December 03, 2010
December 01, 2010
Class Materials for Lecture 17 (Thursday 12/2)
Brief Outline of Topics Covered in Lecture 17
Chapter 25 Rational Expectations and Implications for Policy [cont.]
- Anti-inflation policies
- Traditional model
- New classical model
- New Keynesian model
- The role of credibility in fighting inflation
- Show with AD-AS and Phillips curve diagrams
Video:
Materials from class:
Additional Reading:
- Fed’s Kocherlakota Wants Inflation Expectations Increase - RTE
- Bernanke: Job Creation Is Top Problem - Real Time Economics
- Europe and China: is this deja vu all over again? - Econbrowser
- Fed Discount-Rate Minutes Show 2 Banks Want Higher Rate - RTE
- Defining Structural Unemployment - Paul Krugman
- Kucinich Cancels Fed Hearing - Washington Wire
- And This Is Going to Lead to High Inflation? - Econbrowser
- Can central bank communication be an effective policy tool? - voxeu.org
Application:
Fed Discount-Rate Minutes Show 2 Banks Want Higher Rate, by Jeff Bater, Real Time Economics: Federal Reserve ... minutes released Tuesday of central bank discount rate meetings ... showed the directors of 10 of the 12 banks voted to hold the discount rate steady.
The directors of the Kansas City and Dallas banks dissented, as they had at a previous meeting on the interest rate charged on emergency loans to U.S. lenders. The dissenting bank directors called for an increase in the discount rate, to 1.0%.
The discount rate meetings were held prior to the Fed’s latest policy-setting meeting Nov. 2-3. ... The Fed has kept the discount rate unchanged at 0.75% since February, when it was raised by a quarter percentage point as the economy worked to recover from deep recession and financial markets tried healing from crisis. The rate had been reduced early in the financial crisis to relieve U.S. banks. ...
November 29, 2010
Class Materials for Lecture 16 (Tuesday 11/30)
Brief Outline of Topics Covered in Lecture 16
Chapter 25 Rational Expectations and Implications for Policy [cont.]
- New Classical Macroeconomics Model
- Effects of unanticipated and anticipated policy
- Can an expansionary policy lead to a decline in aggregate output?
- Policy ineffectiveness and implications for policymakers
- New Keynesian Model
- Effects of unanticipated and anticipated policy
- Implications for policymakers
- Comparisons of New Classical, New Keynesian, and Traditional Keynesian Models
- Short-Run Output and Price Responses
Video:
Materials from class:
Additional Reading:
- Ben Bernanke, the Fed, and quantitative easing - James Surowiecki
- F.D.I.C. Says Hundreds of Small Lenders Remain at Risk - NYTimes.com
- Fed lowers economic expectations for 2011 - washingtonpost.com
- Thoughts on QE2 - Robert Barro
- The nerve center of the Treasury Department - washingtonpost.com
- Two percent or a bit below - Antonio Fatas
- Peak oil in Pennsylvania - Econbrowser
- Federal Reserve policies focused - macroblog
- Fed Weighed Setting Inflation Target, Minutes Show - NYTimes.com
- Fed Adopts Political Tactics to Fight Critics - NYTimes.com
- The Fed's communication problem - Econbrowser
- Behind the Numbers: PCE Inflation Update - FRB Dallas
Application:
TARP is expected to cost $25 billion:
TARP expected to cost U.S. only $25 billion, CBO says, by Lori Montgomery, Washington Post: The Troubled Asset Relief Program, which was widely reviled as a $700 billion bailout for Wall Street titans, is now expected to cost the federal government a mere $25 billion...
A new report released Monday by the nonpartisan Congressional Budget Office found that the cost of the program, known as TARP, has plummeted since its passage in October 2008, when policymakers thought that the world stood on the brink of an economic meltdown.
"Clearly, it was not apparent when the TARP was created two years ago that the cost would turn out to be this low," the CBO report says. ...
The TARP was conceived in the final days of the Bush administration and pushed through a reluctant Congress in less than three weeks. It is widely thought to have helped stabilize a financial sector on the verge of collapse, though it remains hugely unpopular with the public. ...
All told, $389 billion has been distributed through the TARP, which expired in October. The CBO estimates that an additional $44 billion is still waiting to go out the door, primarily to troubled insurance giant American International Group and federal mortgage programs. That would bring total TARP outlays to $433 billion, of which about half - $216 billion - has been repaid.
The rest of the TARP investments, meanwhile, have become markedly less risky, according to the CBO, and in many cases even profitable. ...
While the cost of the TARP is coming in far below expectations, it is just one of several massive government programs aimed at propping up the financial industry. The Federal Reserve and the FDIC have together guaranteed billions of dollars in bank debt.
November 27, 2010
November 22, 2010
November 17, 2010
Class Materials for Lecture 14 (Thursday 11/18)
Brief Outline of Topics Covered in Lecture 14
Chapter 24 Money and Inflation (cont.)
How does inflationary policy arise?
- Cost push - demand for higher wages
- Demand pull - shooting at the wrong target
- Budget deficits and inflation
The activist/non-activist debate
- Policy lags and other problems in pursuing activist policies
Chapter 25 Rational Expectations and Implications for Policy
RE and the Lucas critique
New Classical Macroeconomics Model
- Effects of unanticipated and anticipated policy
- Can an expansionary policy lead to a decline in aggregate output?
- Policy ineffectiveness and implications for policymakers
Video:
Materials from class:
Additional Reading:
Application:
What is QEII, by Mark Thoma, CBS MoneyWatch: What is QEII? Quantitative easing, which the Fed has done once already (known as QEI) and is about to do again (QEII), can be understood through a device called the yield curve. The yield curve shows how the expected return on financial assets changes with differences in the maturity of the assets:
The horizontal axis shows the time to maturity, with overnight financial assets such as the federal funds market on the left and 30 year assets such as mortgages on the right. Other maturities, e.g. 3 month, 6 month, one year, 5 years, 10 years, 20 years, etc., lie between these values. The vertical axis shows the expected return on the assets. The curve generally slopes upward due to the extra return that is required to induce people to tie their money up for longer and longer periods of time.
Prior to the housing bubble, the Fed was able to shift the entire yield curve up and down by buying and selling short-term Treasury bills. Thus, the Fed had control of both long-term and short-term interest rates:
However, during the housing bubble but prior to its collapse, the Fed seemed to lose control over the long end of the yield curve. Buying and selling short-term T-Bills no longer seemed to have much impact on long-term interest rates:
Since it is predominantly long-term rates that determine business investment, the purchase of new homes, and the purchase of consumer durables such as cars and refrigerators, this was of concern within the Fed. But the reason for this was never fully understood, and the crisis diverted attention away from this issue. However, one way the Fed can potentially overcome this problem is to buy and sell longer term Treasury bonds, i.e. those that exist on the long end of the yield curve, to bring long term rates up or down as desired.
This is, essentially, all that QEII is. It is conventional monetary policy that operates at the long end of the yield curve through the buying and selling of long-term financial assets rather than through the more traditional buying and selling of short-term assets.
However, the need to operate at the long end of the yield curve presently is not because the Fed has lost control of long-term rates as it seemed to prior to the crisis -- that control returned once the bubble popped. It's because the Fed can no longer move rates at the short-end.
Presently, the Fed cannot operate at the short end of the yield curve because the short-term rate the Fed generally targets –- the overnight federal funds rate -- is at or very near zero. Operating at the short-end of the yield curve doesn’t do much good since those rates can’t come down any further. However, the Fed can still bring down rates at the long-end:
The hope is that the fall in rates at the long end will spur new investment and consumption (along with other effects such as an increase in net exports due to a fall in the exchange rate, though see here for a denial that the Fed is intending to change the value of the dollar with QEII).
