Wednesday, May 4, 2016

Central Bank Governance and Oversight Reform

The Hoover Institution Press just published "Central Bank Governance and Oversight Reform," the collected volume of papers, comments, and discussion from last May's conference here by the same name. You can get the  book or e-book here at the Hoover press or here at amazon.com. The individual chapter pdfs are available here.  Press release here.

(My modest contributions are in the preface and a discussion of Paul Tucker's Chapter 1. I agree it would be nice to have a more rule-based approach to lender of last resort and bailout functions, but wouldn't lots of equity so you don't have to mop up so often be even better?)

This is part of an emerging series of monetary policy conferences at Hoover. Tomorrow we will have a conference on international monetary policy. Stay tuned...


Tuesday, May 3, 2016

Growth Interview


I did a short interview with the WSJ's Mary Kissel about my growth oped. If you can't see the embed above, try this direct link or this one

WSJ Growth Oped

I did an oped on growth in the Wall Street Journal, titled "Ending America’s Slow-Growth Tailspin." I'll post the full thing here in 30 days.

Blog readers will recognize a distilled version of my longer essay on growth (blog post herehtml here,   pdf here), and the graph from Smith v. Jones blog post. I think out loud. The growth essay is much more detailed on diagnosis and especially on policy.

There are three basic ideas (two too many for a good oped).

1) Growth is everything. Increasing growth will do way more for every problem you can name than anything else on the economic agenda. Even if workers in 1910 could have taken all of Rockefeller's wealth, they would have been disastrously poor compared to today.

2) Can policies actually improve growth? The tut-tutters mocked Jeb Bush's 4% aspiration. I outline the "we've run out of ideas" school of thought, most recently in Bob Gordon's thoughtful book; the "everything is right but the zero bound" secular-staglation school, and the view that the growth giant is being held back by a liliputian army of politicized regulators.

As evidence,  I improved on the graph from an earlier post of the World Bank's ease of doing business score vs. GDP per capita,


Saturday, April 30, 2016

Equity-financed banking

My dream of equity-financed banking may be coming true under our noses. In "the Uberization of banking" Andy Kessler at the WSJ reports on SoFi, a "fintech" company. The article is mostly about the human-interest story of its co-founder Mike Cagney. But the interspersed economics are interesting.

SoFi started by making student loans to Stanford MBAs, after figuring out that the default rate on such loans is basically zero. It
has since expanded to student loans more generally and added mortgages, personal loans and wealth management. Mr. Cagney says SoFi has done 150,000 loans totaling $10 billion and is currently at a $1 billion monthly loan-origination rate. 
Where does the money come from?
SoFi doesn’t take deposits, so it’s FDIC-free. ... Instead, SoFi raises money for its loans, most recently $1 billion from SoftBank and the hedge fund Third Point, in exchange for about a quarter of the company. SoFi uses this expanded balance sheet to make loans and then securitize many of them to sell them off to investors so it can make more loans
Just to bash the point home, consider what this means:
  • A "bank" (in the economic, not legal sense) can finance loans, raising money essentially all from equity and no conventional debt. And it can offer competitive borrowing rates -- the supposedly too-high "cost of equity" is illusory.
     
  • There is no necessary link between the business of taking and servicing deposits and that of making loans. Banks need not (try to) "transform" maturity or risk.
     
  • To the extent that the bank wants to boost up the risk and return of its equity, it can do so by securitizing loans rather than by borrowing. (Securitized loans are not leverage -- there is no promise of your money back when you want it. Investors bear any losses immediately and without recourse.)
     
  • Equity-financed banking can emerge without new regulations, or a big new Policy Initiative.  It's enough to have relief from old regulations ("FDIC-free").
     
  • Since it makes no fixed-value promises, this structure is essentially run free and can't cause or contribute to a financial crisis. 

Tuesday, April 26, 2016

Macro Musing Podcast

I did a podcast with David Beckworth, in his "macro musings" series, on the Fiscal Theory of the Price Level, blogging, and a few other things.



(you should see the link above, if not click here to return to the original).

You can also get the podcast at Sound Cloud, along with all the other ones he has done so far, or on itunes here.  For more information, see David's post on the podcast.

