In these debates with the MMers the last few days, a favorite example of their's which they claim shows fiscal policy is irrelevant is Japan during the 90s. After all, didn't they do considerable fiscal stimulus there and yet the country stagnated?
Yet, what's interesting about Japan is that GDP growth never shrunk. You can view Japan as showing fiscal stimulus doesn't work or you can ask why Japan in the 90s never went the way of the U.S. in 1929-33 or in 2009. There was never an output gap. It never feel behind, it just grew more slowly.
Richard Koo argues that Japan's decade was not as lost as we might think it was. He argues that what caused it's stagnation was a 'balance sheet recession'-that the economy couldn't come all the way back until companies paid down debt and deleveraged.
Indeed, he goes as far as arguing that what increased the money supply in the 90s was: fiscal policy. This is because no mater how much liquidity the BOJ put into the system it didn't help as there weren't borrowers lined up who where prevented from borrowing but rather private companies couldn't borrow they had to pay down their debts. So what enabled the money supply to grow at all during this time was the government borrowing to pay for fiscal stimulus.
"Japan's monetary policy and money supply have to totally depended on the government's fiscal policy for the past 10 years-private-sector enterprises have been paying down debt since around 1998, leaving the government as the only borrower. An increase in government borrowing produces a corresponding increase in the money supply, augmenting the effectiveness of monetary policy. If the government stops borrowing, the money supply will shrink no matter what the Bank of Japan does. In this sense fiscal policy has been the most important determinant of the size of the money supply."
http://www.amazon.com/Holy-Grail-Macroeconomics-Lessons-Recession-ebook/dp/B006ES4UX0/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1393895556&sr=1-1&keywords=richard+koo
I have the kindle version an this passage is found on location 789 of 7542, 10% into the book. Further:
"At the time time, the Bank of Japan was under heavy pressure from politicians and academics at home and abroad to stimulate the economy by boosting the supply of high-powered money, and it complied. Rebasing to 1990/Q1=100, liquidity had risen to 300 in 2005-in other words the Bank of Japan had tripled the amount of liquidity in the system over the fifteen year period. But the money supply-money actually available to the private sector-rose only 50 percent and this happened only because of government borrowing."
Location 827, 11%.
Just in case this isn't enough red meat for the MMers reading this-Mark, Don Geddis, et. al.-here's more:
"Japan has avoided falling into to depression-like conditions only because the government has continued to borrow and spend. Even as private-sector credit declined, the increase in credit to the public sector-that is, bank purchases of government bonds-enabled the money supply to expand, and ensured that debt repaid by the private sector did not become bottled up in the banking system. In this sense, Exhibits 1-8 and 1-9 confirm that Japan's economy has inhabited a world uncharted by conventional economic theory: a world in which fiscal policy determines the effectiveness of monetary policy."
Ibid.
Obviously Koo's narrative is totally a world not chartered by conventional theory-his 'balance sheet recession' is certainly plenty controversial. Krugman disagrees with him sharply as well, though he still wrote a paper with Eggertsson that was supposed to employ a 'Minsky-Koo' approach.
http://qje.oxfordjournals.org/content/127/3/1469.abstract
Yet, what's interesting about Japan is that GDP growth never shrunk. You can view Japan as showing fiscal stimulus doesn't work or you can ask why Japan in the 90s never went the way of the U.S. in 1929-33 or in 2009. There was never an output gap. It never feel behind, it just grew more slowly.
Richard Koo argues that Japan's decade was not as lost as we might think it was. He argues that what caused it's stagnation was a 'balance sheet recession'-that the economy couldn't come all the way back until companies paid down debt and deleveraged.
Indeed, he goes as far as arguing that what increased the money supply in the 90s was: fiscal policy. This is because no mater how much liquidity the BOJ put into the system it didn't help as there weren't borrowers lined up who where prevented from borrowing but rather private companies couldn't borrow they had to pay down their debts. So what enabled the money supply to grow at all during this time was the government borrowing to pay for fiscal stimulus.
"Japan's monetary policy and money supply have to totally depended on the government's fiscal policy for the past 10 years-private-sector enterprises have been paying down debt since around 1998, leaving the government as the only borrower. An increase in government borrowing produces a corresponding increase in the money supply, augmenting the effectiveness of monetary policy. If the government stops borrowing, the money supply will shrink no matter what the Bank of Japan does. In this sense fiscal policy has been the most important determinant of the size of the money supply."
http://www.amazon.com/Holy-Grail-Macroeconomics-Lessons-Recession-ebook/dp/B006ES4UX0/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1393895556&sr=1-1&keywords=richard+koo
I have the kindle version an this passage is found on location 789 of 7542, 10% into the book. Further:
"At the time time, the Bank of Japan was under heavy pressure from politicians and academics at home and abroad to stimulate the economy by boosting the supply of high-powered money, and it complied. Rebasing to 1990/Q1=100, liquidity had risen to 300 in 2005-in other words the Bank of Japan had tripled the amount of liquidity in the system over the fifteen year period. But the money supply-money actually available to the private sector-rose only 50 percent and this happened only because of government borrowing."
Location 827, 11%.
