Monday, October 17, 2016

Macro Musings Podcast: Izabella Kaminska

My latest Macro Musings podcast is with Izabella Kaminska. Izabella is part of Financial Times Alphaville, where she has been since 2008. She has written extensively on monetary policy, fiscal policy, financial technology, and is key force behind the Financial Times Festival of Finance. As a longtime follower of her work, it was a real treat to have her on the show.

We started our conversation by talking about blockchain technology and its implications for the payment system. Izabella is not optimistic about blockchain's future and wonders whether it will fulfill the expectations and hopes many observers have set out for it. 

Next, we move on to the topic of universal banking. This is the idea that a central bank would open its balance sheet to anyone, including households and non-financial businesses. Doing so would solve the bank run problem and reduce the probability of a financial crisis. There are already movements in that direction with introduction of the Fed's overnight reverse repo program (RRP)  and derivative houses opening accounts with the Chicago Fed. In the limit, universal banking would mean individuals could have personal checking accounts at the Fed. While this might solve the bank run problem, it would also mean a much larger government role in financial intermedation. We discuss why this would probably end very badly.

Izabella then discusses her take on unconventional monetary policy, especially the use negative interest rates. She is very critical of negative interest rates and explains why. Our conversation then segues into what can be done by policymakers during a deep recession. 

We conclude by taking a look at the book Trekonomics, by Manu Saadia, and consider its implications for future of economic growth. We also spend some time comparing the economics of Star Trek to Star Wars.The conversation was fascinating throughout.

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Monday, October 10, 2016

Macro Musings Podcast: Claudio Borio

My latest Macro Musings podcast is with Claudio Borio. Claudio is the director of the Monetary and Economic Department at the Bank for International Settlements (BIS) and has been at the BIS in various roles since 1987. Previously, he was an economist with the OECD. Claudio is the author of numerous publications in the fields of monetary policy, banking, finance and issues related to financial stability. He is a leading voice on macroprudential regulation as well on international monetary stability issues. Claudio joined me to talk about these and other issues.

We began our conversation by considering what it is like to work at the BIS, the banks for central banks. We then segue to a discussion on the period leading up to the Great  Recession, a time when the BIS was one of the few institutions warning about the credit and housing boom. How did they get it right when so many central banks got it wrong? One answer is the BIS perspective on macroeconomics goes beyond the standard took kit of interest rates, inflation, and output gaps. The BIS, for example, does not see price stability as a sufficient condition for financial stability, it looks at gross capital flows rather than net, and it closely follows excessive credit growth. This thinking was largely absent from central banks prior to 2008.

Our conversation next moved to the international monetary system, the outsized role the dollar and the Fed plays in it, the Triffin dilemma, and what can be done to make the global financial system more robust. 

Claudio gave an interesting talk late last year title Revisting the Three Pillars of Monetary Policy. The three pillars are the importance of the equilibrium interest rate, the long-run neutrality of monetary policy, and the need to avoid deflation in all circumstances.We discuss why a more nuanced understanding of these ideas is needed and how it may have produced better macroeconomic policy before the crisis. For example, Claudio notes that this understanding would have made it easier to avoid the 'debt trap' that much of the global economy seems to be stuck in at the present. It also would have made central banks less fearful of benign deflationary pressures--those created by positive supply shocks--and thus avoided unnecessarily easy monetary policy during the housing boom period.

We then consider Claudio's coauthored article that reviews the vast amount of research that has been done on estimating the effect of the various unconventional monetary policies tried since the Great Recession. Claudio's survey of the literature finds that these policies have influenced yields and asset prices, but their effect on the real economy is more uncertain.

Finally, we close by asking Claudio what advice he would give to a young, budding macroeconomist. It was a fascinating conversation throughout. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming. 

