Generally, I favor more "liberal" immigration policies.
I am troubled by moving Syrian refugees into the U.S.
Some suggest that it is cruel not to welcome refugees from ISIS into the U.S.
Some worry that they are too dangerous and that some ISIS supporters might sneak in with all of those Syrians that are fleeing ISIS.
There have been questions about why so few Christian Syrians are being allowed into the U.S.
It seems to me that these concerns are fundamentally confused.
For several years now there has been a civil war in Syria between a the long standing government--a secular dictatorship. The dictatorship is dominated by a small Islamic sect.
The opposition has been mostly been dominated by conservative Sunni Muslims--for decades.
Most Christians have supported the dictatorship, preferring that to Sunni rule.
The regime has committed many atrocities against their "own people." That is, areas dominated by Sunni Muslims that oppose the regime.
That is where the refugees are coming from.
ISIS supports the Sunni Muslim majority against the regime. So does the Syrian branch of Al-Qaeda.
Of course, that doesn't mean that all Sunni Muslims being victimized by the regime (that is supported by many if not most Syrian Christians as the lesser of evils,) support either ISIS or Al-Queda.
But it is horribly wrongheaded to see the Syrian refugees as refugees from ISIS or Al-Queda.
They are not for the most part. Given the longstanding political situation in Syria, they are a highly fertile recruiting ground for both groups.
(And, of course, ISIS and Al-Queda are enemies with one another and the Muslim-Brotherhood traditional opposition to the Syrian regime is rejected by both of the newer groups.)
I generally think it is a good thing to welcome victims of anti-U.S. regimes as refugees to the U.S. But the Syrian civil war is so complicated, with anti-U.S. groups dominating all sides, I don't think that rough rule of thumb applies.
Thursday, December 3, 2015
Negative Nominal Interest Rates
The Economist has an article on negative nominal interest rates, pointing out how common they are now in Europe. Most interesting is that nominal interest rates are negative on Swiss government bonds with terms to maturity of up to 10 years.
One problem with the argument is that that there is some notion that the goal of negative interest rates on central bank liabilities is to prevent people from saving.
The key purpose of negative interest rates on central bank liabilities is to reduce the demand to hold them. Given the quantity, the result will be higher demand for output. Or, the quantity can be reduced for any given demand for output, reducing the size of a central bank's balance sheet.
Whether or not people save more or less is not directly relevant, since it is only saving by accumulating money balances that adversely impacts the demand for output. If people save by accumulating assets other than money, that really isn't a problem.
Of course, looking at the demand for output, spending on consumer goods and services is an important form of demand, and for that to expand, saving must decrease. However, investment spending is another source of demand for output. I am enough of a "classical" economist to think that more saving and more investment is on the whole a good thing. Of course, really what is important is that interest rates coordinate saving and investment so that everyone can best achieve their own goals which most certainly involve consumption at some time or other.
Perhaps the most interesting fact in the article is that banks are passing on the negative interest rate on reserves by imposing a negative return on large deposit holdings. According to the article, banks are not charging for small depositors but are rather taking a loss.
Why would they do this? Perhaps they are just nice to small depositors, but that isn't a very satisfying answer for an economist.
One possibility is that many small depositors would be willing to withdraw currency if they were charged for holding deposits. It would be small for each depositor in an absolute amount, though large relative to their deposits, resulting in large withdrawals in aggregate. While hiding a few thousand dollars around my house might be foolish, it would not be technically difficult.
For large depositors, holding large amounts of currency would be difficult. It is important to keep in mind that the difficulty of storing currency will greatly deter currency withdrawals if interest rates on deposits are temporarily negative. What people would do in a word with permanently negative nominal interest rates is likely very different from when this is something that happens only occasionally.
Another possibility involves the stability of deposits as a funding source for banks. De jure, checkable deposits are payable on demand and would appear to be a very risky source to fund loans. In practice, "consumer accounts," in aggregate are considered by bankers to be a very stable source of funds most of which can be used to fund quite long loans. On the other hand, "hot" money, which has traditionally taken the form of relatively large deposits, sometimes with terms to maturity that are longer than "consumer deposits," are rightly considered a more risky source of funds for an individual bank. If deposits are exceptionally large in aggregate, with large firms holding unusally large amounts of "cash," then each bank will rightly see that much of its funding is such that it is too risky to tie up in longer term loans. It needs to be kept in short and liquid assets--the ones with negative nominal yields.
