bandaids.
Whats interesting is PK likes to rip off bandaids too, but he thinks it takes $2T in new Federal Spending.
If Yellen gets it, PK might have to choose between a pure MM band-aid rip, or none.
18. September 2013 at 20:29
Philippe,
“btw the Fed refers to hedge funds as ‘households’.”
Hedge funds are not required by law to file any documentation on their assets or asset values. Thus the Federal Reserve flow of funds cannot separate these financial intermediaries from the household sector.
Change the law and the Federal Reserve will be able to move hedge funds from the household to the financial sector.
18. September 2013 at 20:45
“…boosting stock prices and house values. The resulting improvement in rich people’s wealth…”
Well, now we know that only “rich people” own homes and have have savings in 401(k)s and IRAs.
Learn something new every day. Thanks!
18. September 2013 at 20:47
Greg Hill: “The fiscal multiplier is zero.”
Only for a competent central bank. As has been said many times, the more accurate quote is: “the fiscal multiplier is an estimate of central bank incompetence.”
“Why not coordinate monetary and fiscal policy?”
Because monetary policy is sufficiently powerful (and quick enough), to achieve whatever outcome it wants, regardless of any change in fiscal policy. Hence no coordination is necessary.
19. September 2013 at 03:00
Don Geddis,
One could add that coordination may disrupt all the other things that fiscal policy can do but which monetary policy can’t do (or can’t do as well).
19. September 2013 at 04:05
Essayist-Lawyer:
Translation of your translation: We asked Congress for help in boosting the economy, but Republicans are evil. They say things like “But we’ve already put $17 trillion on the card and we’ve got this demographic entitlement wave a-coming (have you seen the CBO forecasts? State pension forecasts?) and taxes are historically at least ‘fair’ in terms of high and progressive already, so, as much as I like to stick it to the next generation, we’re painting ourselves into a corner already without any more of your fairy tale spending plans, so…”
19. September 2013 at 04:51
Morgan,
I hope you’re right that Yellen will be that aggressive but I doubt she will be.
I agree with you that Krugman is wrong about the importance of government spending, though.
19. September 2013 at 04:59
Don, I might be misreading your quote, but if monetary policy is so powerful why do we have such a lousy emplyment situation? Still stuck at 7% with the worst particiption rate in a long time. Housing is stalled. GDP growth is poor and slowing (it did get a little boost from change in methodology recently). Whatever recovery we did have was from fiscal deficits. Now that those deficits are shrinking, the economy is slowing. We will be in recession sometime next year if decificts continue to shrink, and QE whatever will not save us.
19. September 2013 at 05:06
Greg Mankiw says a lot of helpful things in this interview with Larry Kudlow:
http://gregmankiw.blogspot.com/2013/09/i-talk-with-larry-kudlow.html
19. September 2013 at 05:12
Mankiw: “If unemployment were high for structural reasons, then inflation would be higher than it is.”
19. September 2013 at 05:29
I would be interested in your take on the following – Bernanke seems to be saying that the Fed would be unable to offset the effects of a debt ceiling crisis:
A factor that did concern us in our discussion was some upcoming fiscal policy decisions. I would include both the possibility of a government shutdown, but also the debt limit issue….I think that a government shutdown, and perhaps even more so a failure to raise the debt limit, could have very serious consequences for the financial markets and for the economy.
….Our ability to offset these shocks is very limited, particularly a debt limit shock, and I think it’s extraordinarily important that Congress and the administration work together to find a way to make sure that the government is funded, public services are provided, that the government pays its bills, and that we avoid any kind of event like 2011, which had, at least for a time, a noticeable adverse effect on confidence on the economy.
19. September 2013 at 06:00
Greg, I meant the fiscal multiplier is zero right now. You coordinate policy by having the Congress adopt the optimal fiscal policy on strict cost/benefit considerations, and the Fed target NGDP.
Philippe. If you are going to make up quotations then people will just ignore you.
JAS I don’t believe all recessions are due to tight money. I’ll try to avoid acronyms, but keep in mind that the audience for this blog is primarily people who already have studied monetary economics. It’s not aimed at laymen. If laymen tune in that’s great, but I can’t always explain things from first principles in each post.
