Friday, May 8, 2015

I love this graph from Paul Krugman

I love this graph. When you just graph the monetary base you give the impression that the Fed is (1.) in complete control and (2.) very expansionary. It takes careful argument to walk people back from each of those impressions. Depending on who you're talking to you usually only get halfway through convincing them that the last one is not true and don't make much progress at all on the first one. Market monetarists are weirdos that get that the second one isn't true but maintain adamantly that the first one is true - practically tautologically in some cases. When you put M2 over the base it makes clear why the second one isn't true and strongly suggests that the first one isn't true either (unless you think there was some radical change in preferences on the part of the Fed at the beginning of the recession).


20 comments:

  1. I'm finding it a bit hard to believe that M2 has been falling since 2010 given those have been years of RGDP growth. Is that really what that chart is showing ?

    How does your chart differ from this one (I see yours is titled "Adjusted" ?

    https://research.stlouisfed.org/fred2/series/M2NS

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    1. Oh, I see

      Your chart is m2/monetary base.

      Sorry - not enough coffee in my system yet.

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    2. Yep and that's not to hide anything, I think it communicates the whole point. When you look at the base and larger aggregates and they're all growing except the base just grows a lot faster than the others at the beginning of the recession it's easy to miss the fact that monetary policy just simply broke down. This makes it a lot clearer.

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    3. BTW: Krugman's description just before showing the chart is:

      "The effects of quantitative easing in Japan a few years later, which failed to raise M2, confirmed this conclusion. And sure enough, here’s what happened to US M2 as the Fed increased the size of its balance sheet"

      I bet I'm not the only inattentive reader (of his post not yours) who might conclude he was showing m2 not m2/base.

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  2. As I wrote in comments on Krugman's blog:

    The drop you see in 2008 in the M2/MB ratio was a result of the Fed's stupid decision to pay interest on reserves (as high as 1% in 2008). This caused banks to hold on to their reserves which helped bring down the M1 money multiplier from about 1.6 to less than 1, making the recession much worse.

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    1. For the banking system as a whole, the total amount of reserves cannot shift. In other words, your comment cannot possibly be correct or make any sense.

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  3. Who is to say that this isn't what the Fed was aiming for? Slow growth and stagnant wages and high profits.

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  4. And by the same token, Daniel, I'm sure you'd agree that if we graph (temperature) / (CO2) over the last 10 years, it's obvious that humanity has engaged in a cooling policy with regard to emissions.

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    1. :)

      The pause definitely, definitely, definitely needs an explanation. I am even less qualified to provide that than I am to talk about macro. But I gather the ones that are qualified think the oceans are a pretty big deal.

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  5. Is your argument that Market Monetarists should be shocked, just shocked, to learn that the the Money Multiplier is not constant (since that is all M2/MB is)? If so, I think you might be underestimating Scott Sumner and his crew. Sumner has been arguing for years now that the Money Multiplier dropped during the Great Recession because the Fed started paying interest on reserves. If you pay banks to hold reserves, then the reserve ratio will go up and the money multiplier goes down. Nothing surprising here.

    Of course, whether Sumner's story holds up is an empirical question. Was the reserve ratio really *that* sensitive to raising the interest rate? Who knows.

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    1. No I don't think anyone should be shocked on that - that's why I differentiate between how it impacts the first and the second claim. I do think it's a much better one than the base money graphs people usually focus on.

      Now something I noted on FB but didn't here is that it still makes things odd for the MM position. You really have to assume that Bernanke was completely clueless (or was not clueless and has remarkably stark change in policy preferences) which doesn't seem to pass the smell test. It is much more reasonable to assume he is not clueless and he just faced major constraints in what he could do in the liquidity trap.

      So even with the IOR point (which I think everyone would agree is not the greatest idea), this version of the graph still poses a challenge to austerians and MM alike (although the REALLY clear challenge is to the austerians). It should be passed around more frequently than the base money graph.

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    2. I mean think about it Dallas - you and I get all this and you and I point to IOR as an issue. What are the chances that the economists at the Fed miss this argument that you and I get? Doesn't that seem unlikely as an explanation? It's possible, of course, but I think the more obvious explanation is that the Fed faces major constraints on what it can do in a liquidity trap. Krugman (1998) still holds. They aren't completely powerless. But they are in a very, very tough situation.

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    3. Then it sounds like we both have a very big question to answer. Why did the Fed start paying interest on reserves if they understood that doing so would only make expanding the money supply harder (when they already faced major constraints)?

      Could it be because the Fed was actually trying NOT to increase the money supply? Expanding the monetary base was mostly a consequence of the Fed's efforts to stabilize the financial sector. If they didn't start paying interest on reserves, then more of that expansion in the monetary base would have translated into increases in the money supply. That could have meant more inflation and it possibly could have encouraged a bubble in another sector. So maybe the Federal Reserve started paying interest on reserves with the hope of avoiding any increase in the money supply. Maybe it was all part of a plan to cautiously tread between avoiding the next Depression without causing hyperinflation or misallocation of real resources? I'm not a macroeconomist, but it doesn't sound far fetched to me.