Related Links
Claudio Borio's web page at the BIS
Global Imbalances and the Financial Crisis: Link or No Link? (2011) Claudio Borio and Piti Disyatat
Unconventional Monetary Policies: A Reappraisal (2016) - Claudio Borio
The Cost of Deflation: A Historical Perspective - Claudio Borio, Magdalena Erdem, Andrew Filardo and Boris Hofmann.
Revisting the Three Pillars of Monetary Policy - Claudio Borio
The Great Liquidity Boom and the Monetary Superpower Hypothesis--David Beckworth and Chris Crowe

Monday, October 3, 2016

Macro Musings Podcat: Andy Levin

My latest Macro Musing podcast is with Andrew Levin. Andy is a professor of economics at Dartmouth College and previously served two decades as an economist at the Federal Reserve Board, including two years as a special adviser to Chairman Ben Bernanke and Vice Chair Janet Yellen. Andy, in short, has a deep understanding of the history and workings of the Board of Governors and the FOMC .

During his time as a special adviser he helped spearhead the advent of the FOMC press conference, the Summary of Economic Projections, and the now infamous dot plot graph. He also was involved with the FOMC's official adoption of its 2 percent inflation target. Andy discusses these developments with me and how he would like to see them further refined. 

We also discussed what happened in 2008. The economy was contracting and yet for much of the year the Fed was signalling it was worried about inflation and wanted to raise rates. Specifically, beginning around April 2008 the market expectation of where the federal funds rate would be 12 months ahead started rising. It rose all the way to about 3.5 percent by June 2008--the market was expecting the Fed to raise rates 150 basis points in mid-2008! Although it slowly came down, the fed fund futures rate 12-months ahead still remained higher than the actual federal funds rate through September. This can be seen in the figure below:

Andy notes that the FOMC transcripts reveal that even by the September 2008 meeting Fed officials were still not grasping the severity of the crisis. Why? We discuss whether they were simply too focused on inflation or whether insular thinking and group think prevented the Fed from appreciating the severity of the downturn during 2008.   

We then moved on to Andy's proposed reforms. These have received coverage in the media and support from the 'Fed Up' campaign. Andy's reforms are driven by four key problems he finds with the Fed: (1) Regional Fed banks face a conflict of interest given their private ownership, (2) the process for choosing Fed officials is opaque and broken, (3) their is a lack of diversity at the Fed, (4) the Fed is shielded from public oversight. Andy's solutions to these problems are to (1) end commercial ownership of the regional Fed banks, (2) make Fed officials limited to a single, non-renewable 7-year term, (3) make all Fed employees public employees with a better representation of the American public, and (4) align transparency at the Fed with the standards of other public institutions. 

We close the discussion by looking at Andy's research on the anchoring of inflation expectations, the need to do periodic evaluations of the Fed's objectives, and the question of why inflation has been persistently below target for the past five years. This was a thought-provoking conversation throughout. 

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming. 

Related Links
Andy Levin's homepage
Andy Levin's twitter account
Andy Levin's reform proposal

Friday, September 30, 2016

The Loflation Pandemic

The IMF reports in the latest WEO that the world has a low inflation problem:
By 2015, inflation rates in more than 85 percent of a broad sample of more than 120 economies were below long-term expectations, and about 20 percent were in deflation—that is, facing a fall in the aggregate price level for goods and services (Figure 3.2). While the recent decline in inflation coincided with a sharp drop in oil and other commodity prices, core inflation—which excludes the more volatile categories of food and energy prices—has remained below central bank targets for several consecutive years in most of the major advanced economies.
Here is the IMF's figure that nicely summarizes this development:

This figure shows this trend toward low inflation started around the time of the Great Recession and has only grown. Given its global nature, I am going to call this development the loflation pandemic. So what is behind it? Here is the IMF's explanation:
Economic slack and changes in commodity prices are the main drivers of lower inflation since the Great Recession.
The commodity story, in my view, is limited in how much it can explain since commodity prices have gone up and down since 2008. Moreover, as Jim Hamilton and Ben Bernanke argue, just under half of the commodity price decline since mid-2014 can be attributed to weak global demand. Weak commodity prices, in other words, are themselves partly the result of anemic demand.