Andrew, Yes, in the very short run monetary policy is unlikely to offset fiscal shocks. They can offset sensible fiscal actions, but not crazy fiscal actions. On the other hand, why would we want to do crazy fiscal actions? So that’s not an argument for activist fiscal policy.
19. September 2013 at 06:03
TravisV,
I don’t disagree.
I’m just saying that IF MM econos can make a credible claim on being the best answer for:
“how do we ever stop tapering”
or asserting “NDGPLT lets us taper / raise rates faster”
They ought to write it down, and explain it, bc lord knows thats going to be a very big concern at fed hearings, right?
19. September 2013 at 07:28
Scott, I know you were asking for TIPS breakeven inflation data a few days ago, following Summers’s withdrawal from Fed chair consideration. I do have some inflation swaps data. Inflation swaps are usually a little higher than TIPS breakevens due to some differences in financing rates between TIPS and nominal treasuries in the repo market.
The most pronounced change in inflation swap rates was in 1-2 yr forward inflation (expected inflation between Sep 2014 and Sep 2015). It rose from 1.80% to 1.95% between Friday 9/13 and Monday 9/16, coincident with the Summers withdrawal. As of Wednesday, it had risen to 2.18% in response to the Fed surprise non-tapering. So, overall in increase of 0.38% between Friday and Wednesday. Over that period, 0-1 yr inflation has not changed much (increased from 1.59% to 1.63%), nor has 2-5 yr inflation (decreased from 2.54% to 2.49%). 5-10 yr inflation has increased from 2.70% to 2.93%.
19. September 2013 at 07:36
Matt McOsker,
“Whatever recovery we did have was from fiscal deficits. Now that those deficits are shrinking, the economy is slowing.”
In my opinion the most objective way of measuring fiscal policy stance is the change in the general government cyclically adjusted balance, particularly the cyclically adjusted primary balance (CAPB). The cyclically adjusted balance takes into account any changes in the general government budget balance due to the business cycle. Thus changes in the cyclically adjusted balance are mostly due to discretionary fiscal policy, and consequently may be taken as a proxy for the degree of fiscal stimulus. The CAPB goes a step further, factoring out changes in net interest on government debt and thus ensuring that practically all of the changes in fiscal balance are discretionary in nature.
You can find estimates of the CAPB in the IMF Fiscal Monitor which comes out twice a year. The CAPB for the Advanced Economies are on the bottom half of Table 2:
http://www.imf.org/external/pubs/ft/fm/2013/01/pdf/fm1301.pdf
The US CAPB was (-6.7%), (-5.7%) and (-4.4%) of potential GDP in calendar years 2010, 2011 and 2012. It is forecast to rise to (-2.7%) of potential GDP in 2013.
Thus the change in CAPB was 1.0% and 1.3% of potential GDP in 2011 and 2012 and is forecast to be 1.7% of potential GDP in 2013. Thus fiscal policy has already been a drag on the economy for three years now.
19. September 2013 at 09:49
I don’t like that the Fed didn’t taper. However, this announcement does make sense if you have a fiscal contraction on the other side by Congress. I don’t know if that will actually be the case, but we’ll see.
19. September 2013 at 12:45
Obviously “the Fed matters.”
And obviously “the Congress should matter.”
But its all tied up in re-election politics and big money, thus the “fiscal policy headwinds” that are counter-productive.
So who benefits by that anti-government group that is holding the Congress and the country hostage? The same group that benefits by deregulation, flatter income taxes, and higher interest rates for everyone else. Guess who? Hint: they make over $1 million per year. Frankly, their is no solution as long as people can still get their checks, so a shut down seems certain, while the only thing worrying those that are driving it, are the blame games.
