Sunday, January 31, 2010
Real GDP Up 5.7 Percent: Good News and Bad
The Price Level and Inflation
Using the GDP deflator measure of the price level, its value during the 4th quarter of 2009 was 109.93 which means that prices were nearly 10 percent higher than in 2005. This is an all time high for the price level.
Friday, January 29, 2010
Nominal Expenditures Increase, but it is Still Too Low!
Monday, January 25, 2010
Nominal Expenditure Targeting and Estimates of Potential Output
Hayek and Keynes Rap
Sunday, January 24, 2010
Hanke on Fed Policy
Sumner's Debating Points
1. Whether to cut the fed funds target from 0.25% to 0%
We should not target the federal funds rate at all. I suppose the proper range is between positive and negative infinity. While Fed actions will impact interest rates of various sorts, none should be subject to specific targets but should rather float with changes in supply and demand.
However, it is especially important that the Fed specifically reject its past policy of targeting the fed funds rate. The Fed's emphasis on a target for that rate has created the myth that monetary policy is no longer effective because it is so low.
The answer isn't to lower it a bit more, but rather to clearly explain that the fed funds rate is no longer of any interest to the Fed.
2. Whether to put an interest penalty on excess reserves.
The Fed should pay an interest rate on excess reserves equal to 1/4 percent below the 4 week T-bill yield. Currently, that would be negative. So, the Fed should be charging banks for holding excess reserves.
3. Whether to do additional QE.
Yes. The Fed should sell off its holdings of mortgage backed securities, but more than offset those sales with purchases of T-bills, bonds, and notes. The interest rates should be driven to zero on up the yield curve. While the yields on 4 week T-bills are nearly zero, the Fed can buy one year T-bills, notes maturing in 2 years, 3 years, and so on.
4. Whether to set an inflation or NGDP target.
NGDP is better than inflation, though I prefer a target for Total Final Sales of Domestic Product. It does not include inventory investment. While including planned inventory investment would be fine, the reason to use that measure of nominal expenditure rather than nominal GDP is to avoid including unplanned inventory investment. That the national income accounting identity counts goods produced and not sold as having been sold to the producer, and that "profits" on those unsold good count as income, hardly makes it consistent with macroeconomic equilibrium.
The level, or rather, growth path, of nominal expenditure should be targeted. However, this only makes sense if it is the growth path of nominal expenditure that is being targeted. Creating monetary disequilibrium to force sticky equilibrium prices back to some arbitrary level is counterproductive. Reversing shortfalls or excess expenditures to avoid the need to make changes in sticky disequilibrium prices or wages is desirable.
6. And of course the key overarching question: Would the economy benefit from an increase in AD, or nominal spending?
Yes, the economy would benefit by an increase in nominal expenditure. Nominal expenditure is currently 9 percent below its long run trend.
P.S. Bernanke should be fired because he listened to Geithner and focused on bailing out broker-dealers on Wall Street rather than maintaining nominal expenditure. He participated in the effort to scare Congress into approving this bailout. Those scare tactics were destructive and plausibly were a key cause of the drop in nominal expenditure. He continues to be committed to going back to the failed policy of targeting the federal funds rate at levels that are expected to be consistent with the core CPI rising at a 2% annual rate from wherever it is.
P.P.S. I will never support a Fed chairman because Obama and Congress are unlikely to provide anyone better.
Taylor Rule and Output Gaps
Taylor Rule is pretty simple. It just says, the interest rate should equal 1 1/2 times the inflation rate, plus 1/2 time the GDP gap, plus 1.
I'm beginning to have doubts.
Using this formula to calculate the proper target for the federal funds rate using different estimates of the output gap naturally results in a variety of targets.
The CBO measure generates a high interest rate target of 8.9 percent in the first quarter of 1990. It also suggests a high rate at the beginning of the Great Recession, 8.09 in the first quarter of 2007. The low is second quarter 2oo9, at -1.66 percent. However, the nominal interest rate was also negative in the fourth quarter of 2009, -.1 percent.
These applications of the Taylor rule do call for negative nominal interest rates, but for some of them, the negative rates are not much different from zero, and only apply to a single quarter.