So that’s QEII. It’s nothing more than conventional monetary policy moved out along the yield curve.
November 15, 2010
Class Materials for Lecture 13 (Tuesday 11/16)
Brief Outline of Topics Covered in Lecture 13
Chapter 22 Aggregate Demand and Supply Analysis
Aggregate supply
- Aggregate supply in the short-run
- Aggregate supply in the long-run
Equilibrium
- Does the economy self-correct?
Chapter 24 Money and Inflation
Inflation
- Monetarist view
- Keynesian view
- Supply shocks
- Always a monetary phenomena?
How does inflationary policy arise?
- Cost push - demand for higher wages
- Demand pull - shooting at the wrong target
- Budget deficits and inflation
Video:
Materials from Class:
Additional Reading:
Application:
Myths about the Fed, by Greg Ip, Washington Post: ...By printing money, the Fed will create runaway inflation. The Nobel Prize-winning economist Milton Friedman issued a famous dictum nearly 50 years ago: "Inflation is always and everywhere a monetary phenomenon." His belief has become widespread over the years, to the point that even many non-economists assume that when the Fed prints money, higher prices inevitably result. But the link between money and inflation is weaker than people think.
The Fed's current policy of "quantitative easing"essentially means it is printing money ($600 billion) to buy assets such as government bonds. The Fed isn't literally printing the $20 bills that end up in your wallet - it's doing the electronic equivalent. When it buys a $100 bond from a bank, it deposits $100 into the bank's account at the Fed. This electronic money is called reserves, and the Fed conjures it up out of thin air.
However, this money can lead to inflation only if banks lend it and consumers and businesses spend it. Banks lend when they have strong balance sheets and when credit-worthy customers demand loans. People and businesses spend when their incomes are growing and they're confident about the future. None of this has been true lately.
The Fed is trying to stimulate spending, but not by showering people with newly minted dollars. Rather, when the Fed buys bonds, it pushes their prices up and their yields down. Lower long-term interest rates will tempt some people to borrow. They will also make stocks more attractive. Higher stock prices will make consumers feel wealthier and spend more. If that spending outstrips the economy's productive capacity, inflation could result. But that's years away: The economy today is awash in idle factories and unemployed workers. ...
November 10, 2010
Class Materials for Lecture 12 (Thursday 11/11)
Brief Outline of Topics Covered in Lecture 12
Chapter 21 Monetary and Fiscal Policy in the IS-LM Model (cont.)
The Fed cannot control both i and M simultaneously
- Unstable IS curve
- Unstable LM curve
Poole's Pules
The IS-LM model in the long-run
- Natural rate of output
- Monetary and fiscal policy in the short-run and long-run
The aggregate demand curve
- Derive from IS-LM model
- Slope of aggregate demand curve
- Shifts in the aggregate demand curve
Chapter 22 Aggregate Demand and Supply Analysis
Aggregate supply
- Aggregate supply in the short-run
- Aggregate supply in the long-run
Equilibrium
- Does the economy self-correct?
Video:
Materials from Class:
Additional Reading:
- Back to a Gold Standard? - Room for Debate - NYTimes
- Gold’s ‘Record High’ in Context - David Leonhardt
- Peter Diamond Gets Another Shot at Fed Seat - Real Time Economics
- The first global recession in decades - voxeu.org
Application:
Gold During the Depression, NYTimes: Mark Thoma is an economics professor at the University of Oregon and blogs at Economist's View.
The ability of countries to use monetary policy to address domestic problems depends upon whether they have a fixed or floating exchange rate.
Under floating exchange rate systems, each country has the ability to set domestic monetary policy independently. However, in fixed exchange rate regimes -- as when the value of the domestic currency is fixed to the value of gold -- countries lose the ability to pursue domestic monetary policy. This is because any attempt to change the money supply to ease domestic economic problems would cause the value of the currency to change relative to gold.
Since the money supply cannot be manipulated at will, an advantage of a gold standard is that it insulates countries from inflation due to excessive money growth – a helpful constraint for countries with a history of inflation problems. The disadvantage is that monetary policy would no longer be available as a stabilization tool. Countries are forced to increase their reliance on fiscal policy, which can create its own problems.
The experience of the Great Depression shows that the loss of the use of monetary policy as a stabilization tool can be quite costly. In the 1930s, the countries that abandoned their commitment to the gold standard had much better outcomes than countries that kept the value of their currency fixed in terms of gold. In addition, historical experience with the gold standard shows that both inflation and deflation will still occur because variations in the supply and demand for gold will alter the price of gold relative to other commodities.
So the cost of giving up monetary policy is high while the benefits from price stability are not very large. So why does Robert Zoellick suggest “employing gold as an international reference point of market expectations about inflation, deflation and future currency values”? Since the gold standard is a proven bad idea, I am going to give him the benefit of doubt and assume he has something else in mind – perhaps Jeffrey Frankel’s interpretation is correct. But whatever he is suggesting, returning to the gold standard is not a policy we should pursue.
November 08, 2010
Class Materials for Lecture 11 (Tuesday 11/9)
Brief Outline of Topics Covered in Lecture 11
Chapter 21 Monetary and Fiscal Policy in the IS-LM Model
Changes in the equilibrium values of output and the interest rate
Effectiveness of Monetary and Fiscal Policy Graphically and Intuitively
- Monetary policy in the IS-LM model
- Fiscal policy in the IS-LM model
- Responsiveness of money demand to the interest rate (including liquidity trap)
- Responsiveness of investment to the interest rate
The Fed cannot control both i and M simultaneously
Poole's PulesThe IS-LM model in the long-run
- Unstable IS curve
- Unstable LM curve
- Natural rate of output
- Monetary and fiscal policy in the short-run and long-run
Video:
Class Material:
See the class materials for the lecture before this one.
Additional Reading:
Application:
There is a lot of confusion over the Fed's use of core inflation as part of its policy making process. One reason for confusion is that we using a single measure to summarize three different definitions of the term "core inflation" based upon how it is used.
First, core inflation is used to forecast future inflation. For example, this recent paper uses a "bivariate integrated moving average ... model ... that fits the data on inflation very well," and finds that the long-run trend rate of inflation "is best gauged by focusing solely on prices excluding food and energy prices." That is, this paper finds that predictions of future inflation based upon core measures are more accurate than predictions based upon total inflation.
Second, we also use the core inflation rate to measure the current trend inflation rate. Because the inflation rate we observe contains both permanent and transitory components, the precise long-run inflation rate that consumers face going forward is not observed directly, it must be estimated. When food and energy are removed to obtain a core measure, the idea is to strip away the short-run movements thereby giving a better picture of the core or long-run inflation rate faced by households. I should note, however that this is not the only nor the best way to extract the trend and the Fed also looks at other measures of the trend inflation rate that have better statistical properties. Thus while the first use of core inflation was for forecasting future inflation rates, this use of core inflation attempts to find today's trend inflation rate [There is a way to combine the first and second uses into a single conceptual framework that encompasses both, but it seemed more intuitive to keep them separate. In both cases, the idea is to find the inflation rate that consumers are likely to face in the future.]
Let me emphasize one thing. If the question is "what is today's inflation rate," the total inflation rate is the best measure. It's intended to measure the cost of living and there's no reason at all to strip anything out. It's only when we ask different questions that different measures are used.
Third, and this is the function that is ignored most often in discussions of core inflation, but to me it is the most important of the three, it is the inflation target that best stabilizes the economy (i.e. best reduces the variation in output and employment).