Monday, April 25, 2016

Blinder on Trade

Alan Blinder has an excellent op-ed in the WSJ on trade. It's hard to excerpt as every bit is good.
1. Most job losses are not due to international trade. Every month roughly five million new jobs are created in the U.S. and almost that many are destroyed, leaving a small net increment. International trade accounts for only a minor share of that staggering job churn. ...

2. Trade is more about efficiency—and hence wages—than about the number of jobs. You probably don’t sew your own clothes or grow your own food. Instead, you buy these things from others, using the wages you earn doing something you do better.  ...
3. Bilateral trade imbalances are inevitable and mostly uninteresting. Each month I run a trade deficit with Public Service Electric & Gas. They sell me gas and electricity; I sell them nothing....

4. Running an overall trade deficit does not make us “losers.”...

5. Trade agreements barely affect a nation’s trade balance. ..a nation’s overall trade balance is determined by its domestic decisions, not by trade deals... America’s chronic trade deficits stem from the dollar’s international role and from Americans’ decisions not to save much, not from trade deals. Trade deficits are not a major cause of either job losses or job gains. ...trade makes American workers more productive and, presumably, better paid.
One could say much more. Trade is not a "competition," for example. But,  having done this sort of thing, I'm sure lots of other good bits are on the cutting room floor.

Alan is more sympathetic to government "help" to trade losers, which I agree sounds nice if it were run by the benevolent and omniscient transfer payment planner, but I think works out poorly in practice when we look at the success or failure of actual trade adjustment programs. But that is a small nitpick.

Alan closes by wishing that Bernie Sanders and Donald Trump understood these simple facts a bit better. I think his list of politicians needing enlightenment could be a little longer. But he's courageous enough for speaking the kind of heretical truth that will come back to haunt him should he ever want a government job.

Saturday, April 23, 2016

Lessons Learned I

I spent last week traveling and giving talks. I always learn a lot from this. One insight I got:  Real interest rates are really important in making sense of fiscal policy and inflation.

Harald Uhlig got me thinking again about fiscal policy and inflation, in his skeptical comments on the fiscal theory discussion, available here. At left, two of his graphs, asking pointedly one of the standard questions about the fiscal theory: Ok, then, what about Japan? (And Europe and the US, too, in similar situations. If you don't see the graphs or equations, come to the original.) This question came up several times and I had the benefit of several creative seminar participants views.

The fiscal theory says
 \[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \frac{1}{R_{t,t+j}} s_{t+j} \]
 where \(B\) is nominal debt, \(P\) is the price level, \(R_{t,t+j}\) is the discount rate or real return on government bonds between \( t\) and \(t+j\) and \(s\) are real primary (excluding interest payments) government surpluses. Nominal debt \(B_{t-1}\) is exploding. Surpluses \(s_{t+j}\) are nonexistent -- all our governments are running eternal deficits, and forecasts for long-term fiscal policy are equally dire, with aging populations, slow growth, and exploding social welfare promises. So, asks Harald, where is the huge inflation?

I've sputtered on this one before. Of course the equation holds in any model; it's an identity with \(R\) equal to the real return on government debt; fiscal theory is about the mechanism rather than the equation itself. Sure, markets seem to have faith that rather than a grand global sovereign default via inflation, bondholders seem to have faith that eventually governments will wake up and do the right thing about primary surpluses \(s\). And so forth. But that's not very convincing.

This all leaves out the remaining letter: \(R\). We live in a time of extraordinarily low real interest rates. Lower real rates raise the real value surpluses s. So in the fiscal theory, other things the same, lower real rates are a deflationary force.

Tuesday, April 19, 2016

Chari and Kehoe on Bailouts

V. V. Chari and Pat Kehoe have a very nice article on bank reform, "A Proposal to Eliminate the Distortions Caused by Bailouts," backed up by a serious academic paper.

Their bottom line proposal is a limit on debt to equity ratios, rising with size. This is, I think, a close cousin to my view that a Pigouvian tax on debt could substitute for much of our regulation.

Banks pose a classic moral hazard problem. In a financial crisis, governments are tempted to bail out bank creditors. Knowing they will do so, bankers take too much risk and people lend to too risky banks. The riskier the bank, the stronger the governments' temptation to bail it out ex-post.