Of course, these calculations are using the GDP deflator, which includes all goods and services. The standard approach is to ignore capital goods and government goods and instead just look at the prices of some consumer goods--well, everything other than food and energy. Further, these calculations used the current inflation rate and output gap to find the proper information. The Taylor rule needs to use available information. Look for another post later.
Saturday, January 23, 2010
Output Gaps and Potential Incomes
Is Inflation "Too Low?"
My Lesson in Monetary Policy
Friday, January 22, 2010
Question: Should the Fed have been more aggressive with monetary stimulus in September-November 2008? (Scott Sumner, The Money Illusion)John Taylor: I think the Fed cut interest rates during that period just about right. I think it was basically coming down, it could have been a little faster at that point, and of course, GDP did fall tremendously. But I think if they had kept the interest rates along the same path it would have been fine. The problems I see at that period was the tremendous amount of uncertainty added by these new effects, if you like, the quantitative ease, and sometimes I've called somewhat **** mundustrial policy to where the actions went well beyond the usual interest rates. And I don't think they were appropriate. We're still studying them. Some of them were inappropriate. I just finished a study on mortgage interest rates.
Question: What is the most important unresolved question in monetary economics? (Mark Thoma, Economist’s View)
John Taylor: I think the most important unresolved question of monetary economics is the interaction between the financial sector and monetary policy. There's been lots of thinking about it over the years, some of it actually done here at Stanford; Girly and Shaw. A lot of it done by Tobin at Yale, Ben Bernacke has done some of it. But I think the most promising part is the combination of the newest work on pricing of bonds and securities. A lot of it's done by Monica Busasy[ph] and some of her colleagues, that combine that with monetary policy so that you have a sense of what's going to happen to longer term rates when the short rate is reduced. What's going to happen to credit flows and how much are credit flows going to impact the economy?
This crisis has been very clear in demonstrating that more work on the connection between the financial economics and monetary policy is needed. In fact, there's still a lot of questions out there in policy about whether the financial markets performed well, or not. It seems to me, if you look at them, they absorbed a tremendous shock from policies. It's effectively a panic induced by some ad hoc policy changes and they responded quickly and they responded in a way which has been smooth, as the markets themselves. The institutions, the financial institutions of course, have been in great difficulty, but the markets themselves have worked well.
So, to me, where we should focus our attention really is this connection between the financial markets, including the financial institutions and the monetary policy itself.
Wednesday, January 20, 2010
The Taylor Rule
First of all, I don't think the Taylor Rule does show a large negative interest rates right now. That's kind of a myth. The Taylor Rule is pretty simple. It just says, the interest rate should equal 1 1/2 times the inflation rate, plus 1/2 time the GDP gap, plus 1. Well, if you plug in reasonable estimates for what inflation is and what the GDP gap is, I get a number that’s pretty close to zero. Not minus four, minus five, not numbers like that. So, in fact I would say the amount of quantitative easing could be reduced right now. I hope it is reduced in a gradual way. Some of the mortgage purchases I think could be slowed down and then actually reversed.That is pretty simple--
The trend inflation rate during the Great Moderation as measured by the GDP deflator was 2.3 percent. The inflation rate has been well below trend during the Great Recession.
The growth rate of this measure of potential output closely tracks the growth rate of Real GDP. The recessions show up as slow or negative growth.
The relationship between the levels of real GDP and this measure of potential output are a bit odd.
While Real GDP and this measure of Potential Output track closely during the first decade of the Great Moderation (though with a clear recession in 1991,) real GDP takes off and stays above potential output for most of the remaining period until the Great Recession. The recession of 2001 shows up as an unusual period where Real GDP was close to Potential Output.
Focusing on the period of the Great Recession, real GDP was greater than potential output and has now fallen well below potential output. The output gap is the percent difference between the two.
This measure of potential income shows very large positive output gaps--unsustainable booms. Focusing in on the Great Recession, the output gap rapidly shifted from positive to negative.
Putting together the inflation rate implied by the GDP deflator and the output gap generated by real GDP and the CBO estimate of potential output, the interest rate implied by Taylor's "simple" rule can be calculated.
Perhaps the CBO estimate of potential output is off. Or, maybe the GDP deflator is the wrong measure of the price level. However, a third possibility is that trying to find some simple rule that relates the proper interest rate on overnight interbank loans to inflation and the gap between real GDP and some estimate of potential real output is a mistake.