Macroeconomic modeling ignored technology for decades, until Romer. Now they are ignoring super-greed. Adam Smith assumed morality before he showed the way to monopoly capitalism. Hayek assumed evil centralism as the enemy of freedom. Both were wrong. Now what is the fix? I vote for technology, randomized congressional district map-making. And regulated financial transactions with appropriate lags in closing, and tiny tax on each transaction, globally, by Basel-style agreement. If Fed matters, then BIS matters, and Basel III and IV matter. If Congress matters, then technology-based fairness and speed of execution on voting matters. If income disparity is based mostly on inherited wealth, assure that it is taxed globally. Comments? Economists must address “morality” and “fairness” and “technology” or remain backward looking modelers. There is no rational market. And disparity of wealth has its limits, where violence gets to vote.
19. September 2013 at 17:44
Matt McOsker: “why do we have such a lousy employment situation?”
Because the Fed failed to stabilize NGDP growth in 2007/2008 (and since then, has not recovered the level to the previous trend line).
So the value of the medium of account (the dollar) rose swiftly, which meant that all prices economy-wide were suddenly too high. Many prices adjusted downward quickly, but wages are very sticky in the downward direction. As with any commodity market where prices are too high, the result is an excess supply of labor that is stuck in “inventory” and doesn’t “sell”.
“Whatever recovery we did have was from fiscal deficits.”
Nope. Fiscal activity has been very volatile in the last few years, but the Fed has offset essentially all fiscal actions.
19. September 2013 at 19:12
Scott: “You coordinate policy by having the Congress adopt the optimal fiscal policy on strict cost/benefit considerations, and the Fed target NGDP.”
This sounds appealing, but even “strict” cost/benefit analysis requires a few macroeconomic assumptions. For example, if you assume “full employment” (tight labor markets) the cost of a particular public investment project will be higher than it will be in the case of significant unemployment (slack labor markets). In the latter case, the benefits generated by the project will be higher if income externalities are included (aka the multiplier).
If you assume the FED is successful in achieving its NGDP target, and if this target entails tight labor markets, then standard CBA (with no income externalities) may give you the result you’re looking for. But if fiscal policy makers are less sanguine about the effectiveness of NGDP targeting, then they’re faced with a more difficult analytical task.
Re: zero fiscal multiplier. There are many studies claiming to show that there’s a statistically significant correlation between changes in a country’s cyclically adjusted (structural) budget balance and its growth rate (see Menzie Chinn, PK, et al). Are these findings consistent with “monetary offset”? Do these studies have a common flaw?
20. September 2013 at 13:44
Greg Hill: “then they’re faced with a more difficult analytical task.” No, that’s the whole point of “coordinating” by division of labor. Fiscal authorities should act as though NGDP will stay on trend. If it doesn’t, you blame the central bank, not the fiscal authorities. They need never concern themselves about a possible multiplier.
“Do these studies have a common flaw?” Only your interpretation does. The problem, of course, is that most central banks don’t in fact do NGDPLT. So they make monetary policy errors all the time. So a fiscal multiplier can be observed, because most central banks do a poor job of making fiscal stimulus irrelevant (which would have been a much better policy).
20. September 2013 at 17:34
I still don’t get this argument-probably never will, not for lack of trying. What the Fed is also saying is:
“If not for fiscal contraction (the sequester) we would taper.”
When you say: ” We won’t taper until we can do so and still hit our targets.”
Another translation is “If the sequester ended tomorrow we could taper tomorrow.’
The sequester and tapering is not their preferred optimum policy. To the contrary, optimum is tapering and no sequester.
Then too, it’s not clear that the Fed has wholly offset fiscal policy. You seem to think it has as growth and employment have not declined since last year. Still, this year was supposed to be better than last anyway.
There’s no way to definitively show that if there had been no sequester we wouldn’t have higher jobs and growth-certainly you can’t tell just by looking at recent history.
20. September 2013 at 18:46
Thanks BC.
Greg, You asked:
“Are these findings consistent with “monetary offset”? Do these studies have a common flaw?”
Yes, they have a common flaw of ignoring monetary offset. But Krugman brags that he doesn’t read conservatives, so he doesn’t know about this embarrassing flaw in the studies he keeps citing. Lots of other people do know, however.
Mike, I didn’t think this year would be better than last year. I warned the Fed, but they didn’t listen.