Chari and Pat write with a beautifully disciplined economic perspective: Don't argue about transfers, as rhetorically and politically effective as that might be, but identify the distortion and the resulting inefficiency. Who cares about bailouts? Well, taxpayers obviously. But economists shouldn't worry primarily about this as a transfer. The economic problem is the distortion that higher tax rates impose on the economy. Second, there is a subsidy distortion that bailed out firms and creditors expand at the expense of other, more profitable activities. Third there is a debt and size distortion. Since debt is bailed out but not equity, we get more debt, and the banks who can get bailouts become inefficiently large.

Saturday, April 16, 2016

A better living will


"US rejects 'living wills' of 5 banks," from FTWSJ puts this event in the larger story of Dodd Frank unraveling. Juicy quotes:
WSJ: “living wills,” ... are supposed to show in detail how these banking titans, in the event of failure, could be placed into bankruptcy without wrecking the financial system.

FT:...the shortcomings varied by bank but included flawed computer models; inadequate estimates of liquidity needs; questionable assumptions about the capital required to be wound up; and unacceptable judgments on when to enter banktruptcy.

FT: David Hirschmann of the US Chamber of Commerce, the biggest business lobby, said the living wills process was “broken”. “When you can’t comply no matter how much money you put into legitimately trying to comply, maybe it’s time to ask: did we get the test wrong?” he said.

WSJ: Six years after the law was passed, and eight years since the financial crisis, regulators given broad authority to remake American finance, with thousands of regulatory officials on their payroll, cannot figure out a system to allow financial giants to fail, even in theory. What are we paying these people for?
It seems like a good moment to revisit an idea buried deep in "Toward a run-free financial system."  How could we structure banks to fail transparently?

Wednesday, April 13, 2016

MetLife

What does "systemically important" mean? How can an institution, per se, be "systemically important?"  The WSJ coverage of Judge Rosemary Collyer’s decision rescinding MetLife’s designation as a "systemically important financial institution:" gives an interesting clue to how our regulators' thinking is evolving on this issue:
The [Financial Stability Oversight] council argued — bromide alert — that “contagion can result when relatively modest direct, individual losses cause financial institutions with widely dispersed exposures to actively manage their balance sheets in a way that destabilizes markets.”
It's not a bromide. It is a revealing capsule of how the FSOC headed by Treasury thinks about this issue.

Sunday, April 10, 2016

NBER AP

On Friday I attended the NBER Asset Pricing meeting (program here) in Chicago, organized by Adrien Verdelhan and Debby Lucas. The papers were unusually interesting, even by the high standards of this meeting. Alas the NBER doesn't post slides so I don't have great visuals to show you.

Tuesday, April 5, 2016

Next Steps for FTPL

Last Friday April 1, Eric Leeper Tom Coleman and I organized a conference at the Becker-Friedman Institute,  "Next Steps for the Fiscal Theory of the Price Level." Follow the link for the whole agenda, slides, and papers.

The theoretical controversies are behind us. But how do we use the fiscal theory, to understand historical episodes, data, policy, and policy regimes? The idea of the conference was to get together and help each other to map out this the agenda. The day started with history, moved on to monetary policy, and then to international issues.

A common theme was various forms of price-related fiscal rules, fiscal analogues to the Taylor rule of monetary policy. In a simple form, suppose primary surpluses rise with the price level, as
\[ b_t = \sum_{j=0}^{\infty} \beta^j \left( s_{0,t+j} + s_1 (P_{t+j} - P^\ast) \right) \]
where \(b_t\) is the real value of debt, \(s_{0,t}\) is a sequence of primary surpluses budgeted to pay off that debt, \(P^\ast\) is a price-level target and \(P_t\) is the price level. \(b_t\) can be real or nominal debt \( b_{t}= B_{t-1}/P_t\), but I write it as real debt to emphasize the point: This equation too can determine price levels \(P_t\). If inflation rises, the government raises taxes or cuts spending to soak up extra money. If inflation declines, the government does the opposite, putting extra money and debt in the economy but in a way that does not trigger higher future surpluses, so it does push up prices.

(Note: this post has embedded figures and mathjax equations. If the last paragraph is garbled or you don't see graphs below, go here.)

That idea surfaced in many of the papers.