      Now, I'm sure you disagree with this story. So I'd be interested to hear why you think the Fed started charging interest on reserves if they understood that it would only make expanding the money supply harder. If they really wanted to expand the money supply, IOR sounds like a dumb move. SO why did they do it?

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    4. Just to make my point a little clearer. You say that the MM position requires Bernanke to be clueless. I'd disagree. I think Sumner routinely argues that the Fed made the decisions they did because they didn't want to increase the money supply. And from that perspective policies like IOR actually make sense (see above for my imperfect take).

      I think it is much harder to make sense of a policy like paying interest on reserves while also arguing that the Fed was doing everything it could to expand the money supply under the constraints they faced. That's why I'd be very interested to hear how you would explain the policy, Daniel. We both agree that Bernanke is not an idiot. So why did he pursue a policy that would only make it harder to expand the money supply during a recession?

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    5. So my understanding of IOR is that they only recently got authority to do it and it's broadly speaking a good idea because it gives them more control over interest rates. As to why they did it when they did it, I imagine it's that they recently got the authority, the rates are low enough that it doesn't make that much of a difference, and it helps shore up balance sheets.

      It's only hard to make the case if you think IOR is that effective at keeping the money multiplier down. Is there any reason to think this?

      re: "You say that the MM position requires Bernanke to be clueless. I'd disagree. I think Sumner routinely argues that the Fed made the decisions they did because they didn't want to increase the money supply."

      Well you're only citing half my claim! I said either they are clueless or there was a remarkably sharp change in policy preferences. As you point out, that's what Sumner tends to lean towards but some people also talk like he doesn't know what he's doing. In either case that seems unlikely compared to the case that he simply faces some major constraints.

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    6. To clean up the claims here a little:

      You say IOR pegged to the lowest fed funds rate minus a certain number of basis points has a big effect on the money multiplier and the Fed wants to be contractionary.

      I say an IOR pegged to the lowest fed funds rate minus a certain number of basis points has little additional contractionary effect and the Fed does not want to be contractionary but is having a hard time getting traction in a liquidity trap.

      Prima facie case on IOR and Fed policy preferences seems to obviously be in my favor. But I am not a monetary economist - what am I missing?

      And what's more if the Fed wanted to be contractionary as you say why don't you hear Bernanke and Yellen talking more like Plosser and Fisher? Why is EVERYONE under the misapprehension that these people are doves? If Bernanke and Yellen really want to tighten given how important Fed communications are why are they so resistant to just plagiarizing a few of the hawks' speeches? Wouldn't that be the first thing you would do as a hawk?

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    7. "As to why they did it when they did it, I imagine it's that they recently got the authority, the rates are low enough that it doesn't make that much of a difference, and it helps shore up balance sheets."

      So Bernanke knew that paying interest on reserves could make the recession harder to fight with monetary policy. But he also knew that this never-before-trued policy instrument was so ineffective. So he figured why not just go ahead and do it? Pretty cavalier attitude to have during the deepest economic downturn since the Great Depression.

      "It's only hard to make the case if you think IOR is that effective at keeping the money multiplier down. Is there any reason to think this?"

      Is there any reason to think that it isn't? :) Like I said earlier, this is an important empirical question, but I have not seen either Sumner or his critics try to answer it.

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  6. I really need to learn to preview my posts before publishing them. :P sorry for the typos.

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  7. "And what's more if the Fed wanted to be contractionary as you say why don't you hear Bernanke and Yellen talking more like Plosser and Fisher?"

    Well, I don't think that the Fed wanted to be contractionary. At the same time, I don't think they wanted to be too expansionary. Like I said earlier, I believe they were wanting to walk a fine line between avoiding the next Great Depression and a hyperinflation. So it makes sense they would want to avoid sounding like hawks.

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    1. "Prima facie case on IOR and Fed policy preferences seems to obviously be in my favor. But I am not a monetary economist - what am I missing?"

      I think Sumner would disagree with you that the evidence is obviously in your favor. In fact, I'd bet he would argue that the evidence is "obviously" in his favor.

      As far as I'm concerned, the "evidence" isn't obviously in anyone's favor because there is no real evidence to speak of. We have a handful of things we can observe directly or indirectly (changes in federal reserve policy, the monetary base, the money multiplier, etc). And we have competing theories that can explain what we observe, At the moment, it is very hard to tell which of these theories is right and which is wrong.

      If we were talking about the behavior of noble gasses on the surface of Mars, then we'd probably all be happy to admit whether the evidence supported our view or if it didn't. But since we are dealing with theories that inform political opinions, some people (like Sumner and Krugman) are trying to position their theory as being "obvious" in the absence of real evidence.

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