In theoretical models used to study monetary policy, the procedure for setting the policy rule is to find the monetary policy rule that maximizes household welfare (by minimizing variation in variables such as output, consumption, and employment). The rule will vary by model, but it usually involves a measure of output and a measure of prices, and those measures can be in levels, rates of change, or both depending upon the particular model being examined, but generally a Taylor rule type framework comes out of this process ( i.e. a rule that links the federal funds rate to measures of output and prices).
However, in the Taylor rule, the best measure of prices is usually something that looks like a core measure of inflation. Essentially, when prices are sticky, which is the most common assumption driving the interaction between policy and movements in real variables in these models, it's best to target an index that gives most of the weight to the stickiest prices (here's an explanation as to why from a post that echoes the themes here). That is, volatile prices such as food and energy are essentially tossed out of the index.
Another feature is that the indexes often include both output and input prices, and occasionally asset prices as well. That is, a core measure of inflation composed of just output prices isn't the best thing for policymakers to target, a more general core inflation rate combining both input and output prices works better.
The core inflation rate you see in the news, the one that strips out food and energy, should be though of as a short-hand, quick measure of all three of these concepts. But in each case the Fed uses measures (formally or informally) designed to best satisfy these three functions. For example, when it forecasts future inflation, it uses a different concept of core inflation than it uses in setting policy.
The Fed paper linked above is one example of how the Fed searches for the optimal way to predict future inflation. All that matters for policy is finding the most accurate way to predict inflation, and they will use whatever definition of inflation is best suite for this job. There is evidence that core inflation is best and that's why it is used, but it is a statistical question and didn't have to come out that way (and the best measure of core inflation may not be simply stripping out food and energy - also, there are different measures of prices to choose from, e.g. the CPI and the PCE).
When it comes to setting policy, the Fed doesn't formally use a Taylor rule, though they certainly have Taylor rule estimates in the information they use when considering policy moves, instead they look at a variety of measures of inflation (both core and total), and they look at the rate of change in input prices such as wages and commodities (e.g. oil) as well. They then weight each of those pieces of information in some way (and hence construct an implicit index of all of this information), and then set the federal funds rate accordingly. While I have no way of knowing if the weights they use are optimal, this is exactly what the theoretical models say they should do. But the point is that it is some implicit combination of all of this information that matters for policy, and hence this core measure is very different from the core measure that is best at predicting future inflation alone.
The core inflation rate you see in the news, the CPI less food and energy, does do a fairly good job of representing the information the Fed uses to forecast future inflation, i.e. it is a measure of the trend rate of inflation (but not the best one), and it also does well at approximating the information the Fed will use to set policy, but the actual process it uses is more complicated than this and the Fed employs measures that are specialized for the job at hand.
Finally, there is also a question of what we mean by inflation conceptually. Does a change in relative prices, e.g. from a large increase in energy costs, that raises the cost of living substantially count as inflation, or do we require the changes to be common across all prices as would occur when the money supply is increased? Which is better for measuring the cost of living? Which is a better target for stabilizing the economy? The answers may not be the same.
November 03, 2010
Class Materials for Lecture 10
Chapter 20 The IS-LM Model
The IS curveThe LM Curve
- Investment and the interest rate
- Net exports and the interest rate
- Derive the IS curve from 45 degree line diagram
- Shifts in the IS curve
- Slope of IS curve
- Derive LM curve from money demand - money supply diagram
- Shifts in the LM curve
- Slope of the LM curve
- The liquidity trap
Video:
not yet available
Class Material:
Additional Reading:
- A currency war has no winners - Joseph Stiglitz
- Negative real interest rates - Econbrowser
- Kohn Says QE2 Won’t Turn Economy Around - Real Time Economics
- The night they burned government bonds - Bluematter
- Will QEII Work? - The Bonddad Blog
- QE2 is risky and should be limited - Martin Feldstein
- Confusing messages from Fed’s many voices - FT.com
- How immigration can benefit native workers - D'Amuri and Peri
- Asian nations tighten ahead of Fed - FT.com
Application:
What the Fed did and why: supporting the recovery and sustaining price stability, by Ben S. Bernanke, Commentary, Washington Post: ...The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.
Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. ...
The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. ...
While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.
Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.
Our earlier use of this policy approach had little effect on ... broad measures of the money supply... Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.
The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.
November 02, 2010
October 27, 2010
Class Materials for Lecture 9
Chapter 19 Money Demand [cont.]
Further Developments in the Keynesian Approach
- Why Transactions demand depends upon i (Baumol)
- Tobin's Uncertainty Theory
- Friedman’s Modern Quantity Theory of Money
Chapter 20 The IS-LM Model
The IS curveThe LM Curve
- Investment and the interest rate
- Net exports and the interest rate
- Derive the IS curve from 45 degree line diagram
- Shifts in the IS curve
- Slope of IS curve
- Derive LM curve from money demand - money supply diagram
- Shifts in the LM curve
- Slope of the LM curve
- The liquidity trap
Video:
Class Material:
Additional Reading:
Application:
The author of your textbook:
The Fed must adopt an inflation target, by Frederic Mishkin, Commentary, Financial Times: Ben Bernanke, the Federal Reserve chairman, discussed his institution’s inflation mandate in a recent speech, leading to speculation a numerical inflation target is under consideration inside America’s central bank. And if there ever was a time to establish such a transparent and credible commitment to a specific target, it is now.
The Fed has a dual mandate, to achieve price stability and maximum sustainable employment. But at the moment it is missing both objectives. ... This combination of economic slack and low inflation raises the possibility that inflation expectations will drift downwards.
Meanwhile, to stimulate the economy, the Fed has signaled that it is likely to restart its policy of quantitative easing... This signal has already led to concerns ... that the Fed may be too soft on inflation in the future, which could see inflation expectations rise.
By establishing an inflation objective ... the Fed can guard against both of these problems. Providing a firm anchor for long-run inflation expectations would make the threat of deflation less likely. But a firm anchor would also ... help ensure that any new moves to quantitative easing would not be misinterpreted as signaling a shift in the central bank’s long-run inflation goal, making an upward surge in inflation expectations less likely too.
The Fed can establish a strong nominal anchor through two straightforward steps. First, the federal open market committee could come to a consensus on the specific numerical value that Mr Bernanke referred to as the “mandate-consistent inflation rate” in his recent speech..., about 2 per cent, or a bit below. Second, the FOMC should announce that this rate would only be modified for sound economic reasons...
Some commentators have worried that establishing an inflation objective will soon lead to an overemphasis on controlling inflation, and not enough concern about stabilizing real economic activity. Agreeing on a mandate-consistent rate is, however, consistent with the Fed’s dual mandate. Indeed the use of the term “mandate consistent” indicates that it should not be misinterpreted as a commitment to control inflation within too tight a range over too short a time horizon. Also, by allowing the rate to be adjusted if sound economic reasoning supports it, the Fed would not be locked in to an inappropriate goal.
A final concern is that these two steps would not provide a sufficient degree of commitment to the target itself. But by stating its intention not to modify the rate without a clear technical rationale, the FOMC would provide a firm nominal anchor ... for long-run inflation expectations.
By adopting an explicit numerical inflation objective at this juncture along the lines I have suggested, the Fed would improve economic outcomes by anchoring inflation expectations more firmly while allowing sufficient flexibility to ensure ... the goal of maximum sustainable employment as well. The Fed and its chairman should move quickly to introduce one.
October 25, 2010
Class Materials for Lecture 8
Chapter 19 Money Demand
Quantity Theory of Money
- Velocity of Money and Equation of Exchange
- Quantity Theory
- Quantity Theory of Money Demand
The Cambridge Approach
Is velocity a Constant?