And so, this suggests that if nominal yields on short and safe assets become highly negative, then banks can be expected to provide negative yields on large deposits. This is both because the large depositors cannot handle huge amounts of currency and because the banks so not want to tie up the money in large loans. While small depositors will be shielded, because many of them can store amounts of currency that are small absolutely though large relative to their deposits and also because banks can depend on those funds in the longer run and lend them in longer term loans with higher nominal yields.
Now, if we were to imagine a world where negative nominal yields on short and safe assets were a permanent feature, then large depositors might well be motivated to develop the infrastructure to handle large amounts of currency.
One problem with the argument is that that there is some notion that the goal of negative interest rates on central bank liabilities is to prevent people from saving.
The key purpose of negative interest rates on central bank liabilities is to reduce the demand to hold them. Given the quantity, the result will be higher demand for output. Or, the quantity can be reduced for any given demand for output, reducing the size of a central bank's balance sheet.
Whether or not people save more or less is not directly relevant, since it is only saving by accumulating money balances that adversely impacts the demand for output. If people save by accumulating assets other than money, that really isn't a problem.
Of course, looking at the demand for output, spending on consumer goods and services is an important form of demand, and for that to expand, saving must decrease. However, investment spending is another source of demand for output. I am enough of a "classical" economist to think that more saving and more investment is on the whole a good thing. Of course, really what is important is that interest rates coordinate saving and investment so that everyone can best achieve their own goals which most certainly involve consumption at some time or other.
Perhaps the most interesting fact in the article is that banks are passing on the negative interest rate on reserves by imposing a negative return on large deposit holdings. According to the article, banks are not charging for small depositors but are rather taking a loss.
Why would they do this? Perhaps they are just nice to small depositors, but that isn't a very satisfying answer for an economist.
One possibility is that many small depositors would be willing to withdraw currency if they were charged for holding deposits. It would be small for each depositor in an absolute amount, though large relative to their deposits, resulting in large withdrawals in aggregate. While hiding a few thousand dollars around my house might be foolish, it would not be technically difficult.
For large depositors, holding large amounts of currency would be difficult. It is important to keep in mind that the difficulty of storing currency will greatly deter currency withdrawals if interest rates on deposits are temporarily negative. What people would do in a word with permanently negative nominal interest rates is likely very different from when this is something that happens only occasionally.
Another possibility involves the stability of deposits as a funding source for banks. De jure, checkable deposits are payable on demand and would appear to be a very risky source to fund loans. In practice, "consumer accounts," in aggregate are considered by bankers to be a very stable source of funds most of which can be used to fund quite long loans. On the other hand, "hot" money, which has traditionally taken the form of relatively large deposits, sometimes with terms to maturity that are longer than "consumer deposits," are rightly considered a more risky source of funds for an individual bank. If deposits are exceptionally large in aggregate, with large firms holding unusally large amounts of "cash," then each bank will rightly see that much of its funding is such that it is too risky to tie up in longer term loans. It needs to be kept in short and liquid assets--the ones with negative nominal yields.
And so, this suggests that if nominal yields on short and safe assets become highly negative, then banks can be expected to provide negative yields on large deposits. This is both because the large depositors cannot handle huge amounts of currency and because the banks so not want to tie up the money in large loans. While small depositors will be shielded, because many of them can store amounts of currency that are small absolutely though large relative to their deposits and also because banks can depend on those funds in the longer run and lend them in longer term loans with higher nominal yields.
Now, if we were to imagine a world where negative nominal yields on short and safe assets were a permanent feature, then large depositors might well be motivated to develop the infrastructure to handle large amounts of currency.
Sunday, November 22, 2015
Ben Carson, the National Debt, and Interest Rates
I am not sure why I find this so irritating, but...
A reporter, Chris Mathews, argues that presidential candidate Ben Carson doesn't understand some basic economic concepts.
And then Mathews goes on to suggest that he has a pretty weak grasp of those same concepts.
A reporter, Ryssdal, tried to ask Carson about his view regarding increasing the debt ceiling and default. From Carson's answers, it does appear that he has no clear understanding of the issue. First, Carson states that he is opposed to an "increased budget." I think that would be opposed to an increase in government spending.
When asked again about the debt limit, he states that that he opposes increasing spending limits. That fits in with the interpretation above.
And then he is asked a third time and says that he thinks we need to "restructure the way we create debt."
Mathews then explains his understanding that Congress must both approve spending and borrowing. He seems to think that if Congress approves spending and then fails to approve borrowing, then it defaults.
Well, I guess that something like that is the Obama Administration's position. But Mathews doesn't appear to be aware of peculiar nature of the argument.