Thursday, March 31, 2016

Neo-Fisherian caveats

Raise interest rates to raise inflation? Lower interest rates to lower inflation? It's not that simple.

A correspondent from an emerging market wrote enthusiastically. His country has somewhat too high inflation, currency depreciation and slightly negative real rates. A discussion is going on about raising rates to combat inflation. Do I think that lowering rates in this circumstance is instead the way to go about it?

As you can tell, posing the question this way makes me very uncomfortable! So, thinking out loud, why might one pause at jumping this far, this fast?

Fiscal policy.  Fiscal policy deeply underlies monetary policy. In my own "Fisherian" explorations, the fiscal theory of price level is a deep foundation. If the government is printing up money to pay its bills, the central bank can do what it wants with interest rates, inflation is coming anyway.

Tuesday, March 29, 2016

A very simple neo-Fisherian model

A sharp colleague recently pushed me to write down a really simple model that can clarify the intuition of how raising interest rates might raise, rather than lower, inflation. Here is an answer.

(This follows the last post on the question, which links to a paper. Warning: this post uses mathjax and has graphs. If you don't see them, come back to the original. I have to hit shift-reload twice to see math in Safari. )

I'll use the standard intertemporal-substitution relation, that higher real interest rates induce you to postpone consumption, \[ c_t = E_t c_{t+1} - \sigma(i_t - E_t \pi_{t+1}) \] I'll pair it here with the simplest possible Phillips curve, that inflation is higher when output is higher. \[ \pi_t = \kappa c_t \] I'll also assume that people know about the interest rate rise ahead of time, so \(\pi_{t+1}=E_t\pi_{t+1}\).

Now substitute \(\pi_t\) for \(c_t\), \[ \pi_t = \pi_{t+1} - \sigma \kappa(i_t - \pi_{t+1})\] So the solution is \[ E_t \pi_{t+1} = \frac{1}{1+\sigma\kappa} \pi_t + \frac{\sigma \kappa}{1+\sigma\kappa}i_t \]

Inflation is stable. You can solve this backwards to \[ \pi_{t} = \frac{\sigma \kappa}{1+\sigma\kappa} \sum_{j=0}^\infty \left( \frac{1}{1+\sigma\kappa}\right)^j i_{t-j} \]

Here is a plot of what happens when the Fed raises nominal interest rates, using \(\sigma=1, \kappa=1\):

When interest rates rise, inflation rises steadily.

Now, intuition. (In economics intuition describes equations. If you have intuition but can't quite come up with the equations, you have a hunch not a result.) During the time of high real interest rates -- when the nominal rate has risen, but inflation has not yet caught up -- consumption must grow faster.

People consume less ahead of the time of high real interest rates, so they have more savings, and earn more interest on those savings. Afterwards, they can consume more. Since more consumption pushes up prices, giving more inflation, inflation must also rise during the period of high consumption growth.

One way to look at this is that consumption and inflation was depressed before the rise, because people knew the rise was going to happen. In that sense, higher interest rates do lower consumption, but rational expectations reverses the arrow of time: higher future interest rates lower consumption and inflation today.

(The case of a surprise rise in interest rates is a bit more subtle. It's possible in that case that \(\pi_t\) and \(c_t\) jump down unexpectedly at time \(t\) when \(i_t\) jumps up. Analyzing that case, like all the other complications, takes a paper not a blog post. The point here was to show a simple model that illustrates the possibility of a neo-Fisherian result, not to argue that the result is general. My skeptical colleauge wanted to see how it's even possible.)

I really like that the Phillips curve here is so completely old fashioned. This is Phillips' Phillips curve, with a permanent inflation-output tradeoff. That fact shows squarely where the neo-Fisherian result comes from. The forward-looking intertemporal-substitution IS equation is the central ingredient.