Keynes’s Liquidity Preference TheoryFurther Developments in the Keynesian Approach
- Transactions Motive
- Precautionary Motive
- Speculative Motive
- Putting the Three Motives Together
Video:
Class materials:
Additional Reading:
Application:
Why QE Needs to Involve non Government Securities - Brad DeLong: ...The point--from one point of view, the neo-Wicksellian point of view--behind quantitative easing is to reduce the interest rate that matters for private business investment: the long-term, default-risky, systemic-risky, beta-risky, real interest rates at which private businesses finance their capital expenditures. You can reduce this flow-of-funds equilibrium interest rate and raise the level of economic activity in any neo-Wicksellian framework in two ways:
Reduce the "safe" real interest rate on short-term, safe government bonds.
Reduce the various premia--duration, default, systemic risk, and beta risk--between the rates the Treasury pays to borrow in T-bills and the rates businesses pay to borrow.
Conventional open-market operations that lower the nominal interest rate on T-bills accomplish the first. Once the nominal interest rate on T-bills has been pushed to zero, quantitative easing policies that create expectations of higher future inflation continue to lower the real interest rate on T-bills and thus help the situation.
Suppose, however, that the nominal interest rate on T-bills is zero and that you cannot alter inflation expectations--cannot commit to keeping your quantitative easing permanent, cannot commit to an exchange rate path, whatever, you cannot do it and inflation expectations are immovable. Then what?
Then, as Paul Krugman says, quantitative easing is working be altering the spread between the short-term safe T-bill rate and the long-term, systemic-risky, beta-risky, default-risky rate. How does it do that? Lloyd Metzler and James Tobin would say that it does so by altering relative asset supplies--by taking duration risk, systemic risk, beta risk, and default premia off of private savers' books and placing them on the government's books (and thus on the taxpayers, who are a very different group of people than are private savers). To the extent that quantitative easing thus involves assets whose risk characteristics are very similar--federal funds and two-year T-notes, say--we would not expect even a lot of quantitative easing to have much of an effect on anything.
Thus a quantitative easing program that is going to have bite should involve Federal Reserve purchases of long-term risky private assets rather than merely long-term U.S. Treasuries. ...
Also, a look inside the FOMC:
Come With Me to the F.O.M.C.: A Sneak Peak Into Fed Life, by Bob McTeer, Economix: Bob McTeer is a former president of the Federal Reserve Bank of Dallas.
Today is the second day of a two-day Federal Open Market Committee meeting. The rate decision along with the accompanying verbiage will be released at 2:15 p.m. If I were still there, I’d go in with a tentative idea of how I would vote, but would try to keep an open mind during the presentations and discussions. ...
“Come With Me to the F.O.M.C.” was the title of a Richmond Fed pamphlet written long ago and updated by others. Its lasting popularity suggests an interest in what goes on behind the closed doors. While I’ve been retired from the Fed almost four years, it changes so slowly that I expect my memories aren’t far off.
Some F.O.M.C. Color
My almost 14 years as an F.O.M.C. member came with the presidency of the Federal Reserve Bank of Dallas from Feb. 1, 1991, to Nov. 4, 2004. Alan Greenspan was chairman during that time and then-Governor Bernanke sat next to me for almost three years. Reserve Bank presidents inherit their place around the table from their predecessors, and Dallas used to sit between St. Louis and Boston. For the first several years of my tenure, Alan Greenspan sat at the head of the long board table, but he announced one day that he was switching to the middle spot. That was a landmark event. We all rotated to keep our relative position, and I got the chairman’s former seat.
Since Chairman Greenspan didn’t normally conduct policy by the seat of his pants, as his successor has been accused of doing, his seat never made me feel smarter. The president of the Boston Fed decided about that time to move to the other end of the table — I don’t know what I did — so I ended up between Bill Poole of the St. Louis Fed and Governor Bernanke, the only two principals around the table with beards. Ben’s was trimmed pretty short, but Bill’s was kind of shaggy. It made my nose itch when I looked his way.
Two-day meetings like the one concluding today used to occur only twice a year — in February and July. Chairman Bernanke added more two-day meetings to the schedule. The July meeting was close to the Fourth, and the British ambassador always had us as dinner guests on the evening between meetings. Those dinners were nice, but they ran on too long. The vice chairman, Alice Rivlin, was the all-time champion at extricating us before midnight. The dialogue during the dinner between the chairman and the ambassador was an education for me — actually for us all — but I’m probably the only one to admit it.
Congress centralized power in Washington in the 1930s, and gave the coveted (in central bank world) title of governor to the seven-member Washington contingent and “demoted” the twelve former regional governors to “president.” It also reduced the number of “presidents” voting from 12 to 5 so Washington would have a 7 to 5 advantage if votes ever split along those lines. The New York Fed president, as vice chairman of the F.O.M.C., always has a vote; 4 of the other 11 regional bank presidents also have a vote, based on an annual rotation.
I mention the voting arrangement because it is often misunderstood. All the presidents participate fully in all the discussions, and an observer would be unable to tell the voters from the nonvoters until the vote at the end of the meeting. A persuasive nonvoting president would probably have more influence on the outcome than a non-persuasive voter.
F.O.M.C. members traditionally don’t discuss their votes or policy before the meeting. If the presidents got together for dinner the night before, they limited their discussion to Reserve Bank business and gossip. Usually they went their separate ways for dinner. Being the introvert that I am, I frequently had take-out Chinese food in my hotel room.
Everyone arrives for the meetings after having done tons of homework. The Reserve Banks have excellent research departments, but they are smaller and less specialized than the board’s research staff. The presidents are expected to say something about their regions, as well as the national and international economy. It’s a lot like cramming for finals. The board staff’s material, mostly contained in the “green book,” included all recent data in context, forecasts made under alternative assumptions, and special topics of current interest. It was always comprehensive and outstanding in quality.
The board staff also prepared a “blue book” with alternative policy choices and commentary. Forecasts based on the board’s econometric models were treated respectfully by everyone...
See also Come with Me to the FOMC, Remarks by Governor Laurence H. Meyer, Willamette University, Salem, Oregon April 2, 1998.