Just in case this isn't enough red meat for the MMers reading this-Mark, Don Geddis, et. al.-here's more:
"Japan has avoided falling into to depression-like conditions only because the government has continued to borrow and spend. Even as private-sector credit declined, the increase in credit to the public sector-that is, bank purchases of government bonds-enabled the money supply to expand, and ensured that debt repaid by the private sector did not become bottled up in the banking system. In this sense, Exhibits 1-8 and 1-9 confirm that Japan's economy has inhabited a world uncharted by conventional economic theory: a world in which fiscal policy determines the effectiveness of monetary policy."
Ibid.
Obviously Koo's narrative is totally a world not chartered by conventional theory-his 'balance sheet recession' is certainly plenty controversial. Krugman disagrees with him sharply as well, though he still wrote a paper with Eggertsson that was supposed to employ a 'Minsky-Koo' approach.
http://qje.oxfordjournals.org/content/127/3/1469.abstract
Sumner and his slobbering sycophants love to pretend that their claims are based on empirical data. If so , they should be willing to concede that Koo's 'balance sheet recession' idea has merit , since there's plenty of data to support it , and more arriving all the time as this crisis claims new victims.
ReplyDeleteArcand finds that growth slows when credit to the private sector exceeds ~ 100% of gdp :
https://www.imf.org/external/pubs/ft/wp/2012/wp12161.pdf
Earlier , Cecchetti found that the threshold for the corporate sector was ~ 90% and that for the household sector ~ 85%.
https://www.bis.org/publ/othp16.pdf
Of course , when debt/gdp levels go up , the size of the financial sector relative to the overall economy tends to rise as well. Several studies have shown negative effects on growth when financialization becomes excessive , e.g. , Cechetti again :
http://www.bis.org/publ/work381.pdf
also :
http://economics.ucsc.edu/research/downloads/Finance%20and%20Economic%20Development_LS.pdf
These empirical studies won't convince the MMs , naturally. They'll say : " What about Canada and Australia ? They have high debt , too. " Then when subsequent growth data shows that those countries suffered from the debt overhang as well , the MMS will scrounge around to find some other outlier to cling to.
When your goal is to justify and maintain a status quo that works to your benefit , data don't matter.
Marko
Let's take a closer look at these papers.
Delete1) Arcand, Berkes and Panizza (2012)
Arcand et al uses "claims on private sector by deposit money banks and other financial institutions" (as a percent of GDP) as their measure of private sector credit. The source of the data is a set developed by Beck et al which can be found here:
http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEARCH/0,,contentMDK:20696167~pagePK:64214825~piPK:64214943~theSitePK:469382,00.html
2) Cecchetti, Mohanty and Zampolli (2011)
Household and corporate debt levels are described in the tables in Appendix 2. Note that Japan's household debt levels are never more than 87% of GDP for the years reported. Household sector debt is relatively low in Japan for an advanced nation.
3) Cecchetti and Kharroubi (2012)
Graph 4 shows that Japan's financial sector share in total employment is below the threshold level. Cecchetti and Kharroubi use two World Bank variables as their measure of "finance": 1) Private Credit, 2) Private Credit by Banks. Private Credit refers to what the World Bank calls "domestic credit to private sector" and can be found here:
http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS
Private Credit by Banks refers to what the World Bank calls "domestic credit provided by banking sector" and can be found here:
http://data.worldbank.org/indicator/FS.AST.DOMS.GD.ZS/countries/1W?display=default
Note that Private Credit by Banks is something of a misnomer since it includes banking sector credit extended to the government sector.
4) Nirvikar Singh
Singh uses three World Bank variables as his measure of "financial development": 1) Private Sector Credit, 2) Liquid Liabilities and 3) Domestic Credit. Private Sector Credit refers to what the World Bank calls "domestic credit to private sector". Liquid liabilities are also known as M3. They are a measure of broad money supply and can be found here:
http://data.worldbank.org/indicator/FS.LBL.LIQU.GD.ZS
Domestic credit refers to what the World Bank calls "domestic credit provided by banking sector".
Now, let’s to get to the point.
The ratio of M3 to GDP is also known by another name, and that is the velocity of money. The velocity of money is well known to be strongly correlated to interest rates and inflation as well as the rate of change in NGDP. By finding that there is a threshold level for M3 above which RGDP growth is adversely affected also suggests that there is a threshold level for inflation and NGDP growth below which RGDP growth is affected. This is not a result that would be at all surprising to MM.
Moreover there are strong correlations between M3 and the other three measures of “finance”. In particular, using the Beck dataset for M3 (the World Bank only has complete M3 for about 40 nations):
1) The R-squared between M3 and "claims on private sector by deposit money banks and other financial institutions" in Japan from 1961 through 2011 is 95.8%.
2) The R-squared between M3 and "claims on private sector by deposit money banks and other financial institutions" for 148 nations in 2011 is 67.2%.
3) The R-squared between M3 and "domestic credit to private sector" in Japan from 1961 through 2011 is 94.4%.
4) The R-squared between M3 and "domestic credit to private sector" for 155 nations in 2011 is 63.7%.
5) The R-squared between M3 and "domestic credit to provided by banking sector" in Japan from 1961 through 2011 is 96.8%.
6) The R-squared between M3 and "domestic credit to private sector" for 155 nations in 2011 is 62.3%.
Needless to say, all of these relationships are statistically significant at the 1% level.