If the debt limit is not increased, then new debt can still be issued to pay off the principal of old debt as it comes due. The debt limit is a limit on total borrowing. Since spending can be financed by taxes as well as borrowing (and most Federal government spending is in fact funded by taxes,) there is no necessary connection between approving spending and approving borrowing.
To avoid default, it is necessary to do more than to borrow new money to pay off government bonds as they come due. Interest must be paid on the debt as well. Interest expense is a current expenditure. Fortunately, the U.S. government collects more than enough tax revenue each year to pay all of the interest due on the existing national debt.
The Federal governments receipts are over $3.2 trillion per year and the interest expense is about $200 billion. The government could pay the interest due on the national debt each year and still spend $3 trillion on other things without any additional borrowing. The total amount the government owes could remain about $18 trillion.
While the government collects substantially more tax revenue than it owes in interest on the national debt, Congress has approved substantially more expenditures than tax revenues. The government is spending close to $3.7 trillion each year. In other words, the current budget includes a deficit which is supposed to be funded by borrowing. The budget deficit is over $400 billion. But cutting spending enough to balance the budget, the government would collect about $3.3 trillion per year. To avoid default on the $18 trillion it already owes, it must pay $200 billion of that in interest. And this leaves a little more than $3 trillion to spend on everything else.
The Treasury Department says that it does not have the administrative capability of doing anything other than spend money already approved by Congress. This mixes in a variety of current expenditures with interest payments and principal payments as they come due. It is able to borrow enough money to cover all the expenditures beyond the tax revenue which comes in from time to time. If the Treasury Department hits the debt limit, it will run out of money and won't be able to make payments. Some of those payments might be for interest and principle on the national debt, and so there will be a default.
Another argument, which Mathews seems to be making, would be that there is nothing special about making payments on the national debt. If Congress has approved an expenditure, then failing to make that payment is a default whether it is a debt or not. While this is not an entirely unreasonable use of the term "default," the consequences of such a default are not nearly as bad. I don't think any organization other than the U.S. Federal government could, much less would, take this approach. Most obviously, if revenues come in less than expected, just about every organization can and will curtail planned expenditures. If the Finance department says they are unable to pay debt service and avoid default unless they are provided enough money to pay every planned expenditure, then it is time to find fire them and get someone competent in charge.
Of course, the reality is that President Obama and the Democrats would probably prefer to default on the national debt rather than fail to pay out money to favored Democrat groups. (And I bet there are plenty of Republicans who prioritize defense spending and even tax relief over avoiding default.) But more importantly, threatening to fail to make principal and interest payment when due and threatening to blame this fiscal irresponsibility on the Republican Congress is a plausible threat to compel the Republicans to vote to increase the debt limit.
Anyway, it is true that Carson didn't make it obvious that he was aware of these issues, though his last answer might be consistent with a good understanding--we need to restructure the way we issue debt.
Mathews' last statement on the matter, that Carson could have replied that when he is President he will balance the budget and increase the debt limit at the same time, really does suggest that Mathews is confused. If the budget were balanced, the debt limit would not need to be increased. Government would need to spend no more than close to $3 trillion per year.
Mathews points out correctly that Carson's proposal for a low flat tax has not been matched by proposals to cut government spending enough to maintain a balanced budget. A 3 to 4 percent cut across the board wouldn't balance the current budget even without tax cuts. It is more than 12%.
If the growth of government spending is held to less than the growth rate of the economy, then even with modest tax cuts, it would be possible to bring the government's budget into balance eventually. But this would take time and there would be budget deficits and an increasing national debt in the meantime. Cutting taxes and immediately balancing the budget requires very steep cuts in government spending.
Mathews also comments on Carson's view on interest rates and debt. Mathews claims that there is no relationship. That is not obviously true. There are a variety of mechanisms through which a higher deficit (which increase the national debt over time,) would lead to higher interest rates. Alternatively, a higher debt would lead to higher interest rates as well, though care should be taken not to double-count. Perhaps these supposed mechanisms do not really occur, but Mathews seems to be unaware of them.
Of course, Carson's view is backwards. He seems to think that a higher national debt is associated with lower interest rates and these lower interest rates are bad because they make it more difficult for savers to accumulate wealth. Carson seems to think that a higher national debt causes the economy to be weak and the Fed responds by lowering interest rates.
I hardly would like to see Carson advocate that the government borrow a lot of money so that lenders will earn higher interest, but it would be nice if Mathews and Carson understood basic supply and demand.
I wasn't planning to support Carson anyway. However, the damage done by bad economic reporting is probably worse than that done by economically illiterate Presidential candidates.
A reporter, Chris Mathews, argues that presidential candidate Ben Carson doesn't understand some basic economic concepts.