October 18, 2010
October 14, 2010
October 13, 2010
Class Materials for Lecture 6
Brief Outline of Topics Covered in Lecture 6
Chapter 14 Multiple Deposit Creation and the Money Supply Process
Three Players in the Money Supply Process
The Fed’s Balance Sheet
- Liabilities
- Assets
Control of the Monetary Base
- Open Market Operations with Bank
- Open Market Operations with an Individual and shifts between Currency and Deposits
The Money Supply Model and the Money Multiplier
- Deriving the Money Multiplier
Factors That Determine the Money Multiplier
- Changes in the Required Reserve Ratio, r
- Changes in the Currency Ratio, c = C/D
- Changes in the Excess Reserves Ratio, e = ER/D
Additional Factors That Determine the Money Supply
- Changes in the Nonborrowed Monetary Base, MBn
- Changes in Borrowed Reserves, BR, from the Fed
Video:
Additional Reading:
- F.D.I.C. Presents Rules to Dismantle Failed Banks - NYTimes.com
- Climate Proposal That Looks Beyond Cap and Trade - NYTimes.com
- Deep Poverty Reaches Record High Nationwide - CBPP
- Why printing money makes sense - Dean Baker
- Why America is going to win the global currency battle - Martin Wolf
- Fed Minutes Add Mystery to What's Next - Daniel Indiviglio
- FOMC September Meeting Minutes - Calculated Risk
- Fed’s Hoenig Again Attacks Asset Buying - Real Time Economics
- The Spousal Safety Net - NYTimes.com
- Behind the Nobel - The Economist
- The Work Behind the Nobel Prize - Ed Glaeser
- Obama to Press for Infrastructure - NYTimes.com
- Yellen Says It’s Possible Low Rates Feed Financial Bubbles - NYTimes.com
Application:
Tim Duy:
The Final End of Bretton Woods 2?, by Tim Duy: The inability of global leaders to address global current account imbalances now truly threatens global financial stability. Perhaps this was inevitable - the dollar has not depreciated to a degree commensurate with the financial crisis. Moreover, as the global economy stabilized the old imbalances made a comeback, sucking stimulus from the US economy and leaving US labor markets crippled. The latter prompts the US Federal Reserve to initiate a policy stance that will undoubtedly resonate throughout the globe. As a result we could now be standing witness to the final end of Bretton Woods 2. And a bloody end it may be.Of course, the end of Bretton Woods 2 has been long prophesied. Back in October 2008, Brad Setser foresaw its imminent demise:
I increasingly suspect that the combination of falling oil prices and falling demand for imported goods will produce significant fall in the US trade and current account deficit in the fourth quarter, with a corresponding fall in the emerging world’s combined surplus. The Bretton Woods 2 system – where China and then the oil-exporters provided (subsidized) financing to the US to sustain their exports – will come close to ending, at least temporarily. If the US and Europe are not importing much, the rest of the world won’t be exporting much….And rather than ending with a whimper, Bretton Woods 2 may end with a bang….….If Bretton Woods 2 ends in 2009 – if US demand for imports falls sharply in the last part of 2008 and early 2009, bringing the US trade deficit down – it won’t have ended in the way Nouriel and I outlined back in late 2004 and early 2005. We postulated that foreign demand for US debt would dry up – pushing up US Treasury rates and delivering a nasty shock to a housing-centric economy... it didn’t quite play out that way. The US and European banking system collapsed before the balance of financial terror collapsed.But Bretton Woods 2 was soon reborn, as the steady improvement to the US current account deficit was soon reversed:
Bretton Woods 2 simply morphed forms. Rather than a reliance on US financial institutions to intermediate the channel between foreign savers and US households, a modified Bretton Woods 2 - Bretton Woods 2.1 - relied on the US government to step into the void created by the financial mess and become the intermediary, either by propping up mortgage markets via the takeover of Freddie and Fannie, or the fiscal stimulus, or a dozen of other programs initiated during the financial crisis.
In essence, a nasty surprise awaited US policymakers - after two years of scrambling to find the right mix of policies, including an all out effort to prevent a devastating collapse of financial markets and a what Administration officials believed to be a substantial fiscal stimulus, the US economy remains mired at a suboptimal level as stimulus flows out beyond US borders. The opportunity for a smooth transition out of Bretton Woods 2 was lost.
How has it come to this? To understand the challenge ahead, we need to begin with two points of general agreement. The first is that the US has a significant and persistent current account deficit, which implies that domestic absorption of goods and services, by all sectors, exceeds potential output. In other words, we rely on a steady inflow of goods and services to satisfy our excess demand, a situation we typically find acceptable during a high growth phase when domestic investment exceeds domestic saving. The second point of agreement is that high unemployment implies that actual output is far below potential output. We clearly have unused capacity.
Points one and two appear that they should be mutually exclusive, but they are not. The fact that they are not begs an explanation. Paul Krugman sends us to Paul Samuelson to provide that explanation:
Here’s what he [Samuelson] wrote in his 1964 paper “Theoretical notes on trade problems”: “With employment less than full and Net National Product suboptimal, all the debunked mercantilist arguments turn out to be valid.” And he went on to mention the appendix to the latest edition of his Economics, “pointing out the genuine problems for free-trade apologetics raised by overvaluation”.I think Samuelson is correct; an excessively high dollar is the explanation for the simultaneous existence of a sizable current account deficit and excessive unemployment. Indeed, there appears to be a externally determined downward limit to real value of the Dollar, and we are close to pushing against it:
The US appears to have little control over that minimum level. Foreign central have repeatedly acted to limit Dollar depreciation. Over the years, US policymakers have happily accepted this state of affairs (the steady financial inflow certainly helped support structural fiscal deficits), all the while ignoring the very real structural outcomes of blind adherence to the idea of a strong Dollar. spencer at Angry Bear succinctly lays out the structural impact:The first chart is of imports market share, or imports as a share of what we purchase in the US. In the second quarter of this year imports market share rebounded to about where it was at the pre-recession peak, or about 16% of consumption. Since the early 1980's when the US started borrowing abroad to finance its two structural deficits -- federal and foreign--trades share of consumption has risen from about 6% to some 16%. Normally this has a small negative impact on the US economy, but sometimes you get quarters like the last quarter. Last quarter real domestic consumption rose at a 4.9% annual rate. That was an increase of $162.6 billion( 2005 $). But real imports also increased $142.2 billion (2005 $). That mean that the increase in imports was 87.5% of the increase in domestic demand.To apply a little old fashion Keynesian analysis or terminology, the leakage abroad of the demand growth was 87.5%. It does not take some great new "freshwater" theory to explain why the stimulus is not working as expected, simple old fashioned Keynesian models explain it adequately.Years of current account deficits - deficits induced not by the decisions of private savers looking to maximize returns but by foreign public sector entities seeking to maintain export growth - has literally resulted in a US economy that, on net, is unable to produce the goods its citizens want to consume. Hence a blast of stimulus flows overseas , the rising trade deficit heralded as a sign of strong US demand despite the inconvenient truth of little net job creation.
Which brings us to this observation by Simon Johnson:
The main reason the U.S. isn’t bouncing back so fast is because of exports and the dollar. South Korea, Russia, and other emerging markets that go through severe crises usually undergo a sharp depreciation in the inflation-adjusted value of the currency, making them hypercompetitive, at least for a while. This makes it easier to replace imports with domestic goods and services and much more attractive to export.In contrast, the global financial crisis actually strengthened the U.S. dollar as it was seen as a haven, although the dollar has fallen somewhat from its recent peak against major trading partners.Currency depreciation - of substantial magnitude - is a mechanism by which economies recover from financial crisis. But we shouldn't underestimate that challenges that accompany such an adjustment. If it happens to quickly - a sudden stop of capital - the most likely short run outcome is that the current account deficit will be resolved with import compression via a sharp drop in demand. This would be painful, to say the least. It is not the optimal path.
Neither, though, is the current path - a painstakingly slow Dollar depreciation. The result so far is persistently high US unemployment, with no relief in sight. In frustration, policymakers lash out against the wrong target, free trade. Krugman's frustration rises to the level that he supports the Levin bill as the only remaining option:
Finally, the idea that what we need is a mature discussion of global rebalancing strikes me as reasonable — if you have been living in a cave the past three or four years. We’ve been reasoning, and reasoning, and reasoning, and nothing changes. Clearly, China does not want to act — not out of national interest, but because of the political influence of its export industries. It won’t change its behavior unless it faces an additional incentive — like the prospect of countervailing duties.But I don't want to make this piece about China. It is more than China at this point. It became more than China the instant US Federal Reserve policymakers woke up one morning and decided they needed to take the dual mandate seriously. And seriously means quantitative easing. Brad DeLong suggests that when the Fed actually acts on November 3, it will be too little too late. But if it is too little, more will be forthcoming.
Put simply, the Federal Reserve is positioned to declare war on Bretton Woods 2. November 3, 2010. Mark it on your calendars.