The bottom line is high levels of “finance” are correlated with low money velocity and tight money.
Delete"Investopedia explains 'M3'
The M3 classification is the broadest measure of an economy's money supply. It emphasizes money as a store-of-value more so than money as a medium of exchange – hence the inclusion of less-liquid assets in M3. It is used by economists to estimate the entire money supply within an economy, and by governments to direct policy and control inflation over medium and long-term time periods.
Each M3 component is given equal weight during calculation. This means, for example, that M2 and large time deposits are treated the same and aggregated without any adjustments. While this does create a simplified calculation, it assumes that each component of M3 impacts the economy the same way. This can be considered a shortcoming of this measurement of the money supply.
Since 2006, M3 is no longer tracked by the U.S. central bank."
So M3 to GDP = velocity?
M3 measurements are basically worthless because they assume that each component of M3 impacts the economy the same way so in their own words;
"This can be considered a shortcoming of this measurement of the money supply"
and since 2006 the US CB doesnt even track M3!!! This was at the end of THE most stable financial period EVAH!! aka "The Great Moderation" So velocity numbers were all over the chart during the great moderation and they stopped using M3
Another nail in the coffin of MV=PQ??
Nicely done Greg.
DeleteGreg,
DeleteM3 is one of the three measures of "financial development" used by Nirvikar Singh, whom Marko cited for evidence, so it wasn't me who first brought up M3. Moreover, the World Bank maintains annual estimates of M3 for the US through 2012, which is where Singh got his data. And not only that, but Arcand et al's source of data (Beck et al.) maintains annual M3 estimates for the US through 2011 as well.
And the specific shortcoming you cite, that that each component of M3 is assumed to impact the economy the same way, is addressed by the Divisia monetary aggregates index developed by William A. Barnett:
http://en.wikipedia.org/wiki/Divisia_monetary_aggregates_index
Current Divisia M3 estimates are available at a monthly frequency from the Center for Financial Stability (CFS):
http://www.centerforfinancialstability.org/amfm_data.php
Divisia appears to be the future of monetary aggregates.
Yes, I find Koo's premise pretty compelling and as you say the question of debt deleveraging is an empirical question. This idea is anthema to Sumner who wants to believe that cause-and cure-of the business cycle is purely nominal.
ReplyDeleteSo if you believe him any 'real' aspect of the economy can't possibly matter in terms of getting an economy into a recession or getting it out again.
Agreed that BSR idea is the best out there.
DeleteBut heres the thing, there is nothing in conflict with BSR and the idea that the BC is purely nominal in my view. Setting aside the word purely perhaps, the BSR works by looking at all entities the way banks look at entities, as balance sheets. Dividing everything and everyone into assets and liabilities it becomes pretty easy to understand why someone might stop spending and start repairing their balance sheet. Most entities cease to exist (as viable economic agents) when their net worth gets too negative for too long. Thats just a fact of modern financial life. The question is how much can each of us do to repair our own balance sheets? Obviously very little in some circumstances like today. As a worker, to repair your balance sheet you need your assets to increase in value and your liabilities to decrease, so you spend less on present consumption and pay past consumption off faster. There is nothing you can do to increase home values, outside of upgrades, but those require more present period spending. There is nothing you can do to increase your 401k (if you have one) value either. Those are influenced way more by others.
Businesses have the same options, increase assets decrease liabilities but they have a few more options out there. They can buy back their stock to goose the price maybe, but if they borrow to do so the price must increase more than the credit costs to be worthwhile.
Banks, while they are businesses, have an ability to actually expand their balance sheets at will, but they wont if its not looking to be profitable and the poorer the balance sheets of everyone else the less profit opportunities the banks have.
The CB is unique because it can actually operate as long as it wishes with negative equity. It can have a negative net worth forever if need be because its JUST A NUMBER for them. Its not real. Its real for everyone else if they run negative equity, its called insolvency and they go out of business or to jail/poorhouse, but the CB is different
So Sumner is correct but he doesnt know why.
I'm willing to stipulate that the CB could , technically , buy up assets , bad debt , etc. indefinitely and we could continue on our merry way , overinvesting in real estate and various nonprofitable ventures - also indefinitely.
DeleteTechnically , we can do that. Realistically , it would be foolish to do. The status of the dollar as a reserve currency and safe haven would be
undermined , a process that has already begun , in fact. Countries are increasingly moving away from trade settlements in dollar terms , and threats like the one made by Russia recently will only become more common. Historically , monetary superpowers never last. At some point they make a dumb move and get displaced by a better , more sound alternative. Setting up your central bank as the enabler of a Ponzi financial system is just such a dumb move , and that's exactly what Sumner is advocating.
Marko
Mike, you know that Sumner says there's still be booms and busts (i.e. a business cycle) even if all nominal problems are solved.
DeleteAlso check out the last paragraph here:
Deletehttp://uneasymoney.com/2014/02/28/exposed-irrational-inflation-phobia-at-the-fed-caused-the-panic-of-2008/#comment-52932
A tie in between MM concepts and the BSR concept?
Marko,
DeleteIm not sure trade settlements in dollar terms really matter all that much. Anyone who does business with us accepts dollars or doesnt get paid. Even if oil stopped being priced in dollars we could still use dollars to buy it. There would still be a dollar price.