That leaves economic slack, or insufficient nominal demand growth, as the main reason for the decline in global inflation. As I said before, nominal demand ain't what it used to be. This, though, begs the question as to why nominal demand growth been so weak? And why have advanced economies been so willing to tolerate it? 

The IMF does not answer these questions. All it recommends is that governments do more with fiscal and monetary policy, complemented with structural policy. This is futile. One cannot expect to change government's behavior without first knowing why they are acting as they do. 

Since the IMF seems unwilling to go there, I will. Governments in advanced economies have avoided robust aggregate demand growth--and therefore have created the loflation pandemic--because of the constraints created by their past successes with inflation targeting. Inflation targeting has become the poisoned chalice of macroeconomic policy:
Central banks have been so good at creating low inflation since the early 1990s that it is now the expected norm by the body politic. Any deviation from low inflation is simply intolerable. In the US, everyone from the media to politicians to the average person start to freak out if inflation heads north of 2%. This mentality seems even worse in Europe. Inflation-targeting central banks, in other words, have worked themselves into an inflation-targeting straitjacket that has removed the few degrees of freedom they had. It is hard to imagine Yellen and Draghi being able to raise inflation temporarily above 2% in this environment. All they can do is operate in the 1-2% inflation window. Inflation targeting's success has become it own worst enemy.  
Another way of saying this is that the space for doing macro policy has shrunk to the small window of 1-2% inflation. Not only is monetary policy constrained by this, but so is fiscal policy...  
For these reasons inflation targeting has become the poisoned chalice of macroeconomic policy. It was a much needed nominal anchor in the 1990s that helped restore monetary stability. Its limitations, however, have become very clear over the past decade and now is preventing the world from having the recovery it needs...
Put differently, no matter what the central banks try--QE, forward guidance, negative rates--they will never push beyond the public's expectation of low inflation. Fiscal policy, including helicopter drops, will also run up against this constraint. 

This constraint also means that policymakers may not have the flexibility they need to stave off recessions:
If a trucker gets stuck in traffic jam, he will have to temporarily speed up afterwards to make up for lost time. On average, his speed for the trip will be the legal speed limit but only if he temporarily speeds up after the traffic jam. Likewise, an economy may need temporarily higher-than-normal inflation after a sharp recession to return to full employment. This also implies temporarily higher-than-normal nominal demand growth. On average, this temporary pickup will keep inflation and nominal demand growth on target. Running a little hot, therefore, is necessary sometimes. Currently, however, this policy flexibility is not possible.
This, in my view, is a key reason why the recovery from 2008-2009 was so weak. It is also why QE was set up to disappoint.

Inflation targeting was a much needed nominal anchor across the globe when it was first introduced in the early 1990s. But now it has put advanced economies into a low inflation straitjacket that is becoming a drag on economic growth. Until we recognize and act upon this observation, we can expect the loflation pandemic to spread.  

Monday, September 26, 2016

Macro Musings Podcast: Morgan Ricks

My latest Macro Musings podcast is with Morgan Ricks. Morgan is a law professor at Vanderbilt University where he specializes in financial regulation. Between 2009 and 2010, he was a senior policy adviser at the U.S. Treasury Department where  he dealt with financial stability initiatives and capital markets policies related to the financial crisis.

Before joining the Treasury Department, Morgan was a risk-arbitrage trader at Citadel Investment Group, a Chicago-based hedge fund. He previously served as a vice president in the investment banking division of Merrill Lynch & Co., where he specialized in strategic and capital-raising transactions for financial services companies.

Morgan is also the author of a new book “The Money Problem: Rethinking Financial Regulation”. He joined me to discuss his new book and its implications for policy. His book is timely and adds some needed perspective to understanding the Great Recession. I happened to review his book for National Review and so it was a nice follow up for me to get him on the show.