So perhaps Bretton Woods does not end because foreign governments are unwilling to bear ever increasing levels of currency and interest rate risk or due to the collapse of private intermediaries in the US, but because it has delivered the threat of deflation to the US, and that provokes a substantial response from the Federal Reserve. A side effect of the next round of quantitative easing is an attack on the strong dollar policy.
The rest of the world is howling. The Chinese are not alone; no one wants it to end. From Bloomberg:
Leaders of the world economy failed to narrow differences over currencies as they turned to the International Monetary Fund to calm frictions that are already sparking protectionism….….Days after Brazilian Finance Minister Guido Mantega set the tone for the gathering by declaring a “currency war” was underway, officials held their traditional battle lines. U.S. Treasury Secretary Timothy F. Geithner and European Central Bank President Jean-Claude Trichet were among those to signal irritation that China is restraining the yuan to aid exports even as its economy outpaces those of other G-20 members.“Global rebalancing is not progressing as well as needed to avoid threats to the global economic recovery,” Geithner said. “Our initial achievements are at risk of being undermined by the limited extent of progress toward more domestic demand- led growth in countries running external surpluses and by the extent of foreign-exchange intervention as countries with undervalued currencies lean against appreciation.”At the same time, officials from emerging economies including China complained that low interest rates in the U.S. and its developed-world counterparts mean investors are pouring capital into their markets, threatening growth by forcing up currencies and inflating asset bubbles. The MSCI Emerging Markets Index of stocks has soared 13 percent since the start of September......“Near-zero interest rates and rapid monetary expansion are geared at stimulating domestic demand but also tend to produce a weakening of their currencies,” Mantega said Oct. 9. As a result, developing countries will continue to build up reserves in foreign currency to avoid “volatility and appreciation.”Consider the enormity of the situation at hand. The Federal Reserve is poised to crank up the printing press for the sake of satisfying their domestic mandate. One mechanism, perhaps the only mechanism, by which we can expect meaningful, sustained reversal from the current set of imbalances is via a significant depreciation of the dollar. The rest of the world appears prepared to fight the Fed because they know no other path.
Bad things happen when you fight the Fed. You find yourself on the wrong side of a whole bunch of trades. In this case, I suspect it means that Bretton Woods 2 finally collapses in a disorderly mess. There may really be no other way for it to end, because its end yields clear winners and losers. And the losers, in this case largely emerging markets, and not prepared to accept their fate.
Moreover, there is no agreement on what should be the post-Bretton Woods 2 rules of the game for international finance. Is there even a meaningful policy discussion? Perhaps a little hope via Bloomberg:
Suggestions for how to resolve currency differences were vague in Washington, with French Finance Minister Christine Lagarde proposing better coordination and more diversification, while Canada’s Jim Flaherty suggested that new “rules of the road” be outlined.Of course, in the next sentence hope is dashed:
European Central Bank Executive Board member Lorenzo-Bini Smaghi suggested the G- 20 may be too big to find a compromise.Unless checked in South Korea, the discord may snap the G- 20’s united front formed to fight the financial crisis and recession.And don’t expect that the International Monetary Fund is prepared to deal with this crisis:
Unable to find common ground themselves, governments agreed the IMF should serve as currency cop by preparing reports which show how the policies of one economy affect others. The studies will focus on the U.S., China, the U.K. and the euro area.“The need to have this kind of spillover report has been discussed for months and now it’s part of our toolbox,” IMF Managing Director Dominique Strauss-Kahn said.Well, thank the Heavens above, the IMF stands ready to produce a report. Now I can sleep easy.
Bottom Line: The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder. The collapse is coming via an unexpected channel; rather than originating from abroad, the shock that sets it in motion comes from the inside, a blast of stimulus from the US Federal Reserve. And at the moment, the collapse looks likely to turn disorderly quickly. If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US. Yet much of the world does not want to accept the inevitable, and there appears to be no agreement on what comes next. Call me pessimistic, but right now I don't see how this situation gets anything but more ugly.
October 11, 2010
Class Materials for Lecture 5
Brief Outline of Topics Covered in Lecture 5
Chapter 13 Structure of Central Banks and the Federal Reserve System [continued]
Formal Structure of the Federal Reserve System
- Federal Reserve Banks
- Member Banks
- Board of Governors of the Federal Reserve System
- Federal Open Market Committee (FOMC)
- The Federal Advisory Council (FAC)
Informal Structure of the Federal Reserve System
- How Power Has Been Centralized Over Time
How Independent is the Fed?
Should The Fed Be Independent?
- The Case for Independence
- The Case Against Independence
Chapter 14 Multiple Deposit Creation and the Money Supply Process
Three Players in the Money Supply Process
The Fed’s Balance Sheet
- Liabilities
- Assets
Control of the Monetary Base
- Open Market Operations with Bank
- Open Market Operations with an Individual and shifts between Currency and Deposits
Video:
Materials from class:
Central Bank Independence and Inflation
From "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," by Alberto Alesina and Lawrence H. Summers, Journal of Money, Credit and Banking, Vol. 25, No. 2. (May, 1993), pp. 151-162 (the link will work on UO net, but I don't expect you to read the paper as it is a bit technical):
This has changed with the adoption of inflation targeting by central banks. Note also that Adam Posen casts doubt on whether causality runs from central bank independence to improved macroeconomic performance in Central Bank Independence and Disinflationary Credibility: A Missing Link?, NY Fed Staff Report, May 1995.
Additional Reading:
- The End of Free Trade? - Douglas Irwin
- Why Are China, India and Brazil Rebounding so Fast - RTE
- Basel and the Wider Financial Stability Agenda - FRB New York
- Unemployment and poor health - washingtonpost.com
Application:
The two rebalancing acts, by Olivier Blanchard, Vox EU: A “strong, balanced, and sustained world recovery” as demanded by the G20 is a daunting challenge for policymakers. This column argues that two rebalancing acts are required: internal rebalancing – replacing government spending with private-sector demand, and external rebalancing – addressing the global imbalances between exporting and importing countries. These two rebalancing acts, it adds, are taking too long.
Achieving a “strong, balanced, and sustained world recovery” – to quote from the goal set in Pittsburgh by the G20 – was never going to be easy. It requires much more than just going back to business as usual. It requires two fundamental and complex economic rebalancing acts (IMF 2010a).
- Internal rebalancing: When private demand collapsed, fiscal stimulus helped reduce the fall in output. This helped avoid the worst. But private demand must now become strong enough to take the lead and sustain growth, while fiscal stimulus gives way to fiscal consolidation.
- External rebalancing: Many advanced countries, most notably the US, relied excessively on domestic demand before the crisis, and they must now rely more on net exports. Many emerging market countries, most notably China, had relied excessively on net exports, but must now look to domestic demand.
Too slow
These two rebalancing acts are taking place too slowly.
Private domestic demand remains weak in advanced countries. This reflects both a correction of pre-crisis excesses and the scars of the crisis. US consumers who had over-borrowed before the crisis are now saving more and consuming less. While this is good for the long run, it is a drag on demand in the short run. Housing booms have given way to housing slumps, housing investment will remain depressed for some time to come, and financial system weaknesses are still constraining credit.
External rebalancing remains limited. Net exports are not contributing to growth in advanced countries – the US trade deficit remains large. Many emerging markets continue to run large current-account surpluses, and to respond to capital inflows primarily through reserve accumulation rather than exchange-rate appreciation. International reserves are higher than they have ever been and continue to increase.