I agree that monetary superpower is a fleeting title but until someone else takes the role of net importer dollars will be the most available currency.
Incidentally, Marko, do you have a blog?
ReplyDeleteNope , no blog. Maybe I'll take the plunge one day , but I have this nagging feeling that the moment I start a blog will be when I can no longer think of a thing to say.
ReplyDeleteThe data on the diminishing returns to growth with higher leverage is so clear , and the example of China is in the finance news almost daily , so I think it has to be confronted. The Great Moderation gave us exactly what Sumner is looking for , but it came at the expense of unsustainably growing debt loads and serial asset bubbles , both of which he conveniently chooses to ignore.
I find it amusing that Abe seems to have lost faith in the magic of monetarism , as he's now talking about more fiscal stimulus and he's jawboning business to raise wages at rates greater than inflation. He's sounding more like FDR and less like a MM every day. It must drive Sumner to distraction , but you can't blame Abe - he's looking for something that works in the real world , unlike the MMs.
Marko
"but I have this nagging feeling that the moment I start a blog will be when I can no longer think of a thing to say."
DeleteLOL!! I know that feeling
I started a blog five years ago, mainly to get my thoughts down in anticipaton of writing a book someday, and I find it harder and harder to find something to write about. I write post length comments at various places I think and that purges me.
I addressed the claims of Richard Koo in four blog posts in June of last year:
ReplyDeletehttp://thefaintofheart.wordpress.com/2013/06/02/koos-wrongheaded-views-on-the-great-depression-as-an-example-of-a-balance-sheet-recession-a-guest-post-by-mark-sadowski/
http://thefaintofheart.wordpress.com/2013/06/10/richard-koo-also-misinterprets-japans-lost-decades-a-guest-post-by-mark-sadowski/
http://thefaintofheart.wordpress.com/2013/06/11/richard-koo-also-misinterprets-japans-lost-decades-part-ii-a-guest-post-by-mark-sadowski/
http://thefaintofheart.wordpress.com/2013/06/20/richard-koos-misleading-take-on-the-great-recession-the-final-chapter-a-guest-post-by-mark-sadowski/
Everyone has probably heard of Keen's work on debt and growth , but I want to use an illustration from Biggs et al , who preceded Keen on the "credit impulse" idea. This shows the relationship between the private sector credit impulse and gdp growth , using private consumption plus investment as the gdp proxy :
ReplyDeletehttp://www.clearonmoney.com/dw/lib/exe/fetch.php?media=public:mayer_fig2.gif
I don't know about others , but I find that pretty compelling. You can do something similar yourself , using FRED , as I've done , here :
http://research.stlouisfed.org/fred2/graph/?graph_id=163727&category_id=9447#
Now , I may have missed it , but I haven't seen any such compelling graphs out of the MM crowd , with any monetary aggregate , using either real or nominal gdp , or C&I as I've shown above. Surely with their advanced monetary theory , they can produce even more compelling graphic correlations. I look forward to seeing them.
I'm amazed how someone can totally destroy the work of IMF economists with just a few lines in a blog post. I wondered who these IMF clowns must be , so I looked them up on Google :
Cecchetti :
http://scholar.google.com/citations?hl=en&user=MRi06CcAAAAJ&view_op=list_works
Arcand's co-author , Panizza :
http://scholar.google.com/citations?hl=en&user=TrHXjXkAAAAJ&view_op=list_works
Pretty prolific in their field , but I bet the blogger above blows them away. Let's see :
Mark A Sadowski :
"Your search - Mark A Sadowski - didn't match any user profiles"
try again :
"Your search - Sadowski Mark - didn't match any user profiles."
??
Hmmmm........
Marko
"I'm amazed how someone can totally destroy the work of IMF economists with just a few lines in a blog post. I wondered who these IMF clowns must be , so I looked them up on Google:"
DeleteTo be absolutely clear, I didn't criticize any of the four papers to which you linked. I'm reasonably familiar Cecchetti, principally because of his work on the Great Depression, in particular the following three papers:
http://www.nber.org/papers/w2472.pdf
http://www.nber.org/papers/w3174.pdf
http://www.nber.org/papers/w6015.pdf
The last paper is particularly relevant to this conversation since Cecchetti essentially comes to the conclusion that Federal Reserve policy was insufficiently proactive and expansionary before and during the contractionary phase of the Great Depression, and he is critical of the gold standard.
I'm not really familiar with Panizza, but then almost all of his papers seem to relate to debt issues and that's not an obsession of mine. I've also never heard of Nirvikar Singh, but again I didn't find fault with any of the four papers, just your interpretation of them.
"Everyone has probably heard of Keen's work on debt and growth, but I want to use an illustration from Biggs et al , who preceded Keen on the "credit impulse" idea. This shows the relationship between the private sector credit impulse and gdp growth , using private consumption plus investment as the gdp proxy :"
Yes, I'm very familiar with the credit impulse concept, having replicated all of Biggs, Mayer and Pick's estimations with respect to the US. There's no doubt the correlations are significant but apparently you haven't heard about the background behind them.