And then Mathews goes on to suggest that he has a pretty weak grasp of those same concepts.
A reporter, Ryssdal, tried to ask Carson about his view regarding increasing the debt ceiling and default. From Carson's answers, it does appear that he has no clear understanding of the issue. First, Carson states that he is opposed to an "increased budget." I think that would be opposed to an increase in government spending.
When asked again about the debt limit, he states that that he opposes increasing spending limits. That fits in with the interpretation above.
And then he is asked a third time and says that he thinks we need to "restructure the way we create debt."
Mathews then explains his understanding that Congress must both approve spending and borrowing. He seems to think that if Congress approves spending and then fails to approve borrowing, then it defaults.
Well, I guess that something like that is the Obama Administration's position. But Mathews doesn't appear to be aware of peculiar nature of the argument.
If the debt limit is not increased, then new debt can still be issued to pay off the principal of old debt as it comes due. The debt limit is a limit on total borrowing. Since spending can be financed by taxes as well as borrowing (and most Federal government spending is in fact funded by taxes,) there is no necessary connection between approving spending and approving borrowing.
To avoid default, it is necessary to do more than to borrow new money to pay off government bonds as they come due. Interest must be paid on the debt as well. Interest expense is a current expenditure. Fortunately, the U.S. government collects more than enough tax revenue each year to pay all of the interest due on the existing national debt.
The Federal governments receipts are over $3.2 trillion per year and the interest expense is about $200 billion. The government could pay the interest due on the national debt each year and still spend $3 trillion on other things without any additional borrowing. The total amount the government owes could remain about $18 trillion.
While the government collects substantially more tax revenue than it owes in interest on the national debt, Congress has approved substantially more expenditures than tax revenues. The government is spending close to $3.7 trillion each year. In other words, the current budget includes a deficit which is supposed to be funded by borrowing. The budget deficit is over $400 billion. But cutting spending enough to balance the budget, the government would collect about $3.3 trillion per year. To avoid default on the $18 trillion it already owes, it must pay $200 billion of that in interest. And this leaves a little more than $3 trillion to spend on everything else.
The Treasury Department says that it does not have the administrative capability of doing anything other than spend money already approved by Congress. This mixes in a variety of current expenditures with interest payments and principal payments as they come due. It is able to borrow enough money to cover all the expenditures beyond the tax revenue which comes in from time to time. If the Treasury Department hits the debt limit, it will run out of money and won't be able to make payments. Some of those payments might be for interest and principle on the national debt, and so there will be a default.
Another argument, which Mathews seems to be making, would be that there is nothing special about making payments on the national debt. If Congress has approved an expenditure, then failing to make that payment is a default whether it is a debt or not. While this is not an entirely unreasonable use of the term "default," the consequences of such a default are not nearly as bad. I don't think any organization other than the U.S. Federal government could, much less would, take this approach. Most obviously, if revenues come in less than expected, just about every organization can and will curtail planned expenditures. If the Finance department says they are unable to pay debt service and avoid default unless they are provided enough money to pay every planned expenditure, then it is time to find fire them and get someone competent in charge.
Of course, the reality is that President Obama and the Democrats would probably prefer to default on the national debt rather than fail to pay out money to favored Democrat groups. (And I bet there are plenty of Republicans who prioritize defense spending and even tax relief over avoiding default.) But more importantly, threatening to fail to make principal and interest payment when due and threatening to blame this fiscal irresponsibility on the Republican Congress is a plausible threat to compel the Republicans to vote to increase the debt limit.
Anyway, it is true that Carson didn't make it obvious that he was aware of these issues, though his last answer might be consistent with a good understanding--we need to restructure the way we issue debt.
Mathews' last statement on the matter, that Carson could have replied that when he is President he will balance the budget and increase the debt limit at the same time, really does suggest that Mathews is confused. If the budget were balanced, the debt limit would not need to be increased. Government would need to spend no more than close to $3 trillion per year.
Mathews points out correctly that Carson's proposal for a low flat tax has not been matched by proposals to cut government spending enough to maintain a balanced budget. A 3 to 4 percent cut across the board wouldn't balance the current budget even without tax cuts. It is more than 12%.
If the growth of government spending is held to less than the growth rate of the economy, then even with modest tax cuts, it would be possible to bring the government's budget into balance eventually. But this would take time and there would be budget deficits and an increasing national debt in the meantime. Cutting taxes and immediately balancing the budget requires very steep cuts in government spending.