The result is a recovery which is neither strong, nor balanced, and runs the risk of not being sustained (IMF 2010b). For the last year or so, inventory accumulation and fiscal stimulus were driving the recovery. The first is coming to a natural end. The second is slowly being phased out. Consumption and investment now have to take the lead. But, in most advanced economies, weak consumption and investment, together with little improvement in net exports, are leading to low growth. Unemployment is high, and barely decreasing.
By contrast, in many emerging market countries, where excesses were limited and the scars of the crisis are few, consumption, investment, and net exports are all contributing to strong growth, and output is back close to potential.
October 07, 2010
October 06, 2010
October 04, 2010
Class Materials for Lecture 3
Brief Outline of Topics Covered in Lecture 3
Chapter 3 What is Money?
Meaning of Money
Functions of Money
- Medium of Exchange
- Unit of Account
- Store of Value
Evolution of the Payments System
- Commodity Money
- Partially backed paper money
- Full backed paper money
- Fiat Money
Measuring Money
- The Federal Reserve’s Monetary Aggregates
How Reliable Are the Money Data?
Chapter 4 Understanding Interest Rates [pages 84-85]
The Distinction between Real and Nominal Interest Rates
- Nominal interest rates
- Ex-ante real rates
- Ex-post real rates
Chapter 12 Structure of Central Banks and the Federal Reserve System
Origins of the Federal Reserve System
- Distribute power to geographic regions, the public sector, the private sector, the business sector, and the financial sector
Formal Structure of the Federal Reserve System
- Federal Reserve Banks
- Member Banks
- Board of Governors of the Federal Reserve System
- Federal Open Market Committee (FOMC)
- The Federal Advisory Council (FAC)
Informal Structure of the Federal Reserve System
- How Power Has Been Centralized Over Time
Video:
Materials from class:
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The Twelve Federal Reserve Districts
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 |
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Central Bank Independence and Inflation
From "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," by Alberto Alesina and Lawrence H. Summers, Journal of Money, Credit and Banking, Vol. 25, No. 2. (May, 1993), pp. 151-162 (the link will work on UO net, but I don't expect you to read the paper as it is a bit technical):
This has changed with the adoption of inflation targeting by central banks. Note also that Adam Posen casts doubt on whether causality runs from central bank independence to improved macroeconomic performance in Central Bank Independence and Disinflationary Credibility: A Missing Link?, NY Fed Staff Report, May 1995.
Additional Reading:
- Changing the Malpractice System - NYTimes.com
- QE2: estimates of the potential effects - Econbrowser
- How an unloved bail-out saved America - FT.com
- National Economic Education Video Competition - St. Louis Fed
- Optimal Pricing of Fee For Service Firefighting Services - Matthew Yglesias
- Causes of the flash crash - Econbrowser
- Tobacco taxes: Implications for public health - voxeu
- Welfare's safety net hard to measure among states - washington post
- These Families Shop When Aid Arrives - WSJ.com
- $10,000 Gold? - Kenneth Rogoff
- A Perspective on the Future of U.S. Monetary Policy - Charles Evans
- The Corruption of the Rating Agencies: Is AAA Junk? - Bruce Bartlett
- Consumers Still Relying on Their Uncle Sam for Wages - Market Talk
- Fed’s Dudley: Further Action Is ‘Likely’ - Real Time Economics
Application:
Fed Official Defends Effectiveness of More Action, by Michael S. Derby, WSJ: Expanding the Federal Reserve balance sheet would have a real and positive impact on the U.S. economy, should officials decide to follow that path, the man responsible for implementing central bank monetary policy goals said Monday.
“The evidence suggests that the expansion of the securities portfolio to date has helped to foster more accommodative financial conditions, and further expansion would likely provide additional accommodation,” said Federal Reserve Bank of New York Executive Vice President Brian Sack. ... But the official stopped short of saying any decision to act had been made. ...
Sack was optimistic about the impact the action can have on the economy. “The sluggish outlook for the economy and the risks that surround that outlook have raised the possibility of further monetary policy accommodation,” Sack said. “In the current circumstances, there would seem to be room for the Federal Reserve to expand its holdings of Treasury securities without creating difficulties for market functioning,” he added.
While asset buying is an “imperfect policy tool,” Sack said “balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.” He countered those ... who doubt the further effectiveness of asset purchases, by saying “it seems highly unlikely that the economy is completely insensitive to borrowing costs and wealth, or to other changes in broad financial conditions.”
Sack warned there are limits to the policy. He noted that asset buying has to be done in fairly large size to move the needle. There’s also reason to believe that as yields fall to “extremely low levels,” such a policy’s effectiveness “would diminish at some point.” ...
September 30, 2010
September 29, 2010
Class Materials for Lecture 2
Brief Outline of Topics Covered in Lecture 2
Chapter 1 Why Study Money, Banking, and Financial Markets? [continued]
Why Study Banking and Financial Institutions?
What Defines Banks and Financial Institutions?
What is Financial Intermediation?
Direct versus Indirect Finance
Why is Financial Intermediation Important?
Chapter 3 What is Money?
Meaning of Money
Functions of MoneyMedium of Exchange
Unit of Account
Store of Value
Evolution of the Payments System
Commodity Money
Partially backed paper money
Full backed paper money
Fiat MoneyMeasuring Money
The Federal Reserve’s Monetary Aggregates
How Reliable Are the Money Data?
Chapter 4 Understanding Interest Rates [pages 84-85]
The Distinction between Real and Nominal Interest Rates
Nominal interest rates
Ex-ante real rates
Ex-post real rates
Video:
Materials from class:
Additional Reading:
- Republicans’ Deficit-Cut Pledge Lacks Specifics - NYTimes.com
- Sociology in China - UnderstandingSociety
- Economics Is Not A Morality Play - Paul Krugman
- Using multiple price indexes to measure changes in inequality - interfluidity
Application:
More Fed action: How would it work?, Washington Post: The debate over new Federal Reserve efforts to boost the economy has rapidly migrated from "whether" to "how."
Since Fed officials met last week and signaled they are open to new steps to try to strengthen the economy, chatter has flown around financial markets about the possibility of a major new infusion of cash, on the order of $1 trillion.
Some of this talk is a little premature: It is not a given that the Fed will take action at all at its the Nov. 2-3 meeting. ... More:
How much quantitative easing?
Shock-and-awe or dribs-and-drabs?
Treasuries or mortgage-backed securities?
Cut the interest rate on excess reserves?
How much quantitative easing?
This is the biggest question of them all. The strategy that Fed Chairman Ben Bernanke and company are most likely to pursue to try to strengthen economic growth and get inflation up closer to their 2 percent target is to buy vast quantities of bonds on the open market, essentially increasing the money supply.
That is called quantitative easing; Fed watchers refer to a new round of such easing "QE2," since it would follow earlier bond purchases announced during the financial crisis.
But how many hundreds of billions of dollars? In its previous efforts to prop up the economy, the Fed expanded the size of its balance sheet from $800 billion to about $2.3 trillion. That may have been a significant factor in ending the recession in June 2009. Still, the government was taking so many audacious steps to try to arrest the economy's free-fall that it's hard to know exactly how much of a role QE1 played.
The first round of quantitative easing probably had a greater impact on the economy than would any steps taken now, in part because the financial markets were dysfunctional at the time. ...
Fed leaders will have to decide... Does that mean they should go even bigger, undertaking $1 trillion or more in bond purchases because smaller numbers won't have enough impact? Or should they move more cautiously, given that the benefits are likely to be small?
Bernanke addressed this question in a speech last month, but had no definitive answers. "The possibility that securities purchases would be most effective at times when they are most needed can be viewed as a positive feature of this tool," Bernanke said. "However, uncertainty about the quantitative effect of securities purchases increases the difficulty of calibrating and communicating policy responses."