Back in 2006, Calvo, Izquierdo and Talvi published a paper in which they described a very similar pattern in emerging market economies following financial crises in which output recovered with virtually no recovery in either domestic or foreign credit, a phenomenon that they termed a Phoenix Miracle:
http://www.iadb.org/res/publications/pubfiles/pubWP-570.pdf
Calvo also showed that the Great Depression could be classified as a Phoenix Miracle.
Biggs, Mayer and Pick developed the concept of the credit impulse specifically to explain the phenomenon of credit-less recoveries:
http://www.banccentraldecatalunya.ch/wordpress/wp-content/uploads/2013/Biblioteca_ERC/2013Oktober/11102013/BankOfNetherlands-Working%20paper%20218_tcm46-220409.pdf
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1595980
I find the second paper more useful since the econometric results are reported and the sources for the data are described in detail.
The credit impulse is essentially the rate of change of the rate of change in credit market debt as a percent of GDP, or the acceleration of credit. So even though the credit impulse is positively correlated with growth in real consumption and investment, it does not imply that the stock of debt must increase in order for economic growth to take place. On the contrary it was developed specifically to explain the role of credit in credit-less recoveries.
Now, as a matter of record, despite the strong correlation, I am somewhat skeptical of the credit impulse concept. I think its theoretical justification is wanting, and I'm not entirely sure it is not committing some econometric sin, since the dependent and independent variables correlate strongly with lagged terms of themselves owing to the fact that they are year on year differences. In fact although Biggs, Mayer and Pick first wrote about their results in 2009, to my knowledge the credit impulse still has yet to appear in any peer reviewed research journal.
I dug up my previous estimations involving the credit impulse and I remember what the problem is. The Durbin-Watson statistic on the estimates using quarterly data are far too low indicating there's a serious problem with autocorrelation. This should be too surprising because of the overlapping observations (i.e. everything is year on year). Biggs, Mayer and Pick don't mention this problem at all in either of their papers. The only indication that they tried to deal with the problem is they report using Newey-West HAC standard errors, which is one possible solution.
DeleteOn the other hand, the credit impulse was reported on Vox and featured in a post on Econbrowser:
http://econbrowser.com/archives/2009/09/credit_stock_gr_1
Biggs appears in comments. In fact in the second paper there are mistakes about where the data comes from. The paper says Flow of Funds F.1 but in fact it is L.1. Moreover in the paper it says lines 3-6 but in comments Biggs says quite clearly that government debt is excluded, so it's only lines 3-5 (line 6 is state and local), and this is easily verified by comparing the graphs.
Now, the reason why the Econbrowser post is significant to me is that Menzie Chinn (and James Hamilton) are expert econometricians, so I imagine if there was a problem they would have noticed. On the other hand I have pointed out minor errors to Menzie Chinn from time to time so maybe this escaped their attention.
In any case, "manipulation" of the data in this fashion is generally considered bad practice (see for example Gujarati page 447 in the section on autocorrelation in the 4th edition) and to be frank I have never seen a peer reviewed economic paper with overlapping observations. This, is the reason for my skepticism.
And as long as we're talking about Biggs, Mayer and Pick, there's another reason for my scepticism, and that actually has to do with Thomas Mayer's personal views.
DeleteThomas Mayer subscribes to Austrian Business Cycle Theory (ABCT). Consequently he blames loose monetary policy for asset price bubbles when there is no evidence for this, and he is opposed to better financial regulation when there is considerable evidence that financial innovation and the loosening of credit standards is responsible for the buildup in household debt. Page 7:
"A revival of Austrian economics could be a good start for such a research programme. Unfortunately, however, the battle cry of the public and politicians is for more regulation: regulate banks, regulate markets, regulate financial products! But those who push for blanket regulation suffer from the same control-illusion that got us into this crisis."
http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000278552/'I'm+an+Austrian+in+economics'.PDF
The IMF has made it clear that loose monetary policy is not responsible for asset price bubbles (Page 106-107):
"If monetary policy were the fundamental cause of house price booms over the past decade, there would be a systematic relationship between monetary policy conditions and house price gains across economies. Certainly, average real policy rates were low and even negative in some economies, and Taylor rule residuals were mostly negative, suggesting that monetary policy was generally accommodative across economies during this period. But there is, at best, a weak association with house price developments within the euro area (Figure 3.13, blue lines).22 And there is virtually no association between the measures of monetary policy stance and house price increases in the full sample (Figure 3.13, black lines). For example, whereas Ireland and Spain had low real short-term rates and large house price rises, Australia, New Zealand, and the United Kingdom had relatively high real rates and large house price rises. Moreover, the association between measures of the monetary policy stance and real stock price growth is extremely weak, whether assessed during the global house price boom (2001:Q4–2006:Q3; not shown) or during a later period, when stock markets rallied from their troughs (2003:Q1) through the stock market declines of 2007 (Figure 3.14).
The fairly regular behavior of inflation and output and the fact that Taylor rule residuals were not associated with recent asset price rises across economies in the sample suggest that monetary policy was not the main or systematic source of the recent asset price booms.23"
http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/c3.pdf
Figure 3.13 is similar to the following graph (note the near zero coefficient of determination):
http://www.federalreserve.gov/newsevents/speech/bernanke20100103slide9.gif
(continued)
(continued)
DeleteAnd the IMF has also made it clear that it is financial innovation and the loosening of credit standards that is responsible for the buildup of household debt (pages 102-103):
"In each of these episodes, a loosening of credit constraints allowed households to increase their debt. This increase in credit availability was associated with financial innovation and liberalization and declining lending standards. A wave of household optimism about future income and wealth prospects also played a role and, together with the greater credit availability, helped stoke the housing and stock market booms.