Mathews also comments on Carson's view on interest rates and debt. Mathews claims that there is no relationship. That is not obviously true. There are a variety of mechanisms through which a higher deficit (which increase the national debt over time,) would lead to higher interest rates. Alternatively, a higher debt would lead to higher interest rates as well, though care should be taken not to double-count. Perhaps these supposed mechanisms do not really occur, but Mathews seems to be unaware of them.
Of course, Carson's view is backwards. He seems to think that a higher national debt is associated with lower interest rates and these lower interest rates are bad because they make it more difficult for savers to accumulate wealth. Carson seems to think that a higher national debt causes the economy to be weak and the Fed responds by lowering interest rates.
I hardly would like to see Carson advocate that the government borrow a lot of money so that lenders will earn higher interest, but it would be nice if Mathews and Carson understood basic supply and demand.
I wasn't planning to support Carson anyway. However, the damage done by bad economic reporting is probably worse than that done by economically illiterate Presidential candidates.
Monday, October 19, 2015
David Beckworth makes a great point here.
Of course, it remains true that the Fed is "fixing" interest rates, though not through a conventional price control. Rand Paul is correct the Fed should stop doing this and let all interest rates be controlled by market forces.
But as David points out, the market clearing interest rate is almost certainly very low right now because of "low spending," or alternative, high saving and low investment.
And worse is the notion that the Fed should manipulate interest rates to "normalize" them, that is to fix them at a level from the past. The job of prices is to coordinate, not be at some traditional level. It is the notion that there is something to "normalize" about any price, including an interest rate, that is the fallacy of price fixing.
Of course, some free marketers have in the back of their mind some notion that the quantity of money should remain fixed, and so present or even past increases in the quantity of money imply that interest rates are below the appropriate level.
It is only when one considers both the quantity of money and the demand to hold it, and then dig deeper into the concept of the nominal anchor of the economy, that any notion any change in the quantity of money is distortionary is shown to be empty.
Saturday, August 22, 2015
Monetary Policy and Bicycles
Nick Rowe does a great job with mechanical analogies for monetary policy.
Scott Sumner mentions Rowe and New Keynesian and Neo-Fisherism and then links to a video about someone who put tremendous energy into learning to ride a bike with reversed steering. Scott found it linked by Tyler Cowen here. Here is link to the video.
I can't begin to link all the relevant posts by Rowe. The video really relates to many posts about how the conventional wisdom today for central banks is that they need to lower nominal interest rates to raise inflation and raise nominal interest rates to raise inflation. Monetary policy in new Keynesian models has traditionally followed that conventional wisdom exclusively.
With neo-Fisherism, a higher nominal interest rate is associated with higher inflation and a lower nominal interest rate is associated with lower inflation. Therefore, couldn't it be that when central banks raise their interest rate target, they cause higher inflation? Could it be that the low interest rate targets set by the Fed for the last 7 years is why inflation continues to run below the Fed's target of 2%?
The video is about a bicycle constructed to go left when the ride turns right and right when the rider turns left. It is about how difficult it was for him to learn to ride the new bike.
Rowe has argued that the conventional view that the way to raise inflation is to first lower the nominal interest rate seems convoluted. This is especially true when the higher inflation will later require the central bank to raise its target for the nominal interest rate.
Those, like Rowe (and I) who have never accepted the new Keynesian approach would point out that a more rapid growth rate of the quantity of money may well result in a lower nominal interest rate in the short run, but that the long run effect is a higher inflation rate and a higher nominal interest rate. If the short run "liqudity effect" on the interest rate were to not materialize, say because of anticipation of inflation or rapid growth in real output, it would not be of central importance. A possible, transitional effect does not appear. So what? Josh Henderson has a good post along those lines. The "problem" with neo-Fisherist results in a new Keynesian model is a reason to believe that the new Keynesian approach to modeling is problematic. If the Fed expands money growth, even if this does lead to a temporary decrease nominal interest rates, it won't result in lower inflation. And if the more rapid money grown results in immediately higher nominal interest rates, that won't result in lower inflation either.
But perhaps most relevant is Rowe's post about how it is all about communication. If the Fed raises interest rates and everyone thinks this means the Fed is trying to stop inflation, then inflation will fall. But if the Fed raises interest rates and everyone thinks this is due to a new inflationary policy, inflation will rise.
And even more relevant to the bicycle experiment is David Glasner's post about central bankers having a couple of centuries of gold standard experience to narrow their perspective--that is, they learned to ride a "normal" bike. In that world, they were trying to keep their own liabilities redeemable in gold. Raise interest rates to attract more gold. Lower interest rates (if you want) because you would rather hold earning assets rather than gold. The price level and inflation rate depended on the world supply and demand for gold.