Shock-and-awe or dribs-and-drabs?
A closely related question is how the Fed would announce new easing measures. In the earlier rounds of asset purchases, the Fed announced vast quantities of planned asset purchases all in a few, dramatic steps (such as a March 17, 2009, announcement that it would buy up to $1.25 trillion in mortgage backed securities, among other steps).
The shock-and-awe strategy has some clear benefits. Interest rates respond rapidly to the initial announcement, and then the Fed can take its time actually undertaking the purchases. It is a clear sign of commitment from the central bank that it is acting boldly, and by creating a boost in financial markets, the benefits for the economy can begin flowing the moment the announcement is made.
But St. Louis Fed President James Bullard has advocated having smaller purchases announced at each policy meeting, an approach that is gaining favor within the central bank. ...
With this strategy, the Fed would lose the immediate benefits of shocking financial markets with an announced wall of money. But they would gain the flexibility to respond to economic conditions as they evolve. That, in turn, may make it easier for some members of the Fed policymaking committee who are resistant to more easing to get on board...
Treasuries or mortgage-backed securities?
Further Fed easing would consist of buying assets. But what assets?
The two major options -- the assets that the Fed can purchase using its standard legal authority, as opposed to invoking emergency lending provisions -- are to buy U.S. Treasury bonds or housing-related debt issued by Fannie Mae and Freddie Mac. During the try-anything crisis response in 2009, the Fed did both. Here are the pros and cons of each.
Buying Treasury bonds is, in a sense, a purer exercise of the Fed's money-creation power. The purchases would lower the long-term rate on Treasury bonds, which are widely viewed as the "risk-free" rate across the economy. Other forms of debt, such as corporate lending, occur at some premium to the risk-free rate, so the Treasury bond purchases should pull down rates across the economy. Also, the Treasury bond market is enormous, so the Fed would have leeway to intervene without crowding out private buyers.
One major downside: If it buys Treasuries, the Fed could (and, if the past is a guide, would) be accused of "monetizing the debt," or printing money to fund large U.S. budget deficits. ...
The second major option would be to buy mortgage-backed securities from Fannie and Freddie (and perhaps the companies' debt). One upside of this tack is that it would stimulate the troubled housing market by targeting mortgage rates directly. That said, mortgage rates have fallen dramatically over the last few months, with little apparent benefit to the housing market overall, so further declines might not make much difference for housing.
There are two major downsides to this strategy. First, it would put the Fed in the position of distorting capital allocation, favoring housing over other sectors. Treasuries would be more of a neutral step. Second, the market for mortgage securities has been slow to return to normal after the earlier Fed purchases -- $1.25 trillion ending in March -- crowded out private buyers. If the Fed gets back in, it may delay the return of private funding even further and thus be counterproductive.
Cut the interest rate on excess reserves?
Since summer, Fed officials have discussed cutting the rate they pay banks on reserves parked at the Fed as a tool to boost the economy. It works like this: For money they keep at the Fed beyond their regulatory minimums, banks are currently paid 0.25 percent interest. The Fed could cut that rate to close to zero, and then banks would have a bit more incentive to do something useful with that cash, such as lending it to clients.
But it would be no panacea. Banks are parking that money at the Fed because they want it to be very safe and readily available should they need it. So money that they no longer keep at the Fed banks would most likely pour into other ultra-safe, short-term investments, such as Treasury bills. That would not create much of an economic bounce, though at the margins it would reduce interest rates across the economy and have some mild benefit on growth.
That economic benefit, however, could prompt technical problems in the money markets caused by the decline of rates closer to zero. Still, the central bank would likely consider cutting the interest rate on excess reserves in conjunction with bond purchases.
September 28, 2010
Class Materials for Lecture 1
Brief Outline of Topics Covered in Lecture 1
Chapter 1 Why Study Money, Banking, and Financial Markets?
Why Study Money and Monetary Policy?
Money and Business Cycles
Money and Inflation
Money and Interest Rates
Conduct of Monetary Policy
Fiscal Policy and Monetary PolicyWhy Study Banking and Financial Institutions?
What Defines Banks and Financial Institutions?
What is Financial Intermediation?
Direct versus Indirect Finance
Why is Financial Intermediation Important?Why Study Financial Markets?
Bond Market
Stock Market
Foreign Exchange Market
Chapter 2 An Overview of the Financial System (pgs 25-27, 39-42)
Functions of Financial Markets
Direct versus Indirect Finance
Structure of Financial Markets
Function of Financial Intermediaries
Example
Chapter 3 What is Money?
Meaning of Money
Functions of MoneyMedium of Exchange
Unit of Account
Store of Value
Video:
Materials from class:
Links:
- Jumping Ship and Punching Hippies - NYTimes.com
- Blaming China Won’t Help the Economy - Anatole Kaletsky
- Bill Clinton gets it wrong - EPI
- Doing CBO’s job - The Incidental Economist
- Would Inflation Cure What Ails the Economy? - Bruce Bartlett
Application: This is something the Oregonian asked me to do awhile back:
Mark Thoma, Guest opinion, Oregonian, Sept. 19, 2008: Many people associate the onset of the Great Depression with the stock market crash in October 1929. But a more important cause was a series of banking panics in the years prior to the Great Depression, and the particularly severe banking collapse from 1930-1933.
The response to this crisis and the devastating economic disruption that came along with it was the Banking Acts of 1933 and 1935, also known as the Glass-Steagall Acts. The goal was to stabilize the banking system by enhancing the power of the Federal Reserve to regulate financial markets and to intervene when problems emerged.
And it worked. The changes resulted in a very long period, over 50 years, where financial markets remained calm.
That calm is now over, and we are experiencing our worst financial crisis since the Great Depression. What happened? What ended the tranquility? Very simply, financial innovation got ahead of regulation.
The problems we are having did not arise in the traditional banking sector; the problems come from what is called the shadow banking sector. This is comprised of firms such as hedge funds that do just what banks do -- they take deposits, they use the funds to purchase financial assets such as housing loans, and they only keep a fraction of those deposits on hand as cash reserves. But these firms are essentially unregulated and hence subject to the same problems that traditional banks faced prior to the 1930s.
What is the solution to our problems? First and foremost, We need to clean up the mess we are in and do all we can to stop things from getting any worse. Recreating the Resolution Trust Co., as we did in the aftermath of the savings and loan crisis, would be a useful step to take to remove the bad financial paper that is poisoning financial markets.
Over the longer run, it is essential that regulation be modernized. The most important task is to bring the shadow banking sector out into the sunlight, and to put it under the same regulatory structure and safeguards faced by traditional banks.
The last time we restructured our financial system from the ground up, the result was more than 50 years of stability. With a determined effort we can repeat that success and modernize our financial system so that it is substantially less likely to suffer a massive meltdown, but still innovative enough to meet our financial needs.
This is from the Wall Street Journal:
The financial crisis—and ensuing recession—has helped
turn economics bloggers like (clockwise from top left)
Greg Mankiw, Paul Krugman, Alex Tabarrok and Mark Thoma
into Internet celebrities (WSJ)
September 24, 2010
Economics 470
Mark Thoma
Office: BRB 3.158
Phone: TBA
Office Hours: M-Th
1:00 p.m.-2:00 p.m.
and by appointment
Web Page
Email
Economist's View Blog
Department of Economics
University of Oregon 1285
Eugene, OR 97403-1285
GTF Info - 470
TA: Yaran Jin
Office: BRB 2.138
Email: [email protected]
Office Hours: W,Th 3:30-4:30
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