Model 2:

You might object that with this static Phillips curve, there is a permanent inflation-output tradeoff. Maybe we're getting the permanent rise in inflation from the permanent rise in output? No, but let's see it. Here's the same model with an accelerationist Phillips curve, with slowly adaptive expectations. Change the Phillips curve to \[ c_{t} = \kappa(\pi_{t}-\pi_{t-1}^{e}) \] \[ \pi_{t}^{e} = \lambda\pi_{t-1}^{e}+(1-\lambda)\pi_{t} \] or, equivalently, \[ \pi_{t}^{e}=(1-\lambda)\sum_{j=0}^{\infty}\lambda^{j}\pi_{t-j}. \]

Substituting out consumption again, \[ (\pi_{t}-\pi_{t-1}^{e})=(\pi_{t+1}-\pi_{t}^{e})-\sigma\kappa(i_{t}-\pi_{t+1}) \] \[ (1+\sigma\kappa)\pi_{t+1}=\pi_{t}+\pi_{t}^{e}-\pi_{t-1}^{e}+\sigma\kappa i_{t} \] \[ \pi_{t+1}=\frac{1}{1+\sigma\kappa}\left( \pi_{t}+\pi_{t}^{e}-\pi_{t-1} ^{e}\right) +\frac{\sigma\kappa}{1+\sigma\kappa}i_{t}. \] Explicitly, \[ (1+\sigma\kappa)\pi_{t+1}=\pi_{t}+\gamma(1-\lambda)\left[ \sum_{j=0}^{\infty }\lambda^{j}\Delta\pi_{t-j}\right] +\sigma\kappa i_{t} \]

Simulating this model, with \(\lambda=0.9\).



As you can see, we still have a completely positive response. Inflation ends up moving one for one with the rate change. Consumption booms and then slowly reverts to zero. The words are really about the same.

The positive consumption response does not survive with more realistic or better grounded Phillips curves. With the standard forward looking new Keynesian Phillips curve inflation looks about the same, but output goes down throughout the episode: you get stagflation.

The absolutely simplest model is, of course, just \[i_t = r + E_t \pi_{t+1}\]. Then if the Fed raises
the nominal interest rate, inflation must follow. But my challenge was to spell out the market forces
that push inflation up. I'm less able to tell the corresponding story in very simple terms.

Friday, March 25, 2016

Central banks as central planners

Two news items cropped up this week on the general topic of central banks as emergent central planers.: a nice WSJ editorial by James Mackintosh on QE extended to buying corporate debt, and the Fed's proposed rule governing "Macroprudential" countercyclical capital buffers. The ECB also has a new Macroprudential Bulletin with similar ideas that I will not cover because the post is already too long. (Some earlier thoughts on the issue here. As usual, if the quotes aren't showing right, come back to the original of this post here.)

The WSJ editorial:
..as the central banks become more desperate to boost inflation and growth, they are starting to break one of the modern tenets of the profession by funneling that cash directly to what they regard as “good” uses.
The Bank of Japan’s conditions for companies to qualify for central bank funding include
offering an "improving working environment, providing child-care support, or expanding employee-training programs".... increasing capital spending, expanding spending on research and development or boosting what the Bank of Japan calls “human capital.” The latter means pay raises for staff, taking on more people or improving human resources.

Monday, March 21, 2016

The Habit Habit

The Habit Habit. This is an essay expanding slightly on a talk I gave at the University of Melbourne's excellent "Finance Down Under" conference. The slides

(Note: This post uses mathjax for equations and has embedded graphs. Some places that pick up the post don't show these elements. If you can't see them or links come back to the original. Two shift-refreshes seem to cure Safari showing "math processing error".)

Habit past: I start with a quick review of the habit model. I highlight some successes as well as areas where the model needs improvement, that I think would be productive to address.

Habit present: I survey of many current parallel approaches including long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes -- both behavioral and from ambiguity aversion -- and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms. They all introduce a business-cycle state variable into the discount factor, so they all give rise to more risk aversion in bad times. The habit model, though less popular than some alternatives, is at least still a contender, and more parsimonious in many ways,

Habits future: I speculate with some simple models that time-varying risk premiums as captured by the habit model can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, as an alternative to  Keynesian flow constraints or new Keynesian intertemporal substitution. People stopped consuming and investing in 2008 because they were scared to death, not because they wanted less consumption today in return for more consumption tomorrow.

Throughout, the essay focuses on challenges for future research, in many cases that seem like low hanging fruit. PhD students seeking advice on thesis topics: I'll tell you to read this. It also may be useful to colleagues as a teaching note on macro-asset pricing models. (Note, the parallel sections of my coursera class "Asset Pricing" cover some of the same material.)

I'll tempt you with one little exercise taken from late in the essay.