And after the gold standard disappeared, we are now suffering through the efforts of our central bankers to ride a new type of bicycle--one that determines the value of money.
My solution is to constrain central banks so that they are no longer responsible for determining the value of money. A nominal GDP level target determines the price level. A central bank (or a free banking system) subject to an nominal GDP level rule would no more be in a position to use the neo-Fisherist approach than a central bank (or free banking system) subject to gold redeemability. The inflation rate necessary to return to target is tied down, so if the rule is credible, so is the expected inflation rate.
Scott Sumner mentions Rowe and New Keynesian and Neo-Fisherism and then links to a video about someone who put tremendous energy into learning to ride a bike with reversed steering. Scott found it linked by Tyler Cowen here. Here is link to the video.
I can't begin to link all the relevant posts by Rowe. The video really relates to many posts about how the conventional wisdom today for central banks is that they need to lower nominal interest rates to raise inflation and raise nominal interest rates to raise inflation. Monetary policy in new Keynesian models has traditionally followed that conventional wisdom exclusively.
With neo-Fisherism, a higher nominal interest rate is associated with higher inflation and a lower nominal interest rate is associated with lower inflation. Therefore, couldn't it be that when central banks raise their interest rate target, they cause higher inflation? Could it be that the low interest rate targets set by the Fed for the last 7 years is why inflation continues to run below the Fed's target of 2%?
The video is about a bicycle constructed to go left when the ride turns right and right when the rider turns left. It is about how difficult it was for him to learn to ride the new bike.
Rowe has argued that the conventional view that the way to raise inflation is to first lower the nominal interest rate seems convoluted. This is especially true when the higher inflation will later require the central bank to raise its target for the nominal interest rate.
Those, like Rowe (and I) who have never accepted the new Keynesian approach would point out that a more rapid growth rate of the quantity of money may well result in a lower nominal interest rate in the short run, but that the long run effect is a higher inflation rate and a higher nominal interest rate. If the short run "liqudity effect" on the interest rate were to not materialize, say because of anticipation of inflation or rapid growth in real output, it would not be of central importance. A possible, transitional effect does not appear. So what? Josh Henderson has a good post along those lines. The "problem" with neo-Fisherist results in a new Keynesian model is a reason to believe that the new Keynesian approach to modeling is problematic. If the Fed expands money growth, even if this does lead to a temporary decrease nominal interest rates, it won't result in lower inflation. And if the more rapid money grown results in immediately higher nominal interest rates, that won't result in lower inflation either.
But perhaps most relevant is Rowe's post about how it is all about communication. If the Fed raises interest rates and everyone thinks this means the Fed is trying to stop inflation, then inflation will fall. But if the Fed raises interest rates and everyone thinks this is due to a new inflationary policy, inflation will rise.
And even more relevant to the bicycle experiment is David Glasner's post about central bankers having a couple of centuries of gold standard experience to narrow their perspective--that is, they learned to ride a "normal" bike. In that world, they were trying to keep their own liabilities redeemable in gold. Raise interest rates to attract more gold. Lower interest rates (if you want) because you would rather hold earning assets rather than gold. The price level and inflation rate depended on the world supply and demand for gold.
And after the gold standard disappeared, we are now suffering through the efforts of our central bankers to ride a new type of bicycle--one that determines the value of money.
My solution is to constrain central banks so that they are no longer responsible for determining the value of money. A nominal GDP level target determines the price level. A central bank (or a free banking system) subject to an nominal GDP level rule would no more be in a position to use the neo-Fisherist approach than a central bank (or free banking system) subject to gold redeemability. The inflation rate necessary to return to target is tied down, so if the rule is credible, so is the expected inflation rate.
Monday, August 3, 2015
NBER Working Paper on the Desirability of NGDP targeting.
http://www.nber.org/papers/w21420
On the Desirability of Nominal GDP Targeting
Julio Garín, Robert Lester, Eric Sims
This paper evaluates the welfare properties of nominal GDP targeting in the context of a New Keynesian model with both price and wage rigidity. In particular, we compare nominal GDP targeting to inflation and output gap targeting as well as to a conventional Taylor rule. These comparisons are made on the basis of welfare losses relative to a hypothetical equilibrium with flexible prices and wages. Output gap targeting is the most desirable of the rules under consideration, but nominal GDP targeting performs almost as well. Nominal GDP targeting is associated with smaller welfare losses than a Taylor rule and significantly outperforms inflation targeting. Relative to inflation targeting and a Taylor rule, nominal GDP targeting performs best conditional on supply shocks and when wages are sticky relative to prices. Nominal GDP targeting may outperform output gap targeting if the gap is observed with noise, and has more desirable properties related to equilibrium determinacy than does gap targeting.