The United States in the 1920s—the “roaring twenties” illustrates the role of rising credit availability and consumer optimism in driving household debt. Technological innovation brought new consumer products such as automobiles and radios into widespread use. Financial innovation made it easier for households to obtain credit to buy such consumer durables and to obtain mortgage loans. Installment plans for the purchase of major consumer durables became particularly widespread (Olney, 1999). General Motors led the way with the establishment of the General Motors Acceptance Corporation in 1919 to make loans for the purchase of its automobiles. By 1927, two-thirds of new cars and household appliances were purchased on installment. Consumer debt doubled from 4.5 percent of personal income in 1920 to 9 percent of personal income in 1929. Over the same period, mortgage debt rose from 11 percent of gross national product to 28 percent, partly on the back of new forms of lending such as high-leverage home mortgage loans and early forms of securitization(Snowden, 2010). Reflecting the economic expansion and optimism that house values would continue rising, asset prices boomed.26 Real house prices rose by 19 percent from 1921 to 1925,27 while the stock market rose by 265 percent from 1921 to 1929.
Rising credit availability due to financialliberalization and declining lending standards also helped drive up household debt in the more recent cases we consider. In the Scandinavian countries, extensive price and quantity restrictions on financial products ended during the 1980s. Colombia implemented a wave of capital account and financial liberalization in the early 1990s. This rapid deregulation substantially encouraged competition for customers, which, in combination with strong tax incentives to invest in housing and optimism regarding asset values, led to a household debt boom in these economies.28 Similarly, following Iceland’s privatization and liberalization of the banking system in 2003, household borrowing constraints were eased substantially.29 It became possible, for the first time, to refinance mortgages and withdraw equity. Loan-tovalue (LTV) ratios were raised as high as 90 percent by the state-owned Housing Financing Fund, and even further by the newly private banks as they competed for market share. In Hungary, pent-up demand combined with EU membership prospects triggered a credit boom as outstanding household debt grew from a mere 7 percent of GDP in 1999 to 33 percent in 2007. The first part of this credit boom episode was also characterized by a house price rally, driven by generous housing subsidies. In the United States in the 2000s, an expansion of credit supply to households that had previously been unable to obtain loans included increased recourse to private-label securitization and the emergence of so-called exotic mortgages, such as interest-only loans, negative amortization loans, and “NINJA” (no income, no job, no assets) loans."
http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/c3.pdf
Haven't we had enough of Austrian economics for one century?
I 'm pretty sure the thinking has evolved considerably since that '09 IMF paper by Fatas et al. I don't place much faith in Fatas anyway , based on a lot of what I've seen on his blog. He must only be a part-timer as an institutional economist , as he seems to have some less-than-prestigious secondary gigs :
Deletehttp://seekingalpha.com/article/2061913-financial-markets-arbitrage-reassuring-or-lovely
Nonetheless , I'm surprised you cited that paper. This is from the "Key Points" summary of the same :
"Monetary policymakers should put more emphasis on macrofinancial risks. This would imply tightening monetary conditions earlier and more vigorously to try to prevent dangerous excesses from building up in asset and credit markets, even if inflation appears to be largely under control. "
"The chapter shows that past asset price busts were often foreshadowed by rapidly expanding credit, deteriorating current account balances, and large shifts into residential investment. With inflation typically under control, central banks effectively accommodated these growing imbalances, raising the risk of damaging busts."
http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/3sum.pdf
That's hardly the sort of message Sumner would want you spreading around.
As stated above , inflation did not function to warn of excesses during the boom , and "potential gdp" is derived by incantations , rather than from any real underlying knowledge about what constrains the economy. Luckily , there's several varieties of potential to choose from , so it's possible to pick one and then claim just about anything you want , which must come in handy.
Maybe a better authority would be someone from the BIS , like Borio , head of the Monetary and Economic dept. After all , the BIS is the "central bankers" bank " , right ? Additionally , Borio has some street cred , since he ( along with William White ) tried to warn Greenspan of the impending disaster back in 2003 at Jackson Hole - to no avail , unfortunately. Der Spiegel had a write-up on it ( more about White than Borio but it's a good read ) :
http://www.spiegel.de/international/business/the-man-nobody-wanted-to-hear-global-banking-economist-warned-of-coming-crisis-a-635051.html
Anyway , Borio put out a nice summary of the state of central banking art , such as it is , in Jan '14 , with particular emphasis on monetary policy during booms and the subsequent busts :
https://www.bis.org/publ/work440.pdf
I recommend it , both because it's brief and accessible to non-economists , and because of the excellent list of references. A quote from the intro :
"...Attaining monetary and financial stability simultaneously has proved elusive across regimes. Edging closer towards that goal calls for incorporating systematically long-duration and disruptive financial booms and busts – financial cycles – in policy frameworks.