Tuesday, March 8, 2016

Deflation Puzzle

Larry Summers writes an eloquent FT column "A world stumped by stubbornly low inflation"
Market measures of inflation expectations have been collapsing and on the Fed’s preferred inflation measure are now in the range of 1-1.25 per cent over the next decade.

Inflation expectations are even lower in Europe and Japan. Survey measures have shown sharp declines in recent months. Commodity prices are at multi-decade lows and the dollar has only risen as rapidly as in the past 18 months twice during the past 40 years when it has fluctuated widely

And the Fed is forecasting a return to its 2 per cent inflation target on the basis of models that are not convincing to most outside observers. 

Central bankers [at the G20 meeting] communicated a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation. This message was reinforced by the highly negative market reaction to Japan’s move to negative interest rates.

So why is inflation slowly declining despite our central banks' best efforts? Here is a stab at an answer. I emphasize the central logical points with bullets.

  • Interest rates have two effects on inflation: a short-run "liquidity" effect, and a long-run "expected inflation" or "Fisher" effect.  

Wednesday, March 2, 2016

Premium increase insurance

Marginal Revolution and the Wall Street Journal both pass on a great quote from Warren Buffett:
It’s understandable that the sponsor of the proxy proposal believes Berkshire is especially threatened by climate change because we are a huge insurer, covering all sorts of risks. The sponsor may worry that property losses will skyrocket because of weather changes. And such worries might, in fact, be warranted if we wrote ten- or twenty-year policies at fixed prices. But insurance policies are customarily written for one year and repriced annually to reflect changing exposures. Increased possibilities of loss translate promptly into increased premiums. . . .
Up to now, climate change has not produced more frequent nor more costly hurricanes nor other weather-related events covered by insurance. As a consequence, U.S. super-cat rates have fallen steadily in recent years, which is why we have backed away from that business. If super-cats become costlier and more frequent, the likely—though far from certain—effect on Berkshire’s insurance business would be to make it larger and more profitable.
As a citizen, you may understandably find climate change keeping you up nights. As a homeowner in a low-lying area, you may wish to consider moving. But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries.
The puzzle to me is, why doesn't Berkshire Hathaway write ten- or twenty-year policies at fixed prices? Or, better, why does it not offer a second contract, that ensures you against the event that your regular insurance will be repriced every six months? If people are worried about it, and nobody else is doing it, it would seem they could charge a huge premium.

You may say BH doesn't want the risk, but in a previous letter Buffett explained that BH was selling 99 year put options. And being hugely diversified is precisely what allows a company like this to take some risk.

If it doesn't want to hold the risk it could sell it. Surely there are lots of investors who are  skeptics of climate change -- not warming, but the claim that warming will give rise to more extreme weather and higher insurance payouts; people who cheered at that quote in the WSG -- and would be happy to put their money where their mouths are in the reinsurance market.  

(These thoughts are obviously related to health insurance,  premium increase insurance and long-term guaranteed renewable contracts that solve the preexisting conditions problem.)

Friday, February 26, 2016

Sanders multiplier magic

The critiques of Gerald Friedman's analysis of the Sanders economic plan  continue. The latest and most detailed and careful so far is by David and Christina Romer.

Bottom line:

  1. The central idea in Friedman's analysis is that taking $1 from Peter to give to Paul raises overall income by 55 cents.  From this, you get multipliers from raising taxes and spending, from higher minimum wages, more unions, and so forth. 
  2. I chuckle a little bit that so many economists who previously liked multipliers now don't like their logical conclusions. 
  3. The Romers charge a serious, elementary arithmetic mistake in treating levels vs. growth rates. If they're right Friedman's whole analysis is just wrong on arithmetic.

The analysis

One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.

Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.



"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.

Thursday, February 25, 2016

Negative rates and FTPL

I've devoted most of my monetary economics research agenda to the Fiscal Theory of the Price Level in the last two decades (collection here). This theory says, fundamentally, that money has value because the government accepts it for taxes, and inflation is fundamentally a fiscal phenomenon over which central banks' conventional tools -- open market operations trading money for government bonds -- have limited power.

Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.

I may have been  exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates,  and central banks powerless to create inflation will be the trigger.

These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)

If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?