Wednesday, May 27, 2015
Asset Price Inflation
Larry White mentioned that Alchain and Klein showed long ago that the measure of the purchasing power of money should include asset prices.
I don't agree.
I strongly agree that it is a mistake to measure the purchasing power of money solely by the prices of consumer goods and services--the CPI or CEP.
But I don't think that the prices of financial assets should be included in a measure of inflation.
As for real assets, I think that only the newly-produced ones should count.
In other words, I think that the GDP deflator, or something like it, is the least bad approach to measuring the purchasing power of money.
First, consider equities. If we assume that a share of stock is a claim to a fixed quantity of goods, then any increase in the price of a share would imply a lower purchasing power of money. However, suppose that a company is expected to become twice as profitable. The price of a share would rise, but it would not be a higher price for the same quantity of future goods. It would be a higher price for a higher quantity of future goods.
Now, suppose the market interest rate should fall, and the lower discount of future returns results in higher prices of equities and existing long term bonds. Superficially, the purchasing power of money is less. It is necessary to pay more for the same quantity of future goods.
However, suppose we lived in a world where the only saving instrument was a saving account. There is no possibility of capital gain or loss on financial assets. If the interest rate should fall, then it ia true that money put into a saving account will provide less future consumption. But is that a lower purchasing power of money? Saving or accumulated wealth now generates a lower nominal and real income. Is that a higher price level? I don't think so.
I guess my thinking on the subject is very much influenced by some sort of presumption that inflation is bad and the monetary regime should be stabilizing the purchasing power of money. And so, I would ask if a monetary contraction would desirable to force down the prices of consumer goods and services enough to offset the increase in long term bond prices. I don't think so.
The coordinating role of the lower interest rate is to raise the demand for both consumer goods and services and capital goods.
For example, suppose there was an increase in saving supply. The direct and immediate effect is a lower demand for consumer goods and services. The coordinating role of the lower interest rate is to increase the quantity of consumer goods and services demanded as well as the quantity of capital goods demanded. The result is what returns saving and investment back into balance.
I certainly grant that it would be inappropriate for this reallocation of resources to occur with stable prices for consumer goods and services. Lower prices of consumer goods and services along with higher prices of capital goods should be expected.
Now, the lower interest rates should result in higher prices of all the existing capital goods--not just the newly produced ones. This doesn't require anyone to spend any money on all of these capital goods. It is just that entrepreneurs will be willing to offer more money for them and those using them now will insist on a higher payment to part with them.
Should the weighting of capital goods in the price level depend on all of the capital goods or just the newly produced ones?
Suppose consumption is $8000 billion and investment $2000 billion. The capital stock, however, is $20,000 billion. There is an increase in saving and a $200 billion shift in demand. Suppose that this 2.5% decrease in demand for consumer goods results in 1% lower prices. However, the 10% increase in the demand for capital goods requires 4% higher prices. If we look at only currently produced goods, the price level remains the same. But if all of the existing capital goods count, then there has been a very substantial inflation--about 2.5%.
Would it be better for the prices of consumer goods to fall more and the increase in the prices of capital goods to rise less? What would this be signalling? That the production of consumer goods and services should be reduced by more? That the expansion in the production of new capital goods should be less?
Presumably this would require that wages be reduced to return to equilibrium. Why? Is this signalling that people should work less?
In my view counting stock prices is more or less the same thing as counting the prices of existing capital goods--in theory.
In reality, is it really the best that if stock prices go up, there is a deflation of consumer prices along with money wage cuts? What is the point? Do we need to get people to work less? Or is it just to free up resources from the production of consumer goods and services to print up more shares of stock?
As for bonds--as old bonds mature and new ones are issued at par with lower coupon rates, does that count as deflation? The "prices" of bonds are falling. Should consumer prices and money wages rise to offset that deflation? Clearly they should not.
Now, perhaps Alchain, Klein, and White have no presumption that the purchasing power of money should be stabilized. If more saving supply or reduced investment demand results in a lower natural interest rate, then that just lowers the purchasing power of money--and there is nothing bad about it. Maybe.
And I must admit, I don't favor a stable price level of any sort, but rather a stable growth path for spending on currently produced output. However, I do favor a growth rate of spending that is consistent with the expected trend growth rate of potential output. And so, this would tend to result in a stable price level for currently produced output. (And I know White does not favor stabilizing the price level, especially when there are changes in productivity.)