For monetary policy, this means leaning more deliberately against booms and easing less aggressively and persistently during busts. What is ultimately at stake is the credibility of central banking – its ability to retain trust and legitimacy. "
And this for the MMs , especially :
" After all , monetary policy is expected to operate by influencing lending, asset prices and risktaking: this is what the transmission mechanism is all about. "
Nary a mention of the Expectations Fairy. Ouch !
Marko
I've never seen the "press points" for "Lessons for Monetary Policy from Asset Price Fluctuations" before. Having read it I would never have summarized Chapter 3 of the October 2009 WEO that way. It's almost as if the Fatas et al. were not consulted about that summary at all.
DeleteThe BIS has a long standing reputation for liquidationism:
“In view of all the events which have occurred, the Bank’s Board of Directors determined to define the position of the Bank on the fundamental currency problems facing the world and it unanimously expressed the opinion, after due deliberation, that in the last analysis “the gold standard remains the best available monetary mechanism” and that it is consequently desirable to prepare all the necessary measures for its international reestablishment.”
BIS Third Annual Report, May 1933
http://www.bis.org/publ/arpdf/archive/ar1933_en.pdf
(Depression? What Depression?)
Nothing much has changed there in the 81 years since. It is the place that Krugman has called "the worst institution in the world":
http://krugman.blogs.nytimes.com/2011/10/24/the-worst-institution-in-the-world/
And the "Sadomonetarists of Basel":
http://krugman.blogs.nytimes.com/2013/05/16/the-sadomonetarists-of-basel/
The views of William White are well summarized by the following paper:
Deletehttp://dallasfed.org/assets/documents/institute/wpapers/2012/0126.pdf
The paper has quotes by both John Maynard Keynes and Ludwig von Mises at the top of the first page. If one reads it you will note this was done intentionally as the paper takes up the Austrian case against the Keynesian.
Pages 3-4:
"From a Keynesian perspective, based essentially on a one period model of the determinants of aggregate demand, it seemed clearly appropriate to try to support the level of spending. After the recession of 2009, the economies of the AME’s seemed to be operating well below potential, and inflationary pressures remained subdued. Indeed, various authors used plausible versions of the Taylor rule to assert that the real policy rate required to reestablish a full employment equilibrium (and prevent deflation) was significantly negative. Such findings were used to justify the use of non standard monetary measures when nominal policy rates hit the ZLB.
There is, however, an alternative perspective that focuses on how such policies can also lead to unintended consequences over longer time periods. This strand of thought also goes back to the pre War period, when many business cycle theorists focused on the cumulative effects of bank‐created credit on the supply side of the economy. In particular, the Austrian school of thought,spearheaded by von Mises and Hayek, warned that credit driven expansions would eventually lead to a costly misallocation of real resources (“malinvestments”) that would end in crisis."
The paper was commissioned by Dallas Fed President Richard Fisher who is an extreme hawk and an ardent opponent of both fiscal and monetary stimulus. Thus it should be of no surprise to find the following on page 5:
"It is also argued in Section C that, over time, easy monetary policies threaten the health of financial institutions and the functioning of financial markets, which are increasingly intertwined. This provides another negative feedback loop to threaten growth. Further, such policies threaten the “independence” of central banks, and can encourage imprudent behavior on the part of governments. In effect, easy monetary policies can lead to moral hazard on a grand scale17. Further, once on such a path, “exit” becomes extremely difficult. Finally, easy monetary policy also has distributional effects, favoring debtors over creditors and the senior management of banks in particular. None of these “unintended consequences” could be remotely described as desirable."
When White says that "easy monetary policies" could lead to "loss of independence" by central banks and could lead to "imprudent behavior" on the part of governments he means that central banks could find themselves in the position of having to monetize government debt and enabling governments to run large deficits.
When White criticizes the distributional effects of "easy monetary policy" he points to the fact it will help debtors at the expense of creditors. This of course implies that "easy monetary policy" will help the poor at the expense of the rich. He notes this cannot be "remotely described as desirable."
I have numerous substantive problems with the paper starting with the fact that it judges the stance of monetary policy purely on the basis of nominal interest rates. Thus the paper makes the implicit judgment that monetary policy was "easy" during the worst contractionary part of the Great Depression, which is patently absurd.
The paper has also been justly criticized by Joe Gagnon and other monetary economists for these same types of judgments. The only people who should be fans of William White are the friends of Paul Ryan.
The views of Claudio Borio are well represented by the following paper:
Deletehttp://www.bis.org/publ/work404.pdf
Graph 9 shows the "Finance Neutral" policy rates. Borio et al. recommend raising the fed funds rate above zero by early 2010 and above 2% by early 2011. They also recommend raising the UK's policy rate to nearly 7% by 2011.
Think this only applies to monetary policy? Of course not.
Go back to Graph 8 to see their fiscal policy recommendations. The most shocking one is for Spain. (Keep in mind that Spain does not have the option of monetary stimulus.) Spain's actual budget deficit was about 9% of GDP in 2010. A production function (conventional) approach to the output gap suggests that the budget deficit should be less than 4% of GDP.
But that isn't tight enough for Borio et al. The Finance Neutral recommendation is a budget deficit equal to less than 0.5% of GDP. (I guess 27% unemployment isn't high enough for them.)
True-Mark will 'blow them away' if they contradict MM. I've still got 2 of his alleged debunkings of Koo to shift through so I won't get into that too much yet. Mark is kind of Sumner's Minister of Information.