A key point he makes in the book, and one that we discuss on the show, is that the standard definition of money is too narrow. Money, properly understood, should include both retail and institutional money assets. This is a point I have repeatedly  made on this blog and in various papers. Morgan, however, does a much better job articulating this point and his chapter two "Taking the Money Market Seriously" by itself make the book a great investment. 

This understanding is important because it helps us better understand the financial crisis of 2007-2008. First, it helps us see that the institutional money assets were susceptible to a bank run just like retail money assets were before FDIC was introduced. The potential for a bank run with the institutional money assets came to fruition in 2007-2008. Second, this understanding also helps us see that the bank run caused a collapse in the broad money supply and that, in turn, helped bring about the sharp collapse in 2008-2009. Money still matters! It also, arguably, played a key role in anemic recovery that followed. 

The collapse in the money supply can be seen in the figure below. It shows several broad measures of the money supply that include both retail and institutional money assets. The measures come from the Center for Financial Stability:

We go on to discuss his proposal for fixing the run-prone nature of the banking system, what it would mean for banking, how policy would operate, and more. Once again, another fascinating conversation throughout. And if you want further details read his book.

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming. 

Related Links
Morgan Ricks Homepage
Morgan Ricks Twitter Account
Morgan Ricks Book 

Wednesday, September 21, 2016

The Bank of Japan: Monetary Mastery or Quantitative Quagmire?

The New Abenomics Program
The Bank of Japan (BoJ) just launched a new phase in its monetary easing program popularly known as Abenomics. It is doing so in the hopes of shoring up economic growth. This monetary program until today had involved a targeted expansion of the monetary base at ¥80 trillion a year matched by ¥80 trillion in government bond acquisitions. There were also targeted purchases of ETFs and REITs on a smaller scale.1

The new phase unveiled today consist of three key developments. First, the BoJ will target the 10-year government bond interest rate at zero percent. Second, it will aim to overshoot its 2% inflation target so that it is truly symmetric. Third, it will drop its quantity target for the monetary base and simply make its expansion conditional on the inflation overshoot. Everything else in Abenomics remains roughly the same. 

So has the Bank of Japan finally mastered its monetary conditions in a way that will spur economic growth? Or is this just another step into the quantitative quagmire of Abenomics? The short answer: do not get your hopes up. There are two reasons why this probably will not make much difference. 

First, the BoJ is pegging the 10-year yield on government bonds at a level it would be at anyways. Because of slow global economic growth and continued uncertainty, yields on safe assets around the world have been falling since 2008. This race to the bottom for safe asset yields can be seen in the figure below:

Over the past eight years, this downward march of yields has occurred before, during, and after various QE programs. So while it is true that the BoJ has been the marginal buyer of Japanese government bonds over the last year, its actions are only doing what the global bond market was already doing and would have continued to do in the absence of BoJ actions. Put differently, the market-clearing or 'natural' interest rate that is based on fundamentals has been falling for some time and is already very low. The BoJ's new long-term interest rate target simply is a recognition of this fact. So there really is nothing new here.

Second, there is a serious credibility issue when it comes to the expansion of the Japan's monetary base. As seen in the figure below, the monetary base has seen a three-fold increase in its size since the beginning of Abenomics. If this expansion were truly permanent, then the price level would also increase threefold over the long-run. There is no way that can happen. The population is aging and depends increasingly on fixed income. Inflation for them is a non-starter. There is no political economy support for such a radical change in the price level.

Here is why this matters: some  portion of the monetary base injection (above that needed for normal money demand growth) needs to be viewed as permanent in order for spending and inflation to rise. If monetary injections are expected to be temporary they would do little to spur spending. If they are viewed as permanent, however, they would raise the expected future price level and thus temporarily push up expected inflation. The higher expected inflation, in turn, would spur robust spending in the present. But this requires some portion of the monetary base growth to be seen as permanent.