But it wouldn't tend to stabilize the prices of current output and existing capital goods and financial assets all together.
And it shouldn't. Or at least, I don't think so.
I don't agree.
I strongly agree that it is a mistake to measure the purchasing power of money solely by the prices of consumer goods and services--the CPI or CEP.
But I don't think that the prices of financial assets should be included in a measure of inflation.
As for real assets, I think that only the newly-produced ones should count.
In other words, I think that the GDP deflator, or something like it, is the least bad approach to measuring the purchasing power of money.
First, consider equities. If we assume that a share of stock is a claim to a fixed quantity of goods, then any increase in the price of a share would imply a lower purchasing power of money. However, suppose that a company is expected to become twice as profitable. The price of a share would rise, but it would not be a higher price for the same quantity of future goods. It would be a higher price for a higher quantity of future goods.
Now, suppose the market interest rate should fall, and the lower discount of future returns results in higher prices of equities and existing long term bonds. Superficially, the purchasing power of money is less. It is necessary to pay more for the same quantity of future goods.
However, suppose we lived in a world where the only saving instrument was a saving account. There is no possibility of capital gain or loss on financial assets. If the interest rate should fall, then it ia true that money put into a saving account will provide less future consumption. But is that a lower purchasing power of money? Saving or accumulated wealth now generates a lower nominal and real income. Is that a higher price level? I don't think so.
I guess my thinking on the subject is very much influenced by some sort of presumption that inflation is bad and the monetary regime should be stabilizing the purchasing power of money. And so, I would ask if a monetary contraction would desirable to force down the prices of consumer goods and services enough to offset the increase in long term bond prices. I don't think so.
The coordinating role of the lower interest rate is to raise the demand for both consumer goods and services and capital goods.
For example, suppose there was an increase in saving supply. The direct and immediate effect is a lower demand for consumer goods and services. The coordinating role of the lower interest rate is to increase the quantity of consumer goods and services demanded as well as the quantity of capital goods demanded. The result is what returns saving and investment back into balance.
I certainly grant that it would be inappropriate for this reallocation of resources to occur with stable prices for consumer goods and services. Lower prices of consumer goods and services along with higher prices of capital goods should be expected.
Now, the lower interest rates should result in higher prices of all the existing capital goods--not just the newly produced ones. This doesn't require anyone to spend any money on all of these capital goods. It is just that entrepreneurs will be willing to offer more money for them and those using them now will insist on a higher payment to part with them.
Should the weighting of capital goods in the price level depend on all of the capital goods or just the newly produced ones?
Suppose consumption is $8000 billion and investment $2000 billion. The capital stock, however, is $20,000 billion. There is an increase in saving and a $200 billion shift in demand. Suppose that this 2.5% decrease in demand for consumer goods results in 1% lower prices. However, the 10% increase in the demand for capital goods requires 4% higher prices. If we look at only currently produced goods, the price level remains the same. But if all of the existing capital goods count, then there has been a very substantial inflation--about 2.5%.
Would it be better for the prices of consumer goods to fall more and the increase in the prices of capital goods to rise less? What would this be signalling? That the production of consumer goods and services should be reduced by more? That the expansion in the production of new capital goods should be less?
Presumably this would require that wages be reduced to return to equilibrium. Why? Is this signalling that people should work less?
In my view counting stock prices is more or less the same thing as counting the prices of existing capital goods--in theory.
In reality, is it really the best that if stock prices go up, there is a deflation of consumer prices along with money wage cuts? What is the point? Do we need to get people to work less? Or is it just to free up resources from the production of consumer goods and services to print up more shares of stock?
As for bonds--as old bonds mature and new ones are issued at par with lower coupon rates, does that count as deflation? The "prices" of bonds are falling. Should consumer prices and money wages rise to offset that deflation? Clearly they should not.
Now, perhaps Alchain, Klein, and White have no presumption that the purchasing power of money should be stabilized. If more saving supply or reduced investment demand results in a lower natural interest rate, then that just lowers the purchasing power of money--and there is nothing bad about it. Maybe.
And I must admit, I don't favor a stable price level of any sort, but rather a stable growth path for spending on currently produced output. However, I do favor a growth rate of spending that is consistent with the expected trend growth rate of potential output. And so, this would tend to result in a stable price level for currently produced output. (And I know White does not favor stabilizing the price level, especially when there are changes in productivity.)
But it wouldn't tend to stabilize the prices of current output and existing capital goods and financial assets all together.
And it shouldn't. Or at least, I don't think so.
Subscribe to:
Posts (Atom)