ReplyDeleteI will say this-he and other MMers are very passionate and I give them credit for that. If you want to to debunk them you have to be equally passionate. I appreciate you responding Marko.
Often reading Mark I'm not sure he's right but can't always say where he's wrong. Part of it is my approach to econ-I do it the wrong way according to guys like Stephen Willaimson and Tony Yates, I go by instinct.
On a gut level something about MM has always kept me on guard. A problem in deciding a lot of these questons is that they're 'overdetermined' where more than one explanation can explain something under debate.
The example of Japan's stagnation is a perfect example of this. What explains it? Is it because the JCB didn't do as much as they should have? Or the balance sheet recession? Or is it structural? Every recession can be explained in these 3 ways.
I'll get into it more later but I see that Koo quotes the JCB itself as saying something very like Bernanke recently said-which suggests the CBs want the fiscal authorities to work in the same direction as they are-they don't say 'fiscal policy is irrelevant as long as we do QE or forward guidance or NGDPLT or futures.'
As for credentials, though I believe Mark has an education background in econ-is this true Mark?
I think MMers usually declare victory once they spot a correlation that's favorable to their claims. That you have a plausible sounding explanation doesn't mean you're right.
Delete"As for credentials, though I believe Mark has an education background in econ-is this true Mark?"
DeleteI have multiple undergraduate degrees in mathematics, 35 graduate hours (with no degree) in mathematics, a BA in economics, an MA in economics and I'm all but dissertation (ABD) PhD in economics, otherwise known as a doctoral candidate. Economics is a second career for me. I used to teach mathematics at the high school level and more recently have taught it at the university level as well.
Part of what kept me on guard I guess is their style. Sumner would always get very cagey if I asked any questions. He would always take it as if I'm a wise guy. So this made me think that he's got an agenda and that it's more about staying on message than on true enlightenment.
ReplyDeleteWhile I do think Mark came up with an not wholly implausible way that MM could have a beneficial impact on the political debates, I still think it's much more likely the opposite. The implications will be seized on by GOPers as meaning all fiscal consolidation all the time.
At the end of the day I think the idea of full monetary offset is overdone. It's clear to me that during bad recessions like Japan's in the 90s or ours the last 4 years, the Fed isn't just going to mindlessly offset anything the fiscal authorities do. If they would then we need a new Fed-a serious reformation is called for. As I think the Fed basically went in the wrong direction i the early 80s with its move to inflation targeting-as if that is the most important concern-that may be in order.
Historically though not all CBs have offset fiscal expansion. Certainly not the Eccles Fed of the 30s and 40s-nor was that Fed 'incompetent' as inflation fighting wasn't it's only concern back then. In fact through the 70s it wasn't. So if we don't want the Fed to offset fiscal policy we ought to direct them to that effect-at the end of the day it's mandate is through Congress and that can be ended or altered at any time.
Mike, you write:
Delete"Sumner would always get very cagey if I asked any questions. He would always take it as if I'm a wise guy."
It's probably too late for this, but have you ever considered using "please" and "thank you"... you know, like this:
"Hi Scott, could you please explain why you wrote all this assinine bull shit in your post today? Thanks!" Lol
As for monetary offset... think about it this way Mike, it cuts both ways: if inflation hawks see an elevated level of inflation some day and insist that we need to make massive cuts to spending immediately to get it under control, the true MM will point out that's bull shit, and that money tightening by the CB should be sufficient to do the job. Actually that came up today in a three way discussion between myself, Vincent Cate, and Mark Sadowski at Sumner's.
I did try to say please and thank you. It didn't work. I don't believe it cuts both ways. The Austrians are an easy target. I still think it just gives us a Paul Ryan utopia. I mean all the MMers have to do is criticize Vincent Cate and that proves their legit? LOL
ReplyDelete"please" "thankyou" ... I was just joking there Mike. :D
DeleteVincent Cate: Well, in fairness, it wasn't all MMers... but the thought occurred to me when I saw this comment form Sadowski:
My question to Mark (Vincent had been on about deficits contributing to hyperinflation):
http://www.themoneyillusion.com/?p=26274#comment-321776
Mark's reply (w/ quote from Friedman):
http://www.themoneyillusion.com/?p=26274#comment-321778
Personally, I don't have a good feeling for whether Mark is correct or not, but I thought his reply there was interesting, and it's actually one I would have anticipated... or rather started to anticipate while I was writing my question... it makes sense right? If monetary offset can undo a fiscal contraction (according to MM theory) then it ought to be able to undo a fiscal expansion too... in terms of it's effects on inflation or other similar targets.
I know you were-but I really tried it. Didn't work. LOL. Clearly deficits don't necessarily lead to hyperinflation. The idea is the MMers would be onlyi f it's monetized.
DeleteThe RBCers think that a deficit drives interest rates in anticipation of higher taxes in the future.
I actually think hyperinflation has nothing to do with deficits at all. Nor do I think as MMers do that hyperinflation proves that the CB can hit any inflation or NGDP target it wants.
Come to think of it that's how my questions sound-'Can you please explain why you wrote tis asinine bullshit today. Thank you! There's just no charming him.
ReplyDeleteHa! :D
Delete