The problem, though, is that the expansion of the monetary base has been so large there is no way this growth can be seen a permanent for fear of excessive inflation taking off. The BoJ wants 2% inflation with some overshoot. If the threefold increase of the monetary base were made permanent, the BoJ would get 300% inflation with overshoot! Put differently, the massive expansion of the BoJ's balance sheet undermines its very goal of raising nominal spending and inflation.

So making the growth of monetary base conditional on inflation hitting its target is not credible. The monetary base is simply too large for the BoJ to get any traction this way.

So Does Abenomics Matter?
With all that said, Abenomics has been able to spur some aggregate demand growth and some inflation. Just nowhere near where the government wants it to be.  Below is a figure that shows the level of nominal spending (as measured by nominal GDP) for Japan.  Nominal spending has grown under Abenomics, far more than under the origional QE program of 2001-2006:

I used to think this moderate success was because the monetary base expansion under Abenomics was permanent. But now that the monetary base has gotten so large, I am doubtful for the reasons laid out above. So Abenomics has been moderately successful, but it is not entirely clear to me why this is happening.

It is worth noting one of the goals of Prime Minister Shinzo Abe's government is to raise nominal GDP to ¥600 trillion by 2020. Yes, Japan has a NGDP level target. The Prime Minister first called for this goal in September 2015 and spoke to it again in December 2015.  Since then, it has been in the government's economic and fiscal projections For example, here is the July 2016 executive summary of the projections. The nominal GDP goal stated near the top of the document.  

When the goal was first introduced, it was an ambitious 20% growth  goal for Japan's nominal GDP. It is now closer to 17% given the growth of nominal GDP since then, but this still remains a very ambitious goal as seen in the figure below. This figure shows different paths towards the ¥600 trillion by 2020. 

All of these paths seem ambitious given the recent growth rate of nominal GDP in Japan. It is not clear how to get there without having a major overshoot of inflation.  Maybe the BoJ could reiterate the governments nominal GDP level target and try to communicate that some small portion of the monetary base will be permanent and that it will be injected via purchases of perpetual government bonds. Admittedly, this would be a tough message to communicate. But it is not clear what alternatives there are for Japan. 

So to answer the question in the title to this post, I suspect Japan may be heading further into a quantitative quagmire rather than mastering its monetary conditions. 

P.S. Yes, the markets seem happy about this development so far. But they also seemed happy about the ECB's added stimulus in March 2016. That euphoria did not last and neither will this reaction to the BoJ. 

1ETFs were and continue be purchased at annual rate of ¥9 trillion while REITs are purchased at a targeted rate of ¥60 billion.

Monday, September 19, 2016

Macro Musings Podcast: Ryan Avent

My latest Macro Musings podcast is with Ryan Avent. Ryan is a columnist at The Economist magazine. He has previously been the news editor, economics correspondent, and online economics editor for The Economist. He is the author of The Gated City. His work has appeared at the Journal of Economic Geography, the New York Times, the Washington Post, the New Republic, Bloomberg, Reuters, and many other places.

Ryan has a new book that just came out titled “The Wealth of Humans: Work Power, and Status in the 21st Century” He joined me to talk about his new book, his work, and some of the pressing macroeconomic issues of the day.

We begin our conversation by covering what it is like to be a journalist at The Economist. We then move on to his new book, which makes the case that the economy is undergoing a transformative change because of the digital revolution. Ryan notes that while this change is ultimately a plus for the longrun, over the short-to-medium run it present challenges for the way we live and work. Work gives us meaning and income, but Ryan argues it is not clear what work will be like going forward as increased smart technologies displace labor. Will we, on the margin, move into new jobs or into more leisure?  We discuss possible solutions to smooth the transition to this new long-run state.

Ryan just returned from the UK so we also spend some time discussing Brexit and the economic and social forces behind it. We also discuss the Eurozone crisis and why it has persisted for so long. 

Finally, we cover the challenges with inflation targeting, the safe asset problem, and the futility of central banks trying to raise rates when global bond markets are pushing yields down. Once again, a fascinating conversation throughout.

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming. 

Related Links